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https://www.courtlistener.com/api/rest/v3/opinions/4621459/	LEETONIA FURNACE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Leetonia Furnace Co. v. CommissionerDocket No. 32272.United States Board of Tax Appeals23 B.T.A. 979; 1931 BTA LEXIS 1793; June 30, 1931, Promulgated 1793 By a plan of reorganization effected through cooperation of the stockholders and principal creditors, all claims held by the creditors, both secured and unsecured, against the taxpayer were acquired by the petitioner in exchange for its stock, the petitioner corporation having been organized for that purpose. The petitioner also acquired in exchange for shares of its stock all outstanding stock of the taxpayer. The Government did not participate in or assent to said reorganization. Petitioner then being the sole stockholder and creditor of the taxpayer, foreclosed its mortgage lien and purchased the assets, which subsequently were resold by the petitioner and the proceeds applied in payment of the lien debts. The assets were insufficient to satisfy the lien debts and nothing remained to apply in payment of the unsecured debts or for distribution to the stockholders. Held, the petitioner is not liable, at law or in equity, as a transferee of the property of the taxpayer, within the meaning of section 280(a) of the Revenue Act of 1926. James Milholland, Esq., for the petitioner. J. R. Johnston, Esq., for the respondent. TRAMMELL 979 1794 This is a proceeding for the redetermination of the liability of the petitioner, as a transferee of the assets of the McKeefrey Iron Company, for deficiencies in income and profits taxes of the latter company for the years 1917 and 1918 in the amounts of $40,394.48 and $98,303.17, respectively. The pleadings raise issues respecting the correctness of the deficiencies determined by the respondent, but, upon motion duly granted, the sole issue submitted for consideration here is whether or not the respondent "erred in proposing to assess tax against the petitioner as the transferee of property of the McKeefrey Iron Company of Pittsburgh, Pa." FINDINGS OF FACT. The petitioner is a Delaware corporation, with its principal office at Pittsburgh, Pa.The respondent determined deficiencies in income and profits taxes against the McKeefrey Iron Company for the years 1917 and 1918 in the respective amounts of $40,394.48 and $98,303.17 and by letter dated September 13, 1927, advised the petitioner that said amounts were proposed for assessment against it as constituting its liability as a transferee of the assets of said McKeefrey Iron Company. Said deficiency letter is the only formal1795 notice received by the petitioner 980 respecting any claim of the United States for taxes against the McKeefrey Iron Company for the years 1917 and 1918. The McKeefrey Iron Company was incorporated under the laws of the State of Delaware by charter dated July 16, 1915, and on or about July 29, 1915, purchased the merchant blast furnace formerly owned by the Leetonia Steel Company. The furnace was operated by the McKeefrey Iron Company from the latter part of 1915 or early part of 1916 until some time in 1920, when it was shut down and has not since that date been operated. The property was operated at a profit during 1917 and 1918, but losses were incurred during 1919 and 1920. During the period of operations the company became largely indebted through moneys borrowed at banks and for amounts due trade and other creditors, and from 1920 to 1924 had no operating revenues from which to liquidate this indebtedness or to meet current expenses covering taxes, insurance and similar items. In default of payment it was necessary to furnish creditors with collateral security for the renewal of old loans and to secure new borrowings to meet current expenses. Accordingly, 1796 on October 1, 1922, the McKeefrey Iron Company placed a mortgage on its property in the amount of $700,000, naming the Peoples Savings and Trust Company of Pittsburgh as trustee under the mortgage. This mortgage was duly recorded on February 2, 1923, in the County of Columbiana, State of Ohio, in the office of the recorder of said county, in volume 458, page 473, and on February 6, 1923, said mortgage was also filed with the county recorder of said County of Columbiana as a chattel mortgage. The mortgage was refiled with a new affidavit thereto attached in accordance with law on the 21st day of January, 1926. Immediately after recording said mortgage or deed of trust, 700 bonds of the par value of $1,000 each were duly executed by the McKeefrey Iron Company, certified by the trustee and redelivered to the McKeefrey Iron Company. The bonds were thereupon hypothecated as collateral security on loans, and became outstanding and constituted a first lien on the property specifically described in the deed of trust, being all of the real and personal property of the McKeefrey Iron Company, with the exception of certain designated raw material, iron ore, coal, coke, limestone, dolomite1797 and flue dust. Said bonds were specifically issued as collateral to secure new loans, or upon the renewal of old loans, and pursuant thereto were hypothecated as security for the following: TO FIRST NATIONAL BANK AT PITTSBURGHDate of noteFace of noteBonds as collateralJan. 24, 1923$408,000$408,000Apr. 16, 192320,000 20,000May 21, 192310,000 10,000May 29, 192310,000 10,000June 5, 192320,000 20,000June 12, 192320,000 20,000June 18, 192320,000 20,000June 28, 192320,000 20,000July 16, 192340,000 3,000July 23, 192340,000 3,000 And other collateral.Total608,000534,000TO McKEEFREY AND COMPANYDate of noteFace of noteBonds as collateralJan. 24, 1923$102,000$102,000Apr. 14, 192310,000 10,000May 21, 19235,000 5,000May 28, 19235,000 5,000June 5, 192310,000 10,000June 12, 192310,000 10,000June 16, 192310,000 10,000June 30, 192310,000 10,000July 14, 192320,000 2,00020,000 2,000 And other collateral.Total202,000 166,000981 As further security on the above enumerated loans, the McKeefrey Iron Company1798 executed two chattel mortgages, the first chattel mortgage being dated January 24, 1923, and given to Graham Kearney as trustee. This chattel mortgage covered all iron ore, limestone, dolomite and flue dust, and certain accounts receivable as enumerated therein. Said chattel mortgage was filed with the county records of Columbiana County, Ohio, on February 2, 1923, and was refiled in accordance with law on June 14, 1926. The second chattel mortgage was dated August 15, 1923, and was given to J. B. Lane as trustee. This chattel mortgage covered all pig iron stored upon the McKeefrey Iron Company property. The second chattel mortgage was filed with the county records of Columbiana County on September 1, 1923. The trustees under these chattel mortgages collected moneys from the sale or collection of assests pledged thereunder, and from time to time made payments to the holders of the notes secured by the chattel mortgages until the mortgaged property was all disposed of. To December 31, 1923, collections and payments by the trustees were sufficient to reduce the above enumerated indebtedness in the 982 sum of $60,000, with interest on payments made, so that on January 1, 1924, the1799 secured indebtedness stood as follows: Due to -Balance due on notes with interestsecured by -First National Bank at Pittsburgh$568,000534 bonds and chattel mortgages.Mc,Keefrey Co182,000166 bonds and chattel mortgages.Total750,000700 bonds and chattel mortgages.From January 1 to May 7, 1924, the trustees realized additional funds from the pledged assets, and on or after May 7, 1924, made a further distribution to creditors under the chattel mortgages of $115,465.21, of which amount $107,641.88 applied on the principal of the above indebtedness and $8,823.33 applied as interest. As of May 7, 1924 (after giving effect to the above distribution), the indebtedness of McKeefrey Iron Company represented by notes outstanding secured by collateral amounted to $642,358.12 and interest, as follows: Due to -Balance due on notes with interestSecured by -First National Bank at Pittsburgh$496,241.52534 bonds and chattel mortgages.McKeefrey and Company146,116.60166 bonds and chattel mortgages.Total642,358.12700 bonds and chattel mortgages.Early in 1924 a petition in bankruptcy was filed against the McKeefrey1800 Iron Company, and to prevent the assets being dissipated and the rights of creditors being jeopardized, the creditors and stockholders of the McKeefrey Iron Company drew up and executed an agreement dated March 15, 1924. This agreement was signed by all the stockholders of the McKeefrey Iron Company and by its four principal creditors, the First National Bank at Pittsburgh; N. J. McKeefrey; McKeefrey and Company; and Producers Coke Company. All of the creditors of the McKeefrey Iron Company, except those shown to have been paid fully in cash, entered into this said agreement. The United States was not a party thereto. On August 23, 1926, an order was entered in the District Court of the United States for the Northern District of Ohio, Eastern Division, dismissing the involuntary proceedings in bankruptcy against the McKeefrey Iron Company, by consent of its sole creditor, the Leetonia Furnace Company, which last-named company had theretofore acquired by purchase or otherwise and then owned all claims against said McKeefrey Iron Company. On May 1, 1924, the board of directors of the Leetonia Furnace Company, composed of F. F. Brooks, W. D. McKeefrey, N. J. McKeefrey, 983 1801 J. H. Hillman, Jr., G. P. Rhodes, Wiley L. Byers and Lawrence E. Sands, held an organization meeting of the Leetonia Furnace Company, notice of which had been given according to law, whereat the following officers of the Leetonia Furnace Company were duly elected: President, F. F. Brooks, Vice president, L. E. Sands, Secretary and treasurer, H. K. Holmes. The president then took the chair and placed before the board the agreement dated March 15, 1924, signed by the various stockholders of the McKeefrey Iron Company and the principal creditors of the McKeefrey Iron Company hereinbefore stated, providing for the incorporation of the Leetonia Furnace Company and the purchase by it of the stock of the McKeefrey Iron Company and of the claims against McKeefrey Iron Company, both those held by the signers of the said agreement and any other stock or claims which might be presented within such period as the board should determine. All of the stockholders of the McKeefrey Iron Company, having entered into the agreement, surrendered the stock which they held in the McKeefrey Iron Company to the Leetonia Furnace Company, and there was issued to them one share of no par value common1802 stock of Leetonia Furnace Company for each share of common or preferred stock formerly held in McKeefrey Iron Company. The stockholders of McKeefrey Iron Company held a total of 10,000 shares of common stock and 10,000 shares of preferred stock of said company, each share of which had a par value of $100. Upon the surrender of this stock, the Leetonia Furnace Company was then the owner of all the capital stock of McKeefrey Iron Company, and this ownership continued to the time of the foreclosure proceedings, which were carried out in the latter part of the year 1926, and until the dissolution of McKeefrey Iron Company. The McKeefrey Iron Company, a Delaware corporation, was voluntarily dissolved in the latter part of the year 1926, and a certificate of consent of stockholders to the dissolution was received and filed in the office of the Secretary of State of the State of Delaware on January 25, 1927. Pursuant to the plan and agreement hereinbefore mentioned, the Leetonia Furnace Company on or about May 7, 1924, issued fully paid up and nonassessable stock as follows: To First National Bank at Pittsburgh, 4,166 shares of preferred stock, with a par value of $100 per share, 1803 and 41,660 shares of no par value common stock; To McKeefrey and Company 1,043 shares of preferred stock, with a par value of $100 per share, and 10,430 shares of no par value common stock; 984 To Producers Coke Company, 548 shares of preferred stock, with a par value of $100 per share, and 5,480 shares of no par value common stock; To N. J. McKeefrey, 13 shares of preferred stock, with a par value of $100 per share, and 130 shares of no par value common stock. In addition thereto, said company issued to the former stockholders of the McKeefrey Iron Company no par value common stock of the Leetonia Furnace Company one share for each share of common or preferred stock formerly held by them, respectively, in the McKeefrey Iron Company, making a total of 20,000 shares in all. No other stock was issued by the Leetonia Furnace Company than that stated above. Voting rights attached to the preferred as well as to the common stock of the Leetonia Furnace Company. The Peoples Savings and Trust Company of Pittsburgh, trustee, under date of August 26, 1926, at the instance of the Leetonia Furnace Company, instituted mortgage foreclosure proceedings in the Court of Common1804 Pleas of Columbiana County, Ohio, in Cause No. 17843, in which the McKeefrey Iron Company, Graham Kearney, Leetonia Furnace and the Hanna Furnace Company were parties defendant; thereafter the McKeefrey Iron Company under date of September 13, 1926, waived summons and entered an appearance. An answer and cross petition was filed by the Hanna Furnace Company, and an answer and cross petition was filed also by Leetonia Furnace Company on October 5, 1926. The other parties defendant above named duly appeared and answered in said proceeding, and under date of October 18, 1926, a decree was entered in favor of the plaintiff for $884,228.33, and an order of sale was issued pursuant thereto, dated October 26, 1926, to the sheriff of Columbiana County, Ohio. An appraisement was filed, dated October 29, 1926, showing the total appraised value of the property covered by the order of sale as $275,000; proof of publication was thereafter filed, and the property was sold at public sale by the sheriff of said county to the Leetonia Furnace Company for a bid price of $185,000. This sale was duly confirmed by order of court, and the sheriff's deed was executed and delivered to the Leetonia Furnace1805 Company conveying all the property of the McKeefrey Iron Company covered by the mortgage. On May 7, 1924, on which date the capital stock, common and preferred, of the Leetonia Furnace Company, was issued as hereinbefore stated, the bonds of the McKeefrey Iron Company in ths sum of $700,000 theretofore held by the First National Bank at Pittsburgh and by McKeefrey and Company as collateral security were released and assigned to the Leetonia Furnace Company, with the assignments to it of the claims secured thereby. 985 A complete statement of the claims purchased by the Leetonia Furnace Company pursuant to the agreement of March 15, 1924, as hereinbefore set forth, is shown by the following: CreditorAmount of claimPayment madeClaims secured by - Secured claims purchased:First National Bank at Pittsburgh (notes).$88,241.52Cash, $88,241.52 Do408,000.00First National Bank at Pittsburgh (interest).12,852.00Capital stock and $86 cash534 bonds and chattel mortgages.McKeefrey & Co. (notes)44,116.60Cash, $44,116.60 Do102,000.00McKeefrey & Co. (interest)3,378.84Capital stock and $35.84 cash.166 bonds and chattel mortgages.Unsecured claims purchased:Producers Coke Co55,387.50Stock and $39.50 cashN. J. McKeefrey1,333.33Stock and $20.33 cashColumbiana County treasurer5,271.01CashHolden, Masten, Duncan & Leckie3,052.48 doReed, Smith, Shaw & McClay2,013.20 doBillingsley & Moore1,857.30 doW. D. McKeefrey270.50 doRichter & Co1,044.65 doCrowther & Co1,468.55 doGrafton Supply Co1,470.71 doMcKeefrey Coal Co40.00 doDirector General of Railroads3,228.00 doErie Railroad Co7,248.45 doR. W. Campbell250.00 doPennsylvania Railroad361.71 doTotal742,886.351806 No capital was paid in at the organization of the Leetonia Furnace Company other than the claims and stock hereinbefore stated for which its capital stock was issued. The mortgage foreclosure proceedings in the Court of Common Pleas of Columbiana County, Ohio, were in foreclosure of the mortgage which had been given to secure the bonds above stated in the total sum of $700,000, which had been held as collateral security by the First National Bank at Pittsburgh and by McKeefrey and Company, and which were released and delivered to the Leetonia Furnace Company as above stated. After the organization of the Leetonia Furnace Company and to December 15, 1926, the date of the sheriff's deed, the Leetonia Furnace Company had become indebted to the First National Bank at Pittsburgh as shown by the following statement: Advanced to Leetonia Furnace Company to finance the purchase of creditors' claims against McKeefrey Iron Company$115,000Advanced to Leetonia Furnace for expenses of maintenance, etc59,500Gross Amount to December 15, 1926174,500Less collections on property covered by chattel mortgages turned over to the First National Bank at Pittsburgh19,087Leaving a net balance due the First National Bank at Pittsburgh, for indebtedness incurred for and after the organization of Leetonia Furnace Company, in the amount of155,4131807 986 After the bonds of McKeefrey Iron Company in the total sum of $700,000 had been released pursuant to the agreements hereinbefore stated, they were rehypothecated as collateral security to the First National Bank at Pittsburgh to secure it for the payment of the advances above stated. At the time the mortgage foreclosure was instituted, the Leetonia Furnace Company was the owner of the bonds above stated, which were held by the First National Bank at Pittsburgh as collateral security for the said advances to the Leetonia Furnace Company. At December 1, 1926, the Leetonia Furnace Company had claims against the McKeefrey Iron Company as shown by the following statement: Claims purchased and/or assigned to Leetonia Furnace Company pursuant to the agreement between stockholders and creditors herein before referred to, secured by bonds and chattel mortgages$584,853.09Unsecured claims purchased84,297.39Current advances, May 27, 1924 to December 1, 192639,395.36Total708,545.84By the summer of 1926 it had been demonstrated that there was no possible outcome but to dismantle the plant and effect a sale of the premises in parcels, as there was1808 no market for a merchant blast furnace of this nature. Consequently, the Leetonia Furnace Company, being the holder of all of the bonds secured by the mortgage or deed of trust, directed the foreclosure proceedings, which culminated in the purchase by the Leetonia Furnace Company of the property covered by the mortgage for the sum of $185,000, of which $3,249.28 was paid by the purchaser in cash to cover costs and taxes, and the balance of $181,750.72 was credited on the bonds pro rata in accordance with the decree of the court in the foreclosure proceedings. OPINION. TRAMMELL: The respondent proposes to assess against the petitioner, Leetonia Furnace Company, as a transferee, deficiencies in income and profits taxes determined by him to be due from the McKeefrey Iron Company for the years 1917 and 1918. The sole issue for decision here is whether or not the petitioner is liable at law or in equity as a transferee of property of the taxpayer corporation within the meaning of section 280(a) of the Revenue Act of 1926. The burden of proof is upon the respondent to show that the petitioner is liable as such transferee, but not to show that the taxpayer was liable for the tax. 1809 Section 602, Revenue Act of 1928. The facts were stipulated by the parties substantially as set out in our findings of fact above. 987 A transferee is one who takes the property of another without full, fair and adequate consideration therefor, to the prejudice of the rights of creditors. Do the stipulated facts show the petitioner to be a transferee of the property of the taxpayer? The record discloses that the taxpayer corporation, McKeefrey Iron Company, operated its business at a profit during the years 1917 and 1918, but sustained losses in the subsequent years, so that it became largely indebted for money borrowed from banks and for amounts due trade and other creditors. In 1922, the iron company placed a mortgage on its property in the amount of $700,000 to secure the payment of its bonds in said amount, which bonds were hypothecated as collateral security on loans. In 1923 the Iron Company executed two chattel mortgages to cover certain property excepted from the bond mortgage. At the beginning of 1924, a petition in bankruptcy was filed against the iron company. By this time it had become reasonably apparent that the business, under conditions then existing, 1810 could not be operated profitably, and it appeared with certainty that the assets of the iron company in a bankruptcy proceeding would not be sufficient to pay the secured creditors. Accordingly, a plan of reorganization was adopted through cooperation of the stockholders and principal creditors. The Government was not a party thereto. The primary, if not in fact the only, purpose of the reorganization plan was to conserve the assets with a view to realizing the maximum amount therefrom for the benefit of the creditors. It was not hoped that anything would remain for distribution to the stockholders, nor that the business could be operated at a profit. Pursuant to such plan, the petitioner corporation was organized, and in exchange for its stock acquired all secured and unsecured claims held by creditors against the iron company, except that of the Government for taxes. The Government's claim was not known at that time; it had not been asserted, nor the amount determined. The petitioner also acquired, in exchange for shares of its stock, all outstanding stock of the debtor corporation. Being then the sole stockholder and sole creditor of the iron company, the bankruptcy1811 proceeding was dismissed. Thereafter, by appropriate court action, the petitioner foreclosed its mortgage on the assets of the iron company and purchased same at sheriff's sale for the bid price of $185,000. Prior to sale, an appraisal was filed showing the appraised value of the property as $275,000. To sustain his contention that these facts establish the liability of the petitioner as a transferee, respondent relies upon the decision of the Supreme Court of the United States in , and the court's later approving opinion in 988 . These decisions, in our opinion, do not support the respondent's position, but impel us to a contrary conclusion. In the Northern Pacific case, the court approved in principle reorganizations such as that involved here, provided the reorganization is so effected as not to deprive creditors of their preferential rights over stockholders. Capital contributed to a corporation and represented by its shares of stock constitutes a fund subject to the payment of the corporate debts, and1812 the rights of creditors therein are superior to the rights of the stockholders. Hence, no part of such fund may be distributed to the stockholders until the claims of all creditors, both secured and unsecured, are satisfied. In this respect, there is no distinction between creditors, except that the secured creditor is entitled to have his debt paid first and the unsecured creditor is entitled to what remains to the extent of his debt. On this point, the court in its opinion, said: Corporations, insolvent or financially embarrassed, often find it necessary to scale their debts and readjust the stock issues with an agreement to conduct the same business with the same property under a reorganization. This may be done in pursuance of a private contract between bondholders and stockholders. And though the corporate property is thereby transferred to a new company, having the same shareholders, the transaction would be binding between the parties. But, of course, such a transfer by stockholders from themselves to themselves cannot defeat the claim of a non-assenting creditor. * * * That was done in the present case. * * * if purposely or unintentionally a single creditor was1813 not paid, or provided for in the reorganization, he could assert his superior rights against the subordinate interests of the old stockholders in the property transferred to the new company. They were in the position of insolvent debtors who could not reserve an interest as against creditors. Their original contribution to the capital stock was subject to the payment of debts. The property was a trust fund charged primarily with the payment of corporate liabilities. Any device, whether by private contract or judicial sale under consent decree, whereby stockholders were preferred before the creditor was invalid. Being bound for the debts, the purchase of their property, by their new company, for their benefit, put the stockholders in the position of a mortgagor buying at his own sale. The court further quoted with approval from its prior opinion in , as follows: Assuming that foreclosure proceedings may be carried on to some extent at least in the interests and for the benefit of both mortgagee and mortgagor (that is, bondholder and stockholder) no such proceedings can be rightfully carried to consummation1814 which recognize and preserve any interest in the stockholders without also recognizing and preserving the interests, not merely of the mortgagee, but of every creditor of the corporation. * * * Any arrangement of the parties by which the subordinate rights and interests of the stockholders are attempted to be secured at the expense of the prior rights of either class of creditors comes within judicial denunciation. 989 In the Northern Pacific case, as the court pointed out, the property of the old company was purchased by the new or reorganized company, under the foreclosure sale held pursuant to the consent decree, for the benefit of the stockholders, and the interests of those stockholders were preferred over the rights of the creditor, Boyd, for the payment of whose claim no arrangement had been made. The railroad cost $241,000,000. The reorganization contract contained the recital that the property at that time was of the full value of $345,000,000. There were lien debts against it in the amount of $157,000,000. It was bid in for $61,000,000 and the new company immediately issued bonds in the amount of $190,000,000 and stock in the amount of $155,000,000, 1815 or an aggregate of bonds and stock in the amount of $345,000,000, the agreed value, against property which it had bought a month before for $61,000,000. Thus, by means of the reorganization sale, the new company acquired property worth approximately $127,000,000 for which it paid nothing. To that extent the interests of the stockholders were preferred over the rights of the nonassenting creditor, and the court held that he was entitled to have his claim satisfied out of such property. In the instant case, a wholly different situation is presented. The reorganization plan and the foreclosure suit under the consent decree pursuant thereto were primarily for the benefit of the creditors. It was a plan designed to reduce to the minimum a loss which it was apparent must fall upon the secured creditors. The assets were not sufficient to pay the lien debts and nothing would be left for the unsecured creditors or for the stockholders. At the time of the foreclosure sale, the mortgaged property was appraised at $275,000, the unpaid mortgage was then $584,853.09. The property was bid in by the petitioner for $185,000, and both the bid price and the appraisal appear from subsequent1816 events to have been in excess of the fair market value of the property. The business could not be operated profitably, nor could the plant be sold as a unit. The property was sold piecemeal, as purchasers could be found, and the total amount of the proceeds was less than the price at which the petitioner purchased at the foreclosure sale. In , approving and applying the Northern Pacific decision, the court said: Unsecured creditors of insolvent corporations are entitled to the benefit of the values which remain after lien holders are satisfied, whether this is present or prospective, for dividends or only for purposes of control. But reasonable adjustments should be encouraged. Practically, it is impossible to sell the property of a great railroad for cash; and, generally, the interests of all parties, including the public, are best served by cooperation between bondholders and stockholders. If creditors decline a fair offer based upon the principles above stated, they are left to protect themselves. After such refusal, they cannot attack the reorganization in a court of equity. 990 The1817 respondent does not contend here that the Government ever at any time had a lien on the assets of the taxpayer corporation for the claimed taxes, or that it is entitled to be preferred before the lien holders. The Revenue Act of 1928, in section 613, provides that the amount of any tax, if not paid upon demand, shall be a lien in favor of the United States upon all property of the taxpayer from the time the assessment list was received by the Collector, but further provides that such lien shall not be valid as against any mortgagee, purchaser or judgment creditor until notice thereof has been filed as therein provided. The tax involved in this proceeding has never been assessed, nor notice thereof recorded. Hence, in respect of the lien holders the Government is in the position of an unsecured creditor, who is entitled to the benefit of the values which remain after the lien holders are satisfied, but in this case no value remained after satisfaction of the lien holders' claims. In fact, the assets were sufficient to pay only a portion of the claims of the lien holders. The respondent lays stress upon the fact that the stockholders of the iron company exchanged their shares1818 for stock in the furnace company, but this fact is unimportant, unless thereby the stockholders were to some extent at least preferred over the creditors, as occurred in the Northern Pacific case, supra. In that case, the court pointed out that the creditor was entitled to subject to the payment of his debt any interest sought to be retained by the stockholders, whether present or prospective, and whether for purposes of dividends or control. But in the instant case, the stockholders did not retain control of the corporate assets by obtaining control of the new corporation. In the process of reorganization they became minority stockholders. Nor was the stock issued to them for dividend purposes; no dividends were anticipated and none was ever derived. The old stockholders were given stock in the new corporation to enable them to participate in the liquidation of the assets for the benefit of the creditors, and the creditors themselves, upon exchange of their claims for preferred stock having voting rights, were in control. The assets of the taxpayer corporation were entirely consumed in paying the mortgage debts. No portion remained to apply against the debts owing1819 to the unsecured creditors or for distribution to the stockholders. As the result of the reorganization, the stockholders of the old corporation were in no sense preferred over the creditors. They got nothing, neither assets, dividends nor control. The petitioner corporation, as the sole stockholder of the taxpayer after reorganization, acquired nothing which it did not apply in payment of the secured debts. 991 If the respondent had sought to collect the taxes in controversy prior to the reorganization, he could have reached only the equity interest of the iron company in its assets, and since those assets were then mortgaged beyond their value, such procedure would not have resulted in satisfaction of the tax claim. The Government's claim prior to the reorganization was subordinate to the recorded mortgages, and certainly no superior rights accrued to it by reason of the reorganization, under the circumstances described. Applying the generally accepted trust-fund doctrine and the principles recognized by the Supreme Court in the cases above cited, it is our opinion that under the agreed facts of this case the petitioner is not shown to be liable at law or in quity, *1820 as a transferee of property of the taxpayer corporation in respect of any portion of the tax determined against it. Cf. . Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621392/	Orthel E. Cassell, Petitioner v. Commissioner of Internal Revenue, RespondentCassell v. CommissionerDocket No. 9342-78United States Tax Court72 T.C. 313; 1979 U.S. Tax Ct. LEXIS 122; May 10, 1979, Filed 122 Taxpayer's petition was received and filed by the Tax Court on Aug. 8, 1978, which was the 96th day after the notice of deficiency was mailed. The envelope enclosing the petition was addressed, in printing, to Internal Revenue Service, P.O. Box 1458, Central Station, St. Louis, Mo. 63188. The address was crossed out in ink and the correct address of the Tax Court in Washington, D.C., was written in ink, but the name of the addressee was not changed. The date of the postmark on the envelope was illegible to the naked eye. At the Court's request, the Postal Service Crime Laboratory determined the postmark date to be Aug. 2, 1978, the 90th day after the mailing of the notice of deficiency. Held: Respondent's motion to dismiss for lack of jurisdiction granted. While it was established that the envelope in which the petition was mailed was timely postmarked under sec. 7502, I.R.C. 1954, the envelope did not meet the further requirement of sec. 7502, I.R.C. 1954, that it be properly addressed to the office with which the petition was required to be filed. Sec. 7502, I.R.C. 1954, is not applicable, and the petition was not timely filed under sec. 6213(a), I.R.C. 1954; hence, the123 Court has no jurisdiction. Orthel E. Cassell, pro se.Robert P. Edler, for the respondent. Drennen, Judge. DRENNEN314 OPINIONThis case is before us on respondent's motion to dismiss for lack of jurisdiction upon the ground that the petition was not filed within the time prescribed by section 6213(a), I.R.C. 1954. 1 In this case that time was "within 90 days * * after the notice of deficiency * * * 124 is mailed."Petitioner resided in St. Louis, Mo., when the "petition" herein was filed. Respondent mailed a notice of deficiency to petitioner in St. Louis on May 4, 1978, in which he determined a deficiency in petitioner's income tax for 1975 in the amount of $ 1,117.09. On August 8, 1978, which was a Tuesday, the Tax Court received an envelope containing the printed form first page of the notice of deficiency addressed to petitioner. Nothing else appeared on the document except that the printed words "to contest this deficiency" were underscored in ink and at the top of the page the words "Received 5-6-78, mailed 7-31-78" were written in ink. Petitioner identified the writing as his.The envelope in which the document was received by the Tax Court is a printed self-addressed return envelope addressed to Internal Revenue Service, P.O. Box 1458, Central Station, St. Louis, Mo. 63188. The address was crossed125 out in ink and opposite it was handwritten in ink "400 2nd St N.W., Washington, 315 D.C. 20217." The latter address is the correct address of the Tax Court, but the addressee was Internal Revenue Service. The name of the Tax Court did not appear on the face of the envelope, and neither the sender's name nor a return address was affixed. The envelope bore a 15 cents U.S. Postal stamp, which was canceled.The envelope had stamped on its face "First Class Mail" and "Important." The envelope also bore a St. Louis postmark with the date "PM -- -- Aug 1978." The words "First Class Mail" were stamped over the postmark and the date in August was illegible to the naked eye.The Tax Court filed the document as a petition, and on August 9, 1978, issued an order directing petitioner to file on or before October 10, 1978, "a proper amended petition on the form enclosed and pay the filing fee of $ 10.00." It was further ordered that if an amended petition and filing fee are not received by October 10, 1978, the case would be dismissed and a decision in the amount of the deficiency determined by respondent would be entered against petitioner. No amended petition or filing fee have been 126 received from petitioner.The respondent filed his above-mentioned motion to dismiss on November 20, 1978, attached to which was evidence that the notice of deficiency was mailed to petitioner on May 4, 1978. The Court thereupon entered an order that the case would be dismissed for lack of jurisdiction unless petitioner, on or before December 29, 1978, filed written objection to respondent's motion setting forth facts, supported by documentary evidence, to indicate that the petition was timely filed. Action on the Court's order of August 9, 1978, was to be held in abeyance pending disposition of respondent's motion. 2On January 12, 1979, 127 the Tax Court received a letter from petitioner dated December 19, 1978, with a salutation, "My Dear Sirs" which alleged that petitioner was not being treated fairly by disallowance of certain expenditures, which we assume gave rise to the notice of deficiency. Reference was also made to the slowness of the mail and concluded with the statement that "This letter mailed befoer [sic] the due date of December 29, 316 1979 [sic]." The Court filed this document as a response to its order of November 24, 1978, and set respondent's motion to dismiss for hearing in St. Louis on March 12, 1979.At the hearing, respondent offered evidence from the manager, Quality Control, United States Postal Service, who testified that a statistical sampling system used by the Post Office to determine whether it was meeting its delivery standards indicated that during the period July 15, 1978, through August 11, 1978, the average volume of mail sent from St. Louis to Washington, D.C., was 1,546 pieces daily, that 18 percent was delivered within 1 day, 46 percent was delivered within 2 days, and 100 percent was delivered within 3 days. Basing his opinion on these statistics the witness testified that128 a piece of first class mail postmarked in St. Louis on Wednesday, August 2, 1978, would normally have been delivered in Washington, D.C., on or before Saturday, August 5, 1978.The only evidence offered by petitioner was his own testimony that he left St. Louis for a 10-day vacation in Chicago in the evening on July 31, 1978, and that he remembers putting the envelope in a post box near his home before he left. He could not remember any specific details about where or when he mailed the envelope.At the conclusion of the hearing, the parties inspected the envelope in the Court's file and the Court offered them an opportunity to have the envelope examined by experts in an effort to determine the date of the postmark. Neither party accepted the offer, so the Court took the matter under advisement. In response to an order of the Court requesting the Director, Crime Laboratory, United States Postal Inspection Service, to ascertain, if possible, the postmark date on the envelope, the Court received a United States Postal Service Crime Laboratory Examination Report which states, in part:PROBLEM:Determine the postmark date appearing onthe face side of the questioned envelopedesignated Exhibit A.FINDINGS:The postmark date appearing on the faceside of the questioned envelope designatedExhibit A is "PM 2 AUG 1978".129 Exhibit A referred to in the report was the envelope in which the "petition" in this case was received by the Court.The issue is one of jurisdiction. Unless a petition is timely 317 filed, the Court has no jurisdiction to decide the case. Estate of Moffat v. Commissioner, 46 T.C. 499">46 T.C. 499 (1966). Since the petition in this case was not actually received by this Court within the statutory 90-day period provided for filing a petition (see sec. 6213(a)), the petitioner must rely on section 7502(a)3 to establish the timeliness of his petition. Under that section, a petition is considered as having been delivered to this Court on the date it is postmarked, provided it is timely deposited in the United States mail in an envelope, postage prepaid, properly addressed to this Court. Section 301.7502-1(c), Proced. & Admin. Regs., provides:(c) Mailing requirements. (1) Section 7502 is not applicable unless the document is mailed in accordance with the following requirements:(i) the document must be contained in an envelope or other appropriate wrapper, properly addressed to the agency, officer, or office with which the document is required to be130 filed.* * * (iii)(a) * * If the postmark on the envelope or wrapper is not legible, the person who is required to file the document has the burden of proving the time when the postmark was made. Furthermore, in case the cover containing a document bearing a timely postmark * * * is received after the time when a document postmarked and mailed at such time would ordinarily be received, the sender may be required to prove that it was timely mailed.131 Although the burden of proving that this Court has jurisdiction is on petitioner ( Harold Patz Trust v. Commissioner, 69 T.C. 497">69 T.C. 497, 503 (1977)), over the years this Court has extended its rules on when and what kind of evidence can be received to determine whether a petition was timely mailed where it is received by the 318 Court after the 90-day period and the date on the postmark is illegible, or indeed where there is no postmark at all. Compare Rappaport v. Commissioner, 55 T.C. 709 (1971), affd. without opinion 456 F.2d 1335">456 F.2d 1335 (2d Cir. 1972), with Sylvan v. Commissioner, 65 T.C. 548 (1975), which overruled Rappaport. The most recent opinion of this Court dealing with the subject is Mason v. Commissioner, 68 T.C. 354 (1977), in which we found the petition to be timely filed based on oral evidence submitted at the hearing on a motion to dismiss. It has also relaxed to some extent its requirements on proof that the cover containing the petition was correctly addressed. See Minuto v. Commissioner, 66 T.C. 616 (1976).132 We conclude from petitioner's testimony and the report of the Postal Service Crime Laboratory that the postmark on the envelope in which the "petition" was mailed is August 2, 1978, and that this carries petitioner's burden of proving that his "petition" was timely mailed; i.e., the envelope in which it was mailed bore a timely postmark and was timely deposited in the mail. However, we cannot find that the facts meet either the requirement of section 7502(a)(2)(B) that the envelope was properly addressed to the Tax Court wherein the petition was required to be filed, or the requirement of section 6213(a) that the petition be filed "with the Tax Court" within 90 days.While there is no evidence showing who marked out the printed address of the Internal Revenue Service in St. Louis on the envelope and wrote in the correct address of the Tax Court in Washington, we could accept as a fact that the correct address of the Tax Court was placed on the envelope by petitioner. On its face, that would appear to be so. However, the addressee on the envelope was "Internal Revenue Service" and the name of the Tax Court does not appear on the face of the envelope in any form. The fact that the133 envelope was eventually delivered to the Tax Court several days late can make no difference. 4 See Axe v. Commissioner, 58 T.C. 256">58 T.C. 256 (1972). The statute requires that the envelope be properly addressed to the "office * * * with which 319 the * * document is required to be filed." The words "Internal Revenue Service" bear no resemblance to the words "United States Tax Court" and do not even suggest that the sender intended the envelope to be delivered to the Tax Court. Compare Minuto v. Commissioner, supra.The facts in this case simply do not bring it within the ambit of section 7502, and we cannot change the statute. See C. Frederick Brave, Inc. v. Commissioner, 65 T.C. 1001">65 T.C. 1001 (1976); Hoffman v. Commissioner, 63 T.C. 638">63 T.C. 638 (1975); Axe v. Commissioner, supra;Lurkins v. Commissioner, 452">49 T.C. 452 (1968).134 Since section 7502 can be of no help to petitioner, we must look to the date the "petition" was actually received and filed by the Court to determine whether it was timely filed under section 6213. Obviously, it was not, and we have no jurisdiction. Respondent's motion to dismiss for lack of jurisdiction will be granted. Possibly petitioner can take advantage of the suggestion made in note 2 hereto, and have his day in Court in the United States District Court or the Court of Claims. 5An appropriate order will be entered. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. If the Court's order of Aug. 9, 1978, is carried out, a decision will be entered against petitioner for the full amount of the deficiency. If respondent's motion is granted and this case is dismissed for lack of jurisdiction, the petitioner may pay the deficiency, file a claim for refund, and, if denied, sue to recover in the United States District Court or the Court of Claims.↩3. SEC. 7502(a). General Rule. -- (1) Date of delivery. -- If any return, claim, statement, or other document required to be filed * * within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed, * * * the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document * * * is mailed shall be deemed to be the date of delivery * * (2) Mailing requirements. -- This subsection shall apply only if -- (A) the postmark date falls within the prescribed period or on or before the prescribed date --(i) for the filing (including any extension granted for such filing) of the return, claim, statement, or other document, or * * (B) the return, claim, statement, or other document * * was, within the time prescribed in subparagraph (A), deposited in the mail in the United States in an envelope or other appropriate wrapper, postage prepaid, properly addressed to the agency, officer, or office with which the return, claim, statement, or other document is required to be filed * * *↩4. We can surmise that the reason an envelope postmarked Aug. 2 was not delivered to the Tax Court until Aug. 8 (a Tuesday) was that the envelope was first delivered to the Internal Revenue Service in St. Louis and readdressed there or was delivered to the Internal Revenue Service in Washington and redirected to the Tax Court there. However, the color of the ink used in readdressing the envelope compares favorably with the color of the ink used to write on the document filed as a petition, which petitioner testified was his writing. But for reasons mentioned in the opinion, such surmises are irrelevant.↩5. We call to petitioner's attention that there are also time limits involved in proceeding along the refund route. The file in this case indicates that petitioner has not been very meticulous in observing the time limits for responding to the Court's orders in this case.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621461/	Frederick and Ethel Kinzler v. Commissioner.Kinzler v. CommissionerDocket No. 80099.United States Tax CourtT.C. Memo 1962-62; 1962 Tax Ct. Memo LEXIS 246; 21 T.C.M. (CCH) 341; T.C.M. (RIA) 62062; March 22, 1962Jerome R. Rosenberg, Esq., for the petitioners. William F. Chapman, Esq., for the respondent. FORRESTERMemorandum Findings of Fact and Opinion FORRESTER, Judge: Respondent determined deficiencies in income tax of petitioners for the taxable years 1954, 1955, and 1956 as follows: Calendar YearDeficiency1954$ 409.591955432.471956806.48$1,648.54247 Petitioners by amended petition, filed at the date of trial, claim an overpayment of tax of $1,978.80 for the year 1956. The issues for our consideration are: (1) Whether petitioners are entitled to depreciation for the years involved in respect to certain machinery; (2) whether petitioners are entitled to an ordinary loss deduction for 1956 upon the disposition of such machinery at a sheriff's sale; (3) whether, if such loss is a proper deduction, it forms part of a net operating loss which may be carried back to the years 1954 and 1955; and (4) whether petitioners have substantiated a deduction of $150 for traveling expenses in 1956. Findings of Fact Some facts have been stipulated and are so found. Petitioners, Frederick and Ethel Kinzler, are husband and wife residing in Rockville Centre, New York. They filed their income tax returns for the years involved herein with the district director of internal revenue at Brooklyn, New York. Petitioner Ethel Kinzler is involved herein solely because of the filing of joint returns, and petitioner Frederick Kinzler will hereinafter be referred to as the petitioner. Petitioner commenced employment as a salesman for the Seely Shoulder248 Pad Corporation (hereinafter referred to as Seely) on September 22, 1953. On that date, he, Seely, and Kagan, Seely's president, entered into an agreement which provided in part as follows: AGREEMENT made September 22, 1953 between SEELY SHOULDER PAD CORP. (hereinafter called Seely), SIMON KAGAN and FREDERICK KINZLER, as follows: 1. (a) Seely shall sell to Kinzler, and Kinzler hereby buys from Seely, all of Seely's plant, equipment, molds, machinery, fixtures and personal property of every description now in or at Seely's premises located at 16 Commercial Street, Rochester, New York * * * (b) Kinzler shall pay and simultaneously herewith has paid Seely the sum of $25,000.00 in cash and Seely shall and simultaneously herewith has executed and delivered to Kinzler a Bill of Sale with affidavit of ownership conveying title to the property described in Paragraph (a) * * * and Seely shall also execute and deliver and has executed and delivered a separate assignment of its said rights as tenant of the said premises. (c) Immediately following the delivery of the said Bill of Sale and assignment to Kinzler, he shall lease the said premises and the property covered by the said Bill249 of Sale to Seely for a rental of $50.00 per week and for a term to and including December 31, 1955. 2. (a) Kinzler is hereby granted the absolute and unqualified option to purchase one-half of the issued and outstanding capital stock of Seely, all as hereinafter in this Paragraph 2 set forth. (b) The said option shall be exercisable at any time during the period commencing on October l1, 1954 to and including December 31, 1955 upon written notice (hereinafter called the option notice) to Seely, * (d) On such 45th day from the date of the option notice, there shall be issued to Kinzler shares representing one-half of the total capital stock of Seely issued and outstanding on such day, and on such day Kinzler shall pay therefor in cash an amount equal to one-half of the said net worth as so determined, less, however, the sum of $25,000.00 and less a further amount equal to 50% of the net profits of Seely after taxes, computed by the said accountants for Seely in accordance with good accounting practice, for the period from the date of this Agreement to such day when payment shall be made by Kinzler and stock issued to Kinzler; provided, however, that if such profits shall250 be an amount which is in excess of the said one-half of the said net worth less $25,000.00, then such excess shall be paid to Kinzler in cash. (e) Concurrently with the said issuance of stock by Seely and the making of such payment by Kinzler, Kinzler shall reconvey to Seely the property covered by the Bill of Sale and shall re-assingnhis rights as tenant both acquired by him under Paragraph 1 above, free and clear. 3. (a) In the event that Kinzler has not exercised his option to acquire one-half of Seely's capital stock as herein provided prior to the expiration date thereof (namely, prior to December 31, 1955), then Seely shall have the option to repurchase the property sold to Kinzler and to re-acquire the rights as tenant of the Rochester premises assigned to Kinzler under Paragraph 1 hereof which option may be exercised no later than February 1, 1956. The said option shall be exercised by Seely by serving written notice upon Kinzler by mail which notice shall be mailed not later than 15 days prior to the said February 1, 1956; and the purchase price (namely, $25,000.00) shall be paid to Kinzler in cash on such February 1, 1956 against delivery of a Bill of Sale and assignment251 in form and substance the same as that delivered to Kinzler under Paragraph 1 above. (b) In such event of Kinzler not so exercising his option to acquire one-half of Seely's capital stock and in the further event that Kinzler shall not have received Seely's said notice of exercise of option provided for in Subparagraph (a) of this Paragraph 3 by January 20, 1956, then Kinzler shall have the right to sell the said property and to assign the said rights as tenant of the Rochester property for such price of $25,000.00, and Seely in the first instance shall be obligated to buy such property and take an assignment of such rights and assume all of Kinzler's obligations as tenant at such price. In the event that Seely shall fail to comply with its said obligation, then Kagan shall be obligated to buy such property, take an assignment of such rights and assume such obligations. Kinzler's said right to sell shall be exercised by him by notice in writing mailed to Seely and to Kagan, which notice shall be mailed on or before February 1, 1956; and the sale shall be effectuated at 2 PM on February 15, 1956 * * at which time there shall be paid to Kinzler by Seely or if it shall fail so to252 do by Kagan the said purchase price of $25,000.00, and concurrently therewith Kinzler shall deliver a Bill of Sale covering the said property free and clear and Kagan and Kinzler shall execute and deliver an instrument of assignment of rights and assumption of obligations with respect to the said Rochester premises. Pursuant to the above agreement Seely executed a bill of sale of the property described therein and an assignment of its lease covering the factory premises to petitioner, who in return paid Seely the sum of $25,000. Petitioner immediately (in form) leased the premises, machinery and equipment back to Seely. He collected rent from Seely for 7 weeks in 1953 in the total amount of $350, but none thereafter. In 1955 petitioner filed a lawsuit against Seely to collect back rent, but said action was discontinued because petitioner believed Seely was then insolvent. Petitioner never insured the equipment and machinery. On February 1, 1954, petitioner executed a chattel mortgage on the machinery and equipment to Max A. Goldbaum to secure a loan of $30,000. Petitioner was not personally liable on the note secured by the chattel mortgage. The proceeds of this loan were paid253 to Seely either directly or through petitioner. Concurrently with this mortgage petitioner assigned the lease of the premises to Goldbaum. Seely was in dire financial straits throughout the entire period, and had stopped manufacturing by July 1955. On July 26, 1955, petitioner and Jerry Kline formed and incorporated Dukay Molded Products Corp. in an attempt to utilize the Seely plant, machinery and equipment. No stock of Dukay was ever issued. In furtherance of this attempt, petitioner obtained permission from Kagan and Seely to occupy the premises from July 26, 1955, through September 1955, and during this time, petitioner, Kline, Jacoby (who had been overseer of the plant for Seely), and another made an effort to see if the plant (including the machinery and equipment here at issue) could be operated for the manufacture of latex products. Petitioner had had no experience in manufacturing latex products; Jacoby was an engineer; and Kline was in the leather business and a "financial person." Dukay incurred various expenses in connection with the above attempt, and also received a bill for rent at $280 per month for August and September 1955 from Abraham G. Francis, one of the254 owners of the premises. No use of the machinery and equipment was made after September 1955 and it was seized by the sheriff of Monroe County, New York, for nonpayment of a debt owed by Seely, and was sold on March 5, 1956. Petitioner did not defend this action. Respondent disallowed the deductions by petitioner for depreciation of the machinery and equipment for 1954, 1955, and 1956. During all of 1956 petitioner was a salesman for Ruth Merzon Originals, a manufacturer of ladies' undergarments, and Park-High, Inc., a real estate corporation. Pursuant to the latter employment petitioner incurred travel expenses in the form of tolls, gasoline, and occasional lunches for maintenance personnel of the corporation's building in Perth Amboy, New Jersey. He was not reimbursed for these expenses. Petitioner's sales activity for Ruth Merzon Originals required him to travel throughout New York City, and to travel to Providence, Philadelphia, and Boston. He incurred expenses for tolls, gasoline, and lunches purchased for certain buyers in Providence. He received no reimbursement for these expenses. Petitioner expended at $150least for such travel and necessary business expenses in 1956255 for which he was not reimbursed. In his income tax returns petitioner reported $3,200 of income for 1954 from his employment with Seely, and reported no income from such source during 1955 and 1956. Opinion Issue 1 The controlling question as to this issue is whether or not petitioner had such an interest in the machinery and equipment, effected by the September 22, 1953, documents, as would entitle him to depreciate them. 1 Petitioner claims to be the owner of property used in a trade or business or held for the production of income, while respondent alleges that the transactions of September 22, 1953, amounted to a loan of $25,000 by petitioner to Seely, with title to the machinery vesting in petitioner only as security. Such ownership, he concludes, is insufficient to permit depreciation. The one fact that becomes crystal clear upon consideration and analysis of the complex dealings of September 22, 1953, is that the actors did not intend, and petitioner did not become the owner of the Seely machinery and equipment. He paid $25,000 and took a legal title impressed with three options. Two of these options256 were in his favor, and under them he could recover his $25,000 or get credit for it against a purchase by him of one-half of Seely's stock. If we were called upon to place an exact label on the effect of the September 22, 1953, dealings we would probably conclude that all or most of petitioner's $25,000 was paid for his first option. He was to get full $25,000 credit against the formula price of the Seely stock and, in addition, one-half of Seely's net profits after taxes during the interim period. Consideration of this option, plus the next option, in favor of Seely, to "sell back" at the same price, and plus the third option, in favor of petitioner, also to "sell back" at the same price, and either to Seely or to Kagan (presumably if Seely's credit was not then good) leads us to conclude, as to this (depreciation) issue, that the substance of the September 22, 1953, dealings was not a sale to petitioner and a lease back to Seely. Therefore, petitioner's rights in, and title to the property were allied to the options, and were akin to security rights (if some part of the $25,000 was a loan) and amounted to bare legal title. This conclusion is confirmed by the unrealistic "lease257 back" price of $50 per week for property which was depreciating at the rate of $68.68 per week. As a general proposition the one with title to property is the one entitled to any depreciation thereon. But one need not be an owner of property to depreciate it. Helvering v. Lazarus & Co., 308 U.S. 252">308 U.S. 252, and, conversely, being the owner of property does not automatically entitle one to the allowable depreciation deductions respecting such property. As was stated in Edith Henry Barbour, 44 B.T.A. 1117">44 B.T.A. 1117, 1121 (1941), reversed on other grounds 136 F. 2d 486 (C.A. 6, 1943), certiorari denied 320 U.S. 778">320 U.S. 778: The test is whether the claimant to depreciation is in such a position as to suffer an economic loss as a result of the decrease in value of the property due to the depreciation. * * * Applying this test we find that petitioner is not entitled to the claimed deductions. Petitioner's argument that he was the party bearing the economic loss from the wear and tear is contradicted by the option prices of $25,000, and further by petitioner's258 failure to insure the property. One who paid $25,000 for machinery and equipment and regarded himself as owner would normally protect his investment by obtaining insurance. The failure of petitioner to insure indicates that he did not regard the property as his own. The loss occasioned by the wear and tear was not borne by petitioner. At the end of 1955 he could (1) exercise his option (if he had not already done so) to buy half of Seely's stock and return the machinery and equipment to Seely, or (2) by February 15, 1956, require Seely (or Kagan) to repurchase the machinery and equipment for $25,000, if Seely had not already done so. The substance of the transaction was that petitioner was to have his $25,000 returned either in cash or in stock of Seely and was to return the legal title to the property to Seely. Petitioner's interest in this property was a form of security interest, and the burden of the wear and tear was not primarily his. In E. J. Murray, 21 T.C. 1049">21 T.C. 1049 (1954), affirmed without discussion of this point 232 F. 2d 742 (C.A. 9, 1956), certiorari denied 352 U.S. 872">352 U.S. 872, a mortgagor out of possession but having a right to redeem259 was held entitled to the depreciation deduction. In Helvering v. Lazarus & Co., supra, a transaction in form a transfer of ownership with a lease back was held to be in reality a mortgage loan, permitting the mortgagor to depreciate. The above cases hold that the mortgagor may deduct depreciation because when he pays off his debt he receives the property which has suffered wear and tear. The fact that he may default and compel the mortgagee to attempt to realize upon the security does not alter this treatment. Even assuming that there was a lease of the property by petitioner to Seely, petitioner's position is no better, for when a lessee must return leased property or its equivalent in value to the lessor at the termination of the lease in as good condition and value as when leased, the lessor may not take depreciation deductions in respect to the property. Terre Haute & Indianapolis & Eastern Traction Co., 24 B.T.A. 197">24 B.T.A. 197 (1931), reversed on other grounds 67 F. 2d 697 (C.A. 7, 1933), certiorari denied 292 U.S. 624">292 U.S. 624 (1934). Just as the260 lessor in the Terre Haute case had a contractual right to be made whole at the expiration of the lease, so petitioner in the instant case had the right to be repaid (either in cash or stock) at the expiration of the option. Therefore, prior to February 15, 1956, at which date petitioner could no longer compel Seely or Kagan to repurchase the property, petitioner was not entitled to depreciation with respect thereto. As to the period after February 15, 1956, no evidence has been adduced showing that petitioner used the machinery and equipment in any trade or business (or that it was being used at all), or held it for the production of income within the intendment of section 167, Internal Revenue Code of 1954: * * 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. We therefore hold that petitioner may not depreciate261 said machinery and equipment after February 15, 1956. Issues 2 and 3 In an amended petition filed at the trial petitioner claimed a loss during 1956 resulting from the seizure and sale of the machinery and equipment. He relies on section 165(a) and (c)2 for this alleged ordinary loss. We have already indicated that petitioner did not use this property in a trade or business in 1956. The262 only possible time he may have so used it was during the occupancy of the plant by Dukay in 1955, but even this possible use was by Dukay, and not by petitioner. The record shows that there was no "use" of the plant (including the machinery and equipment) for at least 5 months and 4 days prior to the sheriff's sale of March 5, 1956. We are therefore unable to find that petitioner was in any trade or business using the machinery and equipment in 1956 and any loss sustained will not form part of a net operating loss as defined in section 172. Petitioner contends that he suffered a 1956 loss in a transaction entered into for profit, but we have not been shown that any loss occurred in 1956. Petitioner had mortgaged this property for $30,000 in 1954, and this $30,000 went to Seely, yet petitioner testified that he had abandoned his suit for rent in 1955 because he believed this obligation from Seely was uncollectible. This together with petitioner's failure to exercise his second option to require Seely or Kagan to repurchase the property in 1956, strongly suggests that whatever loss there was, was sustained before 1956. We therefore decide issues 2 and 3 for respondent. It may be263 that petitioner could have put at issue, and supported the proposition that all or some part of the September 22, 1953, dealings amounted to an equity investment by him, which investment became worthless at some later date, entitling him to a capital loss, but he has not done so in this case. Issue 4 We ruled from the bench after hearing the evidence that petitioner had substantiated his claim of $150 for travel expenses. Upon reviewing the record we find nothing to warrant alteration of that conclusion, and this is reflected in our findings of fact. Decision will be entered under Rule 50. Footnotes1. The useful life and rate of depreciation are not at issue.↩2. All statutory references are to the Internal Revenue Code of 1954. SEC. 165. LOSSES. (a) General Rule. - There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. * (c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to - (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621393/	LARRIMORE WRIGHT and MARY M. WRIGHT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWright v. CommissionerDocket No. 21794-80.United States Tax CourtT.C. Memo 1983-707; 1983 Tax Ct. Memo LEXIS 79; 47 T.C.M. (CCH) 422; T.C.M. (RIA) 83707; November 29, 1983. C. Richard Rayburn, Jr., for the petitioners. James R. Rich, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in petitioners' Federal income taxes for 1976 in the total amount of $57,829. After concessions, the issues for decision herein are as follows: (1) Whether petitioners' loss upon the sale of 10,000 shares of common stock of Texfi Industries, Inc. is deductible as an ordinary loss or a capital loss under section 165; 1 and/or (2) whether petitioners' loss upon the sale of said stock is deductible as an ordinary loss under section 83 and regulations thereunder. 82 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation and the exhibits attached thereto are incorporated herein by this reference. Larrimore Wright (hereinafter referred to as "Petitioner") and Mary M. Wright, husband and wife (hereinafter referred to, collectively, as "petitioners"), were legal residents of Greensboro, North Carolina, on December 5, 1980, the time of filing of their petition herein. Petitioners filed a joint Federal income tax return for the tax year ending December 31, 1976, with the Internal Revenue Service Center in Memphis, Tennessee. Prior to October 1971, petitioner was employed as a partner in the national accounting firm of Price, Waterhouse & Company, where his annual salary was in the range of $70,000 to $75,000. Between July 1971 and October 1971, petitioner participated in negotiations with Joseph H. Hamilton (hereinafter referred to as "Hamilton"), who was then the president of Texfi Industries, Inc. (hereinafter referred to as "Texfi"), concerning possible employment with that company. At all pertinent times herein, Texfi, which was headquartered in Greensboro, North Carolina, was principally83 in the business of designing, producing and selling knitted, woven and printed apparel fabrics produced primarily from textured polyester yarn. For several years prior to petitioner's employment negotiations with Texfi, the market price of the company's common stock had been steadily increasing, and the company had been expanding rapidly. By letter to petitioner dated July 31, 1971, Hamilton offered petitioner a position as vice-president and chief financial officer of Texfi in exchange for an annual compensation of $70,000 for the first two years of his employment. Since that salary, which was the maximum that could be offered by Texfi within its then-effective executive compensation range, was alone insufficient to attract petitioner from his position at Price, Waterhouse & Company, additional inducements were provided. First, pursuant to the July 31, 1971 letter, as soon as practicable after his becoming an employee, Texfi would grant to petitioner an option to purchase, at fair market value on the date of such grant, 10,000 shares of common stock in Texfi pursuant to the company's "Employee Qualified Stock Option Plan" (hereinafter referred to as "ESOP"). Second, Hamilton84 agreed to personally sell to petitioner 7,500 shares of his own common stock in Texfi for $34 per share, conditioned upon petitioner: (1) Representing that he was purchasing Hamilton's Texfi shares for investment, and not with a view toward distribution or resale thereof (hereinafter referred to as "investment warrant"); and (2) agreeing to transmit to Hamilton either 100 percent of the profits from his sale of such shares in the event that petitioner voluntarily left Texfi within his first year of employment or was terminated by Texfi for certain willful misconduct within his first three years of employment, or 50 percent of the profits from his sale of such shares in the event that petitioner voluntarily left Texfi within the second or third years of his employment (hereinafter referred to as "shares profits agreement"). The July 31, 1971 letter also recited Hamilton's offer, in general terms, to personally assist petitioner in financing his acquisition of Hamilton's Texfi shares. Hamilton's agreement to sell to petitioner both the ESOP shares and a portion of his own stock holdings in Texfi was consistent with his philosophy that the textile business was an entrepreneurial business, 85 making it important that top management have an ownership stake in the company. At that time, it was expected both by Hamilton and petitioner that the market price of Texfi's stock would continue its pattern of steady growth, and that petitioner would eventually sell at a profit the shares sold to him by Hamilton, using the proceeds thereof, at least in part, to exercise his options to purchase stock under Texfi's ESOP. On August 10, 1971, petitioner and Hamilton entered into two successive contracts as follows: (1) A letter directed to petitioner from Hamilton, on behalf of Texfi, signed by both parties, providing that petitioner would enter into an employment agreement with Texfi on or before November 1, 1971, and setting forth terms of an option for petitioner to purchase stock pursuant to Texfi's ESOP; and (2) a letter directed to Hamilton personally from petitioner, signed by both parties, renewing the agreement to sell petitioner 7,500 of Hamilton's own shares in Texfi at a purchase price of $34 per share, and revising those terms of the July 31, 1971 letter and the initial August 10, 1971 contract which related to petitioner's option to purchase stock pursuant to Texfi's86 ESOP. Included in the second August 10, 1971 contract, but pertaining solely to petitioner's prospective purchase of Hamilton's shares, were petitioner's investment warrant and shares profits agreement, together with his agreement not to sell or transfer the shares in the absence of either an effective registration statement therefor pursuant to applicable Federal securities requirements, or an opinion of counsel that such registration was not required (hereinafter referred to as "registration agreement"). On October 1, 1971, petitioner and Hamilton executed an employment agreement, providing that petitioner would serve as Texfi's chief financial officer for a term beginning on October 1, 1971, and ending on October 31, 1974, in exchange for a minimum compensation of $72,500 annually, consisting of a $60,000 base annual salary plus bonuses. The contract stated that it contained the "entire agreement" between Texfi and petitioner, and that it could be changed only by written agreement of the parties. The employment agreement made no reference to petitioner's prospective acquisition of common stock in Texfi. Pursuant to the employment agreement, petitioner commenced employment87 as chief financial officer at Texfi in October 1971. Thereafter, at a time not disclosed in this record, petitioner was appointed executive vice-president and chief administrative officer of Texfi, and in March 1972, he was elected to Texfi's board of directors. At the time of his commencement of employment, petitioner had investigated Texfi and had determined that the growth prospects of the company were "very good." Subsequent to petitioner's commencement of employment at Texfi, however, the market value of Texfi's common stock declined. In response to this decline, by letter directed from petitioner to Hamilton, dated March 29, 1972, and signed by both parties, petitioner and Hamilton entered into a new contract, canceling their prior personal contract of August 10, 1971. In entering into the new contract, at a time when petitioner was already employed by Texfi, Hamilton was motivated by his continuing philosophy that top management of Texfi should possess an ownership stake in the company. It was petitioner's expectation, in entering into the new contract in March 1972, that the depressed value of Texfi stock would thereafter increase, and that he would subsequently sell88 the stock at a profit, realizing a capital gain thereon. Under the new contract, Hamilton agreed to sell 10,000 of his own shares in Texfi to petitioner on or before March 31, 1972, for a purchase price of $18 per share. Like its predecessor agreement, the new contract included an investment warrant, registration agreement, and shares profits agreement relating to petitioner's prospective acquisition of Hamilton's 10,000 Texfi shares, providing as follows: 2. I hereby represent and warrant that I intend to purchase the Shares for investment and not with a view to, or any present intention of, selling or otherwise distributing any of the Shares. I agree that I will not sell or otherwise transfer the Shares in the absence of an effective registration statement for the Shares under the Securities Act of 1933, as amended, or an opinion of counsel satisfactory to you and such other assurances as you may reasonably request prior to the proposed transaction that registration is not required under said Act. I further represent that as the Company's principal financial officer, I have access to all financial information relating to the Company and my purchase of the Shares is made on89 the basis of my own independent investigation of the business and financial condition of the Company and not upon any express or implied representations and warranties made by you or any of the Company's other officers, directors or stockholders. 3. If I voluntarily leave the employ of the Company one year or less from the date my employment with the Company Commenced, or if my employment is terminated by the Company within three years of commencement of such employment for wilful misconduct in connection with the performance of my duties and obligations to the Company, I will deliver to you my total profits from the sale of Shares immediately upon the sale thereof, which shall be no later than five years from the date hereof. If I voluntarily leave the employ of the Company more than one year but less than three years after my employment commenced, I will deliver to you 50% of my total profits from the sale of the Shares immediately upon the sale thereof, which shall be no later than five years from the date hereof. In no other event will you be entitled to any profits from the sale of the Shares. 4. There will be imposed upon the certificate or certificates issued to me90 evidencing the Shares the following legend: "The shares evidenced by this Certificate have not been registered under the Securities Act of 1933, as amended. The shares evidenced hereby may not be sold, transferred, pledged, or hypothecated in the absence of an effective registration statement for the shares under the Securities Act of 1933, as amended, or an opinion of counsel satisfactory to the Corporation prior to the proposed transaction that registration is not required under said Act." The registration agreement and investment warrant were included in the contract because the parties thereto believed: (1) That Hamilton could not sell his shares to petitioner without either registering them with the Securities and Exchange Commission, or selling them in a transaction exempted from registration; (2) that registration would be costly; and (3) that provision of an investment warrant was the standard procedure for obtaining an exemption from registration. The new contract made no provision with respect to petitioner's entitlement to acquire shares under Texfi's ESOP. Pursuant to the March 29, 1972 agreement, the total purchase price for 10,000 shares of Hamilton's common91 stock in Texfi, $180,000, was to be due and payable upon delivery of the shares to petitioner. In addition, the new agreement contained the following provision, addressing petitioner's possible need for Hamilton's financial assistance: 5. It may be necessary for me to request assistance from you in the form of a guaranty from you to my lender in connection with financing the purchase price of the Shares. In such event I agree not to pledge or otherwise encumber any of the Shares without your prior written consent so long as any indebtedness of mine is guaranteed as to payment or collection by you, and that, upon any sale of any of the Shares, I will immediately apply the entire proceeds, or such portion thereof as is required, to pay in full any indebtedness of mine guaranteed by you. You may instruct the Company and the transfer agent for its common stock not to transfer the Shares otherwise than as permitted by this agreement. Pursuant to this contract, on or about March 31, 1972, petitioner purchased from Hamilton, 10,000 restricted shares of Texfi common stock at $18 per share, a price below the value of unrestricted shares of Texfi on the New York Stock Exchange on the92 purchase date. 2 This record does not disclose, however, how the purchase price paid by petitioner would compare with the fair market value of similarly restricted shares of Texfi on the same date. The stock was purchased with the proceeds of a loan which petitioner obtained on April 11, 1972 from North Carolina National Bank (hereinafter referred to as "NCNB"), and which was personally guaranteed by Hamilton. The stock certificate evidencing these shares was transmitted to NCNB as collateral for the loan. At no time did petitioner make an election to include93 any amount in his gross income with respect to his purchase of these 10,000 shares of Texfi stock, pursuant to section 83(b). On April 22, 1975, Texfi granted to petitioner an option to purchase 12,500 shares of Texfi's common stock, pursuant to its ESOP, at a price of $5.50 per share. This option was exercisable at any time prior to three months following termination of petitioner's employment with Texfi. Following petitioner's purchase in March 1972 of Hamilton's Texfi shares, Texfi's stock unevenly increased in value until the end of 1972, when it began to decline in value steadily, a trend which continued generally through 1976. For calendar years 1970 through 1976, the yearly high and low prices paid for publicly traded shares of Texfi stock were as follows: YearHighLow19705615 1/2197167 1/227 3/4197235 1/819 1/4197331 1/87 3/8197413 3/42 5/819758 1/22 3/419769 5/83From October 1971 through March 15, 1976, petitioner served continuously as an officer of Texfi. Effective on March 16, 1976, petitioner resigned as an officer and director of Texfi, but agreed with the company to stay on for up94 to one year in a "leave-of-absence" status. The contract to thus retain petitioner, dated March 24, 1976, provides, inter alia, for agreed compensation and for establishment of December 11, 1976 as the date for exercise of options held by petitioner to purchase Texfi shares 3 pursuant to the company's ESOP. In a subsequent undated letter to Hamilton, petitioner added that it was his intention, in the event that he exercised such stock options, within 60 days thereafter, to sell the stock and apply all proceeds thereof in excess of the option price to reduce his indebtedness to NCNB. As a result of the diminished value of Texfi stock in December 1976, when his options were exercisable, however, petitioner never exercised any of his options to purchase stock under Texfi's ESOP. The restrictions of the agreement of March 29, 1972, paragraph 3, concerning the disposition of any95 profits from the sale of petitioner's Texfi stock if he should leave the company, lapsed by their own terms not later than October 1, 1974. By letter dated March 19, 1976, indicating his intention to sell the 10,000 shares of Texfi purchased from Hamilton, and to apply the sale proceeds to reduce his indebtedness to NCNB, petitioner requested that NCNB release the stock certificate evidencing such shares, and permit the sale to occur. On March 26, 1976, 4 in an "attempt to cut [his] losses," petitioner sold on the New York Stock Exchange for $74,092.08, the shares in Texfi which he had acquired from Hamilton in March 1972 for $180,000. Consistent with his March 29, 1972 contract with Hamilton, and his March 19, 1976 letter to NCNB, petitioner applied the full proceeds of the sale to a reduction of his outstanding indebtedness to NCNB. Between 1972 and 1976, 96 petitioners reported no income with respect to these 10,000 Texfi shares, except for dividends received with respect thereto. On their joint Federal tax return for tax year 1976, petitioners claimed an ordinary loss deduction in the amount of $105,908, computed as the difference between the price at which petitioner purchased the shares, $180,000, and the price at which he sold the shares, $74,092.08, rounded to the nearest dollar, and identified on such return as a: Loss under section 165(c)(2) in connection with disposition of equity interest as part of employment contract with Texfi Industries, Inc. terminated in March, 1976. Upon audit, respondent disagreed with this position, and determined that petitioners' loss on the sale of the Texfi stock was a long-term capital loss, as to which only $1,000 was allowable as a deduction in 1976. ULTIMATE FINDINGS OF FACT The 10,000 shares of common stock in Texfi were transferred to petitioner inconnection with his performance of services for Texfi. Petitioner's primary and predominant motive for purchasing the stock of Texfi was for purposes of investment. OPINION Issue 1. Deductibility Under Section 165.The first97 issue presented herein is whether petitioners' $105,908 loss on their sale of 10,000 shares of common stock in Texfi may be deducted as an ordinary loss pursuant to section 165. Section 165(a) states the general rule allowing a deduction for uncompensated losses incurred within the taxable year. Section 165(c) limits this general rule, in the case of individual taxpayers, so as to permit deductions only for losses incurred in a trade or business, a profit-making activity, or a theft or casualty. Losses from the sale of a capital asset are further governed by section 165(f), which adopts the limitations on deductions set forth in sections 1211 and 1212. Resolution of the first issue herein therefore depends upon whether the 10,000 Texfi shares acquired and held by petitioner constituted a capital asset in his hands. Section 1221 defines "capital asset" expansively as property held by the taxpayer, with the exception of five categories of property. It is uncontroverted that the 10,000 shares of Texfi stock at issue do not fit within any of these excepted categories. At the same time, however, it is well-established that an asset outside the literal language of these excepted98 categories may nonetheless be held to be excepted from definition as a capital asset. In Corn Products Refining Co. v. Commissioner,350 U.S. 46">350 U.S. 46 (1955), the Supreme Court, in holding that corn futures contracts bought and sold by the taxpayer were not capital assets in his hands, stated: Admittedly, petitioner's corn futures do not come within the literal language of the exclusions set out in [section 117(a)]. 5 They were not stock in trade, actual inventory, property held for sale to customers or depreciable property used in a trade or business. But the capital-asset provision of § 117 must not be so broadly applied as to defeat rather than further the purpose of Congress. Burnet v. Harmel,287 U.S. 103">287 U.S. 103, 108. Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by § 117 applies to transactions in property which are not the normal source of business income. * * Since this section is an exception from the normal tax requirements of the Internal Revenue Code, the definition of a capital asset99 must be narrowly applied and its exclusions interpreted broadly. [350 U.S. at 51-52] The Corn Products doctrine has since been applied by this Court to other types of assets, including corporate securities. See W. w. Windle Co. v. Commissioner,65 T.C. 694">65 T.C. 694, 707-708 (1976), appeal dismissed 550 F.2d 43">550 F.2d 43 (1st Cir. 1977), cert. denied 431 U.S. 966">431 U.S. 966 (1977), and cases cited therein. To determine whether corporate stock had been acquired by the taxpayer for a purpose so integrally related to his trade or business that such stock would be excepted from definition as a capital asset, this Court in Windle, based upon a comprehensive analysis of judicial precedent on this issue, adopted a test, pursuant to which the existence of a substantial investment motive in a predominantly business-motivated acquisition and retention of corporate stock, will be sufficient to render such stock a capital asset under section 1221. 65 T.C. at 712. See also Hollingworth v. Commissioner,71 T.C. 580">71 T.C. 580 (1979); Miller v. Commissioner,70 T.C. 448">70 T.C. 448 (1978);100 Continental Illinois National Bank v. Commissioner,69 T.C. 357">69 T.C. 357 (1977). As noted by this Court in Windle, "stock is normally a capital asset" owned for investment purposes, and only where the "original purpose of [the] acquisition and the reason for continued retention are both devoid of substantial investment intent should the stock be treated otherwise." 65 T.C. at 714, n. 15. In accordance with the Windle test, to obtain ordinary loss treatment under section 165 on the sale of the Texfi stock at issue herein, petitioners have the burden of proving the absence of a substantial investment motive in petitioner's purchase and retention of the stock. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a). In evaluating petitioner's motivations in light of the foregoing test, we face an essentially factual inquiry. Corn Products Refining Co. v. Commissioner,supra at 51; Hollingsworth v. Commissioner,supra at 585. In support of their contention that the subject shares of stock were purchased and held in a business-motivated, rather than an investment-motivated transaction, petitioners101 rely upon the following: (1) While petitioner was not required to purchase Texfi stock when he was first employed by the company, it was Texfi's policy that high-level management should have a stake in the company, placing him under pressure to acquire its stock when he became a director of Texfi in March 1972; (2) at the time of his stock purchase, Texfi stock had declined repidly in value, and did not appear to petitioner to be a wise investment; (3) restrictions on petitioner's alienation of the stock were exemplary of a business-motivated, rather than an investment-motivated transaction; and (4) petitioner had no history of stock investments prior to his purchase of the subject shares in Texfi, and the price of that stock was in excess of his net worth at the time of purchase. On the basis of the full record herein, including testimony by petitioner and Hamilton at trial, we conclude that petitioner purchased the subject shares of Texfi stock with a substantial investment intent.Such intent consisted of petitioner's expectation that the stock would appreciate in value, enabling him to subsequently sell the stock at a profit, realizing a capital gain thereon. This expectation102 motivated petitioner's initial agreements to purchase the stock in July 1971 and August 1971, as well as his subsequent purchase of the stock, on renegotiated terms, in March 1972. We further conclude that the substantial investment intent which characterized petitioner's acquisition of the stock, prevailed throughout the period he held the stock, thus negating ordinary loss treatment under section 165 in conformance with the test applied by this Court in Windle.In 1971, after "many months interviewing and looking for an individual to become the chief financial officer" at Texfi, Hamilton concluded that petitioner was the "outstanding leading candidate" for the position. Since the salary offered by Texfi was alone insufficient to attract petitioner from his position as a partner at Price Waterhouse & Company, as a further inducement, Hamilton offered to sell to petitioner a portion of his own stock holdings in Texfi.According to Hamilton's testimony, the offer to sell his own stock was "the only way that I could…. get [petitioner] to come into the company." At the time of the employment negotiations between petitioner and Himilton, the market value of Texfi's common103 stock had been steadily increasing, and the Company had been expanding rapidly. It was expected, both by petitioner and Hamilton, that the stock would continue its pattern of steady growth, and that petitioner would eventually sell the shares sold to him by Hamilton at a profit, applying the proceeds thereof to the purchase of stock pursuant to Texfi's ESOP. Subsequent to petitioner's commencement of employment at Texfi, in October 1971, the market value of Texfi stock declined. As a result, petitioner refrained from purchasing Hamilton's shares at the $34 per share agreed price under the August 10, 1971 contract, and on March 29, 1972 petitioner negotiated a new contract with Hamilton which included new price and quantity terms for the stock purchase. Pursuant to the new contract, on or about March 31, 1972, petitioner purchased from Hamilton, 10,000 shares of Texfi stock at $18 per share. Petitioner testified that in March 1972, at the time he purchased Hamilton's shares, he evaluated the possible tax consequences of a latter sale of the stock. Based upon this evaluation, petitioner testified that he concluded, with certitude, that he would realize a capital gain upon his104 subsequent sale of the shares. The Texfi stock purchased by petitioner from Hamilton increased in value, albeit unevenly, between March 1972, when petitioner purchased it, and the last quarter of 1972, but it began to decline steadily on the market thereafter. Nevertheless, "[t]his intent to realize a profit through the eventual sale of the property is indicative of an investment motive." Miller v. Commissioner,supra at 456. Petitioner also testified that he did not intend to accept the economic risks of a decline in the value of the Texfi stock, expecting instead that Texfi would "make [him] clean" upon his termination of service for any losses resulting from such a decline.While this expectation proved incorrect, petitioner's intended participation in such a "no-risk situation" is similarly indicative of an investment intent. Hollingsworth v. Commissioner,supra at 586. Indeed, petitioner apparently recognized this, since he testified as follows: I was brought in and recruited in a very aggresive recruiting effort to help bring this company under financial control, and I did not view that I was taking what I would call a risk. 105 I guess that goes along with making an investment, but * * I did not have the equity [sic] to make that kind of an investment on my own. That the foregoing indications of investment intent were present when petitioner acquired Hamilton's shares is clearly disclosed, therefore, by petitioner's own testimony, and there is no evidence indicating any alteration of that intent during the four-year holding period preceding petitioner's March 1976 disposition of the stock. Consistent with a finding of such investment intent, the investment warrants executed by petitioner, and included both as a legend on the face of the shares certificate and in each successive contract relating to petitioner's purchase of Hamilton's shares, provided that petitioner was purchasing such shares for investment, and not with a view toward resale.While we are mindful that petitioner and Hamilton believed that inclusion of the investment warrant would facilitate acquisition of an exemption from registration under Federal securities laws, we have no reason on this record to doubt the verity of the commitments reflected in such warrant. Neither can the absence of a substantial investment intent be inferred106 from the price petitioner paid Hamilton for his 10,000 shares of common stock in Texfi. This Court has held that payment for stock at a price inexcess of market value may indicate that the stock was not acquired for investment purposes since "[s]uch premium makes it more unlikely that an eventual profit will be made upon resale and indicates a special need for the stock not shared with other investors." Miller v. Commissioner,supra at 456. See also Dearborn Company v. United States,444 F.2d 1145">444 F.2d 1145, 1167 (Ct. Cl. 1971). There is no indication on this record that petitioner paid Hamilton a premium price for his 10,000 Texfi shares. Citing solely a Memorandum Opinion of this Court in Hirsch v. Commissioner,T.C. Memo 1971-235">T.C. Memo. 1971-235, petitioners suggest, first, that the Texfi policy that high-level management should have an ownership stake in the company placed petitioner under pressure to purchase Hamilton's Texfi stock in March 1972, after he had become a director of the company, establishing a business purpose for the stock purchase. In this regard, petitioners suggest only that such Texfi policy placed "pressure" upon107 petitioner, and not that he was compelled thereby to purchase the stock. Assuming that this professed motivation, however, was a factor in petitioner's purchase of Hamilton's stock in March 1972, it does not negate the demonstrated coexistence of substantial investment interests, reflected in petitioner's expectation that the stock purchase would be a profitable and low-risk undertaking, and confirmed by his own warrant of investment intent. Further, petitioners' reliance upon Hirsch is misplaced. First, the Hirsch holding is based upon the primary or predominant motivation test. This test was rejected by this Court in Windle in favor of the substantial investment motivation test. Second, the taxpayer in Hirsch was required, as an explicit precondition of employment, to purchase stock and make loans to his corporate employer so as to assist the company in its expansion plans. Such equity and loan payments were required for the company's expansion, an expansion which was to provide the need for the taxpayer's services. The taxpayer in Hirsch acceded to this procondition because of his own increasingly distressed financial condition. Comparable evidence of108 business and/or taxpayer necessity is absent herein. Third, unlike the taxpayer in Hirsch, whose payments were required by his employer for expansion, petitioner's payment directly enriched the seller, Hamilton, rather than his employer, Texfi. Petitioners next maintain that at the time petitioner purchased Hamilton's shares, the market performance of unrestricted Texfi stock rendered Hamilton's stock a manifestly unwise investment. The fact that the market value of Texfi's unrestricted stock dropped between the date petitioner commenced his employment and his March 1972 stock purchase, however, is not determinative of the wisdom of such purchase. Petitioner purchased the stock for $18 per share. During March 1972, the value of unrestricted shares of Texfi stock on the New York Stock Exchange ranged from a low of over $22 per share to a high of over $26 per share. Significantly, petitioner testified that at the time of his stock purchase, he anticipated that the market value of unrestricted Texfi stock would thereafter increase. By November 1972, the market value of unrestricted Texfi stock had indeed increased, albeit unevenly, to a high of over $33 per share. On these109 facts, we cannot infer that petitioner, or any prudent investor, would have regarded the purchase of Texfi stock as a manifestly unwise investment in March 1972. According to petitioners' third argument, various "complexities, restrictions, and risk[s]," associated with his March 1972 purchase of Hamilton's 10,000 shares in Texfi made the transaction a "highly unusual and speculative 'investment'," suggesting instead a business motivation therefor. In support of this proposition, petitioners allude to several characteristics of the stock purchase transaction which allegedly restricted petitioner's alienation of the 10,000 shares, as follows: (1) Federal securities laws restrictions; (2) Texfi's policy for top management to have a stake in the company; (3) petitioner's contractual commitment to apply the entire proceeds from a sale of the shares to a reduction of any remaining indebtedness to NCNB; and (4) Hamilton's purported control, as guarantor of petitioner's NCNB loan, over when the loan could be called and the collateral sold. We are not convinced that any of the foregoing "complexitites, restrictions, and risk[s]" would have caused petitioner to conclude that Hamilton's110 10,000 Texfi shares constituted an unwise or highly unusual investment in March 1972.We have already found that petitioner's response to applicable Federal security laws was to enter into an explicit declaration of his investment intent in purchasing Hamilton's stock. We have also found that nothing in Texfi's policy that top management have a stake in the company was inconsistent with an investment intent. Nor, is light of petitioner's admission that he expected to sell the stock acquired from Hamilton at a profit, are we persuaded that the requirement to apply the proceeds of such a sale to a reduction of his indebtedness to NCNB, constituted any significant investment disincentive in March 1972. Such a requirement is normal banking practice in the circumstances, where a borrower seeks to sell collateral securing a loan. Petitioners have similarly failed to demonstrate why the terms of Hamilton's guaranty of the NCNB loan negated the existence of a substantial investment motive. It is clear that the fact that an acquisition of property is fully leveraged, as in this case, does not alone negate the existence of a substantial investment motivation. Hollingsworth v. Commissioner,supra at 586.111 Further, this record does not support petitioners' contentions that Hamilton controlled the timing of either NCNB's authority to call the loan or the sale of the Texfi stock.Petitioner committed only not to pledge or otherwise encumber such stock without his guarantor's prior consent, and to apply the entire proceeds from any sale of the stock to pay in full any remaining indebtedness guaranteed by Hamilton. We find nothing in these terms to suggest the business motivation contended for. It is argued, finally, that petitioners' insufficient net worth to undertake the purchase of Hamilton's shares, without assistance, and lack of experience in making stock investments, suggested that petitioner did not believe that he was making an investment in March 1972. Prior to 1971, according to petitioner's testimony, he had made no stock investments of any consequence. We recognize that such an absence of investment experience can be probative of a taxpayer's business intent. Cf. Miller v. Commissioner,supra at 458. Petitioner also testified, however, that he had historically refrained from stock investments, since in his position as a partner at Price, Waterhouse112 & Company, "it was not a practical way to build an equity." The stock purchase at issue here occurred in March 1972, at which time petitioner was employed in an executive capacity at Texfi. There is no evidence that the considerations of professional practicality that apparenty inhibited petitioner's investment in the stock market prior to the date he commenced employment with Texfi, continued to influence him after that date. Nor do we believe that petitioner's insufficient net worth was inconsistent with his intent to invest in Hamilton's Texfi stock. Petitioner, who served as vice president, director and chief financial officer of Texfi, concluded in March 1972 that the stock of his employer would rise in value. Notwithstanding any constraints resulting from his own net worth, Hamilton's assistance in obtaining the NCNB loan enabled petitioner to avail himself of an apparently attractive investment opportunity. Pursuant to the prevailing Windle test, described supra, the existence of a substantial investment motive in a predominantly business-motivated acquisition and holding of corporate stock, will render such stock a capital asset under section 1221. On this113 record, we do not doubt that petitioner was motivated to purchase and hold the shares of stock at issue, in part, for reasons relating to his business relationship with Texfi. We conclude, however, that the record demonstrates the coexistence of a substantial, and indeed predominant, investment intent, thus rendering the subject stock a capital asset under section 1221, and vitiating ordinary loss treatment under section 165. 6114 Issue 2. Deductibility Under Section 83In accordance with sections 64 and 65, respectively, gain or loss will not be treated as deriving from the sale or exchange of a capital asset where it is considered as ordinary gain or loss pursuant to other provisions of Subtitle A of the Code, such as section 83. The next issue presented herein relates to petitioners' claim that the loss sustained on petitioner's sale on March 26, 1976, of the 10,000 shares of Texfi common stock purchased from Hamilton in March 1972, is deductible as an ordinary loss pursuant to section 83(a) and section 1.83-1(b)(2), Income Tax Regs.Section 83(a) provides, in pertinent part, that where property is transferred to a person "in connection with the performance of services," the excess of the fair market value of such property, determined without regard to any restrictions other than a restriction which by its terms will never lapse, over the amount paid for the property, shall be included in the gross income of the person who performed such services, measured at such time as the rights of the person holding the beneficial interest in the property are either transferable or not subject to a substantial115 risk of forfeiture. Although property transferred subject to forfeiture and transferability restrictions is generally taxed to the performer of services when these restrictions lapse, section 83(b) provides for an election to accelerate the taxable event to the time of transfer. It has been stipulated herein, and we have found, that petitioners did not make the section 83(b) election with respect to the Texfi stock at issue. It has also been stipulated by the parties, and we have found, that petitioner did not report on his Federal income tax returns for the years 1972 through 1976, any income with respect to such Texfi stock, except for dividends received relating thereto. The first matter to be resolved herein is the threshold issue whether Hamilton's sale of stock to petitioner constituted a transfer of property "in connection with the performance of services" within the meaning of section 83. In this inquiry, we are guided by the recent decision of this Court in Alves v. Commissioner,79 T.C. 864">79 T.C. 864 (1982), on appeal (9th Cir. June 24, 1983). In Alves, we found "clear indication" that the stock at issue therein was transferred in connection with the116 performance of services under section 83 in the facts that the stock was transferred to provide the transferee employee with an additional interest in the company, and that the stock purchase agreement called for repurchase of the stock by the company in the event the employee left the company within a specified period of time.The latter provision was designed "to provide some assurance that key personnel would remain with the company a number of years." Alves v. Commissioner,supra at 873. Indications of a transfer qualifying under section 83, comparable to those identified in Alves, are found in this case in Hamilton's interest in seeing petitioner acquire a proprietary stake in Texfi, and in the shares profits agreement, entered into by Hamilton and petitioner in March 1972. While we have found herein that petitioner purchased Hamilton's Texfi stock, with restrictions, at a price below the fair market value of unrestricted shares of Texfi on the same date, this record does not disclose whether petitioner's purchase price for such stock was below the fair market value of similarly restricted shares on that date. In any event, restricted stock will not117 fail to be considered as transferred in connection with the performance of services, and section 83(a) will not be held inapplicable, solely because such stock was transferred in an exchange for an amount equal to its fair market value, as restricted, rather than in a bargain sale. Alves v. Commissioner,supra at 877-878. We note, finally, that neither the fact that the Texfi stock was transferred to petitioner with respect to his future services, Alves v. Commissioner,supra at 875, section 1.83-3(f), Income Tax Regs., nor the fact that the Texfi stock was transferred to petitioner, not by Texfi, but by its President and shareholder, Hamilton, will affect the applicability of section 83. 7118 On the basis of this record, and in light of the principles established by this Court in Alves, we conclude that the 10,000 shares of stock of Texfi at issue were transferred to petitioner in connection with his performance of services for Texfi under section 83. While both petitioners and respondent are in accord with this threshold determination under section 83, it is at this point that their analytical paths diverge. Petitioners offer two alternative theories in support of their contention for ordinary loss treatment under section 83 and the regulations thereunder. First, according to petitioners, pursuant to section 1.83-1(b)(2), Income Tax Regs., the 10,000 shares of Texfi stock at issue were forfeited by petitioner while still substantially nonvested in his hands, giving rise to an ordinary loss in the amount of the difference between the purchase price of the stock and the amount received by petitioner upon such forfeiture. Second, petitioners apparently maintain that even if such stock became substantially vested in petitioner's hands on October 1, 1974, when the restrictions stated in the shares profits agreement in petitioner's March 29, 1972 contract with Hamilton119 expired, petitioners were entitled to an ordinary loss deduction in 1974 in the amount of the difference between petitiner's purchase price for the stock and the fair market value of the stock on October 1, 1974, and the character of that loss remained unchanged between October 1, 1974 and petitioner's sale of the stock in March 1976. With respect to petitioners' first argument, respondent answers that, for two reasons, section 1.83-1(b)(2), Income Tax Regs., is inapplicable to the transaction at issue here. First, according to respondent, petitioner disposed of the Texfi stock in a non-qualifying sale transaction, rather than a "forfeiture" which would qualify under section 1.83-1(b)(2), Income Tax Regs. Second, although respondent agrees that the Texfi stock was acquired by petitioner in a transaction which was "in connection with the performance of services" by petitioner, respondent states that the stock was substantially vested when petitioner disposed of it in March 1976. In answer to petitioners' alternative argument, respondent maintains that neither section 83 nor any other provision of the Internal Revenue Code, would permit petitioners to defer until 1976 the recognition120 of a loss on the sale of stock which petitioners allegedly incurred in 1974. Section 1.83-1(b)(2), Income Tax Regs., relied upon by petitioners, provides as follows: If substantially nonvested property that has been transferred in connection with the performance of services to the person performing such services is forfeited while still substantially nonvested and held by such person, the difference between the amount paid (if any) and the amount received upon forfeiture (if any) shall be treated as an ordinary gain or loss. This paragraph (b)(2) does not apply to property to which § 1.83-2(a) applies. This regulation will therefore apply only in the event of a forfeiture of substantiallynonvested property in the hands of the service-performing transferee of such property. Petitioners, however, have failed to demonstrate that the 10,000 shares of Texfi stock purchased from Hamilton were at any time "forfeited" while in petitioner's hands. Rather, the parties herein have stipulated that "[o]n March 26, 1976, petitioner sold the 10,000 shares of common stock of Texfi * * for $74,092.08," [Emphasis added.] Petitioner further indicated that the121 "sale" of the stock in 1976 was an "attempt to cut [his] losses." It is clear on this record that petitioner's sale of Texfi stock in March 1976 was a wholly volitional and self-directed transaction, which was effectuated, for fair market value, in an arm's-length transaction on the New York Stock Exchange. The treatment of substantially nonvested property that has been dold in an arm's-length transaction is governed, not by section 1.83-1(b)(2), Income Tax Regs., but by section 1.83-1(b)(1), which provides, in pertinent part, as follows: If substantially nonvested property (that has been transferred in connection with the performance of services) is subsequently sold or otherwise disposed of to a third party in an arm's-length transaction while still substantially nonvested, the person who performed such services shall realize compensation in an amount equal to the excess of -- (i) The amount realized on such sale or other disposition, over (ii) The amount (if any) paid for such property. * * In addition, section 83(a) * * * shall thereafter cease to apply with respect to such property. Even assuming (without holding) that Hamilton's Texfi stock was substantially122 nonvested property in March 1976, petitioner's arm's-length sale of the stock at that time would have been governed by section 1.83-1(b)(1), which does not address sales at a loss, and which would be ineffective to authorize the ordinary loss contended for. Petitioners' alternative contention under section 83 apparently stems from respondent's suggestion that even if the shares profits agreement in petitioner's March 29, 1972 contract for purchase of the subject shares constituted a substantial risk of forfeiture, such risk lapsed, pursuant to the contract, three years following petitioner's commencement of employment at Texfi, or in October 1974. If section 83 would have authorized an ordinary loss in 1974 when this assumed risk of forfeiture lapsed, according to petitioners, nothing intervened to transform the character of that loss into a capital loss upon petitioner's disposition of the stock in March 1976. In the absence of a forfeiture, however, petitioners have failed to identify any provision of section 83 which would have authorized them to recognize an ordinary loss in 1974 with respect to the Texfi stock. 8 To the contrary, assuming that the shares profits agreement123 engendered a substantial risk of forfeiture, section 83(a) would have operated only to tax, as compensatory ordinary income upon the lapse of the restriction in 1974, at the time such substantial risk ceased, "the excess of - the fair market value of such property" in 1974 over "the amount (if any) paid for such property." Given the absence of such an excess, resulting from the depressed value of Texfi stock in 1974, petitioners recognized no ordinary income in that year. No event occurred in 1974 which gave rise to any recognizable loss; the fact that the stock may have been worth less when the contract restrictions expired than its value when petitioner bought it was not such an event, and petition continued to own the stock for two years thereafter. When petitioner's arm's-length sale of the property occurred in 1976 the character and timing of his gain or loss was controlled by other provisions of the Code, the effects of which are fully examined in our consideration of petitioners' contentions for deductibility under section 165, supra.*124 On this record, we hold that the common stock in Texfi was acquired and held by petitioner as a capital asset, and petitioners are not entitled to an ordinary loss deduction on the sale of such stock under either section 165 or section 83. To reflect the foregoing, as well as those issues which have been conceded, Decision will be entered for the respondent.Footnotes1. All statutory references herein are to sections of the Internal Revenue Code of 1954, as amended and in effect for the years in issue, and all references to the Rules are to the Tax Court Rules of Practice and Procedure, unless otherwise stated.↩2. While petitioner's brief and personal notes, entered into evidence, suggest that the shares were purchased at "market value," Hamilton testified, the Standard & Poor's Corp.'s "ISL Daily Stock Price Index", entered into evidence herein, confirms, and we find, that petitioner's purchase price was below the value of unrestricted shares of Texfi on the New York Stock Exchange on March 29, 1972, and March 30, 1972. According to such Index, March 31, 1972, was a holiday on the New York Stock Exchange. In the month of March 1972, the price range for Texfi shares on the New York Stock Exchange was between $22+ and $26+.↩3. The December 11, 1976 option exercise date applied not only to the option to purchase 12,500 shares dated April 22, 1975, described herein, but also to two subsequent options, both dated October 27, 1975, to purchase 1,210 shares and 1,482 shares under Texfi's ESOP, at a price of $6.125 per share.↩4. While a letter in this record to petitioner from his stockbroker suggests that the 10,000 Texfi shares at issue were sold on March 19, 1976, both the stipulation of facts by the parties and the stockbroker's statement, also in this record, are in accord, and we find, that the shares were sold on March 26, 1976.↩5. Sec. 117(a) of the 1939 Code was the predecessor of sec. 1221.↩6. In lieu of the Windle test, petitioners contend for, and respondent concedes, application herein of the test reflected in Rev. Rul. 75-13, 1 C.B. 67">1975-1 C.B. 67, whereby the sale or exchange of shares of stock will give rise to ordinary gain or loss if business is the predominant motive for purchasing and holding the stock. While, on the strength of Windle and a Memorandum Opinion of this Court, Bell Fibre Products Corp. v. Commissioner,T.C. Memo. 1977-42, Rev. Rul. 75-13 was prospectively revoked in 1978, Rev. Rul. 78-94, 1 C.B. 58">1978-1 C.B. 58, such revocation was not to be applied adversely to taxpayers who acquired stock before March 13, 1978, and disposed of it before September 13, 1978, into which timeframe petitioners' transactions herein uncontrovertibly would fit. While we are, of course, bound to apply the carefully-considered test established by this Court in Windle,↩ we note that investment indications in this record are sufficiently pervasive that the subject stock would be a capital asset even under the alternative test contended for by petitioners.7. Tilford v. Commissioner,75 T.C. 134">75 T.C. 134 (1980), revd. 705 F.2d 828">705 F.2d 828 (6th Cir. 1983), involved sales of stock by taxpayer, a principal officer and either sole or majority shareholder of Watco, Inc., to employees of the corporation in order to induce them to work for the corporation. In a court-reviewed opinion this Court held invalid sec. 1.83-6(d), Income Tax Regs., which treats such transactions as capital contributions to the corporation. In the majority opinion it was noted that: The fact that these sales were in connection with the rendering of services by the purchasers, while it may bring into play certain tax consequences to the employees and Watco under section 83, does not render the transaction any less a sale under section 1002, as far as petitioner is concerned. [75 T.C. at 145]. The Court of Appeals reversed, concluding that the regulation is consistent with both the legislative history and statutory intent of sec. 83(h). The instant case involves the tax consequences to the petition-employee and thus does not involve the issue raised in Tilford. Accordingly, we do not decide whether we agree with the Court of Appeals reversal of our Tilford↩ opinion.8. In addition to sec. 1.83-1(b)(2), sec. 1.83-1(e)↩ provides for recognition of an ordinary loss upon certain forfeitures of substantially vested property.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621397/	MICHAEL S. WASNICK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWasnick v. CommissionerDocket No. 36098-83.United States Tax CourtT.C. Memo 1985-589; 1985 Tax Ct. Memo LEXIS 42; 51 T.C.M. (CCH) 34; T.C.M. (RIA) 85589; December 4, 1985. Michael Waris, Jr. and Bertrand M. Harding, Jr., for the petitioner. Robert F. Geraghty, for the respondent. 43 FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: Respondent determined the following deficiencies in petitioner's Federal income taxes: YearDeficiency1979$20,2201980$17,6241981$60,983In an amended answer, respondent alleged, alternatively, that petitioner is liable for the following income tax deficiencies for the same years: YearDeficiency1979$20,2201980$ 2331981$79,279The parties have stipulated to the disposition of certain issues, 1 and the only issue remaining for decision is whether petitioner's net withdrawals of funds from his wholly owned corporation, Chief Construction Company, Inc., during 1979, 1980, and 1981 were tax-free loans or distributions taxable to him under sections 3012 and 316. There is a subsidiary issue as to whether a $100,000 loan in 1980 was made to petitioner or to the corporation and, if to petitioner, whether he had taxable income when the corporation repaid the loan in 1981. 44 FINDINGS OF FACT GeneralWhen he filed the petition in this case, petitioner's legal residence was Seattle, Washington. Petitioner timely filed Federal income tax returns for 1979, 1980, and 1981. In 1956 to 1959, petitioner worked as a commercial fisherman in Alaska during the spring and summer months and sold automobiles during the winter. From 1960 through 1964, petitioner engaged in the construction and sale of houses through a corporation named Regal Construction (Regal). During at least a part of this latter period, petitioner's father participated in the business with him. In 1964, all of Regal's houses were sold and its business was liquidated. Chief Construction CompanyAfter liquidating Regal, petitioner worked first as a construction laborer and later as a supervisor of construction, receiving as compensation for his services a share of the profits from the construction and sale of homes. In September 1966, petitioner went back into the home building business with his father and operated through a corporation named Chief Construction Company (Chief). The business was incorporated on the recommendation of Gerald H. Shaw (Shaw), a certified public45 accountant who later supervised Chief's bookkeeping and other accounting records. Chief adopted a fiscal year ending March 31. From the date of Chief's incorporation on September 29, 1966, to December 19, 1977, when petitioner's father died, petitioner and his then wife owned 50 percent and his father and mother owned 50 percent of Chief's stock. After his father's death, petitioner and his then wife, under a redemption agreement, became owners of all of the stock and held it until October 23, 1979. At that time, Chief redeemed the community one-half interest of petitioner's then wife in connection with the dissolution of their marriage. Petitioner held 100 percent of the stock from October 23, 1979, until January 2, 1980, when Lenes Rasmussen (Rasmussen), an employee of Chief, acquired 25 percent of Chief's stock. Chief reacquired Rasmussen's stock on March 31, 1982, leaving petitioner, again, as its sole shareholder. Petitioner served as Chief's president from its incorporation at least until March 31, 1984. As president of Chief, petitioner's initial duties included locating land, working with lenders to obtain financing for lot purchases and construction, obtaining bids46 from contractors, and supervising construction. Petitioner was required to have a working knowledge of Chief's financial statements. Petitioner's father served as secretary-treasurer of Chief from its incorporation until his death in 1977. His duties included mainly general oversight and business advice. Chief had several key employees and advisors. To assist in supervising construction, Chief employed Rasmussen in 1969 and he continued to work for the company until 1982. Beverly Southern (Southern) was employed as Chief's bookkeeper, secretary, and general assistant from August 1974 until June 1, 1984, when she retired. Southern kept the corporate books, posted the ledgers, and performed other day-to-day office work. From 1966 to mid-1981, Shaw provided general accounting advice, prepared Chief's periodic financial statements, served as Chief's outside financial and tax advisor, and prepared Chief's as well as petitioner's income tax returns. Because of his long-term relationship with the Wasnick family, Shaw felt that he had a moral obligation and responsibility to ensure that Chief's financial position and accounting records were preperly maintained. In the summer of47 1980, petitioner and Shaw "agreed to disagree" over the handling of Chief's business. During the period from late 1980 forward, Shaw had few, if any, direct communications with petitioner with respect to corporate affairs. John Koenes (Koenes), a certified public accountant, became Chief's accountant in late 1981. He prepared Chief's financial statements for the periods ended March 31, 1982 and March 31, 1983, and its tax returns for those periods and for the period ended March 31, 1984. Koenes prepared petitioner's income tax returns for 1981, 1982, and 1983. Koenes also assisted petitioner in connection with the Internal Revenue Service audit of Chief's and petitioner's income tax returns involved in this proceeding. For its fiscal years ended March 31, 1973 through March 31, 1975, Chief reported losses totaling $151,111, which it carried forward into later years. Chief's taxable income and losses, before reduction for the net operating loss carryovers from prior years were as follows: Fiscal Year March 31Taxable Income (Losses)1977$ 28,646 1978$ 10,469 1979$ 126,924 1980$ 75,113 1981$ 6,959 1982$ 95,667 1983$ (48,347)1984$ (65,495)48 Chief has never declared or paid dividends to its shareholders. General Ledger Account No. 211In keeping with the usual practice of closely held businesses, Shaw set up an account, designated as General Ledger Account No. 211 (GL Account 211), to record the payment by Chief of some of petitioner's personal bills and obligations as well as his cash withdrawals. Amounts that were paid by Chief and charged to GL Account 211 were not deducted on its tax returns as business expenses. In performing her bookkeeping duties, Southern determined which payments pertained to Chief's business and which payments were personal to petitioner. In some instances, petitioner would write a check on Chief's account and initial the stub so that Southern would know the money was for his personal use. In such cases, Southern recorded the withdrawl in GL Account 211 by writing the word "drew" in the margin. She charged what she thought were personal expenses to petitioner's GL Account 211. If she was in doubt as to the nature of the expenditure, she consulted petitioner or Shaw. A similar account, designated as General Ledger Account No. 210, was maintained for petitioner's father up49 to his death. At the close of each of Chief's fiscal years ended prior to March 31, 1977, GL Account 211 for petitioner showed debit or credit balances of relatively small amounts. As of March 31, 1977, GL Account 211 showed a balance due of $30,307. Beginning with the fiscal year ended Marchd 31, 1978, GL Account 211 showed the following debit (i.e., net withdrawal) balances on March 31, the end of Chief's fiscal year, and December 31, the end of petitioner's accounting period, through December 31, 1983: YearMarch 31December 311978($ 33,409.25)($ 86,423.09)1979($ 75,810.79)($114,909.79)1980($ 32,142.37)($ 82,791.29)1981($147,114.86)($208,265.39)1982($497,283.07)($550,151.74)1983($514,906.01)($746,448.23)As of March 31, 1984, the debit balance of GL Account 211 was $779,799. The debit balance of GL Account 211 on December 31, 1981, did not reflect Chief's repayment on July 1, 1981, of a $100,000 loan from Laurel Johnson (Johnson) or petitioner's withdrawal on September 18, 1981, of $154,522 from Chief's account at Washington Mutual Savings Bank. Both of those amounts were debited to GL Account 211 as of March 31, 1982, and50 are more fully described below. The debit balances for GL Account 211, set forth above, remained after giving petitioner the benefit of the following payments or credits: YearMonth of PaymentAmount1979January$ 435.00March155.75March95.00March16,634.84(bonus)May5,000.00August10.57November5,000.00December6,000.00(bonus)1980January80,000.00March20.00March214.00March12,000.00(bonus)April20,000.00June12,000.00(bonus)1981March893.70March100.00March1,393.70August32.00September229.51September1,096.00October7,500.00December19,500.00(bonus)Total Credited Payments$188,310.07The $80,000 credit in January 1980 and the $20,000 credit in April 1980 were derived from the loan from Johnson which, as indicated above, is discussed later in these findings. Also, a number of the credited items represent refunds of amounts previously debited, offsetting entries, and other adjustments. The entries in GL Account 211 show that withdrawals were made to cover a variety of petitioner's expenditures. A substantial portion of the51 withdrawals was in the form of cash ($27,844 in 1979; $15,920 in 1980; $186,042.89 in 1981, including the Washington Mutual Savings Bank withdrawal ($154,522) discussed below). The sum of $23,579.21 was used in October 1980 to remodel a residence at 20013 3rd West. Some $54,302.67 ($44,302.67 and $10,000) in March 1981 and $30,823.49 in October 1981 were withdrawn to cover the cost of remodeling petitioner's residence at 1017 S. W. Normandy Terrace. Still other amounts were used to cover doctor bills, some of the expenses of petitioner's divorce, golf club dues, taxes, and other personal items. Trading in CommoditiesDuring the period from October 1979, through March 1981, Chief maintained accounts with various investment companies through which it made investments in commodities. Initially, Chief invested in interest sensitive commodities, such as T-Bills and T-Bonds. Later, however, Chief expanded its trading into other commodities. Chief reported losses from trading in commodities in the amounts of $309,029 in its fiscal year 1980 and $216,017 in its fiscal year 1981. In the summer of 1980, Shaw had disagreements with petitioner over his management of Chief's business, 52 particularly the use of its funds for commodity trading, and those disagreements led to Shaw's termination of his relationship with Chief. Rasmussen also objected to the use of Chief's funds for commodities trading. In addition, financial institutions threatened withdrawal of credit which was essential to the home construction business. As a result of these objections, petitioner caused Chief to cease trading in commodities in March 1981. Beginning in Approximately August 1981, petitioner began investing in commodities through a trading account maintained in his own name with certain investment companies.Although petitioner had no money of his own and his GL Account 211 had a debit balance of approximately $180,000, he proceeded to make numerous withdrawals of Chief's funds for commodity trading. Petitioner's income tax returns for 1981 and 1982 show losses from such trading totaling $158,323 and $215,870, respectively. On September 18, 1981, petitioner withdrew $154,522.89 from Chief's savings account at Washington Mutual Savings Bank and, to cover losses, deposited the funds in a commodity trading account maintained in his name at an investment company. At that time, petitioner53 did not report the withdrawal to anyone in Chief's management with the result that Chief's financial statements for periods ended September 30, 1981, and December 31, 1981, incorrectly listed the withdrawn amount as an asset in the form of a deposit with Washington Mutual Savings Bank. Southern discovered that the money had been withdrawn from Chief's savings account, called the withdrawal to petitioner's attention, and ultimately on her own initiative charged it to GL Account 211 as of March 31, 1982. Laurel Johnson LoanAt the close of Chief's fiscal years ended March 31, 1977 and March 31, 1978, Shaw recommended that petitioner execute promissory notes covering the increase in petitioner's GL Account 211, and petitioner did so. At the close of the fiscal year ended March 31, 1979, Shaw again recommended that petitioner execute a promissory note to cover the substantial increase in GL Account 211 during the preceding year but petitioner declined to do so, stating that he would endeavor to pay the account by outside borrowing. On December 17, 1979, petitioner, signing for Chief, executed a second mortgage to Johnson stating that it was given to secure payment of a promissory54 note of that date in the amount of $250,000. The mortgage covered Chief's interest in real property known as the Lake Easter Addition. Chief did not execute a note to Johnson dated December 17, 1979. On January 28, 1980, petitioner arranged a loan from Johnson in the amount of $100,000. Johnson, a retired businessman and friend of petitioner, had earlier loaned Chief $100,000 on August 20, 1979, and $50,000 on December 15, 1979, and those loans remained unpaid as of January 28, 1980. The promissory note evidencing the January 28, 1980, loan was signed first by "Chief Const. Co., Inc., Mike S. Wasnick (Pres.)" and second by "Mike S. Wasnick Personally." The note called for interest of 15 percent payable quarterly. To secure the repayment of the note, petitioner named Johnson as beneficiary of a $100,000 insurance policy that he took out on his own life. The loan proceeds were paid in the form of a $100,000 check payable to petitioner. Chief did not carry the note on its books as its obligation. All of the interest payments on the note were made by funds belonging to Chief and were debited to GL Account 211. On July 8, 1981, Chief sold its interest in Lake Easter Addition55 and from the proceeds repaid Johnson $250,000: $150,000 with respect to the notes dated August 20, 1979 and December 15, 1979, respectively, and $100,000 with respect to the note dated January 28, 1980. At Shaw's instruction, Southern charged the $100,000 repayment of the January 28, 1980, loan to a suspense account until she made the closing entries for the fiscal year ended March 31, 1982. She posted the $100,000 loan repayment to GL Account 211 at that time. Internal Revenue Service AuditIn March 1982, the Internal Revenue Service began an audit of Chief's income tax returns for the fiscal years ended March 31, 1980 and March 31, 1981, and petitioner's income tax returns for 1979, 1980, and 1981. During the course of the examination of petitioner's returns, the revenue agent asked Koenes if there were any notes to support petitioner's claim that his net withdrawals represented loans. Koenes in turn asked petitioner if there were such notes and he replied that there were none. Koenes told petitioner that he would like to have such notes and related corporate minutes. Thereafter, sometime between September 1, 1982 and December 31, 1982, petitioner had his attorney prepare56 interest-free demand notes and corporate minutes purporting to evidence the authorization and the making of loans as follows: DateAmountMay 13, 1979$51,502June 8, 1980$28,489June 9, 1981$32,205In response to an inquiry from the revenue agent, petitioner's attorney acknowledged in a letter dated September 21, 1983, that the three promissory notes had been prepared after the loans were made and after the Internal Revenue Service investigation was initiated. Following the audit, a notice of deficiency was mailed to petitioner determining that, based on the withdrawals of funds through GL Account 211, petitioner received dividends from Chief for 1979, 1980, and 1981 as follows: YearAmount1979$39,5701980$23,0731981$70,642In addition, in the notice of deficiency, respondent determined that the withdrawals exceeded corporate earnings and profits and that petitioner received income in the form of capital gains in the amounts of $9,769 for 1980 and $31,413 for 1981. In making these determinations, respondent treated the $100,000 loan of January 28, 1980, from Johnson as having been made to Chief in the amount of $80,00057 and to petitioner in the amount of $20,000. The $80,000 credit to GL Account 211 was disregarded so that, according to respondent's determination, petitioner's withdrawals from Chief increased between 1979 and 1980 by $47,881.50 instead of decreasing by $32,118.50 as shown in GL Account 211. Under this theory, the remaining $20,000 of the Johnson loan was treated as a withdrawal by petitioner in 1981, when Chief repaid the loan. In his amended answer, respondent alleged, as an alternative to the position taken in the notice of deficiency, that all of the $100,000 Johnson loan of January 28, 1980, was made to petitioner personally. Under this alternative theory, the $80,000 January 1980 credit to GL Account 211 would be recognized and the entire $100,000 would be treated as a withdrawal by petitioner in 1981 when Chief repaid the loan. Petitioner has not contested the correctness of respondent's computations of the amounts determined in the notice of deficiency or the amounts alleged in the amendment to answer. OPINION The issue to be decided is whether petitioner's withdrawals from Chief during 1979, 1980, and 1981 were bona fide loans or distributions taxable under sections58 301 and 316. 3Under these sections, any distribution of property made by a corporation with respect to its stock is to be taken into account in computing taxable income. Such distributions are to be treated as dividends or returns of capital depending on the amount of the corporation's earnings and profits. On the other hand, bona fide loans made by a corporation to its shareholders are not taxable. 59 Whether a shareholder's withdrawals from a corporation are distributions or loans depends on whether the shareholder intends to repay and the corporation intends to enforce repayment of the withdrawals at the time they are made. Chism's Estate v. Commissioner,322 F.2d 956">322 F.2d 956, 959 (9th Cir. 1963), affg. a Memorandum Opinion of this Court; Haber v. Commissioner,52 T.C. 255">52 T.C. 255, 266 (1969), affd. per curiam 422 F.2d 198">422 F.2d 198 (5th Cir. 1970). Distinguishing spurious debts from bona fide indebtedness requires consideration of more than mere declarations of intentions and more than the absence or presence of corporate papers with the proper nomenclature. Alterman Foods, Inc. v. United States,505 F.2d 873">505 F.2d 873, 876 (5th Cir. 1974). Rather, all the facts and circumstances surrounding the withdrawals of funds must be weighed and considered. Roschuni v. Commissioner,29 T.C. 1193">29 T.C. 1193, 1202 (1958), affd. per curiam 271 F.2d 267">271 F.2d 267 (5th Cir. 1959). Among the objective factors that have been considered by the courts in60 evaluating whether withdrawals by a shareholder are corporate distributions or loans are: the extent to which the shareholder controls the corporation; the magnitude of the withdrawals; whether a ceiling existed to limit the amount of permissible withdrawals; whether or not security was given; whether there was a set maturity date; whether the corporation ever undertook to enforce repayment; the earnings and dividend history of the corporation; whether the shareholder had a plan and means for repayment of the withdrawals; and whether there was any indication that the shareholder attempted to repay the withdrawals. Alterman Foods, Inc. v. United States,505 F.2d at 877 n. 7, and cases cited therein; Piggy Bank Stations, Inc. v. Commissioner,755 F.2d 450">755 F.2d 450, 454 (5th Cir. 1985), affg. a Memorandum Opinion of this Court. This list of factors is not an exclusive one and no one factor or combination of factors is controlling. The evidence is abundantly clear that petitioner controlled Chief and its activities. There is no suggestion that his former wife attempted to exercise any control over the corporation during the first 10 months of 1979 when she61 held a community one-half interest in the stock. Although Rasmussen, who became owner of 25 percent of the stock in January 1980, argued and complained about petitioner's management of Chief's affairs, petitioner nonetheless made the decisions as to the timing, amount, and use of the funds he withdrew. Thus, in withdrawing funds from the corporation, petitioner controlled the transactions on behalf of the corporation as well as himself, and "such situation invites special scrutiny." Electric & Neon, Inc. v. Commissioner,56 T.C. 1324">56 T.C. 1324, 1339 (1971), affd. without opinion 496 F.2d 876">496 F.2d 876 (5th Cir. 1974); Roschuni v. Commissioner,29 T.C. at 1202. As Chief's president and controlling shareholder, petitioner placed no ceiling on the amount of his withdrawals, gave no security for their repayment, and set no maturity date on the alleged loans. Chief had never formally declared or paid a dividend and took no steps to enforce repayment of the alleged loans. In years subsequent to the ones here in controversy, petitioner continued to withdraw large sums through GL Account 211 but gave neither notes nor security for repayment of the withdrawals.62 Most of these factors support respondent's determination. Electric & Neon, Inc. v. Commissioner,56 T.C. at 1328-1329. Nonetheless, other factors support petitioner's contentions as to 1979 and 1980, and the issue is not to be resolved by counting and comparing the number of factors pro and con. Rather the task is to ascertain petitioner's bona fide intention with respect to the repayment of the withdrawals and Chief's intention with respect to the enforcement of repayment. Because petitioner handled the withdrawals on behalf of himself as well as the corporation, it is important to examine the precise objective facts peculiar to the transactions involved in this case. Based on such examination, we conclude that petitioner's withdrawals for 1979 and 1980 were loans. The withdrawals in 1981, however, were distributions by Chief and are to be so treated for the purposes of this case. From the beginning of Chief's existence until sometime in 1981, all withdrawals made by petitioner were meticulously recorded in GL Account 211, which was set up on the advice of Shaw, an outside accountant, and conscientiously maintained by Southern, Chief's bookkeeper, with petitioner's63 full cooperation. The withdrawals were recorded and treated as loans on both petitioner's books and financial statements. Pierce v. Commissioner,61 T.C. 424">61 T.C. 424, 431 (1974). For each year prior to 1979, petitioner executed a note reflecting the increase in the balance of GL Account 211. The account's balance fluctuated from year to year, 4 and the withdrawals during that period were regarded by all concurned as loans. During 1979, the balance of petitioner's GL Account 211 increased by $28,486.70, from $86,423.09 on December 31, 1978 to $114,909.79 on December 31, 1979. In that year, petitioner and his wife were divorced and he evidently had a number of unusual personal expenditures. The ledger entries indicate that many of the expenditures charged to the account were related to his divorce, and in 1980 and 1981 the expenditures include the renovation of two residences. Petitioner did not execute a note covering the 1979 increase in64 keeping with his past practice. 5 Instead, petitioner told Shaw that he would raise the money from outside sources to cover the withdrawals. In January 1980 petitioner borrowed $100,000 from Johnson and applied the proceeds of the loan to GL Account 211, $80,000 in January and $20,000 in April 1980. As a result of those payments, the balance of the account as of December 31, 1980, was decreased by a net amount of $32,118.50, a sum in excess of the increase for 1979. We think the application of these funds to the account as well as petitioner's sensitivity to Shaw's advice on the handling of the account is evidence that petitioner at that point regarded the account as bona fide indebtedness. Resondent's principal argument is that the $100,000 Johnson loan was, in fact, made to Chief and not to petitioner and that, therefore, the application of the proceeds of the loan on GL Account 211 cannot properly be treated as a repayment. We do not agree. The issue is close but we think a preponderance of the evidence supports our finding. 65 Johnson described the $100,000 transaction as "a loan to Mike Wasnick" and testified that he was "lending it to Mike Wasnick, my understanding at that time." The note was signed by petitioner in his individual capacity as well as on behalf of Chief whereas petitioner as an individual signed none of the several other notes covering loans from Johnson to Chief. The check covering the proceeds of the loan was payable to petitioner whereas the checks for other Johnson loans were made payable to Chief. Petitioner personally provided Johnson with security for the note by naming Johnson as the beneficiary of a $100,000 insurance policy on the life of petitioner. Interest in the net amounts of $11,250 in 1980 and $12,654 in 1981 was paid on the note and charged to GL Account 211. The note was not treated as a liability of Chief on its books. These objective facts confirm petitioner's representation to Shaw that he would borrow the money from outside sources to cover the 1979 increase in GL Account 211 and his testimony that this $100,000 was borrowed for that purpose. This brings us to 1981, and we think respondent's position that the 1981 withdrawals were corporate distributions66 must be sustained. Shaw had terminated his relationship with Chief and petitioner no longer had his guidance and counsel on Chief's financial affairs. GL Account 211 shows that its balance increased more than $125,000 in calendar year 1981, from $82,791.29 as of December 31, 1980 to $208,265.39 as of December 31, 1981. The recorded withdrawals include some $54,000 (consisting of two withdrawals of $44,302.67 and $10,000) in March 1981 and over $30,000 in October 1981, a total in excess of $84,000, for remodeling petitioner's residence. These large recorded 1981 withdrawals indicate that petitioner was using Chief's assets without regard to his ability or capacity to repay. More significant, petitioner used large amounts of Chief's assets for his personal purposes without having them recorded in GL Account 211 until Southern closed the books for Chief's Fiscal 1982. At petitioner's direction, Chief paid petitioner's $100,000 note to Johnson on July 8, 1981, when it sold its Lake Easter Addition property. See, e.g., Commissioner v. Makransky,321 F.2d 598">321 F.2d 598, 601-602 (3d Cir. 1963), affg. 36 T.C. 446">36 T.C. 446 (1961). Contrary to past practice, neither petitioner67 nor Chief's then accountant instructed Southern to charge this amount to GL Account 211. She entered the Johnson loan repayment in a suspense account where it remained until Chief's books for fiscal year 1982 were closed. In addition, petitioner withdrew $154,522 from Chief's Washington Mutual Savings Bank account on September 18, 1981, to cover his commodity trading losses. Petitioner did not tell Southern or anyone else at Chief of the savings account withdrawal. As a result, the amount in the savings account was erroneously reflected as an asset in Chief's financial statements for September 30, 1981, and December 31, 1981. After all 1981 charges were made, the balance of the account stood at $497,283.07 as of Chief's 1982 fiscal year's end. By March 31, 1984, the balance had risen to $779,799 and no steps had been taken to document the withdrawals as loans. There was no practical probability that these huge sums would ever be repaid, and we think petitioner knew that during all of 1981. Petitioner makes the point that Chief did not have enough earnings and profits to cover the withdrawals and that, therefore, he was not using GL Account 211 to disguise dividends, citing68 Pierce v. Commissioner,61 T.C. 424">61 T.C. 424, 431 (1974). True, the withdrawals, according to the notice of deficiency, exceeded Chief's accumulated and current earnings and profits even though Chief had never paid a dividend. In given situations it is also true that attempts are made to disguise dividends as loans. But we do not think the point carries much weight here. Whether petitioner was attempting to disguise dividend distributions is not the test. Under section 301(a) and (c), any distribution of property by a corporation with respect to its stock is a dividend, an amount to be applied against basis, or an amount to be treated as gain from the sale or exchange of property. Absent any convincing evidence of a bona fide intention to repay the large balance as of December 31, 1981, we can only conclude that the 1981 withdrawals were distributions with respect to petitioner's stock. 669 The parties debate whether petitioner had sufficient personal assets with which to repay the withdrawals and whether he had adopted a plan of repaying them. The record does not contain a financial statement showing petitioner's assets and liabilities on any date during the relevant period. His income tax return for 1981 shows a salary of $57,800 from Chief and interest and dividend income totaling less than $1,000. The 1981 return also shows a loss of $158,323 from commodity trading. His 1982 return shows his commodity trading losses to have been $215,870. Absent some dramatic change, there was no prospect that the GL Account 211 balance would be paid from petitioner's income; if it was to be paid, repayment would have to come from some other source. Petitioner argues that he made substantial repayments of the GL Account 211 balances during the years in issue, that he adopted a repayment plan, and that he and Chief had assets which could be used to cover the withdrawals. Petitioner argues that, during this 3-year period, he paid over $54,000 to Chief in salary bonuses that were awarded to him. He argues that these substantial repayments constitute an actual manifestation of70 the requisite intent to repay the withdrawals citing among other cases White v. Commissioner,17 T.C. 1562">17 T.C. 1562, 1569 (1952). 7 We do not find this argument convincing. It is true that GL Account 211 was credited with the following bonuses from Chief: AmountDate$16,6343/31/79$ 6,00012/31/79$12,0003/31/80$12,0006/30/80$19,50012/31/81Some courts have recognized that the application of bonuses and salaries to a taxpayer's withdrawal account71 may constitute repayments of his withdrawals because the bonuses or salaries are taxable income. See, e.g., Shaken v. Commissioner,21 T.C. 785">21 T.C. 785, 793 (1954); Johnson v. Commissioner,T.C. Memo 1979-7">T.C. Memo. 1979-7, affd. 652 F.2d 615">652 F.2d 615 (6th Cir. 1981). In the instant case, however, a $12,000 bonus credited in March 1980 was followed by a $12,000 charge in April 1980 and was described by Southern as an offsetting journal entry. Similarly $19,500 was credited on December 31, 1981, but the credit was followed by a cash withdrawal of $30,000 in January 1982. In terms of repaying the withdrawals, these bonus "payments" thus accomplished nothing. As to petitioner's alleged repayment plan, it is true that Shaw and Koenes testified that they recommended that petitioner arrange for Chief to increase his salary and bonus and apply such increases on GL Account 211. However, there was no practical way that the 1981 withdrawals could be repaid in this manner. Petitioner's salary and bonus for 1981, according to his tax return, was $57,800. Obviously, compensation at that rate would not provide enough money to repay the $497,000 balance of GL Account 21172 as of March 31, 1982. In the meantime, Chief's income dropped from $126,924 in fiscal year 1979 to $6,959 in fiscal year 1981, and Chief incurred losses in a total amount of over $113,000 in fiscal years 1983 and 1984. With such operating results, there were obvious limitations on the amounts of salaries and bonuses that would constitute reasonable compensation under section 162(a). We do not think increasing petitioner's salary and bonus was a practical or meaningful plan for repaying the huge balance of his account. There is a great deal of testimony in the record relating to petitioner's 50-percent individual interest as a partner in four large housing projects. The argument is that, when the Government restrictions on the use of those properties expire between 1987 and 1990, the properties will be very valuable. Had petitioner liquidated his interest in those properties in 1981, according to petitioner, he would have had enough money to repay the GL Account 211 withdrawals. We do not find this evidence convincing. We are not satisfied that petitioner's equity in those properties was substantial during 1981 and there is no evidence that petitioner had committed himself in73 any way, by way of a mortgage or otherwise, to applying his share of any proceeds of those properties toward the repayment of his withdrawals from Chief. A general or contingent intent to repay the withdrawals in case he realized a windfall is not sufficient to show that the withdrawals created bona fide debts. 8We conclude that petitioner's withdrawals from Chief74 in 1979 and 1980 were loans, but his withdrawals in 1981 were not bona fide loans. They were distributions with respect to his stock within the meaning of sections 301(a) and (c) and 316. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Petitioner has agreed that he is taxable on withdrawals of $11,084 in 1979 and $613 in 1980 from Chief Construction Company, Inc., and unreported wages in the amount of $7,243 for 1979. ↩2. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted.↩3. SEC. 301. DISTRIBUTIONS OF PROPERTY. (a) In General.--Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c). * * * (c) Amount Taxable.--In the case of a distribution to which subsection (a) applies-- (1) Amount constituting dividend.--That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income. (2) Amount applied against basis.--That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock. (3) Amount in excess of basis.-- (A) In general.--Except as provided in subparagraph (B), that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property. SEC. 316. DIVIDEND DEFINED. (a) General Rule.--For purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders-- (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxably year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution is, under any provision of this subchapter, treated as a distribution of property to which section 301↩ applies, such distribution shall be treated as a distribution of property for purposes of this subsection.4. During the periods from Mar. 31, 1967 through Mar. 31, 1977, petitioner owed Chief amounts ranging from approximately $9,000 to $18,000. As of Mar. 31, 1977, GL Account 211 reflected a debit (negative) balance of $30,307.↩5. Petitioner did execute notes for each year in controversy after the Internal Revenue Service audit was begun but we give no weight to those notes.↩6. Petitioner points out that Rasmussen owned 25 percent of Chief's stock during 1981 and that the withdrawals, if treated as distributions, were not proportionate among the shareholders. But petitioner had absolute control over the withdrawal of Chief's funds and sec. 301(a) and (c) is not limited to pro rata distributions. Barbourville Brick Co. v. Commissioner,37 T.C. 7">37 T.C. 7, 13↩ (1961).7. The facts in White v. Commissioner,17 T.C. 1562">17 T.C. 1562↩ (1952), are clearly distinguishable from the facts here before the Court. In that case, the taxpayer was a 40-percent shareholder, made withdrawals, but applied his salary, bonus, and travel expense allowances to his account. Subsequent to the year before the Court, the corporation acquired the taxpayer's stock as a pledge, brought suit against him for his withdrawals, obtained a judgment against him, and sold his stock. Here, in contrast, petitioner was, for all practical purposes, Chief's sole shareholder and the balance of his account more than tripled in the 2 years following 1981, the last year before the Court.8. Rasmussen was called by petitioner and testified as follows: Q. Now I'll ask you this question. If Mr. Wasnick were to become successful in commodity trading or in any other business and were to make a lot of money, what do you think he would do with it as far as paying off his creditors? A. I believe if Mr. Wasnick was to make that kind of money that he would pay all of his debts off, both to the corporation and individuals he may owe money to. Such a general intent contingent on a windfall is not sufficient to show that the GL Account 211 withdrawals were true indebtedness. See Rapoport v. Commissioner,T.C. Memo. 1983-657, affd. without opinion 738 F.2d 419">738 F.2d 419↩ (2d Cir. 1984).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621398/	A. R. Ruppert Plumbing & Heating Co., Petitioner, v. Commissioner of Internal Revenue, RespondentA. R. Ruppert Plumbing & Heating Co. v. CommissionerDocket No. 84497United States Tax Court39 T.C. 284; 1962 U.S. Tax Ct. LEXIS 41; October 31, 1962, Filed 41 Decision will be entered under Rule 50. Petitioner was incorporated September 27, 1948. It sustained large net operating losses for the fiscal years ended September 30, 1949 and 1950. On October 1, 1950, it organized a subsidiary by transferring a part of its assets to the subsidiary for all of the latter's stock. Thereafter, the two corporations filed consolidated returns for the fiscal years ended September 30, 1951 through 1956. For the fiscal year ended September 30, 1954 (the taxable year), the group reported a net income, before any net operating loss deduction, of $ 106,898.86. It claimed a net operating loss deduction carryover from prior years of $ 64,832.25 which was arrived at after carrying over and deducting from the subsidiary's income in years prior to the fiscal year ended September 30, 1954, the large losses sustained by petitioner prior to affiliation. Held, the respondent did not err in disallowing the claimed net operating loss deduction carryover from prior years of $ 64,832.25. H. O. Hart (an officer), for the petitioner.Eugene F. Reardon, Esq., and Edward M. Fox, Esq., for the respondent. Arundell, Judge. ARUNDELL284 OPINION.Respondent determined a 42 deficiency in income tax for the fiscal year ending September 30, 1954, in the amount of $ 16,291.34. Instead of a deficiency petitioner claims an overpayment in the amount of $ 4,544.83.The only issue is whether income earned by a subsidiary corporation which filed a consolidated income tax return with its parent corporation (petitioner herein) can be offset by a net operating loss deduction resulting from the carrying over of net operating losses incurred by petitioner in taxable years during which the subsidiary corporation was not yet in existence.The facts were stipulated and are so found.Petitioner is a closely held corporation which was organized and incorporated under the laws of the State of Nevada on September 27, 285 1948. Its principal place of business is in Las Vegas, Nevada. On December 15, 1954, petitioner and its subsidiary hereinafter mentioned filed a consolidated corporate income and excess profits tax return for the fiscal year ended September 30, 1954, with the district director of internal revenue at Reno, Nevada.During the taxable years herein involved, petitioner kept its books and filed its annual income tax returns on the basis of a fiscal year commencing 43 on October 1 and ending on September 30.Petitioner's principal activity since September 27, 1948, has been the conducting of a plumbing and heating contracting business.During the fiscal years ended September 30, 1949, and September 30, 1950, petitioner incurred net operating losses in the amounts of $ 56,978.30 and $ 67,702.92, respectively. Petitioner filed separte income tax returns for the fiscal years ended September 30, 1949, and September 30, 1950, reporting such net operating losses, respectively.Prior to September 30, 1950, the stockholders of petitioner were desirous of obtaining covering from a bonding company on certain anticipated business ventures. Because of the poor financial condition of petitioner, the stockholders felt that petitioner could not obtain bonding coverage.On October 1, 1950, Ruppert Plumbing Co., Inc. (hereinafter sometimes referred to as the subsidiary), was organized and incorporated under the laws of the State of Nevada. In exchange for all of the subsidiary's stock, petitioner transferred to the subsidiary certain of petitioner's assets, including certain inventory items, land, and machinery.Since October 1, 1950, and during the taxable years 44 herein involved the subsidiary has kept its books on the basis of a fiscal year commencing on October 1 and ending on September 30. For each of the fiscal years ending September 30, 1951, through September 30, 1956, the subsidiary has been a member of an affiliated group of corporations consisting of petitioner and itself and, for each of said fiscal years, the subsidiary has joined with petitioner in the filing of a consolidated income tax return.The subsidiary's principal activity since October 1, 1950, has been the conducting of a plumbing and heating contracting business in and around the vicinity of Las Vegas, Nevada.Since October 1, 1950, petitioner and the subsidiary have continued to conduct their respective business activities throughout their respective fiscal years to and including the fiscal year ended September 30, 1956.During the fiscal year ended September 30, 1951, petitioner earned net income, before any net operating loss deduction, of $ 26,853.50. For the same taxable period the subsidiary earned net income, before any net operating loss deduction, of $ 18,475.18. On their consolidated 286 income tax return for the taxable year, the corporations reported consolidated 45 net income, before any net operating loss deduction, of $ 45,328.68. Against said consolidated net income, the corporations claimed a consolidated net operating loss deduction of $ 124,681.22, which deduction represented the carrying over of the net operating losses of petitioner for the 2 preceding years. As the result of the application of the claimed consolidated net operating loss deduction, the corporations reported no consolidated taxable net income and paid no income tax for the fiscal year ended September 30, 1951.During the fiscal year ended September 30, 1952, petitioner incurred a net loss, before any net operating loss deduction, of $ 7,828.77. For the same taxable period, the subsidiary earned net income, before any net operating loss deduction, of $ 82,003.83. On their consolidated income tax return for said taxable year, the corporations reported consolidated net income, before any net operating loss deduction, of $ 74,175.06 ($ 82,003.83 minus $ 7,828.77). Against the consolidated net income the corporations claimed a consolidated net operating loss deduction in the amount of $ 79,352.54, which deduction represented the carrying over of the net operating loss of 46 $ 67,702.92 sustained by petitioner during the fiscal year ended September 30, 1950, and the unused portion ($ 11,649.62) of the net operating loss of $ 56,978.30, sustained by petitioner during the fiscal year ended September 30, 1949, which had not been absorbed by the consolidated net income of $ 45,328.68 earned during the fiscal year ended September 30, 1951. As the result of the application of the claimed consolidated net operating loss deduction, the corporations reported no consolidated taxable net income and paid no income tax for the fiscal year ended September 30, 1952.During the fiscal year ended September 30, 1953, petitioner incurred a net loss, before any net operating loss deduction, of $ 32,324.33. For the same taxable period the subsidiary incurred a net loss, before any net operating loss deduction, of $ 87,442.39. During the same taxable period, the corporations realized consolidated net capital gain of $ 60,160.25. On their consolidated income tax return for said taxable year, the corporations reported a consolidated net operating loss, before any net operating loss deduction, of $ 59,606.47 ($ 32,324.33 plus $ 87,442.39 minus $ 60,160.25).During the fiscal 47 year ended September 30, 1954, which is the taxable year herein involved, petitioner and its subsidiary earned consolidated net income, before any net operating loss deduction, of $ 106,898.86. Against that income the corporations claimed a net operating loss deduction of $ 64,832.25, which deduction allegedly represented the carrying over of the consolidated net operating loss in the amount of $ 59,606.47 sustained during the fiscal year ended 287 September 30, 1953, and the unused portion ($ 5,177.48) of the net operating loss of $ 67,702.92, sustained by the parent corporation during the fiscal year ended September 30, 1950, which had not been absorbed when applied against consolidated net income earned during the fiscal year ended September 30, 1952. The sum of the claimed carryovers which composed the claimed consolidated net operating loss deduction is actually $ 64,783.95 ($ 59,606.47 plus $ 5,177.48) rather than $ 64,832.25 as was claimed on the return. The difference of $ 48.30 resulted from a mathematical error.On their consolidated income and excess profits tax return for the fiscal year ended September 30, 1954, after deducting the claimed net operating loss deduction, 48 petitioner and its subsidiary reported consolidated taxable net income in the amount of $ 42,066.61 ($ 106,898.86 minus $ 64,832.25). Based on their reported taxable consolidated net income in the amount of $ 42,066.61, the corporations reported an income tax liability in the amount of $ 17,215.97 and an excess profits tax liability in the amount of $ 1,303.88, or a total income and excess profits tax liability of $ 18,519.85. Said total tax liability was paid in installments on the following dates: On December 15, 1954, the sum of $ 8,333.93; on May 5, 1955, the sum of $ 5,622.52; on November 9, 1955, the balance of $ 4,563.40.During the fiscal year ended September 30, 1955, petitioner and its subsidiary sustained a consolidated net operating loss in the amount of $ 6,001.75. On March 8, 1956, petitioner filed with the district director of internal revenue at Reno, Nevada, a claim for refund of income tax for the fiscal year ended September 30, 1954, in the amount of $ 3,240.95. On March 8, 1956, petitioner also filed a claim for refund of excess profits tax for the fiscal year ended September 30, 1954, in the amount of $ 1,303.88. These claims for refund were based on the carryback 49 of the consolidated net operating loss for the fiscal year ended September 30, 1955, to the fiscal year ended September 30, 1954, and the application thereof in the earlier year as a consolidated net operating loss deduction from consolidated taxable net income reported for said earlier year. These claims for refund were disallowed by the respondent and no tax for the fiscal year ended September 30, 1954, has been refunded to petitioner.During the fiscal year ended September 30, 1956, the parent corporation and the subsidiary corporation sustained a consolidated net operating loss in the amount of $ 34,323.43. Petitioner has filed no claims for refund with respect to, or resulting from, this consolidated net operating loss.On September 29, 1959, respondent mailed the statutory notice of deficiency to petitioner. In arriving at this determination, respondent determined that petitioner had no unused net operating losses 288 available as carryovers to offset income and, accordingly, disallowed petitioner's claimed consolidated net operating loss carryover deduction in the amount of $ 64,832.25. However, respondent allowed petitioner the benefit of a consolidated net operating loss carryback 50 deduction in the amount of $ 40,325.18, which deduction represents the carrying back of the consolidated net operating losses in the amounts of $ 6,001.75 and $ 34,323.43 sustained in the fiscal years ended September 30, 1955, and September 30, 1956, respectively.A recapitulation of the net income (or loss) of petitioner and of its subsidiary and the consolidated net income (or loss) of both corporations, before any net operating loss deduction, for the fiscal years ended September 30, 1949, through September 30, 1956, are as follows:Fiscal year ended Sept. 30 --PetitionerSubsidiaryConsolidated1949($ 56,978.30)1950(67,702.92)195126,853.50 $ 18,475.18 $ 45,328.68 1952(7,828.77)82,003.83 74,175.06 1953(32,324.33)(87,442.39)1 (59,606.47)19542 2 106,898.86 19552 2 (6,001.75)19562 2 (34,323.43)On the consolidated return for the fiscal year ended September 30, 1954, petitioner and its subsidiary claimed a net operating loss deduction of $ 64,832.25 thus reducing the consolidated net income from $ 106,898.86 to $ 42,066.61. The $ 64,832.25 51 was arrived at as follows:Net loss of petitioner for FYE 9/30/49($ 56,978.30)Net loss of petitioner for FYE 9/30/50(67,702.92)Total(124,681.22)Less consolidated net income for FYE 9/30/5145,328.68 Unused net loss79,352.54 Less consolidated net income for FYE 9/30/5274,175.06 Unused net loss(5,177.48)Add consolidated net loss for FYE 9/30/53(59,606.47)Add error made by petitioner(48.30)Net operating loss deduction claimed by petitioner64,832.25 The only issue before us is whether the respondent erred in disallowing the claimed consolidated net operating loss carryover deduction in the amount of $ 64,832.25.Insofar as petitioner's claimed net operating loss deduction is made up partly of the mathematical error of $ 48.30, we of course sustain the respondent.289 The issue is thus narrowed to whether petitioner could carry over and deduct from the consolidated net income for the taxable year ended September 30, 1954, the consolidated net loss of $ 59,606.47 for the fiscal year ended September 30, 1953, and an alleged unused net loss of $ 5,177.48 from the fiscal year ended September 30, 1952.By filing consolidated returns for the taxable years ended September 30, 1951 through 1956, petitioner 52 and its subsidiary, under section 141(a), I.R.C. 1939, 1 consented to all the consolidated return regulations prescribed under section 141(b), I.R.C. 1939. 253 Charles Ilfeld Co. v. Hernandez, 292 U.S. 62">292 U.S. 62.In accordance with the congressional mandate, the Secretary prescribed Regulations 129 relating to consolidated income and excess profits tax returns (applicable to taxable years ending after December 31, 1949).The first consolidated return here commenced October 1, 1950, and ended September 30, 1951.Section 24.31(a)(3) of Regulations 129 defines the term "Consolidated net operating loss carry-overs" as follows:The consolidated net operating loss carry-overs to the taxable year shall consist of -- (i) The consolidated net operating losses, if any, for the five preceding taxable years (not including as a third, fourth, or fifth preceding taxable year any taxable year beginning prior to January 1, 1950) to the extent that the consolidated net operating loss for any such preceding taxable year was not attributable to a corporation making a separate return * and, with respect to a net operating loss sustained by a corporation in a taxable year for which 54 a separate return was filed * * * but subject to the limitations prescribed in section 24.31(b)(3), (ii) The amount of the net operating losses, if any, of such corporation for the five preceding taxable years (not including as a third, fourth, or fifth preceding taxable year any taxable year beginning prior to January 1, 1950) to the extent that the net operating loss for any such preceding taxable year was not absorbed as a carry-over or carry-back by consolidated or separate net income for preceding or intervening taxable years.[Emphasis supplied.]290 Section 24.31(b)(3) sets forth the limitations referred to in section 24.31(a)(3), supra, as follows:(3) Limitations on net operating loss carry-overs and carry-backs from separate return years. In no case shall there be included in the consolidated net operating loss deduction for the taxable year as consolidated net operating loss carry-overs under (a)(3)(ii) of this section (relating to the net operating losses sustained by a corporation in years for which separate returns were filed * * an amount exceeding in the aggregate the net income of such corporation * * * included in the computation of the consolidated net income for 55 the taxable year * These regulations make it clear that carryovers of net operating losses sustained by a corporation in a separate return may be included in the computation of a consolidated net operating loss deduction only to the extent of that corporation's contribution to the consolidated net income for the taxable year.The first consolidated return was filed for the fiscal year ended September 30, 1951. For that year petitioner contributed $ 26,853.50 to the consolidated net income of $ 45,328.68. Therefore, the only net operating loss allowable as a carryover for that year is the amount of $ 26,853.50 instead of the amount of $ 124,681.22 claimed by petitioner, and for that year the consolidated group had a net income, after the net operating loss deduction, of $ 18,475.18 instead of an unused net loss of $ 79,352.54.The second consolidated return was filed for the fiscal year ended September 30, 1952. For that year petitioner had a net loss of $ 7,828.77. Therefore, there was no net operating loss allowable as a carryover for that year, and for that year the consolidated group had a net income of $ 74,175.06 instead of an unused net loss of $ 5,177.48.The third consolidated 56 return was filed for the fiscal year ended September 30, 1953. For that year the consolidated group had a consolidated net loss of $ 59,606.47 which petitioner claims as carryover to the succeeding fiscal year ended September 30, 1954, together with the claimed unused net loss of $ 5,177.48 for the preceding fiscal year ended September 30, 1952. In the preceding paragraph we held that for the fiscal year ended September 30, 1952, the consolidated group had a consolidated net income for 1952 of $ 74,175.06 instead of an unused net loss of $ 5,177.48. Therefore, petitioner had no unused net loss from the fiscal year ended September 30, 1952, to carry over to fiscal year ended September 30, 1954, and, under the provisions of section 24.31(a)(3)(ii) of Regulations 129, supra, the consolidated net loss of $ 59,606.47 could be allowed as a carryover to fiscal year ended September 30, 1954, only --to the extent that the net loss for any such preceding taxable year [fiscal year ended September 30, 1953] was not absorbed as a carry-over or carry-back by 291 consolidated or separate net income for preceding or intervening taxable years. [Emphasis supplied.]Section 122(b)(1)(B), I.R.C. 1939, 57 provides that "If for any taxable year beginning after December 31, 1949, the taxpayer has a net operating loss, such net operating loss shall be a net operating loss carry-back for the preceding taxable year." (Emphasis supplied.) Also, section 122(b)(2)(B) provides:If for any taxable year beginning after December 31, 1949, the taxpayer has a net operating loss, such net operating loss shall be a net operating loss carry-over for each of the five succeeding taxable years * * . For the purpose of the preceding sentence, the net operating loss for any taxable year beginning after December 31, 1949, shall be reduced by the amount, if any, of the net income for the preceding taxable year * * [Emphasis supplied.]In other words, both under the regulations and the statute, petitioner is required to carry back the consolidated net loss of $ 59,606.47 for the fiscal year ended September 30, 1953, to the preceding taxable year and deduct it from the consolidated net income of $ 74,175.06 for that year and, since the entire net loss would be absorbed in the net income for the fiscal year ended September 30, 1952, nothing remained to be carried over to the fiscal year ended September 30, 58 1954.As thus analyzed, it would appear that the respondent committed no error in disallowing the claimed consolidated net operating loss carryover deduction of $ 64,832.25 made up of the three amounts of $ 5,177.48, $ 59,606.47, and $ 48.30. See Capital Service, Inc. v. Commissioner, 180 F. 2d 579 (C.A. 9, 1950), affirming a Memorandum Opinion of this Court dated May 10, 1949; Olivier Company v. Patterson, 151 F. Supp. 709">151 F. Supp. 709, and cases cited therein, affirmed per curiam 249 F. 2d 894 (C.A. 5, 1957). See also section 272(g), I.R.C. 1939, and section 6214(b), I.R.C. 1954, insofar as we have considered years prior to the fiscal year ended September 30, 1954.Notwithstanding the aforegoing analysis, petitioner, in its brief, argues thus:At all times since October 1, 1950 Ruppert Plumbing Co., Inc. was owned, controlled and operated by the Petitioner, conducting the Petitioner's business for the sole benefit of Petitioner. Petitioner furnished all the capital of Ruppert Plumbing Co., Inc., and its management was under the direct supervision of the officers of Petitioner, and, due to the stock ownership, any profit or loss in Ruppert Plumbing Co., Inc. accrued to the benefit or detriment 59 of Petitioner.Respondent in his reply brief has interpreted this argument as an attempt on the part of petitioner to bring the instant case within the doctrine of a line of cases such as Helvering v. Metropolitan Edison Co., 306 U.S. 522">306 U.S. 522; Newmarket Manufacturing Co. v. United States, 233 F. 2d 493 (C.A. 1, 1956); and F. C. Donovan, Inc. v. United States, 261 F. 2d 470 (C.A. 1, 1958).292 In an earlier case, New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, the Supreme Court had held that a successor corporation resulting by reason of a reorganization, was not the "same taxpayer" as its predecessor, and since a net operating loss deduction was available only to the "same taxpayer" who incurred the loss, the successor corporation was not entitled to carry over the predecessor's operating loss sustained prior to the reorganization.The above line of cases were cases wherein the courts were of the opinion that the facts involved in those cases were such as to cause one of the corporations there involved to be treated in substance as the "same taxpayer" as another corporation and thus entitled to assume the latter's tax attributes.We do not think the instant case falls within the above line of cases. 60 In Libson Shops v. Koehler, 353 U.S. 382">353 U.S. 382 (1957), the Supreme Court held that where 16 separate sales corporations operating retail clothing stores and one separate corporation providing managements services were merged into one corporation, surviving corporation was not entitled to carry over premerger loss of three merged corporations as an offset to postmerger income, since income was not produced by substantially the same business as produced the loss.In the instant case we do not have the merger of one corporation into another corporation. Petitioner merely organized the subsidiary by transferring to it a part of petitioner's assets for all of the subsidiary's stock. The stipulated facts, in our opinion, do not warrant a finding that the businesses conducted by the two corporations were in substance the same business previously carried on by petitioner alone. This leaves the instant case within the rationale of such cases as New Colonial Co. v. Helvering, supra, and Libson Shops v. Koehler, supra.The subsidiary in the instant case is not the same corporate entity which incurred the net operating losses in the fiscal years ended September 30, 1949 and 1950. For these reasons 61 the subsidiary cannot be the "same taxpayer" entitled to the use of a net operating loss deduction under the provisions of section 122 of the 1939 Code.We hold, therefore, that the respondent did not err in disallowing the claimed consolidated net operating loss carryover deduction in the amount of $ 64,832.25.Decision will be entered under Rule 50. Footnotes1. $ 32,324.33 plus $ 87,442.39 minus a consolidated net capital gain of $ 60,160.25.↩2. Not shown for separate companies.↩1. SEC. 141. CONSOLIDATED RETURNS.(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 in lieu of separate returns. The making of a consolidated return shall be upon the condition that all corporations which at any time during the taxable year have been members of the affiliated group consent to all the consolidated return regulations prescribed under subsection (b) prior to the last day prescribed by law for the filing of such return. The making of a consolidated return shall be considered as such consent. * *↩2. (b) Regulations. -- The Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such manner as clearly to reflect the income- and excess-profits-tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such tax liability.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621399/	WALTER H. SUTLIFF, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sutliff v. CommissionerDocket No. 103669.United States Board of Tax Appeals46 B.T.A. 446; 1942 BTA LEXIS 869; February 25, 1942, Promulgated 869 The petitioner's son, the fee owner of certain real estate, gave the petitioner a lease thereon. Thereafter in connection with the sale of the property and during the term of the lease the petitioner executed to the purchaser a quitclaim deed to the property, reciting his intent to convey thereby all of his rights and interest in the property and more particularly to convey all his rights under the lease. No other instrument of conveyance was executed by the petitioner, nor was any instrument of cancellation executed between him and the son, nor was any endorsement of cancellation made on the lease instrument. Held:(1) The petitioner did not cancel his lease but sold it. (2) In computing his gain on the transaction, the petitioner is entitled to the use of a basis. (3) The lease was a capital asset in the hands of petitioner and the gain therefrom was capital gain. David A. Gaskill, Esq., for the petitioner. Thomas F. Callaham, Esq., for the respondent. TURNER 446 The Commissioner determined a deficiency of $3,355.87 in the petitioner's income tax for 1937. The only issues presented are whether the gain realized by the petitioner870 in 1937 on the disposition of a lease owned by him was capital gain and if so whether the petitioner was entitled to use a basis in computing the amount of his gain. FINDINGS OF FACT. The petitioner is a resident of Cleveland Heights, Ohio, and filed his income tax return for 1937 with the collector of internal revenue for the eighteenth district of Ohio. The petitioner was born January 23, 1878, and is the widower of Bassie T. Sutliff, who died August 3, 1909. Taylor H. Sutliff, only son of petitioner and Bessie T. Sutliff, was born July 31, 1909. 447 Bessie T. Sutliff died seized of a certain parcel of land situated in Jackson, Michigan. The property was known as No. 167 West Michigan Avenue and a three-story business building was located thereon. Bessie Sutliff left a will executed in November 1906 in which, except for a specific bequest of $500, she devised and bequeathed to the petitioner her residuary estate, which included the property in Jackson, Michigan. The will was offered for probate but was never admitted, the petitioner being advised that it had been revoked by the birth of the petitioner's son. The petitioner was told by the probate judge of871 Jackson County, Michigan, that he had a life estate in the property and that the fee was vested in his son, Taylor H. Sutliff. From 1909 to 1929, during the infancy and minority of his son, the petitioner managed and controlled the property in the belief that he was the life tenant. In 1929, however, and in connection with the negotiation of a long term lease on the property to the Lourim-Yocum Co. of Jackson, Michigan, he learned that under the law of descent and distribution in the State of Michigan he had no interest in the property and that title thereto was vested in his son. The petitioner then qualified as special guardian of his son in the Probate Court of Jackson County, Michigan. As such guardian he leased the property to the Lourim-Yocum Co. for a term commencing August 1, 1929, and expiring May 31, 1956, at a rental of $7,200 a year from August 1, 1929, to January 31, 1936; $7,750 a year from February 1, 1936, to January 31, 1946; and $8,750 a year from February 1, 1946, to May 31, 1956. The lease was duly recorded in the Register's Office of Jackson County, Michigan. The petitioner, at or about the time of the negotiation of the lease to the Lourim-Yocum Co. 872 , discussed the situation with his son, who, though still a minor, had been in business about two to two and one-half years. The petitioner stated that he was disturbed over the situation because it would cast doubt on all that had been done in the past 20 years as well as what would be done in the future. The son told him not to worry as he would be of age the next year and then they would enter into some kind of an agreement. During the following year they discussed the kind of agreement they would make. The son thought the petitioner was entitled, morally if not legally, to an interest in the property. During the year they arrived at an agreement which the son, who had been in the insurance business and was familiar with life expectancies, thought was fair. The son became of age on July 31, 1930, at which time the petitioner was approximately 53 years of age. The petitioner and his son again discussed the matter and on August 5, 1930, the son leased the property to the petitioner for a nominal consideration of $25 a year, the lease 448 to terminate upon the death of the petitioner or on May 31, 1956, whichever first occurred. Under the lease the petitioner acquired873 and assumed all the rights and liabilities arising from the lease which he, as special guardian, had entered into with Lourim-Yocum Co. In addition to the nominal rental, petitioner was to pay all real estate taxes and water rents assessed against the property during the term of his lease and at his own expense comply with the laws, rules, orders and regulations of the Federal, state, and city governments applicable to the property. All improvements, additions, alterations, or repairs made to the property were to be at the expense of petitioner. At the termination of the lease all alterations, additions, and erections on the property were to become a part of the demised premises. The petitioner could not assign the lease without the written consent of his son. The lease also contained a provision for its termination in event of nonpayment of rent for a period of 60 days after it should become due or in event the petitioner should be adjudicated a bankrupt. The lease was recorded on September 4, 1930, in the deed records of the Register's Office of Jackson County, Michigan, liber 324 of deeds, pages 491, 492, and 493. The lease to petitioner remained in full force and effect874 until the consummation of a certain transaction with Floyd D. Avis, hereinafter described. At all times subsequent to the execution of the lease and prior to the Avis transaction, the petitioner managed said property, collecting rentals from tenants occupying it, and saw that the charges required by the terms of the lease were paid. The Lourim-Yocum Co. defaulted in the payment of rentals required under its lease and by reason thereof the lease to it was terminated on or about December 21, 1932. The property remained vacant until June 1, 1933, when The Great Atlanctic & Pacific Tea Co., sometimes referred to as A & P, took possession under a lease from the petitioner for a term of two years, with a renewal term of two years. A & P continued in possession of the property as lessee and occupied it as a tenant at the time of its sale to Avis as hereinafter described. In December 1936 an offer to purchase the property was received from Floyd D. Avis of Jackson, Michigan. After discussing the offer the petitioner and his son decided that it would be advantageous to them to sell the property. Counsel was consulted and prior to the preparation of the purchase and sale agreement875 the son, as "owner" of the property, and the petitioner, as "lessee", entered into a written agreement which was prepared for them by their counsel. Pertinent portions of the agreement are as follows: WHEREAS, Owner owns the fee simple title to the said property: WHEREAS, Lessee holds and is tenant under a lease of said premises dated August 1, 1930, and expiring May 31, 1956, unless sooner terminated by Lessee's death; and WHEREAS parties hereto have received from one Floyd D. Avis, of Jackson, Michigan, an offer to purchase the fee simple title to said premises for the 449 gross purchase price of Sixty-two Thousand Five Hundred Dollars ($62,500.00) less adjustments and the unpaid balance due upon a first mortgage to the New York Life Insurance Company and certain taxes and assessments; and WHEREAS, the parties desire to accept said offer and complete said sale and divide the net proceeds; Now, THEREFORE, Owner and Lessee, in consideration of the promises and covenants hereinafter set forth, agree as follows: That both Owner and Lessee will accept the purchase agreement and evidence such acceptance by signing duplicate originals thereof. Lessee agrees to cause876 his lease to be cancelled and released of released of record as a part of the closing of the transaction. Owner agrees to execute the necessary deeds and other documents necessary to consummate and complete the sale and transfer in accordance with the terms and provisions of said purchase agreement. Out of the proceeds of the purchase price, there shall be paid all sums necessary to make adjustments of taxes and assessments, pro-ration of rents, and any and all other charges and expenses, including real estate commissions and attorneys' fees, and Owner hereby appoints Lessee to act in his behalf in closing the transaction and making or authorizing such deductions and payments. After all such charges, deductions and payments have been made, the net proceeds arising from such sale shall be divided between Owner and Lessee so that each shall receive one-half thereof. The equal division of net proceeds provided for in the foregoing agreement represented the son's suggestion and was thought by petitioner and the son roughly to approximate their repective interests in the property under the mortality tables. The son never said anything to the petitioner about paying the petitioner877 a sum of money to cancel the lease or otherwise in connection with the transaction. The agreement was primarily for the purpose of providing for a division of the proceeds to be received from the property. The insertion therein by counsel of the provision that "Lessee agrees to cause his lease to be cancelled and released of record as a part of the closing of the transaction" was purely procedural and to provide for the petitioner's disposition of his interest in the property on account of his lease. In inserting the provision counsel did not mean that the parties were intending to follow the particular method which cancellation would imply. Subsequent to the execution of the written agreement between the petitioner and the son respecting the division of the proceeds to be realized from the sale of the property, the petitioner and the son received a purchase and sales agreement prepared by Avis, the purchaser of the property. Certain minor changes were made in the agreement by counsel for the petitioner and the son and under date of December 23, 1936, the son as "owner" of the property and the petitioner as "lessee" of the property, both designated as "sellers", executed the878 purchase and sale agreement with Avis, who was designated therein as the "purchaser." In this agreement the "sellers" agreed to sell and the "purchaser" agreed to buy the property for the sum of 450 $62,500, the "purchaser" agreeing to accept the property subject, among other things, to the lease of A & P. Pursuant to the provisions of the purchase and sale agreement the petitioner's son, on January 4, 1937, executed and delivered a warranty deed conveying all his interest in the property to Avis. The deed contained a recital that Avis accepted the property "subject to the occupancy of said premises in connection with the adjoining premises on the wast by The Great Altantic & Pacific Tea Company under lease, and does hereby agree to hold the vendor harmless as to the condition or terms of said lease." On the same day the petitioner executed and delivered to Avis a quitclaim deed to the property which contained, among others, the following provision: It is the intent of this conveyance to convey herein all rights and interest of said vendor in said property, and more particularly to convey all rights of said vendor under lease dated August 5, 1930, between Taylor Hurst879 Sutliff and Walter H. Sutliff and recorded in Liber 324 of Deeds on pages 491-2-3 in the office of the register of deeds for Jackson County, Michigan, on the 4th day of September, 1930. The warranty deed from the son and the quitclaim deed from the petitioner were drawn by the purchaser of the property or by his representative and after delivery to the purchaser were recorded simultaneously. Aside from the quitclaim deed given by petitioner to Avis, the petitioner executed no other form of conveyance of his lease nor was there any instrument of cancellation of the lease executed by the son and the petitioner nor was any endorsement of cancellation made on the lease instrument. The cash proceeds from the sale of the property were paid by check of Avis drawn payable to the petitioner and the son. The check was endorsed by both the petitioner and the son and deposited in the petitioner's bank account with the Cleveland Trust Co. The petitioner then gave the son a check for the son's share. The petitioner and the son divided the net proceeds equally between them pursuant to their previous written agreement, and the amount received by the petitioner from the transaction was880 $28,896.62. In his income tax return for 1937 the petitioner reported his share of the net proceeds from the transaction as $28,896.62. Treating the lease as a gift from the son, the petitioner computed the cost basis thereof to him to be $13,224.22 and showed a net gain of $15,672.60 from the transaction. On the ground that the property was a capital asset and had been held for more than 10 years and that therefore only 30 percent of the amount of $15,672.60 or $4,701.78 was includable in income, the petitioner entered only that portion of the gain as income in his return. In determining the deficiency the respondent determined 451 that the $28,896.62 represented ordinary income and that the entire amount thereof was taxable. OPINION. TURNER: The first question to be considered is whether the portion of the net proceeds received by petitioner from the sale of the property represented consideration received from the sale of his lease, as petitioner contends, or was payment to him for the cancellation of his lease, as respondent contends. In support of his contention the respondent points to the agreement between the petitioner and the son respecting the division881 of the net proceeds and containing the provision that the petitioner agreed "to cause his lease to be canceled and released of record as a part of the closing of the transaction", and urges that under the decision in Hort v. Helvering,313 U.S. 28">313 U.S. 28, the amount received by petitioner was essentially a substitute for the rental payments which the petitioner might receive throughout the unexpired period of his lease. From the testimony of Robert F. Bingham, the attorney who drew not only the lease for the petitioner but also the agreement containing the above quoted provision, it appears that said provision was intended to be merely procedural and for the purpose of providing for the petitioner's disposition of his interest in the property, and that it was not inserted to show that the parties were intending to follow the particular method which cancellation would imply. The sale of the property was consummated by two deeds which were prepared by the purchaser or his representative. The petitioner's conveyance of his interest in the property was by quitclaim deed which indicated the petitioner's intention to convey all his rights and interest in the property including882 all his rights under his lease. Aside from the quitclaim deed, petitioner executed no other form of conveyance of his lease nor of his interest arising therefrom. Neither was there any instrument of cancellation executed by the petitioner and the son nor was any endorsement of cancellation entered on the lease instrument. In addition, the warranty deed from the son to Avis specifically provided that the latter accepted the premises subject to the occupancy thereof by A & P under a lease. This indicates an intent to preserve as between Avis and A & P the latter's rights and liabilities with respect to the property arising from its lease, which was obtained from the petitioner, who in turn held his lease from the son. From the evidence before us we are unable to find that the petitioner canceled his lease or that the amount received by him from the sale of the property was anything other than consideration received by him through the sale of his leasehold interest. We are also unable to see wherein the decision in Hort v. Helvering, supra, is applicable 452 to the instant case. In the Hort case the taxpayer was the owner of certain real estate883 which he had acquired by devise from his father in 1928. Prior to his death the father executed a lease on a portion of the property to a trust company for a period of 15 years beginning on February 1, 1932, at an annual rental of $25,000. In 1933 the trust company found it unprofitable to continue the occupancy of the property. After some negotiations the taxpayer in December 1933 canceled the lease in consideration of the payment to him of $140,000 by the trust company. In his income tax return for 1933 the taxpayer claimed a loss deduction on the transaction of $21,494.75 on the theory that the amount he received for cancellation was $21,494.75 less than the difference between the present value of the unmatured rental payments and the fair rental value of the portion of the property covered by the lease. The respondent disallowed the loss deduction claimed and included the $140,000 in income. The Court held that the taxpayer was not entitled to deduct the claimed loss because to allow it would result in the reduction of ordinary income actually received and reported by the amount of income that the taxpayer had failed to realize, a result which was not permissible under the884 act. It was also held that the $140,000 received was essentially a substitute for the unmatured rental payments under the lease and as such constituted ordinary income and not capital gain. Obviously the factual situation in the instant case is materially different from that in the Hort case. That case was grounded on the uncontroverted and apparently conceded fact that the taxpayer had canceled a lease on real estate which he owned in fee. Here the petitioner was not the owner of the fee nor was the amount in controversy received by him from his lessee. After the sale of his lease he no longer owned any interest in the property. To apply to the instant case the rule of the Hort decision would be the equivalent of holding that when the owner of an interest in a rental property disposes of such interest the consideration received therefor in excess of the cost basis is essentially the equivalent of anticipated rentals therefrom. We find nothing in the Hort decision to indicate that the Court intended that it should be given such a construction. Under his lease from the son the petitioner was required to pay a rental of $25 a year for the property. Concededly885 such a rental was nominal and obviously was not intended to and did not approximate the annual rental value of the property. Under the circumstances we think the lease is to be considered as a gift from the son to the petitioner. Since the lease appears to have been of considerable value, it is our opinion that for the purpose of computing the gain to the petitioner from its disposition he is entitled to the use of a basis. Secs. 111(a) and 113(a)(2) of the Revenue Act of 1936. At the hearing the parties stipulated that in event we should hold that the petitioner 453 is entitled to a basis in computing his gain from the transaction the amount of such basis is $7,909.90. Accordingly we hold that amount to be the basis to which the petitioner is entitled. The lease was an asset in the hands of the petitioner and we think comes within the definition of capital assets as contained in section 117 of the applicable act. Therefore the gain realized by the petitioner from the sale of the lease was capital gain within the meaning of that section of the act. But compare 886 John D. Fackler,45 B.T.A. 708">45 B.T.A. 708, arising under section 117 of the Revenue Act of 1938, which contained a different definition of capital assets from that contained in the act applicable herein. In his petition the petitioner alleged that only 30 percent of the gain realized from the sale was to be taken into account in computing net income. However, on brief he concedes that he held the lease for more than five years but less than ten years. In view of this and in accordance with the provisions of section 117, supra, 40 percent of the gain is to be taken into account in computing his net income. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621406/	Dolores M. Hulick v. Commissioner.Hulick v. CommissionerDocket No. 4873-62.United States Tax CourtT.C. Memo 1964-300; 1964 Tax Ct. Memo LEXIS 35; 23 T.C.M. (CCH) 1863; T.C.M. (RIA) 64300; November 19, 196435 Dolores M. Hulick, pro se, 302 W. 79th St., New York, N. Y. Alan M. Stark, for the respondent. WITHEYMemorandum Opinion WITHEY, Judge: A deficiency has been determined by the Commissioner in the income tax of petitioner for the taxable year 1960 in the amount of $288.60. The sole issue is whether respondent has erred in disallowing as a deduction the amount of $600 taken as such by petitioner representing expenses for dependent's care in order that petitioner might be gainfully employed. Other issues raised have been settled by the parties and will be given effect under Rule 50. All of the facts have been stipulated either by written stipulation or orally upon the record herein and are found accordingly. Inasmuch as both parties agree that petitioner's original income tax return for 1960 was timely filed and contained the $600 deduction referred to in our opening paragraph, it is not necessary that respondent produce or offer the same in evidence. The only issue is one of law, i.e., was petitioner entitled to a $600 deduction representing the statutory limitation upon deduction of amounts spent for the support of a dependent in order that a taxpayer may be gainfully36 employed under section 214(a), (b)(1)(A), (b)(2)(A), and (c)(3) of the Internal Revenue Code of 1954. 1It is agreed that taxpayer expended in excess of $600 in 1960 for the care of her37 dependent child, Barbara Hulick, and that such expenditure was necessary in order that petitioner might be gainfully employed. The sole question remaining is whether petitioner, during 1960, was married to her husband and thus required to file a joint income tax return with him for that year in order to avail herself of the permitted deduction or whether she was legally separated from her husband under a decree of separate maintenance at the close of the year and thus relieved of the joint return requirement. Petitioner and her husband were married on August 13, 1958, and their daughter Barbara was born of the union. The husband deserted petitioner in January of 1959 and she has been unaware of his exact whereabouts since. Petitioner instituted proceedings in the Domestic Relations Branch of the Muncipal Court for the District of Columbia to obtain custody of Barbara and for her (Barbara's) support. On December 18, 1959, that court entered an order granting petitioner the temporary custody sought and requiring the husband to pay the sum of $30 for child support every two weeks. On May 11, 1960, the order both for custody and support was made permanent. During the year 1960 no application38 for divorce or a decree of separate maintenance was made by petitioner or issued by any court. The orders above mentioned do not constitute such decrees, but relate solely to the desertion of petitioner by her husband, place custody of their child in petitioner, and require the husband to carry out his marital obligation of support. Petitioner concedes that she did not file a joint return with her husband for the taxable year 1960. Petitioner also concedes, at least in effect, that under section 214 of the 1954 Code as it existed in 1960 she does not qualify for the deduction there provided, but she contends that in equity she is nevertheless to be considered to have been unmarried in that year particularly in view of later amendment of that section under which she contends she would have been qualified. From the standpoint of equity, petitioner's plight is appealing, but this Court's powers are statutory only and permit of no such relief as petitioner requests. There can be no doubt on this record that petitioner was still married to her husband at the close of the year at issue and that she was not legally separated or divorced from him by the decree of any court. For this reason39 she was required under the statute to have filed a joint return with her husband for the taxable year 1960 in order to qualify for the $600 deduction she now seeks. This she did not do and the failure of her attempted deduction must follow. We sustain respondent's determination of deficiency. Decision will be entered under Rule 50. Footnotes1. SEC. 214. EXPENSES FOR CARE OF CERTAIN DEPENDENTS. (a) General Rule. - There shall be allowed as a deduction expenses paid during the taxable year by a taxpayer who is a woman or a widower for the care of one or more dependents (as defined in subsection (c)(1)), but only if such care is for the purpose of enabling the taxpayer to be gainfully employed. (b) Limitations. - (1) In general. - The deduction under subsection (a) - (A) shall not exceed $600 for any taxable year; and * (2) Working wives. - In the case of a woman who is married, the deduction under subsection (a) - (A) shall not be allowed unless she files a joint return with her husband for the taxable year, and * (c) Definitions. - For purposes of this section - * *(3) Determination of status. - A woman shall not be considered as married if she is legally separated from her spouse under a decree of divorce or of separate maintenance at the close of the taxable year.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621407/	Harold Kushel and Rae Kushel, Petitioners, v. Commissioner of Internal Revenue, RespondentKushel v. CommissionerDocket No. 23886United States Tax Court15 T.C. 958; 1950 U.S. Tax Ct. LEXIS 8; December 28, 1950, Promulgated 8 Decision will be entered for the respondent. Loan to real estate corporation by petitioner engaged in the paper business held not shown to be not a non-business bad debt under section 23 (k) (4), I. R. C.Samuel Sklar, Esq., for the petitioners.Stephen P. Cadden, Esq., for the respondent. Opper, Judge. OPPER958 Petitioners challenge respondent's determination of a deficiency in income and victory tax of $ 6,685.60 for 1943. The only issue is whether or not a loss sustained by petitioner Harold Kushel resulted from a non-business bad debt under section 23 (k) (4), Internal Revenue Code, and thus gave rise only to a short term capital loss.FINDINGS OF FACT.Petitioners, husband and wife, are residents of Brooklyn, New9 York, and filed a joint return for 1943 with the collector of internal revenue for the first district of New York.Petitioner Harold Kushel, hereinafter called petitioner, has been active in the paper and bag business since 1910. In that year he founded the National Paper & Supply Co., which was later incorporated as the National Consumers Paper Corp., and which became, in 1933, the Metropolitan Paper & Bag Corporation, hereinafter called Metropolitan. In 1934 the East Coast Paper Products Corp., hereinafter called East Coast, was organized for the business of converting 959 and producing various paper products, and since that time petitioner has been connected with that corporation as its treasurer. In 1943 petitioner owned an interest of 29 per cent in Metropolitan, and petitioner and his wife owned 50 per cent of the stock of East Coast.In 1919 petitioner and others formed the Continental Contracting Corporation, which completed several construction jobs, including building repairs and street paving contracting work. Petitioner was a stockholder and served as treasurer. The corporation acquired certain property on Bay Parkway, between 70th and 71st Streets, and constructed10 six single-family houses which were sold. Petitioner and his brother, Benjamin Kushel, each bought a house which they subsequently made their home. Some years later, some of the six houses on Bay Parkway, between 70th and 71st Streets, were acquired by Ray-Gen Corporation, all of whose stock was owned by petitioner, his brother Benjamin, and their wives, with petitioner serving as president.In 1932 the 7004 Bay Parkway Corporation was organized. All of the stock was owned by petitioner's wife and sister-in-law. The corporation acquired some of the six houses on Bay Parkway, between 70th and 71st Streets. Petitioner and his brother became liable on a $ 13,000 bond, in connection with one of those houses. An application for a change in zoning of the area was granted, and construction plans for a large apartment house and stores were filed. However, the plans were never carried out due to the depression and war. In order to aid the corporation to hold the property and to meet its expenses such as taxes, mortgage payments, and repairs, petitioner and his brother extended loans at various times. Petitioner's loans were made either from his personal funds, or were made by corporations11 in which he had an interest and charged to his personal account. Petitioner received six promissory notes of varying dates and amounts. Petitioner never received interest, had no security, made no demands for repayment, and instituted no suits for recovery of the money.Petitioner has invested in other real estate enterprises. In 1939 or 1940 petitioner and his brother formed the Broadway Petit Corporation which owned and operated a commercial building in Elmhurst, Long Island, with petitioner serving as treasurer of the corporation. At another time petitioner and his brother each owned 50 per cent of the stock of a corporation which owned and managed an apartment house at 2155 71st Street in Brooklyn. Petitioner and his brother formed a corporation to acquire property on Avenue H between 7th and 8th Streets in Brooklyn, which was subsequently conveyed to them, and which they own in their own names.From 1939 to 1941 or 1942 petitioner was ill and not active in business. At the end of that period petitioner opened an office from which 960 to develop his own paper business. He advanced a loan of $ 9,000 to East Coast which was in difficulties. In 1942 or 1943 petitioner12 gave up his own office to use the offices of East Coast. He also used the offices of Metropolitan. During 1943 petitioner rendered services to both Metropolitan and East Coast, as well as engaging in his own paper business. In 1943 East Coast's volume of sales was about $ 500,000. Metropolitan had a volume of sales in that year of between $ 600,000 and $ 1,000,000.In December 1943 the 7004 Bay Parkway Corporation liquidated. Prior to that time petitioner had made loans to it amounting to $ 15,054.02. Upon liquidation petitioner received assets worth $ 1,244.78 in part payment of the indebtedness, and the balance of the debt, amounting to $ 13,809.24, became worthless. Petitioner had no other investment in that corporation.During 1943 petitioner did not hold himself out to the public as a money lender or as a contractor. Petitioner was not in the real estate business in that year; he did not maintain a separate office for a real estate or money lending or contracting business; he had no employees for any such business; and he kept no separate bank accounts for any such business. Petitioner had no similar type of loans outstanding to other real estate holding companies in13 1943.Petitioner's income tax return for 1943 reported a salary of $ 3,900 from Metropolitan, a salary of $ 1,652, from East Coast, and net profit of $ 23,017.79 from petitioner's business as a dealer in paper and paper products. The total receipts of the latter business were reported as $ 543,141.23. The only other income reported was the sum of $ 250 as net capital gain and $ 45 interest income. Petitioner claimed a deduction for a bad debt loss of $ 13,809.24.Respondent's notice of deficiency disallowed the deduction on the ground that it "is a loss from worthlessness of a nonbusiness debt * "Petitioner was not in the real estate, contracting, or money lending business but was engaged in the paper business in 1943.The loss from the worthlessness of the debt in question was not incurred in petitioner's trade or business.OPINION.Petitioner's failure to carry his burden of proof has resulted in our finding the ultimate fact in accordance with respondent's determination. There is no evidence from which we can conclude that, with respect to the business as to which the bad debt was suffered, petitioner was more than a "passive investor," Foss v. Commissioner (CCA-1), 75 Fed. (2d) 362;14 or that he was in the tax year either 961 in the real estate business or in the business of making loans, Regulations 111, section 29.23 (k)-6; or for the matter of that, that he was ever in any business other than that of paper and bags. Certainly the record, unlike that in Vincent C. Campbell, 11 T. C. 511, shows affirmatively that he was not a stockholder, and it is not clear that he was even a nominal officer or director of the debtor corporation. It follows that since the debt was not represented by a "security," 1 and the loss was not incurred in the trade or business of the taxpayer, the requirements of section 23 (k) (4) to constitute the deduction in controversy a business bad debt have not been met. The Omaha National Bank v. Commissioner (CCA-8), 183 Fed. (2d) 899.15 Similarly, we find no proof that as far as this taxpayer was concerned, the transaction was entered into for profit so that the deduction could be taken as a loss 2 under section 23 (e) (2) even if we assume that the two remedies are not mutually exclusive. See Spring City Foundry Co., 292 U.S. 182">292 U.S. 182.Decision will be entered for the respondent. Footnotes1. SEC. 23. * * (k) Bad Debts. -- * * (4) Non-business debts. -- In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩2. SEC. 23. * (e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -- * * (2) If incurred in any transaction entered into for profit, though not connected with the trade or business: * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621408/	Wood Process Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentWood Process Co. v. CommissionerDocket No. 110072United States Tax Court2 T.C. 810; 1943 U.S. Tax Ct. LEXIS 49; September 30, 1943, Promulgated 49 Decision will be entered for the respondent. Petitioner, owner of rights under certain patents, made a contract by which a certain corporation agreed to pay royalties to the petitioner. Later, petitioner made a contract to sell 30 percent of its stock for $ 30,000, payable over a period of four years, with a provision that there should be credited on the $ 30,000, 30 percent of any royalties received by petitioner. This contract was made with the parent of the corporation which agreed to pay royalties. Thereafter, the parent corporation dissolved the other and took over the royalty contract by assignment, with provision for assumption of duty of paying royalties; and the royalties were, when payable, credited against the $ 30,000 due until the whole amount was, by application of royalties and cash, discharged. The contract with the parent corporation had provided that petitioner's receipts thereunder, except as required to redeem certain stock, pay indebtedness, and for retention as capital, should be distributed to petitioner's stockholders. Held, the royalties applied upon the $ 30,000 indebtedness constituted income taxable to the petitioner. Lucien H. Boggs, Esq50 ., for the petitioner.J. Marvin Kelley, Esq., for the respondent. Disney, Judge. DISNEY811 This proceeding involves the redetermination of the following deficiencies in income tax:1935$ 148.671936475.121937385.55193848.49The only question at issue is whether, as determined by the Commissioner, the entire amounts of certain royalty payments received by the petitioner during the taxable years constituted taxable income, or whether, as contended by the petitioner, only 70 percent of the amounts received are taxable.FINDINGS OF FACT.The petitioner is a corporation organized and existing under the laws of the State of Florida, having its principal office at 1001 Bisbee Building, Jacksonville, Florida. It filed its 1935 income and excess profits tax return with the collector for the district of Florida.Since the time of its incorporation the petitioner has held certain patents and applications for patents on inventions of McGarvey Cline, its president and principal stockholder. Included among them in 1932 were applications numbered 443,616 and 539,585 covering inventions for treating oleo-resins so as to make them available for shipment in liquid51 form. On August 3, 1932, the petitioner and Cline entered into a contract with the Glidden Co., an Ohio corporation hereinafter referred to as Glidden, under the terms of which Glidden agreed to cause the incorporation of Nelio-Resin Corporation, hereinafter referred to as Nelio, to operate under the two patent applications and any letters patent subsequently issued thereunder. The contract provided that Nelio should have a capital of 11,000 shares of common stock of the par value of $ 10 a share, of which 10,000 were to be issued to Glidden in exchange for cash and securities of the value of $ 100,000, and 1,000 were to be issued to the petitioner in consideration of the subsequent execution of a contract by the petitioner and Cline with Nelio to provide, in so far as is here material, as follows:That petitioner grant to Nelio an exclusive license for a period of two years from August 3, 1932, to operate, manufacture and sell under the application and patents;That Nelio have the option to extend the license for the full term of the letters patent upon agreement to pay royalties of $ 1.20 per ton on all products produced thereunder during the extended period;That at any time 52 after the expiration of five years from August 3, 1932, Nelio have the option to purchase the patents at a price to be computed by capitalizing average annual royalties, the price in no event to be less than an amount equaling $ 30,000 multiplied by the 812 number of years of the term of the first patent issued them remaining unexpired; andThat additional applications and patents issued dealing with the same subject matter be subject to the agreement.Other material provisions of the agreement of August 3, 1932, were to the effect that, in the event Nelio should fail to exercise its option to extend the license beyond the initial two-year period, then Glidden should purchase petitioner's 1,000 shares of Nelio stock at the price of $ 10 a share; that the petitioner would not sell its holdings in Nelio to any person without having first given the opportunity to Glidden to purchase the shares at book value or at $ 10 a share, whichever be the higher; that Nelio employ Cline for a period of two years as technical director of operations under the patents; in the event sufficient raw materials be unobtainable at prices enabling Nelio to make a net profit of 10 percent on operations, 53 that Glidden have the right to terminate the contract and also the license agreement to be executed, the petitioner thereupon to transfer its Nelio stock to Glidden at $ 10 a share.After the execution of the contract of August 3, 1932, Glidden procured the incorporation of Nelio and paid in to it $ 100,000 in cash and property. The petitioner received the 1,000 shares of Nelio stock and Cline entered its employ as technical director, all in accordance with their agreement. On January 12, 1933, a license agreement was executed by the petitioner, Cline, and Nelio, embodying the terms and agreements for which provision had been made in the contract with Glidden. It became apparent from experimental operations that operation under the patents could be made commercially profitable, but that considerably more than the original capital of $ 100,000 would be required for plant enlargement and working capital. Cline entered into negotiations with Glidden and Nelio in order to induce them or either of them to make additional investments. These negotiations culminated in the execution of a contract on February 20, 1934, between the petitioner and Glidden. By its terms the petitioner agreed54 to sell and Glidden agreed to purchase 500 shares of class B common stock of Wood Chemical Products Co., the petitioner's 1,000 shares of Nelio stock, and 273 shares of class A and 273 shares of class B of the petitioner's common stock for the total price of $ 50,000, payable $ 20,000 for the Wood Chemical Products Co. stock and the Nelio stock, delivery and payment to be made forthwith, and $ 30,000 for the petitioner's stock, to be issued and paid for as follows: The petitioner to deliver the requisite number of certificates to an escrow agent, and Glidden to make payments of not less than $ 3,600 on or before January 17 in each of the years 1935, 1936, and 1937, and the balance on or before January 17, 1938. The petitioner agreed to 813 redeem all its outstanding preferred stock promptly upon payment by Glidden of the $ 20,000. Further provisions were as follows:4. (a) Process [the petitioner] entered into a certain license agreement with Nelio-Resin Corporation, a Delaware corporation, dated January 12, 1933, under the terms and conditions of which (if the option there given be exercised by Nelio-Resin Corporation) certain royalties are provided to be paid to Process 55 at the times and in the amounts particularly specified in said license agreement. Process hereby agrees that so long as Glidden shall not be in default hereunder and Nelio-Resin Corporation shall not be in default under said license agreement, and shall make prompt payment to Process of the royalties as provided in said license agreement in the amounts and at the times therein specified, that, upon such payment of such royalties being made, and without further payment to itsef or to the escrow agent, Process will execute and deliver to Glidden its certificate, certifying to said escrow agent that Glidden is entitled to credit on account of the purchase price of said stock to an amount equivalent to 30% of the royalty payment then made. At the option of Glidden it may call for and receive two or more credit certificates aggregating the total amount of credit to which it is then entitled, in such denominations as it may specify.(b) Stock Certificates surrendered to Glidden in whole or in part on the basis of royalty payments hereunder shall not be entitled to participate in any dividend which may be declared by Process out of the 70% of such royalty payment not so applied to the payment56 of stock.5. Glidden agrees to forthwith cause to be assigned, transferred and delivered to Process 250 shares of Class B common stock of Wood Chemical Products Company, an Ohio corporation, and Process, upon the delivery to it of such stock, shall assign, transfer and deliver to Adrian D. Joyce of Cleveland, Ohio, 91 shares of Class A and 91 shares of Class B of the common stock of Process.6. All the moneys and stock received by Process under this agreement (except such portion of said moneys as shall be required for the purpose of redeeming said issued and outstanding preferred stock, and for the purpose of paying the present indebtedness of Process, and such portion as Process may elect to retain in its treasury as operating capital) shall be paid and distributed by Process to the holders of its common stock of record on February 1, 1934, ratably and in proportion to stock held by them.7. The certificates evidencing the stock of Process herein agreed to be sold to Glidden and deposited with said Bank for delivery under the terms hereof, and those herein agreed to be transferred to said Joyce, shall bear appropriate legend reciting that the rights of the holder of such certificates57 are subject to the terms of this agreement.8. Process represents that, excluding the shares of its stock herein agreed to be sold to Glidden and the shares agreed to be transferred and delivered to said Joyce, it has issued and outstanding a total of 546 shares each of Classes A and B common stock, and that it holds and owns as treasury stock 4090 shares of Class A and 4090 shares of Class B common stock. Process agrees that during the life of this agreement and so long only as Glidden shall not be in default thereunder, Process will not dispose of or sell any further shares of its common stock without the consent of Glidden.9. No share of the stock of Process herein agreed to be sold to Glidden shall have any voting right or right to participate in any dividends that may be declared or paid by Process until Glidden shall have become entitled to delivery thereof under the terms of the escrow agreement hereto attached. Nothing in this paragraph contained shall be construed as altering or changing the provisions of paragraph 4 (b) above.814 10. Upon full performance of this agreement by Glidden, the stock of Process acquired thereby it shall be relieved of the legend specified58 in paragraph 7 hereof, and at the option of Glidden, new certificates free of such legend may be issued therefor.Prior to the execution of the foregoing contract of February 20, 1934, the petitioner had received no return from the patents. Cline and the other stockholders were anxious that operations on a large scale be begun. They regarded the conditions imposed by Glidden, that the 1,000 shares of Nelio stock be sold to it and that 30 percent of all royalty payments be credited on account of the purchase price of the petitioner's stock, as essential concessions for them to make in order to procure the investment of additional capital by Glidden. Certificates for the number of shares of petitioner's stock to be acquired by Glidden were issued and placed in escrow, in accordance with the agreement. The escrow agent was directed to deliver certificates to Glidden from time to time in numbers which bore substantially the proportion to the whole number of shares as the amounts then paid or credited bore to the entire price of $ 30,000. The shares so placed in escrow comprised 30 percent of the total number of the petitioner's shares then issued and outstanding. In the fall of 59 1934 Nelio exercised its option to extend the license for the full term of the patents. Thereafter the investment in plant for production of the product was increased to the point where, by January of 1943, it amounted to about $ 500,000. At the same time the amount of working capital employed ranged from $ 1,000,000 to $ 1,500,000.Glidden completed its agreement for the purchase of petitioner's stock in January of 1938. At that time the cash payments, together with the credits of 30 percent of royalty payments received by the petitioner, equaled $ 30,000. During the taxable years, until Glidden became entitled to receive the last of petitioner's stock in January 1938, 30 percent of the amounts received by the petitioner as royalties was as follows:1935$ 3,585.6719363,842.0619373,505.021938321.34Total 11,254.09Those amounts were credited, as received, on the purchase price of the stock. They were never taken up on the petitioner's books nor reported on its returns as income, but were immediately distributed to stockholders of record on February 1, 1934, ratably in proportion to their respective holdings on that date. Neither Glidden nor others60 who acquired stock subsequent to February 1, 1934, participated in the distributions. The remaining amounts of the royalty payments 815 were entered on the books and reported on petitioner's returns as income. Dividends paid therefrom were paid to all stockholders of record.On January 20, 1936, Glidden notified the petitioner that it had decided to dissolve Nelio and to procure the assignment to itself of the license agreement. The petitioner consented to the assignment upon the condition that Glidden assume Nelio's obligations. On January 30, 1936, Glidden agreed to do so, and since that time has operated as licensee. The respondent determined that the full amounts of royalties paid to the petitioner at first by Nelio and thereafter by Glidden constituted taxable income of the petitioner, and adjusted reported net income accordingly. Other adjustments are not in issue.OPINION.In January 1933 the petitioner granted to Nelio-Resin Corporation an exclusive license to operate under certain patents for a term of two years from August 1932, in consideration of the issuance by Nelio to the petitioner of 1,000 shares of its total authorized capital stock of 11,000 shares. 61 Nelio received also an option to extend the license for the full term of the patents, subject to the obligation to pay royalties of $ 1.20 a ton on all products which it produced during the extended period. In February 1934 the Glidden Co., the owner of the remaining 10,000 shares of Nelio stock, as a condition for increasing its investment in that corporation, required the petitioner among other things to sell its holdings in Nelio to Glidden, to redeem its own preferred stock, and to agree to issue to Glidden for $ 30,000 sufficient of petitioner's common stock to constitute Glidden the owner of 30 percent of all outstanding stock. A contract including the above terms was executed on February 20, 1934. The purchase price was to be paid by Glidden over a period of about four years, during which time the petitioner agreed to credit 30 percent of any royalties received by it on the unpaid balance of purchase price. The contract contained the following provision:6. All moneys and stock received by Process under this agreement (except such portion of said moneys as shall be required for the purpose of redeeming said issued and outstanding preferred stock, and for the purpose of 62 paying the present indebtedness of Process, and such portion as Process may elect to retain in its treasury as operating capital) shall be paid and distributed by Process to the holders of its common stock of record on February 1, 1934, ratably and in proportion to stock held by them.In the fall of 1934 Nelio exercised its option to extend its license for the remainder of the term of the patents. In January 1936 Glidden dissolved Nelio, took over its assets, including the license contract, and thereafter itself operated as licensee. Until January 21, 1938, 816 when Glidden completed the payments for petitioner's stock, the petitioner, in accordance with its agreement, credited 30 percent of all royalties received by it on the unpaid balance of the purchase price, such credits aggregating about $ 11,250. The balance of the agreed price was paid in cash. The portions of the royalties so credited to Glidden were not entered by the petitioner on its books nor reported on its returns as income, but were immediately distributed to stockholders of record on February 1, 1934, in proportion to their respective holdings.The question for decision is whether the respondent correctly63 determined that royalties constituted taxable income in their entirety, or whether the petitioner properly excluded the 30 percent of each payment credited to Glidden and distributed to stockholders. In our opinion, the respondent's determination must be sustained. There can be no doubt that as a general rule royalties received in consideration of the grant of a license to operate under or use a patent constitute taxable income. , and cases there cited; ; modified, . Our only inquiry is whether any of the circumstances present in this case operate to take it out of that rule. The petitioner contends that the execution and performance of the contract of February 1934 with Glidden have that effect. We think otherwise. It is true that prior to the execution of the contract with Glidden no income had been realized, and it may be assumed for purposes of argument that, had the petitioner refused to accede to the conditions imposed by Glidden, the latter would not have taken steps to make 64 operations profitable, and therefore that no income would have been realized. Thus, the petitioner's reasons for entering into the contract are apparent, and under the circumstances the fact that it did execute and perform it would constitute consideration sufficient to support the promise by Glidden to increase its investment in Nelio. But the question of the legal effect of the contract upon income tax depends upon the contract itself, rather than upon circumstances motivating its execution. Here the petitioner was under obligation to credit 30 percent of all royalties to Glidden. It is difficult to see upon what theory that obligation may be said to deprive the amounts in question of their character as royalties and as income. Standing alone, it does not even amount to an assignment of income. Its only effect was to reduce the amount of money the petitioner received in exchange for its stock, and to reduce Glidden's cost correspondingly. Cf. .According to the petitioner it was under further obligation to distribute the amounts in question to the persons who were its stockholders 817 of record65 on February 1, 1934. The contract, however, required distribution only of moneys received under "this agreement," except such portions as might be required for redemption of preferred stock, for payment of indebtedness, or as petitioner might elect to retain for operating capital. The royalties were not received by the petitioner under "this agreement," but under the preexisting license contract with Nelio. Moreover, even if the parties intended that royalties be included, and if the contract permits such a construction, there is still no evidence to show the amounts required for the redemption of preferred stock, for payment of indebtedness, or what portions the petitioner might have elected to retain in its treasury; therefore the amount distributable is unascertainable. Thus it does not appear that the contract imposed any obligation upon the petitioner to make distribution of the amounts in question, i. e., the royalties, to its stockholders. However, even under the petitioner's theory that it was bound to distribute, the most that can be said is that the provision in question effected an assignment of income, and it is well established that such an assignment, however binding, 66 does not operate to prevent taxation of the income to the assignor. ; ; ; . It is true that at the time of the "assignment" the petitioner had no vested right to future income, nor even any certainty that it would subsequently become entitled to receive income, but in this respect the situation is not different from that in , where in 1901 the taxpayer by contract agreed that all earnings and property which he might receive at any future time would be received and owned by him as a joint tenant with his wife. The Supreme Court held that the whole of the salary and attorney fees earned by the taxpayer in 1920 and 1921 were taxable to him. The determinative factor in this case is that the property constituting at first the potential and later the actual source of the income remained at all times in the petitioner's ownership. Whether the patents themselves or the67 license agreement with Nelio be considered the income-producing property is immaterial, since the petitioner owned both, and never purported to dispose of any interest in either. We have held that earnings of a corporation, though never paid to it, but paid to its stockholders, nevertheless constitute income to such corporation. ; affd., ; certiorari denied, .The petitioner contends that 30 percent of the royalties were distributed to stockholders as compensation for the diminution of their proportionate interests in the equity of the corporation caused by the issuance of stock to Glidden. However true, that does not alter the fact that the patents and the license contract remained the petitioner's 818 property, nor the consequent conclusion that the income therefrom is taxable to it. Cf. ; affd., ; ; affd., ;68 . Even if the contract of February 20, 1934, could be considered as in substance a contract by the petitioner's stockholders individually to sell 30 percent of their respective holdings, an agreement that they receive a like percentage of all royalties would not have effected a transfer to them of any interest in the patents or the license contract. See . The petitioner held one contract with Nelio under which it would become entitled to receive royalties taxable to it if Nelio should elect to extend its license. It then entered into another contract with Glidden by which it obligated itself to make certain application of the royalties it would receive from Nelio if the license should be extended. The two separate contracts were with two separate entities. The character of the rights enjoyed by the petitioner under the one was not affected by the contractual obligations imposed upon it by the other; and the same would be true if we consider the stockholders as agreeing to sell stock and receive royalties. The character of the royalties would not be69 changed.The petitioner contends in the alternative that the amounts in question were either paid on the purchase price for the stock sold to Glidden, or constituted payments by the petitioner for the development of its patents, and in either event the moneys received were capital items. The facts disclose no justification for upholding either of those contentions. Even if the separate corporate entities of Glidden and Nelio were to be disregarded, the income character of the royalties would not be altered by reason of the fact that the petitioner bound itself to credit a portion of them on the purchase price of the stock. As has been pointed out, the most that may be said is that such an allocation amounted only to an adjustment of the purchase price. We find no basis for the argument that the amounts in question were capital expenditures made for the development of the patents. The only payments made by the petitioner were in the form of distributions to its stockholders, having no regard to patent development.The petitioner's last contention has to do only with royalties paid subsequent to the time when Glidden acquired Nelio's interest in the license contract, assuming the70 obligations and agreeing to be responsible for all the provisions thereof. Thirty percent of the royalties paid after that time, it is urged, can not be income because the same legal entity was both paying the moneys and receiving that percentage as a credit against the purchase price of the stock. It must be remembered, however, that Glidden was obligated to the petitioner 819 under two separate contracts, the one requiring it to pay royalties and the other requiring it to pay for certain stock. The effect of the petitioner's contention is that the stock purchase contract effected a modification or a partial abrogation of the license contract, just as if a new agreement had been entered into between it and Glidden providing that thereafter royalties should be paid at the rate of $ .84 a ton on all production, or 70 percent of the $ 1.20 per ton theretofore agreed to be paid, and that for each such royalty payment there should be a contemporaneous payment of $ 0.36 not as royalty but on account of the purchase price of petitioner's stock, until January 17, 1938, or until such earlier date as the aggregate of the amounts so applied upon the price of the stock plus other cash71 payments therefor should equal $ 30,000; and that thereafter the royalty payments be again increased to $ 1.20 a ton. If the license contract had been modified so to provide, the question whether such provision could affect the character of the payments as income would be presented. That was not done, however. On the contrary, that contract remained in full force in accordance with its terms. The old royalty contract with Nelio was carefully assigned to Glidden, which bound itself to its terms. That was the underlying and preexisting contract, the performance of which will not be completed until the terms of the letters patent have expired. The petitioner does not deny that the payments made thereunder constitute taxable income in their entirety, except for the relatively short period ending in January 1938. Thereafter, on petitioner's theory they would be royalties, as the license contract calls them. We hold that the stock purchase contract did not effect a modification of the license contract, and that the income character of the payments made under the latter was not altered because of the application which petitioner agreed to make and did make of them. It follows that*72 the full amounts paid under the license contract constituted taxable income.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621411/	Estate of James S. Ogsbury, Deceased, Florence N. Ogsbury, Executrix, and Florence N. Ogsbury, Surviving Wife, Petitioners, v. Commissioner of Internal Revenue, RespondentEstate of Ogsbury v. CommissionerDocket No. 52837United States Tax Court28 T.C. 93; 1957 U.S. Tax Ct. LEXIS 213; April 22, 1957, Filed 213 Decision will be entered for the petitioners. As part of his contract of employment, petitioner received an unassignable option to purchase stock of his employer corporation at a bargain price. The option which was to expire December 31, 1945, permitted petitioner to delay payment and passage of title to the stock after exercise for so long as he was still employed by the corporation or for 6 months after his death if he died while in the employ of the corporation. However, upon the exercise of the option, petitioner became unconditionally obligated to pay a certain amount for the stock and, upon payment, the corporation was unconditionally obligated to deliver it to him. Petitioner exercised the option on December 29, 1945, and paid for and received the stock on December 8, 1948. Held, that the exercise of the option on December 29, 1945, bound petitioner and the employer corporation, and that petitioner received the economic benefit of the option as of its exercise in 1945. Harman Hawkins, Esq., for the petitioner.Ellyne E. Strickland, Esq., and A. Jesse Duke, Jr., Esq., for the respondent. Kern, Judge. Bruce, J., dissents. KERN 94 The Commissioner determined a deficiency 214 in petitioners' income tax for the year 1948 in the amount of $ 68,860.56. The issues for decision are (1) whether the employee petitioner received compensation in connection with a stock option in 1948 when he paid for and received title to the stock, or in an earlier taxable year when the option was exercised, and (2) if the petitioner received compensation in 1948, what was the fair market value of the stock so received on December 9, 1948.In light of the recent decision of the Supreme Court in Commissioner v. LoBue, 351 U.S. 243">351 U.S. 243, petitioners have abandoned the contention that the stock option did not give rise to extra compensation for personal services. FINDINGS OF FACT.The stipulation of facts and the exhibits annexed thereto are incorporated herein by this reference.Petitioner Florence N. Ogsbury is the duly appointed executrix of the Estate of James S. Ogsbury, deceased, who died on February 18, 1950. Florence N. Ogsbury, individually, is made a petitioner herein solely by reason of having filed a joint return with her husband, James S. Ogsbury. Hereinafter James S. Ogsbury shall be referred to as petitioner.Petitioner was a resident of Garden City, New York. His income 215 tax return for the year 1948 was filed with the then collector of internal revenue for the first district of New York.On or about September 7, 1937, a contract was entered into between petitioner and Fairchild Aviation Corporation (whose name was subsequently changed to Fairchild Camera and Instrument Corporation, hereinafter referred to as Fairchild), setting forth the terms of his employment as chief executive officer of Fairchild and granting him a nonassignable option to purchase authorized but unissued common stock of Fairchild before December 31, 1941, at the price of $ 4.50 per share. This option was not exercised.On or about August 19, 1941, a new contract was entered into between petitioner and Fairchild continuing his employment. This contract extended the option to purchase Fairchild's stock to December 95 31, 1945, but changed the terms of that option. The pertinent parts of the new option were as follows:2. As further compensation to James S. Ogsbury for his services heretofore and hereafter to be performed, the Company hereby grants to him, or, in the event of his death, to his estate an unassignable option, upon the terms and conditions and for the period hereinafter 216 specified, to purchase at any time and from time to time during said period not exceeding Ten Thousand (10,000) shares of the authorized but unissued common stock of the Company as it is presently constituted, or the equivalent thereof in case of a recapitalization of the Company involving a split-up or a combination of its common stock at a price equal to Four Dollars and fifty cents ($ 4.50) per share. The option hereby granted may be exercised by the mailing of a written notice or notices at any time prior to December 31, 1945, except that the option to his estate will expire one year after the date of said James S. Ogsbury's death, or on December 31, 1945, whichever is sooner. The date of the mailing of such notice shall be the effective date for the transfer of title to the stock so acquired on the exercise of such option.On or about August 7, 1945, petitioner and Fairchild agreed to extend the employment contract dated August 19, 1941. By letter agreement dated August 7, 1945, a change was made in the terms of the option contained in the employment contract. The last sentence of paragraph 2 of the employment contract of August 19, 1941 (reproduced above), referring to the effective 217 date for the transfer of title to stock acquired through exercise of the option, was replaced by the following:Upon the mailing of such notice said James S. Ogsbury shall be obligated to the Company for the full purchase price of the shares with respect to which the option is thus exercised, but payment therefor and delivery of the stock certificates representing such shares may be postponed to such time or times as said James S. Ogsbury shall elect, but not later than the termination of his employment by the Company or, in the event of his death during such employment, within six months thereafter, subject to his right at any time to make payment for and take delivery of all or part of such shares. Pending payment for and receipt of all or any part of such shares by said James S. Ogsbury, title thereto shall remain in the Company and said James S. Ogsbury shall have no rights as a stockholder (including the right to vote and the right to receive dividends) with respect to such shares.On December 29, 1945, petitioner notified Fairchild, by mail, of his election to exercise the option as amended, as follows:Please be advised that I hereby elect to exercise my option to purchase 10,000 218 shares of the common stock of Fairchild Camera and Instrument Corporation in accordance with our agreement dated August 19, 1941, as amended by letter agreement dated August 7, 1945.On or about December 8, 1948, petitioner tendered $ 45,000 to Fairchild in payment for the 10,000 shares of common stock which were issued in his name on December 9, 1948.In accordance with petitioner's instructions 5,000 shares were delivered to the loan department of the Grace National Bank and 5,000 96 shares were delivered to the loan department of the Chemical Bank and Trust Company. Each bank held the stock as collateral security for a loan of $ 25,000 made by it to petitioner which was used to pay for the stock.As of petitioner's death, in 1950, the loans were still unpaid and the stock was still held by the banks as collateral security.Petitioner did not report either the receipt of the option, the exercise of the option, or the receipt of stock as income in any income tax return.Fairchild did not claim a deduction in any income tax return for additional compensation paid petitioner either as a result of granting petitioner the option, petitioner's exercise of the option, or the actual transfer of 219 stock. Following the audit of petitioner's income tax return for the year 1948 and in view of the Commissioner's determination that petitioner realized income in 1948 measured by the difference between the fair market value of the stock and the option price on the date of delivery of the stock, Fairchild filed claims for a refund for both 1945 and 1948, each of which incorporated a claim for a deduction for additional compensation paid with respect to petitioner's stock option.On December 31, 1947, Fairchild had 337,032 shares of common stock outstanding. On December 31, 1948, Fairchild had 347,032 shares of common stock outstanding, including the 10,000 shares issued to petitioner under his option. Approximately 30 per cent of the outstanding shares of the common stock of Fairchild was owned or controlled by the Fairchild family as of March 1, 1948.In form 10K filed by Fairchild with the Securities and Exchange Commission for the year ended December 31, 1945, the exercise of the option is treated as a footnote under the heading "Remuneration of Directors, Officers, and Others" as follows:9. * * * By written notice dated December 29, 1945, Mr. Ogsbury advised the registrant that he 220 had elected to exercise his option to purchase 10,000 shares of the common stock of the registrant pursuant to the terms of the agreement between Mr. Ogsbury and the registrant. In accordance with this agreement, Mr. Ogsbury may pay for and take delivery of said stock at his election, but not later than the termination of his employment by the registrant, or in the event of his death during such employment, within six months thereafter. Title to said stock to remain in the registrant until such time as payment and delivery of all or any part is made.In form 10K filed by Fairchild with the Securities and Exchange Commission for the year ended December 31, 1948, the purchase of the stock is set out under the heading "Sales of Securities by Registrant" as follows:12. * * (c) On December 29, 1945, Mr. James S. Ogsbury, president of the registrant, exercised his option (originally granted in 1941) to purchase, at $ 4.50 per share, 10,000 shares of the common stock of the registrant. Under the terms of the agreement granting him such option, as amended, Mr. Ogsbury, upon the 97 exercise of the option, became obligated to the registrant for the full purchase price of the shares, but had 221 the right to pay for and take delivery of the shares at such time as he should elect, but not later than the termination of his employment by the registrant, or, in the event of his death during such employment, within six months thereafter. On December 8, 1948, Mr. Ogsbury paid for and received delivery of such 10,000 shares of common stock.Fairchild's stock was traded on the American Stock Exchange (formerly known as the New York Curb Exchange). Between September 1948 and June 1949 Fairchild's stock was in a downswing which took it from a high of 28 1/2 to a low of 12 1/4. The monthly high and low prices and total monthly sales of the stock for 1948 and 1949 were as follows:Range of pricesMonth and yearShares soldHighLow1948January5,100129 1/2February5,10011 3/810 1/2March12,50013 5/811 1/8April30,20017 1/212 1/8May54,40027 1/216 1/2June24,50028 1/421July36,9002923 1/2August7,50027 1/223 5/8September14,00028 1/224October6,80025 1/218November12,00019 5/814December7,40018 3/814 1/21949January3,90016 3/415 1/2February3,50015 5/812 1/4March8,00016 5/812 3/8April2,70016 1/813 1/8May3,50014 3/412 1/2June16,70019 3/812 1/2July5,9001917 3/4August6,30021 1/218 1/8September4,40019 3/817 1/2October6,3002117 7/8November2,8001917 1/4December26,90025 3/818 1/4In 222 December 1948 a total of 7,400 shares were traded as follows:Day of monthSalesHighLow150015 14 1/2240015 1/215 1/8321 15 3/41 14 3/4421 15 3/41 14 3/453610014 3/414 3/4730015 1/815 820015 3/815 1/4920015 3/815 1/41030015 3/815 3/81140016 15 1/21231350017 1/816 3/81450018 17 1/21560018 1/818 1630018 3/818 1720017 3/417 3/41820017 1/217 1/21932030017 3/417 1/22110017 5/817 5/82210017 1/217 1/22310017 1/217 1/82420017 1/417 1/82542632760017 1/817 2820016 3/416 5/82910016 5/816 5/83040016 3/416 1/23160017 1/416 3/498 On December 8 and 9, 1948, the average quoted price of Fairchild stock was $ 15.3125 per share. Two hundred shares were traded each day.OPINION.The major issue presented for decision herein is whether petitioner received compensation by means of a stock option granted to him by his employer, Fairchild, in the year in which the option was exercised (1945) or in the year in which payment and transfer of stock was made (1948). If we should determine that petitioner received compensation in 1948, when payment and transfer of the stock was accomplished, then we must determine the fair market 223 value of the stock as of the date of the transfer, December 8, 1948.The petitioner's position is that he received extra compensation upon the exercise of the option in 1945. He contends that the transfer of the stock and payment therefor in 1948 was merely the completion of a fixed contractual obligation entered into in 1945, and that any economic benefit resulting from this transaction must be calculated as of the time at which the obligations and duties under the contract became definite and certain. Respondent, on the other hand, contends that the exercise of the option in 1945 did not bind the parties thereto. He argues that petitioner's notice of exercise of the option contained in his letter to Fairchild dated December 29, 1945, was not an exercise of the option but merely notice that petitioner "intended to exercise the option and would purchase the stock at some future date to be chosen by him during the course of his employment." Respondent also argues that no economic benefit and, therefore, no income was realized until the transaction was completed in 1948 and petitioner had received title to the stock and the benefits and burdens appertaining thereto. Commissioner v. Smith, 324 U.S. 177">324 U.S. 177; 224 Lucas v. North Texas Lumber Co., 281 U.S. 11">281 U.S. 11; Commissioner v. Segall, 114 F. 2d 706, certiorari denied 313 U.S. 562">313 U.S. 562, reversing 38 B. T. A. 43; Fred C. Hall, 15 T. C. 195; J. T. Wurtsbaugh, 8 T. C. 183. Of these cases, only the Smith case involved a stock option.We cannot agree with respondent's interpretation of the option contract. It should be noted, at the outset, that the option was to expire, on its terms, as of December 31, 1945. Nowhere in the record is there any evidence that the option could be extended by a statement of intention. Rather, from petitioner's course of action and Fairchild's statements to the Securities and Exchange Commission, it is clear that both petitioner and Fairchild intended to be and were bound by their amended contract.The terms of the contract are clear and unambiguous. It provides that: "Upon the mailing of such notice [petitioner] shall be obligated to the Company for the full purchase price of the 99 shares * , but payment therefor and delivery of the stock certificates * * may be postponed to such time or times as [petitioner] shall elect, but not later than the termination of his employment by the Company * * ." (Emphasis supplied.) 225 Petitioner could delay payment while he was still employed by Fairchild, or his estate could delay payment for a maximum period of 6 months after his death if he was employed by Fairchild at the time of his death. However, the contract affords no opportunity for cancellation by or on behalf of the petitioner. The language used in the contract is subject to only one interpretation -- that petitioner and Fairchild entered into a binding agreement whereby petitioner's obligation to pay for and right to receive the stock became absolute and unconditional upon the mailing to Fairchild of the notice of petitioner's election to exercise the option. Petitioner could postpone payment within the limits set forth above, but could not rescind the contract thus made, nor refuse to pay for the stock when the limits of the postponement period had been reached. See Blau v. Ogsbury, 210 F.2d 426">210 F. 2d 426.In the alternative, respondent contends that where, as in the instant case, the exercise of the option and payment for and receipt of the stock take place in different taxable years, the year of transfer and payment is the one in which there was "effectual conveyance to Ogsbury of the benefits and burden 226 of ownership of the stock" and, consequently the one in which there was a realization of income. In support of this contention, respondent relies heavily on Commissioner v. Smith, supra,Lucas v. North Texas Lumber Co., supra, and Commissioner v. Segall, supra.The last two cases cited by respondent have to do with tax liabilities resulting from the sales of property and the precise question considered was when the sales took place. The opinion of the Supreme Court in the Smith case indicates that it considered the problem there to be a different one. There, as in the instant case, the tax liability resulted not from a sale of property but from the receipt by the taxpayer of "economic or financial benefit," resulting from an option given to him, as compensation, to purchase the stock of the employer corporation at bargain prices. The precise question was whether income was derived in the year the option was given or the year in which it was exercised. See, also, Commissioner v. LoBue, 351 U.S. 243">351 U.S. 243.With regard to stock options, certain rules now appear to be clear from the decided cases. An assignable option with a readily ascertainable market value may constitute extra compensation 227 and, therefore, taxable income in the year in which the option is granted. Commissioner v. LoBue, supra;Commissioner v. Smith, supra. An unassignable option, however, or one which does not have a readily ascertainable value at the time when the option is granted, may constitute extra compensation and, therefore, 100 taxable income in the year in which the option is exercised. Commissioner v. LoBue, supra;Commissioner v. Smith, supra;Estate of Connolly v. Commissioner, 135 F. 2d 64, affirming 45 B. T. A. 374; I. T. 3795, 1946-1 C. B. 15; Regs. 111, sec. 29.22 (a)-1.However, the instant case involves a factual situation which presents a question not present in any of the cited cases except the LoBue case. Here, the option was exercised and the rights and obligations of the parties were fixed in one year, but the payment for the transfer of the stock did not take place until a later year. The question is: In what year did the taxpayer realize income stemming from the stock option?This question was not answered in the LoBue case. There, as here, the taxpayer was definitely obligated to pay for the stock covered by the option (in that case the obligation was evidenced by notes), and 228 the employer corporation was obligated to deliver the stock to the taxpayer upon payment, these reciprocal obligations being incurred in a year prior to the taxable year. In the latter year the taxpayer paid for the stock and it was delivered to him. The Supreme Court held that taxable gain to the taxpayer should be measured as of the time the options were exercised, and not the time they were granted, and then added:It is possible that a bona fide delivery of a binding promissory note could mark the completion of the stock purchase and that gain should be measured as of that date. * * Since that question had not been passed on by the lower courts, the case was remanded. See, also, concurring and dissenting opinions in the LoBue case.Nor was this question answered in the Smith case, although in that case also the Supreme Court posed the problem. On petition for rehearing in that case, 324 U.S. 695">324 U.S. 695, the Court said:We do not have before us a case where by the exercise of an option in one year the taxpayer acquires an unconditional right to receive the stock in a later year. We express no opinion upon the question whether, in such a case, compensation would be received and would 229 be taxable in the earlier or the later year.It is now our duty in deciding the instant case to resolve the questions left unanswered by the Supreme Court in the Smith and LoBue cases.In our opinion, the taxable economic benefit of the unassignable option held by petitioner was realized by him upon his exercise of the option in 1945. At that time he acquired "an unconditional right to receive the stock" even though it might be, and was, received "in a later year." For all practical purposes, he was then in receipt of the value represented by the stock option. By his own act, that of payment, he could take delivery of the stock at any time and utilize the rights to receive dividends, vote the stock, or sell it at a profit. His right to the 101 stock was conditioned only on his personal decision as to when to make payment, not on the happening of any event beyond his control.It is our conclusion and we so hold that petitioner received the economic benefit of the stock option granted by Fairchild when he exercised the option in 1945 and obligated himself to pay for and accept the stock unconditionally within a limited period of time. The physical acts of payment and transfer of title to 230 the stock, occurring in a later taxable year, did not add to the economic benefit already received. Cf. Hawke v. Commissioner, 109 F.2d 946">109 F. 2d 946, remanding 35 B. T. A. 784; Omaha National Bank v. Commissioner, 75 F. 2d 434, reversing 29 B. T. A. 817; Gardner-Denver Co. v. Commissioner, 75 F.2d 38">75 F. 2d 38, certiorari denied 295 U.S. 763">295 U.S. 763, affirming 27 B. T. A. 1171. In view of our holding on this issue and the fact that the year 1945 is not before the Court, it is unnecessary to determine the fair market value of the Fairchild stock received under the option.Decision will be entered for the petitioners. Footnotes2. None.↩1. Denotes bid and asked price. No sales that day.↩3. Sunday.↩4. Holiday.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621413/	RICHARD P. SCHULZE, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSchulze v. CommissionerDocket No. 1967-81.United States Tax CourtT.C. Memo 1983-263; 1983 Tax Ct. Memo LEXIS 527; 46 T.C.M. (CCH) 143; T.C.M. (RIA) 83263; May 12, 1983. 527 Gary Altman, for the petitioner. Henry E. O'Neill, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined a deficiency of $12,270.00 in petitioner's 1976 Federal income tax. After concessions, the issue is whether petitioner assigned an interest in a certain claim for damages, and if so, whether such assignment effectively shifted the burden of taxation on a portion of the damages subsequently recovered. FINDINGS OF FACT Some of the facts are stipulated and found accordingly. Petitioner, Richard P. Schulze, Jr., resided in Kamuela, Hawaii, when the petition was filed herein. In 1964 petitioner became a partner in a Honolulu law firm. He eventually assumed the role of managing partner and served in that capacity until 1971 when, for health and professional reasons, he began taking steps to withdraw from the central operations of the law firm. In 1971, petitioner and the partnership entered into an agreement (herein the Kamuela agreement) which allowed petitioner to establish and operate a branch office in Kamuela. The partnership was prohibited from terminating the Kamuela operation until after528 December 31, 1973. After he commenced operation of the Kamuela office, a majority of the partners voted to dissolve the partnership, to form a new partnership without petitioner, and to close down the Kamuela office. Alleging breaches of the Kamuela agreement and the general partnership agreement, petitioner sued his former partners for damages. The defendants counterclaimed for damages based on allegations of mismanagement and fraud. The lawsuit was submitted to arbitration in 1974. On March 24, 1975, during the pendency of the arbitration proceeding, petitioner and his second wife, Toni, were divorced. Toni was a real estate agent and former reporter for a Honolulu newspaper. During their marriage, petitioner and Toni owned property both separately and jointly. Excluding petitioner's claim against his former partners, the aggregate value of Toni's separate property exceeded the aggregate value of petitioner's separate property. In connection with their impending divorce, they agreed to divide their assets equally, including petitioner's claim against his former partners. At that time the value of petitioner's claim was undeterminable. In a document dated February 14, 1975, they529 agreed to hold all of their assets, including petitioner's claim against his former partners, for the joint benefit of both parties. 1 Furthermore, in a property settlement agreement executed on March 19, 1975, petitioner and Toni agreed that all property owned by them, including petitioner's claim against his former partners, "will be held by the person having title in trust pursuant to the terms of this Agreement." It was agreed, however, the property would not be conveyed to the trust until "some later time." Petitioner and Toni also executed a "partnership agreement" dated March 19, 1975. The name of the partnership 2 was "R & T Enterprises," and its stated purpose was to manage and operate all of the property owned by petitioner and Toni, including any proceeds recovered by petitioner from his former partners. Petitioner and Toni never conducted business under the name of the partnership, never maintained books and records on behalf of the partnership, never opened a partnership bank account, and never530 formally transferred property to the partnership. On May 11, 1976, the arbitrator awarded petitioner $148,437 on the following bases: Basis of awardAmountPetitioner's share of 1973$36,901partnership income as providedunder the Kamuela agreement.Petitioner's 1973 expense6,000allowance under Kamuela agreement. 36,000Buy-out of petitioner undergeneral partnership agreement: (a) Petitioner's capital account;24,538(b) Petitioner's share of accounts41,672receivable;(c) Petitioner's share of appreciation429in real property owned by partnership;(d) Petitioner's share of partnership8,700goodwill.Interest34,475Total:$148,437531 As evidenced by a document executed by the parties on June 11, 1976, petitioner paid $41,625 of the proceeds to Toni in satisfaction of her "rights and claims in and to the proceeds of the arbitration." 4Based on the assumption that petitioner assigned his claim against his former partners to R & T Enterprises, R & T Enterprises reported ordinary income of $114,770, and long-term capital gain of $9,129, as a result of the arbitration award. 5 The partnership also claimed a deduction of $37,818 for legal fees incurred in connection with the lawsuit. Of these amounts, petitioner reported ordinary income of $35,328, and long-term capital gain of $9,129. 6 In his notice of deficiency, respondent disregarded the assignment to R & T Enterprises and determined that petitioner must report in his individual capacity ordinary income of $107,422 and long-term capital gain of $9,129. 7532 OPINION The issue is whether petitioner validly assigned an interest in his claim against his former law partners, and if so, whether such assignment effectively shifted the burden of taxation on a portion of the damages recovered. For the following reasons, we conclude that petitioner assigned an interest in the lawsuit to Toni in her individual capacity and, therefore, he is not taxable on the portion of the damages attributable to that interest.Whether a transaction constitutes an assignment is a question which must be analyzed under state law. In the absence of a statute or decision by the Hawaii Supreme Court, this Court must apply what it determines the law to be after giving proper consideration to rulings of lower Hawaii courts. Commissioner v. Estate of Bosch,387 U.S. 456">387 U.S. 456 (1967).The parties have not cited any Hawaii case involving facts similar to those in the instant case, nor has our research uncovered any such case. Generally, however, under common law a person533 may assign any right of action arising out of a contract or any interest he might have in the proceeds of a claim. See El Rancho, Inc. v. First Nat. Bank of Nevada,406 F.2d 1205">406 F.2d 1205 (9th Cir. 1968), cert. denied 396 U.S. 875">396 U.S. 875 (1969); Webster v. USLIFE Title Company,123 Ariz. 130">123 Ariz. 130, 598 P.2d 108">598 P.2d 108 (1979); In re Behm's Estate,117 Utah 151">117 Utah 151, 213 P.2d 657">213 P.2d 657 (1950); Staley v. McClurken,35 Cal. App. 2d 622">35 Cal.App. 2d 622, 96 P.2d 805">96 P.2d 805 (1939). To establish such an assignment it is sufficient that the parties' actions shown an intention to assign and there is valuable consideration for the assignment. See Webster v. USLIFE Title Company,supra;Robert Wise Plumbing and H., Inc. v. Alpine Development Co.,72 Wash.2d 172, 432 P.2d 547">432 P.2d 547 (1967). During their marriage, petitioner and Toni owned property both separately and jointly. In connection with their impending divorce, they agreed to divide their assets equally. At such time, however, the value of petitioner's claim against his former partners was undeterminable. Moreover, excluding petitioner's claim, the value of Toni's separate property534 exceeded the value of petitioner's separate property. Consequently, the parties agreed to hold all of their assets, including petitioner's claim against his former partners, for their joint benefit regardless of who actually held title to the assets. Clearly, the parties' objective was to enter into an arrangement for the co-ownership of their assets which would continue until those assets could be split-up equally, In effect, Toni was to receive an interest in petitioner's separately owned property, including an interest in petitioner's lawsuit against his former partners, and petitioner was to receive an interest in Toni's separately owned property. Thus, in 1976 when petitioner was awarded damages, he paid $41,625 of the proceeds to Toni in satisfaction of her rights to those proceeds. Clearly then, petitioner intended to assign an interest in the proceeds, and there was valuable consideration for such assignment. Accordingly, we find petitioner made a valid assignment under state law of an interest in the proceeds to Toni, and that the payment of $41,625 of the proceeds to Toni was consistent with that interest. 8535 Notwithstanding the existence of a valid assignment, respondent contends any such assignment constitutes an anticipatory assignment of income and, thus, the burden of taxation on the arbitration award falls entirely on petitioner. We disagree. In Jones v. Commissioner,306 F.2d 292">306 F.2d 292 (5th Cir. 1962), revg. a Memorandum Opinion of this Court, the taxpayer assigned to a corporation in which he owned 67 percent of the stock his interest in a claim against the United States Government. The claim for additional compensation arose out of services the taxpayer performed as a subcontractor on a government construction project. Applying a facts and circumstances test, the Fifth Circuit Court of Appeals held the assignment did not constitute an anticipatory assignment of income and, thus, the taxpayer was not taxable on the amount ultimately recovered on the claim. After a thorough review of the assignment of income doctrine which originated in the landmark case of Lucas v. Earl,281 U.S. 111">281 U.S. 111 (1930), the Fifth Circuit Court of Appeals based its conclusion in Jones upon the following factors: the claim was uncertain, doubtful, and contingent at the536 time of the assignment; the assignment was an arm's-length transaction, not involving a gift or gratuity; the assignment was not made in the same taxable year in which the claim was paid; and the assignment arose out of the legitimate exercise of reasonable business judgment and for a business purpose. Significantly, these same factors are present in the instant case. When petitioner assigned Toni an interest in his claim against his former partners, recovery was clearly uncertain. The arbitration decision was not made until more than one year after the assignment. Prior to this decision, petitioner was subject to several counterclaims by the defendants which, if upheld, would have more than offset any recovery by petitioner. The outcome of a lawsuit is rarely, if ever, certain or free of doubt, and nothing in the record suggests that the outcome of petitioner's lawsuit was any more predictable. Moreover, unlike most other cases where assignment of income principles have been applied, the assignment herein did not involve a gift or a gratuity. Rather, the assignment was made solely to effectuate an equal division of property in connection with the parties' divorce. At the537 time of the divorce, the value of petitioner's claim against his former partners was undeterminable. Excluding petitioner's claim, the value of Toni's separate property exceeded the value of petitioner's separate property. Instead of estimating the value of petitioner's claim and thereby risking an unequal division, petitioner assigned an interest in the proceeds to Toni. Thus, the assignment was for a legitimate non-tax purpose, that is, to carry out an equal division of their property. Furthermore, the parties' competing interests in dividing up their assets indicate the assignment was also the result of an arm's-length transaction. In summary, we are presuaded by the Fifth Circuit's analysis in Jones v. Commissioner,supra, and find that it is fully applicable to the facts before us. Moreover, where there is an arm's-length assignment of income rights for valuable consideration, this Court has recognized such assignment for tax purposes. 9 See Cotlow v. Commissioner,22 T.C. 1019">22 T.C. 1019 (1954), affd. 228 F.2d 186">228 F.2d 186 (2d Cir. 1955). Accordingly, 538 we hold that the assignment herein was not an "anticipatory assignment of income;" thus, petitioner is not taxable on the portion of the damages previously assigned to Toni. 10*539 To reflect concessions and the foregoing, Decision will be entered under Rule 155.Footnotes1. With respect to petitioner's claim, the parties agreed to share only the proceeds remaining after petitioner paid off alimony obligations to his first wife, Esther.↩2. The term "partnership" is used herein only for descriptive purposes and is in no way intended to imply that petitioner and Toni established a valid partnership for Federal income tax purposes. See text, infra.↩3. It was agreed under the Kamuela agreement that the partnership would pay Toni $6,000 per year to serve as a legal assistant at the Kamuela office. The arbitrator determined that this provision "was intended in the nature of an expense allowance for [petitioner's] benefit" and, therefore, awarded petitioner $6,000 on such basis. Petitioner was also awarded interest of $1,348 on such amount.↩4. After paying $37,576 in legal fees, $26,638 to his first wife, see n. 1, supra,↩ and $41,625 to Toni, petitioner was left with $42,598 out of the total $148,437 award.5. R & T Enterprises determined that the portion of the award based on petitioner's share of the goodwill of the law firm ($8,700) and the appreciation in the value of the real property owned by the law firm ($429) represented items of long-term capital gain, that the portion of the award based on petitioner's capital account ($24,538) represented a non-taxable return of basis, and that the remainder of the award ($114,770) was based on items of ordinary income. ↩6. The ordinary income of $35,328 represents the items of ordinary income reported by R & T Enterprises ($114,770), less the deduction taken by R & T Enterprises for legal fees ($37,818), and less the amount paid to Toni ($41,625). Petitioner does not explain why the long-term capital gain ($9,129) was allocated entirely to him. ↩7. Respondent allocated to Toni that portion of the award which was attributable to petitioner's "expense allowance" under the Kamuela agreement. See n. 3, supra. Accordingly, respondent determined that petitioner must report ordinary income of only $107,422 rather than the full $114,770 reported by R & T Enterprises. Respondent also determined that petitioner was entitled to a deduction of $36,073 for legal expenses incurred in connection with the lawsuit.↩8. Petitioner contends the claim against his former partners was assigned to R & T Enterprises and, therefore, he is taxable only on his distributive share of R & T Enterprises' income. Respondent asserts that no such assignment could have occurred because R & T Enterprises was not a partnership for Federal income tax purposes. On this narrow point we agree with respondent. The record clearly indicates that petitioner and Toni viewed the partnership agreement as simply another method to establish an arrangement for the co-ownership of their assets until those assets could be split-up equally. It was not their intention to join together in the present conduct of a business. They never conducted business under the name of the partnership, never conveyed any of their assets to the partnership, never maintained books and records on behalf of the partnership, and never opened a partnership bank account. Furthermore, they never endorsed the proceeds of the arbitration award to the partnership even though such proceeds had allegedly been assigned to the partnership. Accordingly, we conclude that R & T Enterprises was not a valid partnership for Federal income tax purposes; it constituted at most a continuation of the co-ownership arrangement previously agreed upon by the parties. See Commissioner v. Culbertson,337 U.S. 733">337 U.S. 733 (1949); Commissioner v. Tower,327 U.S. 280">327 U.S. 280 (1946). Additionally, neither of the parties herein argues that petitioner assigned an interest in his lawsuit to a trust. Significantly, the record shows no trust was established in accordance with the terms of the property settlement agreement.↩9. Respondent argues in the alternative that petitioner's assignment of an interest in the lawsuit was itself a taxable event. However, since the assignment occurred in 1975, it is unnecessary for us to consider such argument since petitioner's 1976 taxable year is the only year before us. Furthermore, we refuse to consider the "duty of consistency" argument respondent raises on brief for the first time. "Duty of consistency" is an affirmative defense which must be pleaded and proved by respondent. Southern Pacific Transportation Co. v. Commissioner,75 T.C. 497">75 T.C. 497, 838 (1980). Respondent has failed to plead that petitioner owes a duty of consistency herein. This Court simply will not consider issues not raised in the pleadings. Rollert Residuary Trust v. Commissioner,80 T.C. 619">80 T.C. 619 (1983); Kutsunai v. Commissioner,T.C. Memo. 1983-182↩. 10. Based on our conclusions herein, the amount and character of petitioner's taxable gain must be determined. This determination is a proper subject for the parties under Rule 155, Tax Court Rules of Practice and Procedure.Under the tax law, it is well-settled that an award for damages takes on the character of the underlying claims. Woodward v. Commissioner,397 U.S. 572">397 U.S. 572 (1970); Roemer v. Commissioner,79 T.C. 398">79 T.C. 398, 405 (1982), on appeal (9th Cir., Nov. 15, 1982); Sanders v. Commissioner,21 T.C. 1012">21 T.C. 1012 (1954), affd. 225 F.2d 629">225 F.2d 629↩ (10th Cir. 1955). With respect to the damages awarded on petitioner's claim, $119,048 of the award was based on items of ordinary income (petitioner's share of the law firm's 1973 income, the law firm's accounts receivable, his expense allowance, and interest); $9,129 of the award was based on items of long-term capital gain (petitioner's share of the law firm's goodwill and the appreciation in the value of real property owned by the law firm); and $24,538 of the award was based on a non-taxable return of petitioner's capital investment in the law firm. The computation of petitioner's taxable income must reflect the above allocations and our ultimate finding that $41,625 of the total award was assigned to Toni.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621414/	R. C. Owen Company (a Kentucky corporation) v. Commissioner.R. C. Owen Co. v. CommissionerDocket No. 91234.United States Tax CourtT.C. Memo 1964-120; 1964 Tax Ct. Memo LEXIS 216; 23 T.C.M. (CCH) 673; T.C.M. (RIA) 64120; April 30, 1964William Waller, American Trust Bldg., Nashville, Tenn., and Robert G. McCullough, for the petitioner. William F. Franklin, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined deficiencies in petitioner's income tax for the taxable years and in the amounts set forth below: Taxable YearDeficiency1954$4,145.1519554,368.0019564,368.00 The principal issue presented for decision is whether respondent erred in determining that petitioner was not entitled to deductions claimed in each of the years 1954, 1955 and 1956 as interest paid on certain of its securities called Debenture Bonds because the so-called debentures did not represent bona fide indebtedness, 217 and the payments made thereon were not deductible as interest. Findings of Fact Many of the facts were stipulated by the parties. Their stipulation, together with attached exhibits, is incorporated herein by this reference. R. C. Owen Company (hereinafter referred to as petitioner) is a Kentucky corporation having its principal place of business in Hopkinsville, Kentucky. Its Federal income tax returns for the calendar years 1954, 1955 and 1956 were filed with the district director of internal revenue, Louisville, Kentucky. Petitioner was organized on November 23, 1946, to acquire, and on January 1, 1947 did acquire the family partnership of R. C. Owen Company, manufacturers of hardwood flooring and allied products, the partners being R. C. Owen and his two sons, R. C. Owen, Jr., and Roy Owen. The interest of the father in the partnership was 72 percent and that of the two sons was 14 percent each. In exchange for the business and assets of the partnership, petitioner issued to the partners 20,000 shares of common stock of the par value of one dollar per share and $340,000 of 20-year Three and One-Half Per Cent Debenture Bonds, the stock and debentures being issued to the218 partners in exactly the same proportion as their interests had been in the partnership. Each of these debentures contained the following provisions: This Debenture Bond may be called and paid at any time up to and including January 1, 1957, at the price of 101% of principal and all accrued and unpaid interest, and thereafter at par plus accrued and unpaid interest * * . Interest shall cease on any Debenture Bond, or that part of it called for redemption on the date fixed for redemption * . All Debenture Bonds called and redeemed by the Company shall be cancelled and not reissued. Until the entire amount of Debenture Bonds of this series are paid in full, R. C. Owen Company covenants and agrees not to mortgage, pledge, or place any lien on any property of the Company to secure indebtedness, other than notes for deferred purchase price of realty or personalty secured by a lien on the property purchased or retention of title of personalty, and that it will maintain net current assets in the amount of $100,000, or fifty per cent of the outstanding Debenture Bonds, whichever amount is smaller. The placing of a lien in violation of this agreement or failure to maintain net current219 assets as herein provided, constitutes an event of default. By the acceptance of this Debenture Bond, the holder hereof, for himself and all subsequent holders expressly agrees that this Debenture Bond shall be subject and secondary to any and all indebtedness incurred by R. C. Owen Company, to banks or to others in the ordinary course of business. This subordination shall cease when surplus equals the amount of these outstanding Debenture Bonds. Any and all provisions and agreements of this Debenture Bond, insofar as they affect the holders hereof, may be changed, altered, or amended by a vote in writing of the holders of these Debenture Bonds holding seventy-five per cent of the principal amount thereof. To accomplish this, a writing shall be executed, signed by at least seventy-five per cent of said holders and filed with the Company, and thereupon, the Company is authorized and empowered to execute new Debenture Bonds in exchange for the outstanding Debenture Bonds, with the alterations or amendments as provided in said instrument. In the event R. C. Owen Company fail to pay interest on this Debenture Bond when due, or commit any other event of default hereinabove set out, 220 then and in such event, and after thirty (30) days' notice in writing to the Company of the existence of the default, the holders of 75% in amount of Debenture Bonds then outstanding may declare the entire series of Debenture Bonds due and payable by a notice in writing to the Company, and such declaration shall mature all outstanding Debenture Bonds, with the same effect as if they had matured by lapse of time. Petitioner commenced business on January 1, 1947, with net assets (exclusive of the $340,000 in debentures) per books of $307,987.32. Included in these assets were (1) inventories which, although carried at a book value of $193,292.62, had a market value of perhaps twice that figure in consequence of the removal of O.P.A. price controls in November of 1946; and (2) fixed assets (plant and machinery) having a book value of $115,600.17 but a real value, as a result of postwar inflation, of substantially in excess of this figure. In December 1947, R. C. Owen, chairman of petitioner's board of directors, made an exchange with the two sons, giving 2,300 shares of the one dollar par value common stock to each in return for $2,300 of debentures from each son. By instrument dated221 December 1, 1947, R. C. Owen transferred his remaining 9,800 shares of stock to trustees for the benefit of his six children. 1 The trust deed was irrevocable, and by it R. C. Owen completely divested himself of voting rights and all other control of this stock. After this transaction, R. C. Owen owned $249,400 of the $340,000 of debentures, but he owned no formal stock whatever. Nevertheless, he continued to serve as chairman of petitioner's board of directors until several months prior to his death in 1961. There has been no default in petitioner's Debenture Bonds, as all payments upon them have been made when due. During the years 1947 to 1956 petitioner had the following earned surplus (per books) and paid the following dividends on its common stock: Earned SurplusDividendsYear12/31Paid1947$129,205.68 $01948179,850.0760,0001949227,115.2120,0001950332,435.9550,0001951399,789.9125,0001952431,033.7720,0001953454,394.6510,0001954462,910.0910,0001955546,778.641,0001956629,619.190222 Petitioner has also redeemed $100,000 of its Debenture Bonds as reflected below: YearR. C. OwenR. C. Owen, Jr.Roy OwenTotal1948$29,400$5,300$5,300$ 40,000194930,00030,000195022,0004,0004,00030,000Totals$81,400$9,300$9,300$100,000In 1962, pursuant to agreement of the then holders of petitioner's Debenture Bonds, 2 the debentures were amended in the following manner: (1) By eliminating the two sentences reading as follows: "… Any and all provisions and agreements of this Debenture Bond, insofar as they affect the holders hereof, may be changed, altered, or amended by a vote in writing of the holders of these Debenture Bonds holding seventy-five per cent of the principal amount thereof. To accomplish this, a writing shall be executed, signed by at least seventy-five per cent of said holders and filed with the Company, and thereupon, the Company is authorized and empowered to execute new Debenture Bonds in exchange for the outstanding Debenture Bonds, with the alterations or amendments as provided in said instrument." (2) By striking223 the language in the succeeding paragraph reading: "the holders of 75% in amount of Debenture Bonds then outstanding may declare the entire series of Debenture Bonds due and payable by a notice in writing to the Company, and such declaration shall mature all outstanding Debenture Bonds," to read: "the holder of any of said Debenture Bonds due and payable by a notice in writing to the Company, and such declaration shall mature such outstanding Debenture Bonds,". For each of the taxable years 1954, 1955 and 1956 petitioner deducted as interest expense the sum of $8,400, which it had paid to its debenture holders in those years. Respondent disallowed the claimed deductions on the ground that the same did not constitute "an allowable deduction under section 163 of the Internal Revenue Code of 1954." Opinion Section 163(a) of the 1954 Code permits a deduction for all the interest paid or accrued within the taxable year on "indebtedness". The issue to be decided in the instant case is whether petitioner's Debenture Bonds represent such an "indebtedness," or whether they evidence merely a proprietary equity on the part of the former partners. Resolution of this issue224 depends in general upon all the facts surrounding the issuance of the debentures and in particular upon the provisions of the instruments themselves. Petitioner's Debenture Bonds are by no means unambiguous documents. While unquestionably they contain some of the indicia of debt, they also contain numerous other characteristics which are peculiarly associated with stock. For example, upon their issuance they were subordinated to all other indebtedness of the corporation. Further, a default in their provisions is without effect absent a vote in writing of 75 percent in amount of the debenture holders. Finally, there is the reciation that "any and all provisions and agreements" of the debentures, "insofar as they affect the holders [thereof], may be changed, altered or amended by a vote in writing' of such holders "holding 75% of the principal amount" of the Debenture Bonds. Following notification of a vote for such a change or alteration, "the Company is authorized and empowered to execute new Debenture Bonds in exchange for the outstanding Debenture Bonds, with the alterations or amendments as provided in" the notification. Debenture bond provisions identical with these were225 construed by the Court of Claims in the case of R. C. Owen Company v. United States, 3180 F. Supp. 369">180 F. Supp. 369 (Ct. Cl. 1960) certiorari denied 363 U.S. 819">363 U.S. 819 (1960). Commenting upon the "amendment provisions" of such debentures, the Court of Claims observed: At the least, these provisions give certain important voting rights to the debenture holders. Although it may be that the entire provision only empowers 75% in amount of the debenture holders to make changes and alterations with the agreement of the corporation, it might well be contended that, by an affirmative vote of 75% in amount of the debenture holders, the provisions of the debentures may be changed at will, even to the extent of increasing the interest rate of accelerating the maturity. If such be the case, the holders of the debentures would have almost as much control of the corporation as common stockholders. Of similar import is the case of Luden's Inc. v. United States, 196 F. Supp. 526">196 F. Supp. 526 (E.D. Pa., 1961), involving the question of whether certain debenture bonds issued by Luden's company represented bona fide indebtedness. Contrasting Luden's debentures with those which had been the226 subject matter of R. C. Owen Company v. United States, supra, the District Court stated: In comparing the rights of the debenture holders in the case at bar with the unusual rights of those who held the disputed securities in the Owen case it becomes apparent that the rights of these debenture holders are quite pedestrian in character. These debenture holders do not have the right to rewrite the debentures as did the debenture holders in the Owen case, and by that means control the obligor corporation. We are in complete agreement with both the courts above quoted that "amendment provisions," such as are contained in the Debenture Bonds issued by petitioner herein, give to the holders thereof rights normally enjoyed only by common stockholders. Certainly provisions in a purported debt instrument which grant such substantial rights cast a serious doubt as to whether the holder of such an instrument is in fact a creditor of the issuing corporation. 227 Likewise, the subordination feature of petitioner's Debenture Bonds denigrates the existence of a debtor-creditor relationship between petitioner and its debenture holders. Petitioner's contention that the debentures were not subordinate during the taxable years at issue (because of an excess of surplus over the face amount of outstanding debentures) lacks relevancy to the crucial inquiry whether, at the time of their issuance, they represented true debt or merely a continuing proprietary equity. Moreover, as we see it, an "indebtedness" which is subordinate unless the business prospers (i.e., until such time as earned 4 surplus equals the amount of outstanding debentures) is no indebtedness at all, but rather a classic variety of risk capital. Nor is characterization of these Debenture Bonds as representing risk capital negatived by the factual pattern within which they were issued. The debentures certainly were not given, as is typical, in exchange228 for borrowed money, but rather appear to be the equity interest of the former partners clothed in the dress of corporate debt. 5 And their standing as indebtedness is further subject to attack because of the substantial identity of interest which existed between the holders thereof and petitioner's formal stockholders. Although it is true that after 1947 R. C. Owen owned no formal stock - he having in that year placed all of his stock in irrevocable trust for his children - it is inconceivable that as trust settlor he would thereafter act as a "creditor" in any way inimical to the stock which constituted the trust corpus.229 Under all the circumstances we are persuaded that petitioner's Debenture Bonds do not represent a bona fide indebtedness and we therefore hold that respondent did not err in disallowing to petitioner the claimed deductions for the years 1954, 1955 and 1956 on the ground that the same did not constitute interest on indebtedness within the purview of section 163(a) of the Internal Revenue Code of 1954. Decision will be entered under Rule 50. Footnotes1. The parties have erroneously stipulated that this instrument was executed in January 1948 despite the fact that it was dated and witnessed December 1, 1947.↩2. Being R. C. Owen, Jr., Roy Owen and the estate of R. C. Owen.↩3. Not petitioner herein, but a Tennessee corporation which was organized to acquire and did acquire the assets of a partnership engaged in the tobacco business (the partners having been R. C. Owen, R. C. Owen, Jr., and Roy Owen) in exchange for stock and debentures which for all practical purposes are indistinguishable from those involved in the instant case.↩4. The evidence establishes that petitioner has only one surplus account - that of "earned" surplus - thus eliminating the possibility that the term "surplus" as used in its debentures could refer to any other type of surplus.↩5. Compare Kraft Foods Company v. Commissioner, 232 F. 2d 118 (C.A. 2, 1956) reversing 21 T.C. 513">21 T.C. 513 (1954) wherein the Commissioner's argument that issuance of the controverted debentures brought in no new capital was rejected on the grounds that this principle could not be controlling "where, as here, the debenture is unambiguous and contains all the characteristics of a debt instrument." 232 F. 2d at 126↩. As has been pointed out, the debenture bonds involved herein are definitely not "unambiguous" and their resemblance to usual debt instruments is questionable.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621415/	DANIEL M. KELLMAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKellman v. CommissionerDocket No. 9314-79.United States Tax CourtT.C. Memo 1981-615; 1981 Tax Ct. Memo LEXIS 126; 42 T.C.M. (CCH) 1508; T.C.M. (RIA) 81615; October 22, 1981. 126 Held, petitioner did not substantiate the entire amount of the disallowed contributions and/or prove that the donee organizations were qualified under section 170(c)(2) to receive deductible contributions. Held further, petitioner did not substantiate disallowed expenses for medicine and drugs. Daniel M. Kellman, pro se. Wayne R. Appleman, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: Respondent determined a deficiency of $ 297 in petitioner's Federal income tax for 1976. After concessions by respondent, the issues remaining for our decision are (1) whether petitioner is entitled to a deduction for charitable contributions under section 170 1 and (2) whether petitioner has substantiated certain amounts claimed as a deduction for medicine and drugs under section 213. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner was a resident of Chugiak, Alaska, at the time the petition was filed in 127 this case. He timely filed a Federal income tax return for the 1976 taxable year. For approximately 6 to 8 months during 1976, petitioner lived near Anchorage with several other persons at 6721 East 11th Avenue, Chugiak, Alaska. Petitioner's mailing and legal address during 1976 and at the time of the filing of the petition with this Court was P.O. Box 383, Chugiak, Alaska. During this period petitioner was employed as the manager of "Paga Joes", a "topless, bottomless" nightclub located in Anchorage. Petitioner listed his occupation on his 1976 Federal income tax return as "warehouser". A checking account in the name of Universal Life Church of Snow was maintained with Peoples Bank and Trust in Anchorage during the year at issue. The mailing address listed on the checks and other bank records was P.O. Box 383, Chugiak, Alaska. The persons authorized to sign checks on the account were petitioner, his brother, Norman Kellman and a Ms. Elizabeth Curry. 2 The organization was unincorporated during 1976. Checks were 128 written on the account maintained in the name of the Universal Life Church of Snow for rent, telephone and utility expenses attributable to petitioner's residence at 6721 East 11th Avenue in Chugiak. 3 Petitioner also made payments toward the purchase and maintenance of a new 1975 Fiat automobile with checks written on the account. 4 Title to the automobile was in petitioner's name. Petitioner obtained a "CHARTER" from the Universal Life Church, Inc. of Modesto, California, dated November 10, 1975. The document is a one page certificate numbered 14,611 which reads: "This is to certify that UNIVERSAL LIFE CHURCH OF SNOW of CHUGIAK State or Province of ALASKA has been granted by Universal Life Church, Inc., Modesto." The Universal Life Church, Inc. was a qualified section 170(c) organization during 1976 but did not possess a group exemption. In 1976, petitioner wrote checks on his personal account payable to the Universal Life 129 Church of Snow totaling $ 1,550. Petitioner produced cancelled checks written in 1976 for contributions to NORML (National Organization for the Reform of Marijuana Laws) in the amount of $ 15.00 and to the ACLU (American Civil Liberties Union, Inc.) in the amount of $ 15.00. Petitioner claimed a deduction for charitable contributions on his 1976 income tax return in the total amount of $ 1,950.60. Respondent's notice of deficiency disallowed this deduction in full. On brief, respondent conceded the deductibility of several miscellaneous cash contributions in the total amount of $ 30.00. The remaining disputed amounts are as follows: Cash Contribution 5$ 1,850.00ACLU40.60NORML30.00The taxpayer also claimed medicine and drug expenses of $ 75.99 on his 1976 return. Petitioner produced cancelled checks substantiating his purchase of these items totaling $ 41.86.In his notice of deficiency, respondent disallowed the claimed deduction for medicine and drugs because the substantiated amount did not exceed 1 percent of petitioner's adjusted gross income. OPINION The issues for 130 our decision are whether petitioner is entitled to deductions for charitable contributions in excess of the amounts allowed by respondent and whether petitioner has substantiated amounts expended for medicine and drugs in excess of 1 percent of his adjusted gross income. Initially we note that deductions from Federal income tax are matters of legislative grace. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). As such, the burden of proving entitlement to a deduction is upon the taxpayer. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.CHARITABLE CONTRIBUTIONS The deductibility of $ 1,920.60 in claimed charitable contributions remains in dispute. We must determine whether the alleged donees are qualified under section 170(c) to receive deductible contributions and, if so, whether petitioner has adequately substantiated the amounts claimed to have been donated to these organizations. Section 170(a) allows as a deduction any charitable contribution which is made within the taxable year. The term "charitable contribution" is defined in subsection (c) as follows: (c) Charitable Contribution Defined.--For purposes of this section, 131 the term "charitable contribution" means a contribution or gift to or for the use of-- (2) A corporation, trust, or community chest, fund, or foundation-- (B) organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes or to foster national or international amateur sports competition (but only if no part of its activities involve the provisions of athletic facilities or equipment) or for the prevention of cruelty to children or animals; (C) no part of the net earnings of which inures to the benefit of any private shareholder or individual. The most substantial of the disputed deductions is a claimed cash contribution of $ 1,850. The parties stipulated that Mr. Kellman wrote checks on his personal checking account payable to the Universal Life Church of Snow totaling $ 1,550. Respondent's position is that petitioner has not substantiated that any amount in excess of $ 1,550 was transferred to the organization and, in addition, that the organization does not meet the requirements of section 170(c)(2). Petitioner argues that the Universal Life Church of Snow is an integral and inseparable part of the Universal Life Church, Inc., of Modesto, 132 California. As such, Mr. Kellman would have us find that that organization's recognized tax exempt status under section 501(c)(3) extends to the purported branch. Although it was stipulated that the Modesto organization was a qualified section 170(c) organization itself during 1976, 6133 there was no evidence that it had applied for or received a group exemption. Petitioner's sole evidence was the testimony of his witness, "Bishop" Valiente, a truck driver and the purported Alaska resident agent for the Universal Life Church, Inc. Mr. Valiente testified that the Church considers itself and all its "congregations" to be only one organization. While this may be the viewpoint of Universal Life Church, Inc., it does not suffice to carry petitioner's burden of proof as to the status of the Universal Life Church of Snow for Federal income tax purposes. Thus, we find petitioner has not satisfied his burden of showing that the donee organization is entitled to the benefit of the tax exempt status of the Modesto organization. Except for producing a "CHARTER" from the Universal Life Church, Inc. and stating that he was a minister, petitioner refused to present (on First Amendment grounds) any evidence concerning the organization or operation of the Universal Life Church of Snow. Mr. Kellman steadfastly asserted that the church's affairs were not at issue here and that this Court was not entitled to inquire into such matters. We have held, however, that a taxpayer cannot simultaneously claim a deduction from Federal income tax and a First Amendment privilege as to the same operative facts. The right of an organization or the individual controlling it to declare that information is or is not relevant in a determination of the status of that organization for Federal income tax purposes is clearly beyond the limits of the First Amendment's guarantee of freedom of regulation. Bronner v. Commissioner, 72 T.C. 368">72 T.C. 368 (1979); General Conference of the Free Church of America v. Commissioner, 71 T.C. 920">71 T.C. 920 (1979). At trial respondent introduced the subpoenaed checking account records of the Universal 134 Life Church of Snow for 1976. This evidence shows that substantial amounts of the organization's funds were used to pay rent, telephone and other utility expenses attributable to petitioner's personal residence. In addition, its funds were used to make payments toward the purchase and maintenance of a new 1975 Fiat automobile registered in petitioner's name. 7 Presented with this compelling and uncontradicted evidence we reach the required conclusion that the Universal Life Church of Snow was not organized and operated exclusively for religious purposes as required by section 170(c)(2). Rather, it existed merely to transform petitioner's nondeductible personal living expenses into deductible charitable contributions. 8135 Thus, we find that the Universal Life Church of Snow does not meet the requirements of section 170(c) and, accordingly, respondent's determination disallowing the claimed contribution to that organization is sustained. 9 Mr. Kellman also claimed a deduction in the amount of $ 30.00 for a contribution to NORML. Petitioner produced a receipt in the form of a cancelled check payable to that organization in 1976 in the amount of $ 15.00. However, NORML was not an organization recognized 136 by respondent as a qualified donee 10 in 1976 and petitioner has not offered any evidence demonstrating that NORML meets the requirements of section 170(c). Thus, we sustain respondent's disallowance of the entire claimed deduction. The final disputed charitable contribution is petitioner's deduction of $ 40.60 for a contribution to the ACLU. Although certain branches of that organization were recognized by respondent as qualified to receive donations deductible to the donee in 1976, petitioner has not presented any evidence as to which branch his contributions were made nor substantiated the amount of his contribution in excess of $ 15.00. Thus, we are unable to conclude that respondent's disallowance of the deduction was in error. MEDICINE AND DRUGS The final issue for our determination is whether petitioner is entitled to a medical expense deduction attributable to his purchase of medicine and drugs in 1976. Such expenses are deductible under section 213 only if, and to the extent (1) they exceed 1 percent of adjusted gross income and (2) that excess together with the taxpayer's remaining medical expenses exceeds 3 percent of adjusted 137 gross income. 11Petitioner listed expenses for medicine and drugs totaling $ 75.99 on Schedule A of his 1976 Federal income tax return. After subtracting $ 55.75 (1 percent of his adjusted gross income), he arrived at a net deduction of $ 20.24. Petitioner provided cancelled checks substantiating $ 41.86 of these expenses but failed to produce any evidence explaining the additional amount claimed. 12138 The sole argument for deductibility urged by petitioner is that the claimed amount is reasonable in light of his other uncontroverted medical expenses. 13However, as previously discussed, respondent's disallowance of a deduction is presumed to be correct and thus the burden of proving entitlement to such deduction rests on the taxpayer. Welch v. Helvering, supra; Rule 142(a), supra. We have been given to probative evidence that any additional amounts were spent for medicine and drugs. A claim of reasonableness alone does not provide us with a sufficient basis to find that the disallowed expenses were in fact incurred. Accordingly, we find for respondent on this issue. Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, and in effect during the year in issue.↩2. On the bank's records petitioner was designated as the pastor, Ms. Curry as the secretary and Norman Kellman as the treasurer of the Universal Life Church of Snow.↩3. Checks written on the account during 1976 for rent attributable to petitioner's residence totaled $ 1,925. ↩4. Checks written on the account during 1976 payable to "AlaskaUSA Federal Credit Union" attributable to the purchase of the automobile totaled $ 1,350.↩5. The donee of the $ 1,850 claimed cash contribution was unspecified on schedule A of petitioner's 1976 return.↩6. The Universal Life Church, Inc. of Modesto was held to be a tax exempt organization under section 501(c)(3) in Universal Life Church, Inc. v. United States, 372 F. Supp. 770">372 F. Supp. 770 (E.D. Cal. 1974). However, the holding in that case only applied to the parent church. See Reimers v. Commissioner, T.C. Memo. 1981-456↩.7. In fact, of the total $ 5,544.38 in checks written on the organization's account in 1976 all but $ 42.00 was paid directly to petitioner or was used to pay his rent, utilities, and automobile expenses. ↩8. The term "charitable contribution" itself is synonomous with the word "gift." Dejong v. Commissioner, 36 T.C. 896">36 T.C. 896 (1961), affd. 309 F.2d 373">309 F.2d 373 (9th Cir. 1962). This Court has held that the presence of a substantial direct personal benefit inuring to the taxpayer is fatal to the characterization of the payments as charitable contributions. Seed v. Commissioner, 57 T.C. 265">57 T.C. 265, 276↩ (1971). 9. The petitioner alternatively attempted to substantiate his contribution by producing an undated form letter from the Universal Life Church, Inc., of Modesto, California, stating that Mr. Kellman had contributed $ 1,850 to that organization in 1976. The document was admitted into evidence solely for the purpose of showing that petitioner received such a document. Considering the record as a whole we attach no weight to petitioner's testimony on this point and decline petitioner's invitation to find that he contributed $ 1,850 to Universal Life Church, Inc., of Modesto, California.↩10. See Rev. Proc. 72-39, 2 C.B. 818">1972-2 C.B. 818↩.11. Section 213 provides in relevant part as follows: (a) Allowance of Deduction.--There shall be allowed as a deduction the following amounts, not compensated for by insurance or otherwise-- (1) the amount by which the amount of the expenses paid during the taxable year * * for medical care of the taxpayer * * * exceeds 3 percent of the adjusted gross income. (b) Limitation with Respect to Medicine and Drugs.--Amounts paid during the taxable year for medicine and drugs which (but for this subsection) would be taken into account in computing the deduction under subsection (a) shall be taken into account only to the extent that the aggregate of such amounts exceeds 1 percent of the adjusted gross income.↩12. Because $ 41.86 does not exceed 1 percent of the taxpayer's adjusted gross income, respondent's disallowance of the additional $ 34.13 claimed effectively eliminates the entire deduction for medicine and drugs. 13. Respondent initially allowed $ 748 in other medical expenses and on brief conceded $ 224 in transportation expenses for a total of $ 972.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621417/	Donald G. Peters and Ruth A. Peters v. Commissioner.Peters v. CommissionerDocket No. 6260-69 SC.United States Tax CourtT.C. Memo 1970-314; 1970 Tax Ct. Memo LEXIS 46; 29 T.C.M. (CCH) 1440; T.C.M. (RIA) 70314; November 16, 1970, Filed. Sherwin C. Peltin, 633 W. Wisconsin Ave., Milwaukee, Wis., for the petitioners. Matthew Stanley, Jr., for the respondent. FAYMemorandum Opinion FAY, Judge: Respondent determined a deficiency of $691.32 in petitioners' income tax for the taxable year 1967. Concessions having been made, the only issue to be decided is to what extent real property taxes paid to the City of Milwaukee are deductible by petitioners. All47 of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. During the taxable year 1967 petitioners resided in Milwaukee, Wisconsin, and filed a joint Federal income tax return, using the cash method of accounting, with the district director of internal revenue for the district of Wisconsin. Ruth Peters is a party to this action only by virtue of having filed a joint return, and, therefore, Donald Peters will hereafter be referred to as petitioner. On March 1, 1965, petitioner was granted by warranty deed an undivided two-thirds interest as a tenant in common in certain real property. The other one-third interest in the property was owned by June Noah. The real estate was located in the City of Milwaukee. Pursuant to its taxing authority the City of Milwaukee issued a bill for 1966 real property taxes of $594.22. This bill was paid on June 24, 1967, no portion of the tax being actually paid by June Noah. Payment of the taxes was made by the First Wisconsin National Bank, as mortgagee, from an escrow account maintained by the bank for such purpose. The bank has no interest in the property other than as48 mortgagee. Monthly payments were made to the First Wisconsin National Bank, as mortgagee, including amounts held in escrow for the payment of real estate taxes. These payments were made by Rodon, Inc., a Wisconsin corporation, having no record interest in the property and acting as a mere conduit. Petitioner, Robert P. Peregrine, and Edward R. Cameron each deposited in Rodon's bank account an equal share of the amounts of the checks issued by Rodon to the bank. Neither Peregrine nor Cameron has a record interest in the real estate. Petitioner asserts, in an amended petition, that the entire amount of the taxes paid are deductible from his 1967 income. Respondent claims that having only paid one-third of the taxes out-of-pocket, petitioner is entitled to a deduction only to that extent. Section 164 1 provides that a cash basis taxpayer may deduct local real property taxes when paid. Section 1.164-1(a), Income Tax Regs., specifies the person entitled to the deduction, stating, "In general, taxes are deductible only by the person upon whom they are imposed." In the case of taxes imposed on property owned by tenants in common, both tenants are equally bound to discharge the obligation. 49 Where, because it is necessary to preserve a tenant's interest in the undivided whole, one tenant pays the entire amount of taxes due, he should be entitled to a deduction for the amount of taxes paid. See Estate of Mary Rumsey Movius, 22 T.C. 391">22 T.C. 391 (1954). 2 It is clear in the case before us that had petitioner issued payment in full of the tax bill directly to the City of Milwaukee, his right to a deduction would be uncontestable. In the case before us, however, petitioner not only employed two intermediaries but also claims a deduction for a portion of the taxes paid by two unrelated parties.That petitioner employed intermediaries in paying the tax is not fatal to his claim. Taxes paid by a mortgagee on behalf of the landowner are deemed paid50 by the landowner. Norman Cooledge, 40 B.T.A. 1325">40 B.T.A. 1325 (1939). First Wisconsin National Bank acted in the capacity of mortgagee at the time it paid the taxes. As to Rodon, Inc., the intermediary which furnished the funds used to pay the taxes, 1442 we believe, as the parties apparently agree, that it acted merely as a conduit and as such should be disregarded for purposes of determining the propriety of the deduction at hand. This leaves as the only matter for consideration the argument of respondent that in order to qualify as a deduction the payment of taxes must have been either an out-of-pocket expenditure of petitioner or directly attributable to him. Respondent applies this argument to the facts of the present case and concludes that two-thirds of the taxes paid were paid by Peregrine and Cameron; petitioner has not disclosed the relationship of these parties to himself nor offered any other proof tending to show that the payments made by the third parties are in any way attributable to him; therefore, petitioner is at most entitled to a deduction of only one-third of the amount paid for taxes. We disagree with respondent's basic premise. There is no specified51 statutory requirements that the payment of taxes be an out-of-pocket expenditure of, or directly attributable to, the property owner seeking the benefit of the deduction. 3 The exact relationship between petitioner, Peregrine, and Cameron is undisclosed by the record. It is clear to us that the satisfaction of petitioner's tax obligation confers a benefit on petitioner in the nature of either income, a loan, repayment of a loan, or a gift. See Old Colony Tr. Co. v. Commissioner, 279 U.S. 716">279 U.S. 716 (1929). The record is void of any evidence enabling us to decide which of the above classifications pertains to the case before us, nor is such a decision necessary. Regardless of whether satisfaction of petitioner's obligation is income, a gift, a loan, or repayment of a loan, at least to the extent that it satisfies his obligation it should be deductible by him. 4 Had Peregrine and Cameron transferred the money to petitioner and he in turn used those funds to pay real estate taxes, his right to a deduction would be clear. A case such as the one before us, where third parties choose to omit a step and transfer funds directly to petitioner's obligee, should not be treated differently52 than if all intermediary steps had been taken. June Noah owns a one-third interest in the property and as such one-thord of the taxes owed was an obligation belonging to her. In the absence of proof that the payment by Peregrine and Cameron was not in part on her behalf we conclude that petitioner is entitled to a deduction for two-thirds of the taxes paid, i. e., $396.15. *53 Decision will be entered under Rule 50. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated. SEC. 164. TAXES. (a) General Rule. - Except as otherwise provided in this section, the following taxes shall be allowed as a deduction for the taxable year within which paid or accrued: (1) State and local, and foreign, real property taxes. ↩2. For a more recent case see Lulu L. Powell, T.C. Memo. 1967-32↩.3. On the contrary, sec. 1.164-6, Income Tax Regs.↩, provides for a deduction by the buyer or seller of all or a part of the real estate taxes paid, depending on the circumstances, regardless of who actually paid them. 4. For a revenue ruling holding that where a third party (a bank) satisfied a tax obligation of a taxpayer it was included in his income and deductible under sec. 164, see Rev. Rul. 69-497, 2 C.B. 23">1969-2 C.B. 23, where it says: It is held that if the national banks in Rhode Island elect to pay the tax assessed against depositors in order to compete with State banks and elect to receive no reimbursement from the depositors, the taxes so paid are deductible as business expenses under section 162 of the Code. Further, each depositor in such case is required, under the provisions of section 61 of the Code, to report as taxable income the amount of tax paid on his deposit and may deduct the amount as a tax paid under section 164(a) of the Code. See also Hazel McAdams, 15 T.C. 231">15 T.C. 231 (1950), aff'd 198 F. 2d 54 (C.A. 5, 1952); Royal Oak Apartments, Inc., 43 T.C. 243">43 T.C. 243↩ (1964).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621422/	Cecil R. Warren v. Commissioner. Cecil R. Warren and Helen M. Warren, (Husband and Wife) v. Commissioner.Warren v. CommissionerDocket Nos. 63272, 63281.United States Tax CourtT.C. Memo 1959-15; 1959 Tax Ct. Memo LEXIS 228; 18 T.C.M. (CCH) 75; T.C.M. (RIA) 59015; January 30, 1959James A. Ronayne, Esq., 120 Broadway, New York, N. Y., for the petitioners. James J. Quinn, Esq., and William T. Holloran, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion By a deficiency notice dated April 17, 1956, respondent determined deficiencies in income tax and additions to tax against Cecil R. Warren, petitioner in Docket No. 63272, for the years 1945 and 1946 as follows: Additions to Tax under294(d)294YearDeficiency293(b)(1)(A)(d)(2)1945$500.54$250.27$46.44$30.971946960.43480.2190.0060.00On the same date229 respondent determined deficiencies in income tax and additions to tax against Cecil R. Warren and Helen M. Warren, petitioners in Docket No. 63281, for the years 1947, 1948, and 1949 as follows: Additions to Tax under294(d)294YearDeficiency293(b)(1)(A)(d)(2)1947$ 1,638.60$ 819.30$ 91.3819481,456.76728.38$104.3989.48194949,344.8224,672.412,953.09The deficiencies result from respondent's determination that petitioners' taxable net income for the years in question exceeded the income reported as "computed upon the basis of increase in net worth during the taxable years, with adjustment for personal and other non deductible amounts paid." By affirmative allegations in respondent's answers the issue of fraud is raised. The parties have stipulated many facts relating to petitioners' net worth. As a result the principal issue is whether petitioners received gifts prior to October 1949 from the mother of petitioner Helen M. Warren and received in the latter part of 1949 assets and funds as an inheritance from her subsequent to her death on October 15 of that year, as petitioners contend, or, as respondent230 contends, the assets and funds received by petitioners were in reality theirs and were placed by them in the mother's estate as part of a scheme devised by petitioners for the purpose of fraudulently avoiding the ascertainment by respondent of their correct taxable income by use of the so-called net worth method. Findings of Fact We find the facts to be as stipulated by the parties and incorporate herein by this reference the stipulation of facts and supplemental stipulation of facts filed herein, together with the exhibits attached to such stipulations. Cecil R. Warren, one of the petitioners herein, was appointed to the Bureau of Internal Revenue, United States Treasury Department, on July 1, 1935, and remained in such employment until he resigned on October 31, 1950. His salary from 1935 through 1949 was in the following amounts for the years shown: YearAmount1935$1,300.0019362,600.0019372,600.0019382,800.0019392,800.0019402,900.0019413,200.0019423,800.0019433,800.0019444,600.0019455,153.6119465,738.1619476,337.7819486,822.0619497,451.48He was a very frugal person and spent little money during231 the period 1936 through 1949. On one occasion he bet on a horserace. Cecil R. Warren filed Federal income tax returns for the years 1945 and 1946 showing the receipt of taxable income in the following respective amounts: $5,153.61 and $5,808.16. Petitioners Cecil R. and Helen M. Warren, who were married in 1934, filed joint Federal income tax returns for the years 1947, 1948, and 1949 showing the receipt of the following amounts of taxable income: 1947$6,538.7519487,997.7519497,146.77For a short time after their marriage the petitioners resided with Helen Warren's mother, Rella Roakes, in Washington, D.C. In 1936 the petitioners purchased a home in Flushing, Long Island, New York, for the sum of $5,800, which they continued to own throughout the years 1936 through 1949. In 1936 the Warrens moved from Washington, D.C., to their residence in Flushing. At this same time Rella Roakes also moved to Flushing and resided with the petitioners until her death on October 15, 1949. In none of the income tax returns filed by petitioners was Rella Roakes named as a close relative with an income of less than $500 receiving more than one half of her support from petitioners, 232 and petitioners never claimed an exemption on account of her. However, in a Selective Service questionnaire filed in 1941 Cecil Warren stated that Rella Roakes was a dependent of his within the meaning of the Selective Service Act. Rella Roakes' first husband was Irby Reid, who was an employee of the Columbia Phonograph Company and later the Bridgeport Brass Works. In 1895 the Reids became the parents of a daughter, Rella Winn Reid (hereinafter sometimes referred to as young Rella). Around 1905 the Reids were divorced. Irby Reid subsequently remarried. When he died in 1924 he left nothing to his first wife. After her divorce from Reid in 1905 Rella married a sergeant in the United States Marine Corps named Olin W. Roakes. Petitioner Helen M. Warren is the daughter of Rella Roakes by this marriage and is the half sister of young Rella. Prior to 1912 young Rella lived with her mother and stepfather in Washington, D.C. In that year she married Arthur Erisman and moved to Brookline, Massachusetts. A daughter was born of this marriage. In 1920 Roakes resigned from the Marine Corps and moved with his wife to Brookline, Massachusetts. Erisman employed Roakes as a manager of one of his233 stores in Boston at a salary of $50 per week. Around 1923 Erisman and his wife had marital difficulties and separated. They were subsequently divorced around 1928. In 1924 young Rella went to New York for the purpose of "studying music" and was employed about that time by the late Florenz Ziegfeld, a theatrical producer. Subsequently, young Rella appeared in numerous musical comedy shows on Broadway and enjoyed a large income for a number of years. She made financial contributions to her mother and half sister during those years. Erisman continued to employ Roakes in Boston until 1928 and Rella Roakes kept house for Erisman. Roakes and his wife then returned to Washington, D.C., where he was employed by the Peoples Drug Stores. Commencing in 1924 and ending in 1936 young Rella's daughter lived with Rella Roakes, her grandmother. Young Rella gave her mother $50 a month to reimburse her for the expense of supporting her daughter and in addition thereto paid for her daughter's clothes. Rella Roakes owned two houses in Washington, D.C., one on South Dakota Avenue and the other on 20th Street, N.E. She purchased these houses with the help of gifts of money from her sister. Roakes234 died April 4, 1933, and left a negligible estate. Commencing in 1933 Rella Roakes received a pension from the United States Government which by the time of her death in 1949 had been increased to $40 per month. She was not regularly employed and was not engaged in any business or profession. In 1944 young Rella married a man named Seppeler. Rella Roakes executed a will on February 1, 1947, which provided as follows: * * "FIRST: I hereby revoke any and all other Wills, Codicils or instruments of testamentary disposition made by me at any time heretofore. "SECOND: I direct my executors hereinafter named to pay all of my just debts and funeral expenses as soon as practicable after my death. "THIRD: I give and bequeath to my daughter, RELLA WINN SEPPELER, my diamond ring containing three diamonds in a white gold setting; I also give and bequeath to my said daughter RELLA WINN SEPPELER the following pieces of hand-painted china: wine decanter, vase, tray and pitcher set, and two plate and teacup sets; and I also give and bequeath to my said daughter, RELLA WINN SEPPELER, a cemetery plot in Fort Lincoln Cemetery, Prince George County, Maryland, known as Site #2, Lot 119, 235 Section E. "FOURTH: I give and bequeath to my granddaughter, RELLA ESTHER GOECKER, my mink scarf containing three skins. "FIFTH: I give and bequeath to my great-granddaughter, ROSEMARY RICE, my sapphire lavalier with platinum chain. "SIXTH: I give and bequeath to my daughter, HELEN M. WARREN, for and during her natural life, hereby intending to create in my said daughter an estate for and during her natural life only, the following items: set of Haviland china; set of flat silverware; silver tea set of four pieces; and oil painting of Rella Winn Seppeler and frame. Upon the death of my daughter, HELEN M. WARREN, I direct that said property be distributed to my granddaughter, RELLA ESTHER GOECKER, to be hers absolutely. Should my granddaughter, RELLA ESTHER GOECKER, predecease my daughter, HELEN M. WARREN, I then direct that the property be distributed to and amongst the children of RELLA ESTHER GOECKER. "During such life estate my said daughter, HELEN M. WARREN shall, as such life tenant, be entitled to the possession of the above-described property, and shall not be required to give any bond, security or undertaking as such life tenant or by reason of such life estate. Neither236 my said daughter nor her estate shall be liable for any loss or damage in respect to the above-described property. I further direct that my said daughter shall not at any time during her lifetime be required to furnish any information or render any accounting whatsoever as to any of the above-described property. "SEVENTH: To my friend MRS. HEDY VOGEL, I give and bequeath my gold wrist watch and bracelet; to my friend MRS. ALICE MATTHEWS of Arlington, Virginia, I give and bequeath my gold breast pin set with diamonds, pearls and amethyst; to my friend MRS. FLORENCE PETRANEK I give and bequeath my pair of jet and gold earrings set with pearls; and to my friend MRS. THEOLINDA FAHIE I give and bequeath my cameo pin set in gold. "EIGHTH: I give, devise and bequeath all the rest, residue and remainder of my property and estate, real, personal and mixed, wheresoever situate, of which I may die seized or possessed or over which I may have testimentary control, or to which I may be entitled, of whatsoever the same my [may] consist, to my daughter, HELEN M. WARREN. Should my said daughter HELEN M. WARREN predecease me I then give, devise and bequeath all the rest, residue and remainder237 of my property to my daughter, RELLA WINN SEPPELER. "NINTH: I hereby designate and appoint my daughter, HELEN M. WARREN executrix of this my Last Will and Testament and direct that my said executrix herein shall be required to give no bond or other security. Should my said daughter HELEN M. WARREN fail to qualify, I then nominate and appoint my daughter RELLA WINN SEPPELER as executrix." * * A Federal income tax return for the calendar year 1948 was filed in the name of Rella Roakes with the collector of internal revenue for the first district of New York. This return reported the receipt of dividends in the amount of $650, interest in the amount of $200, and "other income" in the amount of $1,487.04. The last item was made up of capital gains calculated as follows: DateSellingGainName of SecurityAcquiredDate SoldCostPriceor LossUnited M&MMarch,April,$1,578.91$1,690.85$111.9419471948Baltimore & Ohio5/20/4810/11/481,417.001,573.96156.96Central Railroad ofN. J. Bonds5/20/4810/11/482,407.003,385.92978.92Universal Pictures10/15/4810/23/483,105.933,401.12295.19TOTAL TAXABLE GAIN:238 TAXABLEOver 6 mos.50%Name of SecurityLess 6 mos.100%United M&M$ 55.97Baltimore & Ohio156.96Central Railroad ofN. J. Bonds978.92Universal Pictures295.19$1,487.04No Federal income tax returns were filed in the name of Rella Roakes for the years 1936 to 1947 in the various districts of the Internal Revenue Service embracing the greater New York City area. In 1947 young Rella purchased a residence at Clinton Corners, Dutchess County, New York, for $16,000. This residence was adjacent to property subsequently purchased by the petitioners in 1949. In September of 1949 Cecil Warren agreed to purchase the aforementioned Clinton Corners property from young Rella for $17,000, plus approximately $1,000 for furnishings and equipment, both sums to be paid in cash, plus the assumption of a mortgage on the premises in the approximate amount of $9,000. As part of the terms of sale Cecil Warren paid a deposit of $5,000 in currency to young Rella which she needed and demanded in order that she could make a deposit on another residence that she had selected and a short time later gave to her $12,000 in currency. This other239 residence which she wanted very much to buy could be bought by her for $25,000 in cash. During the course of a visit by the petitioners and Rella Roakes to young Rella's residence in Clinton Corners in September of 1949 Rella Roakes, in the absence of petitioners, gave to young Rella Treasury bonds having a face value of $9,000, so that the latter could pay off the mortgage on her house. Rella Roakes had these bonds in a briefcase belonging to Cecil Warren. At the time Rella Roakes handed the bonds to young Rella she said something to the following effect: "I hand you these because if Cecil gave them to you then you - I mean you would say he gave them to you and I give them to you." Young Rella then redeemed these bonds for $9,324.79, deposited the proceeds in her account at the Bank of Millbrook, and used substantially all of the proceeds of the sale to pay off the existing mortgage on the property. On November 19, 1949, young Rella deeded her Clinton Corners property to the petitioners. This deed was recorded on December 1, 1950. On June 1, 1948, young Rella and her half sister, petitioner Helen Warren, entered into partnership formed for the purpose of raising and selling chickens. 240 Helen Warren's capital contribution to the partnership was $7,500 which she paid in currency. On December 17, 1949, after the death of Rella Roakes, the partnership was dissolved and young Rella drew a check payable to the order of "Helen M. Warren" in the amount of $1,584.15 in final settlement of the share of the partnership assets held in the name of Helen Warren and gave the check to her. Shortly thereafter Cecil Warren brought the check back to young Rella and asked her to add to the payee's name "(Executrix For estate of Rella M. Roakes)." Pursuant to Cecil Warren's request, and without asking for any further explanation, young Rella made the change requested. The check was then deposited in an account at the Manufacturers Trust Company entitled "Estate of Rella M. Roakes, dec'd, Helen M. Warren Executrix" on December 27, 1949. On the Federal estate tax return filed in the name of the estate of Rella M. Roakes this amount was reported as an asset of the estate. On October 15, 1949, Rella Roakes died and Helen Warren was appointed the executrix of the estate pursuant to Rella's will dated February 1, 1947. On December 13, 1950, an estate tax return was filed by the executrix241 with the collector of internal revenue, first district of New York, and was subsequently examined by an internal revenue agent who recommended that the return be accepted as filed. The internal revenue agent who examined the said estate tax return only concerned himself with the fact that the value of the assets, as reported, was correct. The Federal estate tax return was prepared by an attorney for the estate from information submitted to him by Helen Warren, with the exception of such financial data that would be in the possession of banks and brokerage firms. The Federal estate tax return reported a gross estate of $91,211.94, made up of the following: 7 United States Defense Bonds$ 156.5018 United States Savings Bonds384.5025 War Savings Bonds506.7548 Series E. Bonds917.1840M Treasury Bonds41,506.989M Treasury Bonds9,339.08Bank Account257.27Loans Receivable5,712.50Cash on Hand16,200.00Cash from Interest Coupons612.50Building and Loan Association1,570.09Proceeds from Sale of Chickens atClinton Corners, New York1,584.15Credit Balance in Laidlaw & Co.7,800.86Income Tax Refund101.83Pension from United States Gov-ernment24.00One 1949 Mercury Station Wagon2,537.75One 1947 Packard1,000.00Personal Property1,000.00$91,211.94242 In addition to preparing an estate tax return on behalf of the estate of Rella M. Roakes, the attorney for the estate also prepared and filed an individual Federal income tax return for Rella M. Roakes, decedent, for the period January 1 to October 15, 1949. This return was signed by Helen M. Warren as executrix and was filed with the collector of internal revenue, Brooklyn, New York, on June 15, 1950. The information reported on this return was also obtained from Helen Warren. This return reported the receipt of dividends in the amount of $714.75, interest in the amount of $664.75, and "other income" in the minus amount of $702.12. This latter amount represented the total net amount of capital gains resulting from seven sales of four different stocks having an aggregate cost basis of $15,158.40 less half the total amount of capital losses of $2,363.74 resulting from two sales of stock in one corporation having an aggregate cost basis of $5,210.08. Shortly after Rella Roakes' death in 1949 Cecil Warren came to young Rella's residence and handed her what purported to be a copy of an affidavit of her mother. This affidavit read as follows: "I, Rella M. Roakes, residing at 162-14 71st243 Avenue, Flushing, N. Y., do hereby state and affirm the following: "I am past 65 years of age. I am a widow. I am the mother of Helen M. Warren, who is married to Cecil R. Warren and lives at 162-14 71st Avenue, Flushing, N. Y. "I hereby swear and affirm that I have made gifts to my daughter, Helen M. Warren of various amounts of cash each year since 1934, from $1000.00 to $5000.00 and other gifts of stocks and bonds and property. In addition I have made gifts to her for specific purposes, such as in 1936, when she and her husband bought their home. I gave them $1200.00 for their down payment. In 1946 I gave my daughter, Helen, a mortgage certificate of $2000.00, and in 1948 I gave her property on Eaton's Neck, Long Island. With respect to this property I did all of the preliminary negotiating in 1947. The purchase was not completed and, because of serious illness, I gave my daughter a Power of Attorney to not only complete the purchase of that property, but also over my personal property. The purchase was not completed until 1948, at which time I then decided my daughter should have the property in her own name. "In May 1949 I gave her and her husband $7000.00 to buy property244 in Dutchess County, N. Y. "I hereby further swear and affirm that I have an older daughter to whom I have made substantial gifts at different times. I gave her $750.00 in 1941 to buy an automobile. In 1947 I gave her $6000.00 to buy her home. During 1949 I have given her approximately $30,000, of which $9000.00 has been used to pay off the mortgage on her home." Cecil Warren then asked young Rella to memorize the contents of the document as he was being investigated and "in case any of the boys came around" she would be able to remember it. In 1948 Helen Warren obtained title to real estate located at Eaton's Neck, Suffolk County, New York. The purchase price of this property was $8,400. Payment was made in the form of $4,000 in cash and a mortgage in the amount of $4,400. The cash payment included a check in the amount of $2,500 payable to Rella Roakes and endorsed by her to the sellers. The parties have stipulated that Rella Roakes transferred to petitioners in May 1949 the sum of $7,128.77, representing the proceeds from the sale of United States Treasury bonds sold for her account by the National Safety Bank & Trust Company. In Schedule G of the estate tax return filed245 by Helen M. Warren as executrix the answer "no" was given to the question: "Did the decedent, at any time, make a transfer of an amount of $5,000 or more without an adequate and full consideration in money or money's worth, but not believed to be includible in the gross estate as indicated in the first paragraph * * of the instructions for this schedule?" In the affidavit attached to this return and signed by Helen M. Warren was the statement: "* * * I have no knowledge of any transfers made or trusts created by the decedent during his lifetime of the value of $5,000 or more, other than bona fide sales for an adequate and full consideration in money or money's worth, except as stated in Schedule G * * ." On April 5, 1952, and in connection with the administration of the estate of Rella Roakes in the State court, Helen M. Warren signed an affidavit containing the following statements: "HELEN M. WARREN, being duly sworn deposes and says: I am the Executrix of the Estate of Helen M. Roakes. I am also her daughter. "For many years prior to my mother's death she lived with me. During all of these years my mother made gifts of money to both my sisters and myself to help us pay off246 our mortgage, to help us buy a car and in many instances to help us buy our clothes. For a great number of years prior to coming to live with us, my mother resided in Washington, D.C."My mother was a widow at the time of her death. To the best of my knowledge she never was engaged in any business or profession and particularly for the last fifteen years when she lived with me. "While residing with me, my mother had her own room and furniture. She came and went as she pleased without my inquiring into her affairs. "After her death I went through her affairs I found the cash and other items listed in the Estate schedules. The source of these items I have no way of knowing as I never questioned my mother. With respect to the jewelry these items were merely of sentimental value and had absolutely no market value. The stone with the diamond ring was merely chips and not real stones." On October 5, 1953, and in connection with the administration of the estate of Rella Roakes in the State court, Helen Warren signed an affidavit containing the following statements: "HELEN M. WARREN being duly sworn deposes and says: I am the executrix of the Estate of Rella M. Roakes. "At the247 time of my mother's death, she had a summer residence at Clinton Corners, New York, at which place she raised chickens and other live stock. She did not own the property. Immediately after her death I sold all of the live stock and whatever furnishings were in the house for which I received the sum of $1584.15, for the same. "Referring to my prior affidavit of April 5, 1952, the gifts that my mother made to my sister and myself, during the preceding five years prior to her death consisted of small sums of money, the aggregate of which did not exceed Five Thousand ($5,000.00) Dollars. None of these gifts were made in contemplation of death, and they were just given to us from time to time to help us defray our living expenses." On December 23, 1949, Newborg & Co., members of the New York Stock Exchange, sold on behalf of the estate of Rella M. Roakes "40M US Treas 2 1/2 67/72 Jun" bonds for $41,506.98 and "9M US Treas 2 1/2 67/72 Dec" bonds for $9,339.08 and remitted the proceeds to "Est. of Rella M. Roakes, Helen M. Warren, Exec." These bonds were received for sale by Newborg & Co. on December 22, 1949. The same number of the same bonds were listed as assets of the estate in the248 estate tax return at a "Value at date of death" identical to the amount of the proceeds received from Newborg & Co. Among the bonds sold by Newborg & Co. were 2 $1,000 bonds which had been bought by the Grace National Bank of New York from C. F. Childs & Co. on November 3, 1949, and 8 $1,000 bonds which had been sold by the Grace National Bank to the National Safety Bank & Trust Company on October 31, 1949. With the exception of these bonds and the items "proceeds from sale of chickens at Clinton Corners, N. Y." and "Pension from U.S. Government," there is no evidence as to the acquisition or ownership of any of the assets in the estate tax return of Rella M. Roakes. The stipulation of facts filed herein by the parties reads in part as follows: "4. As of December 31, 1944, 1945, 1946, 1947, 1948 and 1949 the balances in the savings account of Cecil and Helen Warren at the Federation Bank and TrustCompany, New York, were, respectively, as follows: $557.37, $863.81, $987.18, $1,358.15, $465.52 and $186.95. "5. As of December 31, 1947, 1948 and 1949 the balances in the savings account of Helen Warren at the Bank of Manhattan, New York, were, respectively, as follows: $887.29, 249 $568.30 and $2,750.34. "6. As of December 31, 1944, 1945, 1946, 1947, 1948 and 1949 the balances in the special checking account of Helen Warren at the Bank of Manhattan were, respectively, as follows: $176.37, $15.57, $183.37, $169.23, $248.54 and $137.86. "7. As of December 31, 1949 the balance in the regular checking account of Cecil and Helen Warren at the Bank of Millbrook was $661.51. "8. As of December 31, 1947, 1948 and 1949 the balance in the brokerage account of Cecil and Helen Warren at Laidlaw and Company, New York, New York, were, respectively, as follows: $163.44, $215.27 and $332.83. "9. As of December 31, 1947, 1948 and 1949 Cecil and Helen Warren held common stocks in their brokerage account at Laidlaw and Company which had a cost basis to them in the following respective amounts for the years aforementioned: $1,641.56, $5,507.92 and $3,813.88. "10. As of December 31, 1944, 1945, 1946, 1947, 1948 and 1949 there were United States Savings Bonds outstanding under the names of Cecil Warren and/or Helen Warren in the following respective amounts (cost basis): $1,856.25, $2,625.00, $412.50, $281.25, $225.00 and $243.75. "11. During the taxable year 1936 Cecil250 and Helen Warren purchased a home in Flushing, Long Island, New York, for the sum of $5,800.00, which they continued to own through the taxable years 1944 through 1949. As of December 31, 1944 and 1945 there was a mortgage liability outstanding on said home in the following respective amounts: $3,142.00 and $2,970.00. "12. On May 14, 1949 petitioners purchased a parcel of property located at Clinton Corners, New York, from a Mrs. Fischer for the sum of $16,000. As of December 31, 1949 said property had an outstanding mortgage liability of $9,250.00. "13. On May 9, 1949 the National Safety Bank and Trust Company paid by check to Rella Oakes $7,128.77, which represented the proceeds from the sale of United States Treasury Bonds sold by it for the account of Rella Oakes. The check was endorsed by Rella Oakes to Rella Roakes, who were one and the same person. Said check was then endorsed to the order of Helen M. Warren and/or Cecil R. Warren and was deposited in the Bank of Millbrook in the account of Cecil R. Warren and Helen M. Warren on May 13, 1949. "14. During the taxable year 1949 the petitioners purchased kitchen equipment from Cox Kitchens, Portchester, New York, in the amount251 of $1,939.00. Said purchase was paid by a check drawn on the account of the estate of Rella M. Roakes. "15. During the taxable year 1949 the petitioners contracted for the construction of a new residence on property located at Clinton Corners, New York, for the sum of $33,500. As of December 31, 1949, there was an outstanding loan payable on the construction of said new residence in the amount of $32,131.98. * "20. During the taxable years 1945, 1946, 1947, 1948 and 1949 the petitioners paid the following respective amounts in Federal and state income taxes: $800.00, $790.00, $854.00, $921.00 and $900.00. "21. During the taxable years 1946, 1947, 1948 and 1949 petitioners paid the following respective taxes on their home at Flushing, New York: $186.00, $212.00, $211.00, and $209.00. "22. During the taxable year 1948 the petitioners spent $72.00 on insurance for their Flushing, Long Island, New York, home. "23. During the taxable years 1945, 1946, 1947, 1948 and 1949 petitioners expended the following respective amounts for life and accident and health insurance premiums: $438.00, $438.00, $1,094.00, $1,094.00 and $1,094.00. "24. During the taxable years 1945, 1946, 252 1947, 1948 and 1949 the petitioners expended the following respective amounts for utilities services in their home: $400.00, $400.00, $420.00, $440.00 and $460.00. "25. During the taxable years 1945, 1946, 1947, 1948 and 1949 the petitioners expended the following respective amounts for food: $1,040.00, $1,300.00, $1,450.00, $1,560.00 and $1,560.00. "26. During the taxable years 1945, 1946, 1947, 1948 and 1949 the petitioners expended the following respective amounts for lunches, transportation fares, papers, and cigarettes: $520.00, $520.00, $520.00, $520.00, and $520.00. "27. During the taxable years 1945, 1946, 1947 and 1948 the petitioners made payments for the support of Cecil Warren's daughter Maxine Ann pursuant to a court order in the following respective amounts: $180.00, $180.00, $180.00 and $135.00. "28. During the taxable years 1947 and 1949 the petitioners paid the following respective additional Federal income taxes: $108.51 and $47.80. "29. During the taxable years 1945, 1946, 1947, 1948 and 1949 there were the following respective pension deductions from petitioner Cecil Warren's salary: $240.82, $287.02, $316.98, $369.64 and $447.30. "30. During the taxable253 years 1945, 1946, 1947, 1948 and 1949 the petitioner Cecil Warren purchased United States Savings Bonds in the name of Helen M. Warren or Rella M. Roakes by way of salary deductions from Cecil Warren's salary in the following respective amounts: $243.75, $243.75, $243.75, $243.75 and $225.00. * "32. During the taxable years 1945, 1946, 1947 and 1948 the petitioners received in interest income the following respective amounts: $6.89, $70.00, $90.97 and $80.00. "33. During the taxable years 1947, 1948 and 1949 the petitioners received the following amounts in dividends from stock owned by them: $105.00, $732.00 and $272.63. "34. During the taxable years 1948 the petitioners had a capital gain of $470.33. "35. During the taxable year 1949 petitioners had a capital loss of $1,849.11. "36. During the taxable year 1948 the petitioners received an income tax refund of $115.52. "37. During the taxable year 1949 the petitioners expended the sum of $9,620.40, for various equipment and services on their Clinton Corners, New York, property. Said expenditures were paid from the checking account of the Estate of Rella M. Roakes at the Manufacturers Trust Company. The above amount254 includes the expenditures referred to in Paragraph 15." At the trial herein it was stipulated orally by counsel for the parties that "in the taxable year 1947, the petitioners obtained a mortgage certificate as one of the assets of their joint assets which they held through the taxable year 1948 and disposed of some time during the taxable year 1949," and that "the value of said mortgage certificate was $2,000." In a Federal income tax return for the calendar year 1950 filed by "Cecil R. Warren and Helen M. Warren, d/b/a Pennacre Farms, Clinton Corners, N. Y." the depreciation schedule listed tractor and equipment, trucks, "Sheds-corn crib corrals, pens," and "Cattle-breeding" as having been acquired by taxpayers in 1949 at a total cost of $27,900. In that year the purchase of machinery by Cecil and Helen Warren for their newly acquired farm at a cost of $18,000 was financed by their giving a note for the purchase price, which the then husband of young Rella signed as guarantor and which he eventually had to pay. In 1949 the income tax return filed by petitioners for the year 1948 was examined by the Intelligence Unit of the Internal Revenue Service. In 1953 an investigation255 of petitioners leading to the determinations here involved was made by respondent's agents upon receiving information from young Rella to the effect that she "wondered where [her] mother could have gotten $92,000," that Cecil Warren was spending money which she "knew he never earned," and that she had been asked to memorize the copy of the purported affidavit of her mother. Opinion KERN, Judge: Unless the returns filed by petitioners for the taxable years here involved were false or fraudulent with intent to evade tax, section 276, Internal Revenue Code of 1939, the respondent is precluded from assessment or collection by section 275 of such Code. The burden of proving fraud with regard to each of the returns is on respondent and "the proof must be clear and convincing." Sidney Cohen, 27 T.C. 221">27 T.C. 221, 228. Doubtful questions which may relate both to the amount of deficiencies and also to the issue of fraud must be resolved against respondent on the latter issue, even though they are to be resolved against petitioners with regard to the amount of deficiencies. Sidney Cohen, supra; L. Schepp Co., 25 B.T.A. 419">25 B.T.A. 419, 437. Therefore, in determining256 whether some or all of the returns filed by petitioners for the taxable years were false or fraudulent with intent to evade tax, we can consider only those facts stipulated or established by clear and convincing proof. In these cases the respondent has relied upon the so-called net worth method in establishing the existence of unreported taxable income for each of the taxable years as the basis of his contention that the returns for these years were false or fraudulent with intent to evade tax. We have set out in our extensive findings those facts which we regard as having been established by the voluminous record before us. With regard to some of the years there is no unexplained increase in net worth, while with regard to others in which there were unexplained increases in net worth (but in amounts far less than those determined by respondent) there was a failure on the part of respondent not only to prove a likely source of taxable income in addition to that reported by petitioners, but also a failure to negative by clear and convincing proof all possible sources of nontaxable income. See United States v. Massei, 355 U.S. 595">355 U.S. 595. While many aspects of these cases are*257 puzzling and cause us to suspect the good faith and honesty of petitioners (who did not testify at the trial herein), we must be convinced of fraud and not merely suspect it. We conclude that on the issue of fraud respondent has not borne the burden of proof which is upon him, and that therefore the statute of limitations has run with regard to the years before us. Decisions will be entered for the petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621423/	JOHN S. RANCE and JEANNIE S. RANCE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRance v. CommissionerDocket No. 13913-80.United States Tax CourtT.C. Memo 1983-129; 1983 Tax Ct. Memo LEXIS 654; 45 T.C.M. (CCH) 956; T.C.M. (RIA) 83129; March 14, 1983. John E. Judge, for the petitioners. Christine B. Barish, for the respondent. NIMSMEMORANDUM OPINION NIMS, Judge: Respondent determined a deficiency in petitioners' Federal income taxes for the year 1977 of $1,311. Due to concessions, the issue remaining for decision is whether petitioners may deduct the cost of attending law school as a business expense. All of the facts have been stipulated and are found accordingly. Petitioners John S. Rance (hereinafter "Rance") and Jeannie S. Rance, husband and wife, resided at Huntington Beach, California, at the time they filed the petition. During 1977, Rance was employed as an investigator for the State of California. In 1977, Rance incurred and paid $2,840 of expenses in655 connection with taking courses at a school of law. On their 1977 tax return, petitioners deducted this amount as an ordinary and necessary business expense. In his statutory notice of deficiency, respondent disallowed this deduction on the ground that the law school courses would lead to qualification of Rance for a new trade or business. Section 162(a) 1 allows a deduction for all ordinary and necessary expenses of carrying on a trade or business. Section 1.162-5(a), Income Tax Regs., permits the deduction of education expenses, subject to certain exceptions, as business expenses if the education was undertaken to meet the express requirements of the taxpayer's employer or if it maintained or improved the skills required by the tax-payer in his employment or other trade or business. One of the exceptions to the deductibility of educational expenses under section 1.162-5(a), Income Tax Regs., is that education expenses "made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business" are not deductible. Section 1.162-5(b)(3)(i), Income Tax Regs.656 Petitioners argue that the legal courses Rance took in 1977 are not "part of a program of study * * * which will lead to qualifying him in a new trade or business" because Rance did not complete the whole law school curriculum in 1977. In addition, petitioners contend that admission to the bar alone qualifies one for practicing law and that Rance was not admitted to the bar until later years. There is absolutely no merit to petitioners' arguments. This Court has consistently disallowed education deductions taken by non-lawyers for attending law school. See, e.g., Bodley v. Commissioner,56 T.C. 1357">56 T.C. 1357 (1971); Weiler v. Commissioner,54 T.C. 398">54 T.C. 398 (1970); Bradley v. Commissioner,54 T.C. 216">54 T.C. 216 (1970); Weiszmann v. Commissioner,52 T.C. 1106">52 T.C. 1106 (1969), affd. per curiam 443 F.2d 29">443 F.2d 29 (9th Cir. 1971). In each of the above-cited cases, the taxable year before the Court was a year prior to the taxpayer's graduating from law school and prior to the taxpayer's passing the bar. Nevertheless, we held that the early years of law school were part of a course of study which would lead to qualification in a new trade*657 or business.For the reasons stated in the above-cited cases, we hold that Rance's courses were part of a program which would lead to qualifying him in a new trade or business. Wassenaar v. Commissioner,72 T.C. 1195">72 T.C. 1195 (1979), prominently cited by petitioners, mandates no different result. In Wassenaar a law school graduate who was not yet admitted to the bar sought to deduct the cost of a masters program in taxation as a business educational expense. We denied the deduction on the grounds that at the time the taxpayer took the masters courses he was not yet in the trade or business of being an attorney; consequently, the courses did not maintain or improve his skills in an existing trade or business and were part of a program of study leading to his entering a new trade or business. Wassenaar, therefore, supports respondent, not petitioners. On the authority of the cases cited above, we hold petitioners' educational expense business deduction for the cost of attending law school is not allowable.Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621424/	M. J. TRUMBLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. A. J. GUTZLER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FRANCIS M. TOWNSEND, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. TRUMBLE REFINING CO. OF ARIZONA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Trumble v. CommissionerDocket Nos. 8007-8009, 11763, 17492, 26434, 28985, 32151.United States Board of Tax Appeals14 B.T.A. 348; 1928 BTA LEXIS 2986; November 19, 1928, Promulgated 2986 A composite March 1, 1913, value determined for license contracts. A. L. Weil, Esq., and F. L. A. Graham, C.P.A., for the petitioners. C. H. Curl, Esq., and I. R. Blaisdell, Esq., for the respondent. MILLIKEN 348 In these proceedings, which were consolidated for trial, the petitioners seek redeterminations of the deficiencies which respondent has asserted for the years and in amounts as follows: PetitionerDocket No.YearDeficiencyM. J. Trumble80071918$8.761919444.651920847.332898519222,513.68A. J. Gutzler8008191849.981919415.981920697.91Francis M. Townsend8009191831.581919424.411920584.31Trumble Refining Co. of Arizona11763191825,150.1917492192026,604.39192128,885.122643419225,431.853215119235,431,85In Docket Nos. 8007, 8008, 8009, and 28985, the petitioners allege error in respondent's action in holding that distributions made to them by the Trumble Refining Co. were ordinary dividends subject to tax. Further allegations of error were made in Docket Nos. 8007, 8008, and 8009, but these2987 were withdrawn at the hearing of April 22, 1927, and before the proceedings came on for trial on the merits. In 349 Docket No. 28985 it is also alleged that respondent erred in disallowing $600, of a total deduction of $1,200, claimed as expense of operating an automobile for business purposes. In Docket Nos. 11763, 17492, 26434, and 32151, the sole question raised is the value of certain license contracts at March 1, 1913, for the purpose of computing the annual deduction for exhaustion. In an amended answer to the petitions in the last mentioned cases, respondent alleges that he erred in fixing the value of the license contracts, as of March 1, 1913, at $160,000; and that said contracts had no value at March 1, 1913, which could be made the subject of an allowance for exhaustion. FINDINGS OF FACT. Docket Nos. 8007, 8008, 8009, and 28985.M. J. Trumble, A. J. Gutzler, and Francis M. Townsend are citizens of the United States and residents of California. During the years in controversy these petitioners received certain moneys by way of distributions made by the Trumble Refining Co. Respondent has held that said distributions constituted ordinary dividends, 2988 and are so taxable to the petitioner. In his return for 1922, M. J. Trumble, Docket No. 28985, claimed a deduction of $1,200 as the expense of operating an automobile for business purposes. Respondent disallowed one-half the deduction claimed, to wit, $600, on the ground that the automobile was used only "50 per cent of the time" for business purposes. Docket Nos. 11763, 17492, 26434, and 32151.The Trumble Refining Co. of Arizona is an Arizona corporation with its principal office at Los Angeles, Calif.On April 12, 1911, the Trumble Refining Co. and its stockholders, Milon J. Trumble, Francis M. Townsend, A. J. Gutzler, and John H. Randolph, entered into an agreement with the Esperanza Consolidated Oil Co. (name changed in 1912 by court decree to General Petroleum Co.), which had for its purpose the acquisition by the Oil Company of an interest, through the purchase of stock in the Refining Company. Under its terms, the Refining Company sold 200,000 shares of its preferred and 800,000 shares of its common capital stock to the Oil Company for $25,000 cash, and the stockholders sold 200,000 shares of common and 800,000 shares of preferred capital stock of the Refining2989 Company to the Oil Company for $50,000 cash. The agreement recites that at the date thereof the authorized capital stock of the Refining Company consisted of 1,000,000 shares of preferred and 4,000,000 shares of common, all 350 of the par value of $1 per share, of which there were outstanding 600,000 shares of preferred and 2,400,000 of common. The agreement reads in part as follows: WHEREAS, according to the representations made by the Refining Company, the Stockholders and the Inventor to the Oil Company, the Inventor has invented valuable machines, apparatus and processes for the evaporation and refining of petroleum and other oils and liquids and gas, and patents for the same have been issued, and applications for other patents for the same are now pending, and the Inventor has assigned the same to the Refining Company, and contemplates and intends to assign to the Company further improvements and processes, in any manner relating to the same, which may from time to time hereafter be invented by him; and WHEREAS, it is deemed by the Refining Company to be for the advantage of the Refining Company that the Oil Company shall become a stockholder in the Refining Company, 2990 relying on the representations made to the Refining Company by the Oil Company that the Oil Company will aid and assist the Refining Company in pushing the business of the Refining Company, and will do everything in its power to further the interests of the Refining Company; and WHEREAS, as a further consideration for the sale of the stock agreed to be sold to the Oil Company by the Stockholders at the price and at the times hereinafter provided, it is deemed by the Stockholders to be for the advantage of the Stockholders that the Oil Company shall become a stockholder in the Refining Company, relying on the representations made to the Stockholders by the Oil Company that the Oil Company will aid and assist the Refining Company in pushing the business of the Refining Company and will do everything in its power to further the interests of the Refining Company; and WHEREAS, the Oil Company, relying upon the representations made to it, as hereinabove stated, deems it to be for its advantage to become interested in the Refining Company as a stockholder thereof. During the negotiations which resulted in the aforementioned agreement, the representatives of the Oil Company orally represented2991 to the representatives of the Refining Company that the Oil Company was entering upon the development of a large acreage of new oil land and into the field of refining crude oil; that it was building a pipe line to deliver 30,000 barrels of oil a day at Los Angeles or in the vicinity thereof; that in its operations a very large use would be made of the apparatuses and processes covered by the patents of the Refining Company, which the Oil Company would use exclusively; and that license agreements for the use of such apparatuses and processes by the individual refining plants would be obtained as such plants were erected. The purchase prices stipulated in the agreement to be paid by the Oil Company to the Refining Company and its stockholders for the capital stock acquired from them were fixed after due consideration of these oral representations and were based largely thereon. Under dates of July 4, 1911, and September 5, 1911, there were issued to Milon J. Trumble, United States Letters Patent Nos. 996,736 and 1,002,474, respectively. The first mentioned patent 351 covered the invention of an evaporator for petroleum oils or other liquids, and the later patent covered2992 the invention of an apparatus for refining petroleums. In 1911, these patents were assigned by Trumble to the Trumble Refining Co. The following is a brief resume of license agreements entered into by the Trumble Refining Co. with other companies, between September 27, 1910, and June 11, 1913: Date of agreementLicensed under patent No.Term of agreementRoyalty1. Petroleum Development CoSept. 27, 1910553,656Life of Patent$0.03 per bbl.2. Coalinga National Oil CoJuly 10, 1911996,736Life of Patent.02 per bbl.996,7363. John R. Ott Contracting CoFeb. 15, 19121,002,474Life of Patent.05 per bbl.4. General Petroleum Co. (Sibyl Lease-Taft).Mar. 15, 1912996,73610 Years.01 per bbl.5. Recovery Oil CoMar. 18, 1912996,7362 Years.01 per bbl.6. General Petroleum Co. (Nevada-Midway).May 15, 1912996,7365 Years.01 per bbl.7. General Petroleum Co. (Olinda)June 26, 1912996,7362 Years.01 per bbl.8. General Petroleum Co. (Brea Canyon).June 26, 1912996,7362 Years.01 per bbl.996,7369. General Petroleum Co. (Kerto, Taft)Aug. 28, 19121,002,474Life of Patent.01 1/2 per bbl.10. Santa Maria Oil Fields of California, Ltd.Sept. 28, 1912996,736Not stated.02 per bbl.996,736Not stated1 .02 per bbl.11. Warner Quinlan Asphaltum CoOct. 26, 19121,002,474Not stated2 .01 1/2 per bbl.12. Pacific Crude Oil CoNov. 30, 1912996,736Life of Patent.01 1/4 per bbl.996,736Life of Patent3 .02 1/2 per bbl.13. American Union Oil & Refining CoJan. 8, 19131,002,474Life of Patent4 .01 1/2 per bbl.14. Santa Maria Oil Fields of California Ltd.Feb. 8, 19131,002,474Not stated.00 1/2 per bbl.996,736Life of Patent15. General Petroleum Co. (Los Angeles).June 11, 19131,002,474Life of Patent.01 1/2 per bbl.996,73616. General Petroleum Co. (Mojave)June 11, 19131,002,474Life of Patent.01 1/2 per bbl.In 1915, the Trumble Refining Co. sold its patents to W. Meischke-Smith for $1,000,000 cash, the company reserving to itself, however, all rights under the above listed license agreements and all royalties which might thereafter accrue under those agreements. The Petroleum Development Co. has been merged with the Chancellor-Canfield Midway Oil Co., a subsidiary of the Atchison, Topeka & Santa Fe Ry. Co. The Income Tax Unit of the Bureau of Internal Revenue has determined the net oil reserves of the Chancellor-Canfield Midway Oil Co. as of March 1, 1913, to have been 55,519,171 barrels. At March 1, 1913, the General Petroleum Co. held in fee, under lease and under contract, 23,694.04 acres of land in California, and held under lease 24,493.68 acres in the Republic of Mexico. These lands were being developed as rapidly as possible, and on the date stated there were 160 producing wells on the California lands, 6 more wells were being brought in, and 26 additional wells were being drilled. From the Midway Fields to Los Angeles there had been2994 constructed 352 158 miles of pipe lines. Construction of a spur at Mojave, Calif., of a refinery at Kerville, in the Midway Field, and of a refinery with a capacity of approximately 20,000 barrels per day at Vernon, had been completed, and a 20,000-barrel refinery was in course of construction at Mojave. The company owned four 10,000-ton ships, and had arranged through Andrew Weir, who held a large interest in the company and was also a large shipowner in England, for charters of other ships. The company had approximately 202,000 barrels of oil in storage, and was producing about 8,500 barrels per day from its own wells and handling an additional 7,000 barrels per day under purchase contracts. In 1923 the Income Tax Unit of the Bureau of Internal Revenue determined that at July 11, 1916, the net oil reserves in the lands held by the General Petroleum Co. on March 1, 1913, amounted to 32,896,058 barrels. In arriving at the net reserves the Income Tax Unit deducted royalty oils of 37,789,004 barrels. Between March 1, 1913, and July 11, 1916, there were extracted from these same lands 13,314,841 barrels of oil. The following is a statement of the total capacity, based2995 upon the patented facilities in use and in course of construction at March 1, 1913, of each of the licensees' plants, from March 1, 1913, to the termination of their respective agreements, the number of barrels of oil actually treated by each of the licensees between March 1, 1913, and January 1, 1928, and the royalties earned between those same dates: Total capacityOil actually treatedRoyalties earnedBarrelsBarrels1. Petroleum Development Co50,640,8753,601,622$61,605.772. Coalinga National Oil10,357207.133. John R. Ott Contracting Co4. General Petroleum Co. (Sibyl Lease, Taft)730,000244,9902,449.905. Recovery Oil Co61,000610.006. General Petroleum Co. (Nevada-Midway)1,825,000200,5152,005.157. General Petroleum Co. (.olinda)1,368,750588,4585,884.588. General Petroleum Co. (Brea Canyon)79,006790.069. General Petroleum Co. (Kerto, Taft)5,884,000253,0413,874.5910. Santa Maria Oil Fields of California, Ltd11,680,0001,097,63825,614.8011. Warner Quinlan Asphaltum Co11,315,0001,366,99025,137.3412. Pacific Crude Oil Co28,297,00013. American Union Oil & Refining Co5,657,5009,632292.6014. Santa Maria Oil Fields of California, Ltd15. General Petroleum Co. (Los Angeles)109,500,000129,045,1131,935,676.6916. General Petroleum Co. (Mojave)54,750,00021,294,225226,231,23Totals281,648,625157,852,5872,290,379.842996 The agreements with the General Petroleum Co. of August 28, 1912; with the Santa Maria Oil Fields of California, Ltd., of September 28, 1912; with the Pacific Crude Oil Co. of November 30, 1912; with the American Union Oil & Refining Co. of January 8, 1913; and with the General Petroleum Co. of June 11, 1913, being the agreements numbered above 9, 10, 12, 13, 15, and 16, provide 353 that the licensees shall use the patented apparatus of the Trumble Refining Co. to the exclusion of all other methods and processes for treating oils. In February, 1913, Francis M. Townsend, president of the Trumble Refining Co., sold 1,000 shares of the common capital stock of that company for $500 to A. L. Weil, a director of the company and general counsel of the General Petroleum Co. At March 1, 1913, the outstanding capital stock of the Trumble Refining Co. was 800,000 shares of preferred and 3,200,000 shares of common, all of the par value of $1 per share. Respondent has fixed the value of these license agreements, as of March 1, 1913, at $160,000 and, in computing net income of the Trumble Refining Co. for the years on appeal, has allowed an annual deduction for exhaustion of the2997 agreements based upon that value. OPINION. MILLIKEN: The issues raised in Docket Nos. 8007, 8008, 8009, and 28985 will be disposed of first. These petitioners complain of respondent's action in including in net income of the years in controversy as ordinary dividends subject to the tax, the entire amounts received in those years as distributions from the Trumble Refining Co. of Arizona. It is contended that a portion, if not all, of such distributions were in fact liquidating dividends or a return of capital not subject to tax. The allegations of the petitions are specifically denied by the respondent in his answers. No evidence was offered by the petitioners in support of those allegations. Under the circumstances, we may not disturb the action of the respondent of which petitioners complain. In the case of M. J. Trumble, Docket No. 28985, it is further alleged that respondent erred in disallowing $600 of a total deduction of $1,200 claimed in the return for 1922, as expense of operating an automobile for business purposes. No evidence was offered by the petitioner in support of the material averments of his petition. We are unable, therefore, to find error in respondent's2998 action. In the appeals of the Trumble Refining Co. of Arizona, Docket Nos. 11763, 17492, 26434, and 32151, the sole question raised is the value of certain license contracts at March 1, 1913, for the purpose of computing the annual deduction for exhaustion. The petitioner claims a total value for these contracts at March 1, 1913, of $1,400,000. The respondent has computed the annual deductions for exhaustion upon the basis of a March 1, 1913, value for the contracts of $160,000. In an amended answer, respondent alleges error in the value previously determined by him, and asserts that they were without any 354 value at the basic date which might be made the subject of an allowance for exhaustion. We are not certain of the position of the respondent in this proceeding. At the hearing, counsel filed an amended answer alleging error in allowing a March 1, 1913, value for the contracts of $160,000 and that the contracts had no value as of March 1, 1913, which was or is subject to exhaustion allowances under the Revenue Acts of 1918 and 1921. We will proceed upon the understanding that only a question of fact is involved, i.e., the March 1, 1913, value of the contracts2999 in question. Counsel for respondent in brief filed does not contest the legal right to an exhaustion allowance if the contracts did in fact have an ascertainable value on March 1, 1913, or the long line of Board decisions wherein allowances have been claimed before and allowed by us. Petitioner has offered proof of the value claimed for the contracts along three lines: First, evidence as to a certain transaction which occurred in February 1913, in which 1,000 shares of its common capital stock was exchanged between two individuals for a cash consideration; secondly, evidence of existing circumstances and conditions at March 1, 1913, as the basis of prognosticating the future earnings under these agreements; and, thirdly, the actual results obtained under these contracts to the beginning of the present year. The stock transaction referred to is that in which Francis M. Townsend, president of petitioner company, sold to A. L. Weil, a director of petitioner and general counsel of the General Petroleum Co., in February 1913, 1,000 shares of petitioner's common capital stock for $500 cash. The petitioner relies upon this transaction as establishing a value of 50 cents per share3000 for the entire 3,200,000 shares of common stock outstanding at March 1, 1913, and then reasons that "If the common stock had a value of 50 cents a share, the preferred shares were necessarily worth par [$800,000], and therefore the value of the outstanding stock at the time of the sale, which was just prior to March 1, 1913, was $2,400,000." From this sum, the petitioner deducts $1,000,000, the selling price of the patents in 1915, leaving $1,400,000 which it claims represents the March 1, 1913, value of the rights under the license contracts. The obstacles to accepting this line of reasoning or method of valuation are insurmountable, for the reasoning or method lacks the support of proven facts and takes too much for granted. The stock involved in this transaction was but one thirty-second of 1 per cent of the common stock, and only one-fortieth of 1 per cent of all the stock, outstanding at the basic date. To conclude that the selling price of this negligible quantity of stock fixes the fair market value of all the stock, both common and preferred, notwithstanding the utter lack of proof in that direction, requires the indulgence in assumptions as to diverse factors affecting3001 355 the marketability of 4,000,000 shares of stock and the rights of pre ferred shareholders, which we are unwilling to make. The method requires the further assumptions, wholly without proof of facts upon which to premise them, that the March 1, 1913, value of the patents was neither greater nor less than the selling price in 1915, and that the petitioner, though apparently manufacturing all of the patented apparatus for its licensees, had no assets of value other than the patents and license contracts. Further, it is a matter of common knowledge that the selling price or fair market value of the capital stock of a corporation frequently bears no relation to, and is not a reliable index of, the intrinsic value of the assets behind it; and, for aught that we may know, this case offers no departure from such a situation. Other methods of valuing the rights under the license agreements as of March 1, 1913, are suggested by the petitioner, but, like the first, they depend too greatly upon the most optimistic speculation and their bases lack the essential support of proven facts. One of these is based upon the total number of barrels of oil which the licensees, with the facilities3002 in use or in course of construction at March 1, 1913, would be able to treat between that date and the tetmination of their respective agreements, that is, 281,648,625 barrels. The petitioner deducts from this number 25 per cent thereof to take care of probable losses from casualties, strikes, fires, and the risks of operation, and by prorating the remainder, 211,236,469 barrels, among the 16 agreements and applying the applicable royalty rates, it determines that the anticipated future earnings, at March 1, 1913, were $3,208,222.03. This sum is then discounted to its present value, at March 1, 1913, by the application of Hoskold's formula, the petitioner finally arriving at a value of $2,175,078.29. This method is offered to us with the suggestion that "It is well known that refinery units are expensive to erect, and it cannot be presumed that parties will actually build plants that are larger than they have an economic use for." Nevertheless, the record shows that the plants of the 16 licensees were capable of treating a total of 281,648,625 barrels between March 1, 1913, and the termination of their agreements, but that they actually treated up to January 1, 1928, only 9 months3003 prior to the expiration of the patents and termination of all agreements, only 157,852,587 barrels, just 56 per cent of their possible capacity; and, if we leave out of the reckoning the two plants of the General Petroleum Co. at Los Angeles and Mojave, which were not completed until after the basic date, we find that as against a total rated capacity for the 14 plants of the other licensees, of 117,398,625 barrels, those plants, with but 9 months remaining for their agreements 356 to run, actually treated only 7,513,249 barrels, just approximately 7 per cent of possible production. It does not appear that this wide difference between possible production and actual production is entirely due to the result of conditions which arose after March 1, 1913, and which could not have been foreseen at that date. In the case of the Pacific Crude Oil Co., the possible production with the facilities at hand at March 1, 1913, to the termination of its license agreement, amounted to 28,297,000 barrels, but the record shows that not a single barrel of oil was treated by this company to the beginning of 1928, although it was obligated under its agreement to use the petitioners' patented3004 apparatus for the treatment of oil to the exclusion of all other methods and processes. The American Union Oil Co. had facilities at March 1, 1913, capable of treating, from then to the termination of its agreement, 5,657,500 barrels of oil, but up to the beginning of 1928 it had actually treated only 9,632 barrels of oil, approximately one-sixth of 1 per cent of possible production, though it too was obligated to use the petitioner's patented apparatus for treating oil exclusively. Hardly less striking is the case of the Petroleum Development Co., with facilities at March 1, 1913, capable of treating, to the termination of its agreement, 50,640,875 barrels, though up to the beginning of the present year it has actually treated only 3,601,622 barrels, approximately 7 per cent of possible production. The Pacific Crude Oil Co., without production of a single barrel of oil during its agreement, could not have been treating, or have been in a position to treat oil with petitioner's patented apparatus at March 1, 1913; while the American Union Oil Co. and the Petroleum Development Co., with facilities of a rated capacity of approximately 1,200 barrels and 11,000 barrels per day, respectively, 3005 have had an approximate average daily production of but 3 and 770 barrels, respectively; and there is not a bit of evidence that the facilities of the last two mentioned companies were being used to any great extent at March 1, 1913, or that there was any prospect, at that date, of any greater use in the future. Another method suggested by petitioner is based upon the quantity of oil being handled by the General Petroleum Co. at March 1, 1913, as the result of production from its own wells and oil acquired under purchase contracts, and the net oil reserves of the Chancellor-Canfield Midway Oil Co. with which the Petroleum Development Co. was merged, though the time of the merger does not appear in the record. At March 1, 1913, the General Petroleum Company was producing about 8,500 barrels of oil per day from its own wells and was handling an additional 7,000 barrels per day under purchase contracts. At the same date, the net oil reserves of the 357 Chancellor-Canfield Midway Oil Co. amounted to 55,519,171 barrels. Based on these facts, the petitioner suggests that an estimate at March 1, 1913, of the total amount of oil which the General Petroleum Co. and the Petroleum3006 Development Co. would treat until the expiration of their agreements would have been 143,210,421 barrels. To this quantity the petitioner applies a royalty rate of 1 1/2 cents per barrel, and thereby determines that the expected future royalties from these companies amounted to $2,148,156.31. This sum is then discounted to its present value, at March 1, 1913, by the application of Hoskold's formula, the petitioner finally arriving at a value of $1,456,385.53. There are several objections to the suggested method. There was placed in evidence a resume of the 12 contracts under which the General Petroleum Co. was purchasing oil at March 1, 1913. Of these 12 contracts, 6 expired during 1913, 3 expired during 1914, 1 expired in 1916, the term of another is not shown, and 1, the contract with the Ohio Valley Construction Co., does not expire until June 16, 1930. Whether there have been renewals of the contracts which have expired, or what the prospects for such renewals were at March 1, 1913, does not appear in the record. The contract with the Ohio Valley Construction Co. calls for the purchase of 500,000 barrels of oil and all production thereafter to the termination of the3007 contract. There is no evidence as to the probable amount of oil which the General Petroleum Co. would acquire under this contract. The estimate of the total quantity of oil which would be treated by the General Petroleum Co. and the Petroleum Development Co. includes 55,519,171 barrels for the Petroleum Development Co., which represent the net oil reserves of the Chancellor-Canfield Midway Oil Co. at March 1, 1913. There is no evidence whether the merger of the Petroleum Development Co. with the Chancellor-Canfield Midway Oil Co. took place before or after March 1, 1913, or, if after, whether such a merger was contemplated at that date. Further, there is nothing to show that there was any probability, at March 1, 1913, that the entire oil reserves of the Chancellor-Canfield Midway Oil Co. would be extracted and treated prior to the expiration of the license agreement. With the foregoing observations we reject the several methods of valuation suggested by the petitioner. There is much, however, in the evidence which convinces us that the license contracts had a considerable value at March 1, 1913. Both the president of the General Petroleum Co. and the president of petitioner, 3008 who represented their respective companies in the negotiations, testified that the General Petroleum Co., then known 358 as the Esperanza Consolidated Oil Co., as an inducement to the petitioner to enter into the agreement of April 12, 1911, by which for a nominal cash consideration the Petroleum Company acquired a one-third interest in the petitioner, represented to the petitioner that it was entering upon the development of a large acreage of new oil land, that it was building a pipe line to deliver 30,000 barrels of oil per day at Los Angeles, that it proposed to use the patented apparatus of the petitioner exclusively for the treatment of this oil, and that license agreements for the use of such patented apparatus by its individual refining plants would be obtained as such plants were erected. The agreement itself supports the testimony of these two witnesses that the cash consideration stipulated therein was not the sole consideration, for it makes specific reference to represenatations made by the parties to each other; and the subsequent actions of the Petroleum Company, which are entirely in line with these representations, corroborates the testimony of these witnesses. 3009 There can be little doubt that out of these representations there arose obligations on the part of the General Petroleum Co. and rights to the petitioner which were just as binding and enforceable as though they had been specified in detail in the agreement, and not the least of these was the obligation of the Petroleum Company to use the apparatus covered by petitioner's patents exclusively in the treatment of crude oil. At March 1, 1913, the General Petroleum Co. held in fee simple, by lease and by contract, 23,694.04 acres of oil lands in California, and 24,493.68 acres of such lands in the Republic of Mexico. All of these lands were being developed as rapidly as it was possible to do so. Already 160 producing wells had been brought in on the California lands, 6 more were being brought in, and 26 additional wells were being drilled, but all of this represented the development of only 900 acres of its lands. From these producing wells alone, the company was realizing an average daily production of 8,500 barrels of crude oil. In addition to this daily production, the company had approximately 202,000 barrels of oil in storage, and was handling under purchase contracts approximately3010 7,000 barrels of oil per day. An investigation of its lands by the Income Tax Unit led to the determination that the company's oil reserves at July 11, 1916, in lands which it held at March 1, 1913, was 32,986,058 barrels, but in arriving at this figure there were deducted royalty oils of 3,789,004 barrels. Between March 1, 1913, and July 11, 1916, there were extracted from these same lands 13,314,841 barrels of oil. Thus, at March 1, 1913, the General Petroleum Co. was in possession of oil reserves amounting to 49,999,903 barrels, which it was then bringing to the surface at the 359 rate of 8,500 barrels per day; but it had already adopted the policy of rapid development of its other lands, a policy which was being carried into effect at the date stated. As a matter of fact, the average daily production between March 1, 1913, and July 1, 1916, amounted to approximately 14,000 barrels. The company already had in operation five plants, the patented facilities of which were capable of treating to the termination of the agreements approximately 10,000,000 barrels of oil. The pipe line had been completed to los Angeles, where, and at Mojave, refineries were under construction. 3011 Both of these refineries were located in accordance with petitioner's recommendations, were designed by the petitioner, and were being constructed under petitioner's supervision. The combined facilities of these two refineries when completed were capable of treating, during the life of the license agreements, approximately 164,000,000 barrels of oil, and there were actually treated in those plants up to the beginning of 1928, when the agreements had approximately nine months to run, 157,852,587 barrels of oil, which yielded to petitioner royalties of $2,161,907.92. There is little of evidence as concerns existing conditions at March 1, 1913, in the case of the other licensees. As to them we know nothing more than the possible production of their facilities from March 1, 1913, to the termination of their agreements, the actual production up to the beginning of the present year, and the royalties paid to petitioner by those licensees. The facts given to us are not readily adaptable to the application of any mathematical formula as a means of checking the reasonableness of our own judgment. Recognizing all the facts in existence or in contemplation on March 1, 1913, we have3012 sought to determine what a willing buyer and willing seller, without any compulsion to act in the matter but purely in their own mercenary interests, would fix upon as a fair price for these agreements at the date stated. We have disregarded none of the evidence, but have given all of it due consideration, and have reached the conclusion that these license agreements had a fair market value at March 1, 1913, of $850,000. Since the average life of these agreements, at March 1, 1913, was 11 years, 8 months, 20 days, the petitioner is entitled to a deduction for exhaustion for each of the years in controversy, in the amount of $72,511.90. Judgment will be entered under Rule 50.Footnotes1. For grade D Asphaltum. ↩2. For asphaltum oils for road-making purposes. ↩3. For 4 refined cuts. ↩4. For 2 refined cuts. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621426/	APPEAL OF THE FARMERS COOPERATIVE ASSOCIATION.Farmers Cooperative Asso. v. CommissionerDocket No. 4296.United States Board of Tax Appeals5 B.T.A. 61; 1926 BTA LEXIS 1992; October 13, 1926, Decided 1992 The fixed payments made by a Kansas cooperative corporation to its stockholders upon the capital stock in accordance with a statute providing for "fixed dividends" held not deductible as interest. Warren H. White, Esq., and A. C. Johnson, C.P.A., for the petitioner. Briggs G. Simpich, Esq., for the Commissioner. STERNHAGEN 61 Deficiency of $991.83, income tax for 1920, of which not all is in controversy. The petitioner contends that fixed payments on capital stock are deductible as interest. FINDINGS OF FACT. The petitioner was incorporated under the laws of Kansas in 1915 by certain of the farmers in the vicinity of Hays, Kans. Its purposes are stated in its charter as follows: (a) The conversion and disposal of all agricultural products by means of mills, elevators, stores or otherwise. (b) Buying and shipping grain for profit. 62 (c) Cleaning and handling of grain for its members and others. [(d) Omitted in original.] (e) Buying and selling of coal, flour, farm supplies and other merchandise, including livestock for mutual benefit of its shareholders and such other benefits as the shareholders direct. 1993 The constitution contains the following provisions, among others: ARTICLE VII - RESERVE FUND. After the payment of the operating expenses of this association, the remaining profits, if any, two per cent shall be set apart for a reserve fund and carried on the books as a reserve fund for the payment of any unexpected losses, not otherwise provided for. The reserve fund may be invested or loaned to stockholders, provided that a part of said fund may be used in the payment of interest on capital stock, at the direction of the directors. ARTICLE VIII - CAPITAL STOCK. Section 1. The capital stock of this Association shall be ($50,000) fifty thousand dollars, divided into one thousand (number of shares) at the par value of fifty dollars per share, this stock shall be non-assessable. Section 2. And at least fifty per cent of the face of all shares subscribed shall be paid for in cash; and in case of deferred payments, such payments shall be settled for in full by note secured by the capital stock for which note is taken, as part payment; all such notes to mature in six months from date of issue. Section 3. All shares shall be transferable to members of the F.E. & C. 1994 U. of A. at the option of the holder and the Directorate, and recorded on the books of the Association, Provided, That any credit due the Association by the holder of said stock shall be deducted from said stock before being transferred. ARTICLE IX - INTEREST ON STOCK. (a) After the reserve fund of two per cent is deducted from the profits, pay interest on stock what it earns up to 8 per cent; but no interest shall be paid on any shares of stock that are not paid in full at the time of the annual settlement; and interest shall be paid only from and after date when said shares are paid in full, all interest to become due on the annual settlement. And if any member of said association is found delinquent in his local, such amount shall be taken out of his interest and dividends and paid to his local secretary on or before the 15th day of January of each year. (b) Provided that stockholders before drawing their interest or dividend, from the Association shall present receipt or membership card from their local showing that they are in good standing in the F.E. & C.U. of A. ARTICLE X - NET PROFITS. The net approximate profits of the business shall be paid to the members1995 of the association at the close of each year after having been prorated on the amount of their purchases or sales, for, or by themselves or families during the year. Provided, that if a stockholder holds only one share, his dividend shall be applied on his second share until the full amount of said second share shall be paid in full, Provided, further, that the profits from non-stockholders' business shall be retained as a reserve fund. 63 ARTICLE XIII - MANNER OF CONDUCTING BUSINESS. (a) All money received on account of shares, contributions or otherwise, shall be paid to the Treasurer, unless otherwise ordered by the directors, and said money shall be withdrawn only by a vote of the board of directors, on the written order of the President, countersigned by the Secretary. (b) Such funds as the association may have, not needed for immediate use, in said association's business or to meet accruing liabilities, shall with the consent of the association, given at any regular meeting, be invested by the directors. (c) All business of the association shall be conducted on a cash basis; provided, credit may be extended to stockholders not to exceed the amount of their1996 capital stock; any credit above this amount may be applied for to the directors. Produce or labor taken in exchange for merchandise, and merchandise and produce on deposit at net cash value will be considered as cash. (d) Goods shall be purchased and sold at ordinary market prices to all alike. (e) All members trading or selling with the association shall be furnished statements showing the amount of their purchases and said statements shall be the basis for computing dividends on purchases or sales, and any said statements transferred shall be void and not binding on the association. (f) Dividend duplicates shall be issued only for goods purchased and sold at regular retail prices; said goods to be purchased for use of members of this association or their families. (g) The business manager or trades agent shall keep a sales book showing correct list of all sales, the amount and prices of said sales, the name of purchaser and the kinds of goods sold; this sales book shall be balanced daily and show total sales for each day, week and month for the purpose of aiding in computing the per cent of dividend on purchases for each year, and said sales book shall be kept open for1997 the inspection of any member of the association. ARTICLE XXIII - DECEASED MEMBERS. Any member of the association dying in said locality, the directors may repay to his legal representatives the face value of the capital stock owned by said member, together with all accrued interest and purchased dividends within twelve months after the absence of said member. ARTICLE XXV - DISSOLUTION. In case the members of the association require a dissolution - after the debts of the association are paid, the stock and property of the association remaining, or the proceeds of the sale thereof, shall be divided among the shareholders in proportion to their shares of paid up stock. In case of disagreement among the stockholders, in such division the matter shall be settled by arbitrators as follows: One to be chosen by the officers and directors, one by the other members, and the third by the first two; and their decision shall be final. The petitioner's capital stock originally consisted of 200 shares of $50 each. This was increased to 500 shares in 1919 and to 1,000 shares in 1920. All stockholders are farmers. It handles the products of and does business with farmers in the community1998 who are not stockholders. 64 In addition to wheat, it handles potatoes, cabbage, apples and other fruit and feed which it purchases from members and non-members. It also purchases coal and sells it to any one who wants it. The corporation insures all the wheat in its elevators and is the beneficiary named in the policy. In every year except one during the corporation's existence it has paid 8 per cent to the stockholders upon the outstanding capital stock. The 8 per cent is paid out of earnings from both stockholders' and non-stockholders' business, and payment is made annually in February out of the earnings of the preceding year. The exception was in 1922. In that year there were not enough earnings to make the payment; there was a loss and no accumulated surplus. When the corporation failed to pay the 8 per cent for 1922 no entry was made upon the books in respect thereof, either as a liability or otherwise. The corporation intends at some time in the future to pay the 8 per cent which it omitted to pay for the year 1922. At the time the farmer delivers his wheat a price is fixed in cents per bushel; the corporation pays him for it and takes title. It issues1999 to him a "scale ticket" which shows the quantity and quality of the wheat delivered, the price per bushel, and the total amount paid. At the end of the year, after all necessary payments including the 8 per cent on the stock have been made, the remaining earnings are distributed in accordance with a computation based upon the quantity and price of grain or produce delivered each day by each farmer to the corporation. Each stockholder receives a single check, which includes the 8 per cent, and also his pro rata distributive share of the remaining earnings. For example, one stockholder received a check for $283.04 which represented "$210.06 refund on wheat, $22.15 on merchandise, and $50.83 for interest on capital stock." This payment is accounted for by charging the entire amount against surplus. The surplus account consists of the profits shown by the profit and loss statement before any deduction of the 8 per cent stockholders' distribution. On its tax return the petitioner deducted the 8 per cent payments upon its capital stock as interest. OPINION. STERNHAGEN: Although there was in the presentation of the case some confusion as to whether the petitioner's tax liability2000 is affected by the exemption provision of section 231(11) of the Revenue Act of 1918, it seems to be clear that the only question before us for decision is whether, under the circumstances of its organization and operation, the amount paid out by the corporation to its stockholders $065 65 as 8 per cent on its capital stock is in truth interest and therefore a proper deduction. The question of the nature of this payment as a matter of law can only be decided by looking to the source of the obligation under which it is paid. Since the corporation was organized under the Kansas law governing cooperative associations, we may look to that statute. Kansas Laws, 1913, chapter 137, after authorizing the organization of corporations under the cooperative plan, defines such plan "to mean a business concern that distributes the net profits of its business by: First, the payment of a fixed dividend upon its stock; second, the remainder of its profits are prorated to its several stockholders upon their purchases from or sales to said concern or both such purchases and sales." The petitioner here conducted its business in accordance with this plan. It will be seen that the basis of*2001 the plan is a prescribed distribution of "net profits" was between a "fixed dividend" upon stock and a pro rata distribution of the remaining profits upon the basis of the amount of business done with each stockholder. This is exactly what the petitioner here did, and no matter how thoroughly its contributing stockholders believed that they were investing their money or lending it at 8 per cent, and notwithstanding the equivocal language of the constitution, the legal nature of the payment is exactly what the statute describes as a distribution of net profits by way of a fixed dividend upon the stock. The fact that 8 per cent happened to be the rate at which banks were lending money, or the fact that the president testified that the corporation some day intended to make up for the dividend which it passed in 1922, does not establish a legal obligation as for interest. See . Judgment will be entered for the Commissioner.LANSDON did not participate.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621427/	JOHN F. BRIDGEMAN and LOIS A. BRIDGEMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBridgeman v. CommissionerDocket No. 28207-81.United States Tax CourtT.C. Memo 1984-368; 1984 Tax Ct. Memo LEXIS 301; 48 T.C.M. (CCH) 537; T.C.M. (RIA) 84368; July 19, 1984. 301 John E. Judge, for the petitioners. Valerie K. Liu, for the respondent. FAYMEMORANDUM OPINION FAY, Judge: Respondent determined a deficiency of $1,218 in petitioners' Federal income tax for 1978. After concessions by petitioners, the only issue is whether petitioners are entitled to a residential energy credit under section 44C 1 for expenditures incurred in connection with the installation of a solar heating system for their swimming pool. The facts have been fully stipulated and are so found. Petitioners, John F. Bridgeman and Lois A. Bridgeman, resided in Laguna Niguel, Calif., when they filed their petition herein. In February 1978 petitioners paid $4,717 for a solar heating system which was installed on the roof of their home. Petitioners purchased the solar heating system for the purpose of providing hot water for their outdoor swimming pool. Based on their purchase of the solar heating system, petitioners claimed a residential energy credit in the amount of $1,163 on their 1978 return. In his notice of deficiency, 302 respondent disallowed petitioners' energy credit. The only issue is whether petitioners are entitled to a residential energy credit under section 44C for their expenditures incurred in connection with the installation of the solar heating system for their swimming pool. Section 44C(a) provides that: In the case of an individual, there shall be allowed as a credit against the tax imposed by this chapter for the taxable year an amount equal to the sum of-- (1) the qualified energy conservation expenditures, plus (2) the qualified renewable energy source expenditures. The parties agree that petitioners' expenditures incurred in installing the solar heating system do not constitute "energy conservation expenditures." Thus, resolution of the issue herein depends on whether petitioners' installation expenditures constitute "renewable energy source expenditures." Section 44C(c)(2)(C) specifically provides that "[t]he term 'renewable energy source expenditure' does not include any expenditure properly allocable to a swimming pool used as an energy storage medium or to any other energy storage medium which has a primary function other than the function of such storage." Petitioners' 303 sole contention is that section 44C(c)(2)(C) only excludes from the definition of "renewable energy source expenditure" expenditures allocable to a swimming pool if the swimming pool is used as an energy storage medium. We, however, disagree with petitioners' interpretation of this section. We believe that section 44C(c)(2)(C) excludes from the definition of "renewable energy source expenditure" all expenditures allocable to a swimming pool even when the swimming pool is used as an energy storage medium if its primary function is other than the storage of energy. Our interpretation of this section is supported by the legislative history and the regulations. See S. Rept. No. 95-529 (1978), 1978-3 C.B. (Vol. 2), 199 at 232; sec. 1.44C-2(b), Income Tax Regs.Thus, since the primary function of petitioners' swimming pool was swimming and not the storage of energy, petitioners' installation expenditures incurred for the solar heating system do not qualify as "renewable energy source expenditures" under section 44C(c)(2). Accordingly, petitiopners are not entitled to a residential energy credit under section 44C(c) for those expenditures. To reflect the foregoing, 304 Decision will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621428/	CONNECTICUT & PASSUMPSIC RIVERS RAILROAD COMPANY, PETITIONER, v. Commissioner of Internal Revenue, Respondent.Connecticut & P. R. R. Co. v. CommissionerDocket No. 25987.United States Board of Tax Appeals24 B.T.A. 394; 1931 BTA LEXIS 1650; October 21, 1931, Promulgated 1650 1. The petitioner in 1921, 1922, and 1923 owned all of the outstanding shares of stock of the Newport & Richford Railroad Company, which, together with other property, it had leased in 1887 for a period of 99 years. Held, that the petitioner and the Newport & Richford Railroad Company were affiliated during 1921, 1922, and 1923. 2. In the taxable years 1921, 1922, and 1923 the petitioner had outstanding certain bonds which it had issued and sold at a premium in 1911. It kept its books and made its income-tax returns for those years upon the accrual basis. In each of such returns it deducted an amount representing interest payments on the bonded indebtedness. Held, that the bond premium received in 1911 should be amortized over the life of the bonds and that an aliquot part thereof should be included in the gross income of each of the years 1921, 1922, and 1923. Commissioner v. Old Colony R.R. Co., 50 Fed.(2d) 896. O. R. Folsom-Jones, Esq., and J. S. Y. Ivins, Esq., for the petitioner. J. T. Haslam, Esq., for the respondent. SMITH 395 This proceeding involves deficiencies for 1921, 1922, and 1923 in1651 the amounts of $1,602.38, $21,230.66, and $2,476.87, respectively. In the original petition the Connecticut & Passumpsic Rivers Railroad Company and the Boston & Maine Railroad were joint petitioners. At the hearing, on motion of counsel for the joint petitioners and upon consent of Government counsel, the Boston & Maine Railroad was stricken, leaving only the Connecticut & Passumpsic Rivers Railroad Company as petitioner. The principal issues are: (1) Whether the petitioner and the Newport & Richford Railroad Company were affiliated during the years 1921, 1922, and 1923. (2) Whether the premium on long-term bonds issued by the petitioner in 1911 should be amortized over the life of the bonds, and, if so, whether such amortized portion of the premium should be included in gross income or should apply against the interest payments on the bonds of each of the years 1921, 1922, and 1923. FINDINGS OF FACT. The petitioner is a Vermont corporation, with its principal office at St. Johnsbury. The petitioner filed consolidated returns with the Newport & Richford Railroad Company for 1921, 1922, and 1923. These returns were prepared upon the accrual basis by order of the Commissioner1652 and under protest of the petitioner. During the taxable years and since June 1, 1887, the petitioner owned all of the capital stock of the Newport & Richford Railroad Company. On June 1, 1887, the petitioner leased all of its railroad properties, including its road equipment, franchises, etc., to the Boston & Lowell Railroad Corporation for a period of 99 years from January 1, 1887. On December 13, 1892, the Boston & Lowell Railroad Corporation 396 assigned the lease to the Boston & Maine Railroad. The lease provided, in so far as material here, as follows: The lessor doth grant, demise, and lease unto the lessee, its successors and assigns, its railroad and railroad property of every description * ; including also therein all the right, title and interest of the lessor in and to any and all railroads owned by it or operated by it under lease or otherwise, and in and to any stock of other railroads owned by it, all dividends thereon, and the right of voting on the same * * * * * The lessee shall have the right of voting all stock * * * owned by the lessor in other railroads or corporations, which stock * * * shall not be sold or otherwise disposed of except1653 with the assent of the lessor. The above lease was in full force and effect up to and including the taxable years 1921, 1922, and 1923. On January 2, 1911, the Newport & Richford Railroad Company issued and sold its first mortgage five per cent bonds, due January 1, 1941, of the face value of $350,000, and received in payment therefor the fact value thereof and premiums aggregating $28,101.30. The premiums of $28,101.30 were credited to a ledger account styled "Premium on Funded Debt." During each year beginning with the year 1911, and including the years 1921, 1922, and 1923, the Newport & Richford Railroad Company reduced the balance in the account "Premium on Funded Debt" by transferring therefrom to the credit of income the amount of $936.71, which is one-thirtieth of the total premium of $28,101.30. In the consolidated income-tax returns filed by the Connecticut & Passumpsic Rivers Railroad Company for 1921, 1922, and 1923, the amount of $936.71 credited to income during each of these years was reported as nontaxable income of the Newport & Richford Railroad Company for each of the years. During the years 1921, 1922, and 1923, the Boston & Maine Railroad paid to Boston1654 Safe Deposit & Trust Company, or its successors, for the exclusive use and benefit of the parties to whom the same became due, the sum of $17,500 in accordance with the provisions of section 1, subsection 2, of the lease. The bonds issued by the Newport & Richford Railroad Company were the direct obligation of that company to the owners of the bonds and no agreement has ever been executed between the Newport & Richford Railroad Company and the bondholders releasing the Newport & Richford Railroad Company from such direct liability to the bondholders on any of the bonds. In its consolidated income-tax returns for 1921, 1922, and 1923, the petitioner reported for the Newport & Richford Railroad Company the $17,500 as an item of gross income and also deducted that amount as interest paid during each of the years. The Commissioner, in auditing the returns, made no adjustment with respect to 397 the inclusion of the $17,500 in gross income or the deduction of that amount as interest paid except that he increased the reported consolidated taxable income for each of the years 1921, 1922, and 1923, by including therein the sum of $936.71, which is the amortized proportion, for1655 each of the said years, of the premiums received by the Newport & Richford Railroad Company upon the sale of the bonds in 1911. OPINION. SMITH: The respondent contends for the affiliation of the petitioner and the Newport & Richford Railroad Company on the grounds that the petitioner during all of the years involved owned outright all of the outstanding shares of capital stock of that company. The petitioner contends that it was not affiliated with the Mewport & Richford Railroad Company because of the fact that in the lease of June 1, 1887, it assigned all of its interests in the shares of stock of the Newport & Richford Railroad Company to the Boston & Lowell Railroad Corporation, which lease was in turn assigned to the Boston & Maine Railroad Company, and that therefore the affiliation, if any, was of the Boston & Maine Railroad Company and the Newport & Richford Railroad Company. We are of the opinion that the petitioner in executing the lease in question did not divest itself of its ownership of the stock of the Newport & Richford Railroad Company. Read as a whole, the instrument purports to be no more than an ordinary lease by the petitioner of all of the properties1656 described therein, including the shares of stock of the Newport & Richford Railroad Company, to the Boston & Lowell Railroad Corporation for a period of 99 years. It authorizes the lessee to vote the shares of stock of the Newport & Richford Railroad Company and to receive the dividends therefrom. The lessee could not sell or otherwise dispose of the stock without the consent of the lessor. Counsel for the petitioner and for the respondent have stipulated that: * * the Connecticut & Passumpsic Rivers Railroad Company [petitioner] owned 100 per cent of the stock of the Newport & Richford Railroad Company at the date of the original lease herein discussed, and has owned that stock continuously from inception of the lease down to date, and including the years continuously from inception of the lease down to date, and including the years 1921 to 1923, inclusive. The issue before us is whether the petitioner and the Newport & Richford Railroad Company were affiliated. Section 240 of the Revenue Act of 1921 provides that: (c) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls1657 through closely affiliated interests or by a nominee or nominees substantially 398 all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. Notwithstanding that under the terms of the lease certain rights constituting virtual control in the shares of the stock of the Newport & Richford Railroad Company were released to the lessee for the period of the lease, the ownership of the stock remained in the petitioner. As the court said in Lavenstein Corporation v. Commissioner of Internal Revenue, 25 Fed.(2d) 375: * * * Assuming that the pledge transfers to the pledgee the right to control the corporation, which is not true in all cases, the statute provides for affiliation where there is unity of either ownership or control, and does not require that there be unity in both. To so hold would be to amend the statute in a vital particular and to open the door to evasions of the act. If affiliation is to be denied because the stock of one of the affiliated corporations has been pledged by its owners, then all that would be necessary to evade the high rates of a graduated1658 tax would be for the interests which owned the stock in the affiliated corporations to pledge and stock held in one of them. On the basis of the continued ownership by the petitioner of all of the stock of the Newport & Richford Railroad Company there was a literal compliance with the statutory requirement for affiliation. The remaining issue raises the question whether the premiums received by the petitioner in 1911 upon the sale of its long-term bonds which were outstanding during the years 1921, 1922, and 1923, should be amortized over the life of the bonds and, if so, whether the amortized portions of the premiums allocable to the taxable years constitute taxable income to the petitioner in those years or whether such aliquot portions of the premiums served to reduce the amounts deductible in those years as expenses on account of the annual interest payments by the petitioner on the bonded indebtedness. In his audit of the consolidated returns filed by the petitioner the respondent included the item of $936.71 representing the aliquot portion of the bond premiums in taxable income for each year. The respondent now takes the position that this item should apply in each1659 year to reduce the deductions allowed on account of the annual interest payments on the bonds, amounting to $17,500; that the deduction allowed corporations by section 234(a)(2) of the Revenue Acts of 1918 and 1921 of interest paid or accrued within the taxable year on its indebtedness is interest "computed at the effective or true rate rather than at the nominal interest rate." Section 212(b) of the Revenue Act of 1921, under the provisions of which the petitioner's income-tax returns for 1921, 1922, and 1923 were filed, provides in part as follows: The net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such 399 method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * The Commissioner's regulations prescribed under the Revenue Act of 1921 provide in part, in article 545, under the caption, "Sale and retirement of corporate bonds, 1660 " as follows: (2)(a) If bonds are issued by a corporation at a premium, the net amount of such premium is gain or income which should be prorated or amortized over the life of the bonds. * * As appears from Commissioner v. Old Colony R.R. Co., 26 Fed.(2d) 408, railroad corporations since 1914 have been required by the regulations of the Interstate Commerce Commission to take up in income of each year a prorated portion of the premiums received upon bond issues and have been entitled to deduct from gross income a prorated portion of the discount upon bond issues, regardless of the date the bonds were sold. Under such regulations the petitioner accrued upon its books of account for each of the taxable years $936.71 representing the aliquot portion of the bond premiums involved in this proceeding. The question before us, therefore, is whether the petitioner, in making its income-tax returns for the taxable years in question, may impugn the correctness of its books of account in so far as they reflect the accrued income. We are of the opinion that it may not, unless we can find that the method employed by the petitioner does not clearly reflect its income. 1661 We are not prepared so to find. Surely the accrual of the premiums on bonds in income does not work a greater distortion of the gains of the year than does an accrual of bond discount where the bonds have been sold at a discount. Under the accrual system amounts may be included in the gross income which are not received in the taxable year; and amounts may be deducted which are not paid out within the taxable year. The object of the accounting or bookkeeping is simply to reflect the gain of the taxable year. This sole question of whether the receipt of premiums upon bond issues constitutes taxable income and whether such income should be spread over the life of the bonds was thoroughly considered by the Board in Fall River Electric Light Co.,23 B.T.A. 168">23 B.T.A. 168, where we held that premiums received upon a bond issue in 1925 constituted taxable income to be amortized over the life of the bonds. This was the position taken by the United States Circuit Court of Appeals for the First Circuit in Commissioner v. Old Colony R.R. Co., 50 Fed.(2d) 896. The opinion reads in part as follows: The question to be solved in the case at bar is whether profit1662 arising from the sale of the bonds may be taken into account in determining the expense to 400 be allowed the Old Colony as a deduction. If the books were kept on a cash basis the deduction allowable would be the interest paid on the bonds, and only that, as that would be the cash disbursement for the year. The Commissioner contends, however, that the real expense in connection with the payment of the interest on the bonds is the amount of it less an aliquot part of the profit, apportioned to the year 1921, amounting to $6,960.64, as the bonds cost the company less than the amount represented by the rate of interest. There are no authorities precisely in point, and the decided cases in which somewhat similar questions arose relate to companies whose books were kept on a cash basis. See, for instance, Baldwin Locomotive Works v. McCoach,221 F. 59">221 F. 59; Chicago & Alton R.R. Co. v.United States, 53 Ct. Claims, 41. But there is one decided case which is the converse of the case at bar. In 1663 Western Maryland Ry. Co. v. Commissioner,33 F.(2d) 695, a corporation whose bonds were sold at a discount was allowed to figure the proportionate part of the discount as an expense for the year. The same principle applies to the case at bar. If a corporation is allowed to show a greater expense for a given year by adding a proportionate part of a loss on the sale of bonds, there seems no reason to deny to the taxing authorities the right to show a smaller expense by deducting the proportionate part of a gain on a sale of bonds. Such a result may seem contrary to the case in this circuit of Commissioner v. Old Colony Railroad Company,26 F.(2d) 408, which involved a similar state of facts. The decision was that a profit made in 1904, before the passage of the Sixteenth Amendment to the Constitution of the United States, could not be taxed. The court's attention was not called to the fact that the profit made in the early years was not being taxed, but that it was being used only to determine the expense for the year 1921 of the payment of interest on the bonds. This is not a tax but an allocation, under proper accounting methods for1664 books kept on the accrual basis, of the expense chargeable to the year 1921. See Chicago, Rock Island & Pacific Ry. Co.,13 B.T.A. 989">13 B.T.A. 989, 1029. Although the court there held that the deduction for the interest payment should be reduced by the aliquot portion of the premium on the bond issue allocable to the taxable year, the result is the same if the aliquot portion of the premium be included in the gross income and the taxpayer is permitted to deduct as an expense the total interest paid on the bond issue during the taxable year. We are of the opinion that the Commissioner's regulations on this point should be sustained. The same question presented by this proceeding was before us in Chicago & North Western Railway Co.,22 B.T.A. 1407">22 B.T.A. 1407. There we held that the amortized portion of premiums on bonds issued prior to March 1, 1913, should not be included in the gross income of 1920, but that the amortized portion of premiums on bonds issued subsequent to March 1, 1913, should be included in gross income. We there relied on 1665 Commissioner v. Old Colony R.R. Co., 26 Fed.(2d) 408. In the light of the later pronouncement of the same court upon this question, we sustain the Commissioner's regulation and hold that an aliquot part of the premiums upon bond issues is to be included in the gross income regardless of the date of issue. *401 In accordance with the stipulation of the parties, we find that there is a deficiency for 1921 of $1,602.38, for 1922 of $21,119.50, and for 1923 of $2,195.39. Reviewed by the Board. Judgment will entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621429/	RTS INVESTMENT CORPORATION, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent RTS Inv. Corp. v. CommissionerDocket Nos. 1584-83, 4971-83, 4972-83, 4973-83, 4974-83, 4975-83, 3135-84, 7823-84, 7824-84, 7825-84, 7826-84, 2480-85, 9422-85, 9423-85, 9424-85, 9425-85, 9426-85, 9427-85, 9428-85, 9429-85.United States Tax CourtT.C. Memo 1987-98; 1987 Tax Ct. Memo LEXIS 94; 53 T.C.M. (CCH) 171; T.C.M. (RIA) 87098; February 17, 1987. Michael O. Johanns and 95 Jim R. Titus, for the petitioners. Albert B. Kerkhove, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: In these consolidated cases, respondent determined deficiencies in petitioners' Federal income taxes as follows: TaxablePetitionerDocket No.Year EndedDeficiencyLeRoy and Molly Hilt4975-8312-31-77$50,812.00Robert P. Hilt4971-8312-31-7746,137.0012-31-7867,183.009429-8512-31-7940,628.007823-8412-31-805,689.219426-8512-31-81635,658.0012-31-82286,221.00Roger W. and4973-8312-31-7732,107.00Sandra M. Norris12-31-7835,305.009428-8512-31-7920,918.007824-8412-31-8011,728.399422-8512-31-81485,913.0012-31-82227,191.00Thomas L. and4974-8312-31-7743,109.00Katharina Hilt12-31-7844,708.00Thomas L. Hilt7825-8412-31-8085,670.72Thomas L. and9423-8512-31-81346,697.00Norma J. Hilt12-31-82196,776.00Trucks, Inc.4972-8312-31-77124,761.0012-31-7880,586.009424-8512-31-7993,738.007826-8412-31-8056,967.009425-8512-31-81790,727.00RTS Investment1584-838-31-7832,000.00Corporation8-31-7946,668.003135-848-31-8046,000.002480-858-31-81517,167.009427-858-31-82587,377.0096 The principal issue for which these cases were consolidated is whether amounts paid directly or indirectly for salaries and management fees to shareholder employees of closely held corporations during the years in issue constitute reasonable compensation for services rendered. After concessions, the only other issues are whether LeRoy and Molly Hilt failed to report $294 of taxable income in 1977 and whether Robert Hilt failed to report $29,167 of taxable income in 1978. FINDINGS OF FACT Some of the facts have been stipulated. The facts set forth in the stipulations and exhibits are incorporated in our findings by this reference. The facts surrounding the reasonable compensation issue primarily involve LeRoy Hilt and his three children (the children), Robert P. Hilt (Robert Hilt), Sandra M. Norris (Sandra Norris), and Thomas L. Hilt (Thomas Hilt) (collectively, the Hilts); and the following entities: Trucks, Inc. (Trucks Inc.), RTS Investment Corporation (RTS), Hilt Truck Line, Inc. (Hilt Truck Line), and Western Services Partnership (Western Services). Petitioners LeRoy and Molly Hilt resided in Las Vegas, Nevada, when their petition was filed. The remaining individual97 petitioners resided in Omaha, Nebraska, when their petitions were filed. All of the individual petitioners' Forms 1040, U.S. Individual Income Tax Returns, placed in issue by respondent were prepared on the cash basis and filed with the Internal Revenue Service Center in Ogden, Utah (the Ogden Service Center). Petitioner RTS had its principal office in Council Bluffs, Iowa, when its petitions were filed. It filed 1978 through 1982 Forms 1120, U.S. Corporation Income Tax Returns, and a 1979 Form 1120X, Amended U.S. Corporation Income Tax Return, with the Ogden Service Center. Its returns were prepared on the accrual basis and for taxable years ended August 31. Petitioner Trucks Inc. had its principal office in Council Bluffs, Iowa, when its petitions were filed. It filed 1977 through 1981 Forms 1120, U.S. Corporation Income Tax Returns, with the Ogden Service Center. Its returns were prepared on the accrual basis and for calendar years. Hilt Truck Line, an electing small business corporation, filed 1977 through 1982 Forms 1120S, U.S. Small Business Corporation Income Tax Returns, with the Ogden Service Center. Its returns were prepared on the cash basis and for calendar years. 98 Western Services filed 1978, 1980, and 1981 Forms 1065, U.S. Partnership Returns of Income, with the Ogden Service Center. Its returns were prepared on the cash basis and for calendar years, except that its 1978 return was for a short year, January 2 through December 31. History of the BusinessesLeRoy Hilt began a trucking business out of the basement of his Nebraska home in about 1932. The business was a sole proprietorship for which LeRoy Hilt performed essentially all necessary functions, i.e., operations, sales, and marketing. He incorporated the business as Hilt Truck Line, Inc., in 1961 and elected treatment as a small business corporation under Subchapter S of the Internal Revenue Code. In the late 1960's, the business operations were moved to a new location. Hilt Truck Line did not own tractors or trailers but subcontracted work to independent contractors. LeRoy Hilt's children worked at the trucking business on a part-time basis, including weekends, while they were in grade school. Sandra Norris, who did not attend college, began working full time for the company in the mid 1960's. She performed the bulk of the office work. Thomas Hilt graduated from the99 University of Nebraska, majoring in accounting and economics. He completed approximately 1 year of law school and thereafter attended the College of Advanced Traffic in Chicago, Illinois, to study Interstate Commerce Commission (ICC) law and related subjects. From 1963 to 1965, Thomas Hilt worked as general manager for Nolte Brothers Truck Line, a business in which the Hilt family held an interest, and, in about 1965, he began to work full time for his father's business. Robert Hilt attended the University of Nebraska but did not complete college. He served in the military for approximately 1 year in Vietnam and thereafter returned to work full time for the family business in about 1968. Hilt Truck Line was a motor common carrier authorized by a certificate of public convenience and necessity issued by the ICC. Also, Hilt Truck Line was the only licensed carrier for U.S. Customs in "all 48 states." Permits were required to be filed in every state from which, to which, and through which the company's hired trucks transported goods or other merchandise. A substantial amount of paperwork was required for each trip and on each driver; Sandra Norris completed such paperwork in the100 office. Thomas Hilt's primary responsibility with the company was administrative; although it was not common for trucking companies to have their own ICC practitioner (most would hire an attorney), Thomas Hilt handled the bulk of this work and his father handled the rest. The ICC work included the required filing of tariffs, which were publications describing the company's rates and conditions for hauling. In addition to the tariffs and other required filings with the ICC, Thomas Hilt was often involved in ICC hearings, which occupied substantial amounts of time. The ICC workload declined, however, when the industry was deregulated in 1980. Thomas Hilt also performed certain legal work for the company, maintained the financial records, and signed the company's tax returns. Most motor carriers operated through brokers. A broker would obtain a load of freight and call an ICC carrier to move the freight. The brokers typically charged an average standard fee of 7 to 8 percent. Hilt Truck Line did not commission brokers but performed a similar function itself, in two ways. First, approximately 40 percent of Hilt Truck line's business was conducted through the "trip lease," where101 a tractor-trailer operator needed, for example, a one-way "return" load. Second, approximately 60 percent of Hilt Truck Line's business was conducted through Trucks Inc., which owned trailers that were leased to Hilt Truck Line. Hilt Truck Line was owned as follows in 1977: LeRoy Hilt334 sharesRobert Hilt102 sharesThomas Hilt102 sharesSandra Norris102 sharesOn or about March 1, 1977, LeRoy and Molly Hilt moved their residence to Las Vegas, Nevada. At the end of 1977, LeRoy Hilt's stock was redeemed by the corporation, and for the remaining years in issue, 1978 through 1982, Hilt Truck Line was owned in equal shares by the children. The Board of Directors of Hilt Truck Line, which was composed of the Hilts, held annual meetings each May. The officers of Hilt Truck Line, which included one nonfamily member, Norma Kuebler, were determined at the annual meetings for the years in issue as follows: 1977LeRoy HiltPresident and TreasurerThomas HiltVice President-TrafficSandra NorrisVice President-AdministrativeMolly HiltSecretary1978 - 1982Thomas HiltPresident and TreasurerNorma KueblerVice PresidentSandra NorrisSecretary102 At the May 1977 meeting, the board resolved to pay the following amounts of bonuses and total compensation: BonusTotalLeRoy Hilt$125,750$743,250Thomas Hilt73,500397,500Sandra Norris50,500297,500The resolution also included a statement that "[t]he increase for LeRoy Hilt for 1977 is to be a one time increment to compensate for past services and continued outstanding leadership." At a special December 1977 meeting, the directors resolved that the corporation redeem the shares held by LeRoy Hilt, and he thereupon resigned as an officer and director of the company. At the May 1978 meeting, the directors resolved (1) to pay Thomas Hilt and Sandra Norris salaries in 1978 of $350,000 and $237,500, respectively, and (2) to engage Western Services to provide management services in 1978 for $330,000. At the May 1979 through 1982 meetings, the directors did not discuss or otherwise determine anyone's salary; however, they did resolve to engage the management services of Western Services for "reasonable compensation." The minutes for annual meetings prior to the years in issue describe compensation to officers as follows: YearLeRoy HiltThomas HiltSandra Norris1971$20,000$26,000$15,600"AdditionalCompensation"40,00024,000"For pastservicesrendered"120,00050,000Total180,000100,00015,600 1972189,900105,50076,184 1973189,900111,30376,184 1974237,375139,12891,375 1975296,750174,400114,0001976380,000225,000153,450103 During the years in issue, Hilt Truck Line never maintained more than five employees, including its officers. On its Forms 1120S, Hilt Truck Line reported the following amounts of sales, income, and compensation: Officers SalariesandYearGross SalesTotal IncomeTaxable IncomeManagement Fees1977$16,528,330$2,904,032$627,467 $1,438,250 197816,910,0042,329,26160,380 917,499197916,597,2841,931,738(205)337,011198017,943,8313,426,31343 1,905,221 198115,631,7932,123,7841,863 937,423198214,091,2571,303,388(398,452)765,160On its balance sheets filed with the tax returns, Hilt Truck Line reported the following end of the year amounts of total assets, total liabilities, and total owners' equity: YearTotal AssetsTotal LiabilitiesTotal Owners' Equity1977$2,390,580$2,283,180$107,400 19781,649,3222,109,009 (459,687)19791,346,6421,866,912 (520,270)198098,743618,970 (520,227)198140,443559,850 (519,407)198235,443955,165 (919,722)On each of the returns for years 1977 through104 1982, Hilt Truck Line did not report any dividend distributions out of current year's income. It did report each shareholder's share of undistributed taxable income, most of which was usually distributed in January of the following year, and each officer's amount of compensation as follows: Shareholders' Share of UndistributedTaxable IncomeYearRobert HiltThomas HiltSandra Norris1977$209,155 $209,156 $209,156 197820,126 20,127 20,127 1979(68)(68)(69)198014 15 14 1981621 621 621 1982(132,817)(132,818)(132,817)Compensation of Officers - SalariesYearLeRoy HiltThomas HiltSandra Norris1977$743,250$397,500$297,500 1978349,999237,500197970,654266,3571980768,346296,8751981498,463309,9601982466,660298,500Hilt Truck Line also reported deductions (without further explanation on the return) for management fees as follows: 1978$330,0001980840,0001981165,000Western Services, a partnership owned in equal shares by the children during the years in issue, filed partnership returns describing105 its principal business activity as management services. On its 1978, 1980, and 1981 returns, Western Services reported the following amounts of gross receipts: 1978$330,0001980840,0001981165,000On the same returns, Western Services also reported the following amounts of each partner's share of ordinary income and net earnings: Ordinary IncomeYearRobert HiltThomas HiltSandra Norris1978$110,000$110,000$110,0001980279,987 279,986 279,986 198155,000 55,000 55,000 Net EarningsYearRobert HiltThomas HiltSandra Norris1978$110,000$110,000$110,0001980267,090 267,090 267,089 198155,000 55,000 55,000 Petitioner Trucks Inc., a Nebraska corporation, was formed in about 1969 and was owned in equal shares during the years in issue by the children. 2 They were the directors of the corporation during the years in issue (as were LeRoy and Molly Hilt in 1977 and 1978) and its officers: Robert HiltPresidentThomas HiltVice President and TreasurerSandra NorrisSecretary106 Trucks Inc. did not own tractors but purchased semitrailers which it leased to Hilt Truck Line. Trucks Inc. obtained independent contractors, or owner operators, who were paid on a mileage basis. Robert Hilt performed a majority of the services for Trucks Inc. The minutes of the January 1977 annual meeting of the board of directors of Trucks Inc. describe a resolution to pay salaries in 1977 to Robert Hilt and Roger Norris (Sandra Norris' husband) of $364,000 and $39,300. The minutes of the January 1978 annual meeting describe resolutions to pay Robert Hilt a salary of $145,833 and a bonus of $73,500 (for "exemplary services") and to pay Robco, a name Robert Hilt occasionally used in reference to his management services, $175,000 for management services. On its Forms 1120 for the years in issue, Trucks Inc. described its principal business activity as leasing motor vehicle equipment and reported the following: CompensationOtherOtherTaxableto OfficersIncomeDeductionsYear(To Robert Hilt)(Mgt. fees)(Mgt. Services)1977$437,500$24,0001978145,833 8,000 $175,000 1979428,500198036,000 400,0001981156,000518,333107 Trucks Inc. paid no dividends during years in issue. On Robert Hilt's 1978, 1979, and 1980 individual income tax returns, he reported as "other income" amounts received for "Management Services, Robco" of $175,000, $428,500, and $400,000, respectively. On his 1981 and 1982 returns, he reported no other income but business income, on Schedule C, of $480,500 (for services) and $474,150 (for consulting director: services), respectively. Petitioner RTS, a Nebraska corporation, was owned in equal shares during the years in issue by the children. They were the directors of RTS during the years in issue and it officers: Robert HiltPresidentThomas HiltVice President and TreasurerSandra NorrisSecretaryThe purpose of the corporation was to invest in virtually anything that might turn a profit. Initially, the company purchased land and constructed a trucking terminal in Council Bluffs, Iowa. The family business was moved into the terminal before it was completed in December 1969. In about February or March of the same year, the terminal was burglarized. As a result, Robert Hilt moved into the terminal and lived there through 1975, after which he108 stayed there only periodically. Although LeRoy Hilt held neither an ownership interest in nor an employed position with RTS, his advice on various investments was often solicited by the children. In the mid-1970's, RTS asked LeRoy Hilt to manage its investment in a bank in Lyons, Nebraska. Because of its share of the ownership, RTS was granted a seat on the bank's board of directors. LeRoy Hilt filled that seat and served as chairman of the board for several years. The bank, which was in serious financial difficulty at the beginning of RTS's involvement, eventually became quite successful. RTS acquired an interest in a second bank, in Iowa, that was in similar, if not worse, financial disarray. As before, LeRoy Hilt became involved in management and served on the board of directors. Regarding both banks, LeRoy Hilt received and reviewed daily reports and participated in investment decisions on behalf of both banks. RTS also purchased a Nebraska farm of approximately 1,500 acres in the early to mid-1970's. LeRoy Hilt managed the farm for RTS and made decisions including crop rotation. On its 1977 through 1981 Forms 1120, RTS reported the following: Other deductions:Tax YearCompensationSalary andMgt. Fees orEndedof OfficersWagesServices8/31/78$94,6668/31/79100,0008/31/80100,0008/31/81120,0008/31/82$284,983304,667109 The amounts deducted for management fees or services included the following payments to LeRoy Hilt: Tax YearEndedLeRoy Hilt8/31/78$66,6678/31/79100,0008/31/80100,000The minutes of the September 1978, 1979, and 1980 annual meetings of the board of directors of RTS describe resolutions that the payments to LeRoy Hilt were management fees for necessary management services. On his 1978 and 1979 state income tax returns filed with the State of Nebraska, LeRoy Hilt reported as income from Nebraska sources management fees of $66,667 and $133,333; however, on or about June 12, 1982, he filed amendments to both returns claiming that these amounts should not have been reported as income from the State of Nebraska and that they are actually income from Nevada sources. A letter dated November 11, 1982, addressed to the Nebraska Department of Revenue from LeRoy Hilt's accountant represented that LeRoy and Molly Hilt moved to Las Vegas, Nevada, to "build up the business activities of Hilt Truck Line" and that because he performed these services in Nevada, they were not properly includable in Nebraska income. On its 1977 through 1980 Forms 1120, RTS identified110 itself and Trucks Inc. as a controlled group pursuant to section 1563(a). 3 On its 1981 Form 1120, RTS reported the plan of reorganization whereby RTS received the assets and liabilities of Trucks Inc. and became the transferee of Trucks Inc., effective January 1, 1982. There was substantial overlap among all the Hilt business described above. Hilt Truck Line, RTS, and Trucks Inc. all reported the same mailing address on their tax returns and operated out of the same offices at the terminal. Until his stock was redeemed in 1977, LeRoy Hilt managed sales and marketing and made the major decisions involving the trucking business; thereafter, the decision-making was generally shared by the Hilt children. Although Sandra Norris ran the office, Thomas Hilt tended to ICC and administrative matters, and Robert Hilt oversaw the operations through Trucks Inc., these individuals were quite knowledgeable of each others' duties as well as the business as a whole. Any problems, especially with highway accidents or other problems with trucks111 in route, were generally directed to Robert Hilt at the terminal, and, if he was unavailable, one of the other Hilts would tend to the matter. The trucking business often required one of the Hilts, usually Robert Hilt because he lived in the terminal for a while, to be on call 24 hours a day. The Hilts' workload during the years in issue was approximately as follows: Sandra Norris45-60 hrs/weekRobert Hilt80-100 hrs/weekThomas Hilt80 hrs/weekLeRoy Hilt (1977)100 hrs/weekAlthough the overall operation of the trucking business required considerable travel by one or more of the Hilts, the family often gathered to discuss business. At such meetings, the Hilts, among other things, determined their respective compensation. The years in issue were somewhat volatile years for the trucking industry, marked by a fuel crisis in about 1979 and a rise in the price of diesel fuel of approximately 45 to 50 cents per gallon. In spite of sharp increases in the price of fuel, the hauling rates charged by Hilt Truck Line were governed by tariffs on file with the ICC, which required 30 to 60 days to process changes in those tariffs. Profitability within the overall112 industry, as well as for Hilt Truck Line, fell dramatically. In his notices of deficiency to the individual petitioners, respondent determined the following amounts of disallowed and allowed personal service income: Salary (S)/IndividualTaxableManagementAmountAmountPetitionerYearFee (M)DisallowedAllowedLeRoy Hilt1977$743,250 (S) $441,898.00$301,352.00Robert Hilt1977437,500 (S) 260,690.00176,810.001978145,833 (S) 81,993.0063,840.00285,000 (M) 160,221.00124,779.001979428,500 (M) 203,953.00224,547.001980667,090 (M) 390,933.00276,157.001981480,500 (M) 175,706.00304,794.00Thomas Hilt1977397,500 (S/M) 220,690.00176,810.001978349,999 (S/M) 148,612.00201,387.00110,000 (M) 110,000.000.0019801,035,436 (S/M)785,357.07250,078.931981498,463 (S/M) 222,451.00276,012.001982466,660 (S/M) 173,728.00292,932.00Sandra Norris1977297,500 (S/M) 193,293.00104,207.001978237,500 (S/M) 123,086.00114,414.00110,000 (M) 110,000.000.001979267,184 (S/M) 139,612.00127,572.001980563,964 (S/M) 406,871.00157,093.001981309,960 (S/M) 136,576.00173,384.001982298,500 (S/M) 114,488.00184,012.00113 In certain notices of deficiency, respondent determined the following amounts of disallowed and allowed deductions for salaries and/or management fees by Trucks Inc.: TaxableAmountAmountAmountYearClaimedDisallowedAllowed1977$437,500$260,690$176,8101978145,83381,99363,840175,00098,39276,6081979428,500203,953224,5471980400,000123,843276,1571981518,333518,3330In certain notices of deficiency, respondent disallowed deductions for the following claimed payments of management fees by RTS: TaxableAmountYearDisallowedPayee8/31/78$66,667LeRoy Hilt8/31/79100,000LeRoy Hilt8/31/80100,000LeRoy Hilt8/31/81120,000Not determined instatutory notice8/31/82304,667Not determined instatutory notice,but paid to RobertHilt and reportedby him asSchedule C incomefor 1982OPINION Reasonable Compensation IssueRespondent determined amounts of reasonable compensation for the individual petitioners during the years in issue. Accordingly, deductions for salaries and management fees paid by the related businesses were114 disallowed to the extent they exceeded these amounts. Deficiencies were also determined for the individual petitioners because, inter alia, the amounts in excess of reasonable compensation would not be personal service income and thus would not be subject to the 50 percent maximum tax limit on personal service income for taxable years beginning prior to January 1, 1982. Section 1348. Personal service income as used in section 1348(b)(1) incorporates the definition of "earned income" in section 911(b). Section 911(b) provides, in pertinent part: (b) Definition of Earned Income. -- For purposes of this section, the term "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered, 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 rather than a reasonable allowance as compensation for the personal services actually rendered. * * * Thus, any portion of the distributions received by the Hilts in excess of reasonable compensation is not earned income and, for115 taxable years beginning prior to January 1, 1982, must be subject to a maximum tax rate of 70 percent instead of 50 percent. Section 162(a)(1) provides: (a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including -- (1) a reasonable allowance for salaries or other compensation for personal services actually rendered; To qualify under section 162(a)(1), compensation must be both reasonable in amount and paid purely for services. Section 1.162-7(a), Income Tax Regs. This test is characterized as having two prongs, the second of which requires proof of "compensating purpose." See Elliotts, Inc. v. Commissioner,716 F.2d 1241">716 F.2d 1241, 1243 (9th Cir. 1983), revg. on another issue and remanding a Memorandum Opinion of this Court; Nor-Cal Adjusters v. Commissioner,503 F.2d 359">503 F.2d 359, 362 (9th Cir. 1974). Due to the subjective nature of determining whether compensation was paid purely for services, courts generally focus only on the reasonableness prong (see, e.g., Pacific Grains, Inc. v. Commissioner,399 F.2d 603">399 F.2d 603 (9th Cir. 1968)),116 unless the Commissioner presents evidence that the payments were disguised dividends (see, e.g. 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)). Elliotts, Inc. v. Commissioner,supra.To determine whether compensation is reasonable, we must examine all the relevant facts and circumstances. Home Interiors and Gifts, Inc. v. Commissioner,73 T.C. 1142">73 T.C. 1142, 1155 (1980), and cases cited therein. Factors that have been considered by courts addressing the issue of reasonable compensation include the following: the employee's qualification; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with the gross income and the net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and in the case of small corporations with a limited number of officers the amount of compensation paid to the117 particular employee in previous years. * * [Home Interiors and Gifts, Inc. v. Commissioner,73 T.C. at 1155-1156, quoting Mayson Manufacturing Co. v. Commissioner,178 F.2d 115">178 F.2d 115, 119 (6th Cir. 1949), reversing a Memorandum Opinion of this Court.] No single factor is dispositive of the issue; instead, the Court's decision must be based upon a careful consideration of applicable factors in light of the relevant facts. See Mayson Manufacturing Co. v. Commissioner,supra.Where the corporation is controlled by officer/employees who set their own compensation, as in this case, special scrutiny must be given to such salaries. Charles Schneider & Co. v. Commissioner,500 F.2d 148">500 F.2d 148, 152 (8th Cir. 1974), affg. a Memorandum Opinion of this Court. The test of reasonableness should not be applied to the officers as a group but rather to each officer's salary in light of the individual services performed. L. Schepp Co. v. Commissioner,25 B.T.A. 419">25 B.T.A. 419 (1932). Respondent's determination is presumptively correct, and the taxpayer has the burden of proving otherwise. Botany Worsted Mills v. United States,278 U.S. 282">278 U.S. 282 (1929);118 Rule 142(a), Tax Court Rules of Practice and Procedure. If petitioners successfully prove error, the Court must 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). Section 1.162-7(b), Income Tax Regs., provides in pertinent part: (1) Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. An ostensible salary paid by a corporation may be a distribution of a dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. * * (2) The form or method of fixing compensation is not decisive as to deductibility. * * * (3) In any event the allowance for the compensation paid may not exceed what is reasonable under all the circumstances. It is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. The circumstances to be taken into consideration119 are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned. [Emphasis supplied.] Respondent's determinations generally concern the reasonableness of payments of salaries and/or management fees (1) by Hilt Truck Lines to LeRoy Hilt, to Sandra Norris, to Thomas Hilt, and to Western Services, (2) by RTS to Trucks Inc., to Robert Hilt, and to LeRoy Hilt, and (3) by Trucks Inc. to Robert Hilt. Respondent argues that the amounts paid and at issue here were not the result of arm's-length negotiations and that petitioners have not otherwise established that the amounts constituted reasonable compensation in view of the necessary criteria. Petitioners do not dispute the lack of arm's-length negotiations; however, petitioners insist that the evidence supports their contentions that the amounts in issue were paid as reasonable compensation for services rendered. Petitioners also argue that services, and not capital, constitute the material income-producing factor in the Hilt companies. Petitioners continuously refer to and rely upon the case Trucks, Inc. et al. v. United States,588 F. Supp. 638">588 F. Supp. 638 (D. Neb. 1984),120 where the district court found reasonable, and therefore deductible, salaries paid in 1975 and 1976 by Hilt Truck Line and Trucks Inc. to certain of the individual petitioners in this case. Petitioners contend that respondent has "disregarded the findings of the U.S. District Court" and is attempting to relitigate that case. We note however that, although the law in the area of reasonable compensation is essentially unchanged, the district court considered lesser amounts of compensation paid in different (earlier) taxable years not involving all of the entities in the case before us. See Commissioner v. Sunnen,333 U.S. 591">333 U.S. 591, 597-599 (1948). Robert Hilt, Thomas Hilt, and Sandra Norris received indirect payments from Hilt Truck Line through their partnership, Western Services. In 1978, 1980, and 1981, Hilt Truck Line paid Western Services for management fees. Western Services thereupon distributed equal portions to each of the Hilt partners. Respondent argues that these distributions were disguised dividends from Hilt Truck Line. Although we do not specifically characterize the amounts as "dividends" (because Hilt Truck Line was a subchapter S corporation), we121 must agree that the funds channeled through Western Services were in the nature of dividends, i.e., distributions of earnings and profits. Section 1.162-8, Income Tax Regs.; see Klamath MedicalService Bureau v. Commissioner,supra.The payments to the Hilt children were proportionate to their holdings in Hilt Truck Line and irrespective of individual duties and qualifications. The years that the children received payments from Western Services, i.e., 1978, 1980, and 1981, were Hilt Truck Line's only profitable years, in terms of taxable income, of the years Hilt Truck Line contracted the "services" of Western Services. Thus, the financial success of Hilt Truck Line appears to have been the only distinguishing factor between years Western Services, and hence the children, received payments (1978, 1980 or 1981) and years it did not (1979 and 1982). No evidence indicates that the "services" provided by the children differed in one group of years from the other. Moreover, petitioners do not explain (1) any business purpose of Western Services other than alleged ICC compliance, (2) the nature of their services (to Hilt Truck Line) through Western Services, 122 or (3) why their services would be any different from what they would have otherwise performed without Western Services. LeRoy Hilt received a salary of $743,250 from Hilt Truck Line in 1977. Of this amount, respondent determined that only $301,352 was reasonable compensation. After considering the applicable factors, we sustain respondent's determination. Of all the Hilts, LeRoy Hilt was undoubtedly the most qualified and the most experienced in terms of operating a trucking business. He founded the Hilt trucking business, made all major decisions, and was the driving force behind its growth and success throughout many years. Justifiably, he received substantially larger salaries than the other Hilts -- usually about 80 percent more than Thomas Hilt and 150 percent more than Sandra Norris. From 1972 through 1976, LeRoy Hilt's salary steadily increased approximately 25 percent per year, but, in 1977, the increase was 96 percent. Even considering the individual qualities and experience of LeRoy Hilt, the evidence simply fails to justify such an increase or to support the reasonableness of the amount paid. We recognize that the compensation allowed as reasonable by respondent123 in 1977 is about $80,000 less than LeRoy Hilt's salary in 1976; however, LeRoy Hilt had then moved from Nebraska to Las Vegas, Nevada, and, although his work there was concentrated on west coast company operations, we are not persuaded that he maintained either the same degree of control of overall company business or his intense working style after the move. Thomas Hilt and Sandra Norris received direct payments for salary and/or management fees from Hilt Truck Line, and Robert Hilt received both direct and indirect payments from both Trucks Inc. and RTS. Only a portion of each of these payments was allowed as reasonable compensation by respondent. In applying the requisite factors, because of the overlapping of the three companies and the overlapping of the children's responsibilities and activities among the three companies, we have disregarded the separate identities of the companies but have considered the children individually. Both parties introduced extensive expert testimony. Opinion testimony of an expert is admissible if and because it will assist the trier of fact to understand evidence that will determine a fact in issue. See Fed. R. Evid. 702124 . Such evidence must be weighed in light of the demonstrated qualifications of the expert and all other evidence of value. Estate of Christ v. Commissioner,480 F.2d 171">480 F.2d 171, 174 (9th Cir. 1973), affg. 54 T.C. 493">54 T.C. 493 (1970); Anderson v. Commissioner,250 F.2d 242">250 F.2d 242, 249 (5th Cir. 1957), affg. a Memorandum Opinion of this Court. We are not bound by the opinion of any expert witness when that opinion is contrary to our judgment. Kreis' Estate v. Commissioner,227 F.2d 753">227 F.2d 753, 755 (6th Cir. 1955); Tripp v. Commissioner,337 F.2d 432">337 F.2d 432 (7th Cir. 1964), affg. a Memorandum Opinion of this Court. We may embrace or reject expert testimony, whichever, in our best judgment, is appropriate. Helvering v. National Grocery Co.,304 U.S. 282">304 U.S. 282 (1938); Silverman v. Commissioner,538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. a Memorandum Opinion of this Court; In re Williams' Estate,256 F.2d 217">256 F.2d 217, 219 (9th Cir. 1958), affg. a Memorandum Opinion of this Court. Petitioners' expert on reasonable compensation was Henry Vanderkam (Vanderkam), who was, at the time of trial, the senior125 partner in a Texas law firm. Vanderkam was also a CPA with several years experience at the accounting firm Touche Ross & Co. His experience in the area of reasonable compensation included (1) a number of surveys and evaluations of executive compensation, (2) consulting work relating to stock option plans, and (3) opinion testimony on behalf of numerous taxpayers whose salaries had been challenged by the Internal Revenue Service (IRS) as not reasonable. At the time of trial in March 1986, Vanderkam had visited the Hilt operation in Council Bluffs, Iowa, on six occasions, beginning in 1982. He had interviewed LeRoy Hilt, Robert Hilt, Thomas Hilt, and Sandra Norris, as well as certain members of the shop crew and truck drivers. He also had visited officers of competing companies to assess their views of the Hilt operation. As a result of these interviews, Vanderkam formed the opinion that "Hilt Truck Line, Inc. and the individual family members [named above] * * are in fact unique to the trucking industry." Vanderkam found significant the intensity and dedication of the Hilts, the long hours they worked, and their "unique * * * results oriented" management style. Vanderkam126 prepared a report including comparisons of Hilt Truck Line to other common carriers, specifically, carriers classified as follows: Reporting Carriers Class I Carriers Class II Carriers General Freight Carriers Specialized Carriers Class I General Freight Carriers Class I Intercity General Freight Carriers The data necessary for these comparisons was secured from Hilt Truck Line tax returns and the 1977 through 1982 "Motor Carrier Annual Reports, Results of Operations, Class I and II Motor Carriers of Property Regulated by the I.C.C." Vanderkam used only a nationwide sample and not a regional or state sample because he concluded that any variation would be statistically insignificant. He made no attempt to compare Hilt Truck Line to carriers of like revenue because he believed that such comparison "would be equally as statistically insignificant." The statistical information compiled by Vanderkam and set forth in his report did not include compensation paid by any firms or compare such compensation to the amounts here in dispute. Instead, Vanderkam compared Hilt Truck Line to other firms, in the above classifications, on the basis of the following categories: 127 Return on Equity Before Officers Salaries Return on Equity Gross Revenue per Employee Officers Salaries and Total Wages and Benefits as a Percentage of Revenues Earnings per Employee Before Payroll and Fringe Benefits After Tax Earnings Per Employee According to Vanderkam's report, Hilt Truck Line performed extraordinarily well in the various categories during certain of the years in issue. For example, Vanderkam described Hilt Truck Line's return on equity and, for comparison, the 6-year averages of the categories, as follows: Hilt Truck LineReturn on Equity1977949.67% 197891.39% 1979- .31% 1980.0065%19812.82% 1982- 603.06% Return on EquitySix Year AverageAll Reporting Carriers10.02%Class I Carriers10.17%Class II Carriers10.05%General Freight Carriers9.23%Specialized Carriers11.67%Class I General Freight Carriers9.30%Class I Intercity GeneralFreight Carriers9.32%Hilt Truck Lines, Inc.73.52%Respondent challenged the authenticity of figures Vanderkam used for certain of his comparisons. In all of his equity ratios for Hilt Truck Line, Vanderkam128 apparently used $66,072, the amount of the original investment in Hilt Truck Line, as its equity. This figure, however, does not comport with the amount of owners' equity described in Hilt Truck Line's tax returns in issue. In any event, Vanderkam's opinion was not oriented toward establishing amounts of reasonable compensation by describing what comparable firms pay their executives. Rather, he only attempted to justify the amounts paid by the Hilt companies by showing how unique the Hilt executives were and by showing how superior Hilt Truck Line was compared to other trucking companies in terms of certain overall performance categories. Although Vanderkam was emphatic with regard to the number of hours per week each of the Hilts worked, he had conducted no research on the effect of number of hours worked on the total compensation of shareholder officers. Moreover, Vanderkam's experience in reasonable compensation was limited solely to rendering opinions to support taxpayers who are seeking to justify past salaries. He had never, at the time of this trial, recommended salaries in the trucking industry for future years. One of respondent's experts on reasonable compensation129 was E. James Brennan III (Brennan), who was, at the time of trial, president of Brennan, Thomsen Associates, Inc., a consulting firm on personnel and pay practices. Brennan's experience in reasonable compensation included books, articles, speeches and broadcast interviews on executive compensation, salary administration, comparable worth and personnel management. His firm's list of clientele included members of both the private and public sectors. At the time of trial, Brennan was involved with the analysis and recommendation of executive compensation for future years of approximately 28 to 30 trucking firms which he described as small and closely held. Brennan was retained as a pre-trial consultant and expert witness on personnel management and pay practices, particularly in the area of executive compensation, by the U.S. Department of Justice, the Department of Energy, the U.S. Marshals Service, and the Internal Revenue Service (IRS). In this case, Brennan's firm was retained by the IRS to determine the maximum levels of reasonable compensation for the officer/shareholders of Hilt Truck Line, Trucks Inc., and RTS. To make this determination, Brennan used the same methodology130 used by him to project executive compensation for future years, which includes assessment of the statistical average as well as the maximum limit. Thus, for purposes of Brennan's report, a) information was gathered and studied to identify the highest-paying positions in each industry consistent with the functions of the individuals and the characteristics of their company; b) the actual pay practices of the industries in question were analyzed to identify the actual normal and high pay amounts for like services in like enterprises under like conditions. Based on his analysis, Brennan concluded that "[n]o transportation firm of equivalent size in the country paid as much to its individual top executives as did Hilt Truck Line," and that the Hilts were thus paid amounts in excess of reasonable compensation. Brennan's comparative compensation analysis was based primarily on data compiled by the American Management Association (AMA) in its executive compensation service survey of top executive pay in the transportation industry. The AMA statistics were categorized according to total pay by position and by revenue size. Brennan believed that size is the primary prediction131 of executive compensation. Because "executive compensation practices of firms with sales revenues of 50 to 100 million dollars are substantially more generous than the pay rates of firms whose revenues never exceeded 20 million dollars," Brennan compared Hilt Truck Line to transportation firms whose sales were in the 10 to 30 million dollar range or whose asset size closely approximated the companies in question. Brennan, like Vanderkam, ignored geographic pay differentials. At his request, to prevent any initial bias, all the preliminary statistical and survey data was collected and compiled without Brennan's knowledge of the actual amounts paid to the officer/employees in question. Brennan interviewed the Hilts at a meeting which lasted approximately 3 hours. As a result, in order to make the salary comparisons, Brennan considered the Hilts' descriptions of their responsibilities and classified each of them for each of the years in issue, as either a chief executive officer (CEO), a chief operating officer (COO), or an executive vice-president (ExecVP): LeRoyRobertThomasSandraYearHiltHiltHiltNorris1977CEOCEOCOOExecVP1978COOCEOExecVP1979CEO4COO1980COOCEOExecVP1981COOCEOExecVP1982CEOCOOExecVP132 In making such classifications, Brennan noted that the Hilts did not necessarily provide services equal or approximate to those provided by the comparable positions, whose work descriptions typically indicated "larger jobs" than the Hilts; however, he believed that such comparisons were favorable to the Hilts.Brennan determined and explained the following "'maximum reasonable' total pay amounts": RevenueYear(in millions)CEOCOOExecVP197716.287$ 93,008$57,743$134,987 197817.228147,51987,268107,933197916.547140,78488,344N/A198016.466144,767242,219123,124198115.459132,284135,282118,173198214.091170,61687,005116,740197727$109,227$69,935$152,783 197828169,666103,236117,223197928169,419106,190N/A198029174,695296,961137,881198128167,963158,722137,991198215174,10789,018118,526Two sets of maximum reasonable figures were presented. The first reflects the maximum amounts paid in total compensation for firms133 with the same revenue as Hilt Truck Line. The second is a rough aggregation of all three firms (Hilt [Truck Line], Trucks [Inc.], and RTS) to show the effect of treating all three firms as one composite organization. Brennan's use of maximums involved the examination of salary ranges; however, his focus was not on averages but the "highest figure[s] that could be defended as factual." Thus he concluded the he could determine "a ceiling beyond which no other organization has paid." Regarding the Hilts' workload, according to Brennan, No research has ever shown any positive relationship between the hours of executive work and top executive pay. On the contrary, all available evidence indicates that chief executives who manage their firms so efficiently that they work mere forty-hour weeks or less and delegate routine tasks to subordinates are paid much more than those who work long hours, refuse to delegate detail, perform tasks of a non-executive nature and refuse or decline to train and develop competent subordinate executives. Respondent's other expert on reasonable compensation was Ernest Gruenfeld (Gruenfeld), who was, at the time of trial, a financial analyst with134 the IRS Valuation Analysis Section. His major area of work was in determining value of closely held securities. Gruenfeld prepared a Valuation Report wherein he determined the following amounts of reasonable compensation during the years in issue for each of the Hilts from RTS, Trucks Inc., and Hilt Truck Line, combined: Reasonable Compensation(in thousand)197719781979198019811982LeRoy Hilt$160 $ 67* $133* $100$ 0 $ 0 Thomas Hilt13020071200240270Robert Hilt130200200150180270Sandra Norris100150170130155180$520$617$574$580$575$720In order to determine "what would ordinarily be paid for like services by like enterprises under like circumstances," Gruenfeld's report compiled three sets of data: (a) aggregate compensation (b) compensation for individual positions (c) compensation for specific comparable positions For purposes of the second set of data, Gruenfeld ranked the four Hilts from 1 to 4, reflecting the highest to lowest salary received each year. From surveys of135 executive compensation in the transportation industry by the AMA Top Management Report, the Financial Executives Institute, and the Research Institute of America, Gruenfeld determined that the number 1 position in firms in the transportation industry was never paid more than $120,000 (on the average), the number 2 position was not paid more than $97,000, the number 3 position was paid less than $80,000, and the number 4 position was paid less than $75,000. For purposes of the third set of data, comparing Hilt Truck Line to other trucking firms, Gruenfeld obtained data from the ICC and limited the comparison to trucking companies in Iowa and Nebraska with revenues comparable to Hilt Truck Line. As a result, Gruenfeld determined that the amounts paid to the Hilts were substantially higher than other comparable executives. He also noted that Hilt Truck Line's ratio of total compensation to revenue was always much higher than other companies. In this case, we have devoted considerable time to analyzing the expert witnesses -- their reports, their testimony, and their rebuttal testimony. We have found the opinion of respondent's expert Brennan to be the most persuasive. His credentials136 were unmatched by the other experts, his report was well documented, and his conclusions were supported by considerable factual data. Although we do not adopt the specific amounts of reasonable compensation determined by Brennan, we accept his methodology and his general conclusions about reasonable compensation of executives in the transportation industry. Petitioners argue that Brennan's analysis and opinion are defective because he categorized the Hilts and compared their compensation to other officers within the same category. Petitioners contend that the Hilts "simply defied categorization" because their responsibilities were not so clearly defined and because they each performed the work of several employees. Petitioners cite language in the district court case, Trucks, Inc. v. United States,588 F. Supp. 638">588 F. Supp. 638, 646-647 (D. Neb. 1984), and in Elliotts, Inc. v. Commissioner,716 F.2d 1241">716 F.2d 1241, 1246 (9th Cir. 1983), revg. and remanding a Memorandum Opinion of this Court. In the latter case, the Court of Appeals for the Ninth Circuit stated that if a taxpayer performed the work of three people in a comparable firm, the relevant comparison would137 be the combined salaries of those three people. 5 In this case, however, the evidence indicates only that the Hilts worked long hours and shared responsibilities and decision-making; it does not establish that any one of them performed the work of more than one employee in a comparable concern, as found by the district court on the evidence before it. We are thus unpersuaded that categorizing is not proper where, as here, the categorizations were based on individually described job functions and responsibilities.Petitioners also argue that Brennan's analysis and opinion were defective because he compared a trucking business to other "transportation" firms, which includes all forms of transportation over land and water, not just the trucking industry. While we agree that the category is broader than petitioners' business, we are not persuaded that such a comparison is overly broad or otherwise defeats our purpose here. 6 Deciding where properly to draw the line in determining comparability of business entities is no simple task; however, we believe that Brennan's choices of comparable138 factors were satisfactory in producing firms of adequate comparability and, in any event, were the most persuasive of the methods supported by the evidence. As we stated earlier, we do not adopt the specific amounts of compensation determined by Brennan. Primarily, our reason relates to the performance of the Hilts. Sandra Norris, who did not have a college degree, was responsible for managing the offices. Robert Hilt, who also did not have a college degree, was more of a general operations coordinator, and he worked primarily through Trucks Inc. Thomas Hilt, who held a college degree and a license to practice before the ICC and who had attended a year of law school, was responsible for administrative matters in the company. Thomas Hilt was therefore paid the highest amount of compensation and allowed the highest amount as reasonable by respondent. Although the qualifications of the three and their respective roles in the businesses do not support as reasonable the amounts of compensation actually paid, we are nevertheless impressed by their long hours, the dedication to their work, 139 and the existence of the family unit working together as a team and sharing in the ownership and management. These characteristics made each more valuable than he or she would have been in other separate concerns and thus more valuable than most of the determinations by Brennan. We have considered other factors as well. No particular salary policy was exhibited by any of the Hilt companies. In certain years, the directors of Hilt Truck Line set the officers' salaries during board meetings but provided no explanation for the amounts. LeRoy Hilt's testimony suggests that the salaries were usually based on need and desire instead of merit and services: Q. During this time frame again [1970-1977], who set salaries? A. Probably all of us, as far as that was concerned, we probably held a meeting on it. As far as that was concerned, I might have said, well, what do you need to work, or what do you need to get by, we usually set it at the first of the year. Robert Hilt's testimony was consistent with his father's: Well, up until my dad left, he determined what our salaries were. After that, it was pretty informal, we would meet at the end of the year and decide what140 we were going to pay ourselves next year. Although the compensation paid to the Hilts in 1972 through 1976 increased roughly 25 percent per year, the amounts paid during the years in issue were substantially greater than, often double, those paid in 1975 and 1976; the record does not justify such an increase. Also, the general economic condition of the industry and of Hilt Truck Line declined during the years in issue. We have thus considered the relevant factors in deciding reasonable compensation for the Hilt children. Based on all of the evidence, we conclude that reasonable compensation for the children was no greater than the amounts determined by respondent, except as set forth below. Petitioners argue that, in general, all of the Hilts were undercompensated in prior years. They also advance specific arguments of undercompensation of Thomas Hilt by Hilt Truck Line in 1979 and LeRoy Hilt by RTS in the early 1970's. Courts generally allow current deductions for compensation for past services, Lucas v. Ox Fibre Brush Co.,281 U.S. 115">281 U.S. 115 (1930), "even if the amount paid exceeds a reasonable allowance for current services." Cropland Chemical Corp. v. Commissioner,75 T.C. 288">75 T.C. 288, 297 (1980),141 affd. in an unreported opinion 665 F.2d 1050">665 F.2d 1050 (7th Cir. 1981). The evidence, however, must indicate the amount of undercompensation. American Foundry v. Commissioner,59 T.C. 231">59 T.C. 231, 239-240 (1972), affd. on this issue 536 F.2d 289">536 F.2d 289 (9th Cir. 1976). Petitioners do not elaborate on the general argument; moreover, the evidence indicates that LeRoy Hilt and Thomas Hilt were paid in 1971 for past services. Although the minutes of the 1977 meeting of the board of directors of Hilt Truck Line state that LeRoy Hilt is being compensated for past services, it does not describe, nor does the record otherwise establish, any amount of undercompensation or when it occurred. Petitioners argue that Hilt Truck Line paid additional amounts to Thomas Hilt in 1980 because he was undercompensated in 1979. The evidence reveals that Thomas Hilt received substantially more income in 1980 ($1,035,436) than he received in 1979 ($70,6540), a year for which Thomas Hilt's salary was not challenged by the IRS. Robert Hilt testified that Hilt Truck Line was operating at a loss in 1979, that Thomas Hilt agreed to take a small salary that year on condition that he could142 make it up in 1980, and that he and Sandra Norris agreed to the plan. This testimony was credible and unimpeached and, although the minutes of the annual meetings of the board of directors are silent as to the agreement, no other evidence contradicts the testimony. Moreover, the amount paid to Thomas Hilt in 1979 was substantially less than the amounts allowed by respondent in 1978 and 1980, and the evidence reveals no change in Thomas Hilt's performance and responsibility in 1979. Accordingly, we allow an additional amount of $154,346 as reasonable in 1980, based on an approximate amount of reasonable compensation to Thomas Hilt for his services in 1979 of $225,000 7 minus the actual compensation received of $70,654. Petitioners argue that RTS paid amounts to LeRoy Hilt in 1978, 1979, and 1980 for management services performed in those respective years as well as in prior years in which he received no compensation from RTS. Respondent disallowed the amounts in their entirety because RTS had not established that143 they were bona fide deductions or otherwise reasonable compensation. LeRoy Hilt testified that the amounts were installment payments for services in prior years. The minutes of the annual meeting of the board of directors of RTS describe resolutions approving the payments to LeRoy Hilt for management services but fail to mention past services or that these were part of an installment plan. The assertions as to past services, however, are contradicted by representations made by LeRoy Hilt to the State of Nebraska in an apparent attempt to avoid state income tax for 1978 and 1979. Moreover, aside from these claims, contradicted by other evidence, that the payments were for services in prior years, there is no evidence that LeRoy Hilt performed services for RTS in 1978, 1979, and 1980. The deductions claimed by RTS are therefore not allowed. Respondent disallowed the entire deduction for management fees claimed by Trucks Inc. in 1981, $518.333. The evidence shows that $480,500 of this amount was paid to Robert Hilt for management services. Respondent argued on brief that Trucks Inc. is entitled to a deduction no greater than $304,794, the amount determined to be reasonable compensation144 for Robert Hilt in 1981. We have agreed that this amount is a reasonable allowance for Robert Hilt's services in 1981, and because petitioners have not proven (1) who received the payments equal to the difference between $518,333 and $480,500 or (2) what services were performed for those payments, Trucks Inc. is entitled to a deduction for management services in 1981 for only the amount determined to be reasonable compensation to Robert Hilt, $304,794. Respondent disallowed management fees claimed by RTS during its fiscal years ended in 1981 and 1982. Petitioners argue that the amount claimed in 1981 was actually paid to Trucks Inc. for the services of Robert Hilt. Because reasonable compensation for Robert Hilt in 1981 has been determined, and because the amounts paid directly to Robert Hilt from Trucks Inc. exceeded this reasonable allowance, any amount paid by RTS to Trucks Inc. for Robert Hilt's services is thus in excess of reasonable compensation. The deduction by RTS in 1981 must be disallowed. Regarding the amounts claimed by RTS in 1982, however, the evidence, including respondent's expert's testimony, suggests that they were not more than reasonable compensation for145 Robert Hilt's services in 1982. The amounts were reported by him and taxed to him as business income. RTS is entitled to the deduction for management fees claimed in 1982. Robert Hilt IssueThe only issue remaining with regard to Robert Hilt is whether he failed to report $29,167 of income in 1978. Petitioner offered a Trucks Inc. check made out to "Robco of Nevada" for that amount. The check was dated December 29, 1978. Robert Hilt endorsed the check and deposited it on January 2, 1979. Petitioner testified that he did not receive the check until 1979 and therefore argues that he properly excluded it from 1978 income and included it in 1979 income. In general, checks delivered to a taxpayer are income in the year of delivery. Kahler v. Commissioner,18 T.C. 31">18 T.C. 31 (1952). Petitioner bears the burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). Petitioner's testimony was credible and unimpeached, and we believe him. Thus, in the absence of any argument by respondent of constructive receipt, 8 we conclude that petitioner properly reported the item. LeRoy Hilt IssueRespondent146 determined that LeRoy Hilt failed to report income in 1977 attributable to an agricultural subsidy of $294 paid to him by a Government agency. Robert Hilt testified that LeRoy Hilt received the check when he was managing the farm operations for RTS because the agency assumed it was due him and that he simply endorsed the check over to RTS. In light of Robert Hilt's credible testimony and the lack of any evidence to the contrary, we conclude that petitioner properly omitted the item from his 1977 income. Decisions will be entered for the respondent in docket Nos. 4972-83, 7826-84, 9424-85, 9428-85, and 9429-85.Decisions will be entered under Rule 155 in docket Nos. 1584-83, 4971-83, 4973-83, 4974-83, 4975-83, 3135-84, 7823-84, 7824-84, 7825-84, 2480-85, 9422-85, 9423-85, 9425-85, 9426-85, and 9427-85.Footnotes1. Cases of the following petitioners are consolidated herewith: Robert P. Hilt, docket Nos. 4971-83, 7823-84, 9426-85, 9429-85; Trucks, Inc., docket Nos. 4972-83, 7826-84, 9425-85; Robert W. Norris and Sandra M. Norris, docket Nos. 4973-83, 7824-84, 9422-85, 9428-85; Thomas L. Hilt and Katharina Hilt, docket No. 4974-83; LeRoy and Molly Hilt, docket No. 4975-83; RTS Investment Corporation, docket Nos. 3135-84, 2480-85, 9427-85; Thomas L. Hilt, docket No. 7825-84; Thomas L. Hilt and Norma J. Hilt, docket No. 9423-85; and Trucks, Inc.; RTS Investment Corporation, Transferee and Successor to Trucks Inc., docket No. 9424-85.↩2. Although the parties stipulated that the corporation was owned in equal shares by the children during the years in issue, the corporate tax returns report that from 1977 through 1980, each of the children owned 31-1/3 percent, and in 1981 each owned 33-1/3 percent. The record does not disclose who owned the remaining 6 percent from 1977 through 1980.↩3. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩4. Thomas Hilt was not classified in 1979 because his compensation for that year was not challenged by the IRS.↩*. Assuming LeRoy in fact rendered services to the three companies.↩5. See also Weaver Paper Co. v. Commissioner,T.C. Memo. 1980-72↩.6. Compare Diverse Industries, Inc. v. Commissioner,T.C. Memo. 1986-84↩.7. The amounts allowed as reasonable by respondent, and sustained by us, for Thomas Hilt's years in issue reflect an approximate per year increase of $25,000.↩8. See section 1.451-2(a), Income Tax Regs.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621431/	APPEAL OF UNA LIBBY KAUFMAN, EXECUTRIX OF THE ESTATE OF SAMUEL R. KAUFMAN.Kaufman v. CommissionerDocket No. 4698.United States Board of Tax Appeals5 B.T.A. 31; 1926 BTA LEXIS 1998; October 8, 1926, Decided 1998 1. Upon the evidence submitted, held, that transfer of certain stock by the decedent to his wife was not made in contemplation of death but was a transfer intended to take effect in possession or enjoyment at death. 2. Held, further, that a gift of certain Liberty bonds, which were afterwards exchanged by the donee for stock, was not a transfer in contemplation of or intended to take effect at or after death. 3. A deduction of $15,000 as executor's commissions allowed. Robert L. Floyd, Esq., for the petitioner. Frank T. Horner, Esq., for the Commissioner. LITTLETON31 This is a proceeding for the redetermination of a deficiency of $26,260.44 in estate tax under the provisions of the Revenue Act of 1921. The questions presented are: (1) Whether any portion of the value of certain real estate, located in Powell Township, Mich., owned by decedent and his wife, should be included in the gross estate; (2) whether the transfer of certain stock and bonds by the decedent to his wife and children was made in contemplation of death or was intended to take effect in possession or enjoyment at or after death; and (3) the propriety of1999 a deduction of $15,000 as executor's fees. FINDINGS OF FACT. Samuel R. Kaufman, a resident of Chicago, Ill., died April 29, 1922, at the age of 58 years. By the terms of his will his property passed to his wife and three children, the former and her elder son, Robert Libby Kaufman, being named in the will as executors. Mrs. Kaufman qualified as executrix, but Robert, not having attained his majority, under the statutes of Illinois was unable to qualify. He appears to have been acting, either as executor or trustee, however, when the estate-tax return was filed on April 9, 1923. In computing the value of the gross estate the executrix excluded therefrom the amount of $5,600, representing the total value of certain real estate held by decedent and his wife as tenants in the entirety, 4,434 shares of the common stock of the Congress Hotel Co. of the value of $443,400, and 400 shares of Chatham & Phenix National Bank stock of the value of $94,800, and she deducted $15,000 as executor's commissions. The Commissioner increased the value of the gross estate by including therein the above-mentioned amounts and by disallowing the deduction of $15,000 as executor's commissions. 2000 He thereby increased the tax from $1,718.07, as shown by the return, to $27,978.51, resulting in a deficiency of $26,260.44. 32 At the time of his death the decedent and his wife owned certain real estate located in Powell Township, Mich., of a total value of $5,600. In October, 1915, Samuel R. Kaufman and his brother, Nathan M. Kaufman, entered into an agreement with one another that, in the case of the death of either, the shares of the stock of the Congress Hotel Co. owned by the party so dying should be purchased by the survivor upon the following terms, to wit: 1st. The price to be paid for such stock shall be the par value thereof, without regard being had to the then market value of said stock, whether the same shall be above or below the par value thereof. * * 3rd. Payment for such stock shall be made by the surviving parties hereto by giving their promissory note payable to the order of the Executor or Administrator of such deceased party on or before ten years from and after the date of the death of such deceased party, and shall bear interest at the rate of five per cent (5%) per annum, payable semi-annually. Nathan M. Kaufman died in November, 2001 1918, being the owner at that time of 5,900 shares of Congress Hotel Co. stock. The decedent was the executor under his will and, pursuant to the agreement entered into between them, purchased 4,371 of the 5,900 shares, giving his promissory note therefor and waiving his right to purchase the remainder. The note was payable to the residuary legatees. In March, 1919, a 50 per cent stock dividend was declared upon the stock, increasing thereby the number of shares then owned by Samuel R. Kaufman to 6,556. These shares were owned by him at the time of his death and his note therefor was outstanding. Upon the death of Samuel R. Kaufman the shares of stock purchased by him from the estate of Nathan M. Kaufman, including those issued thereon as a stock dividend in March, 1919, were transferred to the payees of the decedent's promissory note, given by him in payment for the 4,371 shares, whereupon the note was canceled and surrendered to the executrix of the will. On or shortly prior to April 20, 1920, the decedent made an absolute gift to his wife, for herself and the children, of $84,500 in United States bonds and told her to "put them away and take care of them." At the time2002 she had in her safe deposit box $2,000 of Liberty bonds purchased with funds belonging to their three children. Upon the receipt of the bonds from her husband, she rented a larger safe deposit box to which she alone had access. The bonds were given to her absolutely, without reservation of income or any agreement relative thereto. She clipped the coupons from time to time, but instead of cashing them herself sent them to her husband in Chicago, or handed them to him when he was at home, to be cashed by him. 33 This was her usual custom relative to all securities purchased and owned by her and the children with their separate funds, prior to her husband's death. It was not because of any request on his part, or of any agreement between them, but because he handled all matters on her behalf relating to the acquisition or change of securities, or other financial matters. He gave his wife various sums of money from time to time for the payment of household expenses and rent, in excess of $28,000 annually, and he also gave her sums in varying amounts for her personal use. Neither at the time the bonds were given to her, nor at any time thereafter, was anything said by the2003 decedent relative to the income therefrom. As Mrs. Kaufman testified: He never said a word. It was never discussed, any more than when I gave him the coupons, and as I say, at the time when I gave him those coupons I was conscious of the fact that we were under heavy expenses and he expected we would be, and I just gave him the coupons because I thought we needed them. There was never any discussion as to whether he would cash the coupons and give them back to me or not. I did not expect he was going to do that, but there was never any request on the part of Mr. Kaufman about those coupons at all and never any suggestion on his part that the time was due to cut them or what I would do with them or anything of that sort. It was the only thing for us to do at the moment. I had no other use for the money, other than for the family. Certainly, it would have been very strange for me to accumulate an income when I needed it really for the children, if Mr. Kaufman did not have enough at the moment to take care of the expenses. On or before December 15, 1921, the decedent told his wife of an opportunity to invest in some stock of the Chatham & Phenix National Bank, suggesting that2004 it would be a good idea to exchange the Government bonds therefor, and asking her at the same time what she thought about it. She replied that it seemed to her that Government bonds were better for women and children. He stated that he was sorry she regarded it in that light, as he considered it a good investment. Their conversation resulted in her requesting him to negotiate the investment. She removed the $86,500 of bonds from the deposit box, gave them to him and drove with him to the bank to make the exchange. He gave her the receipt of the Chatham & Phenix National Bank for the bonds dated December 15, 1921. This receipt showed the issuance or exchange of the bonds for 400 shares of bank stock, 100 shares to Mrs. Kaufman and 100 shares to each of the three children. Mrs. Kaufman placed the receipt, together with the Chatham & Phenix stock, which she received a few days later, in her safe deposit box, the rent for which she paid and to which she alone had a key. These 400 shares cost $89,500, the difference between the value of the bonds and the cost being paid 34 by the decedent from his funds. At the time of the exchange he purchased for himself 200 shares of2005 the Chatham & Phenix stock. In 1916 the decedent became ill and his physician, believing that he was suffering from appendicitis, performed an operation, removing the appendix. He soon recovered, however, and enjoyed good health, aside from an occasional cold. Some time during 1919 he became slightly indisposed as a result of a cold and consulted a physician who had been his personal friend for many years. This physician made a thorough examination, as was his custom, no matter how slight the ailment might be. The examination disclosed that the decedent had a slight enlargement of the liver, as a result of which he was advised to wear an abdominal support, which he did for a short time. The decedent suffered no further illness or impairment of his general health until the spring of 1921, when he contracted influenza. In a short time he had apparently recovered from this attack and left Chicago to visit his home in New York. Soon after his arrival there he suffered a relapse and developed an intestinal condition which involved the gall ducts and produced jaundice. In addition, erysipelas developed on the ear and neck and, as the physician testified: The toxemia or poisoning2006 was so intense that it not only produced a condition which deprived him - that is, a delirious condition for several weeks, but it involved almost every organ in the body, so that twice, on account of the intensity of the poisoning. I was compelled to wash out the blood, so to speak, with a solution of salts, and at one time death was imminent and I had to take extraordinary measures of stimulation to bring him around again. This illness covered the month of April and the early part of May, 1921. Thereafter his condition improved steadily. He visited his summer camp in Michigan, as was his custom each summer, and upon his return in October, 1921, his health and general condition were better than they had been prior to his illness. He continued in the active management of his affairs, particularly in the management of the Congress Hotel at Chicago, discussing with his counsel and friends certain other business ventures in which he was interested. On December 3, 1918, the decedent and his brothers, Daniel W. Kaufman, Harry L. Kaufman and Louis G. Kaufman, entered into a contract similar to the one hereinbefore referred to between Samuel R. Kaufman and his brother, Nathan M. 2007 Kaufman, dated in October, 1915. On August 30, 1921, his brother, Daniel W. Kaufman, died leaving a will in which he designated Samuel R. Kaufman as his executor, and soon thereafter, in accordance with the terms of the agreement between them, the survivors to the contract took over the shares 35 of Congress Hotel Co. stock owned by him. At this time Samuel R. Kaufman expressed to his attorney his objection to insisting upon the terms of the contract but stated that his brothers desired to carry out the same according to its terms and that he was being coerced, against his judgment, into carrying out his portion thereof. He felt that the agreement was unfair in so far as he was concerned. He was much disturbed over the fact that, being the owner of so much more stock than the other parties to the contract, he would be depriving his family, in case of his death, of one-third of the par value of the stock owned by him, since, if the other parties to the agreement acquired his stock, it would bring only $66.66 a share by reason of the fact that any stock which had been issued as a stock dividend was, under the terms of the contract, to be included as a part of the original2008 shares without cost. He consulted his attorney as to the validity of the agreement and was advised by him that it was binding only in respect of such portion of Congress Hotel Co. stock of which he might be the owner at the time of his death, there being no provision in the contract which would compel him to retain any of the shares of stock or restrict him in the sale or disposition thereof; that whatever portion he might dispose of by gift or sale would not be subject to the terms of the contract upon his death. His attorney thereupon urged him to make a gift of the stock and, as he had for some time contemplated giving a portion of it to his wife, he made plans forthwith as to his indebtedness in order that the stock, which had been placed with certain banks as security, might be released so that the transfer and delivery thereof might be made. By December, 1921, the decedent had obtained the release of 4,434 shares of the stock and had the same transferred upon the books of the company to his wife. Shortly thereafter he informed his attorney of the transfer and stated to him that it was his purpose to endeavor to have his brothers agree to the cancellation of the contract2009 between them relative to the acquisition by the survivors of the stock of the one who should die first. He left Chicago about December 3, 1921, for his home in New York, and upon his arrival delivered to his wife the 4,434 shares of the Congress Hotel Co. stock with the statement, "There is that stock I have been promising you for so long." Nothing further was said relative thereto. Some time later the decedent asked his wife what she had done with the stock and, upon being informed by her that she had placed it in a little closet where she kept her jewelry, he stated that the stock was valuable and asked her if she did not think it should be placed in her safe deposit box. Thereupon she placed it in her safe deposit box on that date. On January 1, 1922, a 4 per cent dividend was declared by the Congress Hotel Co., resulting in a dividend of $17,736 upon the 4,434 36 shares theretofore transferred to Mrs. Kaufman. The decedent directed the secretary of the Congress Hotel Co. to make the check for the stock standing in the name of Mrs. Kaufman payable to him. This was done and the dividend check was deposited in the bank to his credit. On April 1, 1922, a further2010 dividend of 2 per cent was declared and the dividend check of $8,868, due upon the 4,434 shares of stock in the name of Mrs. Kaufman, was made payable and delivered to the decedent and deposited to his credit. About January 10, 1922, the decedent advised his attorney that his brothers had agreed to a modification of the contract relative to the acquisition by the survivors of the stock of the one who should die first, to provide as follows: That the first 5,000 shares should be purchased at par and that any excess above the 5,000 shares of the stock issued at the time of the contract should be purchased at $150 a share, and that only such stock as might be declared as a stock dividend after January 10, 1922, should be included without cost. This modified agreement was executed on January 10, 1922. The decedent was thereafter active in the management of his various interests and enjoyed good health until the night of April 29, 1922, when he was stricken and died a few hours later from a gastric hemorrhage. In a will executed five months prior to his death the decedent named his son, who was under 21 years of age, as one of his executors. The son was not old enough at the2011 time of the decedent's death to qualify as an executor. OPINION. LITTLETON: The first question is whether the Commissioner erred in including in the gross estate certain real estate in Powell Township, Mich., of the value of $5,600. The second issue relates to the question whether the transfer of the 4,434 shares of common stock of the Congress Hotel Co., made by the decedent to his wife on December 3, 1921, about five months prior to his death, was made in contemplation of death or was intended to take effect in possession or enjoyment at or after death. The third issue is whether 3,045 shares of the Congress Hotel Co. stock, being the number of shares remaining in the estate exclusive of the 4,434 shares transferred to Mrs. Kaufman and the 6,556 shares given by the estate in payment of the decedent's note for $437,100 and not purchased by his brothers under the agreement, constituted a part of the gross estate, and whether, if they did, they should be included therein at $101.50 a share, which is conceded to be the fair market value at the time of death, or at the value for which the surviving brothers might have purchased them, had they so elected, under the terms of2012 the contract. 37 The fourth issue relates to the question whether the 400 shares of the capital stock of the Chatham & Phenix National Bank owned by the decedent's wife and three children, received by them in exchange for $84,500 of Liberty bonds given to them by the decedent on April 30, 1920, $2,000 of Liberty bonds owned by the decedent's three children and purchased for them by their mother with their own funds, and $3,000 contributed by the decedent at the time of the exchange on December 15, 1921, should be included in the gross estate as a transfer made in contemplation of death or intended to take effect in possession or enjoyment at or after death. The fifth or last issue relates to the propriety of a deduction of $15,000 for executor's commissions. As to the first issue, it appears that at the time of his death the decedent and his wife owned certain real estate in Michigan valued at $5,600. The executors excluded this property and the Commissioner included the same in the gross estate of the decedent at its full value. We have no evidence as to when or under what circumstances the decedent and his wife acquired this property. It was merely alleged in2013 the petition that they acquired it as tenants in the entirety, and this was admitted by the Commissioner in his answer. Upon this the executrix claimed that no portion of the value of the property should have been included in determining the value of the gross estate of the decedent. The only reason given for this claim was that the statutes of Michigan recognize tenancy by the entirety. The Revenue Act of 1921, section 402(d), provides that the value of the gross estate of a decedent shall be determined by including the value at the time of his death to the extent of any interest therein held jointly or as tenants in the entirety by the decedent or any other person. With no more evidence than is contained in the record concerning this point, we affirm the Commissioner's determination. As to the second issue, the Board is of the opinion that, under the facts hereinbefore set forth in detail, this stock was not transferred in contemplation of death within the meaning of the Revenue Act of 1921. It appears that the decedent, prior to any illness of which the Board has knowledge, had told his wife that he intended to make her a gift of some Congress Hotel Co. stock and that2014 this was not done for the reason that the stock was being used by him as security for loans from various banks. At the time the stock was transferred in DecembeR 1921, the decedent had fully recovered from his illnesses. As a result, however, of a situation arising from the terms of certain agreements between himself and his brothers, he concluded, since he was the owner of practically all of the capital stock of the Congress Hotel Co., to make a gift of some of it to his 38 wife, not because he contemplated death within a reasonably near future, but because he desired to protect his family in the event of his death from loss by reason of the small amount which his brothers would pay for the stock should they decide to purchase it under the terms of the contract between them. On the question of whether the transfer of this stock was one intended to take effect in possession or enjoyment at or after death, the Board is of the opinion that the Commissioner correctly included the value thereof in the gross estate upon the ground that it was a transfer intended to take effect at death. We reach this conclusion from all the fact and circumstances surrounding the gift and relating2015 to the decedent's conduct thereafter. It is true that the stock was delivered to decedent's wife and transferred to her upon the books of the company. It appears however, that he reserved to himself the income therefrom. A 4 per cent dividend was declared on the stock on January 1, 1922 - less than one month after the gift - and he directed that the same be paid to him. This was also true in respect of the dividend of 2 per cent declared in April, 1922. Transactions between husband and wife do not partake of the same formalities as those between strangers, and the intention of the donor in such a case is best determined from his acts and donduct in relation to the subject matter. It was not necessary for the decedent to have a formal understanding with his wife that the dividends upon the stock should be paid to him during his life or for any period of time. He had no reason to believe that she would insist upon the dividends being paid to her. There is nothing in the record to indicate that the decedent, prior to his death, changed his intention in regard to the payment of dividends to him and, under these circumstances, the transfer took effect at his death. 2016 In the case of ; , the decedent had made a transfer of certain stock, reserving to himself the dividends thereon and the right to vote the stock. The court said: The effect of these instruments was to transfer to the daughters the remainder in the stock after the donor's death, reserving to the latter an estate for his life. It is said by the learned appellate division that there is a difference between the stock itself and the dividends that may be declared upon it. This is doubtless true, but it is the same difference that exists between land and its rents and profits or between a fund and its income. A devise of the rents and profits of land or a bequest of the income of a fund grants an estate in the land or the fund itself in fee or for life, depending on whether the gift of the income or rent is for life or without limitation. . The only income stocks can produce is the dividend declared thereon, and the reservation of the dividends for life is the reservation of an estate for life. A stockholder has no title to the earnings of a corporation2017 39 before a dividend is declared. Until that time the earnings pass with the stock as an incident thereof, and when a dividend is declared it is a profit on the stock. * * * * * * Though a remainder may vest in title at its creation, it cannot vest in possession until the determination of the prior estate. It makes no difference in this respect whether the remainder is vested indefeasibly or is contingent or subject to be devested. In the present case the prior estate is one for the life of the donor, and therefore the remainder transferred to his daughters falls within the exact provision of the statute as a transfer to take effect in possession or enjoyment on the death of the donor. See, also, ; . As to the third issue, it is the opinion of the Board that the 3,045 shares which the surviving brothers, under the terms of the contract of January 10, 1922, had a right to purchase at par, but which they did not purchase, constituted a part of the estate and were properly valued by the Commissioner at $101.50 a share for the purpose of the tax. The executrix contends that this stock was subject2018 to an agreement between the decedent and his brothers whereby they had a right to purchase the stock, and that whatever was over and above the price at which they could purchase the same should be considered as a gift from them. The surviving brothers were not compelled to purchase the stock and the most that they can be said to have had was an option to do so. They did not exercise this option and the stock remained a part of the estate. As to the fourth issue, the Board is of the opinion under the evidence that no portion of the value of the 400 shares of the Chatham & Phenix National Bank stock constituted a part of the gross estate. As set forth in the findings of fact, the decedent in April, 1920, gave to his wife, for herself and children, $84,500 in Liberty bonds, which she kept in her possession and over which he did not have or exercise any control. In addition, it appears that Mrs. Kaufman from time to time, with separate funds of her three children, had purchased Liberty bonds in the amount of $2,000. On December 15, 1921, it appears that she concluded to exchange the Liberty bonds for stock of the Chatham & Phenix National Bank and that she delivered the bonds in2019 the amount of $86,500 to her husband and went with him to make the exchange. At that time 400 shares of Chatham & Phenix National Bank stock were issued in the name of his wife and their three children in exchange for the $86,500 of Liberty bonds and $3,000 contributed out of his own funds. At the same time the decedent acquired in his own name 200 shares. This stock was delivered by the bank to Mrs. Kaufman and retained by her without any control thereof by her husband. The evidence does not warrant the conclusion that the gift of the Liberty bonds on April 30, 1920, or that the $3,000 contributed by the decedent toward the purchase of the Chatham & Phenix 40 National Bank stock, was a gift in contemplation of death or intended to take effect at or after death. The only circumstance which might indicate that the gift of $84,500 of Liberty bonds on April 30 was intended to take effect at or after death was the delivery by Mrs. Kaufman to her husband from time to time of the coupons clipped by her from the bonds. In the opinion of the Board, however, this circumstance does not warrant the conclusion that the gift was one intended to take effect at or after death. The2020 decedent made no reservation of the income from the bonds at the time of the gift. The coupons which were attached to the bonds constituted a part of the gift and thereafter constituted her property. Neither at the time of the gift nor at any time thereafter did the decedent ever make any statement to Mrs. Kaufman relative to the income from the bonds. Her reason for delivering the coupons to her husband was because their expenses were heavy and she wished to contribute to the payment thereof. This was entirely a voluntary act on her part and had no relation to the character of the original gift. The fifth and last issue relates to the propriety of a deduction of $15,000 for executor's commissions. Section 403(a)(1) of the Revenue Act of 1921 provides for the deduction of - Such amounts for * * * administration expenses, claims against the estate, * * * as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered * * . The following provision is from Callaghan's Illinois Statutes Annotated, vol. 1, ch. 3, Administration of Estates: Par. 135 [Compensation of representative.] § 133. Executors2021 and administrators shall be allowed as compensation for their services a sum not exceeding six per centum on the amount of personal estate, and not exceeding three per centum on the money arising from the sale of real estate, with such additional allowances, for costs and charges in collecting and defending the claims of the estate and disposing of the same, as shall be reasonable. The total estate left by decedent was in excess of $900,000, $437,100 of which was given in exchange for the decedent's personal note for that amount held as collateral by his brothers. All except $6,500 of this was personal property. The debts of the decedent were $241,117.21, a large part of which was in small amounts. There is nothing to indicate that the executor's duties required less ability or were less onerous than are usual in the settlement of estates of like amounts. The commission claimed is about one and two-thirds per centum. It is not unreasonable and should be allowed. . Order of redetermination will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621433/	Katherine Jean Graham, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentGraham v. CommissionerDocket Nos. 5837-76, 9384-79, 374-80United States Tax Court83 T.C. 575; 1984 U.S. Tax Ct. LEXIS 24; 83 T.C. No. 30; October 15, 1984. October 15, 1984, Filed 24 Decisions will be entered for the respondent. Held: The payments made by petitioners to the various churches of Scientology were not charitable contributions within the meaning of sec. 170(c), I.R.C. 1954. The remittances were made with the expectation of receiving a benefit, and such benefit was received. Thus, the transfers were in reality a quid pro quo. Held, further, denial of the claimed deductions did not violate any of petitioners' constitutional rights. Robert N. Harris, Christopher Cobb, and John E. Taussig, for the petitioners.James M. Kamman and Charles Rumph, for the respondent. Sterrett, Judge. STERRETT575 In these consolidated cases, respondent determined deficiencies in petitioners' Federal income taxes as follows:DocketTYEDate ofNo.PetitionerDec. 31 --Deficiencydeficiency notice5837-76Katherine Jean Graham 21972$ 316.24Apr. 7, 19769384-79Richard M. Hermann1975$ 803.00Apr. 4, 1979374-80David Forbes Maynard1977643.00Nov. 14, 1979576 The issues before the Court are: (1) Whether payments made by petitioners to the various churches of Scientology 25 3 were deductible charitable contributions, and (2) whether denial of the claimed deductions would violate petitioners' constitutional rights.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulations of fact, together with the exhibits attached thereto, are incorporated herein by this reference. The parties specifically stipulated to the entire record in Church of Scientology of California v. Commissioner, 83 T.C. 381">83 T.C. 381 (1984). All relevant findings of fact and court rulings from that case will be incorporated into this opinion. Since neither party argued to the contrary, it will be assumed that the Church of Scientology continued to operate at all relevant times in the same manner as it did in Church of Scientology of California v. Commissioner, supra.For purposes of this litigation only, respondent did not contest petitioners' contentions that: (1) Scientology was at all relevant times a religion; (2) each Scientology organization to which petitioners paid money was at all relevant times a church within the meaning of section 170(b)(1)(A)(i), 26 4 and (3) Scientology was at all relevant times a corporation described in section 170(c)(2) and exempt from general taxation under section 501(a) as an organization described in section 501(c)(3). Petitioners' residences at the time they filed their respective petitions in this case, and the places they filed their timely income tax returns for their respective years are as follows: 577 AppropriatePetitionerResidenceTYE Dec. 31 --office of IRSGrahamHonolulu, HA1972Honolulu, HAHermannLos Angeles, CA1975Fresno, CAMaynardRialto, CA1977Fresno, CAPetitioners were at all relevant times Scientologists. Scientology 5 teaches that the individual is a spiritual being having a mind and a body. Part of the mind, called the "reactive mind" is unconscious. It is filled with mental images that are frequently the source of irrational behavior. Through the administration of a Scientology process known as "auditing," an individual, called a "preclear," is helped to erase his reactive mind and gain spiritual competence. Auditing is also referred to 27 as "processing," "counseling," and "pastoral counseling." Scientologists believe that they can attain benefits from auditing and training, but only in degrees or steps. These include levels called "Grades" and higher levels called "OT sections." The various steps or degrees of accomplishment are set forth in a chart entitled "Classification Gradation and Awareness Chart of Levels and Certificates."A trained Scientologist, known as an "auditor," administers the auditing. He is aided by an electronic device called an "E-meter." This device helps the auditor identify the preclear's areas of spiritual difficulty by measuring skin responses during a question and answer session. These auditing sessions are offered in fixed blocks of time called "Intensives."One of the tenets of Scientology is that, anytime a person receives something, he must pay something back. This is called the doctrine of exchange. The Church of Scientology applies this doctrine by charging a "fixed donation" for training and auditing. With few exceptions, these services 28 are never given for free. 6 Thus, fixed donations are generally a prerequisite to 578 a person's receiving auditing and training. These fixed donation payments constitute the majority of the Church of Scientology's funds, and are used to pay the costs of church operations and activities.The general rates of the fixed donations for auditing in 1972 were as follows:12 1/2-Hour intensive$ 62525-Hour intensive1,25050-Hour intensive2,35075-Hour intensive3,350100-Hour intensive729 4,250In addition, the Church of Scientology offered two specialized types of auditing for a higher fixed donation --Integrity Processing$ 750 per 12 1/2-Hour intensiveExpanded Dianetics$ 950 per 12 1/2-Hour intensiveMembers of the Church of Scientology are encouraged to make advance payments for Scientology courses. If payment is made well in advance of the services to be rendered, a discount of 5 percent can be obtained by the member. When a parishioner makes an advance payment, the Church credits his account. Once the individual begins receiving a service, his account is debited. It is the Church of Scientology's policy to refund advance payments upon request at any time before services are received. 8 The Church of Scientology operates in a commercial manner in providing these religious services. In fact, one of its articulated goals is to make money. This is expressed in HCO PL March 9, 1972, MS OEC 381, 384. It sets out the governing policy of the Church of Scientology's financial offices by 30 exhorting these offices to "MAKE MONEY. * * MAKE MONEY. * * * MAKE MORE MONEY. * * * MAKE OTHER PEOPLE PRODUCE SO AS TO MAKE MONEY." The goal of making money permeates virtually all of the Church of 579 Scientology's activities -- its services, its pricing policies, its dissemination practices, and its management decisions.The Church of Scientology promotes its services through free lectures, congresses, free personality tests, and handouts. Advertisements are placed in newspapers, magazines, and on the radio. These promotional activities are geared to be responsive to community concerns, which are determined from surveys.In 1972, Graham made payments totaling $ 1,682 to the Church of Scientology, Hawaii, and to the Scientology and Dianetic Center of Hawaii. Of this amount, approximately $ 400 went towards training, the balance went for auditing. These payments were for the Hubbard Qualified Scientologist course (HQS), Communications course, and auditing. Some of the payments toward courses were for Graham's daughters, Karen and Laurel. When Graham made those payments, she expected to receive, and did receive, the benefit of those services. On her 1972 income tax return, Graham 31 deducted $ 1,682 as a charitable contribution.In 1975, Hermann paid the Church of Scientology, American Saint Hill Organization (ASHO) $ 4,875. At the time Hermann made these transfers, he expected to receive Class 0 to 9 training. While Hermann did not take these courses, he did take other Scientology courses and has received auditing between 1974 and the present. On his 1975 income tax return, Hermann deducted $ 3,922 as a charitable contribution.In 1977, Maynard paid the Church of Scientology, Mission of Riverside, $ 4,698.91 as advance payments for services. While Maynard did not receive any services in 1977, he made those remittances with the expectation of taking Interiorization Processing, Expanded Dianetics, and auditing. On his 1977 income tax return, Maynard claimed a $ 5,000 9 charitable contribution deduction. In the respective notices of deficiency, respondent disallowed these claimed charitable contribution deductions. Respondent maintains that it was not established that the payments to the Church of Scientology were contributions or gifts rather than payments for 32 services or merchandise.580 OPINIONIssue 1. Deductibility of Payments MadeThe taxpayer has the burden of proving that a particular payment is a "contribution or gift." New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934); Welch v. Helvering, 290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioners argue that their remittances to the Church of Scientology met the statutory requirements of section 170, subsections (a) and (c), and thus were deductible charitable contributions. Respondent maintains that those payments were not "[contributions] or [gifts]" within the meaning of section 170(c). Rather, he insists they were made to purchase services, i.e., a quid pro quo, and thus were nondeductible personal expenditures.Section 170(a)(1) allows as a deduction any charitable contribution payment which is made within the taxable year. Section 170(c) defines the term "charitable contribution" as "a contribution or gift." Neither section 170 nor the regulations further elaborate on the meaning of "charitable contribution." This issue was addressed, however, in DeJong v. Commissioner, 36 T.C. 896">36 T.C. 896 (1961), affd. 309 F.2d 373">309 F.2d 373 (9th Cir. 1962). There, the Court 33 stated --As used in this section the term "charitable contribution" is synonymous with the word "gift." * * A gift is generally defined as a voluntary transfer of property by the owner to another without consideration therefor. If a payment proceeds primarily from the incentive of anticipated benefit to the payor beyond the satisfaction which flows from the performance of a generous act, it is not a gift. * * * [DeJong v. Commissioner, supra at 899. Citations omitted; emphasis added.]Petitioners wanted to receive the benefit of various religious services provided by the Church of Scientology. The Church of Scientology, however, generally provided those services only if they were purchased. To encourage such purchases, the Church of Scientology gave a 5-percent discount to parishioners who made advance payments. A person who made an advance payment but chose not to receive the services could request a refund of his money. Petitioners thus made payments to the Church in exchange for those services.581 The record demonstrates clearly that these payments were not voluntary transfers without consideration, but were made with the expectation of receiving a commensurate benefit in return. 34 In addition, where contributions are made with the expectation of receiving a benefit, and such benefit is received, the transfer is not a charitable contribution, but rather a quid pro quo. Haak v. United States, 451 F. Supp. 1087">451 F. Supp. 1087, 1090-1091 (W.D. Mich. 1978).Petitioners Graham and Hermann made payments for which they received religious services. They received a perceived benefit from their transfers. Petitioner Maynard made advance payments to the Church of Scientology. While he did not receive any religious services in 1977, his account was credited for his remittances. This credit entitled him to receipt of services in the future. It was that entitlement which constituted his receipt of a perceived benefit, or the quid pro quo.Accordingly, none of the payments petitioners made were charitable contributions within the meaning of section 170(c). Instead, they were nondeductible personal expenditures.Issue 2. Constitutional ArgumentsPetitioners maintain that denial of the deduction interferes with their constitutional right to the free exercise of their religion. It is well established that there is no constitutional right to a tax deduction. Benefits granted to taxpayers, such 35 as deductions for charitable contributions, are matters of legislative grace. Interstate Transit Lines v. Commissioner, 319 U.S. 590">319 U.S. 590, 593 (1943); New Colonial Ice Co. v. Helvering, supra at 440; Winters v. Commissioner, 468 F.2d 778">468 F.2d 778, 781 (2d Cir. 1972), affg. a Memorandum Opinion of this Court. Further, denial of this deduction does not violate the free exercise clause of the First Amendment. Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 795 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967); Winters v. Commissioner, supra at 781. The constitutionality of the denial of this deduction was well stated by the Supreme Court in Cammarano v. United States, 358 U.S. 498">358 U.S. 498, 513 (1959) --Petitioners are not being denied a tax deduction because they engage in constitutionally protected activities, but are simply being required to pay for those activities entirely out of their own pockets, as everyone else engaging 582 in similar activities is required to do under the provisions of the Internal Revenue Code. * * Respondent is not precluding petitioners from engaging in constitutionally protected activities. Petitioners may practice their beliefs; they just will not be subsidized for them.Even if denial 36 of the deduction interfered with petitioners' practice of their religious beliefs, not all burdens on religion are unconstitutional. United States v. Lee, 455 U.S. 252">455 U.S. 252, 257 (1982). See also, e.g., Prince v. Massachusetts, 321 U.S. 158">321 U.S. 158, 163-166 (1944); Reynolds v. United States, 98 U.S. 145">98 U.S. 145, 166-167 (1878). The limitation on religious liberty can be justified by showing that it is essential to accomplish an overriding governmental interest. United States v. Lee, supra at 257-258. The Supreme Court has stated that "Because the broad public interest in maintaining a sound tax system is of such a high order, religious belief in conflict with the payment of taxes affords no basis for resisting the tax." United States v. Lee, supra at 260.Petitioners also argue that denial of the deductions violates the establishment clause of the First Amendment. 1037 Their argument is twofold. First, disallowance would result in disparate treatment of petitioners, in violation of the neutrality requirement of the First Amendment. Second, disallowance would be the result of excessive Government entanglement with religion, in violation of the First Amendment.Petitioners place heavy emphasis on Larson v. Valente, 456 U.S. 228 (1982). In that case, Minnesota had enacted a statute imposing registration and reporting requirements on religious groups which solicited more than 50 percent of their contributions from nonmembers. The Supreme Court held that the statute violated the establishment clause of the First Amendment. In so doing, they rejected an argument that the statute was facially neutral and found instead that it made "explicit and deliberate distinctions between different religious organizations." Larson v. Valente, supra at 247 n. 23. The Court further mentioned that "The fifty percent rule of section 309.515, subd. 1(b), effects the selective legislative imposition of 583 burdens and advantages upon particular denominations." Larson v. Valente, supra at 253-254.The instant case is distinguishable from Larson because section 170, unlike the charitable solicitation 38 law in Larson, does not make classifications among religions. Furthermore, unlike Larson, here there is no legislative history revealing overt discrimination. Finally, even if section 170 has the effect of advancing one religion more than another, that fact alone does not make the statute unconstitutional. The establishment clause does not prohibit a statute from having a disparate impact on religious organizations provided the disparate impact results from the application of secular criteria. Lynch v. Donnelly, 465 U.S. , (1984); Gillette v. United States, 401 U.S. 437">401 U.S. 437, 452 (1971); McGowan v. Maryland, 366 U.S. 420">366 U.S. 420, 442-444 (1961). Here the tests for determining the deductibility of claimed charitable contributions are based on secular criteria. Further, Larson is distinguishable from the case at bar because the section 170 classification bears equally upon all religious organizations. Thus, there is not the political divisiveness here that was prevalent in Larson. Accordingly, the argument of unconstitutionality under the establishment clause is rejected.Finally, petitioners insist that denial of the claimed deductions was due to selective discriminatory action. They 39 claim that their rights under the First Amendment and the equal protection component of the due process clause of the Fifth Amendment were violated. The evidence in this case does not demonstrate that any discriminatory action was taken against petitioners by respondent or any of his agents. Petitioners have failed to prove that violation of their rights occurred under either the First or Fifth Amendments. 11Decisions will be entered for the respondent. Footnotes1. Cases of the following petitioners are consolidated herewith: Richard M. Hermann, docket No. 9384-79; David Forbes Maynard, docket No. 374-80.↩2. Petitioner Graham was unmarried during the tax year in question. Subsequently, she married, and her married name is Mrs. Elliott.↩3. For convenience, these various churches of Scientology will be referred to as either the Church of Scientology or the Church.↩4. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable years in issue.↩5. For an indepth review of the Scientology religion and its structure, see Church of Scientology of California v. Commissioner, 83 T.C. 381">83 T.C. 381↩ (1984).6. The Church of Scientology has a nine-volume encyclopedia of Scientology policy called the OEC series. Hubbard Communications Office Policy Letter (HCO PL) Sept. 27, 1970 (Issue I), 3 OEC 89, describes the Church of Scientology's policy against free services and price cutting. It states:Price cuts are forbidden under any guise.1. PROCESSING MAY NEVER BE GIVEN AWAY BY AN ORG. Processing is too expensive to deliver.* * * *9. ONLY FULLY CONTRACTED STAFF IS AWARDED FREE SERVICE, AND THIS IS DONE BY INVOICE AND LEGAL NOTE WHICH BECOMES DUE AND PAYABLE IF THE CONTRACT IS BROKEN↩. [Emphasis added.]7. Historically, the price of a 25-hour intensive was fixed at an amount equal to 3 months of pay for the average middle-class worker in the district of the Scientology Church providing the service.8. No evidence was produced with respect to the actual amounts, if any, of such refunds during the tax years in issue.↩9. This amount consisted of a $ 2,385 carryover from 1976 transfers and $ 2,615 for transfers in 1977.↩10. Petitioners raised similar establishment clausearguments in Church of Scientology of California v. Commissioner, 83 T.C. at 447-454. While that case dealt with the constitutionality of sec. 501(c)(3), its rationale is fully applicable to sec. 170↩ and we incorporate herein by this reference that portion of the opinion.11. This issue of selective enforcement was also raised and rejected in Church of Scientology of California v. Commissioner, 83 T.C. at 453↩ - 454.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621434/	Francis X. Kast and Anne E. Kast, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentKast v. CommissionerDocket Nos. 13643-81, 14902-81, 14903-81, 22428-81, 26661-81, 29082-81, 29083-81, 1035-82United States Tax Court78 T.C. 1154; 1982 U.S. Tax Ct. LEXIS 72; 78 T.C. No. 81; June 29, 1982, Filed 72 Appropriate orders and decisions will be entered in all cases except Warren H. Schumann and Maria T. Schumann, docket No. 26661-81, and an appropriate order will be entered in that case. Each petitioner in 1976 exercised his option to purchase stock of his employer, K Corp., such option having been granted to him pursuant to a qualified stock option plan adopted by the employer. The option price was $ 7 per share; in 1976, at the time the options were exercised, the stock had a fair market value of $ 13.25 per share. In 1977, K Corp. adopted a plan of liquidation and, pursuant to such liquidation, each petitioner as a shareholder in 1977 received a distribution of $ 15.30 per share and further distributions in 1978 and 1979. Each petitioner had voted against the adoption of the plan of liquidation of the corporation. Held: Each petitioner failed to hold the shares acquired under the option the requisite 3 years from the date of his exercise of the option. Sec. 422(a)(1). Since sec. 331(a) provides that amounts distributed in liquidation of a corporation shall be treated as in payment in exchange for the stock, a disposition of each petitioner's shares occurred in 197773 within the definition of sec. 425(c). Secs. 421(a) and (b), 422(a), and 425(c) make no distinction between a "voluntary" as opposed to an "involuntary" disposition. Brown v. United States, 427 F.2d 57">427 F.2d 57 (9th Cir. 1970), which holds to the contrary, is not followed as to petitioners in docket No. 26661-81, since appeal in such case does not lie to the Ninth Circuit Court of Appeals. Accordingly, the motion for summary judgment will be denied as to petitioners in docket No. 26661-81. However, as to petitioners in the other dockets, all of which cases are appealable to the Ninth Circuit Court of Appeals, an appropriate order will be entered granting the motion for summary judgment in favor of such petitioners on the basis of the rule of this Court enunciated in Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. on other grounds 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Julian N. Stern, for the petitioners.Donna I. Epstein, for the respondent. Scott, Judge. Whitaker, J., dissenting. SCOTT 1155 OPINIONOn November 30, 1981, petitioners in the case of Francis X. Kast and Anne E. Kast, docket No. 13643-81, filed a motion for summary judgment which was set for hearing at San Francisco, Calif., on March 8, 1982. When the case was called for hearing, respondent filed a motion to consolidate the remaining above-entitled cases with the Kast case and consider the motion as going to all the cases. There was no objection on the part of any of petitioners since the facts in all these cases are substantially the same. The parties also agree that the Court may accept the facts as set forth in an affidavit in the Kast case submitted with petitioners' motion for summary judgment as being the facts in all the other cases, with the exception of the address of each petitioner, which is as alleged in the petition filed by each petitioner and admitted in the answers filed by respondent, and the number of shares of stock with respect to which each petitioner exercised an option which is material in each case only in the determination80 of the amount of the deficiency, if any.We will therefore find the facts of the Kast case only, since the differences in the number of shares of stock owned by each 1156 petitioner are not material to the consideration of the motion for summary judgment. 2 The issues raised by petitioners' motion for summary judgment are (1) whether payment received by each petitioner as a liquidating distribution with respect to shares of stock in Kaiser Industries Corp. (the corporation) which he had acquired pursuant to a qualified stock option is a disposition of his stock as defined in section 425(c), 3 and (2) if so, whether such disposition was a disqualifying disposition within the meaning of sections 421 and 422.81 Each petitioner, except Warren H. Schumann and Maria T. Schumann, docket No. 26661-81, resided in California at the time of the filing of the petition. Petitioners Warren H. Schumann and Maria T. Schumann resided in Sao Paulo, Brazil, at the time of the filing of their petition with the Court. Each petition involves a deficiency determined by respondent for the calendar year 1977. Each docket involves a husband and wife who filed a joint Federal income tax return with the Internal Revenue Service Center, Fresno, Calif., for the calendar year 1977.On May 27, 1976, each petitioner-husband (petitioner) exercised a qualified stock option that had been granted to him on September 7, 1973, to acquire a specified number of shares of common stock of the corporation. The option price was $ 7 per share. The price of the shares on the American Stock Exchange on the date of the exercise of the option was $ 13.25 per share.On April 20, 1977, stockholders of the corporation, by majority vote, adopted a plan of complete liquidation. Each petitioner voted against adoption of the plan. Following adoption of the plan, the corporation distributed to each petitioner pro rata cash and assets 82 having a fair market value of $ 14.30 per share on June 3, 1977, and $ 1 per share on October 3, 1977. Additional distributions were made pro rata to each petitioner by the corporation in 1978, 1979, and 1980 in the respective amounts of $ 3, $ 0.75, and $ 1.90 per share. The corporation retained a portion of its assets through April 11, 1980, when the balance of the corporation's assets amounting 1157 to $ 19,951,416, subject to any liabilities, was distributed to Touche, Ross & Co. as liquidation agent. The shares of the corporation held by each petitioner as a result of exercise of the qualified stock option were not redeemed in 1977 or at any time thereafter. Shares of the corporation were freely bought and sold through 1977 and thereafter and continued to be listed and traded on the American Stock Exchange until March 21, 1980.Section 421(a) provides (with an exception not here pertinent) that if a share of stock is transferred to an individual pursuant to the exercise of a qualified stock option, and certain requirements in respect of such transfer are met, no income shall result to the individual at the time of the transfer of the shares to him. Section 421(b) provides83 that if the transfer of a share of stock to an individual pursuant to his exercise of an option would meet these requirements except for a failure to meet any of the holding period requirements, any increase in the income of such individual or deduction from the income of the employer corporation for the taxable year in which such option is exercised attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or the employer corporation in which such disposition occurs.Section 422(a) provides (with an exception not here pertinent) that section 421(a) shall apply with respect to the transfer of a share of stock to an individual pursuant to his exercise of a qualified stock option if no disposition of such share is made by the individual within a 3-year period beginning after the transfer of such share.Section 425(c) provides that, except for a joint tenancy acquisition, the term "disposition," as used in sections 421 through 425, includes a sale, exchange, gift, or a transfer of legal title, but does not include (1) a transfer from a decedent to an estate or a transfer by bequest or inheritance; (2) 84 an exchange to which section 354, 355, 356, or 1036 (or so much of sec. 1031 as relates to sec. 1036) applies; or (3) a mere pledge or hypothecation. 485 1158 Petitioners' first position in this case is that they did not make a disposition of their shares of stock within the meaning 1159 of section 421(b), 422(a), or 425(c) since they made no sale, exchange, gift, or transfer of legal title of their stock in the year 1977, the year here involved. In support of this position, petitioners point out that their shares of stock still remained outstanding and, even as of 1980, shares of the corporation were traded on the American Stock Exchange. It is respondent's position that, because of the provisions of section 331(a), 5 a disposition did occur since that section provides that "Amounts distributed in partial liquidation of a corporation * * shall be treated as in part or full payment in exchange for the stock."86 Petitioners argue that section 331 was put into the Code in the twenties solely to change the character of the income received in such a distribution from ordinary income to capital gain. Petitioners point out that, absent this provision, such distributions would be considered dividends taxable as ordinary income because they would be a "distribution of property made by a corporation to its shareholders" under the provision of section 316(a)(1). Petitioners cite certain statements in S. Rept. 398, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 266, 274, in support of their position. In this report, the reason given for the provision (which subsequently became sec. 331) treating a distribution in full or partial liquidation as a payment in part or in full for the stock is that where a corporation liquidates and distributes its assets to its shareholder, the shareholder in effect surrenders his interest in the corporation and receives money in lieu thereof. According to petitioners, the extension of the provision to distributions in 1160 partial liquidation was in order to treat the retirement of a portion of a taxpayer's stock as the sale of87 that stock and a distribution by a corporation in partial retirement of its capital stock as a return of capital, taxable only if, as, and to the extent it exceeds the shareholder's basis in his stock. See sec. 1001.A reading of the complete legislative history of the addition of section 201(c) to the Revenue Act of 1924 (the predecessor of sec. 331) does not support petitioner's position. H. Rept. 179, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 241, 250, likewise pointed out that the retirement of a part of capital stock is a transaction treated as a sale of stock and that where the corporation distributes an amount in partial retirement of capital stock "the amount thereof is to be considered as a return of capital." However, the Senate report stated with respect to the House bill that --The House bill also treated such dividends as a sale of the stock, for the purpose of determining the amount of the gain, but provided that the amount of such gain should be taxed (1) as a dividend to the extent that it does not exceed the taxpayer's ratable share of the undistributed earnings of the corporation accumulated since February 28, 1913; (2) as a88 gain from the exchange of property to the extent that it exceeds such ratable share. It is recommended that this provision of the House bill be stricken out. [S. Rept. 398, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 260, 274.]Conf. Rept. 844, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 300, recited this history and then stated:The Senate amendment strikes out this provision with the result that a liquidating dividend is to be treated as a sale of stock and taxable as a gain from the sale of property; and the House recedes.The District Court in Brown v. United States, 292 F. Supp. 527">292 F. Supp. 527 (D. Ore. 1968), revd. on other grounds 427 F.2d 57">427 F.2d 57 (9th Cir. 1970), specifically considered the argument made by the taxpayer in that case that no disposition of stock occurred within the meaning of the provision of the Code prior to its amendment in 1963 which contained the same provision as section 425(c) in the year in which amounts were distributed to him as part of the process of liquidation of the corporation. The District Court held (at page 529) that on the basis89 of section 331(a) "the term 'disposition' includes a liquidation." The Circuit Court, in reversing on another ground, stated (427 F.2d at 60):1161 Were section 421 drawn simply to require "a disposition" of shares as the event upon which disqualification turned, we might agree with the Government that "a disposition" occurred when M & M reached agreement with Simpson for a sale and complete liquidation of M & M, and we would then have to decide whether or not the date of such disposition was the date upon which the liquidating payment was placed in escrow, or some other time. * * The argument made by petitioners in these cases with respect to no disposition being made of the stock within the meaning of sections 421(a) and (b), 422(a), and 425(c) is the same argument that was not accepted by either the District Court or the Circuit Court in Brown v. United States, supra.Petitioners further argue that their position is supported by the following provision of section 331(b):Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property (other than a distribution referred to in90 paragraph (2)(B) of section 316(b)), in partial or complete liquidation.It is petitioners' position that if section 331(a) was intended to mean that a liquidating distribution should be treated as in part or full payment in exchange for stock for all purposes of the Revenue Code, section 331(b) would be unnecessary since it would be obvious that the distribution could not be treated in the manner provided in section 301.Respondent argues that the wording of section 331(a) is clear, and its caption, "General Rule," makes it clear that its provisions are applicable to all pertinent sections of the Code. Respondent sees no inconsistency in his interpretation of section 331(a) and the provisions of section 331(b), but views section 331(b) as merely clarifying the relationship between the two sections.Petitioners cite a number of cases in which we have held that a collection of a note or bond or similar item does not constitute a sale or exchange, with the result that the amount collected in excess of the taxpayer's basis in the property does not qualify for capital gains treatment but is taxed as ordinary income. See secs. 1001 and 1222. In our view, these cases are not applicable91 here since there is a specific section of the Code prescribing exchange treatment for shareholders of amounts distributed in liquidation. Admittedly, the distribution here involved for the year 1977 was in partial liquidation of the 1162 corporation since it was "one of a series of distributions in redemption of all of the stock of the corporation pursuant to a plan." Under section 346(a)(1), such a distribution is to be treated as a distribution in partial liquidation of the corporation. In our view, the distributions made in 1977 to petitioners must be treated as in part payment in exchange for each petitioner's stock. Sec. 331(a)(2). Because of the provisions of the statute, each petitioner's stock is in legal contemplation surrendered for the payments made by the liquidating corporation, even though the certificate continues to be outstanding. 692 In our view, the fact that the stock of the corporation was listed on the American Stock Exchange until March 21, 1980, does not cause the payment in 1977 not to be treated as in exchange for the stock. Section 331(a) specifically provides that it is in payment for the stock. In Hotel Equities Corp. v. Commissioner, 546 F.2d 725">546 F.2d 725, 728 (7th Cir. 1976), affg. 65 T.C. 528">65 T.C. 528 (1975), the court stated that there is a natural presumption that identical words used in different parts of the same act are intended to have the same meaning. Following this rationale, the word "exchange" as used in section 331(a) has the same meaning as "exchange" as used in section 425(c). In that case, it was held that the statements in section 7502(a)(1), that the postmark date on the cover in which a return is mailed "shall be deemed to be the date of delivery" of the return, meant that the postmark date was to be considered as the delivery or filing date of the return for the purposes of all sections of the Code. This Court, in its opinion, stated, at page 535, that the provision of section 7502(a) is that the postmark date is "deemed" or is to be93 "treated" as the delivery date. In our view, under the provisions of section 331(a), the distribution made by the corporation to each of its stockholders in 1977 is to be treated as a partial payment in exchange for each 1163 stockholder's stock for all purposes of the Code. See United States v. Davis, 397 U.S. 301">397 U.S. 301 (1970); Julia R. & Estelle L. Foundation v. Commissioner, 70 T.C. 1">70 T.C. 1, 6 (1978), affd. 598 F.2d 755">598 F.2d 755 (2d Cir. 1979). We conclude that each petitioner made a disposition of his stock within the meaning of sections 421(b), 422(a), and 425(c) in 1977.Petitioners argue, relying on the holding of the Court of Appeals for the Ninth Circuit in Brown v. United States, supra, that, if we conclude that each petitioner made a disposition of his stock in 1977, it was not a disqualifying disposition within the meaning of section 421(b). Respondent recognizes that the Court of Appeals for the Ninth Circuit in the Brown case held that a disposition of stock in a liquidation is not a "disqualifying disposition" since such a disposition is involuntary. Respondent agrees that the Brown94 case is not distinguishable in any way from the instant case. Respondent argues that the Brown case was incorrectly decided and therefore should not be followed by this Court. All of these consolidated cases, except one, are appealable to the Court of Appeals for the Ninth Circuit. Therefore, if we accept the position of both parties that the case of Brown v. United States, supra, is in no way distinguishable from the instant cases, it follows that we must decide all but one of these cases for petitioners, regardless of our view with respect to the issue. For this reason, we will discuss in some detail the Brown case, although we, too, have concluded that it is not distinguishable from the instant cases. Under the rule of Golsen v. Commissioner, 54 T.C. 742 (1970), affd. on other grounds 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), we follow the holding of the Brown case with respect to each petitioner herein except petitioners Warren H. Schumann and Maria T. Schumann (docket No. 26661-81).The Brown case involved stock in a company which liquidated in 1956. Section 421(a)(1), (d)(4), and (f), 7 applicable to the95 1164 year 1956, insofar as here relevant contained substantially the same provisions as section 421(a) and (b), section 422(a), and section 425(c), except for the length of the required holding period. There was no substantive change in the provisions of section 421(a) and (f), applicable to the year 1956, relied on by the Circuit Court in the Brown case as supporting its conclusion that a disposition by liquidation was not a disqualifying disposition, and the provisions of section 421(a) and (b) and section 422(a), applicable to the year here in issue. The statute applicable in the Brown case referred to a "disposition of such share * * * made by him," and the statutes applicable to the year here in issue refer to a "disposition of such share * * * made by such individual." The Ninth Circuit held that the use of the words "made by him" showed that Congress intended only a voluntary disposition in which the taxpayer affirmatively acted to dispose of his stock to be a disqualifying disposition. All parties recognize that the changing of the words "made by him" to the words "made by such individual" is not a distinction that affects the holding of the Brown case. 96 We agree. The Ninth Circuit stated that the legislative history of section 421 supported its interpretation since the statute 1165 was enacted to give tax benefits to key corporate executives for the purpose of increasing corporate productiveness and thus stimulating the nation's economy. The Circuit Court cited, in support of its holding, S. Rept. 2375, 81st Cong., 2d Sess. (1950), 2 C.B. 483">1950-2 C.B. 483, and H. Rept. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 125. The court stated that "The incentive rationale is obviously no longer served when the executive has chosen to dispose of his stock" (427 F.2d at 60). In a footnote, the court recognized, as had been contended by the Government, that neither is the incentive rationale any longer served when the corporation is liquidated. However, the court stated that this argument ignored the possibility of disincentives arising from disqualification in cases of liquidation since an executive might be disinclined to accept an attractive takeover offer because of this unfavorable tax consequence to him personally. The Circuit Court relied on97 the provisions of the statute recognizing some involuntary dispositions, such as the death of the option holder, as not constituting a disqualifying disposition, to support its conclusion that an involuntary disposition was not a disqualifying disposition. 427 F.2d at 60 n.5.98 While we do not consider there to be any distinction between the Brown case and the instant cases, we respectfully disagree with the conclusion reached by the Ninth Circuit in the Brown case and the rationale of its opinion.A qualified stock option can only be granted to an employee or officer who owns less than 5 or 10 percent of the stock of the corporation granting the option. See Morris v. Commissioner, 70 T.C. 959">70 T.C. 959, 993 (1978); sec. 422(b)(7). For this reason, a controlling shareholder could not be the recipient of a qualified stock option, and any disincentive of an employee to vote his shares in the best interest of the corporation would not be controlling of the corporate action. However, more importantly, the statute as enacted by Congress contains specific provisions that certain dispositions will not be considered as disqualifying dispositions. Had the words "made by him" or "made by such individual" been intended to limit a disqualifying disposition to a "voluntary disposition" as held by the Ninth Circuit, these specific exceptions contained in the statute would be superfluous. None of the dispositions which are excepted by 99 statute from "disqualifying dispositions," are 1166 dispositions in which the individual actually receives money in exchange for his stock. 8 Section 422(c)(5) provides that a transfer by an insolvent individual to a trustee or fiduciary under the Bankruptcy Act does not constitute a disqualifying disposition. Section 425(c)(1) provides that a disqualifying disposition does not include (1) a transfer from a decedent to an estate or a transfer by bequest or inheritance; (2) an exchange to which section 354, 355, 356, or 1036 (or so much of sec. 1031 as relates to sec. 1036) applies; or (3) a mere pledge or hypothecation. However, the income tax regulation, in interpreting this section, states:However, a disposition of the stock pursuant to a pledge or hypothecation is a disposition by the individual even though the making of the pledge or hypothecation is not such a disposition. [Sec. 1.425-1(c)(1)(iii), Income Tax Regs.]100 The legislative history of the Revenue Act of 1964, which made substantial changes with respect to qualified stock options, contains little discussion of the various exceptions provided for situations in which a disqualifying disposition will not be considered to have occurred. There is no discussion whatsoever distinguishing between "voluntary" as opposed to "involuntary" dispositions, nor is there any statement indicating that a further exception was intended. See H. Rept. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 125, 328; S. Rept. 830, 88th Cong., 2d Sess. (1964), 1964-1 C.B. (Part 2) 505, 595-596. When Congress has enumerated in the statute specific exceptions which would not be considered to constitute a disqualifying disposition of the stock acquired pursuant to exercise of the qualified stock option, further exceptions should not be read into the statute. Where an exception is made for corporate reorganizations to cover a situation involving only a substitution of a like-kind investment, the 1167 inference is that the disposition of the stock in a complete or partial liquidation, where there is no101 continuity of investment and the shareholder receives money or other property in exchange for his stock, was not inadvertently omitted.In a case involving a contention by a taxpayer that his disposition of stock pursuant to a purchase offer preparatory to a merger should not be considered a disqualifying disposition, the District Court, in Bayer v. United States, 382 F. Supp. 576">382 F. Supp. 576, 580 (N. D. Ohio 1974), stated that the taxpayer had cited the case of Brown v. United States, 427 F.2d 57">427 F.2d 57 (9th Cir. 1970), for the proposition that an involuntary disposition of option stock is excused from satisfying the statutory holding period and is not a disqualifying disposition under section 421. The taxpayer there was arguing, as petitioners here, that the disqualifying event is not the disposition itself, but the voluntariness of the act of disposing of the stock. The District Court quoted the portion of the Brown case which we have discussed in which the Circuit Court concluded that unless the taxpayer acted voluntarily in disposing of his stock, the disposition was not a disqualifying disposition. The Court stated that, having102 reviewed the legislative history of the statute, it concluded that there was no indication in that legislative history that Congress considered the matter of voluntariness of the disposition within the statutory holding period provided as affecting the tax consequences. Our review of the legislative history leads us to the same conclusion. 9The District Court then pointed out as follows (pp. 580-581):1168 The primary source for determining legislative intent is the statute on its face. Minnesota Mining and Manufacturing Co. v. Norton Co., 366 F.2d 238">366 F.2d 238 (CA 6, 1966). There is nothing in the statutory language to indicate that 1169 voluntariness is a factor in the legislative definition of "disposition". If anything, the broad language of the statute and the nature of the exclusions would indicate the contrary.103 1170 In our view, since the provision of the statute that an employee does not receive income when he purchases stock of his corporate employer at less than its fair market value pursuant to a qualified stock option, removes from the definition of income an item that otherwise would clearly constitute income, it is to be narrowly construed. Any exceptions should be confined to those specifically provided for in the statute and not enlarged upon by a distinction nowhere appearing in either the statute or the legislative history.Prior to the enactment of the predecessor of the present sections 421 through 425, when a stock option was given to an 1171 employee, he either received income at the time of the granting of the option, if the option itself had a fair market value, or received income when the option was exercised, if the option price was less than the fair market value of the stock at that date. Commissioner v. Lo Bue, 351 U.S. 243">351 U.S. 243 (1956). It is to be noted that for an option to be a qualified stock option, the option price must be approximately the amount of the fair market value of the stock at the date the option is granted, so104 that there would be no value to the option when it is granted, and it must be nontransferable. Therefore, absent the special provision with respect to qualified stock options, each petitioner in this case would have received ordinary income at the time of exercise of his option under the holding of the Lo Bue case at page 249:It is of course possible for the recipient of a stock option to realize an immediate taxable gain. See Commissioner of Internal Revenue v. Smith, 324 U.S. 177">324 U.S. 177, 181-182, 65 S. Ct. 591">65 S. Ct. 591, 593, 89 L. Ed. 830">89 L. Ed. 830. The option might have a readily ascertainable market value and the recipient might be free to sell his option. But this is not such a case. These three options were not transferable and Lo Bue's right to buy stock under them was contingent upon his remaining an employee of the company until they were exercised. Moreover, the uniform Treasury practice since 1923 has been to measure the compensation to employees given stock options subject to contingencies of this sort by the difference between the option price and the market value of the shares at the time the option is exercised. * * * Under 105 these circumstances there is no reason for departing from the Treasury practice. The taxable gain to Lo Bue should be measured as of the time the options were exercised and not the time they were granted. [Fn. ref. omitted.]The provisions of sections 421 through 425 grant a specific benefit to a selected group of taxpayers by permitting capital gain treatment to those taxpayers of amounts that would otherwise be taxable as ordinary income. For this reason, the provisions should be strictly construed.For the reasons given above, we conclude that each petitioner herein made a disposition of the stock he acquired pursuant to the option received from the corporation within a period of less than 3 years from the date the shares were acquired by him pursuant to the exercise of his option. However, since an appeal from all of the cases except Warren H. Schumann and Maria T. Schumann (docket No. 26661-81) will be to the Court of Appeals for the Ninth Circuit, motion for summary judgment will be granted with respect to all of the cases except the 1172 Schumann case. Petitioners' motion for summary judgment in the Schumann case will be denied.Appropriate orders and decisions 106 will be entered in all cases except Warren H. Schumann and Maria T. Schumann, docket No. 26661-81, and an appropriate order will be entered in that case. WHITAKERWhitaker, J., dissenting: For the reasons and upon the rationale stated by the Court of Appeals for the Ninth Circuit in Brown v. United States, 427 F.2d 57 (9th Cir. 1970), I dissent. Footnotes1. Cases of the following petitioners are consolidated herewith: Kenneth G. Heinz and Patricia B. Heinz, docket No. 14902-81; James E. Dahl and Louann J. Dahl, docket No. 14903-81; John E. Heffernan and Mary P. Heffernan, docket No. 22428-81; Warren H. Schumann and Maria T. Schumann, docket No. 26661-81; John J. Heck and Lois R. Heck, docket No. 29082-81; Martin Drobac and Becky K. Drobac, docket No. 29083-81; and Edward Durbin and Betty L. Durbin, docket No. 1035-82.↩2. In two of the cases there is, in addition to the common issue, also an issue as to an addition to tax under sec. 6651(a). However, the action on the motion for summary judgment will also dispose of this issue.↩3. Unless otherwise stated, all statutory references are to the Internal Revenue Code of 1954 as amended and in effect during the year here in issue.↩4. Secs. 421(a) and (b), 422(a) and (c)(5), and 425(c) provide as follows:SEC. 421. GENERAL RULES.(a) Effect of Qualifying Transfer. -- If a share of stock is transferred to an individual in a transfer in respect of which the requirements of section 422(a), 423(a), or 424(a) are met -- (1) except as provided in section 422(c)(1), no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share;(2) no deduction under section 162 (relating to trade or business expenses) shall be allowable at any time to the employer corporation, a parent or subsidiary corporation of such corporation, or a corporation issuing or assuming a stock option in a transaction to which section 425(a) applies, with respect to the share so transferred; and(3) no amount other than the price paid under the option shall be considered as received by any of such corporations for the share so transferred.(b) Effect of Disqualifying Disposition. -- If the transfer of a share of stock to an individual pursuant to his exercise of an option would otherwise meet the requirements of section 422(a), 423(a), or 424(a) except that there is a failure to meet any of the holding period requirements of section 422(a)(1), 423(a)(1), or 424(a)(1), then any increase in the income of such individual or deduction from the income of his employer corporation for the taxable year in which such exercise occurred attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or of such employer corporation in which such disposition occurred.SEC. 422. QUALIFIED STOCK OPTIONS.(a) In General. -- Subject to the provisions of subsection (c)(1), section 421(a) shall apply with respect to the transfer of a share of stock to an individual pursuant to his exercise of a qualified stock option if -- (1) no disposition of such share is made by such individual within the 3-year period beginning on the day after the day of the transfer of such share, and(2) at all times during the period beginning with the date of the granting of the option and ending on the day 3 months before the date of such exercise, such individual was an employee of either the corporation granting such option, a parent or subsidiary corporation of such corporation, or a corporation or a parent or subsidiary corporation of such corporation issuing or assuming a stock option in a transaction to which section 425(a) applies. * * * (c) Special Rules. -- * * * (5) Certain transfer by insolvent individuals. -- If an insolvent individual holds a share of stock acquired pursuant to his exercise of a qualified stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary, in any proceeding under the Bankruptcy Act or any other similar insolvency proceeding, neither such transfer, nor any other transfer of such share for the benefit of his creditors in such proceeding, shall constitute a "disposition of such share" for the purposes of subsection (a)(1).SEC. 425. DEFINITIONS AND SPECIAL RULES.(c) Disposition. -- (1) In General. -- Except as provided in paragraph (2), for purposes of this part, the term "disposition" includes a sale, exchange, gift, or a transfer of legal title, but does not include -- (A) a transfer from a decedent to an estate or a transfer by bequest or inheritance;(B) an exchange to which section 354, 355, 356, or 1036 (or so much of section 1031 as relates to section 1036) applies; or(C) a mere pledge or hypothecation.(2) Joint tenancy. -- The acquisition of a share of stock in the name of the employee and another jointly with the right of survivorship or a subsequent transfer of a share of stock into such joint ownership shall not be deemed a disposition, but a termination of such joint tenancy (except to the extent such employee acquires ownership of such stock) shall be treated as a disposition by him occurring at the time such joint tenancy is terminated.↩5. Sec. 331(a) provides as follows:SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS.(a) General Rule. -- (1) Complete liquidations. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.(2) Partial liquidations. -- Amounts distributed in partial liquidation of a corporation (as defined in section 346) shall be treated as in part or full payment in exchange for the stock.↩6. J. Mertens, Law of Federal Income Taxation sec. 9.80, at 219, states as follows:"Sec. 9.80. Necessity of Surrender of Stock↩. The statute says that amounts distributed in complete liquidation or partial liquidation shall be "treated" as in full or part payment in 'exchange' for the stock. The statutory definition of partial liquidation is not in conflict with this. The distinction to be drawn is between the stock and the certificates evidencing the stock. If the distribution is liquidating, the stock is in legal contemplation surrendered in exchange therefor, although the stock certificates may continue outstanding. Physical retirement or cancellation of the certificates is not essential. [Fn. ref. omitted.]"7. Sec. 421(a)(1), (d)(4), and (f), I.R.C. 1954, as applicable to the year 1956, provides as follows:SEC. 421. EMPLOYEE STOCK OPTIONS.(a) Treatment of Restricted Stock Options. -- If a share of stock is transferred to an individual pursuant to his exercise after 1949 of a restricted stock option, and no disposition of such share is made by him within 2 years from the date of the granting of the option nor within 6 months after the transfer of such share to him -- (1) no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share; * * (d) Definitions. -- For purposes of this section -- * * (4) Disposition. -- (A) General rule. -- Except as provided in subparagraph (B), the term "disposition" includes a sale, exchange, gift, or a transfer of legal title, but does not include --(i) a transfer from a decedent to an estate or a transfer by bequest or inheritance;(ii) an exchange to which section 354, 355, 356, or 1036 (or so much of section 1031 as relates to section 1036) applies; or(iii) a mere pledge or hypothecation.(B) Joint tenancy. -- The acquisition of a share of stock in the name of the employee and another jointly with the right of survivorship or a subsequent transfer of a share of stock into such joint ownership shall not be deemed a disposition, but a termination of such joint tenancy (except to the extent such employee acquires ownership of such stock) shall be treated as a disposition by him occurring at the time such joint tenancy is terminated. * * (f) Effect of Disqualifying Disposition. -- If a share of stock, acquired by an individual pursuant to his exercise of a restricted stock option, is disposed of by him within 2 years from the date of the granting of the option or within 6 months after the transfer of such share to him, then any increase in the income of such individual or deduction from the income of his employer corporation for the taxable year in which such exercise occurred attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or of such employer corporation in which such disposition occurred.↩8. We are of course aware that in the exchange of securities or stock in one corporation for securities or stock of another corporation, or a distribution to a stockholder of stock or a security holder of securities in a controlled corporation (secs. 354 and 355), "other property" or "money" commonly referred to as "boot" may be received without disqualifying the gain on the exchange of stock or securities for stock or securities from nonrecognition (sec. 356). Under sec. 1036, dealing with exchange of stock for stock in the same corporation, gain is recognized to the extent of other property or money↩ received (sec. 1031(b)). Under each of these sections, however, the exchange is basically a stock for stock exchange which is not disqualified by receipt of "boot."9. The legislative history cited and relied on by the Circuit Court in Brown v. United States, 427 F.2d 57">427 F.2d 57 (9th Cir. 1970), is contained in S. Rept. 2375, 81st Cong., 2d Sess. (1950), 2 C.B. 483">1950-2 C.B. 483, 526-527, and in H. Rept. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 125, 311-332.S. Rept. 2375 states with respect to employee stock options as follows:(3) Employee Stock OptionsYour committee's bill (section 220) establishes a new set of rules for the tax treatment of certain employee stock options. Such options are frequently used as incentive devices by corporations who wish to attract new management, to convert their officers into "partners" by giving them a stake in the business, to retain the services of executives who might otherwise leave, or to give their employees generally a more direct interest in the success of the corporation.At the present time the taxation of these options is governed by regulations which impede the use of the employee stock option for incentive purposes. Moreover, your committee believes these regulations go beyond the decision of the Supreme Court in Commissioner v. Smith, 324 U.S. 177">324 U.S. 177 (1945). The resulting uncertainty as to whether these regulations are in accordance with the law is an additional reason for legislative action at the present time.The rule applied under existing regulations is that an employee exercising an option to purchase stock from his employer corporation receives taxable income at the time the option is exercised to the extent of the difference between the market value of the stock at the time of exercise and the option (or purchase) price. The difference is taxed as ordinary income, rather than as a capital gain, on the theory that it represents additional compensation to the employee. Since the employee does not realize cash income at the time the option is exercised, the imposition of a tax at that time often works a real hardship. An immediate sale of a portion of the stock acquired under the option may be necessary in order to finance the payment of the tax. This, of course, reduces the effectiveness of the option as an incentive device.Under your committee's bill no tax will be imposed at the time of exercise of a "restricted stock option" or at the time the option is granted and the gain realized by the sale of the stock acquired through the exercise of the option will be taxed as a long-term capital gain. Such treatment is limited to the "restricted stock option" for the purpose of excluding cases where the option is not a true incentive device. Options which do not qualify as "restricted stock options" will continue to be taxed as under existing law.Ordinarily when an option is used as an incentive device, the option price approximates the fair market value of the stock at the time the option is granted. However, many stocks are not listed on exchanges and therefore the fair market value is difficult to determine. Hence, your committee's bill requires that to qualify as a "restricted stock option" the option price at the time of issuance must be 85 percent or more of the fair market value of the stock.A "restricted stock option" is entitled to the treatment provided by the bill only if it is exercised while the grantee is an employee, or within a period of 3 months following the termination of his employment. The benefits of this provision extend to cases where the employee of a parent corporation receives an option to purchase stock in a subsidiary and where the employee of a subsidiary receives an option to acquire stock in a parent corporation.The stock acquired under a "restricted stock option" must not be sold less than 2 years subsequent to the date on which the option is granted, and the stock purchased under the option must be held for a period of not less than 6 months. Thus, under the bill the employee will receive special treatment only if he remains in the employment of the company for a substantial period after the time when he acquires the option and actually invests in the stock of the company for a considerable period."Restricted stock options" cannot be transferable except by will or by operation of the laws of interstate succession.The status of a "restricted stock option" will be denied if the recipient of the option owns directly or indirectly more than 10 percent of the combined voting power of all classes of stock of the employer corporation or of the parent corporation at the time the option is granted. This rule is intended to prevent the use of stock options by employers who seek merely to convert the earnings of a corporation from ordinary income into a capital gain.Since the options which qualify for special treatment are regarded as incentive devices rather than compensation, no deduction is allowed the corporation under section 23(a) with respect to a transfer of stock pursuant to a restricted stock option.The rules governing "restricted stock options" apply to options granted, modified, extended, or renewed after December 31, 1946, and exercised after 1949.H. Rept. 749, in pertinent part, states:SECTION 214. EMPLOYEE STOCK OPTIONS AND PURCHASE PLANS(a) In general. Subsection (a) of section 214 of the bill revises part II of subchapter D of chapter 1 of the code, which deals with employee stock options. The revised part II consists of an amended section 421 of the code and new sections 422, 423, 424, and 425. Section 421 as amended by the bill contains general rules applicable to options described in sections 422, 423, and 424. The new sections 422 and 423 relate to qualified stock options and employee stock purchase plans, respectively, and contain new rules to be applied in determining whether the transfer of a share of stock to an individual pursuant to his exercise of a stock option qualifies for tax treatment similar to that presently provided by section 421(a) of the code. The new section 424 continues the present treatment for restricted stock options granted before the effective date of the new rules. The new section 425 contains definitions and special rules common to the other provisions of the revised part II. The new sections, and the respects in which their provisions differ from the provisions of the existing section 421, are as follows: * * (b) Effect of disqualifying disposition. -- Section 421(b) as amended contains rules relating to the tax effects of an individual's failure to satisfy the holding period requirement of section 422(a)(1), 423(a)(1), or 424(a)(1) with respect to a share of stock acquired pursuant to the exercise of an option with respect to which the other requirements of section 422(a), 423(a), or 424(a) are met. These rules are similar in effect to those contained in the existing section 421(f), and provide that any increase in the income of the individual or deduction from the income of his employer corporation, for the taxable year in which the exercise occurred attributable to the disposition, is treated as an increase in income or deduction from income in the taxable year of the individual or his employer corporation in which such disposition occurred. * * SECTION 422. QUALIFIED STOCK OPTIONS(a) In general. -- The new section 422(a) provides new holding period and employment requirements which must be satisfied if an individual receiving a qualified stock option is to obtain the special tax treatment afforded by section 421(a) as amended. Generally, under present law, a share of stock transferred to an individual pursuant to his exercise of a restricted stock option must not be disposed of within 2 years from the date of the granting of the option nor within 6 months after the transfer of the share to the individual if the individual is to obtain the special tax treatment provided by section 421(a). As an additional prerequisite to the special tax treatment provided by the existing section 421(a), the individual is required to be an employee of the grantor corporation, a parent or subsidiary corporation of such corporation, or a corporation or a parent or subsidiary of such corporation issuing or assuming a stock option in a transaction to which section 425(a) (relating to corporate reorganizations, liquidations, etc.) applies at the time of the granting of the option and at the time the option is exercised, or within the 3-month period preceding the date of exercise. In comparison, the new section 422(a) requires stock acquired pursuant to the exercise of a qualified stock option (as defined in section 422(b)) to be held for at least 3 years after the stock is transferred to the individual and requires that the individual be an employee of a corporation described in the preceding sentence at all times beginning with the date the option is granted and ending on the day 3 months before the option is exercised if the special treatment afforded by section 421(a) as amended by the bill is to be obtained. Thus, section 422(a) provides that section 421(a) applies with respect to the transfer of a share of stock to an individual pursuant to his exercise of a qualified stock option (as defined in sec. 422(b)) if --(1) no disposition of such share is made by such individual within the 3-year period beginning on the day after the day of the transfer of such share to the individual, and(2) at all times during the period beginning with the date of the granting of the option and ending on the day 3 months before the date of such exercise, such individual was an employee of either the corporation granting such option, a parent or subsidiary of such corporation, or a corporation or a parent or subsidiary corporation of such corporation issuing or assuming a stock option in a transaction to which section 425(a)(relating to corporate reorganizations, liquidations, etc.) applies.For example, if an individual is granted a qualified stock option to purchase stock in his employer corporation on January 2, 1964, and such individual continues to be an employee of such corporation until he terminates his employment on June 6, 1965, he may exercise his option at any time from the date the option was granted to him through September 6, 1965. Assuming that such individual exercises his option on September 6, 1965, and that the stock is transferred to him on September 10, 1965, he must not dispose of the stock before September 11, 1968, if he is to qualify for the special tax treatment afforded by section 421(a). * * Certain transfers by insolvent individualsParagraph (5) of section 422(c) provides an exception to the holding-period requirement of section 422(a)(1) with respect to certain transfers by insolvent individuals. If an insolvent individual holds a share of stock acquired pursuant to his exercise of a qualified stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary in any proceeding under the Bankruptcy Act or any other similar insolvency proceeding (including assignments for the benefit of creditors), neither such transfer, nor any other transfer of such share for the benefit of the insolvent individual's creditors in such proceeding, shall constitute a "disposition of such share" for purposes of section 422(a)(1). An individual whose liabilities exceed his assets or who is unable to satisfy his liabilities as they become due is treated as insolvent for purposes of section 422(c)(5). Although the transfer of a share of stock to or by the trustee or other fiduciary is not considered a disposition for purposes of section 422(a)(1), a transfer by the trustee (other than a transfer back to the insolvent individual) constitutes a sale or exchange of the stock for purposes of recognition of any capital gain or loss. If the share is transferred by the trustee back to the insolvent individual, any subsequent disposition of the share by the insolvent individual which is not made in respect of the insolvency proceeding and for the benefit of his creditors in such proceeding is treated as a disposition for purposes of section 422(a)(1). * * *(c) Disposition↩. -- Section 425(c) continues the definition of the term "disposition" contained in paragraph (4) of the existing section 421(d). In general, a "disposition" includes a sale, exchange, gift, or transfer of legal title, but does not include a transfer from a decedent to an estate, a transfer by bequest or inheritance, an exchange to which section 354, 355, 356, or 1036 of the code (or so much of sec. 1031 as relates to sec. 1036) applies, or a mere pledge or hypothecation. No disposition occurs when an employee acquires stock in joint tenancy, or when he transfers stock into joint tenancy. However, a termination of such joint tenancy is a disposition except to the extent such employee acquires ownership of such stock.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621436/	PIONEER COOPERAGE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pioneer Cooperage Co. v. CommissionerDocket No. 4816.United States Board of Tax Appeals17 B.T.A. 119; 1929 BTA LEXIS 2351; August 19, 1929, Promulgated 2351 The basis for the computation of loss on property acquired prior to March 1, 1913, and lost by casualty in the years 1918 and 1919, is cost where its value on March 1, 1913, was in excess of its cost. A. S. Johnston, Esq., and Richard S. Doyle, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. MILLIKEN 119 This proceeding involves the redetermination of deficiencies in income and profits taxes for the calendar years 1918 and 1919 in the respective amounts of $29,342.85 and $30,347.03 and an overassessment for the year 1917 in the amount of $6,608.32. The errors alleged are (1) the loss of timber by storms and worms has been computed by respondent on original cost instead of fair market value in 1916, 1917, and 1918, the years when the losses occurred, or upon the fair market value of the timber on March 1, 1913; (2) the allocation by respondent of the loss to the years 1916, 1917, and 1918, instead of the year 1918 alone; (3) refusal by respondent to grant petitioner special assessment under sections 327 and 328 of the Revenue Act of 1918; (4) respondent's determination in computing petitioner's invested capital for the2352 year 1919 of a value as of March 1, 1913, of $7.30 instead of $12.50 per acre in determining the realized appreciation on 1,241.43 acres of land sold in 1918; (5) respondent's determination of petitioner's income and profits taxes 120 for the year 1918 by reducing petitioner's surplus as of December 31, 1917, in the amount of $22,552.63, being the 200-day prorating of the estimated income and profits taxes for 1917 amounting to $41,208.55; and (6) respondent's determination of petitioner's income and profits taxes for the year 1919 by reducing petitioner's surplus as of December 31, 1918, in the sum of $96,962.54, being the quarterly prorating of the estimated income and profits taxes for 1918 amounting to $229,441.35. At the hearing petitioner withdrew contentions 3, 5, and 6. Contentions 2 and 4 are disposed of by the stipulation of facts made by the parties from which we make the following findings of fact. FINDINGS OF FACT. Petitioner is a corporation organized under the laws of Missouri, with its principal office at St. Louis, Mo.On June 16, 1919, petitioner filed with the collector of internal revenue for the first district of Missouri, at St. Louis, its2353 income and profits-tax return for the calendar year 1918, and on June 24, 1921, filed with the said collector an amended return for that year. Several years prior to 1913, petitioner acquired by purchase 55,400 acres of hardwood timber lands in West Carroll Parish, La., which property it owned on March 1, 1913. Said 55,400 acres of land contained on March 1, 1913, 387,800,000 feet of standing timber, which had cost petitioner $437,480.75 (exclusive of land), or an average cost of $1.13 per thousand feet. The fair market value on March 1, 1913, of the said 387,800,000 feet of standing timber (exclusive of land) was $1,357,300, or an average value of $3.50 per thousand feet. The average stand of timber per acre upon the 55,400 acres of land was 7,000 feet of merchantable saw timber. Petitioner continued to own the said 55,400 acres of timber lands throughout the calendar years 1916, 1917, and 1918, and carried on logging operations thereon during those years for the supply of its mills. In June, 1916, a hurricane or cyclone, accompanied by a severe hailstorm, swept over an area of 2,780 acres of the said 55,400 acres of hardwood timber lands. On June 1, 1916, the said area2354 of 2,780 acres contained 19,460,000 feet of merchantable saw timber, upon the basis of 7,000 feet to the acre. Following the hurricane and during the years 1916, 1917, and 1918, petitioner salvaged on this tract of 2,780 acres a total of 3,997,564 feet of merchantable timber, of which 973,191 feet was salvaged in 1916, 1,908,146 feet was salvaged in 1917 and 1,116,227 feet was salvaged in 1918. As a result of said hurricane or cyclone and the inroad of insects and worms, 15,462,436 feet of timber on the said 2,780 acres of land was lost and destroyed, and it is agreed that the loss occurred in the ratio of 25 per cent in 1916, 25 per cent in 1917 and 50 per cent in 1918. Respondent in auditing the petitioner's returns for 1916, 1917, and 1918 redetermined the amount of the loss at $17,472.56 upon the basis of cost, and apportioned that loss to the years 1916, 1917, and 1918, in the amounts of $4,368.14, $4,368.14, and $8,736.28, respectively, 121 thus reducing the deduction from income for 1918 from $55,943.36, as claimed on the return, to $8,736.28. The cost of the said 15,462,436 feet of timber lost or destroyed was $1.13 per thousand feet, or a total of $17,472.56, 2355 and the fair market value of the said timber on March 1, 1913, was $3.50 per thousand feet, or $54,118.53. In the year 1918 petitioner sold to Geo. W. Luehrman 841.43 acres of timber lands in sections 21 and 22, township 22 north, range 10 of West Carroll Parish, adjoining said 2,780 acres referred to above and containing timber of the same or similar character but unaffected by either the cyclone or the worms, for a price of $42,000, which sale was based upon a value of $12.50 per acre for land and $5.50 per thousand feet for timber at a stand of 7,000 feet to the acre, or a total selling price of approximately $50 per acre. The loss which occurred by reason of cyclone and inroads of insects and worms in 1916, 1917, and 1918 was not compensated for by insurance or otherwise. The invested capital of petitioner for the calendar year 1919 should be increased by the amount of $6,455.44, representing additional realized appreciation on the sale of land in 1918, which realized appreciation was erroneously computed in Schedule D of the deficiency letter at $6.30 instead of $11.50 per acre, on 1,241.43 acres. OPINION. 2356 MILLIKEN: Since respondent has not determined a deficiency for the year 1917 but has determined an overassessment, and such overassessment, so far as the record discloses, not resulting from the rejection of a claim in abatement, the Board is accordingly without jurisdiction as to that year and for that reason this appeal, in so far as that year is involved, is dismissed. . There is but one question before us for decision, and that is the basis upon which petitioner's losses sustained by reason of storms and worms are to be computed. The pertinent parts of section 234 of the Revenue Act of 1918 read: SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * (4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. Section 202 of the same Act contains the following: SEC. 202. (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be - (1) In the case of property acquired before2357 March 1, 1913, the fair market price or value of such property as of that date; and 122 (2) In the case of property acquired on or after that date, the cost thereof; or the inventory value, if the inventory is made in accordance with section 203. Petitioner's first contention is that the measure of its loss is the fair market value of the property at the time it was destroyed by storms and worms. It further contends that if this be not true, then the proper basis is the fair market value of the property on March 1, 1913. It also assets that the provisions of section 202(a)(1)(2) are not pertinent since they apply only to gain or loss arising "from the sale or other disposition of property * * ." Reserving decision on the last point, we pass to petitioner's major contention, which is that the measure of its loss is the fair market value of its timber when destroyed. In making this contention, petitioner seeks to draw a distinction between voluntary and involuntary losses, although no such distinction is to be found in section 234(a)(4). That provision covers "losses" without distinction. It covers all losses, however incurred. To carry petitioner's contention to2358 its logical conclusion would be quite disturbing to the taxpayers of the country. It would deny to them deductions for actual losses where their property had fallen in value. If petitioner's property had decreased in value instead of having increased, we seriously doubt whether it would persist in its present contention. Yet, if one's deductible loss is to be measured by the market value of property at the date of loss, when the property increases in value, by the same token it should be measured by the same standard when it has shrunken in value. To apply the rule contended for by petitioner would be to grant deductible losses only where the property had value when lost, and then only to the extent of its then present value, and thus disregard all questions of cost or value at date of acquisition. The result of this would be that there would be one basis for the computation of gain and another basis for the computation of loss. We can not acquiesce in any such rule. Petitioner's position relative to section 202 is thus stated in the brief filed herein in its behalf: The term "sale" can not apply to the loss of the timber in the present case, as there was no sale. The word2359 "disposition" means "to dispose," which can only mean a transaction in which the taxpayer has voluntarily transferred his property, such as by barter or exchange. There has been no transfer, hence no disposition of this timber. Again, a peculiar result would be reached if we applied petitioner's contention to a state of case other than the one here involved. Thus, if A and B acquired land at the same time and for the same cost and a public service corporation acquired the property of A by a voluntary sale and the property of B by condemnation, and each for the same price, the result would be that A would be taxable upon any gain he made, while B would escape taxation, for the reason that 123 as to him the transfer was involuntary, since, as contended, the basis for computing his gain would be the value at the date of condemnation, which would be the same as the amount received. The same would be equally true as to a deduction for losses, for the reason that gains and losses are correctively. It might well be said that condemnation is an involuntary sale and therefore falls within the statute and such it is. Petitioner's contention, however, goes to all involuntary gains2360 and losses. If petitioner's position is correct, then it is entitled to a loss equal to replacement value. In fact, it is so contended in the brief filed in its behalf, where it is argued: For instance, suppose a company purchased a ship in 1910 for $100,000; on March 1, 1913, it was worth $150,000; on January 1, 1918, it was worth $500,000; and it was wrecked in 1918, and was not covered by insurance. What has the company lost? The cost of replacement would be $500,000. Is that not the amount of the loss? With respect to such basis, it has been the consistent holding of the Board that cost or value on March 1, 1913, is the proper basis for the computation of loss and therefore replacement value is not a factor to be considered. See ; ; ; ; and , affirmed in . See, also, 2361 . In the last case Camden's stable was burned in 1922 and he thereby lost twenty blooded racing horses which he had raised and trained subsequent to March 1, 1913. The value placed upon these horses at the time of the fire was the amount of $150,000. Camden was denied any deduction on account of the loss of the horses, on the sole ground that he failed to prove their cost. This case involved the application of section 214(a)(6) of the Revenue Act of 1921, which differs from section 234(a)(4) of the Revenue Act of 1918 in that it provides as the basis for the computation of loss on property acquired prior relative to property acquired subsequent to that date. In view of the absence of such provision, it was contended there as here that the loss should be measured by the value of the property when destroyed and that contention was denied. By paragraph (4) of subdivision (a) of section 234, the right of a deduction for a loss is made dependent on whether the loss was compensated for by insurance or otherwise. These provisions can not be separated. The basis for computation of loss, which is correlative with gain, is the same, irrespective2362 of whether or not compensation is received for the loss. If we eliminate for the time being the question of value on March 1, 1913, and if we substitute a cost as of 124 March 1, 1913, of $150,000 for the ship referred to in petitioner's example, above quoted, and also assume a recovery of insurance in the amount of $500,000 for the loss of the ship in 1918, and if we further assume that the ship was not replaced, then, according to petitioner's contention, no taxable gain was made, since the value of the ship when destroyed was equal to the amount of the insurance. This starting result is contrary to the concepts of Congress, of the courts, and of the Board. That Congress deemed such compensation taxable income is shown by the fact that in section 234(a)(14) of the Revenue Act of 1921 it in effect provided that where compensation was received for property destroyed, stolen, or taken by condemnation, and where such compensation or part thereof was used for replacements, so much of the compensation so used might be deducted from gross income, and then made the paragraph applicable to such losses under prior revenue acts. This section is evidence of the fact that Congress2363 deemed it necessary to provide this deduction in order to prevent the taxation of insurance or other compensation for property lost and used for replacement. Relative to this provision we said in : * * The provisions of section 234(a)(14) are relief provisions by which a taxpayer may postpone the taxation of so much of the gain derived from an involuntary conversion as it used in replacement. * * * In , we said: That gain derived under a policy of insurance against the loss of a building by fire should enter into the computation of the gain or loss resulting therefrom may not be doubted, for, if the destruction of a taxpayer's property results in a gain by him through insurance, there is a taxable gain growing out of the ownership or use or interest in real or personal property. Under section 234(a)(14) of the Revenue Act of 1921, however, relief is provided in the form of a deduction for taxpayers who expend the proceeds from such an involuntary conversion of property in replacing it with similar property. To the same effect see Fred Frazer; Pelican2364 Bay Lumber Co.; and Pelican Bay Lumber Co. v. Blair, all supra. In the latter case the property lost was acquired subsequent to March 1, 1913. There the Circuit Court of Appeals said: If appellant had elected not to rebuild, there would have been no deductible loss, but, to the contrary, a taxable gain of $67,917.49; that being the difference between the depreciated cost and the insurance collected, plus the salvage of $1,267.68. In other words, the transaction would in effect have amounted to a sale of property costing $98,202.83 at a profit of $67,917.49. Again, speaking with reference to section 234(a)(14) of the Revenue Act of 1921, the court said: Manifestly Congress considered an excess of insurance over original cost as a gain and in case of reinvestment a portion of this gain, which otherwise would be taxable as such, is offset by the authorized deduction. In the instant case the entire amount of the insurance collected was reinvested and hence the Commissioner taxed no gain against the appellant. 125 It seems clear, upon both reason and authority, that petitioner's deduction for its loss by fire, storm, and worms should not be measured by2365 the value of its timber when destroyed. Since it is apparent that petitioner has suffered a deductible loss, and since the measure of this loss for income-tax purposes is not the value of the property at the date of destruction, there remain but two other bases upon which the amount of the loss can be computed, and these are (1) the cost of the timber when purchased, or (2) its fair market value on March 1, 1913. Here, the latter value of the timber is in excess of its cost. The question presented is whether the loss suffered is the difference between the fair market value of the timber when destroyed and what it actually cost, or is it the difference between such value at date of destruction and what petitioner could have obtained but did not obtain for it on March 1, 1913. To put it another way, is petitioner entitled to take as a loss an amount, part of which cost him nothing but which is in the nature of unrealized income, or only that amount which it is actually out of pocket? On this point we are of opinion that the question is foreclosed by the decisions of the Supreme Court in 2366 , and . It is urged by petitioner that these cases have no application since they had for construction section 202 of the Revenue Act of 1918, above quoted, which, as contended, applies only to a "sale or other disposition of property * * ." It is argued that a loss by storm is neither a sale nor a disposition within the meaning of the Act. We do not deem it necessary to decide this point, although the Circuit Court of Appeals in , seems to have held that if insurance was collected the transaction was in the nature of a sale. It appears to be petitioner's view that the Flannery and Ludington cases literally applied the particular words of section 202 when in fact the court refused to so apply that section. The contention of appellees in the Flannery case is thus stated in the opinion: The executors contend, on the other hand, that section 202(a) established the market value of such property on March 1, 1913, as the sole basis for ascertaining the loss sustained, without regard to its actual cost, 2367 and that if such market value was higher than the sale price, this conclusively determined that there had been a deductible "loss" in the transaction, and fixed the amount thereof at the difference between the market value on that date and the sale price. Here, we have the contention that the statute should be literally applied. The court refused to hold that the statutory basis of "fair market price or value" of the property on March 1, 1913, was the only basis. It held that Flannery, who had purchased prior to March 1, 1913, stock for which he paid (in these examples we use 126 round numbers) less than $95,000 and which on March 1, 1913, had a market value of $116,000, and sold it in 1919 for $95,000, suffered no deductible loss. In the Ludington case the court held that where the taxpayer in 1919 sold stock purchased prior to March 1, 1913, for $3,800, which amount was $28,000 less than cost and $33,000 less than its value on March 1, 1913, the loss was the difference between cost and sale price. The decisions in the Flannery and Ludington cases were largely based on 2368 , and . In these latter cases the court, applying the Revenue Act of 1916, held that no taxable gain was realized where the taxpayers sold property acquired prior to March 1, 1913, for an amount greater than its value on March 1, 1913, but for less than cost. In the Flannery case the court said: These decisions are equally applicable to the Act of 1918. There is no difference in substance between the language of the two Acts in respect to the ascertainment of the gain derived or loss sustained from the sale of property acquired before March 1, 1913; and the correlative nature of these two provisions is emphasized in the Act of 1918 by their combination in one and the same sentence. As it was held in these decisions that the Act of 1916 imposed a tax to the extent only that gains were derived from the sale, and that the provision as to the market value of the property on March 1, 1913, investme;nt, so we think it should be held that the Act of 1918 imosed a tax or an actual loss sustained from the investment, and that the provision in reference to the market value on2369 March 1, 1913, was applicable only where there was such an actual gain or loss, that is, that this provision was merely a limitation upon the amount of the actual gain or loss that would otherwise have been taxable or deductible. (Italics supplied.) The court concludes: Since Flannery sustained no actual loss in the transaction in question, having sold the stock for more than it had cost, his executors were not entitled to the deduction which they claimed because it was sold at less than its market value on March 1, 1913. (Italics supplied.) It will be observed that the court limits the term "actual loss" to the difference between cost and selling price and further that it holds that the provisions of section 202 are merely limitations "upon the amount of actual gain or loss that would otherwise have been taxable or deductible." If we accept petitioner's contention that section 202 has no application to cases of involuntary losses, we find ourselves without any statutory limitation whatever, in which state of case we must find that petitioner's loss is only his actual loss; that is, the actual cost of the property destroyed. 2370 It is not necessary to decide whether section 202 is or is not applicable to cases of involuntary loss until that question is presented. It is sufficient here to say that irrespective of whether that section is or *127 is not applicable, the result in this proceeding will be the same; that is, that petitioner's deductible loss, is, under the facts of this case, the actual cost of the property destroyed. This is in harmony with , and , both of which are squarely in point. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621437/	Estate of Bessie L. Thompson, Deceased, Terrence R. Moses, Executor, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Thompson v. CommissionerDocket No. 1231-78United States Tax Court74 T.C. 858; 1980 U.S. Tax Ct. LEXIS 95; July 28, 1980, Filed 95 Decision will be entered for the respondent. Two weeks prior to her death in 1974, decedent executed a 1-year note with the bank. The period provided under Indiana law for making claims against the estate expired 2 months before the maturity date of decedent's note. No claim for the note was filed by the bank during the claims period, and no payment of the note was made by the executor. On or about the maturity date of decedent's note, the executor executed, on behalf of the estate, another 1-year note, the proceeds of which were used to pay the principal and accrued interest of decedent's note in full. Successive 1-year notes were executed and applied similarly to the respective prior note; the final note was paid in 1979. Petitioner contends that the execution of the succeeding notes on behalf of the estate was the result of an oral compromise of the decedent's original obligation, that this compromise was reached during the statutory claims period, and that the original note is a valid claim against the estate, deductible under sec. 2053(a)(3), I.R.C. 1954. Held: Under Indiana law, an oral compromise does not preserve a valid claim against an estate. Therefore, the96 note executed by decedent is not a deductible claim against the estate within the concept of sec. 2053(a)(3). Lawrence A. Jegen III, for the petitioner.Rodney J. Bartlett, for the respondent. Bruce, Judge. BRUCE 859 Respondent determined a deficiency of $ 12,724.07 in the Federal estate tax of the Estate of Bessie L. Thompson. The entire deficiency results from respondent's disallowance of a deduction from the gross estate, claimed by petitioner under section 2053, 1 of a claim against the estate in the amount of $ 50,000. 2 The issue presented97 for our decision is whether petitioner is entitled to a deduction from the gross estate for the amount of a debt owed by the decedent during her lifetime, for which no formal claim was filed during the claims period provided by local law, but which was satisfied subsequent to that claims period.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.Bessie L. Thompson died on June 10, 98 1974, a legal resident of Frankfort, Clinton County, Ind. Terrence R. Moses, decedent's grandson and executor of her estate, was a legal resident of Indianapolis, Ind., when the Federal tax return was filed for petitioner.On September 4, 1974, the decedent's will was admitted to probate in the Clinton County Circuit Court. Notice to creditors of the estate was published by the executor on September 18, 1974. Pursuant to Indiana law, 3 the 6-month period for filing creditors' claims against the petitioner expired March 18, 1975.99 860 On May 28, 1974, the decedent borrowed $ 50,000 from the Clinton County Bank & Trust Co. (hereinafter the bank) for which she executed a promissory note at 8 1/2-percent simple annual interest with a due date of May 28, 1975. The bank did not file a claim against the petitioner for this amount with the Clinton County Circuit Court prior to the claims period expiration date of March 18, 1975. Nevertheless, on May 30, 1975, the executor executed on behalf of petitioner a promissory note in the amount of $ 54,332.64 at 9-percent simple annual interest due on May 30, 1976. The proceeds of this note were applied by the bank in full payment of the principal and accrued interest of the note executed by decedent on May 28, 1974.Subsequent notes, for the corresponding amounts shown, all at 9-percent simple interest and all with 1-year maturity dates, were executed by the executor on behalf of petitioner, as well.Date of noteAmount of noteAmount of checkMay 28, 1976$ 54,332.64$ 4,930.69May 28, 197750,000.009,276.91May 26, 197850,000.004,514.55The proceeds of each of these notes were applied to the principal and interest of the immediately preceding100 note along with checks from the petitioner for the payment of unpaid principal, if any, and accrued interest on the preceding note, as shown above. In this way, the principal and interest of each note were satisfied upon the date of execution of the succeeding note.On June 27, 1979, the Clinton County Circuit Court granted an order, pursuant to a joint petition to that court by the bank and the executor, providing that the principal and accrued interest of the note executed on May 26, 1978, be paid by petitioner. The amounts due on that note were paid in full on June 28, 1979. 4101 861 In its Federal estate tax return, filed on March 7, 1975, petitioner listed the original note, executed by decedent on May 28, 1974, as a deductible claim against the decedent's estate pursuant to section 2053. Petitioner contends that the execution of the subsequent promissory notes on the behalf of petitioner was a compromise of the original debt claim, pursuant to an oral agreement between the bank and the executor reached prior to the expiration of the creditors claims period on March 18, 1975.On November 28, 1977, the respondent issued a notice of deficiency in which the respondent disallowed the deduction as not within the concept of section 2053. Respondent determined that no deduction for a claim against the estate was allowable since no formal claim was filed timely by the bank against the estate for the amount of the original note.OPINIONSection 2053(a)(3) provides for a deduction from the gross estate, in the determination of the taxable estate, of the amounts of those claims against the estate which represent personal obligations of the decedent at the time of her death. However, the deduction is limited to those claims which are allowable under the laws102 of the jurisdiction in which the estate is administered. Sec. 2053(a); sec. 20.2053-1(a)(1), Estate Tax Regs. Since the estate was administered in Indiana, Indiana law governs. The effect upon the debt obligation in question of events subsequent to decedent's death will be examined pursuant to Indiana law to determine the validity of the claim, and, thus, its deductibility. Estate of Courtney v. Commissioner, 62 T.C. 317">62 T.C. 317 (1974); Estate of Hagmann v. Commissioner, 60 T.C. 465">60 T.C. 465 (1973), affd. per curiam 492 F.2d 796">492 F.2d 796 (5th Cir. 1974); Estate of Shedd v. Commissioner, 37 T.C. 394">37 T.C. 394 (1961), affd. 320 F.2d 638">320 F.2d 638 (9th Cir. 1963); cf. Estate of Lewis v. Commissioner, 49 T.C. 684">49 T.C. 684 (1968). 5103 862 Under Indiana law, 6 the claims of creditors against the estate must be filed within the period of 6 months from the date of the first published notice to creditors. Any claims not filed within that period are forever barred. Ind. Code Ann. sec. 29-1-14-1 (Burns 1972). However, prior to the expiration of this 6-month period, the personal representative of a solvent estate may pay any claims he believes just and correct, regardless of whether such claims have been filed by that time. Ind. Code Ann. sec. 29-1-14-19 (Burns 1972). He may similarly compromise such obligations, but such compromise must be consummated within the 6-month claims period and be authorized previously or approved subsequently by the probate court. Ind. Code Ann. sec. 29-1-14-18 (Burns 1972).104 Section 29-1-14-1 is not a statute of limitations, but is a nonclaim statute which imposes a condition precedent to enforcement of a claim against the estate and precludes recovery when the condition is not met. Woods v. Klobuchar, 257 F.2d 313">257 F.2d 313 (7th Cir. 1958); Rising Sun State Bank v. Fessler, Ind. App. , 400 N.E.2d 1164 (1980); Donnella v. Crady, 135 Ind. App. 60">135 Ind. App. 60, 185 N.E.2d 623">185 N.E.2d 623 (1962), transfer denied 244 Ind. 205">244 Ind. 205, 191 N.E.2d 499">191 N.E.2d 499 (1963). Therefore, the only remedies open to a claimant are those provided by statute. In re Estate of Ropp, 142 Ind. App. 1">142 Ind. App. 1, 863 232 N.E.2d 384">232 N.E.2d 384 (1968). Equitable rules of waiver or estoppel do not apply, and nonclaim statutes may not be extended by disability, fraud, or misconduct. In re Estate of Ropp, supra;Donnella v. Crady, supra.When the claims period has expired without a particular claim being filed, paid, or compromised, that claim is forever barred. 105 Clearly, no claim for payment of the decedent's note was filed by the bank against the estate within the claims period, nor was payment of the note made during this time. Therefore, the note executed by decedent on May 28, 1974, would be a valid claim against the estate only by way of a valid compromise of that obligation by the executor with the bank prior to March 18, 1975. Petitioner claims that the note executed on May 30, 1975, by the executor, as well as the subsequent notes executed in succession, were the result of an oral agreement of compromise between the executor and the bank, reached sometime during the claims period prior to March 7, 1975. No specific date for the alleged agreement was given.Even if we accept petitioner's argument and supporting testimony 7 on the oral agreement of compromise, we cannot find that the agreement was a valid compromise of a claim against the estate consummated within the claims period under Indiana law.106 Indiana courts have strictly construed the nonclaim statute provisions. An out-of-State claimant did not escape the strict 6-month claims period provisions. Woods v. Klobuchar, supra.The failure of an executor's attorney to keep his promise to forward the claim of a trusting claimant to the executor did not validate the otherwise unfiled claim. Donnella v. Crady, supra.In a situation somewhat resembling that of the instant case, an oral promise from an executrix to pay an obligation of an estate was held unenforceable, even though the promise was in response to an oral claim made within the 6-month claims period. In re Estate of Ropp, supra.In Ropp, the court held that any oral 864 transactions concerning claims against the estate were not binding, since no provision was made in the nonclaim statute for the oral allowance or disallowance of claims; the provisions for claims against estates were found to be exclusive of all methods not specifically listed therein. In re Estate of Ropp, supra at 387.We do not see a distinguishing difference107 between the facts in Ropp and the facts in the instant case. Instead of an oral promise to pay, the instant situation involves an alleged oral agreement of compromise by which an obligation of the estate itself would be substituted for the decedent's obligation. The substitution took place after the claims period expired. It is presumed the alleged compromise was reached under the assumption that the subsequent obligation of the estate would be paid eventually. Thus, the instant case is merely the set of facts in Ropp with a deferral of the orally promised payment. We cannot find that this deferral would create a completely different result under the provisions of Indiana law as strictly construed by the courts. 8108 To reflect the foregoing, we find that, under Indiana law, there was no valid compromise within the 6-month claims period of the note executed by decedent on May 28, 1974. Therefore, the claim against the estate for that obligation was not valid under Indiana law and, thus, is not deductible under section 2053(a)(3).Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect at the time of decedent's death, unless otherwise noted.↩2. One other adjustment in the notice of deficiency, unrelated to the issue presented here, reduced the taxable estate and is not contested by petitioner. Therefore, a decision under Rule 155, Tax Court Rules of Practice and Procedure↩, would be necessary for evaluation of petitioner's liability or refund, should we decide the issue presented in petitioner's favor.3. Since the estate was administered in Indiana, Indiana law governs. Sec. 2053(a); sec. 20.2053-1(a)(1), Estate Tax Regs. The relevant Indiana statute, as in effect in 1974, reads as follows:Ind. Code Ann. sec. 29-1-14-1 (Burns 1972)"Limitations on filing claims -- Statutes of limitation -- Claims barred when no administration commenced -- Liens not affected -- Tort claims against estate. -- (a) All claims against a decedent's estate, other than expenses of administration and claims of the United States, and of the state and any subdivision thereof, whether due or to become due, absolute or contingent, liquidated or unliquidated, founded on contract or otherwise, shall be forever barred against the estate, the personal representative, the heirs, devisees and legatees of the decedent, unless filed with the court in which such estate is being administered within six [6] months after the date of the first published notice to creditors."↩4. Other notes executed by the executor were for $ 10,000 on Mar. 7, 1975, for 1 year, and for $ 5,000 on June 5, 1975, for 6 months, both at 9-percent simple annual interest. The two notes were both paid by the estate in full, including accrued interest, by check on June 27, 1975. The proceeds of these notes were not involved in the satisfaction of the notes discussed above. The Mar. 7, 1975, note was executed specifically to obtain funds to pay Federal estate taxes due that day.↩5. These cases contradict the rationale expressed in Russell v. United States, 260 F. Supp. 493">260 F. Supp. 493 (N.D. Ill. 1966), and Winer v. United States, 153 F. Supp. 941">153 F. Supp. 941 (S.D. N.Y. 1957), both of which were cited by the petitioner. In those two cases, the courts applied the doctrine of Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151 (1929), also cited by petitioner, which dealt with charitable contribution deductions, holding that an estate is settled, as far as practical, as of the date of decedent's death. We have rejected the application of that doctrine in the area of claims against the estate in the past. Estate of Hagmann v. Commissioner, 60 T.C. 465">60 T.C. 465 (1973), affd. per curiam 492 F.2d 796">492 F.2d 796 (7th Cir. 1974). Petitioner cites Greene v. United States, 447 F. Supp. 885 (N.D. Ill. 1978), as a recent case in which the Ithaca Trust doctrine was applied in analysis of a claim against an estate. Nevertheless, we will continue to follow our prior decisions and reiterate our rejection of the rationale of Russell, Winer, and Greene. Events subsequent to the date of death are necessarily examined under the concept of sec. 2053↩.6. Pertinent Indiana statutes, as in effect in 1974, are set forth below. See also n. 3 supra.Ind. Code Ann. sec. 29-1-14-18 (Burns 1972)."Compromise of claims. -- The personal representative may, if it appears for the best interests of the estate, compromise any claim against the estate, whether due or not due, absolute or contingent, liquidated or unliquidated, but if such claim is not filed such compromise must be consummated within six [6] months after the date of the first published notice to creditors. In the absence of prior authorization or subsequent approval by the court, no compromise shall bind the estate."Ind. Code Ann. sec. 29-1-14-19 (Burns 1972)."Payment of claims. -- (a) At any time the personal representative shall pay such claims as the court shall order, provided such claims are filed within six [6] months after the date of the first published notice to creditors, and the court may require bond or security to be given by the creditor to refund such part of such payment as may be necessary to make payment in accordance with provisions of this [Probate] Code."(b) Prior to the expiration of six [6] months after the date of the first published notice to creditors, the personal representative, if the estate clearly is solvent, may pay any claims which he believes are just and correct, whether or not such claims have been filed. * * *"↩7. Respondent argues under the parol evidence rule that since the note executed by the executor on May 30, 1975, was a complete written document, the terms should not be expanded or contradicted by oral testimony. In deciding the validity of the claim against the estate, we find, even assuming the facts in petitioner's favor, that the claim does not survive the statutory claims period. Since we decide the issue on another level, we need not, and do not here, determine the admissibility of petitioner's evidence as to the alleged oral compromise agreement.↩8. On June 27, 1979, the Clinton County Circuit Court directed payment of the principal and interest on the note executed by the executor on May 26, 1978. Nevertheless, in light of the holding against the oral allowance or disallowance of claims as stated by the Appellate Court of Indiana in Ropp↩, we do not find persuasive the implicit approval of the alleged oral compromise by the Clinton County Circuit Court.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621438/	ROBERT BURD, EX REL BENJAMIN R. FOGEL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Burd ex rel. Fogel v. CommissionerDocket No. 29035.United States Board of Tax Appeals19 B.T.A. 734; 1930 BTA LEXIS 2331; April 28, 1930, Promulgated 2331 Respondent's determination of deficiencies approved and penalties for failure to file returns approved. Benjamin R. Fogel pro se. J. E. Marshall, Esq., for the respondent. BLACK 734 The respondent determined deficiencies, penalties and interest against the petitioner as follows: YearAdditional taxPenaltyInterestTotal1919$96.82$24.21$5.30$126.331922150,158.8937,539.7234,758.70222,457.3119233,240.42810.11555.664,606.19Petitioner asks redetermination and as cause therefor alleges the following errors: The Commissioner erred in computing the income taxes of the petitioner for the taxable years 1922 and 1923 in that in computing said tax the Commissioner included in gross income the sum of the bank deposits made by petitioner during said years without any allowance whatsoever for sums withdrawn by petitioner representing transfers of capital assets or legal deductions from the gross income; whereas the Commissioner in computing said tax should have allowed as a deduction from said gross income the amounts shown by the petitioner to have been capital transactions or legal deductions2332 from gross income. It is further alleged by the petitioner that during the years 1922 and 1923 he was the secretary and treasurer of the Penn Distilling Co., a corporation, and that practically all of the bank deposits made in his name belonged to the Penn Distilling Co. and not to him. Petitioner does not contest the deficiency, penalty, and interest for 1919, and does not allege that the action of the respondent in imposing penalties constituted error. FINDINGS OF FACT. Petitioner filed no returns for 1919 to 1923, both inclusive. The petitioner Benjamin R. Fogel is an individual and resides in Philadelphia, Pa. He was sometimes known by the name of Robert Burd and it was under the latter name that the deficiencies, penalties, and interest herein were determined against him. 735 During the year 1919, petitioner was a toolmaker in the employ of the Government at the Navy Yard in Philadelphia, at a salary of $1,800 a year. He received other income of $2,820.54 during that year. In 1920 and 1921 he was engaged in a commission business handling butter and eggs. For those years he made no returns and no deficiencies were determined. During 1922 and until2333 May or June, 1923, petitioner was the secretary and treasurer of the Penn Distilling Co., a corporation, which was engaged in distilling industrial alcohol. He was the custodian of the company's funds and deposited them in the Southwark National Bank, Philadelphia, Pa., in his own or his assumed name, to his own credit and mingled them with his funds. As the petitioner made no returns for 1922 and 1923, and did not make satisfactory disclosures to the investigating revenue agent, respondent determined deficiencies based on his bank deposits. In 1923 he purchased 17 two-family residences in the name of his wife, but the consideration was not shown. In the same year he bought the residence in which he resides for $8,200, property at 717 South 56th Street for $9,100, property at 721-3 South 56th Street for $3,000, property 4810 to 4842 Sansom Street for $216,000, and 4720 Chestnut Street for $50,000. In addition he was half-owner with his brother of certain real estate on North 12th Street, which they purchased for $50,000 and sold at a profit. The properties were all located in Philadelphia. Other sources of income were a salary of $50 per week and a profit of approximately2334 $6,000 in real estate transactions during 1923. Prior to 1920 petitioner and his brother were interested in a garage business, which in 1920 was transferred to their wives, through a third party. It was rented out at $500 monthly and sold in 1922 or 1923. Most of the property purchased was mortgaged, but substantial down payments were made on all. OPINION. BLACK: In cases of this character, where the taxpayer makes no returns and refuses to make a statement to the investigating revenue agent, the Government must resort to any other information it may find and base its determination of income thereon. That was done in this case, resulting in the discovery of the bank deposits upon which the deficiencies are based. The Board has in a number of cases approved deficiencies determined from bank deposits of the taxpayer. ; ; . The determination of the respondent is prima facie correct and the burden is upon the petitioner to establish his correct income for the 736 years involved. 2335 ;; ; ; . The petitioner contends that the money deposited to his credit in bank really belonged to the Penn Distilling Co., with the exception of a possible 5 per cent thereof which represented his own funds, and that the most of the property purchased by him and put in his wife's name belonged to Herman D. Jaffe, a business associate. Beyond his mere indefinite statements at the hearing, there is not a scintilla of evidence to corroborate him. Jaffe did not testify. Jaffe was a real estate agent and interested in the Penn Distilling Co., and was under investigation by revenue agents at the same time petitioner was. No documentary evidence of any kind relative to the real estate transactions or bank account was introduced by petitioner. In his petition, petitioner does not assign as error that respondent taxed his bank deposits, but complains that respondent failed to make proper allowances for withdrawals and other legal deductions. On the hearing, *2336 he offered no sufficient evidence of withdrawals or deductions, but merely stated that he frequently deposited several thousand dollars one day and drew it out the next. Purposes and amounts were not given. When we consider that petitioner kept his bank account under an assumed name, that he purchased property of the aggregate value of $340,000 in addition to the 17 two-family residences, and had it placed in his wife's name, and had his garage business transferred to her, in connection with his failure to make returns, and his refusal to make a statement to the revenue agent, it is plain that the purpose was to conceal the source of his income and evade taxes. Such a state of facts rarely happens, it is designed. . We are not convinced by petitioner's testimony. He has failed to show what his correct income was for the years 1922 and 1923, and has admitted the deficiency for 1919. Under the circumstances the deficiencies, penalties, and interest as determined by respondent are approved. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621439/	LUTHER E. SMITH AND LAWANDA N. SMITH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmith v. CommissionerDocket No. 15886-93.United States Tax CourtT.C. Memo 1995-406; 1995 Tax Ct. Memo LEXIS 409; 70 T.C.M. (CCH) 483; August 22, 1995, Filed 409 Decision will be entered under Rule 155. Luther E. Smith and Lawanda N. Smith, pro sese. Steven B. Bass, for respondent. KORNER, Judge KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in and an addition to petitioners' Federal income taxes for the years and in the amounts as follows: Addition to TaxYearDeficiencySec. 6651(a)(1)1987$ 79,252--19887,004$ 350All statutory references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise noted. After concessions, the issues for decision are: (1) Did petitioner husband's separate and community property, and deductions and losses attributable to such property, become property of his bankruptcy estate upon the filing of a chapter 11 bankruptcy petition? We hold that they did. (2) Are petitioners entitled to deduct one-half of the disallowed losses incurred during 1987 and 1988 based on petitioner wife's community property interests in the same? We hold that they are not. (3) Are petitioners entitled to a deduction for worthless stock in First National410 Bank of Irving in 1986, although a deduction for the same was taken in 1988? We hold that they are not. (4) Did petitioners have a basis of $ 491,642 in the stock of TPI Industries, Inc. (TPI), despite having reported on their 1987 income tax return that the basis was $ 20,000? We hold that they did not. (5) Are petitioners entitled to a worthless stock deduction or a nonbusiness bad debt deduction attributable to the Future Communications Network Co., Ltd. (FCNC), prior to petitioner husband's bankruptcy filing? We hold that they are not. (6) Are petitioners liable for an addition to tax under section 6651(a) for an untimely filing of their 1988 Federal income tax return? We hold that they are. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners resided in Austin, Texas, at the time they filed their petition. On August 3, 1987, petitioner Luther E. Smith filed a chapter 11 bankruptcy petition. On September 12, 1988, petitioner Lawanda N. Smith filed a chapter 11 bankruptcy petition. On December 7, 1988, petitioners' bankruptcy cases were consolidated. 411 Petitioners reported all items of income and loss on their joint personal Federal income tax returns for the 1987 and 1988 tax years. Petitioners were not aware that separate Federal income tax returns were required to be filed for their bankruptcy estate, nor were any filed. Petitioners reported on their joint return for 1987 two long-term capital gains in the amounts of $ 313,350 and $ 120,000 on January 20, 1987, and February 12, 1987, respectively. Respondent disallowed various losses and deductions claimed on that return and on petitioners' joint return for 1988, determining that these items were properly allowable, if at all, to the bankruptcy estate. The disallowances gave rise to increases in petitioners' income tax of $ 79,252 and $ 7,004 for 1987 and 1988, respectively. Specifically, petitioners claimed losses from real estate rentals for $ 25,274 in 1987 and $ 67,129 in 1988. Respondent disallowed $ 10,497 of the loss in 1987, and disallowed the entire loss in 1988. The $ 10,497 reduction in the 1987 loss represents the pro rata portion of the loss for the period the bankruptcy estate was deemed to have held title to the property (i.e., 151 days/365 days x $ 25,274). 412 Petitioners claimed partnership losses of $ 132,835 and $ 1,016,906 for the tax years 1987 and 1988, respectively, and a $ 100,000 small business loss in 1988. Also in 1988, petitioners reported a net capital loss in the amount of $ 2,457,769, and deducted a capital loss of $ 3,000 from their 1988 ordinary income. Respondent denied all of these losses, determining that they belonged to the bankruptcy estate. OPINION Petitioners have not disagreed with respondent's specific determinations, but rather have advanced four arguments as to why there should be no tax liability. First, petitioners claim that stock they owned in First National Bank of Irving became worthless in 1986 when the bank went into receivership, and not in 1988 when they originally claimed a deduction for worthless stock. Second, petitioners claim that petitioner wife was entitled to one-half of the alleged 1986 loss of $ 1,111,111 attributable to the stock in the First National Bank of Irving. Petitioners argue that under section 541 of the bankruptcy code, petitioner wife's interest in community property would not enter the estate of petitioner husband until 1988 when petitioner wife filed for bankruptcy. Petitioners413 argue that petitioner wife's share of the deduction, $ 555,555, was mistakenly reported on their 1988 tax return, whereas it should have been reported on the 1986 tax return. Third, petitioners argue that their 1987 income tax return mistakenly listed their cost of purchase of stock in TPI as $ 20,000 when it should have been listed as $ 491,642, which is the paid in capital and the purchase price. At trial, petitioner testified that the corporate books and the tax returns of TPI showed the capital in excess of $ 400,000. Petitioner offered no evidence to show the contributions to capital with respect to TPI other than a balance sheet showing total stockholder equity to be $ 327,592. If such basis is found to be correct, it would create long-term capital loss of $ 158,292, as opposed to the long-term capital gain of $ 313,350 as reported on their 1987 return. Fourth, petitioners alleged that they founded and funded FCNC, and that the venture became worthless in 1986, prior to petitioner husband's filing for bankruptcy. FCNC filed a Federal income tax return for the 1987 tax year. FCNC never earned any income, but it did incur expenses which gave rise to losses. The business purpose414 of FCNC was to construct microwave towers and lease microwave tower sites. Such purpose was never actualized as funding could not be obtained. 1. Effect of Bankruptcy on Petitioner Husband's PropertyUpon the filing of a petition for chapter 7 or 11 bankruptcy, the bankruptcy estate is deemed to become another taxable entity, separate from the individual debtor. Sec. 1398; Bloomfield v. Commissioner, 52 T.C. 745">52 T.C. 745, 750 (1969), supplemented by 54 T.C. 554">54 T.C. 554 (1970); In re Pflug, 146 Bankr. 687, 689 n.4, (Bankr. E.D. Va. 1992). The taxable income of the estate generally is taxable in the same manner as for an individual. Sec. 1398(c)(1). If an estate receives gross income in an amount greater than the sum of the exemption amount, plus the basic standard deduction, it must file a return. Sec. 6012(a). The gross income of the estate for each taxable year is any income to which the bankruptcy estate is entitled as determined under the bankruptcy code, while the debtor's gross income is generally any income from services performed by the debtor after commencement of the case, and not included in 415 the income of the estate. Bankruptcy Act, 11 U.S.C. sec. 541(a) (1978); sec. 1398(e). The bankruptcy estate is composed of all property of the debtor at the commencement of the bankruptcy case. 11 U.S.C. sec. 541(a). The estate will succeed to any tax attributes of the debtor as of the commencement of the bankruptcy case. Sec. 1398(g). Any deductions available to the estate are not available to the individual debtor. Petitioner husband filed for bankruptcy on August 3, 1987. At that time, a bankruptcy estate was formed, and it was composed of all assets which were community property. Petitioner wife filed for bankruptcy September 12, 1988. The two individual estates were consolidated on December 7, 1988. If any of these estates earned gross income that was above the exemption amount and the basic standard deduction, an income tax return must be filed. Because the notice of deficiency was issued to petitioners individually, and they filed their petition with this Court as individuals, we make no determination as to whether petitioner husband's estate, petitioner wife's estate, or their consolidated estate was required416 to file a return. Rule 13(a). Whatever the answer to that question, petitioners have not shown that their own gross income was so small as to relieve them of the obligation to file income tax returns for the years in which they were in bankruptcy. Petitioners have the burden of overcoming the presumption of correctness afforded respondent in the notice of deficiency. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Deductions are a matter of legislative grace, and petitioners bear the burden of proving they are entitled to any deductions claimed on their return. Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934). Partnership LossesPetitioners claimed losses in 1987 and 1988 from interests in various partnerships, all of which held interests in real property. Respondent disallowed such deductions, determining that they are properly deductible, if at all, on the return of the bankruptcy estate. Respondent argued that the bankruptcy estate is entitled to all losses of the partnerships for the tax year 1987. Respondent also argued that, pursuant to section 1398(f), the transfer of the partnership417 interests to the bankruptcy estate is not to be treated as a sale, exchange, or liquidation of a partnership interest, which would require that the taxable year close for that partner under section 706(c). Section 1398(f) provides that a transfer of an asset to the estate will not be treated as a disposition for Federal tax purposes. We agree with respondent that under section 1398(f) the transfer of the partnership interest to a bankruptcy estate should not be treated as a sale, exchange, or liquidation. Petitioners have not introduced any evidence to establish the partnership losses. They have not established that any possible losses were incurred prior to petitioner husband's filing for bankruptcy. Furthermore, petitioners have not alleged any error on the part of respondent, nor have they advanced any argument as to why the partnership losses are not deductible by the bankruptcy estate. We hold therefore that any partnership losses, incurred after bankruptcy, are unavailable to petitioners. Small Business LossPetitioners claimed a small business loss of $ 100,000 on their individual Federal income tax return for 1988. Such deduction was determined by respondent to be418 properly deductible by the bankruptcy estate. Petitioners have presented no evidence to suggest that such determination is erroneous, or that they are entitled to the $ 100,000 deduction from gross income. Accordingly, we hold for respondent on this issue. Nonbusiness Bad Debt ExpensePetitioners claimed bad debt expenses as short-term capital losses on Schedule D of their 1987 return in the amounts of $ 975,062, $ 307,780, and $ 308,850 on account of TexPaint, Inc., New Mexico Telephone Exchange, Inc., and FCNC, respectively. Petitioners also claimed $ 12,479 on their Schedule D as a short-term capital loss attributable to partnerships, S corporations, or fiduciaries. Respondent disallowed $ 1,601,171 of the total amount claimed as a short-term capital loss. Petitioners have not contested respondent's determinations with respect to the deductions claimed on account of TexPaint, Inc., New Mexico Telephone Exchange, Inc., or the short-term capital loss attributable to partnerships, S corporations, or fiduciaries. We deem these points conceded by petitioners and hold for respondent with respect to them. We will address petitioners' arguments as to FCNC below. Net Capital419 LossesPetitioners claimed on their 1988 income tax return a net capital loss in the amount of $ 2,457,769. Respondent disallowed such loss. Petitioners have not addressed this argument and have not introduced any admissible evidence which would show that respondent is in error. We hold for respondent on this issue. 2. Petitioner Wife's Community Interest in the DeductionsPetitioners have claimed that because petitioner wife did not file for bankruptcy until 1988, she was entitled to one-half of the deductions otherwise available to petitioner husband's bankruptcy estate by virtue of the fact that she held a community property interest in such deductions, or that she held a community interest in the assets which gave rise to the deductions. Petitioners claim that the loss attributable to the First National Bank of Irving was in the amount of $ 1,111,111, and that petitioner wife is entitled to $ 555,555 of that loss. Petitioner quoted parts of bankruptcy code sec. 541(a) at trial, and then concluded that those passages made it clear that petitioner wife's community property would not go into his bankruptcy estate, but would be available to petitioner wife. 11 U.S.C. section 541420 (a) provides: (a) The commencement of a case * * * creates an estate. Such estate is comprised of all of the following property, wherever located and by whomever held: (1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case. (2) All interests of the debtor and the debtor's spouse in community property as of the commencement of the case that is-- (A) under the sole, equal, or joint management and control of the debtor; * * * [Emphasis added.]Subsections (b) and (c)(2) of section 541 identify property that is not included in the estate. At trial, petitioners did not allege that those subsections apply, and accordingly we do not analyze them. All community property of a debtor's spouse that is under the sole, equal, or joint management and control of the debtor will be included in the debtor's estate. We must examine State law to ascertain what is community property. Butner v. United States, 440 U.S. 48">440 U.S. 48 (1979); In re Knobel, 167 Bankr. 436, 440 (Bankr. W.D. Tex. 1994). Texas is a community property421 State, which means that property is classified as separate or community. Tex. Const. art. XVI, sec. 16. In Texas, marital property is presumed to be community property absent a showing that property is separate property, which is any property owned by a spouse before marriage, acquired during marriage by gift, devise, or descent, or is the recovery for personal injuries. Tex. Fam. Code Ann. sec. 5.01 (West 1993). Community property is considered subject to the joint management, control, and disposition of the husband and wife, unless either there is an agreement to the contrary, or the property is shown to be from personal earnings, revenue from separate property, recoveries for personal injuries, or the increase or mutations of such separate property. Tex. Fam. Code Ann. sec. 5.22 (West 1993). Petitioners have not introduced any evidence nor any testimony to support the position that any property was the separate property of petitioner wife. Petitioners did not allege or prove that there was an agreement that marital property was separate as opposed to community, or that marital property was derived from petitioner wife's personal earnings, earnings of her separate property, or 422 recoveries for personal injuries sustained by her. In light of the absence of any testimony or evidence, we conclude that under Texas law all property held by petitioners during the years in issue was community property under joint management and control, and therefore all such property became part of the estate when petitioner husband filed for bankruptcy in 1987. 3. First National Bank of IrvingPetitioners alleged at trial and on brief that stock in the First National Bank of Irving became worthless in 1986, when the bank went into receivership, and not in 1988, when they originally claimed the deduction. No evidence was introduced to support the $ 1,111,111 claimed deduction. 1 There is also no evidence that establishes a basis in any stock held, or even that stock was held. On Schedule D of their 1988 income tax return, there is a loss shown attributable to "bank stock" of $ 272,546. Petitioners have failed to explain the discrepancy between this amount and the $ 1,111,111 loss allegedly reported. There was a letter that showed that the bank was declared insolvent and went into receivership in 1986, but without having first established that they held stock in such bank, 423 such letter will not establish that they are entitled to a deduction. We therefore hold that petitioners have failed to establish that they are entitled to a worthless stock deduction for 1986 with respect to the First National Bank of Irving. 4. Stock of TPIOn Schedule D of their 1987 income tax return, petitioners reported a long-term capital gain from the sale of TPI stock. Such stock was reported to have been purchased on January 1, 1986, for $ 20,000 and sold on January 20, 1987, for $ 333,350, producing a long-term capital gain of $ 313,350. Petitioners alleged that the reported purchase price did not reflect their paid in capital in the amount of $ 491,642, and therefore they now seek to amend such amount. To establish the paid in capital amount, petitioners introduced the corporate returns424 of TPI for 1985 through 1988. Total stockholder equity on those returns was reported as $ 175,000, $ 359,366, $ 39,764, and zero for those years, respectively. On Schedule L of the 1987 corporate income tax return of TPI, the "paid in capital" was listed as $ 491,642. Additionally, common stock was reported as $ 20,000, and unappropriated retained earnings were reported as ($ 471,878). When considered together, the total stockholder equity shown is $ 39,764. Petitioners failed to substantiate any of these figures, but even if they had they would have proven that the stockholder equity was $ 39,764, far short of the alleged $ 491,642. We hold that petitioners have failed to establish that they are entitled to a deduction with respect to the TPI stock. 5. FCNCWe must decide whether petitioners have met their burden in proving the losses attributable to FCNC. Petitioners argue that the debt pertaining to FCNC was erroneously claimed in 1987, when it should have been claimed earlier. Petitioners have introduced no exhibits whatsoever at trial with regard to this debt. Petitioner alleged at trial that FCNC had financial difficulty during 1986 and 1987, that one of its general425 partners filed for bankruptcy in 1988, and that the company lost its construction license in 1987. Even if all of these allegations were sufficiently established at trial, and they were not, they only indicate that FCNC may or may not have become insolvent prior to petitioner husband filing for bankruptcy. Petitioners have failed to show that they are entitled to any deduction with respect to FCNC, and accordingly we hold for respondent. 6. Timely Filing of Petitioners' 1988 Income Tax ReturnIn the notice of deficiency, respondent determined that petitioners' joint income tax return for 1988 was not timely filed, and that the addition to tax for an untimely filing under section 6651(a) is applicable. Petitioners' income tax return was due, after extensions, on October 15, 1989. The return was not signed until October 31, 1989. It was stamped received by respondent; however, the stamp is illegible. The stamp reads either "11-06-89" or "12-06-89". Petitioners introduced no evidence on this issue. Therefore, we hold for respondent that the return was not timely filed. We will give petitioners the benefit of the doubt as to the actual date of filing, and hold that the return 426 is to be treated as received as of November 6, 1989. Decision will be entered under Rule 155. Footnotes1. Petitioners did attach to their brief an amended return for 1987 dated Jan. 27, 1995. We did not consider any information that the return may contain for it was not introduced into evidence at trial. Rule 143(b).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621442/	CLAUDIAN B. NORTHROP, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Northrop v. CommissionerDocket No. 20358.United States Board of Tax Appeals17 B.T.A. 950; 1929 BTA LEXIS 2215; October 15, 1929, Promulgated 2215 1. Motion for judgment by default denied. 2. Respondent's computation of earned income credit approved. 3. Deduction for repairs to house used as home but occasionally rented for short periods denied. Claudian B. Northrop pro se. A. S. Lisenby, Esq., for the respondent. VAN FOSSAN 950 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1924, amounting to $281.80. The petitioner assigns the following errors: (1) The computation of earned net income under section 209(a)(3) and (b) of the Revenue Act of 1924 by erroneously deducting as credits the personal exemption of a married person living with husband or wife and the amount of the allowance for dependents under section 216(c) and (d). (2) The refusal of the Commissioner to allow as a deduction from gross income the cost of certain repairs to a house alleged by the petitioner to have been made for the purpose of putting the house "in shape to rent or sell." MOTION FOR JUDGMENT BY DEFAULT. At the beginning of the hearing the petitioner moved for a judgment by default granting the relief prayed for in his petition. This motion2216 was based on the alleged illegality of an extension of the respondent's time to answer. The petition was filed October 2, 1926. On November 23, 1926, the respondent filed with the Board a motion for an extension of his time to answer, of which the following is a copy: 951 UNITED STATES BOARD OF TAX APPEALS Appeal of: Claudian B. Northrop Washington, D.C. Docket No. 20358 MOTION Comes now the Commissioner of Internal Revenue, by his attorney, A. W. Gregg, General Counsel, Bureau of Internal Revenue, and requests an extension of time from December 4, 1926 to April 3, 1927, within which to file his answer or to move in respect to the petition of the above-named taxpayer. (Signed) A. W. GREGG, General Counsel, Bureau of Internal Revenue.On the face of this document is the following endorsement: "GRANTED November 27, 1926, J. G. Korner, Jr., Member, U.S. Board of Tax Appeals." This endorsement, with the exception of the name "J. G. Korner, Jr." was made by a rubber stamp. The name "J. G. Korner, Jr." is written in the member's handwriting. The answer was filed February 23, 1927. The motion for judgment was taken under advisement. FINDINGS2217 OF FACT. The petitioner is a lawyer with an office in the City of Washington. For about twenty years he was assistant general counsel to the Southern Railway Co. In 1925, in due course, the petitioner filed a return of his income for the calendar year 1924, reporting a gross earned income from his practice as a lawyer of about $20,500. From this amount the taxpayer deducted the sum of $457.38 on account of various expenses connected with his practice as a lawyer. The evidence does not disclose clearly whether or not the petitioner's return for the year 1924 showed any income other than that derived from professional services. On his return for 1924 the petitioner deducted from gross income the cost of repairing a house "for the purpose of putting it in shape to rent or sell." This deduction amounted to $2,205.11, distributed as follows: Paints and painters$1,128.24Carpenters and flooring786.64Electricians35.30Papering172.03Plumbers and tinners82.902,205.11There is no dispute as to the actual total expenditure or as to the items composing it. The petitioner's actual earned net income for the year 1924 was considerably in excess of2218 $10,000. On his return he credited the tax 952 as computed by him with the sum of $90, said sum being 25 per cent of the amount of tax calculated by him as payable on an earned net income of $10,000. He arrived at the amount of this credit by the following calculation: Maximum amount of earned income (section 209(a)(3))$10,000Taxable at 2 per cent $4,00080Taxable at 4 per cent 4,000160Taxable at 6 per cent 2,000120$10,000$360The respondent disallowed the deduction made by the petitioner on account of repairs to the house and also reduced the credit of 25 per cent of the tax payable on a maximum earned income of $10,000 to $47. The respondent calculated the credit of $47 by crediting the maximum earned net income of $10,000 with the sum of $2,500, the personal exemption of a husband living with his wife, and with the further sum of $800 on account of two dependent children, these amounts being credited under provisions of section 216 of the Revenue Act of 1924. In 1908 the petitioner purchased a house at 13 East Lenox Street, Chevy Chase, Md. It is the cost of repairs to this house, made in 1924, which is in question. When the petitioner2219 purchased this house in 1908 it was occupied by a tenant. He received from this tenant the sum of $752 as rent for the months of July, August, and September, and for two weeks in October, 1908. Upon the expiration of the tenacy in 1908 the petitioner and his family moved into the house. He rented it again for the months of July, August, September, and October of 1909. In 1910 and 1911 the house was not rented and the petitioner and his family occupied it as a residence except when he and his family were in the mountains of North Carolina, where he also owned a house. In 1912 the house at 13 East Lenox Street, Chevy Chase, was rented for the months of May, July, August, and September and in 1913 it was rented for the months of June, July, and August. In 1914 the house was rented for the month of July only. It was not rented at any time during 1915 or 1916. In the year 1917 the petitioner had a tenant in the house during the months of June, July, and September. In the year 1918 he rented it for the months of April, May, June, July, August, and September and received as rent the sum of $375. The house was not rented in 1920 but in 1921 was rented for the months of July and August. 2220 In 1922 it was rented for some period of time and in 1923 it was rented for the months of July, August, and September. In 1924, the year in question, the house was not rented for any period of time nor did the petitioner sell it. The petitioner 953 owned the house at date of the hearing, namely, November 12, 1928, at which time it was occupied by a tenant. It was not, however, rented during the years 1925 or 1926. The petitioner's family consisted of his wife and three children, the younger two of whom were in boarding school in 1924. He traveled a good deal in connection with his law business, but whenever the house at 13 East Lenox Street, Chevy Chase, Md., was not rented, he occupied it as a residence with his family. For a number of years before the date of the hearing the house at 13 East Lenox Street, Chevy Chase, Md., had been held out by the petitioner as his permanent home and residence. During the years between the date of the purchase of the property, namely, 1908, up to and including 1924, on such occasions as he had rented the property he had rented it only during the summer months, at which time he and his family were in the mountains of North Carolina2221 occupying his house there. The petitioner made efforts to sell the property as well as to rent it but was never successful in his efforts to sell it. He kept it listed with real estate agents for rent or for sale. He gives as the reasons for his difficulty in renting or selling the property that since his purchase of the property there had been an increase of building in Chevy Chase and there were many houses which were easier to dispose of than his. Up to 1924 the petitioner had kept the house in fairly good condition, but in that year the floors were worn out in some of the rooms and the house needed new papering, painting and guttering. The petitioner, therefore, made the repairs needed but did not make any alterations or additions or lay out any new sidewalks on the premises. OPINION. VAN FOSSAN: At the hearing petitioner moved for judgment by default, basing his motion on the alleged error of the Board in granting respondent additional time to answer. Without pausing to discuss the several arguments advanced by petitioner in support of this motion, we are of the opinion that the motion should be and it hereby is denied. With respect to the petitioner's first2222 assignment of error, namely, as to the amount of credit allowed by respondent because of earned net income, we are of the opinion that the respondent's method of calculating the amount to be allowed under the provisions of the Revenue Act of 1924 is correct. The applicable provisions of the statute are contained in sections 209, 210, and 216 thereof. Paragraph (2) of section 209(a) provides that the term "earned income 954 deductions" means such deductions as are allowed by section 214 for the purpose of computing net income, and are properly allocable to or chargeable against earned income. Section 209 further provides, in part, as follows: (a) For the purposes of this section - * * (3) The term "earned net income" means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpayer's net income is not more than $5,000, his entire net income shall be considered to be earned net income, and if his net income is more than $5,000, his earned net income shall not be considered to be less than $5,000. In no case shall the earned net income be considered to be more than $10,000. (b) In the case of an individual the tax2223 shall, in addition to the credits provided in section 222, be credited with 25 per centum of the amount of tax which would be payable if his earned net income constituted his entire net income; but in no case shall the credit allowed under this subdivision exceed 25 per centum of his tax under section 210. Section 210(a) is as follows: In lieu of the tax imposed by section 210 of the Revenue Act of 1921, there shall be levied, collected and paid for each taxable year upon the net income of every individual (except as provided in subdivision (b) of this section) a normal tax of 6 per centum of the amount of the net income in excess of the credits provided in section 216, except that in the case of a citizen or resident of the United States the rate upon the first $4,000 of such excess amount shall be 2 per centum, and upon the next $4,000 of such excess amount shall be 4 per centum * . Section 216, referred to in section 210(a), provides, among other things, that for the purposes of normal tax only there shall be allowed a credit of $2,500 in the case of the head of a family living with husband or wife and a credit of $400 for each person dependent upon and receiving his2224 chief support from the taxpayer within the terms of the section. The petitioner's actual earned net income was considerably in excess of $10,000. He is therefore entitled to a credit of 25 per cent of the tax on a maximum earned net income of $10,000, pursuant to section 209(a)(3) and (b). He argues that because paragraph (2) of section 209(a) defines "earned income deductions" as such deductions as are allowed by section 214 for the purpose of computing net income, therefore, in computing the amount of tax on earned net income to be credited under section 209(b), it is improper to deduct from the maximum earned net income of $10,000 the amount of credits provided in section 216(c) and (d). In our opinion the provisions of the statute do not sustain the petitioner's position. Section 209(b) provides that an individual's tax shall "be credited with 25 per centum of the amount of tax which would be payable 955 if his earned net income constituted his entire net income." Therefore, in the instant proceeding the credit of 25 per cent of the amount of tax on $10,000 of earned net income is to be computed as if the maximum earned net income of $10,000 constituted the petitioner's2225 entire net income for the year 1924. Under section 210(a) the normal tax is to be levied, collected and paid on the amount of net income of each individual "in excess of the credits provided in section 216." We are, therefore, of the opinion that the respondent's method of calculating the credit to be allowed pursuant to the provisions of section 209(a)(3) and (b) is not erroneous. The petitioner's second assignment of error raises the question whether or not the cost of repairs to his house at 13 East Lenox Street, Chevy Chase, Md., was an ordinary and necessary expense paid or incurred "in carrying on any trade or business." The phrase "trade or business" has been construed by this Board in various decisions involving its interpretation as used in several connections in the revenue acts. In the case of , we referred with approval to the definition of "trade or business" given in Bouvier's Law Dictionary as "that which occupies the time, attention, and labor of men for the purpose of a livelihood and profit." The Sheridan case involved the interpretation of the term "trade or business" as used in section 214(a)(4) of the*2226 Revenue Act of 1918, but in the case of , we said that Bouvier's definition was equally applicable to that term as used in section 214(a)(1) of the Act of 1918. It is also applicable to the term "trade or business" as used in section 214(a)(1) of the Revenue Act of 1924. See, also, . It is apparent from the facts that petitioner occupied his house at 13 East Lenox Street, Chevy Chase, Md., as a residence for himself and his family. He was not in the business of renting the house. He lived in it and rented it only occasionally. This occasional rental was a mere by-product of petitioner's ownership and occupancy. The mere fact that he wanted to sell the house or rent it, when and if he could, does not make the possible rental or sale of it a trade or business within the contemplation of the statute here involved. The deduction of the cost of the repairs in question, therefore, is not permissible under the statute. 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/4621443/	RICHARD W. COX AND KAY L. COX, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCox v. CommissionerDocket No. 7502-92United States Tax CourtT.C. Memo 1994-189; 1994 Tax Ct. Memo LEXIS 188; 67 T.C.M. (CCH) 2809; April 28, 1994, Filed 188 Decision will be entered under Rule 155. For petitioners: John McDuff. For respondent: Steven B. Bass. FAYFAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in Federal income tax and additions to tax for petitioners as follows: Additions to TaxSec.Sec.Sec. Sec. 6653Sec.YearDeficiency6653(a)(1)6653(a)(1)(A)6653(a)(1)(B)(a)(2)66611984$ 64,333$ 3,216.63-- --1$ 16,083198510,333516.65-- --12,583198736,544-- $ 1,827.201--9,13619883,940-- -- ------ All section references are to the Internal Revenue Code in effect for the years remaining in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. After concessions by petitioners, 1 the remaining issues are: (1) Whether in 1987 petitioners have a taxable gain of $ 38,169 from a foreclosure sale of property owned by Mr. Cox. We hold that they do. 189 (2) Whether petitioners have shown that, as a result of a credit of the foreclosure proceeds from Mr. Cox's property to debts of his corporation, petitioners are entitled to a bad debt deduction for 1987. We hold that they have not. (3) Whether in 1987 petitioners are entitled to a business bad debt deduction in the amount of $ 59,198. We hold that they are not. (4) Whether petitioners are liable for the additions to tax under section 6653(a)(1) and (2) for 1984 and 1985, section 6653(a)(1)(A) and (B) for 1987, and section 6661 for each of those years. We hold that they are to the extent described herein. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of fact and attached exhibits are incorporated herein by reference. Petitioners resided in Paige, Texas, when the petition was filed. Mr. Cox started working for Texas Lightbulb Supply Co., Inc. (the corporation), in August 1972. 2 From then through 1987, his source of personal income was almost exclusively from his employment with the corporation. During 1987, Mr. Cox was the sole shareholder of the corporation. At some point during the period 1972 through 1987, Mr. Cox loaned190 a total of $ 100,000 to the corporation. The corporation's 1987 yearend financial statements indicate that there was a note payable to Mr. Cox of $ 59,198. A promissory note dated May 15, 1987, in the amount of $ 977,500 and maturing August 3, 1987, payable to MBank Round Rock (MBank) and identifying the corporation as borrower was signed with Mr. Cox's name as president of the corporation and individually. A second note payable to MBank, dated May 31, 1987, in the amount of $ 247,248.14, also matured August 3, 1987, identified the corporation as borrower, and was signed in the same manner as the May 15, 1987, note. Each of the notes payable to MBank was a renewal of a prior note. A third note (the first lien note) dated June 8, 1987, in the principal amount of $ 342,000, this one payable to Frontier National Bank (Frontier), was signed in petitioners' 191 names as makers. This note provided for monthly payments of principal and interest beginning July 28, 1987, with all unpaid amounts due June 8, 1989. The first lien note and each of the above-described notes payable to MBank provide that Texas law is applicable. A deed of trust (the Frontier deed of trust) dated June 8, 1987, covering certain property (the property) owned by Mr. Cox and securing payment of the first lien note was executed by petitioners and recorded. The property included a building leased by Mr. Cox to the corporation. Mr. Cox executed a second deed of trust covering the property (the MBank deed of trust), also dated June 8, 1987, to secure payment of all notes owed to MBank by the corporation and him. The MBank deed of trust was recorded after, and expressly provided that the lien created was secondary and inferior to that of, the Frontier deed of trust. On September 16, 1987, MBank filed in State court a petition and application for appointment of a receiver against the corporation and Mr. Cox. MBank's petition alleged that (1) there were defaults by the defendants in the payment of their promissory notes to MBank with outstanding principal amounts totaling192 $ 1,161,280.54, plus interest, (2) the corporation was losing at least $ 20,000 per month, and (3) Mr. Cox made misrepresentations regarding the corporation's business status and, if left in control, would deplete its inventory, in which MBank had a security interest. On September 25, 1987, the corporation and Mr. Cox filed a petition for damages and injunctive relief (the State court case) against MBank in the same court. In this petition, they alleged tort violations, fraud, breach of contract, and a violation of trust and confidence by MBank. 3193 On October 15, 1987, the corporation filed a voluntary petition under chapter 11 of the Bankruptcy Code, 11 U.S.C. (the bankruptcy petition), in the United States Bankruptcy Court for the Western District of Texas. The statement of all liabilities of debtor attached to the bankruptcy petition includes a secured trade debt in the amount of $ 1,100,000 owed MBank, but no debt to Mr. Cox. On October 15, 1987, the corporation owed Mr. Cox $ 59,198. Eric Borsheim, the attorney who handled the chapter 11 proceedings relating to the corporation, testified in this Court that in the fall of 1987 it looked "pretty hopeless" that the corporation "would pay any sort of significant dividend 4 to its creditors"; he advised petitioners not to waste their time filing a proof of claim for the $ 59,198; and the corporation was "hopelessly insolvent". Mr. Borsheim testified further: This was a case that was never going to pay 100 percent to the unsecured creditors in the case; never. And as such, the only way the Coxes were ever going to keep this corporation was to convince the creditors in the case to vote for the payment of a dividend that was going to be substantially less than 100 cents194 on the dollar. It was going to be perhaps ten or 20 cents on the dollar, at the most. And under those circumstances, the debtor can never, with a straight face, say, Well, creditor I am going to only pay you 20 cents on the dollar and, by the way, I want to keep my company and I want to pay me 20 cents on the dollar. That will never work in the real-day world. That claim is worthless on the day that they filed bankruptcy. On December 1, 1987, there was a foreclosure sale of the property, and MBank bid $ 490,000 as buyer. A recorded substitute trustee's deed dated December 1, 1987, indicates that ownership of the property was conveyed to MBank. An internal record of MBank entitled "Managed195 Assets Changes Memorandum" dated December 9, 1987, indicates that the foreclosure resulted in a "Payoff [of Frontier's] 1st Lien $ 342,888.47." MBank drew a cashier's check dated December 11, 1987, payable to Frontier in the amount of $ 342,888.47, with the notation "Payoff First Lien MBRR/Ref. Richard Cox Texas Light Bulb Supply Company, Inc." The first lien note was endorsed "Pay to the order of [MBank] without recourse" by the executive vice president of Frontier on December 11, 1987. The record here includes a copy of a release of lien effective December 31, 1988, and notarized March 22, 1989, 5 relating to the first lien note, which states that the holder of the note, MBank, releases the property from the lien but "reserves its rights against any and all parties for payment of the note and performance of the other obligations therein." 196 At the time of the foreclosure, Mr. Cox's adjusted basis in the property was $ 451,831. By March 28, 1989, the Office of the Comptroller of the Currency had declared MBank insolvent, placed it in receivership, and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. The FDIC filed a notice of removal of the State court case with the District Court for the Western District of Texas and a motion to dismiss the claims of Mr. Cox and the corporation for failure to state a claim upon which relief could be granted, alleging that MBank's agreement, if any, regarding the tax refund was an oral agreement and did not bind the FDIC. Pleadings and an affidavit filed with the bankruptcy court indicate that, in 1988 and 1989, the successor bank 6 agreed with Mr. Cox and the corporation to take most of the corporation's inventory and cash and reduce its claim to an unsecured claim to the corporation's property in the amount of $ 500,000. The record includes an unsigned copy of an abstract of judgment in favor of the successor bank, as assignee of FDIC, indicating that, on July 25, 1989, a judgment was recovered against Mr. Cox in the amount of $ 520,000. 197 On May 24, 1990, the corporation filed a proposed second amended plan of reorganization, under which the successor bank would release the abstract judgment against Mr. Cox with the bankruptcy court. An order confirming the corporation's second amended plan of reorganization 7 was entered by the bankruptcy court in July 1990. On November 8, 1990, the United States Magistrate in the District Court case recommended granting the FDIC's motion to dismiss the claims of the corporation and Mr. Cox. A judgment to that effect was entered by the District Court on November 30, 1990. Petitioners' income tax return for 1987, which was prepared by an accountant, included Form 4797, Gains and Losses From Sales or Exchanges of Assets Used in a Trade or Business and Involuntary Conversions, reflecting the following regarding the property: Gross sales price$ 490,000Cost or other basis plus expense of sale515,707Depreciation * * * allowed (or allowable)63,876Adjusted basis451,831Total gain38,169198 Petitioners conceded that, in 1987, they received $ 18,824 in rental income which was unreported on their return (see supra note 1). On Form 1040X, Amended U.S. Individual Income Tax Return for 1987, prepared by a second accountant, 8 petitioners reflected a gross sales price of $ 700,000 and total gain of $ 248,169 relating to the property, and deduction of business bad debts totaling $ 409,198: 1. DATES OF LOANS:06/30/8759,19812/01/879 350,000199 On second and third Forms 1040X for 1987, also prepared by the second accountant, petitioners reflected a loss in the amount of $ 409,198 and no gain relating to the property, including the following statement: Income previously included gain related to the reposession of a building in the amount of $ 248,169. Taxpayers contend this repossession was unlawful and litigation has been undertaken by both the taxpayer and the lender. Accordingly, the amount of income or loss, if any, has not been determined in 1987 and there should be no gain recognition in that year. Mr. Cox testified that he relied on his second accountant to file his returns. Mr. Corn testified that the original return was "incorrect in reporting the foreclosure proceeds as taxable income" to petitioners because Mr. Cox no longer owned the property, and there was no indication that the foreclosure proceeds had been applied to Mr. Cox's debt, at least until confirmation of the chapter 11 plan, inasmuch as Mr. Cox was still negotiating with the successor bank. The parties stipulated that petitioners' second accountant would testify to the same effect. The record includes a copy of a Form 1099-A, Information 200 Return for Acquisition or Abandonment of Secured Property for 1987, relating to the property, reflecting MBank as the lender, the corporation as the borrower, "12/01/87" as the date of lender's acquisition or knowledge of abandonment, $ 1,565,081.28 as the amount of the debt outstanding, $ -0- as the amount of debt satisfied, and $ 490,000 as the fair market value of the property at acquisition or abandonment. The record also includes a copy of a Form 1099-A, Information Return for Acquisition or Abandonment of Secured Property for 1987, relating to the property, reflecting MBank as the lender, Mr. Cox as the borrower, "12-1-87" as the date of lender's acquisition or knowledge of abandonment, $ 490,000 as the gross foreclosure proceeds, and that the borrower was personally liable for repayment of the debt, but no amounts are stated under balance of principal outstanding or appraisal value of the property. In the notice of deficiency, the Internal Revenue Service (1) disallowed the $ 409,198 loss ultimately claimed on petitioners' Forms 1040X and (2) determined a gain of $ 38,169 as "realized on the repossession" of the property. In their petition, petitioners allege that the determinations201 relating to repossession of the property were erroneous for the following reason: In 1987 a lender took possession of a business building owned by the Petitioners by a foreclosure of a lien which the lender held. The lender bid in the property at foreclosure, yet the lender did not give the Petitioners credit on their debts to the lender in 1987 as a result of the lender's seizure of the property. The lender has never delivered to the Petitioners a Form 1099 for the Petitioners with respect to the foreclosure. The Petitioners had engaged an attorney who had filed suit on their behalf to seek compensation for various business torts by the lender. The foreclosure was one of the controversies in this suit. Subsequently the lender was closed by Federal regulators and the resulting estoppel of claims against the successor in interest prevented a trial. The only substantial economic effect in 1987 is the loss of the Petitioners' property. OPINION ForeclosurePetitioners contend that Mr. Cox did not receive "absolute credit" for the foreclosure sale of his property because there was no indication (1) that he was not still liable to MBank for the $ 342,888.47 paid Frontier202 or (2) that the foreclosure bid was credited toward the notes due MBank until after 1987 (when MBank, the corporation, and Mr. Cox settled their claims and MBank and the successor bank agreed to the second amended plan of reorganization). Alternatively, petitioners argue that, to the extent that the foreclosure proceeds were credited to the corporation's debts, which Mr. Cox guaranteed, petitioners are entitled to deductions for business bad debts. Petitioners suggest that they should bear a lesser burden of persuasion because they must prove a negative, i.e., that they do not have income and the notice of deficiency "could almost be viewed in retrospect as arbitrary and excessive." Respondent contends that petitioners have failed to establish that (1) they did not have a $ 38,169 gain resulting from the foreclosure on Mr. Cox's property considering the bid price of $ 490,000 and his adjusted basis of $ 451,831, and (2) that they are entitled to the $ 350,000 loss claimed on the amended returns, the computation of which was not explained, on the transaction. In the reply brief, respondent argues that (1) the settlement relating to the corporation's chapter 11 proceedings was irrelevant203 to the foreclosure, (2) petitioners did not raise in the pleadings the argument that they are entitled to a bad debt deduction to the extent the foreclosure proceeds were credited to the corporation's debts, and (3) petitioners did not raise an affirmative defense in the pleadings that the burden of persuasion should be shifted because the notice of deficiency is arbitrary. In their reply brief, petitioners assert that the foreclosure proceedings did not result in a sale of the property because it was not court ordered and that there was no gain realization event or economic benefit to petitioners. We agree with respondent. Despite petitioners' attempt to obfuscate the issue with arguments relating to the corporation's claims against MBank, the chapter 11 proceedings of the corporation, and the failure of MBank, the essential facts are that, in 1987, the property was disposed of in a foreclosure sale for a bid of $ 490,000, at which time Mr. Cox's adjusted basis was $ 451,831. Petitioners failed to show that Mr. Cox did not recognize $ 38,169 of gain on this transaction. It is well settled that a foreclosure sale, including a nonjudicial foreclosure, is a "sale or exchange" for204 purposes of Federal income taxation. Chilingirian v. Commissioner, 918 F.2d 1251 (6th Cir. 1990), affg. T.C. Memo. 1986-463; see also Helvering v. Hammel, 311 U.S. 504 (1941). Section 1001(a) provides that the gain or loss from the sale or other disposition of property shall be the difference between the amount realized and the adjusted basis of the property. In general, the amount realized from the sale includes the amount of liabilities from which the transferor is discharged as a result of the sale. Sec. 1.1001-2(a)(1), Income Tax Regs.Section 1.1001-2(a)(4)(ii), Income Tax Regs., provides that the sale of property that secures a recourse liability discharges the transferor if another person agrees to pay the liability, even if the transferor is not in fact released from the liability. In 1987, there was a foreclosure sale of the property owned by Mr. Cox for $ 490,000, at which time his basis was $ 451,831. Under Texas law, he was entitled to a credit of at least the $ 490,000 foreclosure bid 10 toward his debts. See Resolution Trust Corp. v. Westridge Court, 815 S.W.2d 327">815 S.W.2d 327, 330 (Tex. Ct. App. 1991);205 Hayner v. Chittim, 228 S.W. 279">228 S.W. 279, 281 (Tex. Civ. App. 1921). As respondent points out on brief, there is nothing in the record here to show that, in the State court case, Mr. Cox attacked the validity of the foreclosure sale or that he tried to set it aside or alleged a right of redemption to the property. See Scott v. Schneider Estate Trust, 783 S.W.2d 26">783 S.W.2d 26, 28 (Tex. Ct. App. 1990); Rogers v. Fielder, 392 S.W.2d 797">392 S.W.2d 797, 798 (Tex. Civ. App. 1965); see also Hawkins v. Commissioner, 34 B.T.A. 918 (1936), affd. 91 F.2d 354">91 F.2d 354 (5th Cir. 1937). Although the petition in the State court case alleged that the notes to MBank were obtained "wrongfully and with deceit" and asked the court to restrain MBank from foreclosing on the deeds of trust (see supra note 3), petitioners did not introduce evidence here as to the court's resolution of these claims (other than the ultimate dismissal) or even their validity. Mr. Corn, the accountant, who negotiated and supervised negotiations relating to claims and the plan of reorganization in the chapter 11206 proceedings of the corporation, testified that MBank would not credit the $ 490,000 foreclosure proceeds except in connection with a comprehensive resolution of all claims. However, Mr. Corn's testimony suggests that this was a voluntary course of action by Mr. Cox on behalf of the corporation, intended to preserve his business by facilitating MBank's settlement and agreement with the plan of reorganization. More importantly, the credit of the $ 490,000 foreclosure proceeds to Mr. Cox's debts was not legally tied to the chapter 11 proceedings of the corporation, a debtor separate from Mr. Cox. Mr. Cox was legally entitled to the credit of at least the $ 490,000 amount of the bid in 1987. Indeed, on brief, petitioners concede that the second deed of trust provides for a credit of the foreclosure proceeds to reduce the debt secured by the deed of trust. Petitioners did not present any evidence to prove that Mr. Cox asked that the $ 490,000 be credited toward his debts in the State court case, or that the court rejected his request or did not act on his request until after 1987. Under these circumstances, we conclude that petitioners are taxable in 1987 on $ 38,169 in gain ($ 490,000207 foreclosure bid less $ 451,831 adjusted basis) from the foreclosure sale of the property. Petitioners' primary contention regarding this issue appears to be that there was no discharge of Mr. Cox's liability or credit to his debt on the foreclosure of the property, but MBank and the successor bank forced this to be "entwined" with the corporation's chapter 11 proceedings and resolution of the claims of the corporation, Mr. Cox, and MBank. Their argument suggests that the 1987 foreclosure was not the appropriate point in time for recognizing gain or loss, but they fail to point to any event which triggered gain or loss, for example, when the successor bank reduced its claim in 1989, or when the order confirming the corporation's second amended plan of reorganization was entered in 1990. Although 208 Mr. Corn testified that MBank failed to acknowledge a credit to Mr. Cox in order to improve its negotiating position in the chapter 11 proceedings of the corporation and the documents stipulated as exhibits are unclear as to the extent to which Mr. Cox was credited, which debts were credited, and when the debts were credited, the fact remains that the foreclosure sale occurred in 1987, and, under the terms of the deed of trust and Texas law, Mr. Cox was entitled to a credit of the foreclosure proceeds toward his obligations as of that time. Petitioners have not cited any authority under Texas law or of this Court that supports their argument. The only cases we have found are inapposite to the situation here. In R. O'Dell & Sons Co. v. Commissioner, 8 T.C. 1165">8 T.C. 1165 (1947), affd. 169 F.2d 247">169 F.2d 247 (3d Cir. 1948), mortgaged property was sold in foreclosure for a minimum bid price. Under State law, the mortgagee had the right to seek a deficiency judgment during a 3-month period which extended into the taxable year following the foreclosure sale, and, if the mortgagee did so, the mortgagor had a limited right to redeem the property. 209 In affirming our opinion, the Court of Appeals concluded that, under State law, "the transaction of foreclosure and sale * * * [was not] completed, until" the later year when the right of redemption expired. 169 F.2d at 249. Thus, the issue in R. O'Dell & Sons Co. v. Commissioner, supra, was whether the taxpayer would be treated as realizing an amount greater than the bid price as a result of the foreclosure, and whether the property would be redeemed. In contrast, the foreclosure sale of the property here was not for a minimal bid, which necessitated waiting to see whether a deficiency judgment for the amount of the debt was obtained in order to determine if there was gain. The foreclosure sale here resulted in a $ 490,000 bid, an amount in excess of Mr. Cox's $ 451,831 adjusted basis in the property so that gain was determinable to that extent on foreclosure. Respondent does not contend that petitioners realized income in excess of the bid price. Moreover, petitioners have not cited nor have we found a statutory structure under Texas law comparable to the 3-month period under the State law applicable in R. O'Dell & Sons Co. v. Commissioner, supra.210 Eisenberg v. Commissioner, 78 T.C. 336 (1982), involved a foreclosure sale of a ship in an in rem proceeding in which the sales proceeds were paid into court to be used to satisfy claims of a group of creditors, including some which were not creditors of the taxpayer but instead had claims arising from the operation of the ship by the taxpayer's corporation. The foreclosure proceeds were deposited into court in December 1977 but not distributed to the creditors until 1978. The $ 490,000 proceeds from the foreclosure sale here were not paid into a court but were in the control of Mr. Cox's creditor, MBank, which paid Frontier, the only other creditor with a deed of trust as to the property, in 1987 shortly after the foreclosure sale. Petitioners have not shown that the proceeds were claimed by anyone who was a creditor only of the corporation and not of Mr. Cox, as in Eisenberg v. Commissioner, supra.Both Mr. Cox and the corporation were indebted to MBank, which had control over the proceeds. Gain from the foreclosure was determinable in 1987. The facts here are not akin to those in Eisenberg v. Commissioner, supra.211 Petitioners' contention that the foreclosure sale here does not constitute a sale for purposes of gain recognition under section 1001(a) because it was not court ordered is contrary to Chilingirian v. Commissioner, 918 F.2d 1251 (6th Cir. 1990), affg. T.C. Memo. 1986-463, which concluded that a nonjudicial foreclosure is a "sale or exchange" for Federal tax purposes. In their reply brief, petitioners argue further that they did not receive any income under a claim of right, free of restrictions, and, even if they did, there were restrictions on their economic use of the income. Under the deed of trust and Texas law, Mr. Cox had the right to have the foreclosure proceeds credited to his debts. We need not decide whether this is a "claim of right" situation because petitioners have not shown us a legal restriction on Mr. Cox's right to have the proceeds credited. The cases cited by petitioners 11 in support of this argument have no bearing on the situation here. 212 Rev. Rul. 55-142, 1 C.B. 339">1955-1 C.B. 339, which is also cited by petitioners, is totally inapposite. It provides that no taxable gain results when the owner of separate contiguous parcels of land consolidates them as a single parcel by conveying them to a nominee which immediately reconveys them to the owner, without any consideration for the transfers. Obviously, after the foreclosure, Mr. Cox no longer owned the property and was entitled to a credit of at least $ 490,000 to his debts. Petitioners have raised a plethora of other similar arguments to the effect that the foreclosure does not result in taxable gain to Mr. Cox, which we have considered and concluded are meritless. We reject petitioners' arguments regarding the burden of persuasion in this case. We note that they did not plead that the burden should be shifted to respondent. See Rules 39, 142(a). Moreover, under any of the various standards suggested in their rambling discourse on this point, the record indicates that the property was sold for $ 490,000 in 1987. Under the deed of trust and Texas law, Mr. Cox was entitled to a credit of at least that amount, and respondent does213 not contend that the credit, and amount realized, were greater. Bad Debt Deduction Relating to ForeclosureAlternatively, petitioners contend that they are entitled to a bad debt deduction to the extent the foreclosure proceeds from the property, which belonged to Mr. Cox, were credited to the corporation's debts. This issue was raised for the first time on brief, so that arguably respondent was prevented from presenting evidence on the issue at trial. See DiLeo v. Commissioner, 96 T.C. 858">96 T.C. 858, 891 (1991), affd. 959 F.2d 16">959 F.2d 16 (2d Cir. 1992); Shelby U.S. Distributors, Inc. v. Commissioner, 71 T.C. 874">71 T.C. 874, 885 (1979); Markwardt v. Commissioner, 64 T.C. 989">64 T.C. 989, 997 (1975). However, even if we were to consider this argument, petitioners did not show that Mr. Cox treated the crediting of the proceeds as a debt from the corporation to him (such as by appropriate entries in the financial statements). Thus, to the extent that the foreclosure proceeds were credited to the debts of the corporation, the analysis below regarding the $ 59,198 petitioners contend was a business214 bad debt applies. They have not established that any claim by Mr. Cox, as guarantor or otherwise, to recover the amount credited from the proceeds to the debts of the corporation became worthless in 1987. Other Bad Debt DeductionPetitioners contend that the $ 59,198 amount outstanding from the corporation to Mr. Cox was a business bad debt which became uncollectible or worthless even had he filed a proof of claim in the chapter 11 proceedings of the corporation. Respondent argues that petitioners have not shown the worthlessness of the amount, but instead "voluntarily chose not to file a claim" in the chapter 11 proceedings. We agree with respondent that petitioners have not shown worthlessness of the $ 59,198 in 1987. In general, section 166(a) allows a deduction for any debt which becomes worthless within the taxable year. The $ 59,198 was reflected on the 1987 financial statement of the corporation as a note payable to Mr. Cox. Mr. Borsheim's testimony indicates that Mr. Cox opted not to file a proof of claim in the chapter 11 proceedings of the corporation because it was necessary to convince the other creditors to confirm the plan of reorganization for the corporation. 215 Although it was a difficult choice, Mr. Cox did not pursue collection in order to preserve his business, thereby converting the $ 59,198 to a contribution to capital. Petitioners have not shown us "the identifiable event" causing the amount to became worthless in 1987. See Estate of Mann v. United States, 731 F.2d 267">731 F.2d 267, 275-276 (5th Cir. 1984); Hubble v. Commissioner, T.C. Memo. 1981-625. Nor have petitioners demonstrated, nor even argued, that the $ 59,198 amount became partially worthless in 1987. See section 166(a)(2). Additions to TaxIn their reply brief, petitioners contend that the additions to tax under section 6653(a)(1) and (2) for 1984 and 1985, section 6653(a)(1)(A) and (B) for 1987, and section 6661 for each of the years in issue should not apply because (1) they relied on their second accountant's advice relating to the positions as to the foreclosure and the bad debt, and (2) they "reasonably believed" that the receipt of the amount determined by respondent to be rental income (which they conceded 12 (see supra note 1)) was not taxable. 216 Respondent argues that petitioners have failed to show that the additions to tax do not apply. We agree with respondent to the extent that petitioners have not shown that they were not negligent or that they had substantial authority for the position relating to the unreported rental income. Section 6653(a)(1) for 1984 and 1985 and section 6653(a)(1)(A) for 1987 provide for an addition to tax of 5 percent of the underpayment of tax if any part of the underpayment is due to negligence or intentional disregard of the rules and regulations. Section 6653(a)(2) for 1984 and 1985 and section 6653(a)(1)(B) for 1987 impose a further addition to tax equal to 50 percent of the interest due on the portion of the underpayment attributable to negligence. Negligence is the lack of due care or the failure to do what a prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioners bear the burden of establishing that the negligence additions to tax do not apply. Petitioners' witness, Charles Matthews, testified that he was paying amounts to continue to live on certain property sold by him to Mr. Cox (the second property). 217 Mr. Cox testified that the payments were made to him. Respondent's agent testified that, in connection with his examination, he found bank deposits in 1987 totaling about $ 18,000, the deposit slips as to which bore the notation "Rent from Bastrop property" (the second property), and Mr. Matthews told him that these were "rental for living on the property." On brief, petitioners conceded that this was unreported income. They never explained their position for not reporting this in their 1987 return or whether information regarding this item was provided to their accountants. They have not demonstrated that they were not negligent with regard to the $ 18,824 in rental income. Their argument that they reasonably believed that this was not taxable is not sufficiently supported by the record. However, for purposes of section 6653(a)(2) for 1984 and 1985 and section 6653(a)(1)(B) for 1987, we are convinced that they relied on the advice of competent and experienced accountants who were supplied with all the necessary information relating to the foreclosure and bad debt issues. To the extent that the underpayments are attributable to these issues, they are not attributable to petitioners' 218 negligence. See Weis v. Commissioner, 94 T.C. 473">94 T.C. 473, 487 (1990); Pessin v. Commissioner, 59 T.C. 473">59 T.C. 473, 489 (1972). Mr. Corn and, by the parties' stipulation, Mr. Cox's second accountant, who prepared the amended returns, testified that they were fully aware of the circumstances involved in the foreclosure, the bad debt, and the chapter 11 proceedings of the corporation. Section 6661 provides for an addition to tax equal to 25 percent of the amount of any underpayment attributable to a substantial understatement of income tax. Under section 6661(b)(1)(A), for individual taxpayers a substantial understatement must exceed the greater of $ 5,000 or 10 percent of the tax required to be shown on the return. The amount of the understatement is reduced by the portion of the understatement attributable to the tax treatment of any item if there was substantial authority for the return position regarding the item or adequate disclosure of the relevant facts 13 affecting treatment of the item in the return or a statement attached to it. Sec. 6661(b)(2)(B). Substantial authority is less stringent than a "more likely than not" standard219 (i.e., a greater than 50 percent likelihood of prevailing in litigation), but stricter than a reasonable basis standard applicable under section 6653(a). Sec. 1.6661-3(a)(2), Income Tax Regs. In general, substantial authority includes court cases. Sec. 1.6661-3(b)(2), Income Tax Regs.Under section 6661(c), the Secretary has authority to waive all or part of the section 6661 addition to tax on showing by the taxpayer that there was reasonable cause for the understatement and that the taxpayer acted in good faith. The taxpayer may make such a showing if there is reliance on a tax professional, which was reasonable, and the taxpayer acted in good faith. Sec. 1.6661-6(b), Income Tax Regs.Under the circumstances here, we conclude that the section 6661 addition to tax does not apply to the portions of understatements*220 of income tax attributable to the positions relating to the foreclosure and the bad debt issues. However, petitioners have not articulated their position or the authority, if any, for not including the $ 18,824 in taxable income in 1987. There is no evidence that they relied on an accountant in reaching their position. Our conclusions regarding the additions to tax necessitate a Rule 155 computation. The addition to tax under section 6661 is sustained, provided that the Rule 155 computation reflects an understatement of tax attributable to this item which is substantial under section 6661(b)(1)(A). See DiPlacido v. Commissioner, T.C. Memo 1993-169">T.C. Memo. 1993-169. To reflect the parties' concessions and the foregoing, Decision will be entered under Rule 155. Footnotes1. 50 percent of the interest due on the portion of the underpayment attributable to negligence, which respondent determined to be the full deficiency amounts.↩1. In the petition petitioners conceded the deficiency for 1988 and on brief conceded an adjustment in the amount of $ 18,824 for unreported rental income for 1987. The deficiencies for 1984 and 1985 result from a net operating loss carryback from 1987. Respondent also made miscellaneous computational adjustments (medical and dental expense deductions and child care credits, political contribution credits, and general business credits), which result from the primary adjustments.↩2. Pleadings filed on behalf of Mr. Cox and the corporation in State court indicate that, until 1976, the corporation was operated as an unincorporated entity.↩3. More specifically, in the petition in the State court case, the corporation and Mr. Cox alleged such breach of contract and tort violations by MBank in (1) preventing Mr. Cox from refinancing the property and thereby preventing him from pursuing a business opportunity, (2) claiming $ 200,000 of the corporation's tax refund, instead of $ 100,000 as allegedly agreed, (3) refusing to extend the promissory notes and wrongfully seizing about $ 117,000 deposited by the corporation with MBank and applying it as an offset to the amount due on the notes, which resulted in MBank's failure to honor the corporation's checks, (4) inducing the corporation's management to enter into notes "wrongfully and with deceit," and (5) attempting to close the corporation and assume management of it. In the prayer for relief, they sought damages, the return of the $ 117,000 seized, injunctive relief restraining MBank from foreclosing on "various Security Agreements and/or Deeds of Trust", and attorney's fees and court costs.↩4. Mr. Borsheim appears to be referring to distributions from the bankruptcy estate (see, e.g., 11 U.S.C. secs. 1143, 1326 (1988)). The term "dividend" appears in rules 3009 and 3010 of the Bankruptcy Rules↩, 11 U.S.C. app. at 251 (1988), which apply to ch. 7 liquidation and ch. 13 cases.5. There is no court clerk file-mark on the copy of the release of lien. This release may not have been filed, for Frontier filed a release of lien against the property on May 30, 1991.↩6. Mark Dietz, the attorney who represented all of the banking entities in the litigation involving the corporation and Mr. Cox, testified that the successor bank, which was Deposit Insurance Bridge Bank, was "created at the time [MBank] failed in March of 1989", and, thereafter, it was acquired by Bank One. The successor bank entities are referred to herein as the successor bank.↩7. There is no evidence of the payments received by the various classes of creditors under the second amended plan of reorganization.↩8. The second accountant worked in the same accounting firm and under the supervision of Harvey Corn, who negotiated and supervised negotiations relating to claims and the plan of reorganization in the ch. 11 proceedings of the corporation. In 1987, Mr. Corn was a tax partner in Coopers & Lybrand with about 4 years' experience regarding accounting and financial matters relating to bankruptcies. Mr. Corn testified in this case to matters regarding the negotiations and the preparation and positions taken on the Forms 1040X filed. The parties stipulated that the second accountant would testify to the same effect as Mr. Corn.↩9. Although the amended return does not identify which loans are referred to, it is apparent from the proceedings in this case that the $ 59,198 amount represents the loan from Mr. Cox to his corporation, and the $ 350,000 amount relates to the alleged credit from the foreclosure of Mr. Cox's property to his corporation's debts.↩10. Mr. Cox was entitled to have the reasonable market value of the property credited on his debts. See Resolution Trust Corp. v. Westridge Court, 815 S.W.2d 327">815 S.W.2d 327, 330↩ (Tex. Ct. App. 1991).11. See North American Oil Consolidated v. Burnet, 286 U.S. 417 (1932) (profits earned on oil land placed in receivership pending legal action over its beneficial ownership were taxable to one of the claimants upon his receipt of the profits pursuant to a District Court's order, even though the order might be reversed on appeal); All Americas Trading Corp. v. Commissioner, 29 T.C. 908">29 T.C. 908↩ (1958) (kickback payments from corporate suppliers to corporate president-minority shareholder were not taxable to the corporation during the years in issue where shareholder received the payments under claim of right).12. Although the deficiency notice and respondent's requested findings of fact refer to the amount of rental income as $ 18,824, elsewhere on brief the parties refer to the amount as $ 18,829. We conclude that the correct amount is $ 18,824.↩13. In lieu of disclosure of the facts affecting the tax treatment of the item, the taxpayer may set forth a description of the legal issue presented by the facts. Sec. 1.6661-4(b)(2), Income Tax Regs.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621444/	COMMISSIONER OF INTERNAL REVENUE, RESPONDENT., PETITIONER, v.Lyon Bros. Millinery Co. v. CommissionerDocket No. 18123.United States Board of Tax Appeals17 B.T.A. 1244; 1929 BTA LEXIS 2154; November 6, 1929, Promulgated 2154 Action of the Commissioner in rejecting closing inventories approved. Fred J. Wolfson, Esq., for the petitioner. Arthur H. Murray, Esq., for the respondent. LANSDON 1245 This appeal seeks a redetermination of a deficiency in income and profits tax in the sum of $2,637.98, asserted by the respondent against petitioner for the fiscal year ended November 30, 1920. Petitioner charges error on the part of respondent in rejecting valuations claimed in its closing inventories for the year. FINDINGS OF FACTS. The petitioner is a corporation engaged in the manufacture and sale of millinery goods at Mansas City, Mo. At the close of the taxable year the petitioner prepared a closing inventory of its stock of merchandise in which it attempted to arrive at its market value by arbitrarily discounting the cost price of each article, then in stock, 33 1/3 per cent. These values were claimed by petitioner in reporting its net income for the year and rejected by the Commissioner of Internal Revenue, which resulted in the increase of the taxable income, as reported, by $5,709.90. Upon being notified of the Commissioner's rejection of these valuations, 2155 the petitioner filed an amended return in which it revised its closing inventory. The values arrived at in this revised inventory were obtained by separately appraising each item of merchandise in respect to both its cost price and market value. In each case the lower value, cost or market, was adopted for inventory purposes. This invoice was likewise rejected by the Commissioner. Neither of these invoices was put in evidence, nor was there any testimony offered as to the market value of the property they covered. OPINION. LANSDON: The petitioner argues that the methods employed, in making inventories, are immaterial, so long as they reflect the true value of the property affected; that one or the other of these invoices should be accepted, and, that in view of the fact that, in either case, the result is "substantially" the same its appeal should be sustained. It is true that we are interested in concrete values, rather than theories or methods, and either of these inventories might have been acceptable had the petitioner introduced proof as to the value of the merchandise they covered. No evidence, however, as to any values, or the income of the petitioner, is given, 2156 and there is nothing in the entire record upon which we can base the determination of any tax; much less a finding that the respondent erred in his determination. The petitioner has failed to sustain its allegations of error and judgment will be for the respondent. 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/4621447/	John Verra v. Commissioner.Verra v. CommissionerDocket No. 2266-67.United States Tax CourtT.C. Memo 1972-199; 1972 Tax Ct. Memo LEXIS 57; 31 T.C.M. (CCH) 996; T.C.M. (RIA) 72199; September 14, 197257 Petitioner filed no Federal income tax returns for the years 1952 through 1961, inclusive. Respondent determined deficiencies in income tax and additions thereto against petitioner based on unreported income in said years. Held, petitioner failed to show that the burden of proof was shifted to respondent; held further, respondent's determination of deficiencies in income tax sustained, as petitioner failed to introduce credible evidence sufficient to carry his burden of proving by a preponderance of the evidence that respondent's determination of deficiencies was wrong or, moreover, even to rebut the presumptive correctness attaching to such determination; held further, respondent's determination of additions to the tax sustained on petitioner's failure of proof. David M. Markowitz, 261 Broadway, New York, N. Y., for the petitioner. Richard J. Mandell and Marwin A. Batt, for the respondent. HOYTMemorandum Findings of Fact and Opinion HOYT, Judge: Respondent determined deficiencies in petitioner's Federal income tax and additions thereto as follows: Additions to taxSec. 294Sec. 291(a),(d)(1)(A),I.R.C.I.R.C.YearDeficiency193919391952$12,006.05$3,001.51$1,073.27195312,006.053,001.511,073.27195412,796.351,141.96195512,814.35195612,814.35195714,856.8819589,018.8319598,815.1819603,365.201961463.63Total$98,956.87$6,003.02$3,288.50Additions to taxSec. 293(b),Sec. 6653(b),Sec. 6654,I.R.C.I.R.C.I.R.C.Year1939195419541952$ 6,003.0319536,003.031954$ 6,398.1819556,407.18$ 355.2719566,407.18355.2719577,428.44412.0319584,509.42248.5519594,407.59241.7919601,682.6088.191961231.829.05Total$12,006.06$37,472.41$1,710.1558 Respondent has conceded that there are no additions to the tax under section 293(b), Internal Revenue Code of 1939, or section 6653(b), Internal Revenue Code of 1954, for the years before the Court. The issues remaining for our decision are: (1) whether petitioner received income in each of the taxable years 1952 through 1961, inclusive, aggregating $246,645; (2) whether the additions to the tax pursuant to section 997 291(a) and section 294(d) (1) (A), Internal Revenue Code of 1939, and section 6654(a), Internal Revenue Code of 1954, were properly determined against petitioner; and (3) whether recorded testimony at a prior trial is admissible in the instant proceeding. Findings of Fact Petitioner, John Verra, is an individual whose legal residence at the time his petition was filed herein was Roselle, New Jersey. Petitioner filed no Federal income tax returns for the taxable years 1952 through 1961, inclusive. During the years at issue, petitioner's former wife, Anna, and four children resided with petitioner. Petitioner was convicted at least twice for violations of Federal laws relating to the transportation and sale of untaxed alcohl, once in approximately 1939 and once in 1961. 59 The 1961 conviction was on four counts of an indictment for violation of the Internal Revenue laws relating to transporting and selling untaxed liquor and conspiracy to do so, and was the result of an investigation conducted by the Alcohol and Tobacco Tax Division, Internal Revenue Service, into petitioner's transportation and sale of alcohol activities. Subsequent to these convictions, an investigation was commenced to determine petitioner's possible income tax liability for the years 1952 through 1961. Based on information gathered by the Alcohol and Tobacco Tax Division's investigation leading to the 1961 conviction, respondent issued a statutory notice of deficiency to petitioner determining that he had realized unreported income from the sale of alcohol in the following years in the amounts indicated: YearAmount1952$ 27,592.50195327,592.50195430,842.50195530,842.50195630,842.50195734,092.50195824,542.50195924,132.50196013,040.0019613,125.00Opinion Issue 1. Unreported Income As petitioner has cited no authority whatsoever on brief with respect to the substantive issue in this case, we can only infer upon what theories petitioner has postured his case. On brief and reply brief, 60 petitioner's position appears to be that not only was his offered testimony sufficient to rebut the presumption of correctness attaching to respondent's determination of deficiencies in income tax and additions to the tax, but that such evidence sustained petitioner's burden of proving the determination to be incorrect. Further, the general import of petitioner's allegations in his petition 161 appears to be that respondent's determination was arbitrary and excessive, and on brief and reply brief petitioner implies that respondent has the burden of proof in this case. Our evaluation of the evidence offered by petitioner, which we discuss below, simultaneously disposes of petitioner's arguments. First, the record before us leads us to conclude that respondent does not have the burden of proof in this case. Second, we further conclude that petitioner has failed to carry the burden of proof remaining on him. The only evidence offered by petitioner at trial was his own testimony to the effect that he did not earn or receive any income from the sale of alcohol or from any other source as asserted in the notice of deficiency during the period from 1952 through 1961, but, rather, that he was unemployed during that entire period. Petitioner testified that for this period of ten years he spent his time at home or with friends, playing cards, frequenting cafes, and the like. There was nothing more than a vague general statement to the effect that petitioner, his wife and four children were supported by various relatives who gave petitioner money and that petitioner's wife and children worked to support him and the family. None of these 62 people were called to testify or in any way corroborate petitioner's story. 998 Petitioner recounted no specifics as to how much he received in the way of support, or when or from whom such support was received. There was testimony by petitioner that his present wife, to whom he was unmarried during the years before us, operated an auto repair shop and that petitioner spent some time there, although he never worked there. However, this appears to be after the years in issue and the record is void as to how much, if any, income was derived therefrom by the second wife. Neither petitioner's present wife, nor anyone else was called to testify in corroboration or support of petitioner's story. In explaining his reason for unemployment during the ten year period, petitioner's testimony was conflicting. At times petitioner stated it was because jobs were unavailable. At times petitioner stated he could not work because of a nervous condition; yet he also stated that he actually was able to work during this period. Petitioner's entire story is questionable on its face, and its presentation was so vague, unresponsive and evasive as to render it improbable. In short, we think that petitioner's 63 testimony is not worthy of credit, and we reject it as having no probative value in this case. This Court is not bound to accept at face value uncorroborated testimony of a taxpayer where such testimony appears improbable, unreasonable or questionable. Banks v. Commissioner, 322 F. 2d 530 (C.A. 8, 1963), affirming in part and remanding in part a Memorandum Opinion of this Court; Urban Redevelopment Corporation v. Commissioner, 294 F. 2d 328 (C.A. 4, 1961), affirming 34 T.C. 845">34 T.C. 845 (1960); Commissioner v. Smith, 285 F. 2d 91 (C.A. 5, 1960), affirming a Memorandum Opinion of this Court; Factor v. Commissioner, 281 F. 2d 100 (C.A. 9, 1960), affirming a Memorandum Opinion of this Court, certiorari denied 364 U.S. 933">364 U.S. 933 (1961); Pool v. Commissioner, 251 F. 2d 233 (C.A. 9, 1957), affirming a Memorandum Opinion of this Court, certiorari denied 356 U.S. 938">356 U.S. 938 (1958); Winters v. Dallman, 238 F. 2d 912 (C.A. 7, 1956); Archer v. Commissioner, 227 F. 2d 270 (C.A. 5, 1955), affirming a Memorandum Opinion of this Court; Carmack v. Commissioner, 183 F. 2d 1 (C.A. 5, 1950), affirming a Memorandum Opinion of this Court, certiorari denied 340 U.S. 875">340 U.S. 875 (1950). This is true even where such testimony is uncontroverted. 64 Diamond Bros. Company v. Commissioner, 322 F. 2d 725 (C.A. 3, 1963), affirming a Memorandum Opinion of this Court; Banks v. Commissioner, supra; Commissioner v. Smith, supra; Factor v. Commissioner, supra; Pool v. Commissioner, supra; Archer v. Commissioner, supra.Second, it is significant that petitioner failed to offer any testimony by those from whom he claimed support or from anyone else, for that matter, who might corroborate any part of his testimony. This failure on petitioner's part reduces the probative value of petitioner's story, and we draw the inference that such testimony, if introduced, would have been adverse to petitioner's claims. Interstate Circuit v. United States, 306 U.S. 208">306 U.S. 208, (1939); Thomas E. Snyder Sons Co. v. Commissioner, 288 F. 2d 36 (C.A. 7, 1961), affirming 34 T.C. 400">34 T.C. 400 (1960), certiorari denied 368 U.S. 823">368 U.S. 823 (1961); Stoumen v. Commissioner, 208 F. 2d 903 (C.A. 3, 1953), affirming a Memorandum Opinion of this Court; Joseph F. Giddio, 54 T.C. 1530">54 T.C. 1530 (1970); Samuel Pollack, 47 T.C. 92">47 T.C. 92 (1966), affirmed 392 F. 2d 409 (C.A. 5, 1968); Wichita Terminal Elevator Co., 6 T.C. 1158">6 T.C. 1158 (1946), affirmed 162 F. 2d 513 (C.A. 10, 1947). Third, the credibility of petitioner's 65 testimony is further rendered suspect by the fact that petitioner had at least three times been the subject of Federal criminal convictions, the third one of which was for obstructing justice by way of offering money to, and threatening persons testifying as witnesses in a trial resulting in a prior conviction. We have taken these convictions into account as discrediting petitioner's testimony. Masters v. Commissioner, 243 F. 2d 335 (C.A. 3, 1957), affirming 25 T.C. 1093">25 T.C. 1093 (1956); Kilpatrick v. Commissioner, 227 F. 2d 240 (C.A. 5, 1955), affirming 22 T.C. 446">22 T.C. 446 (1954); Nathan Bilsky, 31 T.C. 35">31 T.C. 35 (1958), petition to review dismissed 271 F. 2d 414 (C.A. 8, 1959). 999 Each of these three considerations alone might serve as a basis for not accepting petitioner's story at face value. However, we have evaluated petitioner's story in the cumulative light of these considerations and we reject petitioner's testimony as unconvincing and substantially lacking in credibility. Petitioner has utterly failed to produce evidence that respondent's determination of deficiencies was arbitrary and excessive. See Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935); see also, Joseph F. Giddio, supra. Compare Federal National Bank of Shawnee, 16 T.C. 54">16 T.C. 54 (1951). 66 Indeed, respondent's determination was based on specific information developed by the prior Alcohol and Tobacco Tax Division investigation.2 Our evaluation of the evidence, discussed above, convinces us that respondent's determination of deficiencies as set forth in his statutory notice has the support of a presumption of correctness, and petitioner has the burden of proving it wrong. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 32, Tax Court Rules of Practice.367 Petitioner has failed initially to produce credible evidence to establish a prima facie showing that respondent's determination is in error so as to rebut the presumption of correctness attaching thereto, Paul J. Byrum, 58 T.C. - (Aug. 1, 1972); Joseph F. Giddio, supra.On the record before us we conclude and hold that petitioner has failed to carry his burden of proving by a preponderance of the evidence, American Pipe & Steel Corp. v. Commissioner, 243 F. 2d 125 (C.A. 9, 1957), affirming 25 T.C. 351">25 T.C. 351 (1955), certiorari denied 355 U.S. 906">355 U.S. 906 (1957), that respondent's determination of deficiencies was wrong, as he must do if he is to prevail here. Welch v. Helvering, supra; Rule 32, Tax Court Rules of Practice. We therefore must uphold respondent's determination as to the income tax deficiencies for the years in question. Issue 2. Additions to the Tax As respondent has conceded the fraud penalties, the only additions to the tax remaining against petitioner are as follows: Section 291(a), Internal Revenue Code of 1939 (failure to file a 68 return), for the years 1952 and 1953; Section 294(d)(1)(A), Internal Revenue Code of 1939 (failure to file declaration of estimated tax), for the years 1952, 1953 and 1954; section 6654(a), Internal Revenue Code of 1954 (failure to pay estimated income tax) for the years 1955 through 1961, inclusive. Petitioner has presented no evidence as to the specific issues of additions to the tax, aside from his testimony relevant to the first issue, which we have evaluated and rejected; petitioner has therefore also failed to carry his burden of proof with respect to these additions to the tax. Accordingly, we also sustain respondent's determination as to the additions to the tax as noted above. Issue 3. Admissibility of Recorded Testimony at Prior Trial At the trial of this case, respondent offered into evidence testimony contained in the record of a prior trial. As respondent has conceded the fraud issue and as we have already sustained respondent's remaining determinations because of petitioner's failure to carry his burden of proof, we find it unnecessary to rule on the admissibility of this evidence. Decision will be entered under Rule 50. Footnotes1. Paragraph 5 of the petition is, in part, as follows: The facts upon which Petitioner relies as the basis of this proceeding are as follows: (a) The taxable income as set forth for the year 1952 is not founded upon any facts or any information received from Petitioner. (b) All figures for the said year, 1952 is [sic] based upon an estimate which has no basis in fact whatsoever. [Similar allegations are made with respect to the years 1953 through 1961.] See Joseph F. Giddio, 54 T.C. 1530">54 T.C. 1530 (1970), footnote 2, wherein a similar allegation was deemed to raise the issue of whether the determination of deficiencies was arbitrary and excessive such that the burden of proof might be shifted to respondent under Helvering v. Taylor, 293 U.S. 507">293 U.S. 507↩ (1935).2. See, for example, Sam Goldstein [dec. 27,527(M)], T.C. Memo. 1965-223↩. 3. Although respondent would have the burden of proof as to the fraud penalties determined in the notice of deficiency and specifically pleaded in his answer, respondent on brief has conceded the fraud issue in this case. Even without such concession, the burden of proof with respect to the deficiencies in income tax would still rest with petitioner. Thus, the initial assertion of fraud penalties and their subsequent concession in no way disturbs petitioner's burden of proof with respect to the deficiencies in income tax. See Snell Isle, Inc. v. Commissioner, 90 F. 2d 481 (C.A. 5, 1937), affirming a Memorandum Opinion of this Court, certiorari denied 302 U.S. 734">302 U.S. 734 (1937); Henry S. Kerbaugh, 29 B.T.A. 1014">29 B.T.A. 1014 (1934), affd. per curiam 74 F. 2d 749 (C.A. 1, 1935). See also Frank Caruso, T.C. Memo 1966-190">T.C. Memo 1966-190↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621449/	C. Blake McDowell, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentC. Blake McDowell, Inc. v. CommissionerDocket No. 3852-76United States Tax Court67 T.C. 1043; 1977 U.S. Tax Ct. LEXIS 130; March 30, 1977, Filed 130 Petitioner, a personal holding company, paid deficiency dividends partly in cash and partly in other property which had a fair market value in excess of its adjusted basis in petitioner's hands. Held, sec. 1.562-1(a), Income Tax Regs., providing that the measure of the dividends-paid deduction for purposes of the personal holding company tax is the adjusted basis of the property, is valid, following Fulman v. United States, 545 F.2d 268">545 F.2d 268 (1st Cir. 1976). Held, further, despite the foregoing, the Court is required to hold for petitioner herein in view of H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033 (6th Cir. 1972), which holds to the contrary, and of the fact that an appeal herein will be to the Sixth Circuit. See Jack E. Golsen, 54 T.C. 742">54 T.C. 742, 756 et seq. (1970), affd. on the substantive issue 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). C. Blake McDowell, Jr., and Gilbert V. Kelling, Jr., for the petitioner.William P. McKeithan, for the respondent. Tannenwald, Judge. Drennen, J., concurring. Fay, J., agrees with this concurring opinion. Goffe, J., concurring. Dawson and Wiles, JJ., agree with this concurring opinion. Wilbur, J., concurring. Fay and Irwin, JJ., agree with this concurring opinion. TANNENWALD1043 OPINIONRespondent determined the following deficiencies representing personal holding company taxes asserted to be due from petitioner:YearDeficiency1972$ 12,504.18197358,740.42135 This matter is before the Court on petitioner's motion for judgment on the pleadings. Respondent has admitted all facts alleged in the petition. A hearing on petitioner's motion was conducted by Special Trial Judge Lehman C. Aarons and the Court has had the benefit of his analysis in reaching its decision.1044 Petitioner is a corporation organized under the laws of Ohio, with its principal office in Akron, Ohio, at the time of the filing of the petition herein. It timely filed Federal income tax returns for the calendar years in question with the Internal Revenue Service Center at Cincinnati, Ohio.On November 19, 1974, there was a determination, within the meaning of section 547(c), 1 that petitioner was liable for the personal holding company tax for 1972 and 1973 in the amounts of $ 15,364.13 and $ 59,383.02, respectively. Pursuant to resolution of petitioner's board of directors, timely deficiency dividends were paid to petitioner's shareholders (all of whom were noncorporate shareholders) in the amount of $ 3,881.64 in cash and in shares of stock of another corporation having an adjusted basis of $ 1,122 to petitioner and an aggregate fair market value on the dates136 of distribution of $ 102,900.Petitioner claimed a deficiency dividend deduction against its personal holding company income under section 547 measured by the fair market value of the distributed stock. Respondent determined that petitioner's deduction should be limited to its adjusted basis in respect of the property distributed, in accordance with section 1.562-1(a), Income Tax Regs., which provides:If a dividend is paid in property (other than money) the amount of the dividends paid deduction with respect to such property shall be the adjusted basis of the property in the hands of the distributing corporation at the time of the distribution. * The sole issue before us is the validity of the foregoing regulation. It is a case of first impression for this Court, although the identical issue has been the subject of conflicting decisions by two Courts of Appeals. 137 Fulman v. United States, 545 F.2d 268 (1st Cir. 1976), sustaining the validity of the regulation, and H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033 (6th Cir. 1972), holding the regulation invalid and sustaining the position taken by the petitioner herein. 21045 The standards for determining the validity of respondent's regulations are well established:138 Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and * * * they constitute contemporaneous construction by those charged with administration of these statutes which should not be overruled except for weighty reasons. * * * [Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496, 501 (1948).]Examining the statutory framework, we find that section 541 imposes a special tax on "undistributed personal holding company income (as defined by section 545)." Because a substantial purpose of this tax is to preclude the sheltering of substantial investment income in a corporate entity without distribution thereof to the individual shareholders (see, generally, Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.20 (3d ed. 1971)), section 545 defines undistributed personal holding company income as a corporation's taxable income after certain adjustments. Included in such adjustments is a deduction for "dividends paid * * * as defined in section 561." Similarly, section 547(a) provides for a deduction for deficiency dividends and section 547(d) defines deficiency dividends139 as "the amount of the dividends paid * * which would have been includible in the computation of the deduction for dividends paid under section 561 for the taxable year with respect to which the liability for personal holding company tax exists, if distributed during such taxable year." Section 561(a)(1) provides for a deduction of "the dividends paid during the taxable year" and section 561(b) provides that "in determining the deduction for dividends paid, the rules provided in section 562 * * * shall be applicable." Completing the framework is section 562(a), which provides:(a) General Rule. -- For purposes of this part, the term "dividend" shall, except as otherwise provided in this section, include only dividends described in section 316 (relating to definition of dividends for purposes of corporate distributions).Thus, even after undistributed personal holding company income has been determined, the corporate taxpayer can reduce or eliminate the sting of its tax liability in respect 1046 thereof by distributing a "deficiency dividend" as defined in section 547(d) for which it is entitled to a deduction under section 547(a) in computing its personal holding company140 tax.Neither section 561 (together with its definitional followup in section 562) nor section 547, providing for the dividends paid deduction and the deficiency dividends deduction, respectively, expresses any valuation procedure for determining the amount of the deduction for dividends in kind. 3Section 562 explains that, in order to be a deductible "dividend," a distribution must be a dividend described in section 316. That section merely defines dividends by reference to their source of payment; 4 dividends are distributions from earnings and profits or, in the case of personal holding companies, "any distribution of property * * * made by the 1047 corporation to its shareholders, to the extent of its undistributed personal holding company income." See sec. 316(b)(2)(A).141 H. Wetter Manufacturing Co. v. United States, supra, concluded that, by this language, Congress clearly and unambiguously provided for a dividends-paid deduction 5 in the amount of the fair market value of the property distributed, when such language is read in conjunction with section 301, which provides that the amount of a dividend in kind to a noncorporate distributee is its fair market value in the distributee's hands.We think neither section 316 nor section 301 compels this result. The language of section 316 upon which the Sixth Circuit focuses derives from section 186 of the Revenue Act of 1942, ch. 619, 56 Stat. 798, 895-896, which added the language to section 115(a) of the Internal Revenue Code of 1939. The reason for the addition of such language to the tax laws was merely to provide a source for dividend distributions by a personal holding company other than its earnings and profits. Because of differences in the computation of ordinary net 142 income and undistributed personal holding company income, the possibility that a corporation could have undistributed personal holding company income in excess of earnings and profits meant that such corporation could not mitigate its personal holding company tax liability by making distributions if such distributions exceeded earnings and profits and did not qualify as taxable dividends in the recipient shareholders' hands. To remedy this "anomalous" result, Congress provided an additional source of dividend distributions to personal holding companies. See H. Rept. No. 2333, 77th Cong., 2d Sess. 53, 136-137 (1942), 2 C.B. 372">1942-2 C.B. 372, 414, 473; S. Rept. No. 1631, 77th Cong., 2d Sess. 176-177 (1942), 2 C.B. 504">1942-2 C.B. 504, 634-635.The addition of this provision to the revenue laws had no effect upon the amount of a dividend distribution to be taken into account by a distributing personal holding company in computing what was then a dividends-paid credit. A specific statutory section (sec. 27(d), I.R.C. 1939) already provided:1048 Dividends in Kind. -- If a dividend is paid in property other than money * * * the amount143 with respect thereto which shall be used in computing the basic surtax credit shall be the adjusted basis of the property in the hands of the corporation at the time of the payment, or the fair market value of the property at the time of payment, whichever is the lower.Contemporaneously, section 506(c) of the Internal Revenue Code of 1939 specified that "the term 'deficiency dividends' mean the amount of the dividends paid * * which are includible * * * in the computation of the basic surtax credit for the year of distribution."Further, prior to 1942, Congress enacted section 115(j) of the 1939 Code, which provided that in the hands of a shareholder a dividend in kind was measured by fair market value at the time of distribution.It is thus apparent that, from 1942 until 1954, sections 27(d), 115(a) and (j), and 506(c) of the 1939 Code existed side by side. It cannot be gainsaid that, if these provisions, and particularly sections 27(d) and 506(c) of the 1939 Code, had all been specifically incorporated into the 1954 Code revision, the issue involved herein would not have arisen and respondent's regulation would unquestionably set forth the correct rule. The difficulty arises144 because this did not occur. The provisions of old section 115(a) and (j) found their way into sections 316(b)(2)(A) and 301(b)(1)(A), respectively, of the 1954 Code. Neither old section 27(d) nor the cross reference language of section 506(c) was specifically set forth in the new Code.The question, therefore, is whether the fact that these two latter sections did not find an in haec verba place in the 1954 revision sufficiently reveals a legislative intention to overturn the previously existing rule. We think not. Indeed, what little evidence is contained in that history points in the opposite direction. Thus, in discussing section 562, the House Ways and Means Committee stated (H.Rept. No. 1337, 83d Cong., 2d Sess. A181 (1954)):Subsection (a) provides that the term "dividend" for purposes of this part shall include, except as otherwise provided in this section, only those dividends described in section 312 (relating to definition of dividends for purposes of corporate distributions). The requirements of sections 27(d), (e), (f), and (i) of existing law are incorporated in the definition of "dividend" in section 312, and accordingly are not restated in section 562.145 [Emphasis added.]1049 The Senate Finance Committee made an almost identical statement (S. Rept. No. 1622, 83d Cong., 2d Sess. 325 (1954)):This section conforms to section 562 of the House bill except for a clerical amendment.Subsection (a) provides that the term "dividend" for purposes of this part shall include, except as otherwise provided in this section, only those dividends described in section 316 (relating to definition of dividends for purposes of corporate distributions). The requirements of sections 27(d), (e), (f), and (i) of existing law are contained in the definition of "dividend" in section 312, and accordingly are not restated in section 562. [Emphasis added.]Because section 312 of the House bill became section 316 of the Internal Revenue Code of 1954, there has been some speculation as to whether there was a typographical error in the second reference of the Senate report. See Fulman v. United States, 545 F.2d at 270 n.2, as well as the discussion in the District Court opinion (see 407 F.Supp. at 1039 n.5 (D. Mass. 1976)). In our view, it is unnecessary, for the purposes of decision herein, 146 to resolve the editorial or printing conundrum thus posed. Clearly, any confusion thereby created cannot be said to evince an intent on the part of Congress to change or eliminate the rule laid down by section 27(d) of the 1939 Code. Indeed, whether Congress was referring to section 312 or section 316, the committee language that "the requirements of [section] 27(d) * * * of existing law are incorporated [contained]" not only does not hint of any change but indicates the belief that the old rule would continue to be applied.Moreover, such change or elimination would have been a substantial departure from the prior treatment of personal holding companies. At least where the adjusted basis of distributed property is less than its fair market value at the time of distribution, personal holding companies would have been treated far more generously than in the past and the aggregate tax bite could have been sharply reduced by making deficiency dividends in kind. Certainly, Congress has not otherwise indicated its intent to extend such generous treatment to personal holding companies.A further indication of the consistency of the "adjusted basis" rule with the current statutory pattern147 is the "consent dividend" provision contained in section 565. Under that provision, Congress has indeed prescribed a way in which a 1050 personal holding company may retain its realized earnings and still escape the impact of the penalty tax. But, under the consent dividend procedure, the shareholder pays the full tax at the individual level and ends up with nothing in his pocket other than a receipt for a capital contribution in the amount of the dividend that he did not in fact receive. The disposition sought by the petitioner here, if finally sanctioned by the courts, would enable a personal holding company (such as a family investment company) to retain its realized earnings in a far less painful manner, i.e., by actually distributing its appreciated securities and still having its retained earnings as working capital for further investments -- without paying the penalty tax. Such a result should not prevail unless clearly mandated by the statute.Thus, we are satisfied that sections 316 and 301 do not justify overturning respondent's regulations. Those sections had their genesis in the comparable provisions of the 1939 Code, which could not have enunciated any valuation148 procedure for a personal holding company dividends-paid deduction since a separate section articulated the statutory yardstick. Nothing in the legislative history indicates that sections 316 and 301 should be accorded an interpretation which would establish an entirely new measuring rod. In short, such sections do no more than had been done historically, namely, define dividends in respect of source of payment and determine the extent of a distributee shareholder's receipt.Nor are we convinced that section 312(a)6 necessarily provides the touchstone for decision. See Fulman v. United States, supra. That section prescribes adjusted basis as the appropriate measure of the charge to corporate earnings and profits for distributions in kind. The only significance of section 312 is that, unlike sections 316 and 301, it concerns the effect of a dividend on the earnings and profits of distributing corporations. Since section 312 is applicable to corporations generally and most corporations (unlike personal 1051 holding companies) merely account for but do not deduct dividends paid, it offers only indirect assistance in answering the question before149 us, although we believe it fair to observe that it has a greater bearing than either section 316 or 301.We are unimpressed by the argument, essentially grounded on policy considerations, that so long as the distributee is taxed on the full value of the distribution, the distributing corporation should be allowed a deduction for the same amount. This argument was available prior to 1954 and yet for more than a decade Congress saw fit to measure the deduction in terms of the distributing corporation's investment rather than the distributee's taxable receipt. Indeed, there150 is a discernible rationale that this was done to effectuate a countervailing policy of taxing or forcing distribution of income rather than unrealized appreciation. See Fulman v. United States, supra.Cf. Ivan Allen Co. v. United States, 422 U.S. 617">422 U.S. 617 (1975). Under these circumstances, we can perceive no basis for concluding that respondent's regulation is so unrealistic as to be unreasonable. Cf. United States v. Cartwright, 411 U.S. 546">411 U.S. 546 (1973).In sum, we are confronted with a situation where the Code is silent in terms of a specific direction in respect of the issue before us and the legislative history is at most ambiguous. Respondent's regulations represent a contemporaneous construction of the 1954 Code; they have been in effect since 1958 7151 and are substantially a continuation of prior law. 8 In this context and applying the standard set forth in Commissioner v. South Texas Lumber Co., 333 U.S. 496 (1948) (see p. 1045 supra), we conclude that the validity of respondent's regulation should be sustained.Our conclusion does not, however, dictate that petitioner's motion should not be granted. An appeal from our decision herein lies to the Sixth Circuit Court of Appeals and that court has already decided the issue involved herein and invalidated respondent's regulation. H. Wetter Manufacturing Co. v. United States, supra.In accordance with the policy enunciated in Jack E. Golsen, 54 T.C. 742">54 T.C. 742, 757 (1970), affd. on 1052 the substantive issue 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), we have articulated our views on the merits, even though we are mandated by Golsen to apply the rule of Wetter herein. Cf. Of Course, Inc., 59 T.C. 146">59 T.C. 146, 148 (1972), revd. on substantive grounds 499 F.2d 754">499 F.2d 754 (4th Cir. 1974), where there was a conflict among152 the Courts of Appeals and we took issue with the Court of Appeals to which the appeal therein lay, adhered to our previously expressed position which that court had previously reversed, and persuaded the Court of Appeals to change its position.In accordance with the foregoing, petitioner's motion for judgment on the pleadings will be granted.An appropriate order and decision will be entered. DRENNEN; GOFFE; WILBURDrennen, J., concurring: I agree with the result reached in the majority opinion because it is mandated by the rule established by Jack E. Golsen, 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), and the conclusion reached by the Sixth Circuit in H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033 (6th Cir. 1972), since an appeal from this case would lie in the Sixth Circuit. However, I do not necessarily agree with the conclusion reached by the majority opinion on the merits of the issue presented, and I believe it is unfortunate that we have chosen this case to express for the first time the views153 of this Court on that important and complex issue. It would be difficult to determine from the vote on the majority opinion how many Judges voted favorably because of the Golsen rule and how many voted favorably on the treatment of the issue involved. I prefer to reserve judgment on the merits of the issue and have it considered by this Court in a case wherein the result is not foreordained by the Golsen rule and there would be more incentive for the petitioner and the Judges of this Court to argue the merits of the issue.1053 Goffe, J., concurring: I agree with the majority that petitioner's motion for summary judgment must be granted by reason of the policy enunciated in Jack E. Golsen, 54 T.C. 742">54 T.C. 742, 757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), because an appeal in the instant case would lie to the Sixth Circuit which has decided the identical issue favorably to petitioner. H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033">458 F.2d 1033 (6th Cir. 1972). Because the majority has undertaken to express this Court's view as to Wetter and the conflicting view of the First154 Circuit in Fulman v. United States, 545 F.2d 268">545 F.2d 268(1st Cir. 1976), it is incumbent upon me to express the view that Wetter is correct in order that there be no misapprehension that the view of the Tax Court is unanimous.The majority, following Fulman, bases its analysis on murky legislative history occurring in 1939. The primary fault in such analysis is that it does not go back far enough in the legislative history. Moreover, it is not consistent with the overall purpose of the personal holding company tax. An analysis of the purpose and complete history of the personal holding company tax, on the other hand, amply supports a finding that section 1.562-1(a), Income Tax Regs., is invalid in holding that the dividends-paid deduction is limited in amount to the basis of the property in the hands of the personal holding company, rather than its fair market value. Wetter, therefore, reaches the proper result and the Tax Court should follow Wetter, and Gulf Inland Corp. v. United States, an unreported case ( W.D. La. 1975, 36 AFTR 2d 75-5511, 75-2 USTC par. 9620), on appeal to the Fifth Circuit. 155 The present personal holding company tax and the accumulated earnings tax are codified in part I, subchapter G of the Internal Revenue Code of 1954, entitled Corporations Used to Avoid Income Tax on Shareholders. The dividends-paid deduction, with which we are concerned here, and the dividends-paid deduction used in computing "accumulated taxable income" for the accumulated earnings tax are both determined under section 561 of the Code. The codification under such common heading and use of the same section (561) for the dividends-paid deduction is not accidental. The two penalty taxes were enacted to prevent individuals in high surtax brackets from shielding their personal income from higher individual rates through the use of a corporate device 1054 which enabled taxation of that income at the flat corporate rates. The accumulated earnings tax, enacted in the Revenue Act of 1921, required a finding of a tax-avoidance purpose in the accumulation; thus it was inadequate to attack the "incorporated pocketbooks." Congress responded in 1934 with the personal holding company tax. Clearly, therefore, the purpose of the personal holding company tax was to strengthen the means 156 of taxing certain undistributed corporate earnings at rates above the corporate tax rates. Maryland Land & Transportation Corp., 40 B.T.A. 1067">40 B.T.A. 1067, 1068 (1939). The personal holding company tax, automatic and drastic in operation, sought to prevent tax avoidance described as follows by Sherman in "Taxation of Corporations Used to Avoid Taxes Upon Stockholders," 13 Taxes 19">13 Taxes 19, 20 (1935):Essentially this method of tax avoidance does not effect a complete avoidance of tax on the part of the individual stockholder, but merely a postponement or deferment of part of the tax. For, if the holding company should distribute its earnings or surplus in future years, the stockholder would then have to pay a surtax on the dividends that he received. However, a complete or partial avoidance of tax may ensue upon the happening of any of the following events:1. If the corporation should spread the distribution of its annual income over a series of years, a real saving in tax would accrue to the stockholder from the mere fact that his distributive share of the income would fall in the lower surtax brackets.2. If the corporation should time the distribution of its income157 so that it is made during a year when the stockholder has personal losses or other deductions to offset against the dividend received, a real saving in tax would result.3. If there should be a reduction in tax rates upon individual incomes during any future year, the distribution of the corporate income in such year would result in an actual saving to the stockholder.4. If the corporation should incur any losses on its investments or otherwise, which deplete the earnings or surplus accumulated during preceding years, there will be an avoidance of tax, for the Government will be deprived of the surtax which the stockholder would have had to pay, had the corporation made a distribution of its annual income in the year when the same was earned. * * Sanford Corp. v. Commissioner, 106 F.2d 882">106 F.2d 882, 883 (3d Cir. 1939), affg. 38 B.T.A. 139">38 B.T.A. 139 (1938), cert. denied 309 U.S. 659">309 U.S. 659 (1940).When the personal holding company tax was enacted in the Revenue Act of 1934, two deductions were allowed from "adjusted net income": (1) An arbitrary allowance of 10 1055 percent to allow the corporation a reserve for158 contingencies and (2) a deduction for dividends paid to prevent the additional tax from applying to sums actually distributed. H. Rept. No. 704, 73d Cong., 2d Sess. 11 (1934). The term "actually distributed" clearly indicates an intent to allow the dividends-paid deduction to the extent of the fair market value of the property because the recipient must report that amount as dividend income. See sec. 301, I.R.C. 1954.In 1936, an undistributed profits surtax on all corporations was enacted. The House version of the bill eliminated the personal holding company tax and in the House version section 27 was proposed. It defined the dividends-paid credit for purposes of the undistributed profits tax, allowing a credit for dividends paid in the amount of the basis or fair market value of the property, whichever is lower. The House Ways and Means Subcommittee included the following example to demonstrate how tax was being avoided:Case No. 4Corporation A owns all the stock of Corporation B. Corporation B has a surplus of $ 1,000,000 and included among its assets are distillers' warehouse receipts, which cost it $ 100,000, but which are now worth $ 500,000. It is desired to sell159 these warehouse receipts without the payment of any tax. This can be done in the following manner:Corporation B distributes the warehouse receipts to Corporation A by declaring a dividend in kind. This being a dividend from one corporation to another, corporation A pays no tax upon its receipt.The cost basis for these warehouse receipts in A's hands is now $ 500,000. A sells the warehouse receipts for $ 500,000 (its costs basis) and, therefore, pays no tax on the sale. [Report, Ways and Means Subcommittee, 73d Cong., 2d Sess., H. Rept. Dec. 4, 1933, at 40.]See Broenen & Preston, "Undistributed PHC Income: The Sixth Circuit in H. Wetter Mfg. Co. Is Historically Sound," 2 J. Corporate Taxation 69, 72 (1975). It is apparent that the example does not apply to the personal holding company tax because the recipient of a dividend from a personal holding company is taxed on the dividend at its fair market value.When the bill which became the Revenue Act of 1936 reached the Senate, the personal holding company tax was restored and section 27, which was drafted to apply to the undistributed profits tax, became applicable to the personal holding company tax. Curiously, however, 160 there is nothing in the committee reports to indicate why it was made applicable 1056 or why such an important change in the former rule was made. S. Rept. No. 2156, 74th Cong., 2d Sess. (1936). The undistributed profits tax continued until 1939 and section 27 found its way into the Internal Revenue Code of 1939 without any indication of congressional intent. It was not, however, included in the Internal Revenue Code of 1954. Indeed, section 562, I. R. C. 1954, conforms to the original personal holding company tax provisions of the Revenue Act of 1934.To hold that section 562 allows the deduction only to the extent of the basis (as sec. 1.562-1(a), Income Tax Regs., provides) because the earnings and profits of the personal holding company are reduced by the adjusted basis of the property ( sec. 312(a)(3), I.R.C. 1954) is not consistent. Section 312(b)(3) provides for a reduction of earnings and profits only to the extent of the basis of the property distributed, regardless of its fair market value. Section 321 is merely a device to provide a source for dividends at the shareholder level; it provides no useful analogy in resolving whether a tax should be levied at the corporate161 level. Moreover, the fallacy in the reasoning of the majority and the Court of Appeals in Fulman v. United States, supra, is, what happens if the personal holding company distributes property which has a fair market value lower than its basis? The shareholder would report the fair market value as dividend income and, applying section 1.562-1(a), Income Tax Regs., the corporation would receive a dividends-paid deduction in the amount of the basis. Thus, the personal holding company would receive a dividends-paid deduction in excess of the dividend reported by the shareholder. This demonstrates the need that the interpretation of section 562 must coincide with section 301(b)(1) and fair market value must be the measure to the personal holding company for its deduction just as it measures the amount of dividend income to the noncorporate shareholder.The precise question of distribution of property which has depreciated in value was before this Court in General Securities Co., 42 B.T.A. 754">42 B.T.A. 754 (1940), affd. 123 F.2d 192">123 F.2d 192 (10th Cir. 1941). That case involved interpretation of the personal holding162 company tax as it existed in 1934, which in this regard is no different from the way it exists at the present time. The taxpayer personal holding company distributed property to its shareholders having a fair market value of 1057 $ 1,068.33 but a basis of $ 110,654.64. The taxpayer claimed a dividends-paid deduction for the property distributed of $ 110,654.64, which the Commissioner disallowed. We held that the dividends-paid deduction was allowable only in the amount which the shareholders were required to report as dividend income, $ 1,068.33. We examined the legislative history and purposes of the personal holding company tax.We think the Congressional reports from which we have quoted show that it was the intent of Congress that a personal holding company coming within the provisions of the act should receive a deduction against its "adjusted net income" for "dividends paid" of an amount equal to the amount of such dividends taxable to the stockholders. If this were not true, petitioner would receive a deduction for dividends paid of $ 103,898.17, which would be taxable to the stockholders only to the extent of $ 1,068.33. This result, we think, would be contrary163 to the intent of Congress.In Foley Securities Corporation, 38 B.T.A. 1036">38 B.T.A. 1036, in discussing the House committee report on H.R. 7835, we said, among other things:"But the report continues: 'The stockholders will, of course, be subject to the graduated surtaxes upon such distributions', which demonstrates that the distributions referred to were those on which the stockholders would be taxable."We went on to hold in that case that, of a distribution of $ 42,375 which the taxpayer made to its stockholders in the taxable year 1934, only $ 26,258.97 could be deducted in computing the taxpayer's "undistributed adjusted net income" under section 351(b) because only that amount was a taxable dividend to the stockholders.In the instant case, regardless of the cost of the stock which petitioner distributed to its stockholders in 1934 and regardless of the way it entered it on its books, only $ 1,068.33 can be taxed to the stockholders, and we hold that is all that petitioner can deduct as "dividends paid" in computing its "undistributed adjusted net income." Petitioner argues that it could have sold the stock to outsiders for $ 1,068.33 and distributed that164 amount of cash to its stockholders and in that way could have realized a loss of the difference between its adjusted cost and the selling price and could have deducted this loss on its income tax return and the same tax result would have been attained as petitioner contends for in the present proceeding. Perhaps that is true, but it takes no argument to establish the proposition that tax consequences are frequently very different on one state of facts from what they are on another state of facts. So it is in the instant case.Congress has prescribed how a personal holding company shall be taxed and what deductions it shall receive in determining its "undistributed adjusted net income" and we must give effect to those provisions even though the taxpayer personal holding company might have avoided the surtax if it had handled its transactions in some other way. [42 B.T.A. at 758. Emphasis added.]1058 In affirming our decision the 10th Circuit specifically agreed with our analysis that the amount of the dividends-paid deduction should coincide with the amount reported by the shareholders as dividends.The reason for the allowance of the dividend165 deduction is that the shareholder, provided he receives income in the requisite amount, is subject to graduated surtaxes on the dividends distributed to him, and it would be unfair also to subject dividends to a surtax against the corporation. 4General Securities Co. v. Commissioner, 123 F.2d 192">123 F.2d 192, 194 (10th Cir. 1941).In Foley Securities Corp., 38 B.T.A. 1036">38 B.T.A. 1036 (1938), again interpreting the 1934 personal holding company tax, we had to decide whether the personal holding company should be allowed a dividends-paid deduction for dividends which were not taxable in full to its shareholders because of the lack of earnings and profits. We held that the dividends-paid deduction provision and the provision requiring inclusion of dividends in the shareholders' income were in pari materia and that "On such distributions out of current income as are not166 taxable to the shareholders because of the definition of 'dividend' in section 115(a), that purpose can only be effectuated by giving the term dividend the same interpretation and imposing the surtax on the corporation." (38 B.T.A. at 1038.)Finally, the Court of Appeals in Fulman and the majority herein find some justification for the result they would reach by noting that the regulations would prevent the distribution of accumulated gain; we can perceive no reason in logic or policy why such a distribution should be prevented. The personal holding company mechanism does not mandate a distribution of currently earned income; rather, a tax is imposed on "undistributed personal holding company income." Thus a corporation with substantial taxable income may not need to make a dividend distribution if it has a section 564 dividend carryover; in the same vein a corporation with little taxable income may have to make such a 1059 distribution if its taxable income reflects a section 243 dividend-received deduction. See Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.25, p. 8-51 (3d ed. 1971).It is clear, therefore, 167 that we interpreted the 1934 Act to mean that the amount of the dividends-paid deduction should equal the amount of the dividend reported by the shareholders and that the limitation on the dividends-paid deduction to the fair market value or basis, whichever is lower, was never intended to apply to the personal holding company tax. If any conclusion can be reached as to why Congress deleted the limitation when it enacted the 1954 Code, it is probably because it never should have been applied to the personal holding company tax. Accordingly, I agree with the result reached by the Sixth Circuit in H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033">458 F.2d 1033 (6th Cir. 1972).Wilbur, J., concurring: I concur on the basis of Jack E. Golsen, 54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). On the facts before us, petitioner has little incentive to do more than simply cite Golsen and H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033">458 F.2d 1033 (6th Cir. 1972), which as the majority recognizes, requires that petitioner's motion for judgment on the pleadings168 be granted. Nevertheless, the majority states, "we have articulated our views on the merits, even though we are mandated by Golsen to apply the rule of Wetter herein."The majority discusses no exigencies requiring that we include gratuitous essays in our opinions volunteering our views on the validity or invalidity of the regulations. Whatever value may accrue from this practice is far outweighed by the disadvantages of locking ourselves into a position on an important issue not really addressed by the adversary process in the proceedings before this Court. Footnotes1. Unless otherwise stated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue.↩2. The issue involved herein is also pending in the Fifth Circuit. See Gulf Inland Corp. v. United States, F.Supp. (W.D. La. 1975), on appeal (5th Cir., Oct. 14, 1975). We note that Wetter dealt with a deduction under sec. 561 for a current dividend in kind rather than a deficiency dividend as is the case in Fulman and herein. But respondent's regulation is equally applicable to deductions for dividends paid under sec. 561 and sec. 547 (see sec. 1.547-2(a)(3), Income Tax Regs.↩), the only difference between the two types of dividends being the time when they are paid.3. The former section speaks of a deduction for "the sum" of various dividends; the latter speaks of a deduction for "the amount of deficiency dividends."↩4. The pertinent portions of sec. 316 are:SEC. 316. DIVIDEND DEFINED.(a) General Rule. -- For the purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders -- (1) out of its earnings and profits accumulated after February 28, 1913, or(2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution is, under any provision of this subchapter, treated as a distribution of property to which section 301 applies, such distribution shall be treated as a distribution of property for purposes of this subsection.(b) Special Rules. -- * *(2) Distributions by personal holding companies. -- (A) In the case of a corporation which --(i) under the law applicable to the taxable year in which the distribution is made, is a personal holding company (as defined in section 542), or(ii) for the taxable year in respect of which the distribution is made under section 563(b) (relating to dividends paid after the close of the taxable year), or section 547 (relating to deficiency dividends), or the corresponding provisions of prior law, is a personal holding company under the law applicable to such taxable year,the term "dividend" also means any distribution of property (whether or not a dividend as defined in subsection (a)) made by the corporation to its shareholders, to the extent of its undistributed personal holding company income (determined under section 545 without regard to distributions under this paragraph) for such year.↩5. See n. 2 supra↩.6. SEC. 312. EFFECT ON EARNINGS AND PROFITS.(a) General Rule. -- Except as otherwise provided in this section, on the distribution of property by a corporation with respect to its stock, the earnings and profits of the corporation (to the extent thereof) shall be decreased by the sum of -- (1) the amount of money,(2) the principal amount of the obligations of such corporation, and(3) the adjusted basis of the other property, so distributed.↩7. T.D. 6308, 2 C.B. 279">1958-2 C.B. 279↩, 313, 338-339.8. Where fair market value exceeds adjusted basis, the regulations adopt the old rule. Where fair market value is less than adjusted basis, respondent would allow a larger deduction than that permitted under prior law.↩4. Report of the Ways and Means Committee of the House, H. Rep. No. 704, 73d Cong., 2d Sess., pp. 11, 12 (1939-1 Cum. Bull., Part 2, 554, 563); Report of the Senate Committee on Finance, S. Rep. No. 558, 73d Cong., 2d Sess., pp. 13-15 (1939-1 Cum. Bull., Part 2, 586, 596).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621451/	JOHN T. GRIFFITHS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGriffiths v. CommissionerDocket No. 27872-89United States Tax CourtT.C. Memo 1991-55; 1991 Tax Ct. Memo LEXIS 70; 61 T.C.M. (CCH) 1880; T.C.M. (RIA) 91055; February 12, 1991, Filed 70 Decision will be entered for the respondent. John T. Griffiths, pro se. Steven B. Bass, for the respondent. COUVILLION, Special Trial Judge. COUVILLIONMEMORANDUM OPINION This case was heard pursuant to section 7443A(b)(3) 1 and Rule 180 et seq. Respondent determined a deficiency of $ 3,060.51 in Federal income tax for petitioner's 1985 tax year. The only issue for decision is whether petitioner is entitled to a deduction of expenses incurred while "away from home" within the meaning of section 162(a)(2). Other adjustments in the notice of deficiency were agreed to in the audit, prior to issuance of the notice of deficiency. The parties stipulated to some of the facts, and these facts, with the annexed exhibits, are so found and incorporated herein by reference. In his petition, petitioner71 alleged he was a resident of El Paso, Texas. At trial, however, petitioner testified that this allegation was in error. The El Paso, Texas, address was that of his Certified Public Accountant, who was assisting petitioner with this case. Petitioner testified that his legal residence at the time he filed his petition was La Canada, California. Petitioner is a business and management consultant. Although his education is in chemistry, he developed considerable experience over the years with various employers in resolving management and business problems. Since 1971, he concentrated his activities to consultation, most of the time in a self-employed capacity, and at times as an employee of a business. He described his work as that of a "business doctor," advising businesses in serious financial distress. He would attempt to find and isolate the problem, then recommend steps to solve the problem. Sometimes a solution to a business problem was to steer the business into voluntary bankruptcy, such as a chapter 11 reorganization, with the objective of posturing the business into a sale or merger with a healthy ongoing concern. In late 1984, after petitioner had completed work for72 a client at Austin, Texas, he was contacted by a former client at El Paso, Texas, Elias Brothers Construction Company, Inc. (the company), for assistance with management and business problems the company was having. The company was a utility construction contractor and, even though the company had numerous contracts, it was having nepotism and quality control problems. Petitioner's assistance was sought to either restore the company to a profit status or position it for a merger or sale. Petitioner accepted the offer to assist the company and worked 302 days during 1985 for the company, concluding the job in late 1985. During this time, he lived in various motels in El Paso except, occasionally, when he was out in the field on some of the company's contract sites. For his services during 1985, petitioner was paid $ 23,685. On his 1985 return, petitioner's total earnings as a consultant were $ 43,526; however, the amounts in excess of the $ 23,685 paid by the company represented payments petitioner received from other clients for services rendered prior to 1985. Petitioner reported his consultation activity as a trade or business for Federal income tax purposes on Schedule C73 of his return. For his living expenses incurred at El Paso during 1985, petitioner claimed a deduction for lodging expenses of $ 9,268 and meals of $ 5,136. In the notice of deficiency, respondent disallowed $ 7,248 of the lodging expenses and $ 4,147 of the meals expenses on the ground that El Paso, Texas, was petitioner's tax home during 1985; therefore, petitioner was not away from home within the meaning of section 162. At trial, counsel for respondent conceded that all disallowed amounts had been properly substantiated but denied deductibility for the reasons set out in the notice of deficiency. Petitioner contends that El Paso, Texas, was not his home during 1985. Respondent's determinations in the notice of deficiency are presumed correct and petitioner bears the burden of proving otherwise. ; Rule 142(a). Section 162(a)(2) allows a taxpayer to deduct traveling expenses, including amounts expended for meals and lodging, if such expenses are (1) ordinary and necessary; (2) incurred while "away from home"; and (3) incurred in the pursuit of a trade or business. ; . If such expenses are not incurred away from home, such expenses are considered nondeductible personal, living, or family expenses under section 262. The concept of "home" in tax cases generally arises where the taxpayer lives in one city and works in another city. Generally, when a taxpayer has a home in one city and works in another city, the expenses of traveling to and from the city in which the taxpayer resides are not incurred in pursuit of a trade or business. . Rather, such expenses are nondeductible personal living expenses under section 262 resulting from the taxpayer's decision to maintain a residence in a place other than the city in which the employment or business is located. . A "home" for purposes of section 162(a)(2), therefore, means the vicinity of the taxpayer's principal place of business whenever the personal residence of the taxpayer is not in the same vicinity as the place of employment. ; , affd. en banc . A recognized exception to this rule, however, exists where the taxpayer's employment is temporary as opposed to indefinite in duration. ; . If the employment is temporary, the tax home is considered to be the place of the taxpayer's residence; whereas, if the employment is indefinite, the tax home is the location of the employment. . Whether employment is temporary or indefinite is a question of fact. . No single element is determinative of the ultimate factual issue of temporariness, and there are no rules of thumb, durational or otherwise. . The mere fact that employment lacks permanence does not make that employment temporary. . Employment 76 is considered "temporary" only if termination within a short period of time can be logically expected and foreseen. Conversely, employment is considered "indefinite" if termination cannot be expected or foreseen within a fixed or reasonably short period of time. ; , affg. ; , affd. . Moreover, employment which is originally temporary may become indefinite due to changed circumstances, or simply by the passage of time. ; ; ; . Traveling expenses relating to an "indefinite" job are not deductible regardless of how justified the taxpayer may be from a personal perspective in maintaining a residence away from where his business is located. 77 , affd. per curiam . At the time petitioner accepted the consultation job with his client at El Paso, it was his understanding that he would be there one or two months, perhaps less "if the money runs out." After he commenced assisting the company, certain assets were liquidated which provided sufficient cash to allow the company to continue in business and allowed petitioner's work to continue. He concluded his work for the company in late 1985, when both he and officers of the company felt that petitioner had accomplished as much as could be accomplished. When questioned at trial as to whether he had been engaged by the company for a specific time period, petitioner replied "no" and that neither he nor the company had any idea as to how long his assistance would be required. The only factor which supported the notion that his employment might be brief was the "strong possibility of it [the company] being shut down and padlocked." This contingency did not occur while petitioner was engaged in his consultation work with his client. Although a taxpayer may discharge the burden78 of proof in establishing that a job is temporary by showing that "termination within a short period could be foreseen," , the taxpayer fails to carry the burden where "termination [could not have been] foreseen within a fixed or reasonably short period of time," . The record here establishes that petitioner's termination could not be foreseen within a fixed or reasonably short period of time. Even if petitioner's termination could be reasonably foreseen within a fixed or reasonably short period of time, circumstances did change in the company through its realization of cash from asset liquidations, which allowed petitioner's work to continue indefinitely. ; . Petitioner argued that, although he once had his residence at El Paso, Texas, his marriage terminated there in 1980 and, because of unpleasant memories associated with his divorce, he vowed never again to live at El Paso. The only reason, therefore, why he was in El Paso during 198579 was because of his client and for no other reason. In , affd. , this Court held that, while the subjective intent of the taxpayer is considered in determining the tax home, for purposes of section 162(a)(2), this Court and other courts consistently have held that objective financial criteria bear a closer relationship to the underlying purpose for the deduction. In , this Court stated that the determination of a taxpayer's home is not based upon where the taxpayer's heart lies. The facts and circumstances of this case, therefore, do not sustain a finding that petitioner's activity at El Paso, during 1985, was temporary. Even if the record would sustain such a finding, there is an additional requisite which must be met under section 162(a)(2), and that is the taxpayer must establish that he had a home to be away from in order to justify the deduction for expenses away from home. ; . 80 The rationale for this rule is to ease the burden on taxpayers who, because of their jobs, are required to incur extra expenses for meals and lodging above and beyond the expense of maintaining their homes; it reflects congressional concern both for unavoidable duplication of expenses and for the fact that meals and lodging are more costly for a person who must travel than they are for a person who can maintain a year-round home. . Where the taxpayer is unable to establish that he had a "home" to be "away from," the taxpayer's home is considered to be wherever he happens to live at any given time. , affg. a Memorandum Opinion of this Court; , cert. denied ; . During the audit of petitioner's 1985 tax return, petitioner represented to respondent's agent that his home was at Gilla, New Mexico. On Schedule C of his 1985 income tax return, petitioner also listed81 Gilla, New Mexico, as the location of his business. However, at trial, petitioner testified that this was incorrect. He once lived at Gilla, New Mexico, some two and one-half years earlier; however, during 1985, he laid claim to two homes: One at Cheshire, England, and the other at La Canada, California. He admitted that he did not own homes at either of these locations; however, he testified he spent substantial amounts maintaining these homes. He did not indicate the nature of his maintenance expenses nor the amounts he spent. Nor did petitioner establish other factors which would establish a residential connection to either California or England, such as visits to his claimed residences and the frequencies thereof, where he voted, where he maintained bank accounts, where he registered his motor vehicle, whether he paid local taxes there, or any other significant relationship which would show that petitioner's home or homes were in either or both of the claimed locations. During 1985, petitioner was in El Paso, Texas, 302 days. He stayed in Austin, Texas, the remaining 63 days of 1985 doing consultation work for another client. Perhaps the most telling evidence on this issue82 is the response petitioner gave to the question why, on his 1985 income tax return, he listed the address of his Certified Public Accountant as petitioner's address: "the reason for this * * is * * * because I have to travel very often and because I have to be prepared to go somewhere and stay in a hotel * * * I want a central point where someone can handle it for me." This testimony does not indicate to the Court that petitioner had or maintained a permanent home in either California or England. The Court finds, therefore, that petitioner did not have a home to be away from. Respondent, therefore, is sustained in the disallowance of petitioner's meals and lodging expenses for 1985. Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621464/	BYRNECE S. GREEN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGreen v. CommissionerDocket No. 13089-81.United States Tax CourtT.C. Memo 1987-503; 1987 Tax Ct. Memo LEXIS 499; 54 T.C.M. (CCH) 764; T.C.M. (RIA) 87503; September 28, 1987. Earl G. Thompson, Alan J. Garfunkel and Marc S. Orlofsky, for the petitioner. Nancy M. Vinocur, for the respondent. WRIGHTMEMORANDUM FINDINGS OF FACT AND OPINION WRIGHT, Judge: Respondent determined deficiencies of $ 41,709.93 and $ 253,083.00 in petitioner's Federal income taxes500 for 1977 and 1978, respectively. The issues for consideration are: (1) whether proceeds received by petitioner in settlement of a claim against an estate are taxable as income under section 61; 1 and (2) if so, whether the attorney's fees necessary for pursuing and realizing the claim are deductible as section 212 expenses. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. Byrnece S. Green (hereinafter petitioner) resided in New York, New York, at the time the petition was filed. Petitioner timely filed individual Federal income tax returns with the Andover Service Center, Andover, Massachusetts, for the taxable years 1977 and 1978. On March 24, 1981, respondent issued a notice of deficiency wherein he determined that petitioner had failed to report income in the amounts of $ 139,311.61 and $ 760,688.39 for the taxable years 1977501 and 1978, respectively. Petitioner had received these amounts pursuant to a settlement agreement from the estate of Maxwell E. Richmond (hereinafter referred to as decedent). Petitioner first met the decedent on November 18, 1962, in Boston, Massachusetts. Within a few weeks petitioner had fallen in love with him. The decedent returned her affection and by late December the couple were engaged to be married. Ten months later the decedent begged to be released from the engagement, explaining that he had "a mental problem about marriage." He suggested to petitioner that they forego the legal ceremony, and that she "stay with him without marriage." In return, he promised that he would leave her "everything" when he died. Petitioner reluctantly agreed. Petitioner characterized her relationship with the decedent as that of "an old-fashioned traditional wife." Although they always maintained separate apartments, she made his life as comfortable as possible; she watched his diet and his health, cared for him when he was ill, kept track of his appointments and concerned herself with his personal needs. She also accompanied the decedent frequently on business related trips and attended502 meetings and social engagements with him. They were essentially inseparable for the nine years of their relationship and traveled together in the United States and abroad. The couple celebrated the anniversary of their first date every November. Petitioner, who was employed as a stockbroker, advised the decedent on his business affairs and kept him informed about the value and activity of his investments. Decedent owned and operated a radio station in Boston. Petitioner reported on the stock market activities at his radio station every afternoon. She went to the radio station to wait for him every evening and helped with various tasks. Although petitioner never saw the decedent's will, he promised her that he had provided for her. After he died on October 21, 1971, no will could be found. Several months later the decedent's brother, Richard Richmond, discovered a will which left the entire estate, valued at around $ 7,000,000 to Richard and Dorothy, the decedent's sister. Petitioner sued the estate for the value of services rendered to the decedent in reliance upon his promise to leave her the entire estate. The jury found for petitioner under the theory of quantum503 meruit and awarded her $ 1,350,000. The only evidence offered to show the value of the services was the inventory of the estate. She maintained that the decedent had himself valued her performance at that amount. The estate appealed the trial court's ruling. The Supreme Judicial Court of Massachusetts upheld the decision, remanding on the sole issue of the measure of damages. The court held that it was erroneous to allow the inventory of the estate as the only measure of damages. Following that decision, petitioner and the decedent's executor settled the claim for $ 900,000 payable over two years: $ 139,311.61 was paid in 1977, and $ 760,688.39 was paid in 1978. Consequently, petitioner withdrew her notice of claim in the probate proceeding. Petitioner did not include these amounts in income on the returns she filed in 1977 and 1978. She did attach a statement to the return explaining why she believed the sums were not taxable. The failure to include these sums in income for taxable years 1977 and 1978 is the basis for respondent's determination of a deficiency. OPINION Respondent's determination of deficiencies in income tax are presumptively correct and petitioner504 has the burden of proving them erroneous. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Based on the record before us, we conclude that petitioner has not met her burden of proof. Respondent determined deficiencies in petitioner's income taxes for 1977 and in 1978 resulting from the amounts she received in settlement from the estate of Maxwell E. Richmond. Respondent maintains that the proceeds were neither a gift, bequest nor devise, but were compensation for services rendered by petitioner to the decedent between the years 1962 and 1971. Petitioner claims, on the other hand, that the services she performed were merely "wifely services" and not compensable services within the meaning of section 61. She contends that the payment was a gift or bequest from the decedent and exempt from taxation under section 102. She further maintains that the fact that she had to press her claim through litigation does not alter its essential character as a gratuitous transfer. We are not required to investigate the relationship between petitioner and the decedent to resolve this question. We have long recognized the rule that "The taxability of the proceeds of505 a lawsuit, or of a sum received in settlement thereof, depends upon the nature of the claim and the actual basis of recovery." Sager Glove Corp. v. Commissioner,36 T.C. 1173">36 T.C. 1173, 1180 (1961), affd. 311 F.2d 210">311 F.2d 210 (7th Cir. 1962), cert. denied 373 U.S. 910">373 U.S. 910 (1963); see also Gidwitz Family Trust v. Commissioner,61 T.C. 664">61 T.C. 664, 673 (1974); State Fish Corp. v. Commissioner,48 T.C. 465">48 T.C. 465, 472 (1967), modified by 49 T.C. 13">49 T.C. 13 (1967). The nature of litigation recovery is determined by reference to the origin and character of the claim which gave rise to the litigation. Lyeth v. Hoey,305 U.S. 188">305 U.S. 188 (1938), Raytheon Production Corp. v. Commissioner,144 F.2d 110">144 F.2d 110 (1st Cir. 1944), affg. 1 T.C. 952">1 T.C. 952 (1942), cert. denied 323 U.S. 779">323 U.S. 779 (1944). 2 See also State Fish Corp. v. Commissioner supra, wherein we relied heavily upon the allegations set forth in the complaint. 506 The proper inquiry is into the nature of the loss in lieu of which the damages were awarded. Fono v. Commissioner,79 T.C. 680">79 T.C. 680, 692 (1982), affd. without published opinion 749 F.2d 37">749 F.2d 37 (9th Cir. 1984); Entwicklungs & Finanzierungs A.G. v. Commissioner,68 T.C. 749">68 T.C. 749, 759 (1977); Henry v. Commissioner,62 T.C. 605">62 T.C. 605 (1974). If the award of damages was a substitute for income then the damages themselves are income. In the instant case, petitioner herself characterized the nature of the claim when she sued the estate as a creditor, claiming compensation for past services rendered. She established that the decedent had promised to provide for her through his will. She introduced evidence of the services she had performed. She proved that although she had performed what she promised, the decedent had reneged on his promises. The jury was fully instructed on the elements of recovery under the theory of quantum meruit and held for petitioner under that theory. Because the underlying claim was a suit for earned, but unpaid compensation, the claim dictates the tax treatment for the income received. 3 We therefore conclude507 that the settlement payment received in lieu of the damages is taxable income to her for the settlement award can go no further than the underlying claim to which it relates. 4Petitioner has urged upon us several alternative analytical approaches which allegedly would allow these settlement payments to be excluded from income. After reviewing these arguments, we find that neither has merit. We first address petitioner's claim that the settlement payments should be excluded from income under section 102. 5 In support of her position, petitioner relies on Pascarelli v. Commissioner,55 T.C. 1082">55 T.C. 1082 (1971), a case wherein we held that payments in exchange for "wifely services" are not compensation within the meaning of section 61 even when the provider is not legally a wife. In the Pascarelli case, the taxpayer had lived as though she were a wife with the transferor who supported her. 508 Petitioner's reliance on Pascarelli v. Commissioner, supra, is misplaced. The Pascarelli case is factually distinguishable from the instant case because in Pascarelli we concluded that the lifetime transfers made to the taxpayer were gifts, specifically transfers that "were motivated by sentiments of affection, respect, and admiration," and that conclusion was supported by the testimony of the transferor. 55 T.C. at 1091. In the case herein, however, we have determined, based on petitioner's lawsuit, that she had a compensatory arrangement with the decedent. Thus, the amounts petitioner received from the estate cannot be characterized as gratuitous transfers. We are further asked to consider the arrangement between petitioner and the decedent as an antenuptial agreement. In an antenuptial agreement the parties agree, through private contract, on an arrangement for the disposition of their property in the event of death or separation. Frequently, in exchange for the promises of property, one party agrees to relinquish his or her marital rights in other property. Occasionally, however, the relinquishment of marital rights is not involved. 509 These contracts are generally enforceable under state contract law. See Marvin v. Marvin,18 Cal. 3d 660">18 Cal.3d 660, 557 P.2d 106">557 P.2d 106 (1976). Nonetheless, transfers pursuant to an antenuptial agreement are generally treated as gifts between the parties, because under the gift tax law the exchanged promises are not supported by full and adequate consideration, in money or money's worth. Commissioner v. Wemyss,324 U.S. 303">324 U.S. 303 (1945); Merrill v. Fahs,324 U.S. 308">324 U.S. 308 (1945). Despite initial appeal, we find that this analogy is inapposite. While an exchange of promises was involved in the agreement between petitioner and decedent, there was no contract. In the Massachusetts litigation petitioner was awarded damages under a theory of quantum meruit. The jury was fully instructed on a contract theory of recovery but rejected it. Without a contract there can be no antenuptial agreement. A mere exchange of promises falls short of being an antenuptial agreement. Moreover, it is consistent with petitioner's theory in her litigation with decedent's estate that such exchange of promises be viewed as an arrangement for services to be rendered. Accordingly, *510 after a careful analysis of all the facts and circumstances we hold that the payments petitioner received in settlement of her claim against the estate of Maxwell E. Richmond constitute taxable income to her in the amounts of $ 139,311.61 and $ 760,688.39 during the years 1977 and 1978, respectively. The parties have stipulated that if the payments are deemed to be taxable income, the legal expenses incurred by petitioner are deductible under section 212. Furthermore, the parties agreed that those expenses equalled $ 52,172.19 in 1977 and $ 253,562.74 in 1978. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references refer to the Internal Revenue Code of 1954, as amended and in effect for the taxable years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩2. For example, a suit for damages in recovery for a personal injury results in tax exempt income for the claimant whether the tortfeasor pays damages pursuant to court order or pursuant to a private settlement agreement. Sec. 1.104-1(c), Income Tax Regs.; Seay v. Commissioner,58 T.C. 32">58 T.C. 32 (1972). Similarly, damages which represent a recovery of loss profits or income will be taxed as gain or income regardless of an intervening settlement. Swastika Oil & Gas Co. v. Commissioner,123 F.2d 382">123 F.2d 382 (6th Cir. 1941), affg. 40 B.T.A. 398">40 B.T.A. 398 (1939), cert. denied 317 U.S. 639">317 U.S. 639↩ (1943). 3. Gross income, as defined in section 61, includes compensation for services. ↩4. See Wolfson v. Commissioner,T.C. Memo. 1978-445↩. 5. Section 102 excludes from income "the value of property acquired by gift, bequest, devise or inheritance." ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621466/	RALPH AND GERTRUDE TOBJY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentTobjy v. CommissionerDocket No. 17484-81.United States Tax CourtT.C. Memo 1986-62; 1986 Tax Ct. Memo LEXIS 542; 51 T.C.M. (CCH) 449; T.C.M. (RIA) 86062; February 11, 1986. Ralph Tobjy, pro se. Peter Devlin, for the respondent. HAMBLENMEMORANDUM FINDINGS OF FACT AND OPINION HAMBLEN, Judge: Respondent determined a deficiency of $8,100.00 in petitioners' joint 1978 Federal income tax. Respondent made the following adjustments in his statutory notice of deficiency: Residential Rental Expenses$34,072.00 ExemptionDisallowance of exemptionclaimed for Roscio MenoscalInterest Expense1,000.00 Contributions1,290.00 Medical and Dental Expenses911.00 subject to limitation as determinedStandard - Itemized Deductions(226.00)Total Adjustments$37,047.00 This case was tried and submitted to the Court at New York, New York on April 24, 1984. The Court directed the parties to file briefs on or before June 25, 1984. Subsequently, 544 the Court extended such due date until July 25, 1984. Respondent timely filed a brief. However, petitioners failed to file a brief within the extended due date of July 25, 1984. Consequently, on October 4, 1984, this Court ordered that no further briefs be accepted in this case. Because this case concerns substantiation of asserted deductions and a dependency exemption, we note at the outset that respondent's determinations are presumptively correct and petitioners bear the burden of proof. , (1933); Rule 142(a).1 For convenience our Findings of Facts and Opinion are merged and are segregated by issue. The stipulation of facts and attached exhibits are incorporated herein by this reference. Residential Rental PropertyPetitioner Ralph Tobjy purchased the following properties as newly constructed residential property: Description of propertyYear acquiredPurchase PriceTwo-family residence at750 Schenck AvenueBrooklyn, New York("Schenck Avenue")1962$25,000.00Three-family residenceat 41-32 Little Neck Parkway,Little Neck, New York("Little Neck Parkway")1971$80,000.00One-family condominiumapartment at GirasolCondominium, Isla VerdeRoad, Isla Verde, PuertoRico ("Isla Verde Road")1973$30,000.00One-family condominiumresidence at 274 ArtistLack Drive, Middle Island,New York ("Artist Lake Drive")1975$30,000.00545 On their joint 1978 Federal income tax return, petitioners claimed deductions for depreciation and other expenses as follows: PropertyDepreciationOther ExpensesSchenck Avenue$1,250.00$3,700.00Little Neck Parkway5,333.008,126.00Isla Verde Road2,285.005,645.00Artist Lake Drive2,571.005,162.00Total$11,439.00$22,633.00Petitioners assigned a twenty-year useful life to each residential property for depreciation purposes. Petitioner Ralph Tobjy testified that the twenty-year useful life was determined based upon his life expectancy. In depreciating the subject rental properties, petitioners included the value of land within the unadjusted depreciable basis. During the year in issue, petitioners occupied one of the two six-room apartments at the Little Neck Parkway property as a personal residence. On their 1978 joint Federal income tax return, petitioners did not allocate the portion of depreciation and other expenses associated with the Little Neck Parkway property which were attributable to personal use but, rather, deducted all such expenses. For prior taxable years, petitioners' depreciation deductions on the subject rental546 properties for which petitioners received a tax benefit totalled as follows: PropertyPre-1978 DepreciationSchenck Avenue$19,625.00Little Neck Parkway29,071.00Isla Verde Road7,617.00Artist Lake Drive6,160.00Petitioners have used the straight-line method and the sum of the years digits method to compute depreciation on the subject residential properties. Respondent does not take exception to the use of such methods. At issue is petitioners' depreciable basis in each property and the useful life of each property. Respondent has determined an allocation of basis and the economic useful life of the subject properties at the time of purchase as follows: Economic UsefulPropertyLandBuildingTotalLifeSchenck3,750.00$21,250.00$25,000.0040 yearsAvenueLittle Neck7,000.0073,000.0080,000.0045 yearsParkwayArtist Lake3,000.0027,000.0030,000.0040 yearsDriveIsla Verde4,500.0025,500.0030,000.0040 yearsRoadThese determinations reflect the opinion of respondent's expert witness Leonard S. Rodwin ("Rodwin"). Rodwin has been an employee of the Internal Revenue Service ("IRS") 547 for 17 years. Rodwin was hired by the IRS during 1966 as a real estate appraiser in the Manhattan District. Since 1969, he has been assigned to the National Office in Washington, D.C., where his responsibilities concern the determination of the fair market value of real estate, the fair rental value of real estate, the allocation of lump sum purchases, and the economic useful life of real estate. Rodwin viewed the Schenck Avenue, the Little Neck Parkway, ahd the Artist Lake Drive properties and determined the allocation of basis and economic useful life of such properties within his valuation report. At trial, Rodwin testified as to his opinion concerning the Isla Verde Road property in Puerto Rico which he did not view. Petitioners did not introduce any objective evidence of value concerning the allocation of basis or economic useful life. Therefore, we find that petitioners have failed to meet their burden of proof. ; Rule 142(a). Rodwin was a credible witness. We agree with respondent's determination of the allocation of basis between depreciable property and nondepreciable land as well as respondent's determination548 of the economic useful life of each subject property. Petitioners' assertion that useful life be determined by reference to the owner's life expectancy is specious and without merit as useful life may not be determined by reference to the owner's life expectancy. , affg. a Memorandum Opinion of this Court. Furthermore, the facts are inconsistent with petitioner Ralph Tobjy's testimony that useful life was determined by reference to his life expectancy as the residential properties were purchased during the years 1962, 1971, 1973 and 1975 and each was assigned a twenty-year useful life. We find that petitioners arbitrarily assigned a twenty- year useful life to each property and that such determination was not reasonable. 2On their joint 1978 Federal income tax return, petitioners claimed other expenses concerning the residential properties in the amount $22,633.00 which respondent disallowed in his statutory notice of deficiency. 549 Subsequently petitioners substantiated the following expenses concerning the subject residential properties: LittleIslaArtistSchenckNeckVerdeLakeAvenueParkwayRoadDriveTotalRealEstateTaxes$755.75$3,237.48$321.09$1,358.66$5,672.98Interest3,460.471,543.352,083.857,087.67Water andSewer124.69210.00334.69Insurance111.0043.89154.89Maintenance452.04452.04Heating793.07793.07Total$1,673.51$7,018.95$2,360.37$3,442.51$14,495.34At trial, respondent conceded an additional expense of $248.28 for real estate taxes on the Schenck Avenue property. On brief, respondent further conceded an additional expense in the amount of $197.16 as repairs constituting ordinary and necessary expenses. 3 Accordingly, other expenses in the amount of $14,940.78 have been either substantiated by petitioners or conceded by respondent. 550 During the year in issue, petitioners occupied one of the two six-room apartments at the Little Neck Parkway property. The Little Neck Parkway property consists of two six-room appartments plus one four-room apartment, for a total of 16 rooms. Respondent asserts that three-eighths of the depreciation expense and other expenses concerning the Little Neck Parkway property constitute nondeductible personal living expenses. Petitioners have introduced no evidence to refute respondent's allocation as to personal expenses concerning the Little Neck Parkway property. Therefore, petitioners have failed to satisfy their burden of proof. ; Rule 142(a). We agree with respondent's assertion that the business ue portion of the Little Neck Parkway property is limited to five-eighths of the determined depreciation amount and other expenses. 4In 1977, petitioners installed window guard rails at the Schenck Avenue property at a cost of $1,800.00. Petitioners551 assert that they are entitled to depreciate the window guard rails, however, they have introduced no evidence as to the economic useful life of such property. We therefore determine that petitioners have not met their burden of proof necessary to establish entitlement to depreciate such improvements. ; Rule 142(a). At trial, petitioners offered various cancelled checks concerning automobile insurance and related expenses as well as oral testimony regarding purported travel expenses incurred with regard to the rental properties. Petitioners maintained no records to support the travel expenses asserted. Petitioner Ralph Tobjy's testimony concerning the automobile insurance was inconsistent and equivocal. Petitioners also assert entitlement to depreciate a Volkswagon automobile purchased during 1976 at a cost of $4,384.50. In depreciating the automobile, petitioner Ralph Tobjy testified that he used the straight-line method and assigned a three-year useful life with no salvage value. Petitioner Ralph Tobjy further testified that the business use portion of the Volkswagon was 75 percent and that personal use was limited to 25 percent. 552 Petitioners failed to substantiate their assertions by means of reliable objective evidence such as contemporaneous records. Additionally, petitioner Ralph Tobjy's testimony was inconsistent and not credible. We do not doubt that expenses attendant to the use of an automobile concerning the residential rental properties were incurred. As in , the inexactitude herein was of petitioners' own making by failing to maintain adequate records, and this must weigh heavily against them. However, petitioners have not given us any basis other than petitioner Ralph Tobjy's self-serving testimony upon which we may estimate reasonable allowances.5 Therefore, we find that petitioners have not offered sufficient evidence to establish an entitlement to automobile depreciation or the attendant automobile expenses for travel and insurance. 6Petitioner Ralph Tobjy also testified553 at trial that petitioners were entitled to telephone expenses, postage expenses, and a home office deduction under section 280A. No evidence other than self-serving testimony consisting of estimated expenses was introduced to substantiate these claims. Therefore, petitioners have failed to satisfy their burden of proof as to these expenses. ; Rule 142(a). Interest ExpensePetitioners claimed an interest expense deduction of $1,000.00 on their joint 1978 tax return. Subsequently, petitioners substantiated interest expenses for the 1978 taxable year in the amount of $1,175.51. Petitioners substantiated an additional interest expense of $3,460.47 incurred with respect to the mortgage on the Little Neck Parkway property. We have previously determined that the business use portion of the Little Neck Parkway property was limited to a pro rata five-eighths of such property during 1978. Consequently, we have determined that petitioners were entitled to depreciation and other expenses relating to such property in an amount not in excess of a pro rata five-eighths allocation of such expenses. Petitioners are, however, entitled to554 deduct additional interest as an itemized deduction in the amount of $1,297.68 which represents a pro rata three-eighths of the mortgage interest expense incurred with respect to the personal use portion of the Little Neck Parkway property. 7 Petitioners, by aggregating the interest expense substantiated and the interest expense allocated to personal use property, are entitled to an itemized interest expense deduction in the amount of $2,473.19 for 1978. Charitable Contribution DeducationPetitioners claimed a charitable contribution deduction of $1,290.00 on their joint 1978 Federal income tax return. Petitioners have substantiated that they donated the amount of $875.00 during 1978 to various qualified charitable donees under section 170. At issue is whether petitioners are entitled to deduct the amount of $400.00 that they donated in 1978 to an organization titled FANN. 8FANN is a private orphanage in Ecuador which is not affiliated with any organization in the United States or with any church. FANN is privately financed by a wealthy555 Ecuadoran businessman. We determine that FANN does not qualify as charitable donee under section 170(c)(2)(A) since it was not created or organized in the United States, a state or territory, the District of Columbia or a possession of the United States. . 9 Consequently, petitioners are not entitled to deduct as a charitable contribution in 1978 the $400.00 they paid to FANN. ExemptionPetitioners claimed a dependency exemption for Roscio Menoscal ("Roscio"). Roscio is a citizen of Ecuador and is not related to petitioners. Roscio resided with petitioners during 1978. Petitioner Ralph Tobjy was unable at trial to recall the approximate duration of Roscio's residence with petitioners. Roscio entered the United States with a student visa although she was not a recipient556 of a scholarship or any government assistance. Roscio desired to study English in the United States. Petitioners accommodated Roscio with necessities and paid certain tuition expenses on her behalf at Queens College and the English Language Institute to enable Roscio to study language. Section 152 provides a dependency exemption where certain criteria are established. Petitioners have failed to satisfy their burden of proof to establish entitlement to a dependency exemption under section 152. Section 152(b)(3) provides that an individual who is not a citizen, resident, or national of the United States cannot qualify as a dependent unless such individual is a resident of a foreign country contiguous to the United States. Roscio was a nonresident alien as defined in section 7701 and was a citizen of Ecuador, a noncontiguous country. Therefore, petitioners fail to satisfy the section 152(b)(3) requirement. , (1969).10 Furthermore, petitioners failed to introduce sufficient evidence to determine whether petitioners furnished over one-half of Roscio's support. Sec. 152(a). Therefore, petitioners are not entitled to claim a dependency557 exemption for Roscio. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and all rule references are to the Tax Court Rules of Practice and Procedure.↩2. , affd. per curiam, , cert. denied .↩3. Because the record is not clear as to the subject properties to which the repairs related, we allocate the $197.16 to properties other than the Little Neck Parkway property so as to avoid further allocation of such expense between business and personal use property relevant to the Little Neck Parkway property.↩4. Respondent concedes three-eighths of the real estate taxes and interest on the Little Neck Parkway property are otherwise deductible as itemized deductions on Form 1040, Schedule A.↩5. . ↩6. ; ; .↩7. Little Neck Parkway property interest: ↩Personal allocation$1,297.68Business allocation2,162.79$3,460.478. Petitioners claimed a charitable contribution deduction in the amount of $1,290.00 on their 1978 joint tax return. Petitioners substantiated the amount of $875.00 and respondent has disallowed the amount of $400.00 paid to FANN. Therefore, the amount of $15 is unreconciled.↩9. .↩10. .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621467/	Claridge Apartments Company, an Illinois Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentClaridge Apartments Co. v. CommissionerDocket No. 106868United States Tax Court1 T.C. 163; 1942 U.S. Tax Ct. LEXIS 26; December 4, 1942, Promulgated 26 Decision will be entered under Rule 50. 1. Neither expenses incident to 77B reorganization assumed by transferee nor nominal stock interest in reorganized company accorded to stockholders of predecessor held to disqualify transaction as a "reorganization" under Revenue Act of 1934, section 112. Helvering v. Southwest Consolidated Corporation, 315 U.S. 194">315 U.S. 194, distinguished. Held, further, on facts exchange of property was solely for petitioner's stock.2. Provisions of the Chandler Act relating to taxation of income resulting from reduction of indebtedness in reorganizations, held applicable to the entire calendar year 1938, and to interest forgiven, but held, further, not applicable in the case of substitution of common stock for outstanding principal of bonds. Walter Hamilton, Esq., for the petitioner.David Altman, Esq., and George E. Gibson, Esq., for the respondent. Opper, Judge. Smith, J., concurring. OPPER163 By this proceeding petitioner charges that respondent erred in determining deficiencies in the amounts and for the years indicated as follows:Excess profitsYearIncome taxtax1935$ 844.39$ 57.051936706.921937752.761938985.6710.8027 164 The contested issues relate to petitioner's basis for depreciation of its apartment house property and deduction of items for painting and repairing.FINDINGS OF FACT.Petitioner is a corporation, organized May 28, 1935, under the laws of the State of Illinois pursuant to a proceeding under 77B of the National Bankruptcy Act. It filed its income and excess profits tax returns for the years 1935 to 1938, inclusive, with the collector of internal revenue for the first district of Illinois.The Claridge Building Corporation, also an Illinois corporation, and hereinafter for convenience referred to as the Building Corporation, acquired the lot at 4501 Malden Street, Chicago, Illinois, from Charles F. Henry in 1924. The acquisition was pursuant to a contract whereby the Building Corporation agreed to issue and did issue its entire authorized capital stock to Charles F. Henry in consideration of the transfer of the lot by Henry. During the spring and summer of 1924 the Building Corporation caused an apartment building to be erected on the lot at a cost of $ 385,326.37. By August 1, 1935, $ 139,253.71 depreciation had been taken, on a "cost" of $ 424,609.19 which included a28 contractor's commission to Henry.Up to 1932 the stock of the Building Corporation, with the exception of two qualifying shares, was owned by Charles F. Henry. In 1932 and thereafter it was stated to be held as follows: Minnie H. Case, sister of Charles F. Henry, 198 shares; Howard D. Henry and Albert A. Henry, brothers of Charles F. Henry, one share each.On March 25, 1924, the Building Corporation issued its 6 1/2 per cent first mortgage bonds in the principal amount of $ 340,000. The bond issue was secured by trust deed and chattel mortgage covering the property located at 4501 Malden Street, executed March 25, 1924, to Melvin L. Straus, as trustee. On October 1, 1931, the bonds were outstanding and unpaid in the principal amount of $ 277,000. Defaults having therefore occurred in the payments of principal and interest, the trustee filed a bill of foreclosure on October 1, 1931, and all of the bonds were declared immediately due and payable. A decree of foreclosure was entered on February 19, 1932, but there was no sale of the mortgaged property under the decree and the foreclosure proceeding was never consummated. The trustee took possession of the property and collected29 the rents after October 1, 1931.On September 9, 1931, a bondholders' committee was organized under a deposit agreement of that date with the American National Bank & Trust Co. of Chicago. As of November 27, 1934, the committee had on deposit with the bank $ 258,600 of the bonds, or approximately 93 percent of the total amount of the bonds outstanding.165 On June 16, 1934 the Building Corporation filed a voluntary petition in the District Court of the United States for the Northern District of Illinois, Eastern Division, under section 77B of the National Bankruptcy Act as amended.On November 27, 1934, the bondholders' committee, the Building Corporation, and Minnie H. Case agreed on a reorganization plan. The plan recited that Minnie H. Case was the record holder of the title to the property in question, but that she held title for the benefit of the Building Corporation, and that she owned the furnishings of some of the apartments.The plan provided, inter alia, as follows:1 -- A new corporation shall be organized under the laws of the State of Illinois with an authorized capital stock consisting of 3,080 shares of common stock without par value, or with such par value30 as may be agreed upon by the parties hereto. Upon completion of the reorganization, Minnie H. Case shall convey title to the property to said new corporation and the [Building] corporation shall execute a confirmatory quit-claim deed to the new corporation. 2,770 shares of the common stock of the new corporation shall be issued to three Trustees to be selected by the Committee subject to the approval of the court. Trust certificates shall be issued to the holders of the first mortgage bonds and each first mortgage bondholder shall receive a trust certificate representing one share of stock for each $ 100.00 in face amount of bonds owned by him. The stock so issued to said Trustees shall constitute 90% of the outstanding stock of the new corporation. 10% of the outstanding stock of the new corporation shall be issued to or upon the order of the Owner [the stockholders of the Building corporation].* * * 4 -- The new corporation shall by written agreement indemnify the present Trustee under the bond issue against any and all liability which he may suffer or incur by reason of his operation of the property (other than for wrongful acts of the Trustee) and against any and all taxes, 31 assessments or other governmental charges which may be levied or assessed against him covering the period of his possession of the property. The new corporation shall also by written agreement indemnify the Committee against any and all taxes, assessments or other governmental charges which may be levied or assessed against it and against any and all liability which may be suffered or incurred by the Committee by virtue of the reorganization plan, including the expenses and reasonable attorneys' fees in the event that litigation is instituted against the Committee or any member thereof.The new corporation shall assume and agree to pay the reorganization expenses hereinafter referred to and these expenses shall be paid in full before any dividends shall be declared or paid upon the stock of the new corporation. Subject to the approval of the court, the following reorganization expenses shall be allowed: (a) To cover the general expenses and compensation of the Committee including the charge of Securities Service Corporation, 1 1/2% of the face amount of deposited bonds plus out-of-pocket expenses:(b) Charge of the Depositary on the basis of three-fourths of 1% of the face amount32 of deposited bonds plus out-of-pocket expenses;(c) Compensation of counsel for the Committee;(d) Compensation of counsel for the owner.166 In addition there shall be allowed the expenses and charges in the foreclosure proceeding, including the Trustee's fee, the fee of Trustee's counsel, court costs and Master's fees. There shall also be allowed and paid the actual expenses to be incurred in connection with the organization of a new corporation, printing of the trust agreement and the new securities, stamp taxes, title guaranty expense, court costs in the bankruptcy proceeding and other similar items.Upon consummation of the reorganization, the present Trustee shall surrender possession to the new corporation and all net assets of the Trustee over and above the liabilities of the Trustee in connection with the operation of the property shall be applied towards the payment of the reorganization expenses.The plan also provided that Minnie H. Case was to execute and deliver to the new corporation a bill of sale covering all of the personal property owned by her which was located in the apartments, for which she should be paid the sum of $ 1,400. The new corporation was33 to enter into a management contract with Minnie H. Case and she was to be one of the three directors of the new corporation. The plan, after amendment not material here, was confirmed and approved by the court in an order dated May 14, 1935.The court order provided for the release of the trust deed and chattel mortgage of March 25, 1924, and stated that the bonds and interest coupons were satisfied and of no further force and effect and authorized the issuance of the new securities.The final decree in the 77B proceeding entered March 1, 1937, provided in part as follows:1: The plan of reorganization theretofore confirmed by this court is hereby declared to be in all respects fully executed, carried out and accomplished. * * 4: That all of the first mortgage bonds in the principal amount of $ 277,000.00 and interest coupons thereto attached, secured by trust deed and chattel mortgage to Melvin L. Straus, dated March 25, 1924, recorded in the office of the Recorder of Deeds of Cook County, Illinois, as document No. 8340617, and said trust deed and chattel mortgage, are hereby declared to be of no further force and effect as against the Debtor or its property, and the holders34 thereof shall be entitled to receive only the new securities provided for in said plan of reorganization, and all holders, pledgees and owners of bonds and interest coupons secured by said first mortgage trust deed and chattel mortgage, and Melvin L. Straus, Trustee, thereunder, shall be and they are hereby forever jointly and severally enjoined from commencing and/or prosecuting any proceedings of any nature whatsoever against the Debtor, its grantees, successors or assigns, or against any of the property of the Debtor on any of said first mortgage bonds or interest coupons, and all creditors and stockholders of the Debtor, secured and unsecured, are hereby forever enjoined and restrained from taking or continuing any action, steps or proceedings or bringing or continuing any suit or action at law, in equity or otherwise against the Debtor or its property for, on account of, or by reason of any claim, matter, judgment or thing, excepting only such liabilities and claims which the Debtor has expressly assumed or agreed to pay pursuant to the terms and provisions of said plan of reorganization.167 5: Melvin L. Straus, as trustee, complainant in the suit entitled "Melvin L. Straus, 35 trustee, v. Claridge Building Corporation, et al," case No. 544125, Superior Court of Cook County, and all other persons be and they hereby are permanently restrained and enjoined from taking any further action in connection with said proceedings.Pursuant to the plan petitioner was organized and the property transferred to it. Minnie H. Case also transferred the furniture which she owned in the apartment building to petitioner.As of August 1, 1935, there were delinquent taxes outstanding of $ 13,000. The reorganization expenses amounted to approximately $ 13,500. The trustee had approximately $ 8,000 on hand.Expenses of the foreclosure proceeding in the state court were as follows:Master's fee$ 1,250.00Trustee's fee1,050.98Attorneys for trustee2,970.985,271.96Minutes of petitioner's board of directors meeting of August 7, 1935, recited as follows:Whereas, pursuant to the Reorganization Plan as amended of Claridge Building Corporation (Claridge Apartments), this corporation is required to assume and agree to pay the unpaid reorganization expenses, the approximate amount of which is $ 13,500.00; andWhereas, the Claridge Apartments are subject to delinquent36 taxes, the approximate amount of which, including estimated taxes for the first half of 1934, is $ 13,000.00; andWhereas, from the funds available and about to become available from the operation of the property approximately $ 8,000.00 can be applied on account of the payment of the unpaid reorganization expenses and taxes, so that a sum of approximately $ 18,500.00 is required to provide for the payment of the balance of such unpaid reorganization expenses and taxes; * * On a reference of the matter to the stockholders similar recitals were made in the minutes of their meeting held September 9, 1935.In order to meet these obligations it was necessary for petitioner to borrow $ 18,500. A loan in this amount secured by a mortgage on the property was obtained by petitioner and approved by the court on July 26, 1935.The reorganization expenses in the approximate total amount of $ 13,500 were paid by petitioner in the latter part of 1935 or the early part of 1936.The certificates of deposit which were issued by the bondholders' committee were traded in as an over-the-counter security in Chicago during the year 1935 at a market price ranging from $ 190 to $ 207.50 for a certificate37 representing a $ 1,000 bond. In December of 1935, after most of the petitioner's stock had been issued, the market price 168 for certificates of deposit not yet turned in for petitioner's stock was $ 190 per thousand-dollar certificate of deposit. The market for securities of Chicago real estate corporations, organized or in the process of being reorganized, was poor during the year 1935.Under the plan the petitioner's stock was issued at the rate of one share per $ 100 face value of bonds of the old company. The fair market value of petitioner's stock never exceeded $ 45 per share at any time during the year 1935.Petitioner's capital stock consisted of 3,080 shares of common stock without par value. On September 5, 1935, 2,770 shares were issued to certain nondepositing bondholders and to voting trustees for the depositing bondholders to whom were issued trust certificates, each certificate representing one share of stock. Three hundred and eight shares of petitioner's stock were issued to the old stockholders, Minnie H. Case receiving 300 shares and Charles F. Henry 8 shares. Two shares remained unissued.The building at 4501 Malden Street is a three-story and basement38 court type apartment building with a large terrazzo floored lobby from which stairways lead up to the various groups of apartments. It contains 106 apartments. There are eighty 2 1/2-room apartments (living room, in-a-door bed, large dressing closet, dinette, kitchen, and bath) and twenty-six 3 1/2-room apartments (extra bedroom). The first story of the building is fireproof and the other two stories are brick and frame, with brick walls surrounding each apartment unit. Pressed brick was used on the street fronts and courts. Each apartment has a refrigerator, gas range, tall china cabinet and linen case, a full size door mirror, vitreous china lavatory and toilet, and a bay window. The building has two large Kewanee boilers (one of which gives sufficient service), six laundries, intercommunicating telephone system, Government approved mail boxes, push bells and speaking tubes, carpeted stairs and hall, and best grade clear oak floors.The property in question, including the apartment building and furnishings and the lot on which situated, was sold in July 1940, for $ 126,200, plus an assumption of about $ 20,000 of liabilities. The market in 1940 was much higher and more active39 than in 1935.The fair market value of the apartment building located at 4501 Malden Street, Chicago, exclusive of the land as of May 14, 1935 (the date on which the court confirmed the plan) was not in excess of $ 141,000. The fair market value of the land on that date was $ 16,000.The adjusted basis of petitioner's predecessor in 1935 was $ 239,377.33.At the date of acquisition by petitioner the building had a remaining useful life of 25 years.Petitioner reported its income and deductions on an accrual system of accounting. Under the system of accounting used by petitioner 169 it deducted on its returns all expenses for painting and decorating and repairs in the year in which such expenses were paid. On its 1936 return petitioner included in its expense deductions an amount of $ 1,219.44 expended in that year for painting and decorating and $ 389.60 expended in that year for repairs. These identical items were deducted for a second time in petitioner's 1937 return, and for that reason were disallowed by respondent for that year.OPINION.The first point in controversy is the correct basis for depreciation on petitioner's property, the problem being whether that is cost40 to petitioner or its predecessor's adjusted basis. The primary question is whether under Revenue Act of 1934, section 112, and particularly under the recent decisions of the Supreme Court 1 interpreting it, there was a reorganization when, in a 77B proceeding, petitioner's predecessor transferred to it its only asset, a building called the Claridge Apartments, in exchange for the issuance to the predecessor's creditors of 90 percent, and to its stockholders of 10 percent of petitioner's stock.Whatever doubt there may have been that creditors of an insolvent predecessor corporation can furnish the continuity or41 proprietary interest necessary to a technical reorganization has recently been dispelled. Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179; Palm Springs Holding Corporation v. Commissioner, 315 U.S. 185">315 U.S. 185. Nor are we by any means satisfied of the correctness of respondent's assertion that Helvering v. Southwest Consolidated Corporation, 315 U.S. 194">315 U.S. 194, determines the present issue in his favor. It is true that that case emphasizes the requirement of the 1934 Act that to constitute a reorganization the transfer of property must be solely in exchange for the tranferee's voting stock, and holds that even an indirect payment partly in cash defeats the attempt to apply it.But effect is given, of course, to the retroactive amendment of 1939 removing from consideration the assumption of a transferor's indebtedness or acceptance of property subject to it; and the Court is at pains to point out that the transferee in the Southwest Consolidated case did more than this when it undertook under the plan to repay cash which had been borrowed to satisfy nonassenting creditors. "But 42 in substance," it remarks, "the transaction was precisely the same as if respondent [the taxpayer] had paid cash 170 plus voting stock for the properties. * * * part of the consideration which respondent paid for the properties of its predecessor was cash in the amount of about $ 106,680. The fact that it was paid to the bank rather than to the old corporation or its creditors is immaterial. The requirement to pay cash arose out of the reorganization itself. It derived, as did the requirement to pay stock, from the plan pursuant to which the properties were acquired. * * "Here the only payments of cash contemplated by the plan were for past-due taxes on the property, expenses of an abortive foreclosure action previously instituted against it, and costs and disbursements of the 77B proceeding itself. Respondent's brief concedes that "the delinquent realty taxes, fees paid to the counsel for the debtor corporation, and possibly fees paid in connection with foreclosure proceedings brought by the indenture trustee, * * quite possibly (had petitioner offered and introduced the proof relating thereto) might have been shown to represent liabilities of the old debtor company." 43 We can not conceive that the only remaining item, the expense connected with the reorganization itself, including fees and disbursements to the bondholders' committee and its depositary, court costs, and payments for printing and for the organization of petitioner can be of the character to which the Supreme Court referred when it excluded items of which the "nature and amount were determined and fixed in the reorganization." Such payments did not, like those in the Southwest Consolidated case, go indirectly to the old corporation or its creditors. True, in a general sense they constituted part of the cost paid by petitioner for the property received. But they were of a nature characteristic of all reorganizations of this kind, and normally there is no source of payment for them save the new corporation or its property. If they are fatal here, then it is difficult to envision any plan growing out of an equity or 77B receivership which would qualify under section 112. We can not believe such a result was intended.But, however that may be, we think petitioner has shown enough here to sustain its contention that nothing was paid except liabilities of the predecessor or its property. 44 In Illinois real estate taxes are imposed, if not on the owner, at least on the land and building -- Edward C. Kohlsaat, 40 B. T. A. 528, 535; Pyramid Metals Co., 44 B. T. A. 1087, 1088 -- upon which they constitute a lien. These amounted to $ 13,000. The foreclosure proceedings likewise set up a liability for costs and expenses to which any conveyance of the property would presumably be subject. Benton State Bank v. Bennett, 249 Ill. App. 539">249 Ill. App. 539; Christensen v. Niebert, 259 Ill. App. 96">259 Ill. App. 96; Chicago Trust Co.v. 12-14 West Washington St. Building Corporation, 278 Ill. App. 117">278 Ill. App. 117. These amounted to $ 5,270.98. In addition, 171 the cash in the hands of the trustee for the old company was committed to payment of expenses to its full extent, namely $ 8,000.There was thus a total of $ 26,270.98 which must be regarded either as indebtedness of the transferor assumed by the transferee or as a charge against the transferred property within the express terms of the 1939 amendment. The small balance of $ 229.02 is not only45 negligible under the circumstances, but we may take notice that it could reasonably have covered only such items as cost of petitioner's incorporation, stamp taxes, printing bills and the like, which were clearly no part of any payment by the transferee to the transferor "in exchange" for the transfer of the property. In the premises we are unwilling to say that petitioner has failed to sustain its burden of showing the necessary facts to invoke the provisions of section 112.Respondent suggests that this fell short of a tax-free reorganization for the additional reason that, while the creditors received 90 percent of petitioner's stock, indicating that they had acquired effective ownership of the predecessor, the stockholders were given a 10 percent interest, which demonstrated that the creditors had not succeeded to an exclusive interest. It is urged, which is the fact, that no such situation existed in the cases recently decided by the Supreme Court.We think, however, that this is a distinction without a difference. In the first place, if it were possible to imagine a set of circumstances where a corporation was insolvent to the extent that a 90 percent proprietary interest46 had accrued to its creditors but 10 percent was left in its former stockholders, no reason is apparent why the statutory language would not apply to a plan which gave effect to that division of ownership. The preservation of proprietary interests would be respected quite as much there as in, say, Helvering v. Southwest Consolidated Corporation, supra.The bondholders here "acquired substantially the entire proprietary interest of the old stockholders."But in any event, the insolvency of the transferor in the present case is inescapable. There can be no question but that in fact and in law the creditors were in exclusive control. If the plan was improper and subject to disapproval upon the bondholders' objection, see Northern Pacific Railway Co. v. Boyd, 228 U.S. 482">228 U.S. 482, that would not make it any the less a plan of reorganization upon acceptance by the necessary percentage of bondholders and confirmation by the court, although it might fail to qualify as an "exchange" under 112 (b) (5). See Helvering v. Cement Investors, Inc., 316 U.S. 517">316 U.S. 517. What reason there may have been for47 the voluntary recognition of the old stockholders to the extent of a nominal share in the new enterprise does not appear. It may well have been a desire not to be ungenerous, or, more likely, a selfish hope that their 172 pecuniary interest would encourage the former shareholders to more effective efforts under the management agreement. Certainly we need not view it as a concession that they retained any equity when the facts deny that possibility. It follows that, as far as the reorganization question goes, petitioner was entitled to the original basis.Apart from this, however, respondent insists that the provisions of the so-called "Chandler Act," 2 particularly section 270, as amended, require that petitioner's basis be reduced to the fair market value of the property when petitioner received it, but he concedes that under The Commodore, Inc., 46 B. T. A. 718, no year earlier than 1938 would be affected.48 173 That the provision does apply to the petitioner's 1938 tax liability, however, seems to us not subject to serious doubt. The act was made effective September 22, 1938, before the end of the petitioner's 1938 tax year, and long before its return for that year became due. The reasons advanced in The Commodore, Inc., supra, including reference to the legislative history, are hence inappropriate. The "future" liability to which the Committee referred was evidently an apt description of the present situation, since the end of the year as of which the tax was to be computed and the date when the first installment would become due both lay ahead when the act became effective.While not strictly a revenue act, the legislation by its terms dealt with taxes, and can be assumed to have envisaged like principles as to periods to which it would apply. It is now so familiar as to be virtually traditional that revenue acts cover calendar years during which they take effect. See United States v. Hudson, 299 U.S. 498">299 U.S. 498. In fact, it possibly requires express language to avoid application even to earlier periods. Cf., e.g., 49 Revenue Act of 1938, secs. 1 and 903. And our system of administering income tax computation on an annual basis makes impractical such suggestions as petitioner's that if relevant at all the Chandler Act should be construed to fix depreciation only for the part of the year remaining after it went into effect.The question remains, however, whether in this case the "indebtedness * * * has been canceled or reduced" as described in section 270. Section 268 is an obvious legislative effort to release 77B reorganizations from the tax burden of the Kirby case, 3 and, since section 270 is manifestly in pari materia with it, we have to consider whether this is the sort of situation to which either section was intended to apply. It may advance us little to grant that in the meantime some courts have devised a formula for lifting certain types of debt adjustment out of the Kirby rule. E.g., Hirsch v. Commissioner (C. C. A., 7th Cir.), 115 Fed. (2d) 656. But cf. Frank v. United States (U. S. Dist. Ct., E. Dist. Pa.), 44 Fed. Supp. 729. For the theory of that limited group of cases is that the property for 50 the purchase of which the debt was incurred has so declined in value that the cancellation may be regarded as no more than a retrospective readjustment of the original purchase price. That being so, there is no reason to grant the owner a deduction for depreciation computed on a larger base, any more than to permit him to report his ultimate gain or loss on disposition by using the original higher cost. See Hirsch v. Commissioner, supra.But in another setting, the same result has been reached on a totally different theory. The substitution of common stock for bonds 174 is not a cancellation or reduction of the liability represented by the bonds, no matter how much less the stock may be worth, since "the assets are not thereby freed from obligation. * * * While the bond loan has been terminated, the amount borrowed is now committed to capital stock liability instead of to the liability of 51 a fixed indebtedness." Capento Securities Corporation, 47 B. T. A. 691.Using this approach, it is evident that there was here no true reduction or cancellation of the original indebtedness, but what amounts to a continuation of it in another form. It follows that neither the language nor the reason for section 270 has any application here. Both gain or loss and depreciation to the new corporation can appropriately be measured by the old basis, without doing violence either to the tax consequences of the reorganization or to the doctrines upon which those consequences rest.What we have said, however, relates only to the outstanding principal of the bonded debt. The interest was also due, and that it was forgiven rather than transformed into stock appears affirmatively, although its amount is not shown. Adjustment for this item must be made. Capento Securities Corporation, supra. True, the statute excludes "accrued interest unpaid" from the write-down of basis on account of forgiveness, but only if "not resulting in a tax benefit on any income tax return." We can not say from the evidence what the facts are in this 52 respect, and accordingly must assume, in respondent's favor, that petitioner's predecessor had obtained a tax benefit as to the entire amount. What that amount should be can, it is to be hoped, be agreed upon by the parties in connection with the computation under Rule 50.We are not concerned by fears for the constitutionality of such an interpretation in so far as it involves a retroactive application to reorganizations previously completed, like the one before us. The legislative intention to deal with such cases must be accepted. The Commodore, Inc., supra. Only the tax liability for the year of enactment is in question. See United States v. Hudson, supra.A new basis growing out of a previously completed reorganization may constitutionally be provided. Schweitzer & Conrad, Inc., 41 B. T. A. 533. And in any event, the doctrine of the Hendler case 4 prevented this from being a tax-free reorganization at the time it took place. See Helvering v. Southwest Consolidated Corporation, supra.The proper depreciation basis then became petitioner's53 cost. Only the retroactive amendment of 1939 eliminated the Hendler principle and in the meantime the Chandler Act had been enacted. There was hence no hiatus in petitioner's continuing liability, and the provision, if it can be said to be 175 retroactive at all, certainly made no change in petitioner's position and hence obviously had no unconstitutional effect upon its substantial rights.This conclusion requires that we find both the predecessor's basis, for the years 1935 5 through 1937, and the fair market value on confirmation for 1938. The latter is necessary in the event that adjustment for the forgiven interest would otherwise reduce the adjusted basis below that amount. The required figures have been included in our findings of fact. Although petitioner and its predecessor consistently used a higher basis, we have found the one determined by the Commissioner, since the petitioner's witness failed to convince us that54 any amount was actually paid by the old company for contractor's services, or that the original stock issue in fact covered any more than the land.In ascertaining fair market value upon confirmation we have given consideration to the highest figure estimated by respondent's expert for the property as a whole, bearing in mind the actual sale in 1940, and the value placed upon the land alone by petitioner's witness, as being most conducive to a computation which is reasonably fair under all the circumstances. This market value may constitute petitioner's basis for 1938, if it develops that it is higher than the original basis reduced by the part of the debt adjustment ratably allocated to the depreciable property in the proportion of original land value to total basis. See Regulations 94, art. 113(b)-2, as amended (1940-2 C. B. 107).55 There remains the question of petitioner's claim for deductions of decorating and repair items as business expense for 1937. While the parties are in accord that petitioner's books and tax returns were figured on the "accrual" basis, the explanation given rather resembles a cash or reverse accrual system. The deductions in question were customarily taken in the year payment was made, but they were set up as a sort of reserve running into the following year, not because payment was not due, but apparently on the theory that leases to which they were applicable would return income during that period.For tax purposes, however, there seems little question that items deducted in one year can not properly be duplicated in the next, and that, whatever the system of accounting, it can not be authorized if it calls for that treatment. Since we are satisfied from the evidence that petitioner is seeking for 1937 a deduction already taken and allowed for the prior year, respondent's disallowance is approved.Decision will be entered under Rule 50. SMITH 176 Smith, J., concurring: I agree that the basis for depreciation of petitioner's assets for 1938 is the fair market value56 of the assets at the date of reorganization. It is stated, however, in the Court's opinion that:* * * The substitution of common stock for bonds is not a cancellation or reduction of the liability represented by the bonds, no matter how much less the stock may be worth, since "the assets are not thereby freed from obligation. * * * While the bond loan has been terminated, the amount borrowed is now committed to capital stock liability instead of to the liability of a fixed indebtedness." Capento Securities Corporation, 47 B. T. A. 691.I think that this observation is contrary to well recognized principles of law. Where a corporation substitutes shares of stock in exchange for bonds the corporation is freed from indebtedness. A corporation does not owe any debt in respect of its capital stock. Footnotes1. Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179; Palm Springs Holding Corporation v. Commissioner, 315 U.S. 185">315 U.S. 185; Bondholders Committee, Marlborough Investment Co. v. Commissioner, 315 U.S. 189">315 U.S. 189; Helvering v. Southwest Consolidated Corporation, 315 U.S. 194↩.2. Public No. 696, 75th Cong., 52 Stat. 840, as amended:"Sec. 268. Except as provided in section 270 of this Act, no income or profit, taxable under any law of the United States or of any State now in force or which may hereafter be enacted, shall, in respect to the adjustment of the indebtedness of a debtor in a proceeding under this chapter, be deemed to have accrued to or to have been realized by a debtor, by a trustee provided for in a plan under this chapter, or by a corporation organized or made use of for effectuating a plan under this chapter by reason of a modification in or cancelation in whole or in part of any of the indebtedness of the debtor in a proceeding under this chapter."Sec. 269. Where it appears that a plan has for one of its principal purposes the avoidance of taxes, objection to its confirmation may be made on that ground by the Secretary of the Treasury, or, in the case of a State, by the corresponding official or other person so authorized. Such objections shall be heard and determined by the judge, independently of other objections which may be made to the confirmation of the plan, and, if the judge shall be satisfied that such purpose exists, he shall refuse to confirm the plan."Sec. 270. In determining the basis of property for any purposes of any law of the United States or of a State imposing a tax upon income, the basis of the debtor's property (other than money) or of such property (other than money) as is transferred to any person required to use the debtor's basis in whole or in part shall be decreased by an amount equal to the amount by which the indebtedness of the debtor, not including accrued interest unpaid and not resulting in a tax benefit on any income tax return, has been canceled or reduced in a proceeding under this chapter, but the basis of any particular property shall not be decreased to an amount less than the fair market value of such property as of the date of entry of the order confirming the plan. Any determination of value in a proceeding under this chapter shall not be deemed a determination of fair market value for the purposes of this section. The Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall prescribe such regulations as he may deem necessary in order to reflect such decrease in basis for Federal income-tax purposes and otherwise carry into effect the purposes of this section.* * * *"Sec. 276. c. the provisions of sections 77A and 77B of chapter VIII, as amended, of the Act entitled 'An Act to establish a uniform system of bankruptcy throughout the United States', approved July 1, 1898, shall continue in full force and effect with respect to proceedings pending under those sections upon the effective date of this amendatory Act, except that --(1) if the petition in such proceedings was approved within three months prior to the effective date of this amendatory Act, the provisions of this chapter shall apply in their entirety to such proceedings; and(2) if the petition in such proceedings was approved more than three months before the effective date of this amendatory Act, the provisions of this chapter shall apply to such proceedings to the extent that the judge shall deem their application practicable; and(3) sections 268 and 270 of this Act shall apply to any plan confirmed under section 77B before the effective date of this amendatory Act and to any plan which may be confirmed under section 77B on and after such effective date, except that the exemption provided by section 268 of this Act may be disallowed if it shall be made to appear that any such plan had for one of its principal purposes the avoidance of income taxes, and except further that where such plan has not been confirmed on and after such effective date, section 269 of this Act shall apply where practicable and expedient."↩3. Kirby Lumber Co. v. United States, 284 U.S. 1↩.4. United States v. Hendler, 303 U.S. 564">303 U.S. 564↩.5. Petitioner conceded at the hearing that as owner for only the last five months of 1935 it was entitled to only that proportion of the year's depreciation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512558/	DISTRICT COURT OF APPEAL OF THE STATE OF FLORIDA FOURTH DISTRICT HOWARD AND ASSOCIATES ATTORNEYS AT LAW, P.A., a Florida Professional Association, and TIMOTHY HOWARD, individually, Appellant, v. BWCI PENSION TRUSTEES LIMITED in their capacity as Trustees of the Deferred Retirement Annuity Trust Scheme A/C REF 1123/055, PROVIDENCE CAPITAL HOLDINGS, LLC, a Nevada limited liability company, CAMBRIDGE CAPITAL GROUP, LLC, a Nevada limited liability company, CAMBRIDGE CAPITAL GROUP ADVISORS, LLC, a Nevada limited liability company, A&T DEVELOPMENT, LLC, a Nevada limited liability company, LANCE FRIEDMAN, JEFF KAHN, ADDYS WALKER, JOSE CORDERO d/b/a JOSE ANTONIO PRIVATE LENDING, LLC, and individually, and JIM KEEFER d/b/a DIRECT PRIVATE LENDERS, INC., AND/OR ALTERNATIVE FUNDING LENDERS, INC., and individually, Appellees. No. 4D19-1791 [March 4, 2020] Appeal of a nonfinal order from the Circuit Court for the Fifteenth Judicial Circuit, Palm Beach County; Lisa S. Small, Judge; L.T. Case No. 50-2018-CA-004464-XXXX-MB. Stephanie Reed Traband of Levine Kellogg Lehman Schneider + Grossman LLP, Miami, and John P. Leonard of McElroy, Deutsch, Mulvaney & Carpenter, LLP, Morristown, New Jersey, for appellant. Steven M. Katzman and Charles J. Bennardini of Katzman Wasserman Bennardini & Rubinstein, P.A., Boca Raton, for appellee, BWCI Pension Trustees Limited in their capacities as Trustees of the Deferred Retirement Annuity Trust Scheme A/C REF 1123/005. GROSS, J. A law firm and a money manager entered into an “equity” agreement where the law firm received $640,000 from the money manager. As collateral, the law firm pledged attorneys’ fees it anticipated from certain cases identified in the agreement. The money manager alleged that the law firm breached the agreement, and it filed suit, asserting actions at law. The money manager moved to compel the law firm to hold the attorneys’ fees listed in the collateral and security agreement in trust pursuant to Rule 5-1.1(f) of the Rules Regulating the Florida Bar. The circuit court granted the motion. The narrow issue in this case is whether Rule 5-1.1(f) authorized the circuit court to issue a prejudgment order requiring the law firm to hold “in trust” attorneys’ fees received on cases “until the dispute is resolved.” We hold that Rule 5-1.1(f) did not authorize the order because a rule regulating professional conduct does not create substantive or procedural rights for matters left to statute, common law, or rules of procedure. Appellee, BWCI Pension Trustees Ltd., is a foreign entity that provides pension management services to high net-worth individuals. On January 4, 2018, BWCI entered into an “Equity Plus Bonus” agreement with appellants, Timothy Howard and his law firm, Howard & Associates. The funds in the agreement related to a proposed real estate project in Jacksonville. The agreement provided that appellants would repay the $640,000 on January 19, 2018, along with a $1,000,000 bonus. 1 To secure BWCI’s investment, the law firm pledged its entitlement to attorneys’ fees from a list of cases contained in a collateral and security agreement. After filing suit, BWCI moved to compel appellants to hold the attorneys’ fees at issue in trust pursuant to Rule 5-1.1(f). The circuit court granted the motion and entered the order described above. Rule 5-1.1(f) provides: Disputed Ownership of Trust Funds. When in the course of representation a lawyer is in possession of property in which 2 or more persons (1 of whom may be the lawyer) claim interests, the property must be treated by the lawyer as trust property, but the portion belonging to the lawyer or law firm must be withdrawn within a reasonable time after it becomes due unless the right of the lawyer or law firm to receive it is disputed, in which event the portion in dispute must be kept separate by the lawyer until the dispute is resolved. The 1 We do not address the validity of the agreement in this opinion. -2- lawyer must promptly distribute all portions of the property as to which the interests are not in dispute. (Italics supplied). Rule 5-1.1(a)(1) states the general rule that a “lawyer must hold in trust, separate from the lawyer’s own property, funds and property of clients or third persons that are in a lawyer’s possession in connection with a representation.” (Italics supplied). BWCI’s claim on the attorneys’ fees did not arise “in the course of” the law firm’s representation of BWCI. The rule contemplates a connection between a claim to the funds and the underlying case where the attorney’s representation occurs. This is supported by the Comment to Bar Rule 5- 1.1, which recognizes that “[t]hird parties, such as a client’s creditors, may have claims against funds or other property in a lawyer’s custody.” (Italics supplied). Here, BWCI’s claim arose not from any legal representation by appellants, but from an arm’s length business transaction with them that had no relationship to any of the cases identified in the agreement. More importantly, Rule 5-1.1 governs ethical conduct of attorneys. The rule does not create substantive or procedural rights that would support the court order in this case, an area reserved for statutes, rules of procedure, or the common law. Entitled “Remedies,” Paragraph 5 of the parties’ agreement states that BWCI has “all the rights and remedies of a secured party under the Code;” that paragraph does not explicitly describe the type of relief granted in the order on appeal. The agreement defines “Code” as “the Uniform Commercial Code as from time to time in effect in the State of Florida.” Part of Florida’s UCC, section 679.601(1)(a), Florida Statutes (2019), generally describes a secured party’s options under the Code after a default by the debtor: (1) After default, a secured party has the rights provided in this part and, except as provided in section 679.602, those provided by agreement of the parties. A secured party: (a) May reduce a claim to judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure; and (b) If the collateral is documents, may proceed either as to the documents or as to the goods they cover. As White and Summers explain, -3- The Code does not say what the creditor must do to obtain judgment and execution on the debt; state statutes and common law of ancient vintage specify those steps, and they vary somewhat from state to state. James J. White and Robert S. Summers, Uniform Commercial Code (4th ed. 2002) § 34-4. BWCI used no recognized remedy or procedural device to secure the order at issue in this case. The order was tantamount to an injunction, because it ordered appellants to hold, in trust, attorneys’ fees they received from certain cases. But an injunction was improper in this case, because BWCI had an adequate remedy at law. See Weinstein v. Aisenberg, 758 So. 2d 705 (Fla. 4th DCA 2000). Also, since the order was a temporary injunction, entered before a final judgment, the order contravened the requirement that “[n]o temporary injunction shall be entered unless a bond is given by the movant in an amount the court deems proper, conditioned for the payment of costs and damages sustained by the adverse party if the adverse party is wrongfully enjoined.” Fla. R. Civ. P. 1.610(b). The order relied on no statutory mechanism available to creditors, such as a Chapter 76 attachment or a Chapter 77 garnishment, both of which require the posting of a bond when orders are entered before judgment. BWCI has called our attention to no provision of Chapter 679 which would authorize the circuit court’s order. BWCI’s sole authority for the order was Rule 5-1.1, as utilized in a previous order of the trial judge. That rule does not create substantive legal rights that empowered the circuit court to grant the relief it did. The Preamble to the Rules of Professional Conduct explains why the Rule was improperly applied in this case: Violation of a rule should not itself give rise to a cause of action against a lawyer nor should it create any presumption that a legal duty has been breached. In addition, violation of a rule does not necessarily warrant any other nondisciplinary remedy, such as disqualification of a lawyer in pending litigation. The rules are designed to provide guidance to lawyers and to provide a structure for regulating conduct through disciplinary agencies. They are not designed to be a basis for civil liability. Furthermore, the purpose of the rules can be subverted when they are invoked by opposing parties as procedural weapons. The fact that a rule is a just basis for a lawyer's -4- self-assessment, or for sanctioning a lawyer under the administration of a disciplinary authority, does not imply that an antagonist in a collateral proceeding or transaction has standing to seek enforcement of the rule. Accordingly, nothing in the rules should be deemed to augment any substantive legal duty of lawyers or the extra-disciplinary consequences of violating a substantive legal duty. Preamble: A Lawyer’s Responsibilities, Rules Regulating the Florida Bar, Rules of Professional Conduct (emphasis added); see Lee v. Fla. Dep’t of Ins. & Treasurer, 586 So. 2d 1185, 1188 (Fla. 1st DCA 1991). We reverse the Amended Order Granting Plaintiff’s Motion to Hold Attorneys’ Fees in Trust and remand for further proceedings. CIKLIN and CONNER, JJ., concur. * * * Not final until disposition of timely filed motion for rehearing. -5-	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621470/	Red Star Yeast and Products Company, Petitioner, v. Commissioner of Internal Revenue, RespondentRed Star Yeast & Products Co. v. CommissionerDocket No. 48691United States Tax Court25 T.C. 321; 1955 U.S. Tax Ct. LEXIS 36; November 30, 1955, Filed 36 Decision will be entered under Rule 50. 1. Petitioner made certain payments to Best Yeast in 1943 and 1944 pursuant to a contract between petitioner and Best Yeast, under which Best Yeast rendered technical assistance and know-how services to petitioner in the course of and in connection with petitioner's development of a technique and process for the manufacture of active dry yeast. Held, that the payments constituted a capital expenditure and that petitioner could not elect to expense or capitalize the expenditure as one for research and development. Held, further, that petitioner failed to establish a loss thereon in either 1945 or 1946.2. Petitioner's plant was located on a bluff adjacent to Lake Michigan. By 1944, the lake bank had substantially deteriorated. Petitioner sought advice from two professional engineers and thereafter constructed two permeable groins extending into the lake, certain drains in the lake bank, since washed away, and a new sewer running down the lake bank onto the end of one of the permeable groins. Certain of the advice of one of the engineers was not followed by petitioner. Petitioner attributed all of these items of cost to the construction37 of permeable groins and deducted the total amount in 1944 as an ordinary and necessary business expense. Held, that the costs of constructing permeable groins, drains and a new sewer constituted capital expenditures for improvements and betterments having a life of more than 1 year. Held, further, that petitioner did not show in what year the drains washed away and thus is not entitled to a deduction therefor in 1944. And held, further, that petitioner is entitled to deduct as an ordinary and necessary expense the cost of the professional advice which was not followed. Harvey W. Peters, Esq., for the petitioner.George T. Donoghue, Jr., Esq., for the respondent. Fisher, Judge. FISHER322 The respondent determined deficiencies in the corporate income taxes of petitioner for the taxable years 1943 and 1945, in the amounts of $ 20,371.22 and $ 32,184.99, respectively. The deficiency for 1945 is, in part, a consequence of adjustments made by respondent for the taxable year 1944, including the carryback of a net operating loss sustained by petitioner in 1946.The questions presented for our consideration are: (1) Whether certain payments made by petitioner in 1943 and 1944 pursuant to a contract between petitioner and Best Yeast, under which Best Yeast was required to render certain technical assistance services on the basis of the Best experience, know-how, techniques, and processes in the manufacture of active dry yeast, are to be capitalized or whether they were deductible currently either as ordinary and necessary business expenses or otherwise; (2) alternatively, 39 if such payments are considered capital in nature, whether they are deductible under 23 (f) as losses from abandonment in either 1945 or 1946; and (3) whether certain expenditures for the construction of permeable groins, a new sewer, drains which have since washed away, and for professional advice which has never been followed are properly deductible as ordinary and necessary business expenses in the year in which made.FINDINGS OF FACT.Petitioner is a corporation organized under the laws of the State of Wisconsin, with its principal office and place of business in Milwaukee, Wisconsin. Petitioner's business consists mainly of manufacturing yeast and other related products. Petitioner maintains two plants, one in the city of Milwaukee, located on North 27th Street, and the other in Cudahy, Wisconsin, a suburb of Milwaukee. In addition, it maintains distribution branches in various other cities in the United States. Petitioner is an accrual basis taxpayer and files its Federal tax returns for the calendar year. For the taxable years here involved petitioner filed its Federal corporate income and excess profits tax returns with the then collector of internal revenue for the district40 of Wisconsin.Best Yeast Payments.Petitioner's business in the main consists of manufacturing and selling yeast.Yeast is a fungus which grows in liquid solutions of carbohydrates, proteins, and oxygen. Commercially, it is grown by placing in a large fermenter a dilute solution of nutritive material, consisting of a base of either grain or molasses to supply the necessary carbohydrates and inorganic (ammonium sulfate) and organic substances to supply the 323 required protein (nitrogen). The fermenter is equipped with an aerating device which blows air through the solution. A starting batch of seed yeast is placed in the fermenter, aeration begun, temperature controlled and during growth additional amounts of nutritive materials added. After fermentation the yeast is harvested in a type of centrifuge machine. This product is then put through a filer press and the resultant product is a solid cake of fresh compressed yeast.Such fresh compressed yeast is comprised of 70 per cent water and 30 per cent active solids which induce fermentation. Yeast in this state is bulky and highly perishable and must be kept under refrigeration. Certain types of fresh compressed yeast41 can be dehydrated and thereby become a substance known as active dry yeast which has a moisture (water) content of approximately 8 per cent and a solid content of approximately 92 per cent. In this state the yeast is considered dormant. In contrast to fresh compressed yeast, active dry yeast is compact and has an extended shelf life; it is capable of being kept without appreciable deterioration for periods as long as 6 months without refrigeration. In order to utilize active dry yeast water must first be added back and the substance returned to essentially its original active state as compressed yeast. Various techniques, formulas and secret processes are used by manufacturers of active dry yeast both to produce compressed yeast suitable for drying and in dehydration.In 1940, petitioner began to consider the problem of producing active dry yeast, and incident to its general research activity at that time, carried on certain negotiations with the Northwestern Yeast Company of Chicago and the Mellon Institute, mainly in relation to the development of a process for the production of active dry yeast. Both Mellon and Northwestern were then engaged in work in the field.About June42 1942, petitioner was requested by the Quartermaster Corps Subsistence Research Laboratory, United States Army, (hereinafter referred to as Quartermaster Research), to develop a process for the production of active dry yeast, and to produce active dry yeast for sale to the United States Army for use by combat troops overseas. The Army was interested in having petitioner become a supplier of active dry yeast both because of the Army's large demand for the product and because the existence of only a single supplier prior to petitioner's entry into the field, was not, from the Army's point of view, a satisfactory situation in regard to either price or quantity.Largely in accordance with this request, petitioner shortly thereafter undertook to develop a process for the production of active dry yeast. Petitioner's research and experimentation in this respect was conducted under the supervision of Robert Irvin, a research chemist. Irvin's work actually began in the early part of the summer of 1942 with his reading of all of the available literature on the subject of 324 active dry yeast and later by collecting apparatus and equipment considered necessary to the conduct of the research. 43 Irvin's first laboratory experiment was conducted on October 13, 1942, and related solely to the drying of yeast. Thereafter, further experiments were conducted both with respect to the drying of yeast and with respect to making petitioner's commercial compressed yeast suitable for dehydration.During the period from January 19 to 21, 1943, petitioner conducted a group of experiments known as the F-80 series. In these experiments commercial compressed yeast produced in petitioner's plant was subjected to an "after-treat," which is a secondary fermentation applied to finished yeast in order to render it more suitable to withstand drying. Irvin considered the active dry yeast produced as a result of these experiments to be good, testing well as to gassing power and showing a good probable stability in storage. Samples of this product were sent in January to the Department of Agriculture, Beltsville Laboratory, Baltimore, Maryland, for testing and were approved as meeting that department's specifications.Shortly thereafter, petitioner submitted a number of samples of active dry yeast produced in its laboratory to Quartermaster Research for testing. The samples submitted were found44 to be satisfactory as to moisture content and ability to raise bread. Quartermaster Research then had no facilities for testing the keeping qualities of the samples. Because of the limited number of personnel attached to Quartermaster Research at that time most of the reporting on the tests of these samples was done verbally, by phone or in person.In the period February to April 1943, petitioner was contacted on several occasions respecting when and to what extent it might be able to supply active dry yeast to the Armed Forces. On March 11, 1943, in response to one such inquiry from the United States Department of Agriculture, Food Distribution Administration, dated February 25, 1943, petitioner by its vice president, R. D. L. Wirth, replied, in part, as follows:We have been and are presently conducting a research program to work out methods that will enable us to produce a dried yeast to meet the specifications of the United States Army. At present, however, we are not in a position to answer all the questions contained in your letter of the 25th. More particularly those questions concerning the amount of dried yeast we could produce with type of equipment and priorities45 needed for this production, as our results to date have not advanced to the point where we know exactly what process and equipment we will ultimately use.Irvin continued his experiments and on April 22, 1943, (in series F 134) produced an active dry yeast in petitioner's laboratory which was stored by petitioner until June 18, 1943, at a temperature of 70 degrees Fahrenheit without deterioration. On April 29, 1943, petitioner 325 submitted to Quartermaster Research samples of the yeast dried by Irvin on April 22. Under date of May 17, 1943, Quartermaster Research wrote petitioner that the results of the moisture and baking tests conducted on the samples submitted were satisfactory and met Army standards. Quartermaster Research's principal standard of judgment then was whether the yeast submitted would produce a nice, high loaf of bread. The report indicated that all but one of the samples produced very good bread. At that date Quartermaster Research still had no facilities for testing the keeping quality of active dry yeast, and it was expected that the producer would run his own keeping quality tests by exposure to high temperatures. Properly interpolated, such exposure46 would be indicative of the keeping quality of yeast at different temperatures for different periods. It was not until January 8, 1944, that Quartermaster Research had available equipment for testing the keeping quality of active dry yeast.In accordance with petitioner's practice, when it deems a process to be sufficiently developed at the laboratory stage to indicate commercial feasibility, experimentation and production is shifted from the laboratory scale to that of the pilot plant, a somewhat larger operation. On May 21, 1943, after receipt of the report from Quartermaster Research in respect to the moisture and baking qualities of the April 22 samples of active dry yeast produced by Irvin, petitioner, under the supervision of Oswald Freund, director of petitioner's fermentation laboratory, using Irvin's laboratory product as developed under the F-80 series of experiments, undertook to produce active dry yeast on a pilot plant scale.On June 18, 1943, petitioner submitted to the Special Commodities Branch of the Department of Agriculture a sample of the yeast dried by Irvin on April 22 and from that time stored in an oven at 70 degrees Fahrenheit. By letter, dated July 30, 47 1943, the petitioner was informed of the results of the Special Commodities Branch tests, that the samples produced bread that was equal in loaf volume and crumb color to bread with 2 per cent compressed yeast and thus met the standard basis for judging test samples.Meanwhile, on May 21, 1943, the same day on which Freund first began his experiments (numbered 104), and undertook the first pilot plant run, petitioner entered into a contract with Best Yeast, Ltd. of Canada (hereinafter called Best) for the purpose of securing certain aid from Best, hereinafter described.For some time since January 1943, when the F-80 series of experiments proved successful, petitioner believed that its work on the production of active dry yeast was being conducted along the proper lines. Ultimate success and conversion to commercial production, however, involved certain substantial risks, considering that petitioner had never before produced active dry yeast on a commercial scale. Some 326 uncertainty existed, therefore, as to the usability of its laboratory and pilot plant processes and techniques for producing active dry yeast on a commercial scale. Accordingly, Irvin suggested that before48 the company spend a great deal of money for specially designed manufacturing equipment, petitioner obtain such aid and information as it could to assist in guiding the necessary conversion and expansion. Irvin suggested specifically that petitioner contact Best to learn about its manufacturing procedures. Colonel Rohland Isker of Quartermaster Research, who was particularly anxious for petitioner to go into production as soon as possible, also suggested that petitioner contact Best in this regard.No one then doubted that within a reasonable length of time petitioner could perfect to an even greater degree the technique and process it had developed for producing active dry yeast, or that further pilot plant experiments would satisfactorily assure the feasibility of producing active dry yeast on a commercial scale in accordance with such technique and process. Petitioner, however, in an endeavor to assure itself of the probable cost of production, to accelerate conversion over to production on a commercial scale, to confirm the adequacy or inadequacy of its own technique and process from a standpoint of economic feasibility, and if necessary, to learn of or to develop an economical49 process and technique for producing active dry yeast, decided to seek the aid and technical assistance and advice of a commercial producer such as Best, as suggested by both Irvin and Isker.By entering into an agreement for such assistance petitioner hoped to glean whether the process and the technique it had thus far developed were superior or inferior to those currently employed by a producer of dry yeast, and to study such a producer's techniques. Petitioner also hoped to obtain data on the costs of production and thus be able to better evaluate its prospective costs for producing dry yeast in accordance with its then perfected laboratory process.Accordingly, on May 21, 1943, petitioner and Best entered into a contract which provided, in pertinent part, as follows:Whereas, BEST represents that for some time past under its exclusive patent rights it has been making compressed yeast from a sulphite liquor base and, in the process thereof, has developed certain knowledge and information concerning types of yeast suitable for dehydration and has been producing a compressed yeast with constituent elements suitable for effective dehydration and has been dehydrating such yeast and50 selling the same in dry form on a commercial basis in the Dominion of Canada; andWhereas, RED STAR and BEST are of the opinion that the dried yeast of BEST'S manufacture meets the present requirements of the United States Government as per Exhibit A attached, and BEST is of the opinion that with the knowledge and information now possessed by it on this subject, and the skills, methods or processes used by it in the making of its compressed yeast for drying, it is able to adapt the same to compressed yeast made from a molasses base and prepare such yeast suitable for dehydration and marketing 327 in the dry form, and that such dried yeast will likewise meet the requirements of the United States Government, Exhibit A attached; andWhereas, RED STAR for many years has made and sold throughout the United States compressed yeast made from a molasses base, and is desirous of obtaining knowledge of the processes, methods, skills and ways and means of producing such yeast for dehydration that it may engage in the commercial manufacture and sale of dried yeast, and to such end is desirous of acquiring from BEST detailed and complete knowledge and information of its skills and methods51 or processes and in adapting the same to the making of a molasses base compressed yeast (hereinafter referred to as "Red Star type") suitable for drying and to the drying of such yeast, together with the right and license to make, use and sell the same;Now, Therefore, for and in consideration of the premises and of the mutual covenants and agreements hereinafter expressed to be performed, the parties hereto have agreed and do hereby agree as follows:1. RED STAR agrees to pay to BEST concurrently with the execution of this agreement the sum of Twenty Five Thousand ($ 25,000.00) Dollars in United States funds.2. Promptly following the signing of this agreement, and at a time mutually agreeable to both parties, representatives of the technical staffs of BEST and RED STAR shall meet together at the plant of RED STAR in Milwaukee, Wisconsin, and at such meeting RED STAR shall disclose fully to BEST all information concerning RED STAR'S present commercial yeast production methods as may be necessary or helpful in applying or adapting BEST'S knowledge, information, skills, methods and processes to the working out of the problems of producing a compressed yeast of the RED STAR type suitable52 for dehydration; and RED STAR, through its technical staff, in ccoperation [sic] with the representatives of the technical staff of BEST, shall thereupon proceed to apply or adapt to RED STAR'S type of yeast and procedure, BEST'S knowledge, information, technique, skills, methods or processes which BEST shall fully divulge to RED STAR in order to produce a compressed yeast of the RED STAR type suitable for dehydration and which, when dried at BEST'S Liverpool plant will meet the United States Government requirements as per Exhibit A attached. In the event that BEST decides at this stage of performance that yeast of the RED STAR type suitable for dehydration cannot be produced as aforesaid, BEST agrees to refund forthwith to RED STAR Twenty thousand ($ 20,000.) Dollars of the Twenty five thousand ($ 25,000.) Dollars initial payment, retaining for itself Five thousand ($ 5,000.) Dollars thereof.3. Immediately following the production at the Milwaukee plant of RED STAR of fresh compressed yeast, pursuant to the foregoing paragraph, the technical staffs of BEST and RED STAR shall meet together at the Liverpool Nova Scotia plant of BEST where said RED STAR fresh compressed yeast 53 shall be dehydrated by BEST in the presence of the representatives of RED STAR'S technical staff on the drying equipment now in operation at BEST'S Liverpool Nova Scotia plant, and said dehydrated yeast shall thereupon be tested to ascertain whether it will probably meet the requirements of the United States Government as per Exhibit A attached. If, as a result of such tests, such yeast appears to be satisfactory, samples thereof shall be promptly delivered to the Chicago Quartermasters Depot, No. 1819 West Pershing Road, Chicago, Illinois, U. S. A. for further examination, analysis and test, to determine whether or not such product meets the Government requirements as per Exhibit A attached, and in the event said Depot finds that said product meets said requirements, RED STAR agrees to make a further payment to BEST of Twenty Five Thousand ($ 25,000.00) Dollars in United States funds within thirty (30) days of such finding. (It is 328 understood and agreed that, at RED STAR'S option, BEST will, during the stay of RED STAR'S technical staff at the Liverpool plant, permit inspection of its commercial operation in making compressed yeast and will disclose and furnish to RED STAR54 detailed and complete information concerning BEST'S skills, processes or methods, procedure, technique, formulae, materials, controls, and all other data concerning BEST'S present commercial operations employed in the production of its compressed yeast for dehydration).4. Time is of the essence in respect to the foregoing, and BEST agrees that it will dehydrate such compressed yeast of the RED STAR type and test the same at its Liverpool plant and deliver such tested samples to the Quartermasters Depot, as aforesaid, within ninety (90) days from the date hereof, provided RED STAR will, at all times, promptly and fully cooperate with BEST with respect to the procedure contemplated under the foregoing paragraphs "2" and "3" and comply with the requests of BEST in connection therewith, and will furnish all necessary facilities, equipment (including a pilot plant) and materials for the carrying out, adapting and perfecting BEST'S knowledge, skills, processes and methods in and to the production of such yeast. This RED STAR agrees fully and unreservedly to do, and in consideration thereof BEST binds itself to deliver such dried yeast to the said Quartermasters Depot within said ninety55 (90) day period, failing which this agreement shall be cancellable at the option of RED STAR on ten (10) days' written notice to BEST, and in the event of such cancellation BEST agrees forthwith to refund to RED STAR Fifteen Thousand ($ 15,000.00) Dollars of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder, retaining for itself Ten Thousand ($ 10,000.00) Dollars thereof.5. In the event the said Chicago Quartermasters Depot finds that the yeast delivered to it by BEST as aforesaid does not meet said requirements, this agreement shall also be cancellable at the option of RED STAR on ten days' written notice to BEST, and in the event of such cancellation BEST agrees forthwith to refund to RED STAR one-half ($ 12,500.00) Dollars of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder, retaining for itself the balance thereof ($ 12,500.00). If RED STAR does not cancel as aforesaid, BEST agrees to continue its cooperation with RED STAR to produce a yeast of the RED STAR type suitable for drying and to test the same as aforesaid. At any time thereafter, and before obtaining success in producing yeast of the RED STAR type according to the aforesaid56 conditions, RED STAR shall have the right to cancel this agreement, and BEST shall likewise have the right to cancel this agreement. In either event BEST shall forthwith refund to RED STAR one-half ($ 12,500.00) of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder.6. In the event compressed yeast of the RED STAR type suitable for drying is produced pursuant to the provisions of paragraph "2" hereof, and such yeast as dehydrated at Best's Liverpool plant meets the Government requirements as per Exhibit A attached, all in compliance with the foregoing, RED STAR agrees, subject to the provisions of paragraph "11" hereof, and further subject to its ability to obtain equipment and materials, to promptly and diligently proceed with the design, purchase and installation of drying equipment at its Milwaukee plant for the commercial production of such yeast and shall, within sixty (60) days from the date of the initial operation of its said drying equipment, pay to BEST the further sum of Fifty Thousand ($ 50,000.00) Dollars in United States funds.7. On RED STAR'S request, BEST agrees to furnish to RED STAR full information and knowledge based upon its experience in 57 the dehydration of yeast at its Liverpool plant as concerning the design, development and installation of commercial drying equipment in the plant of RED STAR to the end that such 329 equipment may operate and function economically and to the best possible advantage in the dehydration of such yeast.8. It is understood and agreed that in the event RED STAR enters upon the commercial manufacture and sale of dried yeast pursuant to the provisions hereof, RED STAR shall have the exclusive right, so far as BEST is concerned, throughout the United States and the territories and possessions thereof, in, to and under the knowledge, skills, methods and processes and technique pertaining to the subject matter hereof made known to RED STAR by BEST during the workings of this agreement and BEST agrees not to sell the same or divulge any information or knowledge pertaining thereto to any person, firm or corporation engaged or for use in the manufacture or sale of yeast made from a molasses base.9. BEST agrees that should RED STAR desire to file application for Letters Patent in the United States on any of BEST'S knowledge, skills, processes or methods and technique pertaining to the subject58 matter of this agreement made known to RED STAR by BEST during the workings of this agreement, BEST will at any time upon request and without further compensation, but at the expense of RED STAR, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, all such papers, including applications for patent, as may be necessary to obtain patents thereon in the United States and to vest title thereto in RED STAR, its successors or assigns. In the event Letters Patent are granted to RED STAR as aforesaid, there shall be granted to BEST, or to an assign owning a majority of its common shares, a paid up and unlimited license thereunder. BEST does not, however, represent that it is a pioneer in the art of producing compressed yeast from a molasses base suitable for drying, or the drying thereof, or that its knowledge, skills, processes and methods with respect thereto are patentable.10. It is understood and agreed that following the production hereunder of a compressed yeast of the RED STAR type suitable for drying pursuant to paragraph "2" hereof, RED STAR may proceed to cause a patent infringement investigation to be made in respect of the product and process59 or method of producing the same. Said patent infringement investigation must, however, be concluded and RED STAR'S election (as provided in the next succeeding paragraph) announced to BEST within sixty (60) days from the date of delivery of yeast by BEST to the said Chicago Quartermasters Depot pursuant to paragraph "4" hereof.11. Should RED STAR conclude, upon the results of said infringement investigation, that there is infringement, RED STAR shall have the right to elect not to proceed with the development and installation of drying equipment and the manufacture and sale of dried yeast, and in such event RED STAR shall be relieved of all obligation to make further payments hereunder; provided, however, that in the event the Chicago Quartermasters Depot finds that the yeast delivered to it by BEST meets the said Government requirements and RED STAR at any time within a period of three (3) years from the date hereof engages upon the manufacture and sale of a dried yeast under any process, the provisions of paragraphs "3" and "6" shall apply and RED STAR shall pay to BEST the full amounts as and when herein provided.12. In the event, however, that the Chicago Quartermasters Depot60 rejects the yeast delivered to it by BEST, and RED STAR by reason thereof cancels this agreement pursuant to the provisions of paragraph "5" hereof, but neverthless [sic] RED STAR, at any time within three (3) years from the date hereof, proceeds with the manufacture and sale of a dried yeast which, when tested by the same methods and under the same conditions as employed by the Chicago Quartermasters Depot in testing the said rejected yeast, shall show a moisture 330 content the same as or higher than, and baking and keeping qualities the same as or lower than, the corresponding findings of the said Chicago Quartermasters Depot in respect of said rejected yeast, then only the additional payment of $ 50,000.00 provided by paragraph "6" hereof shall be made by RED STAR to BEST, the refund under paragraph "5" ($ 12,500.00) and the second payment under paragraph "3" ($ 25,000.00) being forgiven. If, despite the aforesaid rejection by the Chicago Quartermasters Depot, RED STAR sells said dry yeast to the United States Government within eighteen (18) months of said rejection, then the entire $ 100,000.00 as provided for herein shall be paid.13. BEST represents that it has the61 unrestricted right to make and enter into this agreement and that the knowledge, skills, methods, processes and technique developed by it in the production of its compressed yeast which, when dried at its Liverpool plant, meets (as agreed by BEST and RED STAR) the requirements of the United States Government test as per Exhibit A attached hereto, are the result of its own independent efforts and development work and constitute part of its own knowledge and skill acquired in the course of the manufacture by it of fresh or compressed yeast at its yeast plant; that it is free to transfer to RED STAR full and complete information and knowledge thereof, and the right to use the same in connection with the manufacture of dried yeast made from a molasses base within and throughout the United States, its territories and possessions, to the full extent herein contemplated, and that there are no outstanding licenses, interests or agreements inconsistent herewith, or which will impair or restrict BEST in the performance of its obligations or RED STAR in the enjoyment of its rights hereunder.14. In consideration of the knowledge and skills to be imparted hereunder by BEST to RED STAR, RED STAR62 agrees for the period of two years after it has commenced commercial production of dried yeast not to manufacture or sell dried yeast within the Dominion of Canada or Newfoundland, except sales of dried yeast to the Government of the United States, or its authorized agencies.15. The provisions of this agreement shall not be construed as granting any rights to RED STAR to manufacture, dehydrate and sell yeast made from a sulphite liquor base in any part of the territories mentioned herein, or likewise as prohibiting BEST from such manufacture, dehydration and sales, if such yeast is made from a sulphite liquor base.Exhibit A attached thereto provided, as follows:GRANULAR DEHYDRATED YEAST: Shall be clean cultures of bread yeast (Saccharomyces cerevisae) of good commercial quality, grown on a clean nutrient medium, from which separation is effected and dehydration executed, all under modern sanitary conditions, to the end that the final product shall be capable of producing a vigorous and a well-risen dough.Shall be composed only of yeast cells which have been dehydrated to a mositure [sic] content of not more than 8 per cent. Shall contain sufficient live yeast cells to do63 the work of compressed yeast under standard conditions when used at the rate of 1 part of granular dehydrated yeast in lieu of 2 parts of compressed yeast. Shall be in prime condition at the time of delivery and shall not be appreciably affected as to its baking time after storage for six (6) weeks at 70 deg. F. and only slightly affected after three months' storage at such temperature. Shall not require cold storage, but shall not be affected adversely by storage for six months at 38 deg. to 42 deg. F. and on removal from such storage, shall be in as good condition as when placed in storage. Shall be free from mold, dirt, grit, starch, or other extraneous or added matter. The rope spore count shall not exceed 200 per gram.331 In accordance with the provisions of the contract with Best, Sidney Breese, managing director of Best, and Felix Block, a research chemist with Best, came to Milwaukee on June 15, 1943. They stayed at first for about 10 days, returning thereafter to Canada, once again coming to Milwaukee early in July and remaining for about three weeks, and then again coming back from Canada on August 12 for Breese and August 26 for Block, finally returning to Canada64 at the end of August. While in Milwaukee Breese worked with Irvin on methods for drying yeast and Block worked with Freund on the development of a process for producing compressed yeast suitable for drying. Duplicate records of work carried on by either Irvin or Freund during Block's or Breese's absence were furnished them upon their return from Canada.Breese and Irvin conducted their first joint experiment on June 18, 1943. Breese proposed the conditions for drying. These were different from those previously employed by Irvin in respect to both temperature range and humidity, Breese using low temperatures, while Irvin had previously dried his yeast samples at relatively higher temperatures. The finished yeast produced in accordance with Breese's first suggested drying procedure ranged from poor to only commercially acceptable, and utilization of the process commercially would have been quite costly. Subsequently, Breese and Irvin used a higher temperature level in their joint experiments and were able more efficiently to produce a good dry yeast.While Breese's and Irvin's joint experiments ultimately produced an active dry yeast which was commercially acceptable as to quality, 65 Irvin considered the product no better than that he had previously obtained in the F-80 series of experiments. At the conclusion of the joint experiments, in August, Irvin reported to Wirth that he thought petitioner's staff had learned nothing from the Best people and that he thought petitioner's staff knew more about drying yeast than Best.During the conduct of the joint drying experiments by Breese and Irvin, Block and Freund worked together in petitioner's pilot plant. The first pilot plant experiment was conducted on June 16, 1943, upon instruction of Block. It consisted of an after treat (or secondary fermentation) of petitioner's commercial compressed yeast. The resultant yeast was poor in quality, because the amount of air supplied in the fermentation was in the wrong proportion; the recovery of raw material was only about 45 per cent, whereas 70 per cent or better is considered normal. Block indicated to Freund that since the Best experience was with a sulphite liquor base and petitioner used a molasses base, it would be necessary for him to feel his way. After further experimentation and substantial changes in the original Best procedure, Block and Freund were able66 to produce in petitioner's pilot plant a satisfactory compressed yeast suitable for drying. For this 332 they employed instead of commercial finished yeast a different type of compressed yeast, especially adapted to respond more readily to an after-treatment. This latter type of yeast was, on an average, a yield in weight of approximately 62 per cent of the weight of the nutrients used in the special process. Since the pilot plant experiment looked promising, it was decided to conduct a semi-commercial run. On August 6, 1943, petitioner used this process (under label of D C-27 and D C-28) successfully on a commercial scale at its Cudahy plant, producing a compressed yeast suitable for drying. This final process and technique was the result of a joint effort, including close consultation and exchange of views between Block and Freund.Petitioner dehydrated the yeast produced by Block and Freund on August 6 on the pilot plant driers, borrowed from the company from whom it intended to purchase similar equipment. On August 25, 1943, in accordance with its contract with Best, petitioner submitted samples of the resultant active dry yeast (D C-28 (5) series) to Quartermaster67 Research, the Office of the Quartermaster General at Washington, and the Department of Agriculture at Washington. All of the samples met United States Government standards, and petitioner was so informed in writing by the several authorities.Freund did not consider the process and technique developed jointly with Block as an economical one and consequently did not think that it would be very practical from a commercial standpoint for petitioner to produce yeast for drying in accordance therewith.After conclusion of the various joint experiments conducted by petitioner's and Best's representatives, petitioner continued to experiment in both its laboratory and pilot plant. Irvin, himself, conducted several hundred experiments during the period from August 20, 1943, to January 9, 1945. This further experimentation was carried on particularly to develop an economical process for the production of a satisfactory active dry yeast. Petitioner did not feel that it was possible to so produce commercially on the basis of the processes and techniques developed in conjunction with the Best representatives.On October 22, 1943, Irvin conducted experiments in the 173 series. Samples of the68 product were submitted to Quartermaster Research and to the War Food Administration at Washington and were found to meet Government standards. The 173 series of experiments were based upon the original F-80 series under which Irvin had originally produced a satisfactory active dry yeast on January 19, 1943. The active dry yeast process of the 173 series was basically the type of process used by petitioner in 1944 when it first began to produce active dry yeast for sale to the Army.Following the departure of the Best people from Milwaukee, Freund also returned to experimenting somewhat along those lines established before beginning the series of joint experiments with 333 Block. The Freund-Block process, developed jointly, required two separate fermentations, necessitating a separation and washing of each fermentation. During this two-part separation and washing a certain amount of raw material was lost. Freund's further experiments in the 105 series, after the Best people had left, resulted in a process which combined two fermentations in a single synchronized step. This technique produced a maximum yield from raw material (yield of compressed yeast equal in weight to69 a percentage of the weight of the nutrients used in the process) of 81.25 per cent, with an average yield of approximately 70 per cent, as compared with a yield of only 62 per cent from the D-28 pilot plant experiments made by Freund and Block, utilized less equipment, water, time, and labor, and was thus less costly and more efficient than that evolved with Best. Consequently the process and technique for making active dry yeast evolved in joint effort by petitioner's staff with the Best representatives was never utilized by petitioner for commercial production. The process used by petitioner for commercial production in August 1944 was that of Freund, developed in the 105 series of experiments.In November 1943, Freund visited the Best plant at Liverpool, Nova Scotia, Canada. In accordance with the contract between petitioner and Best, Freund was permitted to observe Best's method of producing active dry yeast by the sulphite liquor process. Freund considered this process complicated and the raw material difficult to work from. He also concluded that the expense of utilizing Best's process of manufacture would be prohibitive for petitioner, since petitioner's plant was not 70 located very near a paper mill. It was, therefore, not feasible for petitioner to consider employing Best's particular methods and procedures in the production of active dry yeast.In each of the years 1943 and 1944, petitioner paid $ 50,000 to Best in accordance with the contract of May 21, 1943. Petitioner determined to make the payments to Best because it believed that Best had fully complied with its obligations under the agreement. Best's representatives in conjunction with petitioner's technical staff had conducted a series of joint experiments which yielded samples of dry yeast meeting Army standards. To carry on this work, Breese and Block, in accordance with the contract, had drawn upon Best's experience and technical know-how, formulas, processes, and methods in the making of dry yeast using a sulphite liquor base and had adapted that knowledge and skill to the production of a satisfactory dry yeast from petitioner's product. Further, Best had disclosed to petitioner everything that Best did to produce dry yeast commercially, its costs and selling price. Finally, having produced satisfactory samples of dry yeast, such payment had to be made if petitioner, under the 71 terms of the contract, was to be permitted to sell yeast to the Army or to 334 any trade for given periods of time, regardless of the process employed to produce yeast for sale.At the conclusion of World War II, petitioner was unable successfully to sell for commercial trade the active dry yeast product it had developed for sale to the Army, since commercial trade required a yeast product with faster baking quality and longer shelf or storage life. Consequently, petitioner was required to develop another active dry yeast suitable for its commercial peacetime trade.Petitioner's program of experiment and research in the development of active dry yeast began in 1942 and has continued without interruption through the years 1943 to 1946, inclusive (here material).During the years in question petitioner regularly maintained a research department, in which experiments were constantly conducted to improve petitioner's manufacturing processes and its products, and to develop such new processes and products. In accordance with its established method of accounting, petitioner charged to laboratory and experimental expense accounts on its books the costs for salaries, insurance, taxes, 72 supplies, repairs, and other expenses incurred in the operation of the research department, including certain amounts not exceeding $ 2,866.64 in any year paid to the University of Wisconsin under a fellowship grant. The total of these expenditures for the years prior to 1943 was not more than $ 26,000 per year. For the years 1943, 1944, and 1945, these expenditures totaled approximately $ 34,000, $ 45,000, and $ 71,000, respectively. Petitioner deducted these amounts as business expenses for the years 1939 to 1945, inclusive. For the years 1943 and 1944 petitioner charged the two $ 50,000 payments to Best to a separate expense account for "dry yeast." Petitioner claimed these amounts as a deduction in its returns for the years 1943 and 1944, as "Non-Apportionable Expense" for "Professional Services." Respondent disallowed the deductions and determined that the payments to Best were capital expenditures.We find as an ultimate fact that the $ 50,000 paid by petitioner to Best in each of the years 1943 and 1944, pursuant to the contract between them, was a capital expenditure.Permeable Groins.Petitioner's Cudahy plant, consisting of a number of buildings, is situated on a73 bluff immediately adjacent to the shore of Lake Michigan, approximately 112 feet above the level of the lake. Running from part of petitioner's plant at the top of the bluff, down the bluff, to the lake, and emptying into the lake was a sewer, built as an open drainage pipe, employed by petitioner to discharge pure waste water used in the course of its manufacture. During the late 1930's and early 1940's, 335 the lake bluff, a substantial portion of the side of which had been covered with trees and foliage, began to erode and deteriorate. As a consequence the sewer was left without necessary support and was damaged.In 1942, petitioner's director of engineering undertook to construct a wharf consisting of three 40-foot long 14 x 14's placed one on top of another and threaded by bolts to old boiler flues which were filled with concrete and rock, extending back onto the beach for 18 feet. The sewer pipe was placed on top of this wharf. For a short time the sewer remained stable. After a series of storms, however, the rocks began to fall underneath the 14 x 14's and to wash out into the lake, ultimately causing the flues and the 14 x 14's also to wash out into the lake. 74 The sewer was then discharging on the lake bed.Petitioner consulted two engineers, Charles Whitney and Sidney Makepeace Wood, in connection with the erosion of the bluff. Whitney recommended that a flat rock be built out into the lake and up onto the beach and shore, with sand underneath to act as a filter. Wood, on the other hand, recommended that permeable groins (sometimes called jetties) be constructed. Whitney's recommendation was not followed. His fee of $ 1,381.65 was paid by petitioner in 1944 and a portion thereof, in the amount of $ 1,106.43, was charged to the construction of two permeable groins, described below. Whitney's advice had no relation to such groins, construction of which was suggested by Wood.On July 29, 1944, pursuant to petitioner's request, the War Department issued a permit to petitioner for the erection of four concrete permeable groins in the lake opposite its property, extending from 100 to 150 feet in length. Thereafter, in 1944, in accordance with Wood's recommendations, petitioner erected two concrete permeable groins, 200 feet apart, extending into the lake from the shore line perpendicular to petitioner's property, one to the north, 68 feet75 in length, and the other to the south, 100 feet in length. The groins, an open type, were precast on the bank of the lake, then slid down and threaded on concrete piles which had been sucked into the lake bottom by hydraulic pressure. The two groins were constructed at a cost of $ 12,911.50, exclusive of the $ 1,106.43 attributed thereto by petitioner for the cost of Whitney's services.Wood's recommendations also included the construction of drains in the lake bank for the purpose of draining surface water and thus to keep the bank from being washed away. The drains were built at a cost of $ 3,543.61, but their operation was not successful, since the bank constantly crumbled and fell as a result of the winter freeze and spring 336 thaw, and it was therefore impossible for the drains to be held in the bank. The drains were finally washed into the lake and no longer exist.Wood further advised petitioner to build a new sewer opposite one of the groins, to be supported at one end by the groin. The old sewer could not be moved because of the then present condition of the portion of the bank upon which the old sewer rested. In 1944, petitioner had constructed a new sewer of76 6-inch copper pipe, at a cost of $ 1,860.06. This sewer is presently in operation.In respect to the benefits that might be expected from construction of the two permeable groins, it was Wood's view that the jetties might build a beach for petitioner for some 200 feet between the two jetties, and that it could be expected that petitioner's shore line would be stabilized in the vent of the jetties. Such would be the consequence of the jetties which would trap sand and other material carried in suspension by the current along the shore line. However, it was not expected that erosion of the bluff would cease. To the contrary, Wood indicated that erosion of the lake bank would continue despite the construction of the jetties. Wood also indicated that the probable useful life of the jetties, if constructed, would be 10 years or more.Erosion of the lake bank has continued to date as expected and the distance between the lake bank and petitioner's buildings is constantly diminishing. At certain points not protected by the jetties, the bluff has receded considerably, perhaps some 90 feet, between April 1944 and June 1954. In 1946, as a consequence of this continued erosion, petitioner77 was forced to tear down a 1-story building used as a machine shop. The permeable groins, however, have maintained the lake bank at the point at which the new sewer rests on the bank.On the other hand, since the erection of the jetties, some beach has formed at the foot of the bluff in the area between the jetties. There has been practically no erosion at the site of the long jetty for approximately 35 to 40 feet about the site of the jetty. This is the point at which the new sewer is located.Petitioner deducted $ 19,421.60 as a business (repair) expense in 1944, consisting of $ 1,106.43 paid to Whitney for advice which was not followed and charged by petitioner to the cost of building the permeable groins, $ 3,543.61 attributable to the construction of drains in the lake bank, since washed away, $ 1,860.06 representing the expense of constructing the new sewer, and $ 12,911.50 expended in the construction of the two permeable groins. The compensation paid to Wood was allocable to and included as a part of the last three items. Respondent capitalized $ 19,253.56 of the entire amount and allowed such amount to be depreciated over a 50-year life basis.337 OPINION.Best78 Yeast Payments.In each of the years 1943 and 1944 petitioner paid $ 50,000 to Best Yeast under an agreement with that company, dated May 21, 1943. These amounts were deducted by petitioner in 1943 and 1944 as ordinary and necessary business expenses under section 23 (a) of the Internal Revenue Code of 1939. Respondent has capitalized both payments and has not allowed any deduction for depreciation in either of the years 1943 or 1944, or in any of the subsequent years involved in this proceeding.Petitioner's main contention is that the expenditure in question was not made to acquire, develop, or improve a capital asset, but was incurred only for certain technical assistance and know-how services rendered to petitioner by Best Yeast in connection with petitioner's undertaking to engage in the manufacture of dry yeast. Petitioner argues that in the circumstances of the instant case such expenditure should be considered currently deductible as an ordinary and necessary business expense. We cannot agree.In January 1943, some 4 months before Red Star entered into a contract with Best, petitioner had developed a laboratory technique and process (described generally in our Findings79 of Fact, supra) for producing active dry yeast. Samples so produced had tested well, satisfying the standards and specifications of both the Department of Agriculture and Quartermaster Research. Subsequent to the January F-80 series of experiments, petitioner continued its research, conducting further experiments along these same lines, and was able to produce additional samples of active dry yeast which also tested satisfactorily. In view of these successful experiments, petitioner, on May 21, 1943, the same date on which the contract with Best Yeast was entered into, stepped up its scale of operation and undertook to produce active dry yeast in its pilot plant, in accordance with the basic process and technique developed in the F-80 series of experiments.Clearly, for some time prior to entering into the contract with Best Yeast in May 1943, petitioner knew it had a satisfactory laboratory technique and process for producing active dry yeast, meeting Army standards. But conversion from the laboratory to commercial production in accordance with the technique and process so developed would involve a large expenditure of money for special equipment. Red Star's management, 80 considering that petitioner had never before produced dry yeast commercially, appears to have been somewhat apprehensive of the substantial risks inherent in such conversion. Moreover, petitioner was being pressed by the Army to get into production as quickly as possible to supply the large Army demand for active 338 dry yeast. Accordingly, petitioner, upon the suggestion and advice of Irvin and Isker, proceeded to contact a commercial producer of dry yeast with which petitioner was not and would not be in competition, with a view to obtaining technical assistance to guide the necessary conversion and to confirm the adequacy or inadequacy of its own technique and process by comparing it with the techniques and processes then being employed by a commercial producer of dry yeast, and if necessary, to learn of or to develop an economical process and technique for producing active dry yeast. On May 21, 1943, petitioner entered into a contract with Best Yeast of Canada, hoping thereby to perhaps accelerate conversion from its laboratory scale to commercial production, to glean whether the process and the technique it had thus far developed were superior or inferior to those currently81 employed by a producer of dry yeast and thus be better able to evaluate the quality and economic feasibility of utilizing the process it had already developed, to study such a producer's production techniques and methods, and to obtain cost and other production data.We have carefully reviewed the circumstances under which the services of Best were sought and employed by petitioner, the terms of the contract with Best Yeast, and the services rendered to petitioner by the representatives of Best Yeast, and we think that petitioner did not intend to and never did acquire everything possessed by Best in the way of knowledge, skills, methods, techniques, formulas, processes, materials, and other data relating to the commercial production of dry yeast, somewhat in the nature of a unitary process, for use as such. Petitioner only intended to obtain certain technical assistance from an experienced producer of dry yeast. The contract with Best clearly recognized that the Best techniques and processes could not and would not be simply transferred in whole for production of active dry yeast by petitioner with its molasses base compressed yeast product, since the Best processes and techniques82 were developed for production of dry yeast from a sulphite liquor base. Thus it was provided that both parties contemplated and believed that Best could "with the knowledge and information * * possessed by it * * * and the skills, methods or processes used by it in the making of its compressed yeast for drying, * * * adapt the same to compressed yeast made from a molasses base and prepare such yeast suitable for dehydration and marketing in the dry form * * ." Best, therefore, was engaged to render technical assistance in adapting its experience as a commercial producer of dry yeast to the particular requirements of petitioner's product. These services were to be based on the total of Best's experience and know-how in such manufacture, not with the aim of introducing or converting petitioner to the sulphite liquor process but with the purpose of adapting such techniques, skills, processes, 339 and know-how possessed by Best to the manufacture of dry yeast on the basis of petitioner's product.Our view that petitioner contracted with Best for technical assistance services is further supported by the undertakings of the parties' representatives in their actual work together83 during July and August. The Best people and Red Star people worked closely together during that period on adapting the Best experience to petitioner's product, eventually producing satisfactory samples of active dry yeast. The process and technique ultimately developed was essentially different from any previously employed by Best and neither Best nor petitioner had any prior knowledge of the final process and technique.From the beginning of their joint work, it was obvious to both groups that the Best experience could not be transferred in whole to production of active dry yeast with petitioner's type of compressed yeast. The first experiments undertaken on the advice of the Best representatives, based on Best's experience, were not successful and indicated clearly that the petitioner's basic product required a different process and technique for producing dry yeast. Block, who worked with Freund on the production of a compressed yeast suitable for drying, indicated that since his experience was with the sulphite liquor process he would have to feel his way with petitioner's molasses base product. Subsequently, Block and Freund, by working closely together, did evolve jointly84 a process and technique for producing a compressed yeast suitable for drying, samples of which tested satisfactorily. This process, however, was costly, and after the Best people left Milwaukee, Freund continued his experiments, ultimately developing a single-step synchronized process, described briefly and somewhat generally in our Findings of Fact. It was this later developed process that was finally employed by petitioner in its manufacture of active dry yeast in 1944.Irvin and Breese also conducted their first experiments upon the instruction of Breese, but it was clear that his instructions, based on Best's experience, were not adequate for dehydrating petitioner's product and producing satisfactory samples of dry yeast. Irvin, drawing on his own experience with drying from January through April of 1943, prior to the contract with Best, and Breese, both working closely together, were finally able to produce a satisfactory product. But Irvin concluded that the Best people did not know as much about drying as petitioner's technicians and, after the Best people left, he returned to further experimenting along the lines he had previously followed, ultimately developing a technique85 and process which was different from that worked out jointly with Breese. This latter process and technique was finally employed by petitioner in its manufacture.340 We think it is clear from the record that the experimentation carried on jointly by the representatives of both petitioner and Best during a 2-month period was not merely incidental to the acquisition by petitioner of a unitary process from Best. The experimentation carried on was contemplated by the contract between petitioner and Best, and was an essential and important part of the services to be rendered to petitioner, if the Best knowledge, experience, skills, techniques, processes, formulas, and other materials were to be adapted satisfactorily to the requirements of petitioner's basic type of yeast.We think that the Best services, and the cooperative experimentation and research carried on by the representatives of Best and Red Star must be considered in connection with, and as an integral part of, the general program of research and experimentation undertaken by petitioner to develop a process and technique for the manufacture of active dry yeast.Petitioner was engaged for some time in research, study, 86 and experimentation in an effort to develop a process and technique for the successful manufacture commercially of active dry yeast. Whether the payments to Best Yeast constituted a cost incident to the development of that technique and process depends on whether the technical assistance and advisory services rendered to petitioner by Best were a part of and incident to the conduct by petitioner of its experimental research for development of a satisfactory commercial technique and process for the manufacture of dry yeast. It is our view that the services of Best are not significantly separable from the conduct by petitioner of its research and experimentation in development of a technique and process for the manufacture of dry yeast. The services contracted for and rendered by Best were primarily aid in research to adapt the Best experience and know-how to producing dry yeast from petitioner's molasses base compressed yeast product. It is clear, therefore, that the expenditure was really for development or in the course of development of a technique and process for the manufacture of dry yeast. It is true that further experimentation was carried on after the Best people left87 Milwaukee and that such experimentation and research was somewhat outside of the scope of the Best assistance. But from this perspective we think that the services rendered may be likened to a series of unsuccessful experiments conducted in the course of research and development of a process and obviously incident to and part of that development. While the information and services of Best were, perhaps, not otherwise beneficial in a practical sense, petitioner was at least heartened thereby and was confirmed in its confidence in the technical competence of its own research staff and in its reliance upon the commercial value and feasibility of the product resulting from their work. Upon consideration of the whole picture, we think that the expenditure here in issue was a capital expenditure 341 incurred in the course of and in connection with the development of a technique and process for the manufacture of active dry yeast, and was incident to and a part of petitioner's research and experimental activity undertaken to develop such a process and technique. Hart-Bartlett-Sturtevant Grain Co., 12 T. C. 760 (1949), affd. (C. A. 8, 1950) 182 F. 2d 153;88 Claude Neon Lights, Inc., 35 B. T. A. 424 (1937); Hazeltine Corporation, 32 B. T. A. 110 (1935), affirmed on this issue (C. A. 3, 1937) 89 F.2d 513">89 F. 2d 513; John F. Canning, 29 B. T. A. 99 (1933).Homer L. Strong, 14 B. T. A. 902 (1928), relied on by petitioner, is distinguishable from the instant case. There the taxpayer acquired a certain machine which had many mechanical imperfections. The taxpayer expended the amounts there in issue in an attempt to perfect the machine. However, the attempted improvements were not successful and the machine was considered to be imperfect and "an absolute failure" in the year of acquisition. We held that the expenditure did not result in the acquisition, development, or improvement of a capital asset having a useful life beyond the taxable year in which the outlay was made and permitted deduction of such amounts as losses sustained (or alternatively as expenses incurred) in that year. Such is not the instant case. Here the Best services were a part of petitioner's whole course of development of a 89 technique and process for the manufacture of dry yeast, which program was ultimately successful, causing creation for petitioner of a process and technique subsequently used in commercial manufacture. Any lack of usefulness to petitioner of the particular services performed by Best under the contract would not render the expenditure therefor a business expense, but only in the proper circumstances a loss in a particular year upon proof of discard by petitioner of that process and technique in the development of which this expenditure and service was only a part. W. B. Harbeson Lumber Co., 24 B. T. A. 542 (1931), also cited by petitioner, is distinguishable for essentially the same reasons.Petitioner contends alternatively that the Best Yeast payments, if in the nature of a capital expenditure, as decided above, are nevertheless deductible as business expenses in the year in which made, in accordance with the respondent's publicly expressed policy regarding development and research expenditures. Petitioner argues that a statement of the position of the Internal Revenue Service by former Commissioner Dunlap to the Joint Committee on Internal Revenue90 Taxation, authorizes deduction of the payments as business expenses, if such deduction is consistent with petitioner's established method of accounting.The criteria for expensing certain research and development costs as set forth by Commissioner Dunlap are, in part, as follows:It is the policy of the Bureau, where the taxpayer under its established method of accounting has elected to adopt the practice of charging to expense research 342 and development costs, to allow such costs as deductions in computing net income. Such costs, however, may include only such expenditures as would normally be considered to represent research and development costs in the experimental or laboratory sense. Thus, in the case of experimental airplanes, the salaries of engineers working on development of the planes, the cost of materials which enter into the construction of the planes, the cost of test flights and similar expenditures is deductible as expense items. However, amounts paid out for new buildings and equipment including tools which have a substantial life beyond the taxable year, or which are adaptable for use other than the particular research or development project for which 91 they were constructed or acquired, must be capitalized even though such buildings or equipment are necessary for the particular research or development project.Petitioner argues that the payments to Best are such research and development costs as contemplated thereby and are properly deductible as business expenses in the year in which they are incurred. Respondent, on the other hand, contends that the circumstances of the payments to Best are not such as to bring petitioner within the purview of the policy set forth in the Commissioner's statement. Respondent contends mainly that the Best payments were not such expenditures as would normally be considered research and development costs in the experimental or laboratory sense. While we agree largely with petitioner's over-all conception of the nature of the Best expenditure, we must, nevertheless, disagree with its ultimate conclusion that the capital expenditure here in issue is currently deductible as a business expense because of the respondent's apparent administrative practice.Neither the Internal Revenue Code nor the regulations provide any general definition for determining what constitutes research and development costs. 92 Such determination, therefore, must be made in each case upon the particular circumstances involved therein. In some measure, the research and development costs which the Service contemplated were particularized and qualified in terms of such costs in an "experimental or laboratory sense," and related mainly to the constant carrying on of laboratory and research operations. Petitioner points out that it has consistently for many years deducted as business expenses the various costs of operating its laboratory and research facilities, and in particular indicates that it properly so expensed those costs incurred over a period of about 4 years in converting from a grain base to a molasses base in the production of fresh compressed yeast. Petitioner argues that the Best Yeast payments should be treated in the same manner. It should be noted that petitioner has consistently in its accounting deducted currently its research and experimental expenses and that this practice has been allowed by the Commissioner except for such treatment by petitioner of the Best expenditure.We think that the payments to Best were essentially research and development costs in a laboratory or experimental93 sense. The contract 343 between petitioner and Best is complex, but in essence it provided that Best make available to petitioner all of Best's knowledge, skills, techniques, formulas, etc., regarding its processes for manufacturing dry yeast and adapt such experience and know-how as Best had acquired in such manufacture to the development of a technique and process for manufacturing dry yeast from petitioner's molasses base compressed yeast product. This was to be accomplished by representatives of the technical staffs of both Best and petitioner meeting together at petitioner's plant in Milwaukee and there engaging in the necessary laboratory and pilot plant research and experimentation. The record indicates that the representatives of both companies met and worked together in accordance with the agreement. They jointly undertook a series of experiments for the production of a compressed yeast suitable for drying and in the dehydration of such yeast to produce an active dry yeast. These experiments were carried on intermittently over a period of approximately 6 weeks over the summer of 1943. After utilization and adaptation of each of the parties' knowledge and skills94 in respect to the production and drying of yeast, the joint experiments ultimately produced a satisfactory product meeting the Government's standards as tested in accordance with the terms of the contract. On the basis of the foregoing, we think that the Best payments should be considered research and development costs in the laboratory or experimental sense as such terms were employed by Commissioner Dunlap. Accordingly, we think that the expenditure incurred by petitioner for payments to Best Yeast was such as would qualify for deduction as a business expense in accordance with the policy statement of Commissioner Dunlap.We must, nevertheless, hold for respondent. The statement of policy by Commissioner Dunlap is not in any way binding, absent provision for this view in the Internal Revenue Code or the regulations appropriate to and promulgated thereunder. We need indicate only briefly that under the applicable provisions of the Internal Revenue Code and regulations no election exists with respect to the treatment to be accorded to expenditures which are capital in nature. If challenged by the Commissioner, they must be capitalized. Gilliam Manufacturing Co., 1 B. T. A. 967 (1925);95 Hazeltine Corporation, supra;Claude Neon Lights, Inc., supra;Hart-Bartlett-Sturtevant Grain Co., supra.See also Goodell-Pratt Co., 3 B. T. A. 30 (1925); John F. Canning, supra.At one time article 168 of Treasury Regulations 45, 62, and 65, permitted taxpayers incurring expenses of an experimental nature calculated to result in improvement of their facilities or products to elect to deduct such expenses currently from income in the year in which incurred or to capitalize such expenditures. Subsequently, in 344 Gilliam Manufacturing, supra, we held that under the then applicable revenue act a taxpayer had no option to treat expense items as capital or capital expenditures as ordinary and necessary expenses of carrying on a trade or business. In 1926, the Treasury deleted from article 168 of Regulations 69 the previously permitted option. Thereafter, the then Internal Revenue Bureau, nevertheless, permitted taxpayers to deduct expenses incurred in conducting regular and continual research activities. 96 For the most part, the courts, however, have constantly held that experimentation and research expenditures incurred in the development of new processes, formulas, or patents are capital expenditures and that no option exists for the taxpayer to capitalize or expense such items in accordance with its particular established method of accounting period. Ultimately the service policy was publicly stated in the expression by Commissioner Dunlap heretofore discussed. 1In view of the long-standing and well-settled position taken by this Court in these respects, we think that, having determined petitioner's expenditure to be capital in nature, we must find that it is not free to deduct such amounts as business expenses. Accordingly, we hold that respondent was justified in capitalizing the payments to Best Yeast.Petitioner further argues that whatever it acquired from Best was discarded or abandoned within the year of97 acquisition, and, therefore, that the entire cost is currently deductible "whether the expenditure be designated as expense or capital." W. B. Harbeson Lumber Co., supra. Petitioner, however, has not by appropriate pleading raised a claim for loss deduction under section 23 (f) for either of the years 1943 or 1944, and, therefore, such contention is not properly before us. Even if the issue had been properly raised, however, we think its determination would have been controlled by the views expressed infra in connection with petitioner's like claim of loss grounded upon abandonment in 1945 or 1946.As indicated above, petitioner has, by appropriate pleading, raised a similar contention in respect to the taxable years 1945 and 1946. Petitioner argues that if the Best Yeast payments were properly capitalized by respondent and are not deductible as business expenses or otherwise during the years in which incurred, such amounts are nevertheless deductible as a loss in either the taxable year 1945 or 1946, under section 23 (f) of the Internal Revenue Code of 1939. Petitioner's position is that such loss was from discard and abandonment of that for 98 which it made the payments to Best and that such abandonment occurred either in 1945, when sales of active dry yeast to the 345 Army ceased, or in 1946, when petitioner adapted its process and product to the requirements of the commercial trade.If the payments to Best were segregable and deductible on the theory of abandonment as items separate and distinct from other capital outlays covering the research and experimental activities of petitioner in relation to the development of a technique and process for manufacture of active dry yeast, the deduction should have been claimed for a year or years not later than 1944. Cf. Dresser Manufacturing Co., 40 B. T. A. 341 (1939). As already indicated, however, petitioner has not raised this issue by appropriate pleading.Petitioner argues on brief, however, that its development of processes to make active dry yeast, including the payments to Best, was undertaken for the sole purpose of being able to supply active dry yeast to the Army for war purposes; that sales to the Army ceased in 1945, and that when such sales were resumed in 1946, they were on a limited basis. It further argues that, except for99 the urgency of war conditions, it would have been able to take its time in developing its processes to make active dry yeast, and would never have entered into the contract with Best.Petitioner further argues on brief as follows:At the termination of World War II, petitioner, unlike other manufacturers of yeast, was not satisfied to drop the sale of active dry yeast even though the demand from the United States Army ceased. Accordingly, petitioner began selling active dry yeast in commercial channels. The result of such attempts at commercial sale proved unsuccessful, but petitioner still would not give up on the matter of selling active dry yeast in commercial channels, and petitioner's research staff set out to produce an active dry yeast that would be acceptable to the bakers' trade and the housewife. Petitioner then realized that in order for active dry yeast to be sold in commercial channels it would have to have a faster baking quality and a better (longer) shelf life or storage life. Petitioner proceeded to change its processes of making active dry yeast that were in existence at the conclusion of World War II so as to permit the production of active dry yeast that 100 had a faster baking quality and a better (longer) shelf life or storage life, and then experienced such success in commercial sales of active dry yeast that other companies followed its lead in selling active dry yeast to the commercial trade.We do not think that the events occurring in 1945 or 1946 amounted to an abandonment or gave rise to circumstances warranting a loss deduction. The record establishes that petitioner, in 1942, embarked upon a program of research and experimentation looking to the development and manufacture of an active dry yeast product. The contract with and the payments to Best were incident to and a part of that program. The immediate objective was to manufacture for and sell to the Army an active dry yeast suitable for its purposes. This objective was achieved, but the market for the particular product ceased (as no doubt was anticipated) when war activities ceased. Petitioner continued its program of research and its experiments in 346 order to develop a product which would meet the requirements of the commercial trade for a faster baking quality and a longer shelf life. The product, however, continued to be active dry yeast. The research program101 was continuous and developing. It began prior to any of the years here material and has continued to the present day. The Army was an easier customer than the housewife or baker, and when the Army ceased to be a good customer, a process was developed to satisfy the commercial trade. The process developed with Best's representatives differed from that ultimately used to meet Army requirements, and the latter differed from the process used to meet the requirements of the commercial trade. It is our view, however, that the various steps were merely parts of a whole experimental, research, and development program which began with the objective of producing active dry yeast, achieving one of its objectives in selling active dry yeast to the Army and another in adapting the active dry yeast product for sale to the commercial trade. We find nothing in the record which establishes an abandonment of the program at any of these stages and the affirmative evidence appears rather to support a contrary view.Accordingly, we hold that petitioner is not entitled to deduct the amount of the payments to Best as a loss upon discard or abandonment in either of the years 1945 or 1946, the only years102 in respect to which such issue was raised by appropriate pleading.Deduction for Permeable Groins.The respondent has determined that of an amount of $ 19,421.60 deducted by petitioner on its 1944 corporate income tax return as an ordinary and necessary repair expense, $ 19,253.56 should be capitalized and that such amount should be depreciated over a period of 50 years. Petitioner, in its amended petition, segregated the $ 19,421.60 amount, previously deducted as a single expenditure without segregation, into four separate elements of cost composed of the following four items: (1) $ 1,106.43 paid by petitioner to Whitney for certain advice which was not followed; (2) $ 3,543.61 attributable to the construction of certain drains in the lake bank (and including $ 275.22 of a total of $ 1,381.65 paid to Whitney, representing the allocable portion of that amount paid for advice concerning such drains); (3) $ 1,860.06 representing the expense of constructing a new sewer; and (4) $ 12,911.50 expended in the construction of two permeable groins. We will consider whether any or all of such cost items were properly capitalized by respondent.The largest expenditure in issue is that 103 incurred in the actual construction of two permeable groins. Respondent contends that the expenditure was capital in nature. He argues that the permeable groins constituted permanent improvements or betterments having a useful 347 life of more than 1 year and prolonging the beneficial life of the property so improved. Petitioner, on the other hand, contends that construction of the permeable groins was a repair made only to keep petitioner's plant in its ordinarily efficient operating condition. Petitioner argues that the groins did not add to the value of petitioner's property or prolong its useful life. We hold for respondent for the reasons set out below.Questions concerning the capital or expense nature of an item have often been before the Court, and though in broad application the legal principles are well settled, it nonetheless remains in each particular case for us to determine whether in the circumstances of that case the expenditure was in fact a repair expense or a capital improvement or betterment, an issue which is frequently a matter of degree. We think that the construction involved in this case, namely, two permeable groins, was capital in nature. The104 groins represented new and permanent construction and had a useful life extending beyond the one year in which the expenditure was incurred. We think the record indicates that the groins improved and bettered petitioner's property, in some measure successfully stabilizing a portion of petitioner's shore line and building a beach within the immediate area of the groins. The existence of the groins has also enabled petitioner to construct a new sewer opposite one of them. Admittedly the groins have only to a degree prevented further erosion of petitioner's lake bank, and obviously have not prolonged the useful life of petitioner's property beyond that for which it would have been useful had no erosion taken place, but we nevertheless think that they have added to the value of petitioner's property for use in its business. See Hotel Sulgrave, Inc., 21 T. C. 619 (1954), where it was held that installation of a sprinkler system did not represent a repair but was an improvement or betterment which, while it did not increase the value of the hotel property, did render such property more valuable for use in the taxpayer's business, and accordingly, that 105 the cost of such installation was properly added by respondent to petitioner's capital investment in the building and depreciated over the life of the building. Cf. Black Hardware Co., 16 B. T. A. 551 (1929), affd. (C. A. 5, 1930) 39 F. 2d 460, certiorari denied 282 U.S. 841">282 U.S. 841; International Building Co., 21 B. T. A. 617 (1930); Difco Laboratories, Inc., 10 T. C. 660 (1948).Petitioner argues further, on the basis of Illinois Merchants Trust Co., Executor, 4 B. T. A. 103 (1926) and American Bemberg Corporation, 10 T. C. 361 (1948), affirmed per curiam (C. A. 6, 1949) 177 F. 2d 200, that the two permeable groins merely restored its property to its ordinarily efficient operating condition and did not otherwise constitute an improvement or betterment in the nature of a capital item. We think that both cases are readily distinguishable on their facts.348 In Illinois Merchants Trust, a sudden lowering of the water level in the south branch of the106 Chicago River left the upper ends of certain wood piles upon which the taxpayer's building rested exposed to the air, causing that part of the piles to decay from dry rot. As a consequence, the wall on the river side of the taxpayer's building settled to a point where it was likely that the entire building would collapse. In order to maintain the building in serviceable condition it was necessary to saw off the rotted piles at a point below the new water level and to insert concrete supports between the ends of the submerged piles in the floor of the building, thus raising the river wall. This wall was also considerably shored up. We held that the taxpayer was entitled to deduct the cost of this work as a business expense for repairs. Regarding the distinction between a repair expense and a capital expenditure we said:In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily107 efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. * * It is clear that in Illinois Merchants Trust the expenditure did not prolong the useful life of the building beyond its probable normal life, even though it did extend the life of the building beyond what it would have been had the piles not been repaired. But the critical basis for permitting the taxpayer to deduct the expenditure currently was that there was a restoration of "damaged fabric" in order to keep the property in operating condition and that the work did not represent a complete replacement of any sizable unit or totally new construction such as is involved in108 the instant case. See Buckland v. United States, (D. Conn., 1946) 66 F. Supp. 681">66 F. Supp. 681.Similarly, American Bemberg is also a case of repairs. There several large cave-ins occurred in the taxpayer's plant, caused by the condition of the soil and bedrock. In order to prevent having to abandon the plant, the taxpayer undertook certain drilling and grouting operations. Relying somewhat on Illinois Merchants Trust, we held that consideration should be given to the physical nature of the work, the effect of the work undertaken, whether something new was created, and whether the work afforded permanent relief or merely maintained the level of operation of the plant. We concluded in that case that the purpose of the work was to enable the taxpayer 349 to continue the plant in operation on the same scale as before, and was not to rebuild or replace the plant. We pointed out that neither the drilling nor the grouting was a work of construction nor did it create anything new, and that only the intermediate consequences of the original geological defect had been dealt with. Accordingly, we held that the expenditures were for repairs and were109 not capital expenditures. Such circumstances obviously are quite different from those of the instant case where there was no damage to petitioner's plant to which the construction of permeable groins related. (In this respect the expenditure was wholly anticipatory.) The construction was entirely new and, as is apparent from the record, did substantially more than merely maintain petitioner's plant in its ordinarily efficient operation.The second item of expense to be considered is that incurred for construction of a new sewer of 6-inch copper pipe. In large measure for the same reasons heretofore expressed in respect to the groins, we think that the cost of constructing the sewer was a capital expenditure. However, petitioner argues further in respect to this item that the sewer was merely a replacement of one already in existence and therefore that such expenditure should not be considered a capital expenditure. Petitioner urges that it should not be required to capitalize an expenditure for duplicating a facility which was still in existence and which physically was still in usable condition, but which for other causes was not usable. The old sewer apparently was not deteriorated110 but because of the washing away of the lake bank it could not be moved from its position along the side of the bluff to the location of the present (new) sewer along an end of one permeable groin.In Illinois Merchants Trust we distinguished a repair expense from a capital expenditure by considering expenditures for replacement which prolong the life of property or increase its value as capital expenditures. The expenditure here was such a capital replacement expenditure. There was no restoration of the old facility but construction of a completely new one. It is evident that the distinction between the terms "repair" and "replacement" is one of fine degree. However, we think that a repair involves something more in the nature of a substitution of new parts or restoration of certain parts of a given whole, whereas in the instant case the entire structural unit was replaced and a new one substituted therefor without relation to the original physical facility. See Russell Box Co. v. Commissioner, (C. A. 1, 1953) 208 F. 2d 452, affirming a Memorandum Opinion of this Court, holding that the cost of constructing a steel fence to provide protection111 against sabotage and to replace an old wooden fence was a capital expenditure. Cf. Hoyt B. Wooten, 12 T. C. 659 (1949), affirmed per curiam (C. A. 6, 1950) 181 F. 2d 502.350 We hold that respondent has properly capitalized the expenditure incurred in construction of a new sewer.The third item in issue is the cost of constructing certain drains in the lake bank adjacent to petitioner's plant. The drains proved unsuccessful and, at a time not disclosed in the record, were washed into the lake. Petitioner argues that the expenditure for drainage did not result in the acquisition of a capital asset and therefore that such amount should be allowed as a deductible expense in 1944 under section 23 (a) of the Internal Revenue Code of 1939. It is our view, based upon consideration of the entire record, that the expense incurred by petitioner for construction of these drains was capital in nature. The drains appear to have had a useful life of more than 1 year and certainly represented new construction as distinguished from the repair or restoration of an existing facility. Also, in some measure, they doubtless increased112 the value of petitioner's property for the period of their existence. Subsequent destruction or loss of the drains does not in any way reflect on the nature of the original expense. The issue in this respect would have to be drawn in terms of a deduction for loss under section 23 (f) of the Internal Revenue Code. Our examination of the pleadings does not reveal any claim on such basis and the record discloses no evidence from which we might infer such a claim. Consequently, we must sustain the respondent's determination in respect to this item.The last item in issue is the fee paid to Whitney for certain advice which was not subsequently acted upon by petitioner. Petitioner's contention in respect thereto is essentially the same as that urged in regard to the expenditure for drains, namely, that the payment in question constituted a business expense for the reason that there was no acquisition by petitioner of a capital asset as a consequence of the expenditure and to which the expenditure could properly be attributed.Petitioner sought advice from both Whitney and Wood in connection with deterioration of the lake bluff. Ultimately petitioner followed some of the recommendations113 of Whitney and Wood in respect to the construction of drains, but followed only the recommendations of Wood in respect to the construction of permeable groins. Petitioner did not follow or otherwise utilize the recommendation of Whitney respecting the construction of certain stone filters. It is the portion of the fee that is attributable to this latter advice which is now in issue.We think that while the single same circumstance prompted petitioner to seek the advice of both Whitney and Wood, Whitney's advice concerning construction of stone filters is clearly separable from and has no relation to that advice of Wood concerning the construction of permeable groins. Accordingly, we agree with petitioner that the 351 expenditure did not result in the acquisition of an asset to which the fee may be attributed as a cost factor. It would obviously not be proper to attribute this fee to the cost of permeable groins since the advice for which the fee was paid had nothing at all to do with construction of permeable groins, except in an extreme causal sense in which it might be considered that both cost factors (and also the cost of drains) related to preservation of the lake bank. *114 This does not seem to us to be a case where the cost of architectural or engineering services is related to construction of some kind and consequently attributable thereto. We think that in the circumstances of this case the amount is properly deductible as a fee for professional services in the year in which it was incurred and is not to be considered as a capital expenditure.At several points during the course of the hearing and on brief, petitioner appears to contend alternatively that should the $ 19,421.60 expenditure have been properly capitalized in any amount by respondent depreciation is properly calculable over a lesser period than that of 50 years as determined by respondent. Petitioner offered no proof in respect to this matter, only challenging respondent's expert witness' expertise regarding the probable useful life of permeable groins located in Lake Michigan. And a careful review of the pleadings discloses no assignment of error in regard to this portion of respondent's determination. Accordingly, no such issue is before us and respondent's determination is sustained.Decision will be entered under Rule 50. Footnotes1. Certain Congressional action has since been taken in the 1954 Internal Revenue Code, section 174↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621471/	THEODORE J. SCARDINA, AS POSSESSOR OF CERTAIN CASH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentScardina v. CommissionerDocket No. 26778-84.United States Tax CourtT.C. Memo 1988-20; 1988 Tax Ct. Memo LEXIS 20; 54 T.C.M. (CCH) 1544; T.C.M. (RIA) 88020; January 14, 1988. Stanley P. Gimbel, for the petitioner. Andrew A. Vanore, III, for the respondent. RAUMMEMORANDUM FINDINGS OF FACT AND OPINION RAUM, Judge: The Commissioner determined that petitioner, an artificial entity, the "possessor of certain cash," created by operation of section 6867, I.R.C. 1954, had a deficiency in Federal income tax in the amount of $ 26,500 for the taxable year ending December 31, 1983. The primary issue before us is whether petitioner is liable for the deficiency under section 6867, I. 23 R.C. 1954. For convenience, our findings of fact and opinion are combined. Some of the facts have been stipulated. The stipulation of facts and related exhibits are incorporated herein by this reference. Theodore J. Scardina (Scardina) is a resident of Ft. Lauderdale, Florida. On the evening of September 9, 1983, Scardina went to Logan International Airport (Logan Airport or the airport) in Boston, Massachusetts, and attempted to board a Delta Airlines flight to Ft. Lauderdale, Florida. At the security checkpoint for passengers departing on Delta Airlines, he placed a soft, blue suitcase on the conveyor belt leading to the X-ray machine. On examination of the bag under X-ray, the security guard manning the X-ray machine became suspicious that the bag contained a large amount of cash. The guard brought the bag to the attention of a Massachusetts state trooper who was present at the security checkpoint. That state trooper questioned Scardina about the bag and its contents, and then called other state troopers, who were patrolling the airport, to the security checkpoint. Two troopers arrived at the checkpoint, questioned Scardina, and then brought him to the state police office24 located at the airport. They then called for John J. Kelley (Kelley or Detective Kelley), the police detective then on duty at Logan Airport. 1At the time of trial, Detective Kelley had been a Massachusetts State Trooper for 15 years. In 1983, 25 he was stationed at Logan International Airport in Boston. As a detective at the airport, Kelley's duties were to investigate crimes occurring in or around the airport. In fulfilling these duties, Kelley would often cooperate with Federal authorities such as the Customs Service, the Drug Enforcement Agency, the FBI, the Federal Aviation Administration, and the Coast Guard. By the time Detective Kelley arrived at the police office, the troopers had opened the bag Scardina was carrying and had found it to be filled with money. The troopers explained to Kelley in the presence of Scardina that Scardina had attempted to put the bag through the X-ray machine at the security checkpoint for Delta Airlines, that they had determined the bag to be full of money, and that on questioning Scardina had denied that either the bag or the money belonged to him. At that point, Kelley himself questioned Scardina. Scardina recounted to Kelley only the barest outline of the events that led up to his being stopped at Logan Airport. He told Kelley that while he was in Ft. Lauderdale, he was given a bus ticket to Boston, $ 200 in cash, and an airplane ticket back to Ft. Lauderdale by bus on September 6, 1983 and26 arrived in Boston early on September 8th. During the next one and one half days in Boston, "he just goofed off". At some point while in Boston, he visited a Holiday Inn where he was given the soft, blue suitcase which he had been sent to pick up. He claimed that he did not remember at which Holiday Inn he picked up the suitcase or even where he spent the night before being stopped at the airport. On his return to Ft. Lauderdale, he was to put the bag in a locker at the Ft. Lauderdale airport. Outside of these basic facts, Scardina's story was vague. He professed not to remember the details of the few days leading up to the airport incident. He could not tell Kelley on what bus line he traveled to Boston, what he did when he arrived in Boston, or where he stayed in Boston. Further, he claimed that he did not know the person for whom he was bringing the bag back to Florida. While Scardina admitted that he had been given the bag and had been carrying it to the security checkpoint, he was evasive when asked for details about how he received possession of the bag. Further, he claimed that he did not know the person who gave him the bag. He told Kelley that on his return to Ft. 27 Lauderdale, he was supposed to put the bag in a locker at the Ft. Lauderdale airport, but he could not remember which locker he was to put it in. After obtaining Scardina's consent, Kelley searched Scardina. In a purse that Scardina was carrying, Kelley found a receipt showing that Scardina had spent the previous night in the Sheraton Inn at La Guardia Airport in New York. In the same purse, he found a white envelope containing two hundred dollars and "an official document of the Hialeah Police Department questioning the criminal background of" a person with a Hispanic surname. Scardina was also carrying a leather garment bag, in which Kelley found a device used to detect police radar. Scardina gave inconsistent and evasive explanations of how he got to the hotel in New York the night before and how he planned to use the radar detector. He had previously told Kelley that he had come straight to Boston from Ft. Lauderdale by bus. When confronted with the hotel receipt, he said he had driven from Boston to New York with a friend the night before. When asked to describe the car in which they drove, he said they had taken a bus. Similarly, when Kelley questioned Scardina about28 the radar detector, Scardina responded that he had used it for the trip to Boston. When reminded that he had taken a bus, he said it was for the ride back to Ft. Lauderdale. When asked how it would be of help to him when he was flying back, his response was that he was bringing it back to Ft. Lauderdale for a friend. Scardina did acknowledge ownership of the $ 200 found in the purse. Kelley returned the $ 200 to Scardina and obtained a receipt therefor, signed by Scardina. Kelley then counted the money discovered in the bag in the presence of Scardina and found there to be $ 53,000, in bundles of $ 1,000 each. Scardina again denied that the $ 53,000 belonged to him. Kelley seized the $ 53,000 and told Scardina that it would be turned over to the District Attorney pending further investigation. He provided Scardina with a receipt, signed by Kelley and the two other troopers involved, stating that the money was taken from him at Logan Airport. Scardina was not arrested and no criminal action was thereafter taken against him in connection with the $ 53,000. On September 30, 1983, an assistant district attorney, acting for the Commonwealth of Massachusetts, petitioned the Superior29 Court for Suffolk County in a proceeding in rem to order forfeiture of $ 26,500 of the cash taken from Scardina. The petition took the form of a complaint against "TWENTY SIX THOUSAND FIVE HUNDRED DOLLARS IN U.S. CURRENCY", half of the $ 53,000 seized from Scardina. The complaint was based upon the allegations that the money was owned by Scardina, and that it "was intended to be used in the procurement, manufacturing, compounding, processing, delivery or distribution of a controlled substance, or that it constitutes the proceeds of a sale of a controlled substance" in violation of Massachusetts law. Also on September 30, 1983, the Commonwealth of Massachusetts requested that the court issue a preliminary order "authorizing the securing and holding of the above money pending the outcome of the forfeiture proceeding against the money". The request was made based, at least in part, on an affidavit prepared by Detective Kelley. On December 13, 1983, a default judgment was entered against the cash and it was forfeited to the Commonwealth of Massachusetts. The remaining $ 26,500 was turned over to the Internal Revenue Service in connection with the events set forth in the next paragraph30 herein. Within a few days of the September 9 incident, Detective Kelley's supervisor and the Internal Revenue Service were in contact in connection with an IRS levy against the $ 53,000 seized. In accordance with sections 6851 and 6867, the IRS then sent Scardina, in his capacity as possessor of certain cash under section 6867, a "Notice of Termination Assessment of Income Tax". That notice stated that the IRS had "found that the collection of income tax for the period January 1, 1983 to September 13, 1983 is jeopardized or rendered ineffectual" because Scardina was found in possession of the $ 53,000 which he did not claim as belonging to himself or to an individual whose identity could be readily ascertained. As a result, $ 26,500 in income tax for the shortened 1983 year was determined, under the presumptions contained in section 6867(a) and (b), to be due and payable from the cash seized. On April 26, 1984, as required under section 6851(b), the Commissioner sent Scardina, as possessor of certain cash, a notice of deficiency for the tax year ended December 31, 1983. In the notice, the Commissioner determined a deficiency of $ 26,500 based on Scardina's possession of $ 53,00031 which "you did not claim as yours or belonging to another person whose identity the Secretary can readily ascertain and who acknowledges ownership of such cash". The deficiency was determined to be payable from the cash found in Scardina's possession. The notice informed Scardina that the determination therein "is independent of and has no effect upon your personal income tax liability for the calendar year 1983". It used a taxpayer identification number different from Scardina's individual social security number. On July 24, 1984, petitioner filed a petition in this Court. By notice dated June 10, 1985 the Internal Revenue Service informed Scardina that it had received an estimated tax payment in the amount of $ 26,500 on September 14, 1983. The payment was applied to the tax liability for the year ended September 30, 1983 of the taxpayer with the identification number of the possessor of cash, not Scardina's personal social security number. On August 14, 1986, only about five months prior to the trial of this case, Scardina filed his personal income tax return for a short tax year beginning January 1, 1983, and ending September 30, 1983. In filing the return, he used his32 own social security number as his taxpayer identification number, not the number assigned to the possessor of cash. That return was prepared by petitioner's counsel herein, and gave as Scardina's "home address" the office address of counsel. On that return, Scardina reported "Other income" described as "fees & commissions" in the amount of $ 31,200. He reported a resulting tax liability of $ 6,558 and "estimated tax payments" made by him in the amount of $ 26,500. He claimed a refund in the amount of $ 19,942, thereby attempting to have the $ 26,500 applied to his personal tax liability. By letter dated October 14, 1986, counsel requested that the IRS credit Scardina's personal tax liability with the $ 26,500 seized. No persuasive evidence was presented to show that Scardina ever filed any income tax return for the full year 1983 or for any other year either as an individual or as the statutory possessor of cash. At trial, Scardina testified that during 1983 he earned part of the $ 53,000 which was found in his possession on September 9, 1983. As to the balance of the cash, he claimed that he either earned it in years prior to 1983 or borrowed it. He stated that although the33 money belonged to him, when asked about it at Logan International Airport on September 9, 1983, he lied, denying ownership of the cash. His explanation for denying ownership of the cash at that time was that he was afraid to acknowledge ownership of it because he had planned to use the cash in an illegal transaction. He testified that he travelled from Ft. Lauderdale to Boston with the cash, planning to buy cocaine with it in Boston. When he arrived in Boston, after failing to contact the person from whom he planned to buy the cocaine, he developed "cold feet", and then attempted to return to Ft. Lauderdale with the cash. It was at this point, according to his testimony, that Scardina was stopped at Logan Airport. It is Scardina's position here that he is the true owner of the cash and that the assessment against him as a possessor of cash should be replaced, under section 6867(c), I.R.C. 1954, with an assessment against him as an individual. As a preliminary matter, however, petitioner claims that the notice of deficiency issued to the possessor is invalid for two reasons. The first reason given is that the notice was issued for the wrong taxable year; the second is that the34 notice was untimely. Central to both claims is the fact that some of the Government's correspondence with petitioner refers to a tax year ending September 30, 1983, for the possessor of cash, while the notice of deficiency is issued for a tax year ending December 31, 1983. Although it is unclear to us why the tax year actually involved was referred to in such correspondence as the year ending September 30, 1983, 2 we nonetheless conclude that such reference to a year ending September 30, 1983, does not warrant a holding for petitioner on the issue of the validity of the notice of deficiency. When a termination assessment is determined by the Secretary to be justified, the tax is assessed and becomes immediately due and payable. Section 6851(a)(1), I.R.C. 1954; section 1.6851-1(a), Income Tax Regs. The tax so assessed is a tax for the period beginning on the first day of the current taxable year and ending on the date of the assessment. Section 6851(a)(2), I.R.C. 1954; section 1.6851-1(a)(2), Income Tax Regs. Thus the termination assessment terminates the taxable year35 for the purpose of computing the amount of tax to be assessed and collected under the expedited termination assessment procedure. That termination occurred here on September 13, 1983. However, it did not terminate the taxable year for all purposes, and it clearly did not cut short the taxable year for the purpose of issuing a notice of deficiency. This is made explicit by subsection 6851(b), which requires that a notice of deficiency based on the taxpayer's "full taxable year (determined without regard to any action taken under subsection (a))" be sent after the assessment under section 6851. 3What constitutes a taxpayer's taxable year is governed by section 441, I.R.C. 1954. In accordance with the regulations36 under section 441, a taxpayer generally adopts his initial taxable year by filing a timely return for that taxable year. Section 1.441-1(b)(3), Income Tax Regs. The taxable year which may be selected is limited. It must be "the taxpayer's annual accounting period, if it is a calendar year or a fiscal year." Section 441(b)(1), I.R.C. 1954; section 1.441-1(b)(1)(i), Income Tax Regs. See Century Data Systems, Inc. v. Commissioner,80 T.C. 529">80 T.C. 529, 531 (1983); Dougherty v. Commissioner,60 T.C. 917">60 T.C. 917, 932-933 (1976); Atlas Oil and Refining Corp. v. Commissioner,17 T.C. 733">17 T.C. 733, 738 (1951). If the taxpayer keeps no books and has no annual accounting period, his tax year is "the calendar year." Section 441(b)(2) and (g), I.R.C. 1954; Maclean v. Commissioner,73 T.C. 1045">73 T.C. 1045, 1051 (1980); Freudmann v. Commissioner,10 T.C. 775">10 T.C. 775, 793-794 (1948). In limited circumstances, which have not been argued to be applicable here, a return is required to be made for a period of less than twelve months. Section 1.443-1(a), Income Tax Regs. In that case, the taxable year is "the [short] period for which the return is made." Section37 441(b)(3), I.R.C. 1954. Since petitioner here is an artificial entity created by operation of section 6867 in 1983, it is clear that petitioner neither filed a return 4 and thereby adopted a taxable year, nor had an annual accounting period or any books or records on which to base a tax year at the time the notice of deficiency was mailed. Consequently, petitioner has not shown that the year ending December 31, 1983, the year on which the notice of deficiency is based, is not petitioner's correct taxable year. The notice of deficiency issued to petitioner was required to be based on the taxpayer's full taxable year for 1983. That full taxable year has not be shown to be anything other than the year ending December 31, 1983, which year appeared in the notice of deficiency. 5 The mere fact that some correspondence from the Internal Revenue Service referred to a September 30, 1983, taxable year for petitioner does not invalidate the notice of deficiency based on the calendar year 1983. 38 Petitioner also argues that the notice of deficiency is invalid because untimely. The expedited assessment procedure used against petitioner was that allowed under section 6851, I.R.C. 1954. In the case of such an assessment, "the Secretary" is required to mail a notice of deficiency "for the taxpayer's full taxable year * * * within 60 days after the later of (i) the due date of the taxpayer's return for such taxable year (determined with regard to any extensions), or (ii) the date such taxpayer files such return." Section 6851(b), I.R.C. 1954. We have already found that the correct taxable year for petitioner is a calendar year. Consequently, the due date of that return was April 15, 1984. Section 6072(a), I.R.C. 1954. The notice of deficiency, mailed on April 26, 1984, was clearly mailed "within 60 days after" the due date of the return and is therefore timely in accordance with section 6851(b). 639 We now turn to the primary issue before us. Section 6867, I.R.C. 1954, was added to the Code in 1982 7 in order to make clear that the termination and jeopardy assessment procedures of section 6851 and 6861 respectively were available to the Commissioner when cash was seized but the owner of the cash was unknown. H. Rept. No. 97-760, 582 (1982), 2 C.B. 654">1982-2 C.B. 654. The section thus enacted provides, in part, as follows: (a) General Rule. -- If the individual who is in physical possession of cash in excess of $ 10,000 does not claim such cash -- (1) as his, or (2) as belonging to another person whose identity the Secretary can readily ascertain and who acknowledges ownership of such cash, then, for purposes of sections 6851 and 6851, it shall be presumed that such cash represents gross income of a single individual for the taxable year in which the possession occurs, and that the collection of tax will be jeopardized by delay. (b) Rules for Assessing. -- In the case of any assessment resulting from the application of subsection (a) -- (1) the entire amount of the cash shall be treated as taxable income for the taxable year in which the possession occurs, 40 (2) such income shall be treated as taxable at a 50-percent rate, and (3) except as provided in subsection (c), the possessor of the cash shall be treated (solely with respect to such cash) as the taxpayer for purposes of chapters 63 and 64 and section 7429(a)(1). Petitioner does not argue that a termination assessment under section 6851 should not have been made against it in accordance with section 6867(a). Clearly, in September of 1983, the requirements of that section were met. At the time he was stopped at Logan Airport, Scardina was carrying $ 53,000 in cash and he denied ownership of that $ 53,000. On questioning, he failed to identify the person who allegedly gave him the money in Boston, the person to whom he was to deliver it in Ft. Lauderdale, or anyone else who might potentially be identified as the owner of the cash. There is no question that in these circumstances, the provisions of section 6867 were properly invoked. Petitioner argues instead that despite his protestations to the contrary when he was stopped at Logan Airport, he is the true owner of the cash and, consequently, that subsection (c) of section 6867, should41 come into play. Section 6867(c) is titled "Effect of Later Substitution of True Owner" and it provides that: If, after an assessment resulting from the application of subsection (a), such assessment is abated and replaced by an assessment against the owner of the cash, such later assessment shall be treated for purposes of all laws relating to lien, levy and collection as relating back to the date of the original assessment.Petitioner urges this Court to rule that "pursuant to Section 6867(c), the assessment under Section 6867(c) [against the possessor] must be abated and replaced by an assessment against the true owner [the individual, Scardina]." Respondent argues that this Court does not have jurisdiction to determine whether Scardina is the true owner of the cash, and alternatively, that if the Court does have such jurisdiction, we should find that Scardina is not the true owner. This Court has previously been faced with the issue of our jurisdiction to decide the owner of the cash seized, in People's Loan & Trust Co., as Possessor of Certain Cash v. Commissioner,89 T.C. 896">89 T.C. 896 (1987), and Matut, as Possessor of Certain Cash v. Commissioner,86 T.C. 686">86 T.C. 686 (1986).42 We need not revisit that issue here except to note that this Court has previously held, on those two occasions, that in a proceeding initiated by the petition of the statutory possessor, we may "determine the identity of the 'true owner.'" Matut v. Commissioner,86 T.C. at 691. The consequences of a determination of the true owner do not need to be addressed here because we are not persuaded that Scardina is the true owner and, consequently, we uphold the deficiency against the possessor.843 To begin with, we found Detective Kelley to be a thoroughly credible witness and we fully accept his account of the events that occurred on September 9, 1983, at Logan Airport. As a result, we are satisfied that at the time he was stopped Scardina repeatedly and unequivocally denied ownership of the cash and told Kelley that he had travelled to Boston to pick up the suitcase filled with cash for a person in Ft. Lauderdale, whom he would not identify. Scardina does not dispute that he denied ownership of the cash and claimed merely to be carrying it for someone else when stopped at Logan Airport. Instead, he now insists that the cash belonged to him and that he was lying when he denied ownership of the cash on September 9, 1983. However, his testimony at trial, which purported to set forth the true story behind his possession of the of the cash, did not ring true. It struck us as simply a transparent attempt to mislead the Court as to the ownership of the cash and thereby have the cash taxed in a manner more favorable than that set out in section 6867(b), I.R.C. 1954. 9 Under section 6867(b)(1) and (2), "the entire amount of the cash shall be treated as taxable income for the44 taxable year in which the possession occurs" and "such income shall be treated as taxable at a 50-percent rate." Scardina's testimony at trial, and his 1983 return filed August 14, 1986, were clearly but ploys to avoid taxation of the cash under either these statutory presumptions or the rates at which it would be taxed if the true owner had come forward. 10 Instead, petitioner would have us believe that the cash belonged to Scardina and was at least in part included as income in his personal income tax return for the artificially shortened year ending September 30, 1983. Taxation of the individual Scardina in the manner reported on such delinquent 1983 return would result in the cash, to the extent shown as attributable to 1983, being taxed at a much lower rate than the 50 percent rate required by section 6867(b). 45 We had ample opportunity to form a judgment of Scardina's credibility on the stand and we found him to be slippery, evasive, and ready to lie whenever he perceived that a truthful answer might be disadvantageous to him. Further, as evidenced by his behavior when questioned by Detective Kelley at Logan Airport, he was clearly willing to change his story from moment to moment as required by the exigencies of the situation. In our opinion, his testimony at trial was just one more story, this one modeled to suit his need to establish ownership in the instant litigation. We found Scardina's story to be untenable, especially when compared to his original story told to Detective Kelley on September 9, 1983. He testified that he owned the $ 53,000 having earned part of it and borrowed part of it. When asked what was the source of earnings he reported on his truncated 1983 return, he became so confused that his attorney felt compelled to explain his answers to the Court. Moreover, while testifying, he could not pinpoint a source of income for 1983 or prior years from which he could plausibly have saved the $ 53,000. 11 Further, no other evidence of gainful employment or of receipt46 of either of any income or of a loan of the money, was offered. Given the spotty record developed with respect to his earnings and borrowings, we do not accept Scardina's self-serving testimony that he was the owner of the cash. Additionally incredible is his testimony that he travelled from Ft. Lauderdale to Boston to buy cocaine, but having been unsuccessful was about to return to Ft. Lauderdale with the money when stopped at Logan Airport. According to his testimony, he went to Boston with the $ 53,000 in search of cocaine on the advice of a man he met in a bar in Ft. Lauderdale. However, he could not explain what he planned to do with the cocaine, as for example, where he planned to sell it. We think it more likely that Scardina was a courier, that he was paid the $ 200 found in his purse for his services on behalf of47 someone else engaged in the illegal drug business, and that he was returning with the cash that he was instructed to receive in Boston when he was stopped at Logan Airport. We are convinced that Scardina is not the true owner of the $ 53,000 cash. Finally, if there ever was a case in which observation of the witness on the stand by the trier of facts could be significant, this is it. Scardina's demeanor on the witness stand and accompanying verbal squirming -- jumping from one explanation to another as holes appeared in his responses -- leave us with the definite conviction that his testimony in the main and in many specific respects was nothing but a tissue of lies. The oath to tell the truth which he made when he took the witness stand obviously meant nothing to him. His ready willingness to bend the truth came through loud and clear, confirming what would otherwise be plainly apparent from a mere reading of the cold record. Accordingly, regardless of whatever view one may hold as to the jurisdiction of the Court to determine the true owner of the cash in a case brought on behalf of the artificial entity (the possessor of cash) as the petitioner, we are satisfied that petitioner48 has neither established that Scardina is the owner nor has it otherwise carried its burden of proof. Decision will be entered for the respondent.Footnotes1. The findings with respect to the events that occurred at Logan Airport on September 9, 1983, were derived almost wholly either from the stipulation of facts or from the testimony of Detective Kelley, who was in charge of the interrogation of Scardina, but who was not present when Scardina was first stopped. At trial, petitioner objected to Kelley's testimony, as hearsay, to the extent it was based on communications made to him by the troopers who were involved in the initial stopping of Scardina. The Court overruled the objection made at trial and relies on the testimony based on those statements. Because the communications made to Kelley by the troopers were made in the presence of Scardina, Kelley's testimony based on those statements comes within the exception to the hearsay rule for a statement which Scardina "has manifested his adoption or belief in its truth". Fed. R. Evid. 801(d)(2)(B)↩. 2. Neither party has offered an explanation for the use of a September 30, 1983, tax year for petitioner. ↩3. Before the Tax Reform Act of 1976, the Code did not provide for the sending of a notice of deficiency after a termination assessment. When the requirement that a notice of deficiency be sent was added, it was decided that sec. 6851↩ should not "end the taxable year for any purpose other than the computation of the amount of tax to be assessed and collected" under the expedited procedures. S. Rept. No. 94-938, 367 (1976), 1976-3 C.B. (Vol. 3) 405. 4. The only return filed for 1983 was filed by Scardina, as an individual not as the possessor, over two years after the notice of deficiency was mailed.↩5. Petitioner relies on a case in which the Government admitted that the year used in the notice of deficiency was clearly not the taxpayer's correct taxable year. See Century Data Systems, Inc. v. Commissioner,80 T.C. 529">80 T.C. 529, 531↩ (1983). 6. Although section 6851(b) allows the notice of deficiency to be mailed within 60 days of the later↩ of the due date of the return or the actual filing of the return, clearly if the notice is mailed within 60 days of the earlier of such dates, as it was here, the notice is timely. 7. Pub. L. 97-248, 96 Stat. 619. ↩8. Petitioner argues that we are precluded from making this finding because, according to petitioner, stipulated documents in the record of this case are inconsistent with that finding. As the basis for his argument, petitioner relies on the following stipulated documents: the complaint filed by the Commonwealth of Massachusetts and the default judgment entered against the cash. The complaint was based in part on the allegation that the cash "is owned by * * * Theodore J. Scardina." Petitioner's argument is that the default judgment resulting from the complaint containing that allegation is a conclusive stipulation that Scardina is the owner of the cash. We do not so view the document as a conclusive stipulation of the ownership of the cash. Instead, we consider it to be a stipulation that a complaint was filed, based in part on the allegation that Scardina was the owner of the cash, and that a default judgment was entered presumably because Scardina "failed to plead or otherwise defend" in accordance with Rule 55, Mass. R. Civ. P. Regardless of whether the judgment would be considered to be an adjudication of that fact for any other purpose, we do not consider it to be a stipulation of that fact here. Moreover, even if it clearly were a stipulation of that fact, we would "refuse to be bound by the stipulation" since that stipulation would be "clearly contrary to facts disclosed by the record." Jasionowski v. Commissioner,66 T.C. 312">66 T.C. 312, 318 (1976). See Weinberg v. Commissioner,44 T.C. 233">44 T.C. 233, 244 (1965), affd., revd on another issue, and remanded 386 F.2d 836">386 F.2d 836 (9th Cir. 1968), cert. denied 393 U.S. 929">393 U.S. 929 (1968); Seatree v. Commissioner,25 B.T.A. 396">25 B.T.A. 396, 401 (1932), affd. 72 F.2d 67">72 F.2d 67↩ (1934). 9. The ultimate remedy sought is not clear from petitioner's brief. Petitioner states in its opening brief that it would be satisfied with either of the results suggested in the dissenting opinions in Matut v. Commissioner,88 T.C. 1250">88 T.C. 1250, at 1259 and at 1261 (1987)↩. 10. As indicated infra,↩ it is our impression that Scardina was merely a courier for someone engaged in the illegal drug business. It is a matter of teasing speculation whether counsel's real client is that other person. However, we give no weight to any such possible speculation in the conclusions that we reach herein. 11. When asked what business or job produced the earnings from which he was able to gather together the $ 53,000, petitioner refused to answer, relying on his Fifth Amendment right. Even if the right was properly invoked, petitioner still bears his burden of proof in this case. See Coulter v. Commissioner,82 T.C. 580">82 T.C. 580, 582↩ n. 2 (1984).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621472/	CLARENCE WHITMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Whitman v. CommissionerDocket No. 14110.United States Board of Tax Appeals16 B.T.A. 197; 1929 BTA LEXIS 2622; April 25, 1929, Promulgated 2622 The action of respondent in disallowing a deduction as a loss on the sale of property approved for lack of evidence. Daniel B. Priest, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. TRAMMELL 197 This is a proceeding for the redetermination of a deficiency in income tax for 1920 in the amount of $3,999.80. The error assigned is the action of the respondent in disallowing a deduction claimed by the petitioner in his return on account of a loss alleged to have been sustained from the sale of a farm, and in disallowing a deduction claimed on account of brokers' commissions, counsel's fees and miscellaneous expenses in connection with said sale. 198 FINDINGS OF FACT. The petitioner is an individual residing at Katonah, N.Y. In 1911 and 1921 the petitioner purchased two farms at Pawling, N.Y., as an investment and with the hope of realizing a profit on the operation or the resale thereof. The two farms cost at least $20,000. After purchasing the farms he built a large dairy barn at a cost of at least $20,000. It was made of cement and stucco and contained modern improvements used on a dairy farm. He also2623 made improvements in the way of water works, fences and other improvements to the extent of $3,500. In addition thereto he made improvements and repairs on the residence which was upon one of the farms to the extent of $3,000. The buildings upon the farms were in bad repair and the residence was fixed up in order to put in into proper condition to be habitable. The improvements were made the latter part of 1912 or in the year 1913. In the purchase of the farms for $25,000 no allocation was made of the purchase price to buildings and land, but the house after the improvements had been made had a probable life of 25 years. The barn had an expected life of 50 years. One thousand five hundred dollars was paid by the petitioner as brokers' commission in connection with the sale of the property. The petitioner in his return claimed as a deduction a loss of $6,000 alleged to have been sustained on the sale of the two farms and also claimed a deduction of $896.93 representing commissions and legal fees in connection with the sales. These deductions were disallowed by the respondent, resulting in the deficiency asserted. OPINION. TRAMMELL: In order to entitle a petitioner to2624 the deduction on account of the loss on sale of the property which was acquired prior to March 1, 1913, there must be evidence both of the cost and of the March 1, 1913, value of the property, and the lesser of these amounts, considering depreciation allowable, whether claimed or not, must be greater than the selling price. Only one witness testified in the case, and he was unable to testify as to the March 1, 1913, value of the properties. Considering the fact that the properties were acquired in 1911 and 1912, and that the improvements were not completed until "about 1913," even if we should assume that the cost and the March 1, 1913, value were the same, still we are unable to determine from the evidence the amount of depreciation which was allowable to the petitioner on the depreciable property. While the petitioner's witness testified that according to his recollection no part of the purchase price of the 199 farms was allocated to the buildings thereon, we do not interpret this as meaning that buildings had no value or that some portion of the purchase price did not represent cost of the buildings which are subject to depreciation allowances. There is no testimony*2625 as to what would be a fair allocation of the purchase price to these buildings. It seems clear that, when land is purchased on which buildings are located, we may not find as a fact, in the absence of evidence to the contrary, that the buildings cost nothing and that the purchaser of such property would not be entitled to some depreciation allowance on buildings so acquired. When we consider the amount of depreciation which would be allowable by law, we are unable to determine that the petitioner has sustained a deductible loss, even if we should assume, as has been stated, that the cost and the March 1, 1913, value were the same, which assumption we do not indulge. With respect to the deduction paid on account of commissions and other expenses in connection with the sale of the property, it is our opinion that the petitioner is entitled to such deductions as ordinary and necessary expenses paid during the taxable year. ; . Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621473/	Langdon L. Skarda, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentSkarda v. CommissionerDocket Nos. 54407, 54408, 54409, 54410, 54411, 54412, 54413, 54414United States Tax Court27 T.C. 137; 1956 U.S. Tax Ct. LEXIS 46; October 31, 1956, Filed 46 Decisions will be entered for the respondent. The petitioners began publishing a daily newspaper in 1949 and took certain steps to incorporate it. In 1949 and 1950, they advanced a total of $ 84,300 to the newspaper to keep it in business. As a result of losses incurred thereby, the petitioners claimed business bad debt deductions in 1949 and 1950 under section 23 (k) (1), 1939 Code, and in the alternative they claimed deductions under sections 23 (a) (1) (A), 23 (e) (1), or 23 (e) (2).Held, a valid corporation, recognizable as a separate taxable entity, was created by the petitioners in 1949; held, further, a debtor-creditor relationship was established between the petitioners and the corporation by virtue of loans made by the petitioners to the corporation; held, further, petitioners are not entitled to business bad debt deductions under section 23 (k) (1) in connection with the advances because the losses resulting from the worthlessness of the debts were not incurred in, or proximately related to, any trade or business of the petitioners. Wentworth T. Durant, Esq., and Lynell G. Skarda, Esq., for the petitioners.John P. Higgins, Esq., for the respondent. Mulroney, Judge. MULRONEY 137 The respondent has determined deficiencies in income tax and additions as follows:Additions to taxYearDocketPetitionerDeficiencyNo.Sec.Sec.294(d)(2)294(d)(1)(A)194954407Langdon L. Skarda$ 617.96195054407Langdon L. Skarda1,742.78$ 141.11$ 141.11194954408Carolyn A. Skarda501.80195054408Carolyn A. Skarda1,826.06153.31153.31194954409Lynell G. Skarda andKathryn B. Skarda1,862.22195054410Lynell G. Skarda1,950.70195054411Kathryn B. Skarda1,885.18194954412Cash T. Skarda andAnnabel S. Skarda1,652.80195054413Cash T. Skarda1,812.22195054414Annabel S. Skarda1,812.2248 The cases were consolidated for trial and opinion.Langdon L. Skarda, Lynell G. Skarda, and Cash T. Skarda, hereinafter sometimes referred to as the petitioners, comprised, from 1942 through the tax years involved, the total membership of a partnership trading and doing business as "Skarda Bros." The questions presented herein are in respect to losses sustained, or reported to have been sustained, in 1949 and 1950 by Skarda Bros., hereinafter sometimes 138 referred to as the partnership, in the publishing of the Clovis Chronicle, a newspaper which will sometimes be referred to as the Chronicle. Two other minor adjustments determined by the respondent relating to understated gross receipts of the partnership in 1949 and failure of Langdon L. Skarda and Carolyn A. Skarda to file estimated tax returns for 1950 have not been contested by the petitioners.The issue for our decision is whether the losses sustained by the petitioners in 1949 and 1950 are deductible in full as business expense or losses under the provisions of either section 23 (a) (1) (A), 2(e) (1), or (e) (2), or were partially deductible as business bad debts under section 23 (k) (1), Internal Revenue Code, as49 alternatively contended by the petitioners, or as nonbusiness bad debts under section 23 (k) (4), as determined by the respondent.FINDINGS OF FACT.Petitioners Langdon L. Skarda and Carolyn A. Skarda were married residents of Clovis, New Mexico, in 1949 and 1950. They filed separate income tax returns on the community property basis in 1949 and 1950 with the then collector of internal revenue for the district of New Mexico.Petitioners Lynell G. Skarda and Kathryn B. Skarda were married residents of Clovis, New Mexico, in 1949 and 1950. They filed a joint income tax return for 1949 and separate income tax returns for 1950 on the community property basis with the then collector of internal revenue for the district of New Mexico.Petitioners Cash T. Skarda and Annabel S. Skarda were married residents of Clovis, New Mexico, in 1949 and 1950. They filed a joint income tax return in 1949 and50 separate income tax returns for 1950 on the community property basis with the then collector of internal revenue for the district of New Mexico.Langdon L. Skarda, Lynell G. Skarda, and Cash T. Skarda formed a partnership in 1942 known as Skarda Bros. for the original purpose of operating farming interests in the area surrounding Clovis, New Mexico. Until about 1946, the partnership was exclusively in the farming business. Langdon L. Skarda, a nonpracticing, licensed attorney, was placed in charge of the partnership farm interests. Lynell G. Skarda, in addition to his partnership interests, was in the active practice of law in Clovis, New Mexico, having been admitted to the bar in 1941. Cash T. Skarda, who was also a nonpracticing, licensed attorney, was cashier in the Citizens Bank of Clovis, of which the brothers' father was president.Beginning in 1946, the partnership began to expand its operations, investing in the cattle business, and to a much lesser degree, the real 139 estate business. Their cattle business consisted of the partnership acquiring and putting up large sums of money with which an experienced cattle buyer, selected by them, purchased cattle for pasturing51 and sale. The cattle buyer performed all of the work and "know-how" of the operation -- buying, fattening, and selling. Sometimes the partnership furnished pasture and feed but the management of the venture was in the hands of the buyer. After fattening and selling the cattle, all expenses of the operation were paid and the profits split between the partnership and the buyer. This division of profits was usually on a 50-50 basis but sometimes it was on a 75-25 basis, depending on the circumstances. If a single operation was of substantial size, the partnership opened a special account at the Citizens Bank of Clovis in the name of one party who had authority to write checks for the operation. From 1946 through the tax years involved, there were eight cattle operations with various buyers involved whereby the partnership invested $ 443,041. Their real estate business consisted of a single purchase of pasture land for $ 15,000.In 1948, as a consequence of long dissatisfaction with the local newspaper, the petitioners decided to look into the possibility of starting an opposition newspaper in the town of Clovis. In December 1948, after discussing the proposition among themselves, 52 Langdon L. Skarda and Lynell G. Skarda, representing the partnership, went to Denver, Colorado, and Cheyenne, Wyoming, where a printing press and allied equipment were located and purchased from E. A. Heinsohn Printing Machinery and Supplies, hereinafter referred to as Heinsohn. On December 11, 1948, the brothers drew a check in the amount of $ 15,000 on their partnership account in partial payment for the equipment. On the same date a regular conditional sales contract, with an installment promissory note for $ 23,426.32, was entered into between Heinsohn and the partnership. A simultaneous supplemental agreement was also entered into whereby it was agreed that the conditional sales contract would not be recorded so long as payments were made by the purchaser when due.On December 12, 1948, Lynell G. Skarda, representing the partnership, entered into contracts with King Features Syndicate whereby the yet to be born newspaper would be furnished with news services, comic strips, a syndicated column, and allied services. Some of the contracts were signed by Lynell G. Skarda, and others were signed "Chronicle Publishing Co." by Lynell G. Skarda. Pursuant to and in consideration 53 of the services acquired by these contracts, a check was drawn in payment therefor on the partnership account in the amount of $ 537.40. From December 11, 1948, until January 8, 1949, when a separate account was set up, many checks totaling $ 16,604.91 were drawn on the partnership account for expenditures in getting the Chronicle started.140 On December 14, 1948, articles of incorporation were filed with the State Corporation Commission of New Mexico for the organization of the Chronicle Publishing Company, sometimes referred to as the company. A certificate of comparison was executed on December 24, 1948. A certificate of incorporation for the company was duly issued to the petitioners by the State Corporation Commission on December 22, 1948. All articles and certificates were duly filed with the county clerk's office of Curry County, Clovis, New Mexico. All filing fees were paid by the petitioners. Notice of incorporation was duly published and proof of publication was filed with the State Corporation Commission on January 7, 1949.The articles of incorporation for the company designated Lynell G. Skarda statutory agent upon whom service of process could be made. The54 articles also named Langdon L. Skarda, Lynell G. Skarda, and Cash T. Skarda as incorporators, having subscribed to 4 shares of stock each, and as having the authority to act as directors of the company for the first 3 months after filing the certificate of incorporation. The articles further provided that "[the] private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatever."Subsequent to the filing of the articles of incorporation, there were no meetings of stockholders, no bylaws were adopted, no officers were elected, no minute books were kept, no corporate stock was issued, and no property was formally transferred to the company by the partnership.On January 9, 1949, a checking account in the name of the Chronicle Publishing Co. was opened at the Citizens Bank of Clovis and Lynell G. Skarda was authorized to draw checks on the account. Complete books of account were set up for the company including a capital account. A credit to the capital account of $ 25,104.91 was entered on January 15, 1949. On the books of the company, this item was described thus: "1949. Item 1, January 15. Capital stock (Equipment purchased, Skarda55 Brothers, and cash advanced), credit $ 25,104.91." This amount included $ 8,500 cash advanced by the partnership to the capital account of the company, and $ 16,604.91 expended by the partnership, before the company account was set up, for equipment, supplies, and personal expenses in getting the Chronicle started.The Chronicle commenced publication on March 20, 1949, and from the beginning it was operated under the corporate name assigned to it by the articles of incorporation. The Chronicle lost money from the outset and between February 10, 1949, and December 5, 1949, 11 checks totaling $ 68,000 were drawn on the partnership account to the account of the company, and between January 19, 1950, and October 13, 1950, 6 checks totaling $ 16,300 were similarly drawn in favor of the company account. All of these checks bore the notation 141 "Loan." Each check was endorsed for the company by either "Lynell G. Skarda, President" or "Cash T. Skarda, Treasurer." On the same date that each check was drawn, a nonsecured promissory note in the same amount of the check was issued payable to "Skarda Bros.," showing the following maker:Chronicle Publishing Co., a corporationBY: [signed] 56 Lynell G. SkardaPresidentATTEST: [signed] Cash T. SkardaSecretaryFive days after commencing publication, March 25, 1949, the conditional sales contract, note, and related agreement between Heinsohn and the partnership were canceled. On the same date a new conditional sales contract, note, and supplemental agreement were entered into between Heinsohn, as seller, and the company, as buyer. The company thereby assumed all liability formerly owed by the partnership in relation to equipment and supplies previously acquired from Heinsohn and the company became the purchaser of the equipment and supplies. The new contract was sealed with the corporate seal of the company and was signed by Lynell G. Skarda as president and Cash T. Skarda as secretary.On May 4, 1949, the State Corporation Commission of New Mexico notified the company that the right to do business in New Mexico was forfeited for failure to file a required annual report for 1949. Subsequent to this notice, the report was filed as required.In October 1949, to retain second-class mail privileges, a statement of ownership was published in the Chronicle in which it was stated that the three Skarda brothers were57 sole stockholders in the "Chronicle Publishing Co., a corporation." The company secured an employer's identification number; filed quarterly returns of income tax withheld; and filed employer's tax returns as a corporation in 1949. A final employer's quarterly Federal tax return was filed as by a corporation in 1950. In 1949 and 1950 the Chronicle was operated in the name of the company, ordering supplies, receiving normal short-term commercial credit, and paying bills by drawing on its corporate bank account.From the inception of the newspaper business by the partnership, it was understood that Lynell G. Skarda was to be in full charge. He worked from 10 to 11 hours per day trying to get the business on its feet financially. He acted as publisher or general manager, he kept books, made the payrolls, wrote the checks, solicited advertising, wrote all editorials, and set the policies for the Chronicle. All checks for the complete operation, about 3,000 in number, were drawn on the Chronicle Publishing Co. account. The newspaper was a losing proposition from the beginning to the end, when it ceased publication 142 February 1, 1950. Efforts were made to sell the newspaper58 in November and December 1949 for $ 50,000, but the petitioners were unsuccessful.After suspension of publication, the assets of the company were disposed of. Complete disposal of the assets was not completed until January 1951 when the printing press, the last principal item of equipment, was sold.In the partnership return of income filed by Skarda Bros. for 1949, the partners claimed a loss of $ 31,000 from bad debts owed by the Chronicle Publishing Company. For 1950, they made a similar claim of a loss in the amount of $ 39,530.71. They arrived at the losses claimed in 1949 by subtracting the estimated value of the plant from the debts which the company owed Heinsohn and the partnership. The losses in 1950 were arrived at by totaling the advances made to the company by the partnership which were not charged off in 1949 and adding that figure to the amount lost and estimated to be lost on the disposition of the plant and materials.The respondent determined that the bad debt deductions claimed by the petitioners in advancing money to the company were not allowable because the debts were nonbusiness in nature; that they were not entirely worthless at the end of 1949 or 1950, 59 and that no partial charge-off could be allowed.The respondent determined that the amount of $ 196.62 should be added to partnership income as unreported receipts in the year 1949. The petitioners allege error in this determination but presented no evidence in regard thereto.Langdon L. Skarda and Carolyn A. Skarda filed no declaration of estimated tax for 1950, and filed their 1950 income tax returns on March 15, 1951. The respondent determined that additions to the tax for failure to file estimates and for substantial underestimation of estimated tax should apply upon the 1950 returns. The petitioners allege error but presented no evidence in regard thereto.The Clovis Chronicle was published in 1949 and 1950 by the Chronicle Publishing Company as a separate entity.The Chronicle Publishing Company did not publish the newspaper as an agent of the partnership.The loans to the company by the partnership were nonbusiness in nature; therefore the petitioners are not entitled to partial bad debt deductions in 1949 or 1950.The gross receipts of the partnership were understated in the amount of $ 196.62 for the year 1949.Additions to the tax for failure to file declaration of estimated60 tax and for substantial underestimate of tax for 1950 were properly determined against Langdon L. Skarda and Carolyn A. Skarda.143 OPINION.Lynell G. Skarda, the only witness at the trial, testified that he and his two brothers were licensed attorneys living in Clovis, New Mexico. He was actively engaged in the practice of law but his brothers were engaged in other businesses. In 1942, the three Skarda brothers, in addition to their regular businesses, formed a partnership to operate farming interests. The partnership invested heavily in cattle from 1946 through the tax years involved. In 1949, they decided to start, and did start, a newspaper in Clovis, New Mexico. They immediately took steps to incorporate the business. The newspaper was a losing proposition from start to finish and the petitioners advanced, in addition to capital of $ 25,104.91, the sum of $ 84,300 to keep the company going. In 1949 and 1950, the petitioners claimed business bad debt deductions for losses sustained from advancements they made to the newspaper.The petitioners contend in the alternative that these losses were deductible as business expenses under section 23 (a) (1) (A), business losses61 under section 23 (e) (1) and (e) (2), or business bad debts under section 23 (k) (1). 362 The respondent, on the other hand, contends that the losses were nonbusiness bad debts within the meaning of section 23 (k) (4), and that such debts, being only partially worthless in 1949 or 1950, are not deductible under section 23 (k) (4)4 in those years.The petitioners make alternative arguments that (1) the Chronicle Publishing Co. never came into existence as a corporation, therefore all of the expenses or losses were their own; (2) if it did come into existence, it should be disregarded as a sham with the same results 144 as above; (3) if not so regarded, the corporation should be found to have been an agent of the partnership with the same results as above; and (4) finally, if found to be a valid corporation which published the Chronicle for itself, then the bad debts resulting from the money loaned to the company63 should be considered business bad debts, thereby allowing partial bad debt deductions for 1949 and 1950. We feel that the petitioners have failed to carry their burden of proving error in the determinations of the Commissioner.Our first concern is with the legal creation of the company as a corporation. In December 1948, articles of incorporation were filed with the proper authorities in New Mexico. Certificates of comparison and incorporation were subsequently issued in common form for the company. These were properly filed in Curry County, where the company was located, and the petitioners paid the filing fees as required. Notice of incorporation was duly published by the petitioners in a county newspaper. The articles of incorporation named the three Skarda brothers as incorporators, subscribing to 4 shares of stock each, and as having authority to act as directors for the first 3 months of incorporation.The petitioners held the company out to the public as a corporation. A sworn statement of ownership was published in the Chronicle by the petitioners, declaring that the newspaper was owned by the company and that the three Skarda brothers were sole stockholders in the64 "Chronicle Publishing Co., a corporation." The company secured an employer's identification number; filed quarterly returns of income tax withheld; and filed employer's tax returns -- all as a corporation.The petitioners contend that the corporation never came into existence since they failed to hold stockholders' meetings, adopt bylaws, elect officers, keep minute books, and issue stock. At this point it might be well to quote from chapter 54, section 211, New Mexico Statutes, Annotated (1941) as follows:Upon making the certificate of incorporation and causing the same to be filed, and a certified copy thereof recorded as aforesaid, and paying the filing fees therefor, the persons so associating, * * * shall from the time of such filing * * * be and constitute a body corporate, by the name set forth in said certificate, * * Under this statute it is obvious that the corporation was in existence to the extent that the State of New Mexico recognized it as a separate jural entity authorized to do business as a body corporate in New Mexico. In other words, the conditions precedent to the creation of a corporate body were complied with by the petitioners. The State of New Mexico, 65 having breathed life into the corporation, and it having complied with the laws of that State giving it the right to transact business under its charter, a separate entity came into being, be it de 145 jure or de facto, which will not be ignored except under unusual circumstances. Fleming G. Railey, 36 B. T. A. 543.The petitioners argue long and forcefully and cite many cases to the effect that a corporate body which does no business is but an empty shell which may be ignored as unreal and a sham, contending that the company was such a corporation, if a corporation at all. While generally a corporation must be regarded as a separate taxable entity, Burnet v. Commonwealth Imp. Co., 287 U.S. 415">287 U.S. 415, we recognize that there are exceptional circumstances whereby the corporate entity may be disregarded as unreal or a sham. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436.Whether or not a corporation should be disregarded as unreal or a sham seems to rest upon whether or not its creation was followed by business activity. In analyzing the three leading decisions of the Supreme66 Court on this issue, Burnet v. Commonwealth Imp. Co., supra;Higgins v. Smith, 308 U.S. 473">308 U.S. 473; and Moline Properties, Inc. v. Commissioner, supra, the court, in National Investors Corporation v. Hoey, 144 F. 2d 466, stated:to be a separate jural person for purposes of taxation, a corporation must engage in some industrial, commercial, or other activity besides avoiding taxation: in other words, * * * the term "corporation" will be interpreted to mean a corporation which does some "business" in the ordinary meaning; * * We believe that the formation of the Chronicle Publishing Co. was followed by business activity in the ordinary meaning.This business activity began with the publishing of a newspaper which it published under its corporate name from March 20, 1949, to February 1, 1950. All business of the Chronicle was transacted under the corporate name. A checking account in the name of the Chronicle Publishing Co. was maintained, from which approximately 3,000 checks were drawn by the company president or secretary in payment for company 67 services and supplies. The petitioners had an accountant set up a complete set of books for the company. These books contained a credit of $ 25,104.91 to the "Capital stock" account, representing money actually spent for equipment and supplies for the company, or cash deposited to the account of the company. The petitioners, in effect, transferred to the company the newspaper press and other equipment previously purchased by them. This was done when their personal conditional sales contract and note were caused to be canceled, and new ones, executed by the company, substituted therefor. The company thereby assumed all liability for the equipment under a contract and note signed and sealed by Lynell G. Skarda, president, and attested to by Charles T. Skarda as secretary of the Chronicle Publishing Co. Day-to-day supplies were delivered to the company in its name, billings were made in the company name, and a 146 company check was drawn in payment therefor. In other words, in the vernacular of the business world, the company was extended short-term commercial credit. The company borrowed money from Skarda Bros. and executed notes therefor. We note here that as late as 68 October 13, 1950, when the last loan was made, the petitioners were very careful in obtaining properly executed notes from the company for each loan. We believe that all of this evidence indicates that more than "some business" was carried on by the company.The petitioners cite and rely heavily on Paymer v. Commissioner, 150 F.2d 334">150 F. 2d 334, affirming in part and reversing in part a Memorandum Opinion of this Court. In that case there were two corporations created by the taxpayers to hold title to real estate. One of the corporations, Westrich, was found by the court, in reversing the Tax Court, to be "a passive dummy which did nothing but take and hold the title to the real estate * * ." This corporation was characterized as a sham. The other corporation, Raymep, was identical in nature to Westrich with one distinguishing exception. This was that Raymep had obtained a loan and to secure it had assigned to the lender its rights as lessor in two leases to property to which it held title. This distinguishing feature was sufficient for the court to sustain the Tax Court's decision and determine it to be a taxable entity. The court said of Raymep: 69 We think that Raymep was active enough to justify holding that it did engage in business in 1938. The absence of books, records and offices and the failure to hold corporate meetings are not decisive on that question. Though Raymep was organized solely to deter creditors of one of the partners, it apparently was impossible or impracticable to use it solely for that purpose when it became necessary or desirable to secure the above mentioned loan * * Certainly there was more business activity transacted by the company here than by Raymep. We therefore hold that the Chronicle Publishing Co. was engaged in sufficient business in 1949 and 1950 to classify it a separate entity.Petitioners next contend that if the company had a corporate existence in the beginning, its charter and the right to do business in New Mexico were forfeited and corporate existence ended on May 4, 1949, for failure of the corporation to make a required report to the New Mexico Corporation Commission. To this proposition we are unable to agree. Chapter 54, section 236, New Mexico Statutes, Annotated (1941), concerning corporations which have forfeited their charter and right to do business under this chapter70 for failure to make the report, provides:Any corporation in this class may be fully revived by the resumption of active business and the filing of the annual report contemplated by the provisions of this section.147 Lynell G. Skarda testified that subsequent to the forfeiture on May 4, 1949, the required report was duly filed. We think this indicated that the petitioners wanted to do everything necessary to maintain the corporate entity. There is nothing in the record to indicate that the business activity of the company was interrupted or changed in the slightest by or after the notice of forfeiture. Whether the company, after the forfeiture of its charter, was a de jure or a de facto corporation, or whether it was merely an association operating in the same form or manner as a corporation, we need not decide. It is sufficient to say that it falls within the classification of entities taxable as corporations under the revenue acts. Calvin Zimmerman, 31 B. T. A. 754.The petitioners further contend that if we determine that a corporate entity existed in 1949 and 1950, we should also find that it was an agent of the partnership. This agency71 argument "is basically the same argument of identity in a different form." Moline Properties, Inc., supra. However, we need not go into the merits of the argument since there is no evidence in the record that an agency relationship existed between the partnership and the company. There was no contract of agency, nor the usual incidents of an agency relationship, therefore we hold that the company in publishing the Chronicle was not an agent of the partnership. The petitioners' argument that they should be permitted to deduct as their own all of the expenses in publishing the Chronicle as business expenses under section 23 (a) (1) (A) is now disposed of since the expenses were those of the company, which we have concluded is a separate entity.The petitioners' last argument is that if we should find that the company was a corporate entity, then we should allow them to claim business loss deductions as provided in section 23 (e) (1) and (e) (2), or business bad debt deductions which they claimed in 1949 and 1950, under section 23 (k) (1). The respondent does not contend that the advancements in excess of $ 25,104.91 were additions to capital, therefore72 we will consider them to be bona fide loans. The petitioners do not contend that the nonsecured debts became totally worthless in 1949 or 1950, therefore any deductions under section 23 (k) (4) would be prohibited.Sections 23 (e) and 23 (k) of the Code are mutually exclusive. Charles G. Berwind, 20 T. C. 808. The special provisions as to debts in section 23 (k) indicate that debt losses are not to be regarded as other losses sustained under section 23 (e). Spring City Foundry Co. v. Commissioner, 292 U.S. 182">292 U.S. 182. Here we have an obvious debtor-creditor relationship; therefore the losses which resulted from the relationship can be deducted only under the provisions of section 23 (k). This 148 leaves only the petitioners' argument with respect to section 23 (k) (1) to be determined.Section 23 (k) (1), as negatively defined by section 23 (k) (4), allows a bad debt, incurred in a trade or business, to be deducted in the full amount of the loss in the year in which it becomes worthless in part or in full. In other words, the petitioners must prove that the loss resulting from the worthlessness of the debts was 73 proximately related to a trade or business of their own at the time the debts became worthless. We do not think that they have proved this.Generally speaking, a bad debt resulting from a loan to a corporation by its stockholders would not be considered a business bad debt because the loss therefrom would not be proximately related to a trade or business of the stockholder. A corporation and its stockholders are generally to be treated as separate taxable entities, Burnet v. Clark, 287 U.S. 410">287 U.S. 410. Consequently, the business of the corporation cannot be considered the business of the several stockholders. Dalton v. Bowers, 287 U.S. 404">287 U.S. 404; Estate of William P. Palmer, Jr., 17 T.C. 702">17 T. C. 702; and Jan G. J. Boissevain, 17 T. C. 325. The fact that Lynell G. Skarda devoted most of his time to the business of the corporation does not alter this conclusion. Skarda's activities in managing the business of the corporation for the corporation cannot in the same breath be held to constitute the conduct of a separate business. Jan G. J. Boissevain, supra.74 A worthless debt, resulting from a loan by a stockholder to his corporation, may qualify as a business bad debt if the stockholder was in reality engaged in the trade or business of promoting, organizing, managing, financing, and making loans to business enterprises. Henry E. Sage, 15 T. C. 299; Vincent C. Campbell, 11 T. C. 510. In such a case the taxpayer, though a stockholder in the corporation to which he loaned money, is also in the business of being a "promoter" of business enterprises, and the loss resulting from the bad debt would be proximately related to that business. We determined in Charles G. Berwind, supra, that the authority contained in such "promoter" cases as those cited above, "is applicable only to the exceptional situations where the taxpayer's activities in promoting, financing, managing, and making loans to a number of corporations have been regarded as so extensive as to constitute a business separate and distinct from the business carried on by the corporations themselves."The petitioners do not contend that they were in the business of loaning money to corporations, 75 and even if they had, the evidence does not support such a claim. The petitioners, by inference, do contend that they come within the forenamed "promoter" cases. The record does not support this contention either. This nebulous business requires that substantial time and effort be expended in various enterprises to an extensive degree. The record discloses that the company 149 was the only enterprise in which the petitioners put any time and effort, and was the only enterprise to which the petitioners loaned money. Their real estate "venture" consisted of one purchase of pasture land. As to their cattle ventures, in which the petitioners invested heavily, it was stated by Lynell G. Skarda, "Well, usually the way they [cattle ventures] were carried on was that we would furnish the money and others would do the work." It was not contended that these investments were loans. We do not think that the passive investing in cattle, the purchase of pasture land, and the organizing, managing, and financing and loaning money to one corporation was sufficient to constitute a separate and distinct business within the intendment of the "promoter" line of cases.After carefully 76 considering all of the evidence, we conclude that the petitioners were not in the separate and distinct business of publishing a newspaper, making loans to corporations, or promoting, organizing, managing, and financing business ventures. We therefore hold that the losses sustained were not proximately related to any business of the petitioners and therefore are not deductible under section 23 (k) (1).We find that the gross receipts of the partnership, Skarda Bros., were understated in the amount of $ 196.62 for the year 1949.We find that the additions to the tax for substantial underestimate of estimated tax and for failure to file declaration of estimated tax were properly determined for 1950 against Langdon L. Skarda and Carolyn A. Skarda.Decisions will be entered for the respondent. Footnotes1. The following proceedings are consolidated herewith: Carolyn A. Skarda, Docket No. 54408; Lynell G. Skarda and Kathryn B. Skarda, Docket No. 54409; Lynell G. Skarda, Docket No. 54410; Kathryn B. Skarda, Docket No. 54411; Cash T. Skarda and Annabel S. Skarda, Docket No. 54412; Cash T. Skarda, Docket No. 54413; and Annabel S. Skarda, Docket No. 54414.↩2. All references to section numbers are hereinafter meant to mean the Internal Revenue Code of 1939, unless otherwise specified.↩3. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) Expenses. -- (1) Trade or business expenses. -- (A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * ** * * (e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -- (1) if incurred in trade or business; or(2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or * * (k) Bad Debts. -- (1) General rule. -- Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * *↩4. (4) Non-business debts. -- In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621475/	RICHARD W. PADDOCK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPaddock v. CommissionerDocket No. 19225-80.United States Tax CourtT.C. Memo 1985-586; 1985 Tax Ct. Memo LEXIS 48; 51 T.C.M. (CCH) 17; T.C.M. (RIA) 85586; December 2, 1985. Richard W. Paddock, pro se. Ray K. Kamikawa, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined the following deficiencies and additions to tax: Additions to taxYearDeficiencySec. 6653(b) 1Sec. 6654(a)1972$4,346.58$2,173.29$140.0519736,556.063,278.03211.24197412,878.256,439.12414.9419753,228.841,614.42139.7950 The issues for decision are (1) whether petitioner is liable for the self-employment tax on his net earnings for the taxable years in issue; (2) whether petitioner is liable for an addition to tax pursuant to section 6654(a); and (3) whether any part of the underpayment for the years in issue is due to fraud or whether, in the alternative, petitioner is liable for the additions to tax pursuant to sections 6651 and 6653(a). FINDINGS OF FACT Pursuant to Rule 90(c) of the Tax Court Rules of Practice and Procedure2, respondent requested petitioner to admit or deny certain matters. Petitioner failed to respond within the required 30-day period, and as a result, the statements in respondent's request are deemed admitted. Taxpayer failed to file Federal income tax returns for the taxable years 1972 through 1975. Petitioner (Mr. Paddock) resided in Kaneohe, Hawaii, at the time he filed his petition. During the years 194551 to 1947, petitioner served in the United States Army Air Corps as a photographer. Following his discharge from the Air Corps, petitioner enrolled in several courses, including a bookkeeping course offered by the Standard Oil Company of California. After graduating from high school in 1949, petitioner enrolled in automotive courses at San Jose State College. During the years 1950 to 1976, petitioner was a self-employed Chevron service station operator. From 1950 to 1962, petitioner operated a service station in San Francisco, and in 1962 he moved to San Jose where he remained until 1970. In 1970 Mr. Paddock and his family moved to Hawaii where petitioner operated a Chevron service station in Waipahu. Petitioner continued to operate the Waipahu service station until February of 1976 when it was closed by Chevron, U.S.A., Inc. He leased another service station in Maili, Hawaii, until September of 1976 when the lease was terminated by Chevron. Petitioner was the sole proprietor of the Waipahu service station during the years in issue and, as such, was responsible for all record keeping, deposits of cash and receipts, finances, operations and compilation of records for tax return52 purposes. Taxpayer submitted the records he maintained to his certified public accountant, Alex Chu, who used this information to prepare a Schedule C "Profit or (Loss) from Business or Profession" for each of the years in issue. Alex Chu provided petitioner with the Schedules C in time for Mr. Paddock to file timely Federal and state income tax returns. The specific items of income, deductions and not profit as shown on the Schedules C are summarized below. 1972197319741975Gross re-$164,538.53 $173,619.88 $197,977.89 $210,857.40 ceiptsCost of(102,219.40)(106,741.24)(126,312.50)(147,723.20)goods soldDeductions(39,020.64)(40,710.79)(32,743.80)(43,441.82)Net profit$ 23,298.49 $ 26,167.85 $ 38,921.59 $ 19,487.61 Petitioner did not file an income tax return for any of the years in issue although he knew that the Schedules C indicated taxable income for each year in issue. Mr. Paddock considered the data prepared by his accountant to be completely accurate. In fact, by petitioner's own account the Schedules C were prepared on the basis of daily records supplied by petitioner. Petitioner received53 taxable income for the years in issue consisting of the items and amounts described below: 1972197319741975Business$23,298.45 $26,167.85 $38,921.59 $19,487.61 incomeLess: Moving(625.50)expensesAdj. gross$22,672.95 $26,167.85 $38,921.59 $19,487.61 incomeLess: Itemizeddeductions: Contri-(403.00)(557.00)butionsInterest(3,821.33)(2,872.61)(2,859.35)(3,117.70)Taxes(1,535.56)(1,130.88)(1,365.93)(1,472.14)Less: Personal(3,000.00)(3,000.00)(3,000.00)(3,000.00)exemptionsTaxable$14,316.00 $19,164.36 $31,293.31 $11,340.77 incomeOn February 16, 1979, an information was filed in the United States District Court for the District of Hawaii charging petitioner with willful failure to file Federal income tax returns pursuant to section 7203 for the taxable years 1972, 1973, 1974, and 1975. On March 16, 1979, petitioner pleaded guilty to three counts of the information for the years 1973, 1974, and 1975. The charges with respect to the taxable year 1972 were dismissed. On May 29, 1979, Mr. Paddock was sentenced by the District Court to a prison term of 654 months for each of the three counts with the sentences to run concurrently. Petitioner sold property in San Jose, California, which generated enough income for he and his family to live on for 4 years after moving to Hawaii. In addition, petitioner's service station business generated sufficient income to support his family during the period in question. Mr. Paddock borrowed money from his life insurance policy in order to purchase a second residence in Maili, Hawaii in 1976. Prior to 1972, petitioner had been a successful businessman who had diligently complied with his responsibility to satisfy his Federal income tax obligations on a timely basis. After moving to Hawaii, however, he began having an extra-marital affair and began to drink heavily. The problems that Mr. Paddock was having in his private life soon began to disrupt his business life and ultimately his employment contract was terminated by his employer. Petitioner failed to file Federal income tax returns or pay any portion of the income tax liabilities owing for the taxable years at issue. He also failed to make any estimated income tax payments during this period. For the two decades prior to the time petitioner55 moved to Hawaii, he fully complied with his duty to file accurate and timely Federal and state income tax returns. In addition, Mr. Paddock filed gross excise tax returns with the State of Hawaii for 3 of the years in question. Mr. Paddock never set aside a fund that could have been used for the eventual payment of his outstanding tax obligations. OPINION The first issue for decision is whether petitioner is liable for the deficiencies in Federal income tax determined by the Commissioner. The Commissioner's determinations are presumed to be correct and petitioner bears the burden of proving them to be erroneous. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a). The amounts of net profit petitioner earned as well as his tax liability for the years in issue, have been established pursuant to Rule 90(e). Rule 90(e) provides that "[a]ny matter admitted under this Rule is conclusively established unless the Court on motion permits withdrawal or modification of the56 admission." Accordingly, we sustain the Commissioner's determinations of deficiencies in tax for the taxable years 1972, 1973, 1974, and 1975. We deal next with whether petitioner is liable for the self-employment tax for the years in issue. An individual who engages in a trade or business as a sole proprietor or as a partner must pay a tax on the "net earnings" 3 from all self-employment activities. Section 1401 et seq. The facts deemed admitted establish that petitioner derived "net earnings" from his activities as a sole proprietor. He is therefore liable for the self-employment tax in the amounts determined by respondent for each of the years in issue. We deal now with the issue of whether petitioner57 is liable for the addition to tax under section 6654(a). An individual who underpays his estimated tax is made subject to an addition to tax based on the amount and duration of the underpayment. Section 6654. The addition to tax is determined by applying an annual interest rate, as set forth in section 6621, to the amount of the underpayment. 4 Paragraph 28 of respondent's request for admissions states that petitioner failed to make any estimated income tax payments for any of the taxable years in issue. This Court, therefore, has little choice but to uphold respondent's datermination of this addition to tax as computed in the notice of deficiency. 558 The next issue for our consideration is whether petitioner is liable for the addition to tax under section 6653(b)6 for fraud. Whether a taxpayer acted fraudulently is determined on the basis of all the facts and circumstances. Stratton v. Commissioner,54 T.C. 255">54 T.C. 255, 284 (1970). Respondent bears the burden of proving, by clear and convincing evidence, that some underpayment exists and that part of the underpayment in each year was due to fraud. Section 7454(a); Rule 142(b). This burden is satisfied if it is shown that the taxpayer "intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes." Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983); Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002 (3d Cir. 1968). The existence of fraud is a question of fact to be gleaned from a consideration of the entire record. Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). Fraud will never be presumed. 59 Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970). The fraudulent intent, however, may be proven by circumstantial evidence emanating from the taxpayer's entire course of conduct. Rowlee v. Commissioner,supra at 1123; Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 223-224 (1971). Taxpayer failed to file an income tax return for the taxable years 1972 to 1975, inclusive. 7 For 3 of the 4 years in issue, taxpayer entered a plea of guilty to a criminal charge of failing to file a Federal income tax return in violation of section 7203. We note that the intent to evade taxes is not an element60 of the criminal offense charged under section 7203. That crime is complete with the willful failure to pay a tax, file a return, maintain records, or supply information. Section 7203. Thus, a conviction under section 7203 does not establish as a matter of law that petitioner failed to file a return with an intent, or in an attempt, to evade taxes. Wright v. Commissioner,84 T.C. 636">84 T.C. 636, 643 (1985). Furthermore, it is well-established that a failure to file an income tax return is not, standing alone, proof of fraud on the part of the taxpayer. Rowlee v. Commissioner,supra;Cirillo v. Commissioner,314 F.2d 478">314 F.2d 478 (3d Cir. 1963), affg. in part and revg. in part a Memorandum Opinion of this Court. Although the failure to file tax returns is evidence that may be considered as indicative of fraud, such an omission "may be consistent with a state of mind other than the intention and expectation of defeating the payment of taxes." Rowlee v. Commissioner,supra at 1123. 61 There is some question as to what respondent must show, in addition-to a taxpayer's failure to file, in order to prove the requisite intent to defraud. In the landmark case of Spies v. United States,317 U.S. 492">317 U.S. 492, 498 (1943), the Supreme Court held that there can be no criminal fraud unless there is some affirmative conduct (i.e. a commission) intended to evade, mislead, or conceal. Such conduct must be in addition to any of the omissions already punishable by the criminal sanctions found in section 7203. Spies v. United States,supra at 499. The Spies test has been followed in civil fraud cases involving the willful failure to file tax returns in the Eighth Circuit ( First Trust & Savings Bank v. United States,206 F.2d 97">206 F.2d 97 (8th Cir. 1953)), the Fifth Circuit ( Jones v. Commissioner,259 F.2d 300">259 F.2d 300 (5th Cir. 1958), revg. and remanding 25 T.C. 1100">25 T.C. 1100 (1956)), and most recently the Tenth Circuit ( Zell v. Commissioner,763 F.2d 1139">763 F.2d 1139 (10th Cir. 1985), affirming a Memorandum Opinion of62 this Court). A second less restrictive test has been adopted by the Third Circuit requiring, in addition to petitioner's failure to file, merely an "affirmative indication" of taxpayer's intent to evade the tax. Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002 (3d Cir. 1968); Cirillo v. Commissioner,supra.Both the Stoltzfus and Cirillo courts found fraud where the failure to file a tax return was accompanied by something less than the type of "affirmative conduct" required by Spies. In Cirillo, petitioner's failure to keep books and records was, when coupled with a long period of non-filing (10 years) enough of an "affirmative indication" of an intent to evade tax to justify imposition of the addition for fraud. Cirillo v. Commissioner,supra at 483. In Stoltzfus, the Third Circuit held that a convincing affirmative indication of an intent to defraud was present where the taxpayer's willful failure to file tax returns for 16 consecutive years was combined with a knowledge on his part that a tax was owing for63 each of the years in issue. Stoltzfus v. United States,supra at 1005. 864 We do not need to decide which of the two approaches described above is appropriate in the instant case because respondent failed to sustain his burden of proof under either the Spies test or the Cirillo-Stoltzfus test. According to the Spies standard, petitioner would not be liable for the addition to tax for fraud because he did not engage in any affirmative conduct evidencing an intent to evade a tax. Although respondent alleges that petitioner purchased certain assets during the period in question, this evidence was proffered solely to contradict Mr. Paddock's claim that he failed to file tax returns because he lacked funds with which to satisfy his tax liabilities. Respondent did show that petitioner's failure to file was with knowledge of his reporting obligations and with knowledge that a tax liability was owing. However, failure to satisfy even a known duty to file a tax return and pay a tax does not involve the type of conduct required to satisfy the Spies test. 965 We further believe that respondent failed to prove fraud by clear and convincing evidence under the more liberal "affirmative-indication" test. Although the Third Circuit found fraud in Cirillo and Stoltzfus, both of those cases can be distinguished from the instant case. In Cirillo v. Commissioner,314 F.2d 478">314 F.2d 478, the taxpayer failed to file a tax return for 10 consecutive years, a period substantially longer than the 4-year non-filing period in the instant case. Furthermore, Mr. Cirillo was an attorney who earned taxable income both as a municipal employee and through the private practice of law. In addition, the taxpayer in Cirillo failed to maintain adequate books and records. Such a failure, when coupled with his failure to file tax returns over a sustained period, greatly increased the problems confronted by respondent in uncovering the taxpayer's misdeeds and in reconstructing his taxable income for the years in question. The Supreme Court has said that the addition to tax for fraud was intended, in part, "to reimburse the Government for the heavy expense of investigation" resulting from the taxpayer's fraud. Helvering v. Mitchell,303 U.S. 391">303 U.S. 391, 401 (1938).66 In the instant case, petitioner maintained meticulous records during all of the years in issue. These detailed records were ultimately turned over to and incorporated by respondent into his statutory notice of deficiency. In Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002, the Third Circuit held that non-filing, when coupled with the taxpayer's knowledge that a tax was owing during all of the years in issue, was sufficient to establish an inference of the requisite specific intent to defraud. In Stoltzfus, unlike the instant case, the taxpayer's failure to file extended over a 16-year period. Certainly the inference drawn from a taxpayer's failure to file is made stronger and more compelling by virtue of the sheer length of the non-filing period. Thus, we believe that, as an indicia of fraud, a failure to file tax returns has a quantitative as well as a qualitative component. In the instant case, although Mr. Paddock's failure to file a tax return can create an inference of fraud when coupled with his knowledge that he owed tax during the years in issue, that inference is made weaker by virtue of the shorter non-filing period and the other mitigating facts and67 circumstances. Petitioner was a forthright and credible witness and although his actions were clearly dilatory and remiss, they do not rise to the level of deception and guile necessary for a finding of fraud. Mr. Paddock had been a successful businessman for nearly a quarter of a century. After moving from California to Hawaii in 1971, however, petitioner's business and personal affairs began to deteriorate rapidly. The evidence indicates that towards the end of the period in question, petitioner became involved in an extra-marital affair and drinking heavily. Ultimately, both his marriage and his career as a service station operator came to an unhappy conclusion. Petitioner's personal problems during the years in issue were manifested in his unfortunate tendency to over-extend himself financially. His service station was ultimately closed by Standard Oil Company in 1976 because he used gas receipts for personal expenditures. We believe from Mr. Paddock's testimony and from the relatively short non-filing period that he would eventually have made efforts to satisfy his outstanding obligations to respondent as his business and personal affairs improved. This Court has recognized68 that an intent to avoid the payment of tax can be distinguished from an intent merely to postpone the payment of tax. Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1124 (1983). 10Petitioner was exceptionally diligent in maintaining complete and accurate records of his gross income and expenditures during the years in issue. Mr. Paddock furnished these records to the investigating agents and they were ultimately incorporated into respondent's statutory notice. The maintenance of detailed financial records during the period in question and the prompt surrender of those records is certainly not indicative of an intent to defraud. 1169 The taxpayer in the instant case diligently complied with his tax obligations for all but 4 of his 25 years of professional life. Mr. Paddock's failure to file tax returns for the years in issue, rather than being indicative of an intent to defraud, is merely reflective of the chaos that was occurring in his life during the period in question. As we later hold, petitioner's conduct was negligent, but negligence is not fraud and respondent's attempt to impose fraud under these circumstances is draconian. We hold that, taking all of the circumstances into account, respondent has not satisfied his burden of proving, by clear and convincing evidence, that some part of the underpayment for each year was due to fraud. Section 7454(a); Rule 142(b). Respondent argues, in the alternative, that petitioner is liable for the additions to tax under sections 6651(a)(1) and 6653(a) for each of the 4 taxable years in issue. Because these assertions were raised by affirmative allegation in respondent's amended answer, respondent bears the burden of proof with regard to these issues. Rule 142(a). Here, there is sufficient evidence in the record to satisfy respondent's burden as to both additions70 to tax. Section 6651(a)(1) provides that an addition to tax will be imposed when a taxpayer fails to file his Federal income tax return unless such failure is attributable to reasonable cause and not willful neglect. As noted above, petitioner was convicted under section 7203 for willful failure to file a return for the taxable years 1973, 1974, and 1975. As to these years, the doctrine of collateral estoppel 12 applies and we are required to find as an established fact that petitioner's failure to file was willful. Gemma v. Commissioner,46 T.C. 821">46 T.C. 821, 834 (1966). The circumstances surrounding petitioner's failure to file a Federal income tax return in 1972 are no different and we therefore find that petitioner's failure to file returns for all 4 years in issue was willful. Consequently, respondent's determination that petitioner is liable for the 6651(a)(1) addition to tax for each of the years in issue will be sustained. 71 Section 6653(a) provides for an addition to tax equal to 5 percent of the total underpayment 13 if any portion of the underpayment in income and gift tax is due to negligence or intentional disregard of the rules and regulations.Petitioner's dutiful compliance with both his filing and his remittance obligations for the years preceding 1972 implies that Mr. Paddock was clearly cognizant of his Federal tax obligations. In addition, the evidence indicates that petitioner received Schedule C worksheets from his accountant which, by petitioner's own admission, indicated that there would be tax due for each of the 4 years at issue. Although we have concluded that petitioner's failure to file does not evidence the intent to conceal necessary for a finding of fraud, that failure to file does support a determination of negligence or intentional disregard of the rules and regulations. Respondent's finding that petitioner is liable for the addition to tax under section 6653(a) for each of the 4 years in issue must therefore be sustained. 72 To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the years in issue.↩2. Unless otherwise indicated, all rule references are to the Tax Court Rules of Practice and Procedure.↩3. The phrase "net earnings from self-employment" is defined in sec. 1402(a)↩ to mean "the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business * ."4. The "underpayment" as defined in sec. 6654(b)↩, is equal to 80 percent of the difference between the actual tax and the amount, if any, of all installments paid on or before the due date. Saltzman, IRS Practice and Procedure par. 7.11 [1] p. 7-84 (1st Ed. 1981.) 5. We note that there is no language in sec. 6654 relating to reasonable cause or lack of willful neglect and therefore extenuating circumstances have no relevance. Estate of Ruben v. Commissioner,33 T.C. 1071">33 T.C. 1071, 1072↩ (1960).6. Section 6653(b) provides as follows: (b) Fraud.--If any part of any underpayment * * of tax * * * is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. In the case of income taxes and gift taxes, this amount shall be in lieu of any amount determined under subsection (a) * * * [relating to negligence or intentional disregard of the rules and regulations regarding the payment of income or gift taxes.]↩7. Although it was deemed admitted that petitioner failed to file a Federal income tax return in 1971, that taxable year is not before this Court. Furthermore, Mr. Paddock provided testimony at trial, which we believed, that he did in fact file a tax return in 1971.↩8. The Court of Appeals for the Ninth Circuit, the circuit to which an appeal in the instant case would lie, has specifically declined to decide whether the Spies test is the appropriate one to follow in a failure to file context. Powell v. Granquist,252 F.2d 56">252 F.2d 56 (9th Cir. 1958). In Powell v. Granguist,supra, the taxpayer failed to file Federal income tax returns for the years 1937 through 1945. The court in Powell found the following facts, not present in the instant case, to be indicative of fraud: 1) The taxpayer was informed of his duty to file income tax returns, and the only answer given for his failure to file was that he did not approve of the manner in which the tax revenues were being spent by the Federal Government. 2) The taxpayer maintained no formal books, and upon a request by revenue agents to produce his records he complied by producing only his cancelled checks and bank statements. 3) The taxpayer failed to cooperate with the Internal Revenue Service by refusing to turn over the records he had relative to certain transactions that he was involved with as a real estate broker. The taxpayer lied by telling revenue agents that he had no such records and only finally complied with their specific requests after it was apparent that the revenue agents had discovered the existence of these transactions through other means. Because the Powell court relied on these factors, it remains unclear whether the Ninth Circuit would find fraudulent intent from a willful failure to file in the absence of these other indications of fraud. In a later case, the Ninth Circuit again found fraud in a case involving the willful failure to file tax returns. Lord v.Commissioner,525 F.2d 741">525 F.2d 741, 745 (9th Cir. 1975), affg. in part and revg. in part 60 T.C. 199">60 T.C. 199 (1973). The facts in Lord, however can be distinguished from those of the instant case. The Lord case involved a taxpayer who failed to file a Federal income tax return for 6 consecutive taxable years. In addition to the willful failure to file tax returns, the court found persuasive the fact that the taxpayer failed to keep records or to retain receipts during the years in issue. In addition, he refused, over a 6-year period to provide his employer with his correct Social Security identification number. Furthermore, the taxpayer in Lord↩ was warned by his employer to pay his taxes and to cease his extravagent life style. Mr. Lord's only explanation for his failure to file was his fear that he would lose his job and face a possible prison term.9. Respondent argues on brief that a number of minor misstatements made by petitioner at trial amount to significant misrepresentations. These misstatements had to do with the accuracy of the Schedules C prepared by Mr. Paddock's accountant, a wristwatch purchased by petitioner and given to a female acquaintance, and the source of the funds used by petitioner to purchase a house in Maili, Hawaii. We believe that the effect of these misstatements on respondent's investigation was negligible and that they lend little weight to respondent's contention that petitioner's failure to file returns and pay tax was motivated by a specific intent to defraud the Government.↩10. See also Anderson v. Commissioner,T.C. Memo. 1973-155 and Morrell v. Commissioner,T.C. Memo. 1971-99↩.11. Respondent argues on brief that petitioner refused to cooperate during the investigation because he was unwilling to stipulate to known facts. We note that Mr. Paddock represented himself in these proceedings. Because of petitioner's lack of sophistication and because of his willingness to cooperate by surrendering to respondent his books and records for the years in issue, we are unwilling to view Mr. Paddock's failure to stipulate as indicative of fraud.↩12. The doctrine of collateral estoppel is intended to avoid repetitious litigation by precluding the relitigation of any issue of fact or law that was actually litigated and that culminated in a valid and final judgment. Montana v. United States,440 U.S. 147">440 U.S. 147, 153 (1979); see Restatement, Judgments 2d, sec. 27 (1982). The doctrine will only apply to situations in which the matter raised in the ensuing suit is "identical in all respects with that decided in the first proceeding and where the controlling facts and applicable legal rules remain unchanged." Commissioner v. Sunnen,333 U.S. 591">333 U.S. 591, 599-600↩ (1948).13. An "underpayment" is generally defined in the same manner as a "deficiency" (essentially the correct tax minus the reported tax) except that the amount reported on a late return does not reduce the amount of the underpayment. Sec. 6653(c)(1)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621476/	Robert Lubets, Petitioner, v. Commissioner of Internal Revenue, RespondentLubets v. CommissionerDocket No. 6407United States Tax Court5 T.C. 954; 1945 U.S. Tax Ct. LEXIS 57; October 22, 1945, Promulgated 57 Decision will be entered for the respondent. On April 1, 1941, petitioner and his brother agreed to dissolve their partnership of public accounting and real estate tax practice, with petitioner taking the accounting practice and his brother the tax practice. At that time there was a considerable number of real estate tax cases pending which the partnership had taken on a contingent fee basis, and the brothers agreed that these cases "shall be liquidated by" the two brothers and "the net profit arising from said liquidation shall belong to" the two brothers in equal shares. On April 30, 1941, petitioner executed a deed of gift in which he gave to his wife all of his right, title, interest and equity "reserved under the terms of said dissolution agreement pertaining to the tax business." Held, petitioner rather than his wife is taxable on one-half of the net profits arising from the liquidation of the tax cases that were liquidated between April 30, 1941, and the balance of the taxable year. Claude B. Cross, Esq., for the petitioner.Joseph D. Donohue, Esq., and Charles P. Reilly, Esq., for the respondent. Black, Judge. BLACK 955 This proceeding involves the determination by the respondent against petitioner of a deficiency in income tax for the calendar year 1941 in the amount of $ 9,042.64.The deficiency results from three adjustments to the net income as disclosed by petitioner's return. By an appropriate assignment59 of error petitioner contests one of the three adjustments; the other two were in petitioner's favor. The contested adjustment is labeled "Income from partnership in liquidation $ 19,064.90" and is partly explained in a statement attached to the deficiency notice as follows:This increase of $ 19,064.90 represents the portion of the income of the partnership Lubets and Lubets in liquidation (as disclosed by the partnership return (Form 1065) filed for the year 1941 under the name and style of "Moses and Lillian Lubets, Liquidation Trustees for Lubets and Lubets, 185 Devonshire Street, Boston, Massachusetts.") which was actually and/or constructively received by you during the said year 1941 and which is now held to be taxable to you for that reason under section 22 of the Internal Revenue Code, instead of to your wife, Lillian Lubets. The difference between the amount you reported from this source, $ none, and the amount deemed to be taxable to you, $ 19,064.90, has been included in your taxable income herein.Petitioner conceded at the hearing that he was taxable on at least $ 4,536.90 of the adjustment above referred to.FINDINGS OF FACT.Petitioner is an individual, residing60 in Brookline, Massachusetts. His income tax return for the calendar year 1941 was filed with the collector for the district of Massachusetts.Petitioner and his brother, Moses Lubets, formed an accounting partnership in 1922 under the firm name of Lubets & Lubets.For several years prior to April 1, 1941, Lubets & Lubets had been engaged, in addition to their accounting practice, in the business of acting on a contingent fee basis for taxpayers in having appraisals made of real estate and endeavoring to secure for the taxpayers a reduction in the assessed value of their real estate.On April 1, 1941, petitioner and Moses agreed to dissolve their partnership. The material provisions of this agreement are as follows:I. Dissolution of PartnershipThe partnership heretofore carried on by said partners in the business of accounting and tax consultants, under the name Lubets & Lubets, wherein said partners were entitled to share equally in the profits and liable for the losses, shall be deemed to have been dissolved by mutual consent as and from the 31st day of March, 1941.A. Transfer of Accounting PracticeSaid Moses Lubets hereby gives, grants and conveys to said Robert Lubets, 61 all his right, title and interest in and to the accounting practice and goodwill arising therefrom formerly carried on by said Lubets & Lubets. * * *956 B. Transfer of Tax PracticeSaid Robert Lubets hereby gives, grants and conveys to said Moses Lubets, all his right, title and interest in and to the real estate tax practice, clientele and goodwill connected therewith formerly carried on by said Lubets & Lubets as tax consultants, but subject, nevertheless, to the limitations hereinafter set forth and subject to the provisions of Clause III * .It is further mutually agreed that Moses Lubets and Robert Lubets shall retain equal interests in the real estate tax consultant business of said Lubets & Lubets limited, nevertheless, to those cases arising from the assessments of taxes prior to the tax year 1941. (All fees or profits realized from real estate tax consultant clients of Lubets & Lubets arising from the assessments of taxes for the tax year 1941 and thereafter shall belong entirely to said Moses Lubets.) All uncompleted real estate tax consultant business arising from cases prior to the 1941 tax assessment, shall be liquidated by said Moses Lubets and Robert62 Lubets in accordance with the provisions of Clause III, hereinafter set forth.II. Division of AssetsAll the assets of Lubets & Lubets now allocated to the accounting department shall be evaluated by said Moses Lubets and Robert Lubets and after the payment of all outstanding liabilities, shall be divided equally between said Moses Lubets and Robert Lubets, after balancing the capital accounts of each partner on the books of Lubets & Lubets.All the assets of Lubets & Lubets now allocated to the tax department shall be divided equally between said Robert Lubets and Moses Lubets. Such assets as are required for the liquidation of the tax cases of Lubets & Lubets shall remain undistributed until final distribution between Moses Lubets and Robert Lubets shall be made at the termination of the liquidation proceedings. It is agreed that a bank balance of Six Thousand ($ 6,000.00) Dollars shall be maintained for the liquidation account hereinafter set forth.III. Liquidation of Real Estate Tax Matters[EDITOR'S NOTE: TEXT WITHIN THESE SYMBOLS [O> <O] IS OVERSTRUCK IN THE SOURCE.]A. All real estate tax matters as hereinbefore set forth involving tax years prior to but not including63 the tax year 1941, [O> (in which Moses Lubets and Robert Lubets have an equal interest, sharing profits and losses equally) <O] shall be liquidated by both Moses Lubets and Robert Lubets as liquidating trustees, the consent of both being required on any matter. The failure of either liquidating trustee to give his prior consent or to object to any action taken by the other liquidating trustee in the course of such liquidation shall not be deemed to be a waiver of his right thereafter to object.B. For such period as the parties hereto may hereafter agree upon, said liquidating trustees shall receive the following weekly salaries:Robert Lubets$ 25.00Moses Lubets100.00together with such reasonable expenses, including travel, hotel and similar expenses as are properly chargeable as a liquidation expense. Each liquidating trustee shall submit weekly to the other a written itemized list of any such expenses incurred by him during the prior week.C. After the deduction of the salary and expenses of said Moses Lubets and Robert Lubets as set forth in the foregoing paragraph, and the further deduction of all other proper expense for appraisals, rent, telephone, supplies, 64 stenographic services, etc., the net profit arising from said liquidation shall belong to said Moses Lubets and Robert Lubets in equal shares.D. For the purposes of the liquidation requirements, and for those purposes only, the name of Lubets & Lubets shall be continued to be used, until such time 957 as it shall no longer be required in the liquidation process, or until such earlier time as may be agreed upon by said Robert Lubets and Moses Lubets.After the tax cases through the tax year 1940 have been finally disposed of, neither Robert Lubets nor Moses Lubets shall use the name "Lubets & Lubets" at any future time nor for any other purpose, it being mutually agreed that each will conduct his own private business under a name other than "Lubets & Lubets". It is further agreed that the name "Lubets" shall not be used by either party signatory hereto in any firm name which either party shall hereafter select or adopt for the conduct of his own real estate tax business.E. A bank account shall be maintained at the National Rockland Bank of Boston. This account shall be the depositary for all funds received from the liquidation of the business of Lubets & Lubets real estate65 tax cases, and shall be used to pay all salaries and expenses payable during the course of the liquidation process. Said funds shall be withdrawn only by the signatures of both Moses Lubets and Robert Lubets together -- neither to have the right of individual withdrawals.It is agreed that should said deposit account at the time of the execution of this agreement or at any time during the term of the liquidation be less than Five Thousand ($ 5,000.00) Dollars, each will contribute equally such sum as may be necessary to increase the total deposit account to Six Thousand ($ 6,000.00) Dollars. If said deposit account at any time during the term of liquidation exceeds Seven Thousand ($ 7,000.00) Dollars, the sum exceeding Six Thousand ($ 6,000.00) Dollars shall be withdrawn and divided equally between said Robert Lubets and Moses Lubets.* * * IV. In the event that said Moses Lubets and Robert Lubets are unable to agree upon any matter requiring their mutual agreement under any clause of this document, the matter shall be submitted to arbitration. * * Such arbitration proceeding shall be a condition precedent to bringing any action, suit or proceeding in any court for the establishment66 of any rights or causes of action arising from this agreement.On April 30, 1941, petitioner executed an instrument which is set forth in full (except for petitioner's signature) as follows:DEED OF GIFTThis indenture made this 30th day of April 1941 between Robert Lubets of Brookline and Lillian Lubets, wife of said Robert Lubets, also of Brookline,WITNESSETH:Whereas said Robert Lubets is desirous of providing for the better support and maintenance of his said wife, Lillian Lubets, andWhereas said Robert Lubets entered into an agreement with Moses Lubets dated April 1, 1941 dissolving the partnership of Lubets & Lubets, andWhereas under said dissolution agreement separate dispositions are made of the accounting business and the tax business of Lubets & Lubets, andWhereas under said dissolution agreement the accounting business was transferred to said Robert Lubets, andWhereas under said dissolution agreement certain rights, privileges, advantages, monies and profits in the tax business were reserved to said Robert Lubets.Now Therefore. In Consideration of the natural love and affection which said Robert Lubets bears for his said wife, Lillian Lubets, and with the full intention67 of transferring by way of gift every right, privilege, advantage and 958 all money and profits reserved to said Robert Lubets in the tax business under said dissolution agreement, said Robert Lubets hereby Gives, Grants, Conveys and Assigns unto said Lillian Lubets, her heirs and assigns forever, free from any control of any kind on the part of said Robert Lubets To Have and To Hold the same for her sole use and benefit, all the Right, Title, Interest and Equity of said Robert Lubets reserved under the terms of said dissolution agreement pertaining to the tax business, all as shown by the books of Lubets & Lubets relating to the Tax Department on and as of the date of these presents consisting principally of cash and accounts receivable and including all monies on hand or in the bank account of said Lubets & Lubets tax account and which is presently due to said Robert Lubets or which may become due at any time during the liquidation process under said dissolution agreement.The tax business referred to in the dissolution agreement and in the deed of gift consisted of accounts receivable, cash on deposit, files, books of account, records, good will, and the contingent interest68 in applications for abatement then pending before various boards of assessors and appeals then pending before the appellate tax board, belonging to owners who had entered into contingent contracts with Lubets & Lubets to pay them for the securing of reductions in the assessed value of their real estate, either as the result of settlements reached with the assessors, or by decision reached by the appellate tax board. Many of the tax cases that were undisposed of on April 1, 1941, had been pending for several years.In order to secure reductions in applications for abatement and appeals, some or all of the following steps would be taken: a. Examination of properties and locations.b. Analysis of neighborhood trends.c. Analysis of sales and rentals in the neighborhood of the property.d. Preparation of preliminary appraisals.e. Ascertaining fair value of property through the employment of expert appraisers.f. Assisting attorneys employed by the taxpayers by furnishing to them statistical information relative to sales, rentals, reproduction cost, depreciation, and obsolescence for the proper presentation of the application for abatement in conferences with the assessors, and 69 for the presentation of evidence on the appeals when heard by the appellate tax board.At the time of the deed of gift on April 30, 1941, only about 2 percent of the pending cases had had any of the steps taken which are outlined in the preceding paragraph. No such work had yet been done on about 98 percent of the pending cases.The accounts receivable included in the deed of gift consisted of amounts billed by Lubets & Lubets to the taxpayers prior to May 1, 1941. During the year 1941 Lillian Lubets received $ 5,671.13 as her share from the collection of accounts receivable outstanding on May 1, 1941. 1959 Petitioner's wife, Lillian Lubets, performed no 70 services for the partnership prior to or subsequent to the dissolution agreement of April 1, 1941.On May 1, 1941, there were pending in the appellate tax board various appeals which had previously been entered by the respective taxpayers. Some work had been performed by Lubets & Lubets prior to this date on all of said pending cases of which there were approximately 100 to 125 different taxpayers. Some of the pending cases involving one taxpayer involved more than one tax year. Petitioner personally had performed services prior to May 1, 1941, on some of the contingent cases which later became accounts receivable.On March 15, 1942, petitioner filed a gift tax return reporting therein a gift to his wife of $ 4,529.48 cash and accounts receivable in the amount of $ 11,000. At the same time Lillian Lubets filed a donee tax return.On his individual income tax return for the taxable year 1941 petitioner reported, among other things, income from salaries and other compensation for personal services of $ 300, and income from the partnership of Lubets & Lubets of $ 14,061.23. The latter amount was for the period from January 1 to April 30, 1941.Lubets & Lubets in March 1942 filed 71 on Form 1065 a partnership return of income, signed and prepared only by petitioner, for the period beginning January 1 and ending April 30, 1941, wherein there was reported an ordinary net income of $ 28,422.46, which was distributed among the partners in schedule J of the return as follows:Robert Lubets, Brookline$ 14,061.23Moses Lubets, Salem14,361.23Total28,422.46In March 1942 petitioner also prepared on Form 1065 a partnership return of income for "Moses and Lillian Lubets, Liquidation Trustees for Lubets & Lubets," for the period beginning May 1 and ending December 31, 1941, which return was signed by Lillian Lubets and wherein there was reported an ordinary net income of $ 38,729.81, 2 which was distributed in schedule J of the return as follows:Moses Lubets, Salem$ 19,964.91Lillian Lubets, Brookline18,764.90Total38,729.8172 In March 1942 petitioner also prepared on Form 1040 an individual income tax return for Lillian Lubets for the calendar year 1941, 960 which was signed by Lillian Lubets and wherein there was reported income from "Moses Lubets & Lillian Lubets, Liquidation Trustees for Lubets & Lubets," of $ 18,764.90. The only other items reported in this return were interest received of $ 32.17, contributions paid of $ 50, taxes paid of $ 10, and a claimed earned income credit of $ 1,400.The respondent determined that petitioner rather than his wife was taxable on the above mentioned distributive share of $ 18,764.90, which he increased to $ 19,064.90, which increase of $ 300 he explained in the statement attached to the deficiency notice as follows:The increase of $ 300.00 in the amount reported by Lillian Lubets and the amount allocated to you herein represents partner's salary of $ 300.00 received by you which was deducted as expense on line 14 of page 1 of the partnership return. In explanation (b) following an offsetting adjustment has been made for this item since you reported it separately on line 1 of page 1 of your return.Both petitioner and the firm of Lubets & Lubets were on73 a cash basis.Petitioner did not at any time receive any part of the above amount of $ 18,764.90. This was retained by Lillian Lubets and treated by her as her own property.As of April 30, 1941, the books of account and records of Lubets & Lubets were changed to reflect the transfer of capital account in the amount of $ 18,542.70 from Robert Lubets to Lillian Lubets. Between June 28 and December 19, 1941, Lillian Lubets withdrew from her capital account $ 13,385.50. On December 31, 1941, her capital account was credited with $ 18,524.22 of net profits and charged with additional drawings of $ 8,750, thus leaving a credit balance in her account on January 1, 1942, of $ 14,931.42.Prior to April 1 or May 1, 1941, petitioner was consulted with reference to employment of appraisers and in connection with offers of settlement. After May 1, 1941, petitioner had nothing to do with the employment of or selecting of appraisers, or passing upon them, or passing upon offers that might be received from assessors.From the time of the dissolution of the partnership of Lubets & Lubets until the fall of 1941, Moses Lubets maintained his own office as a tenant of petitioner and paid rent to 74 petitioner.The partnership of Lubets & Lubets was not terminated by the agreement of dissolution and was still in existence on December 31, 1941. During that time the partnership was in the process of winding up its affairs.The deed of gift made by petitioner to his wife on April 30, 1941, was not a completed valid gift of petitioner's interest in the partnership of Lubets & Lubets; but, so far as the deed of gift entitled petitioner's wife to receive petitioner's share of the partnership income during the winding up period, it was an assignment of income. The 961 portion of net income realized in 1941 in the winding up of the partnership of Lubets & Lubets which was reported by Lillian Lubets in her income tax return is taxable to petitioner.OPINION.The question at issue is whether petitioner or his wife is taxable on one-half of the net profits arising from the liquidation of the tax business of Lubets & Lubets for the period from April 30 to December 31, 1941. The other one-half belonged to Moses Lubets and is not here involved. The parties are in agreement as to the amount of the one-half of the net profits here in question, namely, $ 18,764.90. Of this amount petitioner75 concedes that $ 4,536.90 is taxable to him, which leaves in issue the amount of $ 14,228. Although the contested adjustment is in the amount of $ 19,064.90, the additional $ 300 over the $ 18,764.90 is not in reality at issue, as is indicated by the explanation contained in the statement attached to the deficiency notice which is set out in the findings.Petitioner, in contending that he is not taxable on the net profits of $ 14,228, argues that the deed of gift which he executed on April 30, 1941, was a valid gift of his entire interest in the winding up of the tax end of the partnership between himself and his brother; that the said gift completely terminated that partnership, which had been dissolved on April 1, 1941, but was still in the winding up stage; that thereafter the liquidation of the tax end of the original partnership of Lubets & Lubets was conducted as a new partnership between his wife and his brother; and that, therefore, one-half of the profits of the alleged new partnership were properly taxable to his wife.The respondent's position is that, although there was an agreement to dissolve the partnership dated April 1, 1941, the partnership was not terminated at 76 any time during 1941, and under sections 181 and 182 of the Internal Revenue Code3 petitioner's distributive share of the partnership income is taxable to him. The respondent further contends that the income of the partnership in dissolution was derived solely from personal services and that the alleged "Deed of Gift" was simply an anticipatory assignment of petitioner's income.We think that the respondent's determination must be sustained. Chapter 108A of the Annotated Laws of Massachusetts provides with 962 respect to the dissolution and winding up of partnerships, in part, 77 as follows:§ 29. Dissolution and Winding Up, Terms Distinguished. -- The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business.§ 30. Termination, When Effected. -- On dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed.Both petitioner and the respondent agree that the firm of Lubets & Lubets was dissolved by the dissolution agreement of the partners on April 1, 1941. They disagree as to when the partnership was terminated. As previously indicated, petitioner contends it was terminated by his execution of the deed of gift; whereas the respondent contends that the winding up of the affairs of the partnership of petitioner and his brother Moses continued on past the end of the taxable year 1941. We do not agree with petitioner that the partnership of Lubets & Lubets was terminated by his execution of the deed of gift. The affairs of the partnership had not yet been completely wound up. There were still approximately 125 tax cases to be disposed of, in which petitioner78 and his brother by their agreement retained "equal interests." This agreement between petitioner and his brother remained in full force and effect throughout the remainder of the taxable year in question. We do not think petitioner could terminate that agreement simply by making a gift of his interests therein to his wife. The gift, although effective as between the parties as an assignment of income, could not, in our opinion, effect a "winding up of partnership affairs." Both petitioner and his brother had definite rights and obligations under their agreement. It would seem that before petitioner could contend that there was a termination of the partnership on April 30, 1941, it would be necessary that he submit proof that Moses Lubets accepted Lillian Lubets in substitution for petitioner, particularly in view of the provisions in clause III of their agreement, to the effect that "All real estate tax matters * * * shall be liquidated by both Moses Lubets and Robert Lubets as liquidating trustees, the consent of both being required on any matter" and that "The failure of either liquidating trustee to give his prior consent or to object to any action taken by the other liquidating79 trustee in the course of such liquidation shall not be deemed to be a waiver of his right thereafter to object." Without such proof we can not find that Lillian Lubets and Moses Lubets formed a new partnership. One of the fundamental requirements of a partnership is consent of the parties, which is totally lacking in the instant proceeding. Furthermore, the evidence shows that Lillian Lubets performed no services whatever in connection with the winding up of the tax business in question and put in no capital of 963 her own except that which she received from petitioner and which petitioner under clause III E of the dissolution agreement was required to leave in the business while it was being wound up.We think the case of Burnet v. Leininger, 285 U.S. 136">285 U.S. 136, is similar in some respects to the instant case. In that case the taxpayer was a member of a partnership known as the Eagle Laundry Co. He assigned one-half of his partnership interest to his wife. The Supreme Court, after quoting sections of the Revenue Acts of 1918 and 1921 (which are substantially the same as those of the present code), stated:* * * Upon these findings * * * it 80 cannot be maintained that the agreement between the respondent and his wife made her a member of the partnership. That result could not be achieved without the consent of the other partner or partners, and there is no finding of such consent. The mere communication of the fact that the agreement had been made was not enough. * * His wife took no part in the management of the business and made no contribution to its capital. * * * Upon the facts as found, the agreement with Mrs. Leininger cannot be taken to have amounted to more than an equitable assignment of one-half of what her husband should receive from the partnership. * * Petitioner contends that the Leininger case is distinguishable from the instant proceeding for several reasons. His first reason is "that there is no evidence that Moses Lubets did not consent to the substitution of Lillian Lubets in place of Robert Lubets." Neither is there any evidence that he did so consent. His second reason is "that the evidence clearly shows that Robert Lubets exercised no further control over the business and took no further part in the management thereof." Under the dissolution agreement petitioner had certain rights and81 obligations which were not erased by executing the deed of gift. Although petitioner may have taken no active part in the winding up of the tax business of the partnership, nevertheless, he continued to have certain rights and obligations in connection therewith which would not relieve him from reporting the share of the profits due him under the agreement. Petitioner's remaining reasons for distinguishing the Leininger case from the instant case are:* * * that the capital account was transferred on the books of the partnership to Lillian Lubets; that Lillian Lubets exercised complete control over this account; that Robert Lubets received none of the income in question; that the capital account of Robert Lubets was closed out. It is further submitted that the drawings by Lillian Lubets set forth on Page 8 of this Brief clearly establishes knowledge and consent of Moses Lubets to the acceptance of Lillian Lubets as his partner.We do not regard these distinctions as controlling in view of the specific agreement between petitioner and his brother as to how the tax business of the partnership was to be wound up.Petitioner's briefs contain considerable argument in an attempt 82 to bring the instant case within the rule of Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, 964 and other similar cases holding that, if the gift is of income-producing property, then the income from such property is taxable to the donee. In Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, the Supreme Court concluded as follows:* * * we leave it to future judicial decisions to determine precisely where the line shall be drawn between gifts of income-producing property and gifts of income from property of which the donor remains the owner, for all substantial and practical purposes. Cf. Helvering v. Clifford, supra.In the instant proceeding the principal subject matter of the gift was petitioner's interest in the outcome of the tax cases that were pending at the time of the dissolution agreement and were still pending on April 30, 1941, the date of the deed of gift. These cases were all taken on a contingent fee basis. Only if the partnership was successful in getting the tax assessment reduced would there be a fee. Petitioner had a one-half interest in such fee after all expenses were paid. Under the dissolution agreement83 with his brother, petitioner had certain rights and obligations, and for his services he was to be paid a weekly salary of $ 25 and his expenses. Under such circumstances we think the gift which petitioner made to his wife was one of "income from property of which the donor remains the owner, for all substantial and practical purposes." Harrison v. Schaffner, supra.We sustain the respondent's determination. Burnet v. Leininger, supra.Cf. Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122; and Richard S. Doyle, 3 T. C. 1092; affd., 147 Fed. (2d) 769.Decision will be entered for the respondent. Footnotes1. Petitioner concedes that the said amount of $ 5,671.13, less 20 percent for expenses reasonably attributable to the realization of these accounts receivable, should properly be added to his gross income for the taxable year in question. $ 5,671.13 minus $ 1,134.23 (20 percent of $ 5,671.13) equals the $ 4,536.90 referred to in our opening statement.↩2. This net income of $ 38,729.81 is the result of a reported gross income of $ 49,467 less deductions of $ 10,737.19. The $ 5,671.13 mentioned above and in footnote 1 is included in the amount of $ 49,467. The deductions reported of $ 10,737.19 represent approximately 20 percent of the gross income of $ 49,467.↩3. SEC. 181. PARTNERSHIP NOT TAXABLE.Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.SEC. 182. TAX OF PARTNERS.In computing the net income of each partner, he shall include, whether or not distribution is made to him -- * * *(c) His distributive share of the ordinary net income or the ordinary net loss of the partnership, computed as provided in section 183 (b).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474935/	Thornton and Holmes, JJ., dissenting: We agree with our colleagues that Chevron is the test we have to apply but respectfully disagree with their conclusion that the 2-year limitations period in section 1.6015-5(b)(l), Income Tax Regs., is invalid under either Chevron step 1 or step 2. I. Chevron: Step 1 Chevron’s step 1 asks “whether Congress has directly spoken to the precise question at issue.” Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842 (1984). The majority hears “audible silence” in the absence from section 6015(f) of the expressly stated 2-year deadlines of subsections (b) and (c). Majority op. p. 139. From this it concludes that Congress has foreclosed a 2-year, and possibly any, deadline for subsection (f) relief. The majority likewise hears a whisper from the provision of section 6015(f)(2) that the Secretary may grant equitable relief to a spouse under subsection (f) only “ ‘if * * * relief is not available to such individual under subsection (b) or (c)’”. See majority op. p. 139. From this it similarly reasons that subsection (f) relief must be broader than relief under subsection (b) or (c); and since subsection (b) and (c) relief requires meeting a 2-year deadline, making subsection (f) relief broader requires that requests for subsection (f) relief not be subject to the same deadline. Majority op. p. 139. (The majority does later admit, though, that “the timing of the request for relief is not the only possible element by which subsection (f) relief would be broader than that of subsection (b) or (c).” Majority op. p. 139.) We agree with the majority that the precise question in this case is whether the Secretary can impose a 2-year limit on requests for relief under section 6015(f). And we agree that the answer to this question depends on a close reading of the Code. But we disagree that the express time limits of subsections (b) and (c) denote or even imply that there can be no time limits in subsection (f), for congressional silence may simply be ambiguous. See Crosby v. Natl. Foreign Trade Council, 530 U.S. 363, 388 (2000) (“The State’s inference of congressional intent is unwarranted here, therefore, simply because the silence of Congress is ambiguous.”); Burns v. United States, 501 U.S. 129, 136 (1991) (“An inference drawn from congressional silence certainly cannot be credited when it is contrary to all other textual and contextual evidence of congressional intent.”). Subsection (f) differs markedly from subsections (b) and (c) in giving the Secretary discretion to grant relief where there is an underpayment of tax; i.e., where the joint return shows tax due that is not paid with the return. When added to the Code in 1998, section 6015(f) was new and important and affected a lot of cases, since innocent spouse relief before section 6015(f) was limited to understatements', i.e., where the joint return shows less tax due than is owed. See Butler v. Commissioner, 114 T.C. 276, 283 (2000).1 We think this suggests that it is the Secretary’s discretion, and not the dilatory applicant’s ability to request relief, that subsection (f) makes broad. Consistent with this view, subsections (b) and (c) are mandatory subsections — if a taxpayer meets their requirements, the Secretary has to grant relief. Section 6015(f), in contrast, is a permissive section — if a taxpayer follows the prescribed procedures, the Secretary “may relieve such individual of such liability.” This distinction is important in understanding the majority’s discussion, majority op. pp. 145-147, of the Bureau of Prisons cases. It relies on the Second, Third, Eighth, and Tenth Circuits’ invalidation of 28 C.F.R. secs. 570.20 and 570.21 — regulations that categorically denied some prisoners the chance to serve their entire sentences in halfway houses.2 The problem these cases identified was 18 U.S.C. sec. 3621(b), which gave the bop discretion over where to house inmates but required the agency to consider at least five listed factors. All these Circuit Courts concluded that the BOP regulations categorically removed the agency’s ability to consider these five listed factors for at least some individual prisoners. That meant the challenged regulations stumbled on Chevron step 1. But where is the similar mandatory consideration of any factor in the section of the Code we are looking at? Section 6015(f) does not provide that “if, taking into account all the facts and circumstances, * * * the Secretary shall relieve such individual of such liability;” it provides that “if * * * taking into account all the facts and circumstances, * * * the Secretary may relieve such individual of such liability.” (Emphasis added.) The distinction is an important one. And it is the distinction at the heart of the Supreme Court’s decision in Lopez v. Davis, 531 U.S. 230 (2001) — the decision that, though mentioned briefly in the opinion, majority op. p. 146 — is much more similar to our case than the halfway-house cases on which the majority relies. Lopez involved a different statute, 18 U.S.C. sec. 3621(e)(2)(B), providing that the prison time for an inmate convicted of a nonviolent crime “may be reduced by the Bureau of Prisons”. The BOP issued a regulation that categorically excluded prisoners who had possessed a firearm in connection with their crime; and an affected prisoner sued to invalidate the regulation, arguing that the statutory definition of a class of eligible inmates necessarily invalidated additional exclusions by regulation — he wanted case-by-case consideration. Lopez v. Davis, supra at 239. The Court rejected his argument. In the absence of express statutory language “the agency may exclude inmates either categorically or on a case-by-case basis, subject of course to its obligation to interpret the statute reasonably.” Id. at 240. The Court held that “Even if a statutory scheme requires individualized determinations,” which this scheme does not, “the decisionmaker has the authority to rely on rule-making to resolve certain issues of general applicability unless Congress clearly expresses an intent to withhold that authority.” * * * [Id. at 243-244 (quoting Am. Hosp. Association v. NLRB, 499 U.S. 606, 612 (1991)).3] There is no withholding of such authority here — in contrast to the specific factors Congress told the Secretary to consider in deciding applications for relief under section 6015(b) and (c), it left relief under section 6015(f) to his discretion. It chose to use “may” in section 6015(f) to grant wider discretion to the Secretary than it did in choosing “shall” in section 6015(b) and (c). Read sensibly, section 6015(f) gives the Secretary the authority, but not the duty, to grant relief unavailable under section 6015(b) and (c). And read in the context of delegations of authority to administrative agencies more generally, the statute gives the Secretary authority to issue rules and procedures instead of making case-by-case decisions as to the timeliness of requests for relief. The majority also reads the statutory command to consider “all the facts and circumstances” (emphasis added) as forcing us to toss out the 2-year time limit, because such a strict deadline makes the time that it takes a spouse to request relief into a single, decisive fact or circumstance. Yet section 6015(f), in a passage quoted but unconstrued by the majority, creates discretionary authority to provide equitable relief “Under procedures prescribed by the Secretary”. The question that the majority should have asked is whether setting a deadline is a “procedure” — if it is, then we have no business holding that the Secretary could not set one. The first clue that the 2-year limit is a procedural requirement, and not just another one of the facts to be weighed in each case, is section 6015(b)(1)(D). In that section, the Secretary is also told to take “into account all the facts and circumstances” in deciding whether it is “inequitable” to hold the requesting spouse jointly liable for a particular tax debt. We have already held that the language of section 6015(f) does not significantly differ from this parallel language in section 6015(b). Alt v. Commissioner, 119 T.C. 306, 316 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004); Becherer v. Commissioner, T.C. Memo. 2004-282; Doyel v. Commissioner, T.C. Memo 2004-35. And the equitable factors we consider under section 6015(b) are the same equitable factors we consider under section 6015(f). Alt v. Commissioner, supra at 316. That same section 6015(b) imposes the 2-year deadline for electing relief. Sec. 6015(b)(1)(E). We think this allowed the Secretary to infer that deadlines for seeking relief are just part of the procedural rules a taxpayer seeking relief must follow. Read in this way, the language in section 6015(b)(1) and (f) giving the Secretary power to prescribe “procedures” is identical — except that the Secretary cannot set a deadline of other than 2 years for section 6015(b) relief. The silence on deadlines in section 6015(f), seen in this light, is what courts since Chevron have construed to be an implicit delegation to the agency involved to fill the gap with its own construction. Treating deadlines as procedural is the general rule in nontax administrative cases as well. The Seventh Circuit— the court to which this case may be appealed — has already held that rules setting deadlines for seeking discretionary relief from immigration orders are procedural: are the time limits valid and, if so, * * * is the rule procedural and within the Attorney General’s grant of authority? We conclude that it is. Section 1003.44(h) [the regulation setting the deadline] is similar to time limits imposed in the Federal Rules of Civil Procedure, Appellate Procedure, and even Criminal Procedure. And, in general, the formulation of procedures is left to the discretion of the agencies with responsibility for substantive judgments. Vermont Yankee Nuclear Power Corp. v. NRDC, 435 U.S. 519 * * * (1978). We grant deference to agency interpretations of the law it administers. Chevron U.S.A. Inc. v. NRDC, 467 U.S. 837 * * * (1984). * * * [Johnson v. Gonzales, 478 F.3d 795, 799 (7th Cir. 2007).] See also, e.g., Foroglou v. Reno, 241 F.3d 111, 113 (1st Cir. 2001). We finally note that the majority seems not to notice that the revenue procedure that currently guides the Secretary in the exercise of his discretion has seven threshold conditions — only one of which is the 2-year time limit — and a taxpayer who fails to meet any of them does not currently qualify for equitable relief. If we peek into the future to see where the majority’s reasoning might take us, we can’t help but conclude that at least some of these other threshold conditions4 will have to be invalidated as well. Rev. Proc. 2003-61, sec. 4.01(4), 2003-2 C.B. 296, 297, for example, denies equitable relief to any spouse who transferred assets as “part of a fraudulent scheme”. This language matches section 6015(c)(3)(A)(ii) — and the majority’s reasoning would seem to bar the Secretary from stopping fraudsters at the threshold just as much as it would bar him from stopping the dilatory. For all these reasons, we would hold that Congress has not directly spoken to the precise question of whether the Secretary may impose a deadline for requesting equitable relief. This leaves a gap, and we would therefore climb up to the second step of Chevron: is the 2-year limit “based on a permissible construction of the statute”? Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. at 843. II. Chevron: Step 2 Step 2 of Chevron — whether the contested regulation is a permissible construction of the statute — rests fundamentally on the reasonableness of the choice made by the agency that issued the regulation. See, e.g., Bankers Life & Cas. Co. v. United States, 142 F.3d 973, 983 (7th Cir. 1998). In the Seventh Circuit, this step is also where a court will look to a provision’s legislative history. See id. (we “lean toward reserving consideration of legislative history and other appropriate factors until the second Chevron step * * . In the second step, the court determines whether the regulation harmonizes with the language, origins, and purpose of the statute”); see also Square D Co. & Subs. v. Commissioner, 438 F.3d 739, 745 (7th Cir. 2006), affg. 118 T.C. 299 (2002).5 The legislative history is quite plain on this point, suggesting that what Congress wanted was primarily to extend relief to spouses with underpayments. The original House-passed version of the expanded relief provisions now found in section 6015(b) included no relief for underpayments. See H. Conf. Rept. 105-599, at 249-250 (1998), 1998-3 C.B. 747, 1003-1004. A Senate amendment would have provided limited relief in underpayment situations by making the separate liability election (now in section 6015(c)) applicable to underpayments. Id. at 250, 1998-3 C.B. at 1004. The conference committee omitted this aspect of the Senate amendment and instead gave the Secretary broad authority in subsection (f) to address such situations. The conference report explained: The conference agreement does not include the portion of the Senate amendment that could provide relief in situations where tax was shown on a joint return, but not paid with the return. The conferees intend that the Secretary will consider using the grant of authority to provide equitable relief in appropriate situations to avoid the inequitable treatment of spouses in such situations. * * [Id. at 254, 1998-3 C.B. at 1008.] Although the conference report also indicated that this equitable relief was not to be limited to underpayment situations, the only other specific example involved a “spouse that does not know, and had no reason to know, that funds intended for the payment of tax were instead taken by the other spouse for such other spouse’s benefit.” Id. We find nothing in this legislative history suggesting that Congress wanted the Secretary to use his new discretion under subsection (f) to give relief to those who missed the statutory deadlines for relief under subsections (b) and (c). An ounce of history is worth more than a pound of logic on this question, especially since the majority opinion does not even suggest that — quite apart from any legislative history— the 2-year regulatory deadline for requesting relief under subsection (f) is inherently unreasonable. Indeed, it cites with apparent approval an identical 2-year regulatory deadline that applies to comparable requests for equitable relief from joint and several liability under section 66(c) where a joint return is filed from a community property State.6 And it seems to just assume that a 2-year regulatory deadline under subsection (f) is unreasonable if it is the same as the statutory deadlines found in subsections (b) and (c). We do not share that assumption. Drawing a negative inference from subsection (f)’s lack of the 2-year deadlines found in subsections (b) and (c) falls apart if applied to requests for relief from underpayments, for which there is no statutory deadline but only a delegation of authority to the Secretary. Holding that the Secretary cannot exercise his discretion to set a common deadline isn’t a reasonable inference; it’s the usurpation of the authority that Congress delegated to the Secretary, not us. We would hold that the Secretary acted eminently reasonably in exercising his procedure-making authority by prescribing a deadline under subsection (f) that is comparable to the statutory deadlines under subsections (b) and (c) and identical to the regulatory deadline for equitable relief under section 66(c). Indeed, considerations of admin-istrability strongly support consistent deadlines under these various provisions. Spouses filing requests for relief under either section 6015 or section 66(c) use the same Form 8857, Request for Innocent Spouse Relief. See Rev. Proc. 2003-61, sec. 5, 2003-2 C.B. at 299. Many if not most spouses requesting relief may be unsophisticated in the tax laws and may not fully appreciate which of the various provisions of section 6015 or section 66(c) might be most likely to benefit them. We doubt that most applicants seeking relief carefully parse the different categories for which they might qualify; more likely, they simply plead for whatever relief might be available. In recognition of this reality, the Secretary’s Form 8857 elicits information pertinent to all forms of relief under sections 6015 and 66(c) but does not require the requesting spouse to specify under which section or subsection relief is sought. Similarly, the regulations provide that a single claim for relief will suffice for considering relief under section 6015 (b), (c), and (f). Sec. 1.6015-l(a)(2), Income Tax Regs. Having comparable deadlines for the various types of relief facilitates this sensible administrative practice. The majority would confound this practice in bizarre ways and place undue pressure upon the manner in which the request for relief might be drawn up or characterized. For instance, the Court is today invalidating the regulatory deadline for equitable relief under subsection (f) but approving an identical regulatory deadline for equitable relief under section 66(c). The Court is also holding that a request for relief deemed to arise under subsection (b) or (c) remains subject to their 2-year statutory deadlines but may be considered under subsection (f) even if it misses those deadlines, with the untimeliness apparently to be taken into account as part of a facts-and-circumstances analysis. By contrast, a request for relief deemed to arise under subsection (f) — for example, a request involving an underpayment, which cannot arise under subsection (b) or (c)— apparently would be subject to no deadline because the majority has invalidated the regulatory 2-year deadline under subsection (f). Although the majority states that “a taxpayer’s delay in applying for relief under section 6015(f) is a factor to be considered in applying the ‘all the facts and circumstances’ test of section 6015(f)”, it declines to answer the obvious followup question of “whether any temporal limitation would be appropriate”. Majority op. p. 148. Consequently, in the absence of any “temporal limitation”, it is not apparent how “delay” in applying for subsection (f) relief should be identified or measured. It would have been better to leave the regulation alone rather than create a tangle that will now take so much time to unravel. We respectfully dissent. Halpern and Morrison, JJ., agree with this dissenting opinion. We discuss Congress’s intent in adding sec. 6015(f) in greater detail in our analysis of Chevron step 2, infra p. 157. See Wedelstedt v. Wiley, 477 F.3d 1160 (10th Cir. 2007); Levine v. Apker, 455 F.3d 71 (2d Cir. 2006); Fulls v. Sanders, 442 F.3d 1088 (8th Cir. 2006); Woodall v. Fed. Bureau of Prisons, 432 F.3d 235 (3d Cir. 2005). Am. Hosp. Association v. NLRB, 499 U.S. 606, 612 (1991), decided whether the NLRB’s obligation to decide the appropriate size of the collective bargaining unit “in each case”, 29 U.S.C. sec. 159(b), meant that it had to exercise “standardless discretion in each case.” The answer was “no”, because “[T]he principal instruments for regularizing the system of deciding ‘in each case’ are classifications, rules, principles, and precedents. Sensible men could not refuse to use such instruments and a sensible Congress would not expect them to.” * * * [Id. (quoting Davis, Administrative Law Text, sec. 6.04, at 145 (3d ed. 1972)).] We say “some” because the list, Rev. Proc. 2003-61, sec. 4.01, 2003-2 C.B. 296, 297, includes some conditions that the Code itself requires, e.g., that the requesting spouse have filed a joint return and not be eligible for relief under sec. 6015(b) or (c). Whether to consider legislative history at step 1 or step 2 is a matter of some controversy. See Coke v. Long Island Care at Home, Ltd., 376 F.3d 118, 127 n.3 (2d Cir. 2004) (collecting cases); see also Tax Analysts v. IRS, 350 F.3d 100, 103-104 (D.C. Cir. 2003); Hosp. Corp. of Am. & Subs. v. Commissioner, 348 F.3d 136, 144 (6th Cir. 2003), affg. 107 T.C. 73 (1996) and 107 T.C. 116 (1996). We put it here because the Seventh Circuit will be reviewing our decision in this case. The majority seeks to make much of differing deadlines provided in the sec. 66(c) regulations for so-called traditional relief, for which the statute has made provision since 1984, and for “equitable relief”, which Congress authorized in 1998 in the same legislation containing the sec. 6015 relief provisions. Seeming to hold out the sec. 66(c) regulations as a model of sorts, the majority asserts that these regulations provide a deadline for equitable relief that is “four times as long as the 6-month deadline available for traditional relief under section 66(c).” Majority op. p. 143. The majority falls into error, however, by misconstruing what it simplistically mischaracterizes as a “6-month deadline” for requesting traditional relief under sec. 66(c). The actual deadline for traditional relief under the sec. 66(c) regulations is: 6 months before the expiration of the period of limitations on assessment, including extensions, against the nonrequesting spouse for the taxable year that is the subject of the request for relief, unless the examination of the requesting spouse’s return commences during that 6-month period. If the examination of the requesting spouse’s return commences during that 6-month period, the latest time for requesting relief * * * is 30 days after the commencement of the examination. [Sec. 1.66 — 4(j)(2)(i), Income Tax Regs.] By contrast, the equitable relief deadline under sec. 66(c) is the same as the equitable relief deadline under sec. 6015(f); i.e., 2 years after the first collection activity. It is not accurate to say that the equitable relief deadline is four times longer than the sec. 66(c) traditional relief deadline or, for that matter, that they correlate according to any mathematical ratio. Indeed, the traditional relief deadline would seem no more likely to fall on a date that is (as the majority suggests) exactly 18 months before the equitable relief deadline than it would be to fall on a date that is after the equitable relief deadline. In any event, we do not understand the majority to suggest, nor do we understand how it plausibly could be maintained, that the Secretary’s prescribing a 2-year deadline for requesting equitable relief under sec. 66(c) made it unreasonable for the Secretary to prescribe the same 2-year deadline for comparable requests for equitable relief arising under sec. 6015(f).	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621480/	Brush Wellman, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentBrush Wellman, Inc. v. CommissionerDocket No. 12978-78United States Tax Court79 T.C. 160; 1982 U.S. Tax Ct. LEXIS 59; 79 T.C. No. 11; July 28, 1982, Filed 59 Decision will be entered under Rule 155. Held: Petitioner's practical capacity determinations, which reflected productive capability instead of reflecting average actual production or anticipated sales, satisfy the requirements of the practical capacity regulation, sec. 1.471-11(d)(4), Income Tax Regs. Accordingly, petitioner is entitled under the regulation to deduct the part of fixed indirect production costs which is associated with idle capacity in the year of production rather than waiting to deduct it in the year in which the produced goods are sold. Charles J. Kerester and Wallace M. Wright, for the petitioner.Thomas J. Stalzer, for the respondent. Nims, Judge. NIMS161 Respondent determined a $ 651,156 deficiency in petitioner's income tax for the tax year 1972. Petitioner claims an overpayment of 1972 income tax in the amount of $ 4,032.60 Due to concessions by the petitioner, the only issue remaining for decision is whether petitioner's use of the practical capacity concept in costing its goods for 1975 conformed with the requirements of section 1.471-11(d)(4), Income Tax Regs. Resolution of this issue determines if petitioner incurred a net operating loss in 1975 and is entitled to a carryback deduction for the year 1972.FINDINGS OF FACTSome of the facts of this case are stipulated. The stipulation and attached exhibits are incorporated herein by reference.Petitioner, an Ohio corporation, maintained its principal office in Cleveland, Ohio, when it filed the61 petition in this case.Petitioner, at all relevant times, was an accrual basis taxpayer.Petitioner is a fully integrated miner-manufacturer of products containing beryllium. From its founding in 1931, petitioner has been an engineering and manufacturing company which developed new materials, new processes, and new commercial applications for beryllium and its alloys. During the 1960's and 1970's, petitioner's products fell into three distinct groups: beryllium metal; beryllium alloys; and beryllium oxides. Each product group utilized separate manufacturing processes and served different markets. Metallic beryllium products primarily served U.S. defense projects. Beryllium alloy and oxide products primarily served private commercial customers.Petitioner had a large investment in facilities because it was a fully integrated producer in a capital intensive industry. Petitioner's financial and cost accounting system utilized 28 cost centers, each of which reflected major production departments. 162 Petitioner operated a mine and ore extraction facility in Utah to supply ore concentrate to the three product lines. Petitioner designated the Utah facility as "cost center 62 8000." Prior to 1977, petitioner also operated an ore extraction facility in Elmore, Ohio. This facility, designated "cost center 6111," was designed to process imported ore.Petitioner's manufacturing operations were located in Elmore, Ohio. The cost centers associated with the metallic beryllium product line were:Cost centerProduction department6114Pebbles6121Vacuum castings6123Attrition6124Fine powder6162Hot press6165Machining6166Sheet6167-9Inspection and X-ray6168 Cold pressThe cost centers associated with the beryllium alloys product line were:Cost centerProduction department7200Reduction furnace7210Melting and casting7212Sand casting7213Billet preparation7221Rodmill7222Coil buildup7224Slab milling72254-Hi rolling7226Strand pickle7227Roller hearth7228Breakdown rolling7229General mill7230-1Inspection7270Extrusion74XXReading alloyThe cost centers associated with the beryllium oxide product line were: 163 Cost centerProduction department6113Oxide 613XCeramicsPeriodic booms and busts characterized the demand for petitioner's products. These market forces affected petitioner's63 level of production. Petitioner's facilities were designed specially for beryllium products. Thus, it could not manufacture alternative products when demand for beryllium decreased. Therefore, petitioner produced less in times of slack demand than in times of high demand. Also, the fully integrated nature of petitioner's operation meant that decreases in demand for a product resulted in less utilization of petitioner's facilities at each stage of the production line, from mining through manufacturing.Petitioner used the standard cost method for allocating inventoriable costs for financial and tax accounting. As part of its cost accounting system, petitioner used a concept, which it termed "practical capacity," to allocate fixed indirect costs between inventoriable costs and period costs to account for unused capacity. Under its approach, petitioner, prior to a production year, determined a production level for each cost center. This level was the production department's "practical capacity." If production for the year was less than the practical capacity level, then petitioner immediately deducted the proportionate amount of costs allocable to unused capacity. For example, 64 if a cost center had a practical capacity of 100 units per year; the fixed indirect cost of the cost center was $ 100 per year; and the actual production level for the year was 85 units, then $ 85 would be allocated to inventoriable costs to be deducted in the year the goods were sold, and the $ 15 allocable to unused capacity would be deducted in the year of production.Petitioner carefully set the practical capacity level for each cost center. First, based on engineering studies, petitioner determined the theoretical capacity for the cost center: the level of production which could be attained if the department operated continuously at peak efficiency. Second, petitioner determined the downtime realistically expected due to normal work stoppages arising from the production process, itself, such as machine breakdown. Thus, petitioner reduced theoretical capacity to the maximum production level which, practically 164 speaking, the cost center alone could be expected to maintain.Third, petitioner determined the constraints imposed on a cost center's capacity to produce due to production bottlenecks upstream or downstream in the production process. This step was important65 because of the fully integrated nature of petitioner's operation. The key working material for each cost center came from another of petitioner's production departments. Thus, if cost center X practically could produce 150 units per year if it received 150 units of working material per year, then cost center X's capacity would be less than 150 units per year if it received only 110 units of working material from its feeder department, petitioner's cost center Y. Therefore, petitioner reduced the production level determined in the second step to the maximum production level which, practically speaking, the cost center, when considered as part of an integrated process, could be expected to maintain.These three steps described the process through which petitioner determined the practical capacity of a production department which just came on line or which just experienced an investment or disinvestment which affected its physical capacity to produce. Petitioner also reexamined the practical capacity levels each year to determine if experience proved that the prior estimate of the cost center's practical physical ability to produce was too high or too low. Adjustments were made 66 as necessary to incorporate the results of practical experience.In short, petitioner's practical capacity determination involved an analysis of all factors relevant to estimating its ability to produce. Petitioner did not incorporate market demand in this analysis. Petitioner's practical capacity determination, therefore, reflected its estimated capacity to produce goods rather than its anticipated ability to sell goods.Petitioner's practical capacity determinations for each of its 28 cost centers obviously was a complex undertaking. After a careful review of the record, we find that petitioner in fact applied the process just described in setting its practical capacity levels for each department for 1975.We note that certain production departments were designed to operate 24 hours a day, 7 days a week. For example, cost center 6114, the production department termed "Pebbles," 165 converted beryllium hydroxide into a crude metallic form of beryllium. The process involved the production of beryllium fluoride and the reduction thereof with magnesium. The process is corrosive. It is performed in furnaces which operate at high temperatures. The furnaces require a 4-hour67 heat-up and a 4-hour cool-down period. Therefore, continuous operation is the most efficient mode of operation. Also, some of the upstream processing departments are the bottlenecks in petitioner's integrated production lines. Some of these upstream departments must be operated on a 24-hour day, 7-day week basis to provide adequate material for the downstream departments to operate efficiently. As a result of these factors, petitioner's practical capacity calculation for some departments was based on an assumption of continuous operation.Other departments, however, were designed to operate on a one or two shifts per day basis. These departments generally were the downstream fabrication departments. Accordingly, petitioner's practical capacity determination for these cost centers was based on an assumption of noncontinuous operation. In general, therefore, petitioner's designation of practical capacity levels represented its best estimate of each department's capacity to produce based on a balanced, system-wide analysis.Petitioner started using its practical capacity method in 1964 following disputes with the General Accounting Office concerning petitioner's pricing under 68 certain Government contracts. These disputes were resolved against petitioner because of petitioner's inability to justify its position. The practical capacity method was installed to accurately determine the cost of idle or excess capacity. Petitioner's method has been used consistently since 1964 for both financial and tax accounting.The issue in this case concerns petitioner's 1975 determinations of practical capacity. The 1975 practical capacity levels and the 1975 actual production levels for each cost center were as shown in table 1 on page 166.These figures indicate that petitioner's 1975 production levels were significantly less than its capacity to produce in that year. 1975 was a bad year for petitioner. Sales of petitioner's beryllium products slumped more than 40 percent that year to $ 28,910,334 from $ 50,408,783 in 1974 and 166 TABLE 119751975UnitsPracticalActualCost centerof measurecapacityproductionExtraction departments8000Lbs. Be 1305,000138,9836111Lbs. Be400,000146,465Metal departments6114Lbs. Be235,00061,6806121Lbs. Be500,00062,5816123Lbs. Be450,00057,5046124Lbs. Be30,00010,0326162Furnace hrs.25,0006,7546165Labor hrs.60,00033,9066166Labor hrs.10,0002,7876167-9Labor hrs.16,0008,5436168Labor hrs.12,0005,721Alloy departments7200Labor hrs.22,0005,1527210Furnace hrs.12,0004,1927212Labor hrs.5,9006,1087213Labor hrs.10,0006,1677221Labor hrs.15,0008,5137222Labor hrs.3,4001,3237224Labor hrs.3,8009387225Labor hrs.4,0001,1567226Labor hrs.3,0001,3117227Labor hrs.12,0003,2127228Labor hrs.4,0001,3687229Labor hrs.10,0005,2367230-1Labor hrs.15,00011,5737270Machine hrs.1,30068774XXLabor hrs.100,00040,945Oxide departments6113Lbs. Be25,00010,458613XLabor hrs.69,00048,06869 167 $ 51,366,191 in 1973. Demand was down for all three product lines.The metals departments, which were associated with defense contracts, experienced a boom during the 1960's when petitioner made parts for the C-5A aircraft and inertial guidance systems for various missile systems, among other projects. In order to meet this demand, and in expectation of continued high demand, petitioner made substantial investments to expand its capacity to produce. For example, in 1967, petitioner developed a process and built the Utah extraction facility to ensure a domestic supply of beryllium. Previously, all beryllium ore had been imported.The defense-related business peaked in the late 1960's and early 1970's. Petitioner's beryllium metal sales exceeded $ 20 million in 1971. Subsequently, anticipated contract renewals and new projects did not occur. Some contracts were canceled. Consequently, a precipitous decline in beryllium metal sales occurred, approximately as follows:YearSales volume1972$ 18 million197313 million19747 to 8 million19755 to 6 millionDue to this drop in metal sales, petitioner's70 metal departments were significantly underutilized during the mid-1970's. Demand for beryllium metal products increased in the late 1970's. But sales of beryllium metal products did not exceed the 1971 dollar level until 1980. Sales measured in units of beryllium metal did not exceed the 1971 level even in 1980.Despite the decline in the beryllium metal business, petitioner maintained a reasonable aggregate level of sales in 1973-74 because of the strength of its alloys and oxides business. The alloy and oxide products served the private, commercial market. By 1975, however, the economic recession following the Arab oil embargo hurt demand for petitioner's alloy and oxide products.As demand for petitioner's products decreased, petitioner attempted to reduce its inventories. The absence of sales and the inventory reduction process affected petitioner's employment and production levels and, thus, its utilization of facilities. Petitioner initiated a layoff program and reduced its 168 production schedules in 1975. Petitioner furloughed employees by having people work 2 or 3 weeks and then taking a week off. These layoffs affected employees with as much as 10-years seniority. 71 Petitioner's technique for reducing plant utilization depended on the type of production process involved. Departments designed to operate continuously were shut down for extended periods. When reopened, these departments operated continuously again until the next shutdown. Shutdowns were extended several weeks in some cases.For departments not designed for continuous operation, petitioner utilized a "campaign" operation. Under this approach, petitioner used crews, which had been reduced in size by furloughs, to operate only one part of a production process until it could no longer stockpile the output. Then, the crew moved to the next production step to process the output in a similar manner. In this way, some parts of the production process were used while other stages were idle.Petitioner's practical capacity determinations and actual production levels for the years 1968-75 were as shown in table 2 on pages 170-173.Petitioner deducted $ 16,502,939 in 1975 as the cost of goods sold. Included in this amount was a deduction of $ 8,600,983 for idle capacity which was associated with petitioner's practical capacity method. Respondent determined that $ 7,236,007 of this claimed72 deduction related to idle capacity and properly was deductible in 1975. But respondent disallowed a deduction for the $ 1,364,976 remainder "because it has not been established that any amount in excess of $ 7,236,007 represents a current business deduction within the meaning of Code sections 471 and 162."OPINIONThe question in this case concerns petitioner's use of its practical capacity method in determining the amount of the deduction to which it is entitled for idle capacity. Generally, all manufacturing costs are "inventoriable costs." That is, the costs of producing goods must be allocated to the goods produced during the year. The manufacturer gets a deduction for the costs of producing the goods only when the goods are sold. Sec. 1.471-11, Income Tax Regs. (the so-called "full 169 absorption" regulations). Section 1.471-11(d)(4), Income Tax Regs. (hereinafter referred to as the practical capacity regulation), however, provides an exception to the rule of full absorption for fixed indirect production costs. 1 This section provides:(4) Practical capacity concept -- (i) In general. Under the practical capacity concept, the percentage of practical capacity73 represented by actual production (not greater than 100 percent), as calculated under subdivision (ii) of this subparagraph, is used to determine the total amount of fixed indirect production costs which must be included in the taxpayer's computation of the amount of inventoriable costs. The portion of such costs to be included in the taxpayer's computation of the amount of inventoriable costs is then combined with variable indirect production costs and both are allocated to the goods in ending inventory in accordance with this paragraph. See the example in subdivision (ii)(d) of this subparagraph. The difference (if any) between the amount of all fixed indirect production costs and the fixed indirect production costs which are included in the computation of the amount of inventoriable costs under the practical capacity concept is allowable as a deduction for the taxable year in which such difference occurs.(ii) Calculation of practical capacity -- (a) In general. Practical capacity and theoretical capacity (as described in (c) of this subdivision) may be computed in terms of tons, pounds, yards, labor hours, machine hours, or any other unit of production appropriate74 to the cost accounting system used by a particular taxpayer. The determination of practical capacity and theoretical capacity should be modified from time to time to reflect a change in underlying facts and conditions such as increased output due to automation or other changes in plant operation. Such a change does not constitute a change in method of accounting under sections 446 and 481.(b) Based upon taxpayer's experience. In selecting an appropriate level of production activity upon which to base the calculation of practical capacity, the taxpayer shall establish the production operating conditions expected during the period for which the costs are being determined, assuming that the utilization of production facilities during operations will be approximately at capacity. This level of production activity is frequently described as practical capacity for the period and is ordinarily based upon the historical experience of the taxpayer. For example, a taxpayer operating on a 5-day, 8-hour basis may have a "normal" production of 100,000 units a year based upon three years of experience.(c) Based upon theoretical capacity. Practical capacity may also be established75 by the use of "theoretical" capacity, adjusted for allowances for estimated inability to achieve maximum production, such as machine breakdown, idle time, and other normal work stoppages. Theoretical 170 TABLE 2Units19681969Cost centerof measureP/C 1A/PP/CA/PExtraction departments8000Lbs. Be(2) 46,5306111Lbs. Be300,000432,823420,000355,203Metal departments6114Lbs. Be195,000212,667220,000200,6806121Lbs. Be290,000378,061385,000419,4256123Lbs. Be245,000346,813360,000374,6926124Lbs. Be12,6003,59712,60017,6006162Furnace hrs.27,50032,19532,50031,1156165Labor hrs.14,00023,10423,00024,1156166Labor hrs.12,0009,46812,0009,3926167-9Labor hrs.8,0007,2188,0007,6116168Labor hrs.8,0008848,000404Alloy departments7200Labor hrs.7210Furnace hrs.66,80074,92872,00071,4867212Labor hrs.7213Labor hrs.7221Labor hrs.7223Labor hrs.7222Labor hrs.7224Labor hrs.7225Labor hrs.7226Labor hrs.7227Labor hrs.55,50057,2217220Labor hrs.51,95055,7387228Labor hrs.7229Labor hrs.15,50013,5027230-1Labor hrs.6,4505,4659555197270Machine hrs.74XXLabor hrs.65,00062,10865,00069,898Oxide departments6113Lbs. Be15,00022,63923,00017,524613XLabor hrs.55,00074,04968,00056,48776 TABLE 2Units19701971Cost centerof measureP/CA/PP/CA/PExtraction departments8000Lbs. Be264,000260,657308,000305,6056111Lbs. Be400,000194,640400,000214,135Metal departments6114Lbs. Be220,000183,651220,000248,2036121Lbs. Be410,000447,580460,000655,6736123Lbs. Be360,000439,676450,000636,2686124Lbs. Be12,6004,91912,6002,1236162Furnace hrs.32,50035,39035,00043,1176165Labor hrs.23,00025,60824,70046,7066166Labor hrs.12,0003,21312,0002,8866167-9Labor hrs.8,0005,9988,0006,6676168Labor hrs.6,0001126,0002,405Alloy departments7200Labor hrs.23,20015,4557210Furnace hrs.72,00057,8619,5006,7397212Labor hrs.7213Labor hrs.10,8007,5247221Labor hrs.7223Labor hrs.7222Labor hrs.7224Labor hrs.7225Labor hrs.7226Labor hrs.7227Labor hrs.7220Labor hrs.55,50050,92155,50040,1807228Labor hrs.7229Labor hrs.7230-1Labor hrs.15,50010,84415,50013,5937270Machine hrs.95535694063774XXLabor hrs.68,96565,23280,00063,013Oxide departments6113Lbs. Be23,00020,50123,00020,560613XLabor hrs.68,00056,28068,00041,99077 172 TABLE 2Units19721973Cost centerof measureP/CA/PP/CA/PExtraction departments8000Lbs. Be305,000246,005305,000281,7396111Lbs. Be400,000178,035400,000284,666Metal departments6114Lbs. Be235,000165,191235,000193,0256121Lbs. Be575,000573,240575,000386,8276123Lbs. Be550,000553,473550,000356,7206124Lbs. Be5,00011,88018,00018,5526162Furnace hrs.37,50034,30637,50023,5786165Labor hrs.43,00030,64530,00025,5336166Labor hrs.12,0003,14810,0007,1216167-9Labor hrs.7,0005,1237,0005,6306168Labor hrs.12,0002,84112,0004,056Alloy departments7200Labor hrs.20,00025,35618,00022,3237210Furnace hrs.8,0009,7439,00012,8977212Labor hrs.7213Labor hrs.10,00011,22210,00015,2967221Labor hrs.12,90012,52512,90017,1957223Labor hrs.8,1008,2128,10010,5047222Labor hrs.3,4003,3313,4004,0807224Labor hrs.3,8003,6143,8003,9057225Labor hrs.2,8002,9412,8003,7247226Labor hrs.3,3003,4333,3004,4387227Labor hrs.9,20010,1219,20012,7797220Labor hrs.7228Labor hrs.7229Labor hrs.6,5006,4166,5007,7537230-1Labor hrs.15,00011,15015,00014,8427270Machine hrs.9409069401,36474XXLabor hrs.75,00077,02875,00092,324Oxide departments6113Lbs. Be23,00027,54123,00022,341613XLabor hrs.50,00049,82650,00071,55078 TABLE 2Units19741975Cost centerof measureP/CA/PP/CA/PExtraction departments8000Lbs. Be305,000251,836305,000138,9836111Lbs. Be400,000337,731400,000146,465Metal departments6114Lbs. Be235,000153,789235,00061,6806121Lbs. Be500,000142,735500,00062,5816123Lbs. Be450,000127,625450,00057,5046124Lbs. Be30,00010,62130,00010,0326162Furnace hrs.25,00010,69725,0006,7546165Labor hrs.60,00045,71060,00033,9066166Labor hrs.10,0006,48110,0002,7876167-9Labor hrs.18,00012,16916,0008,5436168Labor hrs.12,0005,26012,0005,721Alloy departments7200Labor hrs.22,00021,71022,0005,1527210Furnace hrs.12,00012,84512,0004,1927212Labor hrs.5,9008,0175,9006,1087213Labor hrs.14,00014,31610,0006,1677221Labor hrs.15,00015,87715,0008,5137223Labor hrs.5,2009,1987222Labor hrs.3,4004,3443,4001,3237224Labor hrs.3,8004,7053,8009387225Labor hrs.3,4003,8324,0001,1567226Labor hrs.2,0004,9963,0001,3117227Labor hrs.7,70012,05812,0003,2127220Labor hrs.7228Labor hrs.1,8009574,0001,3687229Labor hrs.8,9009,10410,0005,2367230-1Labor hrs.15,00014,67415,00011,5737270Machine hrs.1,3001,1041,30068774XXLabor hrs.90,000109,166100,00040,945Oxide departments6113Lbs. Be23,00024,75625,00010,458613XLabor hrs.65,00069,06169,00048,06879 174 capacity is the level of production the manufacturer could reach if all machines and departments were operated continuously at peak efficiency.(d) Example. The provisions of (c) of this subdivision may be illustrated by the following example:Corporation X operates a stamping plant with a theoretical capacity of 50 units per hour. The plant actually operates 1960 hours per year based on an 8-hour day, 5-day week basis and 15 shutdown days for vacations and holidays. A reasonable allowance for down time (the time allowed for ordinary and necessary repairs and maintenance) is 5 percent of practical capacity before reduction for down time. Assuming no loss of production during starting up, closing down, or employee work breaks, under these facts and circumstances X may properly make a practical capacity computation as follows:Practical capacity without allowance for down timebased on theoretical capacity per hour is (1960 x 50)98,000Reduction for down time (98,000 x 5%)4,900Practical capacity93,100The 93,100 unit level of activity (i.e., practical capacity) would, therefore, constitute an appropriate base for calculating the amount of80 fixed indirect production costs to be included in the computation of the amount of inventoriable costs for the period under review. On this basis if only 76,000 units were produced for the period, the effect would be that approximately 81.6 percent (76,000, the actual number of units produced, divided by 93,100, the maximum number of units producible at practical capacity) of the fixed indirect production costs would be included in the computation of the amount of inventoriable costs during the year. The portion of the fixed indirect production costs not so included in the computation of the amount of inventoriable costs would be deductible in the year in which paid or incurred. Assume further that 7,600 units were on hand at the end of the taxable year and the 7,600 units were in the same proportion to the total units produced. Thus, 10 percent (7,600 units in inventory at the end of the taxable year, divided by 76,000, the actual number of units produced) of the fixed indirect production costs included in the computation of the amount of inventoriable costs (the above-mentioned 81.6 percent) and 10 percent of the variable indirect production costs would be included in the cost81 of the goods in the ending inventory, in accordance with a method of allocation provided by this paragraph.Thus, the regulations allow an immediate deduction for the fixed indirect production costs associated with idle capacity; i.e., the costs associated with the difference between the practical capacity level and the actual production level.Neither party argues that the regulation is invalid. The parties disagree solely on whether or not petitioner's practical 175 capacity determinations are consistent with the regulation's requirements. 282 Petitioner argues that its approach satisfies the practical capacity regulation and that it thus is entitled to the full deduction it claimed on its return. Respondent argues that petitioner's approach is fatally defective because it failed to include anticipated market demand in its practical capacity computations. Respondent redetermined petitioner's practical capacity levels using a 3-year moving average. For example, respondent's practical capacity level for cost center 8000 for 1975 was 259,860 pounds Be, which is the average actual production of cost center 8000 for the period 1972-74. By comparison, petitioner's practical capacity determination for cost center 8000 for 1975 was 305,000 pounds Be. Cost center 8000's actual production for 1975 was 138,983 pounds Be. Using his method, respondent determined that petitioner was entitled to deduct only $ 7,236,007 of the $ 8,600,983 amount claimed as a deduction arising from idle capacity.The burden of proof on disputed issues of fact is, of course, on petitioner. Rule 142(a). 3 In matters of inventory accounting, the taxpayer must carry the heavy burden of proving that 176 respondent's determination is arbitrary 83 and a clear abuse of discretion. Thor Power Tool Co. v. Commissioner, 439 U.S. 522">439 U.S. 522, 532-533 (1979).Respondent in this case, however, does not explicitly challenge the way petitioner applied its practical capacity concept to each cost center. Instead, respondent's argument presents a question of law: does the practical capacity regulation require consideration of anticipated sales in setting practical capacity levels, a factor which petitioner concedes it did not consider.Petitioner, however, introduced detailed evidence concerning the way in which the 1975 practical capacity level was determined for each cost center. Because respondent did not challenge this evidence and because of the large amount of material involved, we here report only our conclusion that, 84 based on our detailed review of the evidence, petitioner's 1975 practical capacity levels for each such cost center represented the best estimates based on all relevant factors, as discussed in our findings of fact, of the cost center's physical capacity to produce within a balanced, integrated production process. 485 Therefore, if petitioner is right that its approach to practical capacity is the concept described in section 1.471-11(d)(4), Income Tax Regs., then we will find that petitioner satisfied its burden of proof in this case. However, if respondent is right 177 that the regulation's concept of practical capacity requires consideration of anticipated sales, a factor which petitioner concedes that it did not consider, then petitioner will not be entitled to idle capacity deductions in excess of the amount determined by the respondent.With the issue in focus, we turn to examine the regulation.We think that petitioner's practical capacity approach is consistent with, and satisfies the requirements of, the practical capacity regulation. Petitioner established practical capacity levels using theoretical capacity, "adjusted for allowances for estimated inability to achieve maximum production, such as machine breakdown, idle time, and other normal work stop-pages." Sec. 1.471-11(d)(4)(ii)(c), Income Tax Regs. Petitioner's theoretical capacity determinations were based on engineering studies to determine "the level of production the manufacturer could reach if all machines and departments86 were operated continuously at peak efficiency." Sec. 1.471-11(d)(4)(ii)(c), Income Tax Regs. Petitioner then adjusted the theoretical capacity level downward to take account of the factors listed in the regulation's provision defining practical capacity based on theoretical capacity, the factors listed in the example following the theoretical capacity provision, and other factors to determine the maximum production level which each cost center could sustain given the practical constraints imposed by the production process itself.Petitioner also reexamined the practical capacity levels each year, and adjusted them as necessary, "to reflect a change in underlying facts and conditions such as increased output due to automation or other changes in plant operation." Sec. 1.471-11(d)(4)(ii)(a), Income Tax Regs. Petitioner also used data derived from its experience to fine tune its practical capacity determinations to make sure that they accurately reflected the maximum production levels which each cost center could sustain given the practical constraints imposed by the production process itself. Sec. 1.471-11(d)(4)(ii)(b), Income Tax Regs.Respondent, however, argues that87 the regulation requires petitioner to adjust its practical capacity levels to reflect expected productive activity resulting from anticipated sales. Respondent's theory is that petitioner in 1975 was in the middle of a severe slump. Petitioner's cost centers, especially its metal departments, had been producing significantly below 178 1971 levels for several years. Petitioner, when it established its 1975 practical capacity levels, did not expect to pull out of the slump in 1975. Respondent concludes that petitioner's 1975 practical capacity determinations were inaccurate because petitioner had no expectation of producing at such levels during 1975. Therefore, as he states at page 62 of his brief, respondent "contends that the regulations require occasional modification to reflect other changes in the actual operations of the plant, such as less production, fewer employees, fewer shifts, less overtime, plant shutdowns, etc., to ensure that practical capacity bears a reasonable relationship to normal plant conditions for the period."Respondent emphasizes particular language in the regulation to support his assertion:The determination of practical capacity and theoretical88 capacity should be modified from time to time to reflect a change in underlying facts and conditions such as increased output due to automation or other changes in plant operation. * * ** * * the taxpayer shall establish the production operating conditions expected during the period for which the costs are being determined, assuming that the utilization of production facilities during operations will be approximately at capacity. This level of production activity is frequently described as practical capacity for the period and is ordinarily based upon the historical experience of the taxpayer. For example, a taxpayer operating on a 5-day, 8-hour basis may have a "normal" production of 100,000 units a year based upon three years of experience.* * * Practical capacity may also be established by the use of "theoretical" capacity, adjusted for allowances for estimated inability to achieve maximum production, such as machine breakdown, idle time, and other normal work stoppages. * * Respondent's argument based on the underscored passages is that the regulation's language is broad enough to require reductions in practical capacity levels due to 89 all changes in plant operations, including lower production levels due to decreased demand. Respondent took his 3-year moving average from the example based on the 3 years of experience.Although the question is not entirely free of doubt because the regulation does not explicitly answer respondent's argument, we think, based on an analysis of the language of the practical capacity regulation as a whole, the role the practical capacity concept plays in the full absorption regulations and the theory underlying the practical capacity concept, that the 179 regulation does not require consideration of the demand for goods in determining practical capacity levels.The language of the regulation as a whole indicates that petitioner did not have to consider demand in determining practical capacity. The broad language highlighted by respondent such as "other changes in plant operation" or "idle time, and other normal workstoppages," follows specific references to changes in the physical capacity to produce, such as automation. Also, the example following the definition of theoretical capacity indicates that adjustments for "idle time and other normal work stoppages," means adjustments90 for anticipated normal repairs, employee work breaks, startups, closedowns, holidays, and time other than a plant's ordinary shift. Nowhere in the regulation is there an explicit reference to adjusting practical capacity levels in response to changes in demand. In these circumstances, we think that the broad language cited by respondent, which is found in exemplary lists which refer only to changes in production levels arising from the production process itself, should be interpreted as referring to other and similar types of constraints internal to the production process.Also, we think that respondent errs in concluding that the statement that practical capacity shall reflect the "conditions expected during the period for which the costs are being determined," requires that practical capacity must be merely an estimate of expected production. Respondent's analysis ignores the rest of the sentence from which he quotes. It states that practical capacity represents the expected production level "assuming that the utilization of production facilities during operations will be approximately at capacity." (Emphasis added.) This assumption that the facilities will be operated91 at estimated capacity clearly implies that practical capacity is the practical ability to produce, not, as respondent suggests, the estimated level of production as adjusted for anticipated sales.We note also that the example from which respondent seeks support for his method of calculating practical capacity does not require or even authorize a 3-year moving average as a means of determining practical capacity. The example contains no averages. It merely states that, based on 3 years' experience, a taxpayer's practical capacity was 100,000 units a 180 year. We think that the regulation requires the type of careful analysis of all the relevant factors which petitioner performed. And, based on a reading of the regulation as a whole, instead of examining solely the clauses taken out of context by the respondent, we think that practical capacity for purposes of the regulation means what commonsense implies it means: the ability to produce, not the ability to sell. We conclude that petitioner's use of practical capacity complies with the requirements of the regulation.We think that our conclusion is supported by the fact that the practical capacity regulation is an exception92 to the general rule contained in the full absorption regulations that all production costs are inventoriable costs. If respondent's interpretation were correct so that practical capacity is the expected level of production based on anticipated sales, then the immediate deduction allowed by the practical capacity regulation would serve no useful function. Under the respondent's approach, if a taxpayer's estimates of expected production were accurate, then there would be no deviation between the practical capacity level and the actual production level. A taxpayer would get a practical capacity deduction only if he overestimated future demand. We perceive no reason for respondent's approach, which could encourage some taxpayers to overestimate future demand in an attempt to generate practical capacity deductions. Such an approach, we believe, would open a possibility of abuse within the full absorption regulations which we do not think could have been intended. Accordingly, we will not interpret the regulations the way the respondent requests. 593 Furthermore, we note that our interpretation of the practical capacity regulations is consistent with the theory underlying the practical capacity concept which has been recognized previously by other courts. In Waukesha Motor Co. v. United States, 322 F. Supp. 752">322 F. Supp. 752 (E.D. Wis. 1971), affd. sub nom. Bangor Punta Operations, Inc. v. United States, 466 F.2d 930">466 F.2d 930 (7th Cir. 1972), 6the District Court stated:181 The practical capacity method of accounting involves a basic concept of business economics which is: unit production costs are substantially affected by changes in production volume. While some costs do not fluctuate with changes in production volume, others do. Therefore, because some costs are fixed, there is an inverse relationship between production volume and unit production costs. As production volume increases, unit costs of production decrease. As production volume decreases, unit costs of production increase. The lowest unit cost of production, therefore, is achieved at the maximum attainable capacity of a manufacturing operation.Some accounting theorists believe that the differences in production94 costs that are attributable to differences in production volume should not be accounted for in the same manner as other production costs. This difference, they contend, represents the cost of idle (excess or unused) plant capacity that should not be carried into inventory but rather charged each year against profits. The method of accounting used to reflect this theory is called the practical capacity method. [322 F. Supp. at 757.]This theory 7 that the practical capacity95 concept allocates a fixed per unit cost to goods produced and allocates the remainder of fixed indirect production costs against profit requires that practical capacity levels be set to represent the capacity to produce. Respondent's theory incorporating anticipated sales makes the practical capacity level essentially an expected production level. Under this approach, the fixed indirect production costs per unit will vary year to year depending on the expected level of production. This result is the result which the practical capacity concept was designed to 182 alleviate. It is only when the practical capacity level is selected as the capacity to produce, with adjustments to reflect changes to such physical capacity to produce, that fixed indirect production costs will generate fixed per unit costs. Therefore, it is petitioner's approach instead of respondent's theory which comports with the theory underlying the practical capacity concept.96 We think that this practical capacity theory articulated by the court in Waukesha Motor Co. v. United States, supra, also explains the presence of the practical capacity provision within the full absorption regulations. Under the regulations, all costs, whether fixed or variable, which are fixed per unit costs must be absorbed by the goods. Deductions for these production costs are allowed only in the year of sale. The difference between total fixed indirect costs and the fixed per unit costs allocated to inventoriable costs is allowed as an immediate deduction against current income for idle capacity because it is viewed as a cost of not producing as opposed to a cost of production.Petitioner's practical capacity approach, therefore, provides a coherent approach to the full absorption regulations which is consistent with prior judicial interpretation of the practical capacity concept. As we noted previously, respondent's approach denies the independent role for the practical capacity regulation which its presence in the full absorption regulation requires. Accordingly, we conclude that petitioner's approach satisfies the requirements of the practical97 capacity regulation. Petitioner has demonstrated that respondent's determination was arbitrary and a clear abuse of discretion. We hold that petitioner is entitled to the deductions arising from its use of the practical capacity concept in the amounts reported.Respondent argues that petitioner's approach sets practical capacity levels assuming 24-hour a day, 7-day a week operations. Respondent argues that this approach sets practical capacity levels too high and, thus, produces an idle capacity deduction which is too large. Respondent argues that this approach clearly conflicts with the practical capacity regulation which, in its two examples, speaks of practical capacity determined on a 5-day, 8-hour basis.Respondent's arguments do not convince us that petitioner's practical capacity approach is inconsistent with the regulations. 183 The regulations do not require that practical capacity determinations must be made on a 5-day, 8-hour basis. Instead, the focus is on a manufacturer's normal, or designed production capacity. Petitioner's normal production for some departments was on a 7-day, 24-hour basis. In some departments, this continuous operation was required by98 the machines. In fact, when petitioner cut back production, it still operated these departments on a continuous basis and then shut down for several days or weeks at a time. In these circumstances, petitioner does not have to determine all its practical capacity levels on a 5-day, 8-hour basis. Such an approach would produce an unreasonably low level of practical capacity because it would fail accurately to reflect the amount of idle capacity present in petitioner's production process for which it is entitled a deduction.Also, petitioner did not arbitrarily determine its practical capacity levels for all of its cost centers on a 7-day, 24-hour basis. It used such a basis only for departments for which continuous operation was the designed norm. Practical capacity for many departments was calculated on a one or two shift basis rather than on an assumption of continuous operation. Petitioner determined the basis for each department after analysis of the demands of its integrated manufacturing system in order to keep a balance for efficient production as a whole. Thus, some bottleneck departments were designed to operate on a two or a three shift basis because downstream departments99 needed their output to operate efficiently. We find, therefore, that petitioner did not arbitrarily set its practical capacity levels at the highest possible levels. Instead, petitioner's practical capacity determinations were the result of the careful analysis required by the regulations.Respondent also cites Bangor Punta Operations, Inc. v. United States, 466 F.2d 930">466 F.2d 930 (7th Cir. 1972), as support for his contention that petitioner's practical capacity determinations were based on too high a production level basis. In Bangor Punta, the taxpayer's plant operated for years on a 5-day, 8-hour basis. The taxpayer's capacity on this basis was about 100 units a year. During 1 year, the taxpayer temporarily added a second shift and increased overtime hours. As a result, the taxpayer produced 180 units that year. In the following years, the taxpayer returned to its normal one shift basis but it 184 calculated its practical capacity based on the two shift, 180-unit year. The court held that the taxpayer misused the practical capacity concept when it relied on the extraordinary performance of 1 year in setting its practical capacity levels. 100 Respondent argues by analogy that petitioner in this case artificially inflated its practical capacity levels by setting them at the actual production levels of the extraordinary 1971 year.We think that respondent's argument is meritless. Petitioner did not arbitrarily pick the highest production level it ever reached. In fact, petitioner's practical capacity level often is lower than the highest experienced production level. Instead, petitioner's practical capacity levels represent the capacity level each cost center was anticipated to attain when petitioner invested its money in the 1960's to develop its balanced, integrated system.Petitioner's position is quite unlike that of the taxpayer in Bangor Punta who set its practical capacity levels based on an extraordinary year which it did not expect when it designed the plant and did not plan to repeat. In this case, petitioner consciously invested money in the 1960's to increase its capacity to satisfy its contract obligations and to prepare for anticipated future business. Petitioner planned to achieve, and generally achieved across several years, the practical capacity production levels. The increased production levels101 in the late 1970's also indicate that petitioner's practical capacity determinations were not the artificial result of 1 year's extraordinary production. Accordingly, we hold that petitioner correctly used the practical capacity concept.Respondent argues that petitioner's use of the practical capacity concept is abusive because, for several years, it took large deductions associated with the idle capacity arising from the mid-1970's slump. We disagree with respondent. Petitioner's application of the practical capacity concept was not tax motivated. It adopted the method during the early 1960's for business reasons associated with the allocation of fixed indirect costs in costing contracts. Petitioner consistently used the practical capacity method for financial and tax-accounting purposes since that time, which includes a substantial period before the practical capacity regulation became effective in 1973.185 We further note that petitioner would have a financial incentive to understate practical capacity levels to maximize profit, particularly for financial accounting, as opposed to tax-accounting purposes. Such tension between two competing aspects of petitioner's 102 self-interest tends, in our judgment, to support the impression of objectivity one gains from petitioner's practical capacity methodology in this case.Finally, we do not find petitioner's use of the practical capacity concept to be abusive because the regulation entitled petitioner to take these deductions associated with idle capacity. Petitioner made a huge capital investment during the 1960's in order to produce at the levels established as practical capacity. Petitioner, in fact, generally attained these production levels for some time. But the slack in demand during the mid-1970's left petitioner with unused capacity. Petitioner is entitled to the deductions it reported which are associated with this idle capacity because it satisfied the requirements of the practical capacity regulation.Also, we hold that petitioner made an overpayment of tax for 1972 because of adjustments which the parties concede should be made to petitioner's taxable income.Decision will be entered under Rule 155. Footnotes1. Be is the symbol for the element beryllium.↩1. P/C reflects practical capacity determinations. A/P reflects actual production levels.↩2. Blanks indicate that data is unavailable because cost center, as defined in 1975, was not yet existant or because a previously existant cost center no longer existed in 1975.↩2. Although the parties provided the Court with some discussion about generaly accepted accounting principles and clear reflection of income, there is no indication that either party argues that these principles have any significance in this case independent of their reflection in the requirements of the regulation. For example, respondent, in his brief, stated the issue this way: "Whether, under the provisions of Treas. Reg. § 1.471-11(d)(4), petitioner must adjust its levels of practical capacity, particularly those involved in its beryllium metal business, to reflect changes in plant operation (other than changes in physical facilities) which occurred prior to, and including, 1975." Accordingly, we do not have to decide in this case whether petitioner would have to prove that its practical capacity approach clearly reflected its income and that it was consistent with the best accounting practice in addition to showing that its approach satisfied the terms of the regulation. We note, however, that the respondent, in exercising his authority under sec. 471, apparently determined that if a taxpayer satisfied the requirements of the regulations then the taxpayer's income is deemed to be clearly reflected and consistent with the best accounting practice. See sec. 1.471-11(a), Income Tax Regs. Compare Maple Leaf Farms, Inc. v. Commissioner, 64 T.C. 438 (1975) (respondent's determination in sec. 1.471-6, Income Tax Regs., allowing farmers the choice of cash basis or accrual basis immunizes cash basis farmers from a subsequent challenge that the cash method does not clearly reflect income). We leave this issue for a subsequent case however, because we are asked in this case only to determine if petitioner's practical capacity approach satisfied the requirements of sec. 1.471-11(d)(4), Income Tax Regs.↩3. All references to Rules are to the Tax Court Rules of Practice and Procedure. Additionally, unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect during the years at issue.↩4. We include, solely as an example of petitioner's methodology, the following summary description of petitioner's determination of the practical capacity level for cost center 8000, the Utah ore extraction facility. Stearns Roger Inc. built the plant in 1968-69. A September 1967, Stearns Roger report stated design criteria as follows:Ore feed375 tons/dayLbs. Be at 0.27% ore assay2,025 lbs. Be/dayProcess yield86%Theoretical capacity636,000 lbs. Be/yearReduction for downtime inherentin department (636,000 x 15%)95,000 lbs. Be/yearDesign capacity per Stearns Roger540,000 lbs. Be/yearThe Utah plant met the design criteria except that the ore assay was lower (about 0.22%) than the assay used to determine the original design capacity. Accordingly, petitioner reduced its design capacity to 440,000 pounds Be/year. Plant startup was in the fourth quarter 1969 and practical capacity for 1970, the first full year of operations, was set at 264,000 pounds Be. Based upon completion of the startup and demonstration of the plant's capability by actual production of 305,605 pounds in 1971, practical capacity was increased to 305,000 pounds Be for 1972 and remained at that level beyond 1975. This practical capacity level was lower than the "design capacity" to take account of the ability of the downstream departments to absorb cost center 8000's product and to take account of cost center 6111's productive capacity which also supplied raw beryllium products to petitioner's other departments.↩5. We take the regulation as we find it. See Larson v. Commissioner, 66 T.C. 159">66 T.C. 159, 185-186 (1976). See also Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344, 354-355↩ (1935).6. The Bangor Punta case was decided before the full absorption regulations, which included the practical capacity provision, became effective in 1973. Bangor Punta, therefore, does not interpret the practical capacity regulation, although it describes the practical capacity concept as applied to fixed, indirect costs, during the period in which the practical capacity regulation was being drafted. See Bangor Punta Operations, Inc. v. United States, 466 F.2d 930↩ (7th Cir. 1972).7. Accountants sometimes use an alternate method, which is also sometimes called "practical capacity," for allocating variable production costs in addition to allocating fixed indirect production costs. Swan & Marcus, "Current Developments in Tax Accounting: Inventories (Now You See Them, Now You Don't)," 28 U.S.C. Tax. Inst. 493, 502 (1976). The application of a "practical capacity" concept to variable production costs for financial accounting purposes is based on a different theory than the theory discussed in the text for applying the practical capacity concept to fixed indirect production costs because variable production costs, by their nature, are fixed per unit costs. Therefore, accountants do not always require "practical capacity" levels to be determined as the physical capacity to produce (see Waukesha Motor Co. v. United States, 322 F. Supp. 752">322 F. Supp. 752, 768) because the accountants' use of a "practical capacity" method for all production costs sometimes merges into alternative allocation methods, such as the expected production theory or the average production theory. See R. Hoffman & H. Gunders, Inventories 100-107 (1970). The practical capacity concept contained in the full absorption regulations, however, applies only to fixed indirect production costs. In this situation, the rationale articulated by the Waukesha Motor↩ court of using the practical capacity method to fix unit production costs is appropriate. Also, this rationale, as discussed in the text, provides the explanation for the practical capacity exception to the full absorption regulations.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621481/	Estate of W. W. Fondren, Deceased, Ella F. Fondren, Independent Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ella F. Fondren, Petitioner v. Commissioner of Internal Revenue, RespondentFondren v. CommissionerDocket Nos. 107473, 107474United States Tax Court1 T.C. 1036; 1943 U.S. Tax Ct. LEXIS 171; May 4, 1943, Promulgated 171 Decision will be entered for the respondent. W. W. Fondren and wife created separate, irrevocable trusts for the benefit of each of their seven minor grandchildren. Each trust instrument provided that the trust income, and thereafter trust corpus, if it be necessary, should be used for the proper maintenance, support, and education of each grandchild. If the trust income was not needed for these purposes it was to be accumulated and added to corpus and distributed in stated percentages upon each beneficiary arriving at the age of 25, 30, and 35, with remainder over in case of death. Held, as the obligation to support the beneficiaries rested on the parents, who were able to and did support them, and as the gifts to the beneficiaries were dependent on survivorship and were limited by the discretionary power vested in the trustee, the gifts in trust were of future and not present interests. William M. Cleaves, Esq., for the petitioners.Wilford H. Payne, Esq., for the respondent. Arnold, Judge. ARNOLD 1036 OPINION.These proceedings, consolidated for decision, involve gift tax deficiencies for 1937 of $ 8,400 each. The sole issue is whether gifts in trust172 were gifts of future interests, thereby prohibiting any $ 5,000 exclusion. The cases were submitted upon stipulated facts and exhibits. The stipulated facts are adopted as our findings of fact and the material portions are hereinafter set forth.During the taxable year, and prior and subsequent thereto, Ella F. Fondren and W. W. Fondren were husband and wife, residing and domiciled in Texas. W. W. Fondren died testate January 5, 1939. Ella F. Fondren is the duly appointed executrix of his estate, with offices in Houston, Texas. The gift tax returns of husband and wife were filed with the collector of internal revenue for the first district of Texas.On December 17, 1935, W. W. Fondren and Ella F. Fondren executed a separate trust instrument in favor of each of their five grandchildren, namely, Ellanor Anne Fondren, Mary Doris Fondren, Peter Fondren Underwood, Wash Bryan Trammell, Jr., and Sue Fondren Trammell. At that time the eldest grandchild was less than six years of age. On December 7, 1936, decedent and his wife executed a trust instrument in favor of a sixth grandchild, Walter William Fondren III, born April 29, 1936. On December 2, 1937, they executed a 1037 173 seventh trust instrument in favor of David Milton Underwood, a grandchild born March 5, 1937. The provisions of the various trust instruments were substantially the same, so that the specific provisions of the trust instrument hereinafter set forth are illustrative of the provisions of each indenture. The principal variation in the trust provisions were with respect to the successor beneficiaries in the event of the death of the principal beneficiary, all of whom were living when this proceeding was heard.Each trust instrument constituted W. W. Fondren, trustee, and upon his death or resignation Ella F. Fondren was to succeed to the trusteeship. Each trust instrument expressly provided that W. W. Fondren and/or Ella F. Fondren might transfer, assign, and deliver additional property to the trustee for the benefit of the particular beneficiary. Upon the death of W. W. Fondren on January 5, 1939, Ella F. Fondren succeeded to the trusteeship and has since administered each trust as trustee.The trustee was given full power and authority with respect to the management, control and handling of the trust property. He could sell, mortgage, pledge, encumber or otherwise dispose of the174 same, and invest, reinvest, and keep invested all proceeds from earnings or sales so as to make the trust estate earn the best income consistent with safety of investment and sound business principles. Sales could be made in lots, parcels, or the entirety for such price and purposes and under such terms and conditions as in the trustee's judgment was for the best interests of the trust estate. The trustee could institute, prosecute, maintain, and defend any suits, actions, or legal proceedings necessary in his judgment for the protection or enforcement of the interests of the trust estate. He could employ at the expense of the trust estate such accountants, agents, and attorneys as in his judgment were for the best interests of the trust estate. The exercise of any power conferred on the trustee was not to exhaust the power, but said power could be exercised as often as and whenever in the judgment of the trustee such exercise thereof was necessary or advisable for the best interests of the trust estate.Article three of the trust instruments reads in part as follows:Article ThreeOut of the trust estate hereby created and as the same may hereafter be augmented and increased 175 by gift from the Grantors, by either of them as herein provided for, or from any other source whatsoever, the Trustee shall provide for the support, maintenance and education of our said Grandson, [or Granddaughter as the case may be] using only the income of said estate for that purpose if it be sufficient. If it be necessary to use any of the corpus of the estate for that purpose and in the judgment of the Trustee it is best to do so, said Trustee may make advancements out of the corpus of said trust estate for such purpose for the benefit of our said Grandson.1038 It is contemplated, however, that our said Grandson will have other adequate and sufficient means of support, and that it will not be necessary to use either the income or the corpus of the trust estate hereby created to properly provide for his education, maintenance and support; and, if the income from the trust estate be not needed for these purposes, then all of the income from said trust estate not so needed shall be by the Trustee passed to capital account of said trust estate, and shall be and become a part of said trust estate, it being our hope that all of the earnings and income of said trust estate during176 the period of this Trust may be used to augment the trust estate and be delivered to our said Grandson at the periods herein provided for. It is expressly provided, however, that our said Grandson shall be properly maintained, educated and supported, and if it be necessary to use all of the income and even all of the corpus of the trust estate hereby created and all augmentations thereof, it shall be the duty of the Trustee to see that this obligation shall be properly and reasonably discharged. * * The trusts were to continue until each grandchild attained the age of 35, but 25 percent of the corpus and accumulations, if any, were to be delivered to the grandchild when he or she attained the age of 25, 33 1/3 percent when he or she attained age 30, and the remainder when he or she attained age 35. If the beneficiary died leaving issue before termination of the trust, the trust estate was to be held and administered for the benefit of the issue and delivered share and share alike when the youngest of such issue attained age 21. If the beneficiary died without issue before termination of the trust, successor beneficiaries were provided for by the trust instruments, or the trust177 estate descended to the heirs under the laws of the State of Texas.The stated purpose in creating the trust was "to provide for the personal comfort, support, maintenance and welfare of" each grandchild. The trust fund was not to be liable for obligations of the beneficiary. The beneficiary could not anticipate his or her interest in the trust fund, and the fund could not be reached by judgment creditors or others having claim against any beneficiary. Other provisions common to trust indentures were included in the instruments, but such provisions are not deemed pertinent to the issue and are not set forth.The trusts were absolute and irrevocable, with no interest in the estate or the benefits accruing therefrom received or retained by the grantors. The grantors reserved the right, however, to remove any acting trustee, except W. W. Fondren, and to name and appoint a successor trustee with the same rights, powers, and authority as the first trustee, a right which was also reserved to the survivor of the grantors.On or about December 2, 1937, W. W. Fondren and Ella F. Fondren each gave to the trustee for each of the seven trusts aforementioned 100 shares of Humble Oil & Refining178 Co. stock. The gifts to the trust for David Milton Underwood were the first gifts to this 1039 trust. The gifts to the other trusts were in augmentation of the trust estates theretofore existing. The fair market value of the Humble Oil & Refining Co. stock on December 2, 1937, was $ 59.75 per share.On their gift tax returns for 1937 W. W. Fondren and Ella F. Fondren each claimed the statutory exclusion of $ 5,000 and each reported a taxable gift to each of said trusts of $ 975. Each paid gift taxes on the basis of the taxable gifts so reported.In addition to the seven gifts in trust for the benefit of their grandchildren, W. W. Fondren and Ella F Fondren each made direct gifts of Humble Oil & Refining Co. stock during 1937 to their three children as follows: Walter W. Fondren, Jr., 100 shares; Catherine Fondren Underwood, 100 shares; and Susie Fondren Trammell, 100 shares. At the date of each of said gifts the fair market value of said stock was $ 59.75 per share. In their gift tax returns W. W. Fondren and Ella F. Fondren each claimed a $ 5,000 exclusion with respect to each gift to their children, or a total exclusion for each of $ 15,000.At all times subsequent to179 the creation of the aforementioned trusts the parents of the beneficiaries named therein have adequately and sufficiently provided for the proper and adequate support, maintenance, and education of their children, with the result that no part of the trust income or corpus has been distributed, used, or applied to or for the benefit, support, maintenance, or education of any one of said beneficiaries.In determining the deficiencies involved herein respondent allowed W. W. Fondren and Ella F. Fondren three $ 5,000 exclusions each with respect to the direct gifts made during 1937 to their children and disallowed to each seven $ 5,000 exclusions because of the gifts in trust for the benefit of their grandchildren. The disallowance in each instance was based upon respondent's determination that the gifts in trust constituted gifts of future interest in property against which no exclusions are allowable.The gifts in trust made by W. W. Fondren and Ella F. Fondren for the benefit of their grandchildren in 1937 were gifts of future interests in property as to which no $ 5,000 exclusions are allowable in determining their gift tax liability for 1937.Section 504 (b) of the Revenue Act of180 1932 provides that the first $ 5,000 of gifts made to any person by the donor (other than gifts of future interests in property) shall not be included in the total amount of gifts made during such year. "Future interests" under article 11 of Regulations 79 (1936 Ed.) include "reversions, remainders, and other interests or estates, whether vested or contingent, and whether or not supported by a particular interest or estate, which are limited to commence in use, possession or enjoyment at some future date or time." This regulation has been considered and approved by 1040 the courts in a number of cases, ; ; ; , and cases cited therein.The courts have decided numerous cases involving gifts in trust where the character of the gift, i. e., present or future, depended upon the amount of discretion lodged in the trustee to make distributions of trust income or corpus to the trust beneficiaries. Cf. ,181 with . The latter case stated the rule, based on authorities therein cited, to be that if the right of the beneficiary to the use, possession, and enjoyment of the trust income or corpus is subject to the discretion of the trustee, the gift is a gift of a future and not a present interest. To the same effect is our decision in , where the net income of the trust was distributable "in such proportion as the trustee may in his absolute discretion determine"; in , where the net income was distributable in such proportions as to the trustees "shall seem fit and proper * * * (such portion to be determined solely in the judgment and discretion of the said Trustees, and without any control over them in the exercise of such judgment or discretion) * * "; and in , where income could be accumulated or distributed in the "sole and absolute discretion" of the trustees. In each of these cases we held that the discretion182 lodged in the trustee so postponed the use, possession, and enjoyment of the income or corpus by the beneficiary that the gift was a gift of a future and not a present interest.We think the situation here with respect to the discretion lodged in the trustee is much the same. While the draftsman of the several trust instruments failed to use the word "discretion" in describing the power and authority lodged in the trustee, such phrases as "in the judgment of the Trustee," "for the best interests of said trust estate," and "if it be necessary," which recur frequently in each instrument, adequately vest the trustee with discretionary power and authority. It was the express duty of the trustee to see that the grandchildren were properly maintained, educated, and supported. In the discharge of that duty he could use trust income first and, if it be necessary, all the corpus. Performance of this duty required the exercise of discretion, whether so called in the trust instrument or not.Furthermore, the grantors definitely contemplated that neither income nor corpus would be needed for the maintenance, support, and education of the grandchildren. It is stipulated that the parents of183 the grandchildren provided adequately for each and all of said children. It is apparent from this fact, and from the several trust instruments themselves, that the dominant purpose of the grantors was not so much the present giving to their grandchildren as it was the creation 1041 of a trust estate which would be partially distributed if, when, and as they attained the ages of 25, 30, and 35, respectively. Each trust instrument stated specifically that the grantors contemplated that the beneficiary named therein "will have other adequate and sufficient means of support," so that it would not be necessary to use net income or corpus, but income could be accumulated and added to corpus. The earnest hope was expressed that all earnings and income of the trust estate would be used to augment the trust estate and later distributed as a part of corpus. The trust income and corpus was a reserve which would provide for the grandchildren if necessary. The intent of the grantors, coupled with the legal obligation imposed on parents to support their children, leads us to the conclusion that the effect of the instruments was to postpone the gifts until the grandchildren achieved specified*184 ages. Obviously, the right to possession, use, and enjoyment of the trust corpus was dependent upon survivorship. If so dependent, the gift is a gift of future interest. .Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621483/	ROBERT MITCHELL AND CAROL MITCHELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMitchell v. CommissionerDocket Nos. 5567-78, 5569-78.United States Tax CourtT.C. Memo 1979-207; 1979 Tax Ct. Memo LEXIS 316; 38 T.C.M. (CCH) 854; T.C.M. (RIA) 79207; May 24, 1979, Filed Robert Mitchell and Carol Mitchell, pro se. David W. Johnson, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge: These consolidated cases are before the Court on respondent's "Motion For Summary Judgment" filed March 12, 1979, pursuant to Rule 121, Tax Court Rules of Practice and Procedure. Concurrently, petitioners have, in effect, moved for summary judgment 1 asserting constitutional and legal tender grounds. 318 Respondent determined the following deficiencies in petitioners' Federal income taxes: Robert Mitchell Dkt. No. 5567-78Additions to TaxYearDeficiencySec. 6651(a)Sec. 6653(a) 21974$476.00$119.00$ 23.801975522.00130.5026.10Carol Mitchell Dkt. No. 5569-78Additions to TaxSec. 6653(a)YearDeficiencySec. 6651(a)1974$476.00$119.00$ 23.801975522.00130.5026.10Petitioners are husband and wife who were residents of Hico, Texas, when they filed their separate petitions in these cases. They filed "returns" on Forms 1040 for each of the years 1974 and 1975 but disclosed thereon no information relating to their income or deductions. Respondent determined the deficiencies for 1974 and 1975 based on each petitioner's share of their total community property income which was earned exclusively from wages. On January 24, 1979, the Court granted respondent leave to file a motion for an order to show cause why certain proposed facts should not be accepted319 as established pursuant to Rule 91(f), Tax Court Rules of Practice and Procedure. After a hearing on the matter, the Court's order dated February 28, 1979, deemed certain facts set forth in respondent's proposed stipulation as established for the purposes of these cases. Petitioners received wages from the following sources during the years in issue: Robert Mitchell19741975Hico City HospitalHico, Texas$5,120.80$5,909.06Hafer and DaytonHico Clinic0120.09Carol MitchellGibbs Manufacturing Co.Cranfills Gap, Texas$3,297.68$3,920.01Hico City HospitalHico, Texas122.400Total$8,540.88$9,949.16Under the community property laws of Texas each petitioner's share of the gross income was $4,270.44 in 1974 and $4,974.58 in 1975. Petitioners did not have any itemized deductible losses or expenses, the aggregate of which would exceed the amount of the standard deduction, for the years 1974 and 1975. They also did not have any business losses or expenses for those years. The petitioners have not shown that they are entitled to any dependency exemptions for such years. Petitioners first assert that respondent has not stated320 a claim upon which relief can be granted. Such an argument is fallacious. Petitioners, not respondent, invoked our jurisdiction by filing petitions. Section 6213(a). A petition must 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" as well as clear and concise lettered statements of the facts on which the petitioner bases the assignments of error. Rule 34(a) and (b), Tax Court Rules of Practice and Procedure. Ordinarily, it is the failure of a petitioner to state a claim for relief, i.e., to provide allegations necessary to support a determination that no deficiency exists, which might lead to a dismissal of the petition. Respondent, on the other hand, is statutorily empowered to (1) determine a deficiency and (2) institute certain procedures necessary to collect the deficiency. Sections 6212, 6213(b) through (e), and 6301 through 6305. In the instant cases respondent determined that the petitioners owed additional taxes 3 and has clearly stated, in his deficiency notices, the basis for such adjustments to petitioners' taxes. 321 Petitioners contend that they are properly entitled to claim the Fifth Amendment privilege against self-incrimination with respect to the reporting of income and deductions on their Federal income tax returns and as a complete bar to the deficiency determination. These arguments are without merit. On numerous occasions this Court has held that the Fifth Amendment privilege against self-incrimination does not apply where the possibility of criminal prosecution is remote or unlikely. Wilkinson v. Commissioner,71 T.C. 633">71 T.C. 633 (1979); Roberts v. Commissioner,62 T.C. 834">62 T.C. 834, 838(1974); Figueiredo v. Commissioner,54 T.C. 1508">54 T.C. 1508, 1512 (1970). Petitioners have indicated that they do not believe they are subject to any potential criminal prosecution with respect to their income and the respondent has indicated that no criminal prosecution is contemplated. In fact, petitioners are only asked to pay a deficiency based in whole on a failure to report wages earned at their places of employment.They have an obligation to report all income from whatever source derived. Sections 6001, 6011 and 6012. Petitioners have alleged that respondent failed322 to consider various business expenses. However, when offered an opportunity to come forward and testify with respect to such expenses, petitioners claimed their Fifth Amendment privilege. Deductions are a matter of legislative grace. New Colonial Ice Co., Inc. v. Helvering,292 U.S. 435">292 U.S. 435, 440 (1934). Respondent's determination is prima facie correct and the burden of proof rests with petitioners. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. Since the petitioners have presented no evidence to show that they are entitled to additional deductions, we must sustain the respondent's determination. We likewise sustain the additions to tax under sections 6651(a) and 6653(a).Finally, petitioners contend that the salaries they received were paid in Federal Reserve notes, which in their view are not taxable at face value. This argument is totally without merit. In Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895, 897 (1977), we stated that: The courts have uniformly held that Federal Reserve notes constitute legal tender--"money"--which must be reported on a taxpayer's return in accordance with323 his method of accounting; and they have uniformly rejected, in a summary fashion, all arguments to the contrary….See also Sibla v. Commissioner,68 T.C. 422">68 T.C. 422, 430-431(1977); Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 193-194(1976), affd. without opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978); Hartman v. Commissioner,65 T.C. 542">65 T.C. 542, 547 (1975); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 84 (1975), affd. without opinion 559 F.2d 1207">559 F.2d 1207 (3d Cir. 1977). Accordingly, we will deny the petitioners' motion for summary judgment and grant the respondent's motion for summary judgment. Appropriate Orders and Decisions will be entered.Footnotes1. Petitioners initially filed with this Court a document captioned as a "Motion to Dismiss" in the United States District Court for the Southern District of Texas. Although not denominated as a motion for summary judgment, we have determined that the purpose of petitioners' "Motion to Dismiss" is to obtain a decision in their favor on the grounds that (1) the Fifth Amendment↩ is a complete bar to respondent's deficiency and (2) that respondent has failed to state a claim upon which relief can be granted. Petitioners asserted at the hearing that the Federal Reserve notes used to pay their salaries do not constitute legal tender and are therefore not taxable.2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years at issue.↩3. Respondent has also determined additions to tax under sections 6651(a) and 6653(a) against both petitioners.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621484/	APPEAL OF NEW YORK TRUST CO. ET AL., EXECUTORS OF THE ESTATE OF JOHN BALLOT, DECEASED.New York Trust Co. v. CommissionerDocket No. 6382.United States Board of Tax Appeals3 B.T.A. 583; 1925 BTA LEXIS 2883; February 4, 1925, Decided Submitted November 16, 1925. 2883 1. In order to confer on the Board jurisdiction of the subject matter of an appeal, the appeal must lie from the determination of a deficiency in tax, as defined in section 273 of the Revenue Act of 1924. 2. Where taxpayer filed a return and showed thereon an amount as the tax, and such amount is not increased by the Commissioner, there is not a deficiency, as defined by section 273 of the Revenue Act of 1924, notwithstanding a portion of such amount remains unpaid and a claim for its abatement has been rejected by the Commissioner. Leo B. Kagan, Esq., for the taxpayer. M. N. Fisher and J. T. Dortch, Esqs., for the Commissioner. KORNER583 Before KORNER. This is an appeal from an alleged final determination by the Commissioner of a deficiency in respect of income tax for the taxable missioner of a deficiency in respect of income tax for the taxable period from April 2, 1922, to December 31, 1922, arising under the Revenue Act of 1921. The exact amount in controversy appears to be $40,134.03. The Commissioner moved to dismiss the petition for lack of jurisdiction in the Board, on the ground that the appeal is not from a determination2884 of a deficiency, as defined by the Revenue Act of 1924. FINDINGS OF FACT. 1. John Ballot died at New York City, on April 1, 1922, leaving a will dated March 25, 1922, wherein he nominated and appointed the New York Trust Co. and Elsie Josina Ballot as executors and trustees under such will. 2. The New York Trust Co., as one of the executors of the estate of the said decedent, made and filed income-tax returns for the taxable period from January 1, 1922, to April 1, 1922, and for the taxable period from April 1, 1922, to December 31, 1922, as follows: (a) Return (Form 1040) of the net income of the decedent for the period from January 1, 1922, to April 1, 1922, the date of the death of the decedent. (b) Fiduciary return (Form 1041) on behalf of the estate of John Ballot, the decedent, showing the net income received by the executors for the period beginning April 1, 1922, and ending December 31, 1922. 584 (c) Individual income-tax return (Form 1040) for the estate of the decedent for the taxable period from April 2, 1922, to December 31, 1922. 3. An item of $108,750, which forms the subject of the controversy in the present appeal, was included by the2885 executors, as current taxable income of the estate of the decedent, in the fiduciary return (Form 1041) and in the individual return (Form 1040) on behalf of the estate for the period from April 2, 1922, to December 31, 1922. The tax computed on this item and so reported in the returns just referred to was in the amount of $40,134.03. 4. The taxpayer paid a portion of this tax as thus reported. This payment appears to have been in the amount of $29,824.62. The remainder of the tax just referred to was unpaid when, on or about December 14, 1923, the executors filed a claim for abatement (in the amount of $10,033.52) against the unpaid remainder of the tax shown on the return, and at the same time filed a claim for refund of the amount of the tax theretofore paid on such return. This refund claim was for $29,824.62. At or about the same time these claims were filed, the executors filed so-called "amended returns" (on Forms 1040 and 1041), and in both such amended returns the item of $108,750 was eliminated as taxable income and a revised tax liability was therein set up by reason of such elimination. 5. On February 11, 1925, the Commissioner notified the executors that an2886 audit of the income-tax return for the period January 1 to April 1, 1922, disclosed a deficiency in tax and that this deficiency was due to the fact that the item of income of $108,750 had accrued to decedent prior to his death and should have been reported in the return for the prior period, January 1 to April 1, 1922, instead of for the period April 2 to December 31, 1922, as it had in fact been reported by the executors. 6. On February 18, 1925, the executors filed with the Commissioner a protest against the proposed deficiency for the period from January 1 to April 1, 1922, called the Commissioner's attention to the claims for abatement and refund filed by them relative to the period from April 2 to December 31, 1922, and requested an explanation as to why no reference was made to these claims in the Commissioner's letter of February 11, 1925. 7. On March 14, 1925, the Commissioner, by letter, acknowledged the executors' letter of February 18, 1925, just referred to, and notified taxpayer that the Commissioner's letter of February 11, 1925, was sustained, i.e., that the item of income of $108,750 was properly allocable to the first period of the year 1922, instead of2887 to the latter period in that year, that the claims for abatement and refund for the latter period, in respect of such income, had been allowed, and that proper adjustments would thereafter be made by 585 way of certificates of overassessment and credit. The executors were requested to indicate whether or not they asquiesced in the determinations and adjustments indicated, and were further advised that, if they did not so acquiesce, a hearing would be granted in the matter upon request of the executors. 8. On March 25, 1925, the executors indicated their dissent and protest to the determinations and adjustments just outlined above, and on April 24, 1925, a conference was held in Washington, between the Commissioner and the executors. Thereafter, on July 7, 1925, the Commissioner forwarded to the taxpayer two letters. One of these letters advised the taxpayer that the item of income of $108,750 had finally been determined to be income for the second period of the year 1922, i.e., the period from April 2 to December 31, 1922. This determination was in accordance with the manner in which it had been reported by the executors in the income-tax returns filed by them and2888 first referred to hereinabove. That letter further advised the executros that their claims for abatement and refund covering this second period of the year 1922 would, accordingly, be rejected and that such rejection would appear on the next approved schedule. 9. In his other letter of July 7, 1925, the Commissioner advised the executors that he had reversed his ruling contained in his letter of February 11, 1925, and had determined that the item of income of $108,750 properly represented taxable income to the estate for the period April 2 to December 31, 1922. The letter added: "You may, therefore, disregard office letter dated February 11, 1925." The closing paragraph of this letter of July 7, 1925, contained the following: From the information now on hand it appears that the correct taxes are $4,137.10 and $40,134.03 for the periods January 1, to April 2, 1922, and April 2, to December 31, 1922, respectively, as stated on the original returns. (Italics ours.) 10. The executors treated the two letters of July 7, 1925, as statutory deficiency letters, under the provisions of the Revenue Act of 1924, and the Commissioner's determinations therein as the final2889 determination of a deficiency, as defined in that statute, and brought this appeal. OPINION. KORNER, Chairman: The issue here raised is as to the jurisdiction of this Board to hear and determine the merits of the controversy between the parties. The executors have filed a petition appealing from an alleged final determination by the Commissioner of a deficiency in income tax for the period from April 2, 1922, to December586 31, 1922, due from the estate of the testator. The Commissioner has filed a motion to dismiss the appeal, for the reason that there has not been a determination of a deficiency in tax, as provided by the Revenue Act of 1924, as a predicate for the right of the executors to appeal here. Stripped to their essential elements, the facts are: The executors made a return of income and tax thereon. Thereafter, they discovered what they insist was error in that they included an item as income which was not income. They filed claims for refund and abatement, supported by an amended return showing the income, and the tax thereon, in a lesser amount. After certain conferences were held, the Commissioner rejected the claims and determined2890 the tax to be as reported by the executors in the returns originally filed by them. Whether or not jurisdiction obtains turns on whether there was a determination of a deficiency by the Commissioner. Much of the executors' argument was directed to the issue of determination as defined in , and as applied in , and similar cases. We pass for the moment the question of determination, because a mere determination by the Commissioner is, of itself, not sufficient to support jurisdiction. The determination from which a taxpayer may appeal is one which fixes the amount of deficiency in tax. It is the final decision by which the controversy as to the deficiency is settled and terminated, and by which a final conclusion is reached relative thereto and the extent and measure of the deficiency defined. . If, therefore, the determination made by the Commissioner is not the determination of a deficiency as defined by the statute, then jurisdiction does not obtain. The Revenue Act of 1924 expressly defines the2891 term "deficiency," as follows: SEC. 273. As used in this title the term "deficiency" means - (1) The amount by which the tax imposed by this title exceeds the amount shown as the tax by the taxpayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax; or (2) If no amount is shown as the tax by the taxpayer upon his return, or if no return is made by the taxpayer, then the amount by which the tax exceeds the amounts previously assessed (or collected without assessment) as a deficiency; but such amounts previously assessed, or collected without assessment, shall first be decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax. 587 The facts disclose that a return was filed by the executors for the period in question here. The amount shown as the tax on that return has not been increased by any previous assessment (or collection made without assessment) as a deficiency, nor has the amount shown2892 as the tax upon that return been decreased by any amounts abated, credited, refunded, or otherwise repaid in respect of such tax. This being so, the amount shown as the tax on the return filed by the executors has been in nowise changed by any determination of the Commissioner. The letter of the Commissioner from which this appeal is taken does not find a deficiency. It advised the taxpayer that the original return as filed was correct. It did not advise the executors that the Commissioner proposed to assess a tax greater than that shown by them on their return. The Commissioner is now proposing to collect the exact amount shown as the tax upon the return as filed by the executors; hence, it can not be said there is a proposal to collect a deficiency in tax, as defined in section 273, above quoted. But the executors call attention to the fact that they filed a claim for refund (of a portion of the tax paid on the return filed by them) and a claim for abatement (of the portion of the tax remaining unpaid on the return filed by them), and that they also filed an amended return, wherein is shown the tax to be as now computed and contended for by them. They argue from this the2893 following propositions: (1) The return of the executors should be read as a whole, including the amended return and the claims for refund and abatement filed by them; (2) a deficiency may exist in the case of an original erroneous return filed by a taxpayer; (3) the allowance by the Commissioner on March 14, 1925, of the claims of abatement and refund, on the basis of the amended return as filed by the executors, brings this case within the literal provisions of section 273(1) of the Revenue Act of 1924. We will discuss the propositions in their order. The Board has shown, in the , that no provision is made for the filing of an amended return in either of the Revenue Acts of 1916, 1917, 1918, or 1921. In that appeal the Commissioner contended that, by the filing of an amended return, the taxpayer had extended the period of statutory limitation on the assessment and collection of a tax, in so far as such amended return disclosed taxes in addition to those disclosed by the original return. This contention was based on the theory that, to the extent of such additional taxes so disclosed, the amended return amounted to2894 a limited waiver of the taxpayer to have such additional taxes determined, assessed, and collected within the statutory period running from the date of the filing of such amended return. It is unnecessary to repeat here the reasoning which led to the Board's 588 conclusion in the opinion in that appeal. Suffice it to say that, in conformity with the decision in that appeal, the Board here holds that an amended return can not be considered such a return as may be taken by this Board as a predicate for jurisdiction of the instant appeal. Ibid. p. 241. To the same effect see . In support of their second proposition (that a deficiency may exist in the case of an original erroneous return filed by a taxpayer), the executors cite , and . Both are clearly to be distinguished from the instant appeal. In the Continental Audit Appeal the taxpayer filed a document in the form of a return, but did not purport to show as the tax the amounts set out in that document. 2895 At the time of filing the document, referred to as the return, it annexed to it a statement or protest to the effect that no tax was due from it and that the return was not a true return of its tax liability. The Board held that the statement annexed to the return constituted a part of the return and should not be ignored, and that, when read as a whole, the entire return showed no amount as the tax or showed the tax to be zero. In the instant appeal these elements are lacking. The executors filed their return and showed thereon certain amounts as the tax. Thereafter, they sought to revise this amount and filed an amended return, together with abatement and refund claims, for that purpose. We do not believe the situations just compared are parallel, nor that the Continental Audit Appeal is authority for the executors' second proposition. In , the Commissioner determined a deficiency to exist. That deficiency was in accordance with the meaning defined in section 273 of the Revenue Act of 1924. As a defense to the deficiency proposed, the taxpayer set up an overpayment of taxes on its original return. 2896 It was not the alleged error in the original return which was taken by the Board as the predicate for its jurisdiction, but it was the statutory deficiency determined by the Commissioner. In line with its decision in the , the Board held that it might consider the overpayment claimed by the taxpayer as a proper defense to an asserted deficiency. Jackman's Appeal does not offer a parallel to the instant appeal and does not support the executors' contention here. The third proposition argued by the executors depends for its premise on a favorable resolution of their first two propositions and must stand or fall with them. Since we conclude that the premise is not well founded, the executors' conclusions to the third proposition must fail. 589 We are of the opinion that the letters of July 7, 1925, received by the executors from the Commissioner, do not constitute a determination by that officer of a deficiency in tax, as defined by the statute. In view of our position on this point, it is unnecessary to discuss whether the Commissioner's letters constitute a final determination of some other issue between2897 the parties. The Board is without jurisdiction and the appeal must be dismissed for that reason.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621485/	Jack and Florence Baker, Petitioners v. Commissioner of Internal Revenue, RespondentBaker v. CommissionerDocket No. 3914-77United States Tax Court75 T.C. 166; 1980 U.S. Tax Ct. LEXIS 36; October 22, 1980, Filed 36 Decision will be entered under Rule 155. T received interest-free loans from a family corporation of which he was an officer-stockholder. Held: T did not realize any taxable income based upon his use or enjoyment of such tax-free loans. Stare decisis requires that Dean v. Commissioner, 35 T.C. 1083">35 T.C. 1083 (1961), be followed in the circumstances of this issue, nor is Dean inapplicable on this record by reason of T's investments in federally tax-exempt securities. Benjamin Lewis, for the petitioners.Joan Ronder Domike, for the respondent. Raum, Judge. RAUM166 OPINIONThe Commissioner determined deficiencies in petitioners' income taxes as follows: 167 YearDeficiency1973$ 1,57519743,46219751,97637 After concessions, the only issue presented by this fully stipulated case is whether Jack Baker, the husband petitioner, realized taxable income as a consequence of interest-free loans from Sue Brett, Inc., of which he is the president. He, his wife, and their children own all the issued and outstanding common stock of the corporation.At the time of the filing of their petition herein, petitioners were New York residents.During the years in issue, Mr. Baker maintained a running loan account with the corporation, and used the money borrowed to make estimated tax payments (Federal, State, and city). The loan account was maintained on the corporation's books as "Loans receivable -- Officers." There were no notes, no specific plan of repayment, and no interest was charged or paid. During 1973, Mr. Baker made monthly repayments in amounts of $ 1,000 to $ 3,000. In 1974, he made one repayment of $ 50,000, and made no repayments during 1975.In the notice of deficiency, the Commissioner determined that petitioners realized unreported taxable income with respect to the stipulated average balances of the interest-free loans from the corporation (based on specified interest rates), as 38 shown in the following schedule:AverageloanInterestInterestYearbalancerateincome1973$ 36,8709 percent$ 3,318197495,8348 1/2 percent8,146197552,6897 1/2 percent3,952The parties have stipulated that at a minimum, Mr. Baker would have had to pay interest at the above rates if he had borrowed from a lending institution.At all times relevant, Sue Brett's accumulated earnings and profits were in excess of the amounts determined by the Commissioner to be the equivalent of interest on the interest-free loans. Mr. Baker's annual salary from Sue Brett, Inc., was 168 $ 78,000 in 1973 and 1974, and $ 79,500 in 1975. The parties have agreed that Mr. Baker's compensation from the corporation was not unreasonable and that additional compensation equivalent to the amounts determined by the Commissioner to be additional income to him would not result in unreasonable compensation if paid by the corporation.On December 31, 1972, petitioners owned federally tax-exempt securities totaling $ 129,000, and during the years 1973, 1974, and 1975, they made investments of $ 45,000 in each year in federally tax-exempt securities. On December39 31, 1975, they owned a total of $ 245,000 in such securities. The record does not show that there was any correlation in time or otherwise between the investments in the tax-exempt securities and the interest-free loans.In asking us to sustain the deficiencies, the Government recognizes that its position is adverse to Dean v. Commissioner, 35 T.C. 1083 (1961). It contends that Dean was wrongly decided and should be overruled. We reaffirm Dean, and hold further that, on this record, Dean is not rendered inapplicable by reason of petitioners' investments in federally tax-exempt securities.(1) The Government's frontal attack upon Dean began in 1973 with the announcement of the Commissioner's "nonacquiescence" in Dean. 2 C.B. 4">1973-2 C.B. 4. Thereafter, the first case to face the issue squarely in this Court in the context of a stockholder-officer relationship to the corporation was Suttle v. Commissioner, 37 T.C.M. (CCH) 1638">37 T.C.M. 1638, 47 P-H Memo T.C. par. 78,393 (1978), which reaffirmed Dean. Cf. Greenspun v. Commissioner, 72 T.C. 931">72 T.C. 931 (1979),40 on appeal (9th Cir., Nov. 20, 1979). Suttle has since been affirmed by the Fourth Circuit, 625 F. 2d 1127 (1980). Meanwhile, the issue was again presented to this Court in Zager v. Commissioner, 72 T.C. 1009 (1979), on appeal (5th Cir., Feb. 5, 1980). There, we traced the history of the problem back to the first of our modern revenue acts in 1913, and emphasized our conclusion to apply the principle of stare decisis. Our discussion of the matter in Zager is particularly pertinent and we quote extensively from our opinion in that case (72 T.C. at 1010-1012, 1013):Our modern income tax laws have been in effect continuously since 1913, and the various applicable statutes, using one form of words or another, have characterized the income subject to tax in broad and sweeping terms. Yet, at the time Dean was presented to this Court, there was no indication that there 169 had previously ever been even a single instance in which the Government had taken the position, either in litigation (successfully or unsuccessfully) or by rule, regulation, or administrative practice in any manner, 41 that an interest-free loan by a corporation to its stockholder-officers resulted in the realization of income which the statute sought to reach. Indeed, the position advocated in this respect by the Government in Dean would appear to have been nothing more than an afterthought. No such issue was raised in the deficiency notice or even in the answer as originally filed in response to the taxpayers' petition therein. The point was first raised in an amended answer and appears to have had its origin in a fortuitous dictum in a then-recent Memorandum Opinion of this Court involving gift taxes of the same taxpayers which had been promulgated several months prior to the filing of the amended answer. (See 35 T.C. at 1089.) The theory was further refined in the Government's brief.The problems gave us much difficulty because there appeared superficially to be but little difference between the interest-free use of corporate funds and the rent-free occupancy of corporate property by a stockholder or officer that had been held to constitute a tax benefit the fair value of which was includable in gross income. Conceptually, it did seem that the same result 42 should be reached in both types of cases. Yet, the fact that the Treasury had not theretofore -- for some 48 years -- attempted to treat as income the benefits attributable to such interest-free loans was highly troublesome. We searched for a distinction that would support the administrative practice which had endured for so long a period. And we found a difference in that if the taxpayer had undertaken to pay interest or rent, he would generally have been entitled to a deduction for the payment of interest but not for rent. Thus, the tax benefit resulting from the exclusion from gross income of any amount attributable to such an interest-free loan would be matched dollar for dollar by the tax benefit attributable to the interest deduction in the case of an interest-bearing loan, assuming of course that the interest were fixed at a fair rate. To be sure, there were peripheral situations in which the distinction would not hold, but in general, the neutralizing effect of the interest deduction did seem to afford a basis for supporting the differing treatment which the Government itself had long accorded to interest-free loans and rent-free use of property. In reaching our conclusion, 43 we recognized that "the question may not be completely free from doubt" (35 T.C. at 1089), and our opinion, although reflecting the views of a majority of the Court, was not unanimous.Notwithstanding the potential importance of Dean, the Government failed to pursue an appeal from our decision and accepted the result for a period of some 12 years thereafter. It was not until 1973 that the Commissioner announced his "nonacquiescence," 2 C.B. 4">1973-2 C.B. 4, and mounted a campaign to have Dean overruled. * * ** * * the prior practice spanned a period of 60 years -- from 1913 to 1973. There were undoubtedly at least many thousands of instances during this period when the issue could have been raised. We know that there are a great number of corporations that are wholly owned or subject to the control of a dominant stockholder. And we also know from the records in numerous cases that have been before us that the flow of funds -- often on an informal basis -- between 170 such stockholder and his corporation is a very common occurrence. Sometimes, notes are executed; at other times, there are merely book entries; and 44 at still other times, there may be no documentation whatever. Dean gave effect to the administrative practice that had existed for 48 years as of that time in respect of the non-interest-bearing loans in such situations, and that practice continued thereafter for another 12 years until the Commissioner took his present position by publishing his "nonacquiescence." Moreover, although cogent theoretical arguments could be advanced both for and against the result reached in Dean, it has now been on the books for 18 years. Too much water has passed over the dam to warrant reexamining the situation judicially. We think that the application of the principle of stare decisis is peculiarly called for here, and that if a contrary result is deemed desirable, the appropriate remedy should be legislative rather than judicial.We have since refused to reconsider Dean in several other cases. Creel v. Commissioner, 72 T.C. 1173">72 T.C. 1173, 1179 (1979), on appeal (5th Cir., Feb. 15, 1980); Beaton v. Commissioner, a Memorandum Opinion of this Court, 40 T.C.M. (CCH) 1324">40 T.C.M. 1324, 1327, 49 P-H Memo T.C. par. 80,413, pp. 1779, 1780 (1980);45 Parks v. Commissioner, a Memorandum Opinion of this Court, 40 T.C.M. (CCH) 1228">40 T.C.M. 1228, 1230, 49 P-H Memo T.C. par. 80, 382, p. 1682 (1980); Estate of Liechtung v. Commissioner, a Memorandum Opinion of this Court, 40 T.C.M. (CCH) 1118">40 T.C.M. 1118, 49 P-H Memo T.C. par. 80,352, p. 1569 (1980); Martin v. Commissioner, a Memorandum Opinion of this Court, 39 T.C.M. (CCH) 531">39 T.C.M. 531, 535, 48 P-H Memo T.C. par. 79,469, p. 1833 (1979); cf. Marsh v. Commissioner, 73 T.C. 317">73 T.C. 317, 326 (1979). We reach the same conclusion here. The problem is peculiarly one that calls for a legislative remedy, if one is thought to be appropriate, rather than a judicial departure from the principle of stare decisis.146 (2) The Government makes an alternative argument which in essence is that even if Dean is not overruled, it is distinguishable from the instant case because Mr. Baker's indebtedness to his corporation "was incurred or continued to carry or purchase tax-exempt securities"; that as a consequence, any interest that might be paid by him on such indebtedness would not be deductible by reason of section 265(2), I.R.C. 1954; 247 and that, therefore, the underlying basis for Dean would be absent here 171 thereby rendering that case inapplicable. The possibility that Dean might be distinguishable if section 265(2) were applicable was suggested in Zager (72 T.C. at 1012) as well as in Greenspun (72 T.C. at 948-950), but both opinions made clear that the matter would be decided only when we are confronted with a case specifically raising the issue. 3 We hold against the Government on this alternative issue.48 In the first place, there is serious question whether the issue is properly before the Court. It was not mentioned either in the deficiency notice or in the pleadings, and it was first raised in the Government's brief. This case is thus procedurally in the same posture as Estate of Liechtung v. Commissioner, supra, where the Court declined to reach the issue in such circumstances.In any event, section 265(2) does not appear to be applicable here. The stipulation of the parties explicitly states that "The money borrowed from the corporation was used to make estimated tax payments (Federal, State, and city)." And as noted above, the record does not show any correlation in time or otherwise between the corporate loans and the investments in the tax-exempt securities. Accordingly, it does not appear that such loan indebtedness was "incurred or continued to carry or purchase tax-exempt securities" within section 265(2). Although section 265(2) might be read to cover this situation, the courts have given it a restricted construction that calls for more than 172 the "mere simultaneous existence" of the taxpayer's indebtedness and his ownership of the tax-exempt securities. 49 Swenson Land & Cattle Co. v. Commissioner, 64 T.C. 686">64 T.C. 686, 695 (1975). The statute has been interpreted as requiring a "tighter nexus between the two," a "purposive connection" between the taxpayer's indebtedness and the ownership of the tax-exempt obligations. Swenson Land & Cattle Co. v. Commissioner, 64 T.C. at 696. See also New Mexico Bancorporation v. Commissioner, 74 T.C. 1342">74 T.C. 1342, 1352-1353 (1980). In view of the stipulation of the parties referred to above, the purpose of the tax-free loans was quite clearly to make payments on estimated taxes, and we cannot make the necessary finding as to the nexus between such loans and the tax-exempt securities that would bring section 265(2) into play here.In order to give effect to petitioners' concession in respect of another issue,Decision will be entered under Rule 155. Footnotes1. An additional ground for regarding the problem as legislative rather than judicial was pointed out in Zager, in that interest-free loans to officer-stockholders are akin to fringe benefits, the taxability of which is now the subject of congressional scrutiny. Zager v. Commissioner, 72 T.C. 1009">72 T.C. 1009, 1013-1014↩.2. SEC. 265. EXPENSES AND INTEREST RELATING TO TAX-EXEMPT INCOME.No deduction shall be allowed for --* * * * (2) Interest. -- Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from the taxes imposed by this subtitle.↩3. In presenting its principal argument that Dean should be overruled, the Government challenges the theory articulated in Dean that the deductibility of interest that might be payable on borrowed funds is a relevant consideration. It points out quite correctly that a deduction under section 163(a) for interest paid is a matter of legislative grace the right to which must be established under appropriate criteria, and that the question of what is to be included in income is a separate matter. However, there may well be a relationship between the two, and what we said in this connection in Zager (72 T.C. at 1012 n. 1) bears repetition here:"The question, of course, is whether the benefit derived from the interest-free loan is to be treated as having the quality of realized income; but it is not accurate to suggest that the availability of a related deduction is wholly irrelevant in determining whether the benefit involved should be treated as realized income. Thus, the repayment of a loan is ordinarily considered as a return of capital and not as a receipt of income; but if the creditor has previously charged off that loan and taken a bad-debt deduction in a prior year, the subsequent repayment is includable in gross income. Of course, the analogy is not perfect, but it serves to indicate that the quality of a benefit or receipt as income may be affected by considerations extraneous to the inherent nature of the benefit or receipt itself."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621486/	FREDERICK A. PATMON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPatmon v. CommissionerDocket No. 26954-86United States Tax CourtT.C. Memo 1989-343; 1989 Tax Ct. Memo LEXIS 342; 57 T.C.M. (CCH) 974; T.C.M. (RIA) 89343; July 18, 1989342 Held: Petitioner is not entitled to depreciation deductions with respect to a master recording. Hallison H. Young, for the petitioner. Timothy S. Murphy, for the respondent. WHITAKERMEMORANDUM OPINION WHITAKER, Judge: By statutory notice dated April 11, 1986, respondent determined a deficiency in petitioner's 1980 Federal income tax in the amount of $ 22,940.57. Respondent also determined additions to tax pursuant to sections 6651(a)(1), 1 6653(a), and 6654, in the respective amounts of $ 5,735.14, $ 1,147.03, and $ 1,463.16. 343 By order dated July 14, 1987, we limited the issues to whether petitioner is entitled to Schedule C loss deductions with respect to a master recording. By order dated February 19, 1988, we expanded the issues to include petitioner's entitlement to a net operating loss carry forward deduction, but only to the extent determined in a separate proceeding with respect to petitioner's 1979 Federal income taxes. For convenience, the Findings of Fact and Opinion are combined. Some of the facts have been deemed admitted pursuant to a motion filed by respondent pursuant to Rule 91(f) which we granted on February 19, 1988. At the time he filed his petition herein, petitioner was a resident of Detroit, Michigan. This case concerns petitioner's entitlement to depreciation deductions pursuant to section 167 with respect to a master recording. This case was tried in Detroit, Michigan, on December 13, 1988. Petitioner was not present at trial, and therefore did not testify. *344 Rather, he asserted his Fifth Amendment privilege against self-incrimination through his counsel. The burden of proof in this case is upon petitioner. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Petitioner has failed to produce any acceptable evidence with respect to the merits of his case. Rather, petitioner has chosen to argue that the deficiency should be reduced to zero due to respondent's perceived abuses. We find these arguments to be wholly without merit. We therefore find for respondent on all remaining issues. Because of our earlier orders limiting the issues, Decision will be entered under Rule 155. Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621487/	James J. Glenn and Mary L. Glenn, et al. 1 v. Commissioner. Glenn v. CommissionerDocket Nos. 837-67, 838-67, 847-67, 888-67.United States Tax CourtT.C. Memo 1970-184; 1970 Tax Ct. Memo LEXIS 173; 29 T.C.M. (CCH) 833; T.C.M. (RIA) 70184; June 30, 1970, Filed 173 1. Held, the amounts paid in 1960 and 1961 by the petitioner-company as salaries and bonuses to each of its officers (Bradt, Glenn, and Killian) constituted reasonable compensation for services rendered and are deductible under sec. 162(a)(1), I.R.C. 1954. 2. Held, a portion of the traveling, entertainment, and gift expenses of Bradt, Glenn, and Killian which were paid by the company represented personal expenses of these individuals and were not proximately related to corporate business; therefore, these personal expenses are nondeductible by the company and includable in the gross income of the individuals. The remaining portion of the expenses of this type were ordinary and necessary business expenses which are deductible by the company under sec. 162(a), I.R.C. 1954. 3. Held, Glenn made charitable contributions in 1960 and 1961 which are deductible under sec. 170(a), I.R.C. 1954 in the total amounts of $569 and $752, respectively. 4. Held, respondent's disallowance of Glenn's deduction of an alleged casualty loss in 1961 under sec. 165(c)(3), I.R.C. 1954 is sustained because Glenn failed to carry his burden of proving that a loss actually occurred. Robert C. Duffy, Jr., 1938-42 174 Philadelphia National Bank Bldg., Philadelphia, Pa., and William G. O'Neill, 14th Floor, Packard Bldg., Philadelphia, Pa., for the petitioners. Steven P. Cadden for the respondent. 834 HOYTMemorandum Findings of Fact and Opinion HOYT, Judge: Respondent determined the following deficiencies with respect to petitioners' income taxes: 10Deficiency19601961James J. Glenn and Mary L. Glenn, Docket No. 837-67$ 1,237.59$ 790.85Glenn-Killian Color Com- pany, Docket No. 838-6718,803.317,814.06Herbert Bradt and Irene P. Bradt, Docket No. 847-671,134.80388.43James T. Killian and Mar- jorie A. Killian, DocketNo. 888-671,396.721,807.38These cases were consolidated for trial and opinion. Some of the issues have been conceded by petitioners, and the issues remaining for our decision are as follows: (1) Whether the amounts paid by the petitioner-company as salaries and bonuses to each of its officers (petitioners Bradt, Glenn, and Killian) are deductible as reasonable compensation for services rendered under sec. 162(a)(1), I.R.C. 1954. (2) Whether certain traveling, entertainment, and gift expenses of each of these officers, paid by the company in 1960 and 1961, are deductible by the company as 175 ordinary and necessary business expenses under sec. 162(a), I.R.C. 1954; or whether these expenses, or any portion thereof, represented the personal expenses of the officers, the payment of which is nondeductible by the company and includable in the gross income of the officers for whom the payment was made. (3) Whether in 1960 and 1961 petitioner Glenn made certain deductible charitable contributions under sec. 170(a), I.R.C. 1954, in excess of the amount allowed by respondent. (4) Whether petitioner Glenn incurred a deductible casualty loss within the meaning of sec. 165(c)(3), I.R.C. 1954, for the destruction of a television antenna in a windstorm in 1961. Findings of Fact Some of the facts have been stipulated and are so found. The stipulations and exhibits thereto are incorporated herein by this reference. Petitioners James J. and Mary L. Glenn are husband and wife, as are petitioners James T. and Marjorie A. Killian, and petitioners Herbert and Irene P. Bradt. At the time of the filing of their petitions herein the Glenns resided in Wayne, Pennsylvania, the Killians resided in Valley Forge, Pennsylvania, and the Bradts resided in Medford Lakes, New Jersey. Each couple filed 176 joint income tax returns for the years 1960 and 1961 with the district director of internal revenue, Philadelphia, Pennsylvania. The Glenn-Killian Color Company, also a petitioner herein, is a corporation which was organized on February 11, 1946, under the laws of the Commonwealth of Pennsylvania; at the time of the filing of its petition herein, its principal office was in Philadelphia, Pennsylvania. The said company's United States corporation income tax returns for the taxable years 1960 and 1961 were filed on the accrual basis with the district director of internal revenue, Philadelphia, Pennsylvania. James J. Glenn (hereinafter referred to as "Glenn") and James T. Killian (hereinafter referred to as "Killian") became friends at the Massachusetts Institute of Technology where they were both majoring in physics. Prior to graduation, they collaborated on a thesis concerning the physical measurement of color. In this thesis, they made spectrophotometric measurements of the "Munsell Color System," the latter being a set of colors which Munsell had classified in terms of hue, brightness, and purity. The end result of the thesis was the establishment of a mathematically determined standard 177 for the measurement of the colors in the Munsell system. Glenn and Killian both graduated from M.I.T. in 1935 with a Bachelor of Science degree in physics. After graduation, Glenn worked for the Color Instrument Corporation in New York City, New York, where he was engaged in the development of electronic instruments for the physical measurement of color. In January, 1937, he went to work for Shelton Looms in Shelton, Connecticut, where his main duty was to obtain an "automatic record" from a spectrophotometer, the most advanced instrument for the physical measurement of color. He used the spectrophotometer for "color control and control research, and to interpret the results of the physical measurements." Glenn was in the Navy from the spring of 1942 until December 1945. After his graduation in 1935, Killian worked for a year on the instructing staff at M.I.T. 835 Then he worked for a year in Chicago, Illinois, for Sears, Roebuck and Company in a research laboratory. Subsequently, he worked for two years for the Container Corporation, Philadelphia, Pennsylvania, where he was in charge of ink. During the ensuing six-year period he worked for the Pope & Gray Company, an ink company 178 in New York. On February 11, 1946, Glenn and Killian organized and incorporated the Glenn-Killian Color Company (hereinafter referred to as "the Company"). The Company has been primarily engaged in the manufacture and sale of printing inks. Glenn and Killian have been employees of the Company since its organization. When the Company was first started, Killian had had a considerable amount of experience in both making and selling ink. Although Glenn had a background in color, he did not know how to manufacture ink, and it was necessary for Killian to teach Glenn this aspect of the business. After he received this preliminary training, Glenn worked for some time almost exclusively "on the inside" manufacturing the ink; during this same period Killian was primarily involved with selling the ink. During the first few years the Company only had one other employee. Herbert Bradt (hereinafter referred to as "Bradt") became an employee of the Company in 1952. Prior to that time he had been a lithograph printing specialist and had been the superintendent of one of the largest offset printing plants in Philadelphia, Pennsylvania. During his first few years with the Company, Bradt did some selling 179 "on the outside," but spent most of his time working in the laboratory, where he was engaged in research and development. Soon after he was employed, Bradt suggested that sales would be increased if the Company adopted some sort of color catalogue containing all the popular colors used by the printing industry. During the following three-year period, Glenn and Killian enlarged on this idea and developed the "Offset Color Formulator" which was both a color catalogue and a color matching system. They were able to develop this system because of their prior experience in the field of color measurement. This new color system enabled printers who were customers of the Company to make, by themselves, any one of about 575 colors of ink. The printers would buy eight "standard" colors of ink, plus black and white, and mix them according to the exact proportions which were set forth on the color cards in the "Offset Color Formulator" The system enabled the printers to match almost any color which they needed in a hurry. The color matching system was a significant contribution to the success of the business. Not only was the system widely accepted by the printing industry, but it was subsequently 180 adopted by most of the other ink manufacturers. The gross receipts of the Company from 1946 through 1961 were as follows: YearGross Receipts1946$ 31,832.05194730,552.22194833,798.51194941,806.08195070,714.371951119,363.181952148,007.511953197,465.7 31954226,494.671955247,182.491956320,217.011957347,884.601958414,844.071959489,459.911960579,044.301961594,461.25During the taxable years 1960 and 1961, Glenn, Killian, and Bradt each owned eight shares, or 32 percent of the 25 outstanding shares of common stock of the Company. The remaining share was owned by J. R. Pie, who did not work for the Company. During those years Killian served as president of the corporation, Bradt served as vice president, and Glenn was the secretary - treasurer. These three men were also the only directors of the corporation. During 1960 and 1961, Glenn, Killian, and Bradt were the only managers of the Company and were each involved in all of the major functions of the corporate business - production, research and development, and sales. However, during those years Glenn was primarily responsible for production, Killian was primarily concerned with sales (he spent about half of his time "on the outside" contacting 181 customers), and Bradt was primarily responsible for research and development. During the years 1946 through 1966, Glenn, Killian, and Bradt were employed full time and received salaries, bonuses, and commissions from the Company as follows: 836 J. J. GlennJ. T. KillianH. Bradt1946$ 1,650.00$ 1,650.0019473,850.003,850.0019484,060.004,060.0019495,055.005,055.0019505,555.005,055.0019516,075.006,175.0019526,175.006,175.00$ 5,850.0019538,200.008,200.008,400.00195414,026.1714,026.178,680.00195514,734.1514,734.1510,633.751956 13,250.0013,250.0012,103.75195713,250.0013,250.0013,232.501958Bonus7,032.227,032.225,203.00Salary 15,900.0015,900.0015,900.00Total$22,932.22$22,932.22$21,103.001959Bonus$12,536.41$12,536.41$11,000.00Salary 15,600.0015,600.0015,600.00Total$28,136.41$28,136.41$26,600.001960Bonus$11,069.00$12,538.54$10,000.00Salary 15,600.0015,600.0015,600.00Total$26,669.00$28,138.54$25,600.001961Bonus$ 7,695.14$ 5,434.36$ 2,600.00Salary 15,600.0015,600.0015,600.00Total$23,295.14$21,034.36$18,200.001962Bonus$15,000.00Salary 31,200.00 $15,600.00$10,400.00Total$46,200.001963Com. *182 $ 3,552.85$ 3,540.94Salary $31,200.0015,300.0010,400.00Total$31,200.00$18,852.85$13,940.941964Com.$13,130.43$13,901.67Bonus$15,000.00Salary 31,800.0015,900.0010,600.00Total$46,800.00$29,030.43$24,501.671965Com.$13,242.12$18,613.58Bonus$15,000.00Salary 31,200.0015,600.0010,400.00 Total$46,200.00$28,842.12$29,013.581966Com.$12,929.13$28,846.94Bonus$15,000.00Salary 31,000.0015,600.0010,400.00Total$46,000.00$28,529.13$39,246.94During the years 1958 through 1961 the Company's method of compensation for each of the individual officers was a system of basic yearly salary payments determined near the beginning of the year and a bonus, determined at the end of the year. The minutes of a special meeting of the board of directors which was held on December 1, 837 1960, and another which was held on December 1, 1961, reveal that the bonuses in the latter years were given only after a detailed review of the financial statements and consideration of the services performed. The directors examined the amount of earnings and profits at the end of every three months, after the accountant for the corporation had taken an inventory. When the above-mentioned meetings were held to determine the amount of bonuses for the year, the amount of earnings and profits earned during the last quarter of the year had not yet been determined, and could only be estimated. Since each of the three officers of the Company was involved in all major aspects of the corporate business, and each one spent a different amount of time selling ink, the compensation for services which was paid in 1960 and 1961 was not based upon a percentage 183 of sales or corporate earnings. In fact, the total officers' compensation paid in 1960 and 1961 amounted to only 13.9 percent and 10.5 percent of the net sales, respectively, whereas equivalent calculations with respect to 1958 and 1959 amounted to 16.13 percent and 16.9 percent, respectively. During the period from 1952 through 1961, the total compensation which was paid by the Company to employees other than officers gradually increased from $19,180.90, representing 12.9 percent of net sales, to $132,117, or 22.2 percent of net sales. By 1960 and 1961 the Company had increased the size of its staff to approximately 25 employees. During 1960 and 1961 there were only two salesmen working for the Company other than the officers. One of these men left the Company some time during 1961 because he was not successful in making sales. The other one received a salary of approximately $13,000 a year. His contribution to the success of the business was small in comparison to the services performed by each of the officers. Neither of these salesmen received a bonus during the taxable years. Alfred W. Rexford, the president of one of the Company's competitors, who had been in the ink business 184 for 44 years, had been familiar with the operations of the Company since its organization in 1946. Rexford performs essentially the same duties for his company as the petitioner-officers performed in 1960 and 1961. He was of the opinion that each of the petitioner-officers possessed unique qualities and combinations of skills which distinguished them from other men occupying similar positions in the ink business. He had recently tried to hire both Glenn and Bradt but had been unsuccessful. In 1960 and 1961 Rexford received a salary of $30,000 plus a bonus amounting to 10 percent of his company's profits before taxes. The gross receipts of his company during those years were approximately one-half of the amount of petitioner-Company. Rexford was of the opinion that reasonable compensation (including a bonus) during each of these years for Glenn, Killian, and Bradt, would have been $30,000, $28,000, and $26,000, respectively. As noted previously, the actual amounts of compensation paid to these petitioner-officers were $26,669, $28,138.54, and $25,600, respectively in 1960, and $23,295.14, $21,034.36, $18,200, respectively, in 1961. Since its inception, the Company has grown rapidly, 185 and generally has not had enough physical space in which to comfortably operate the business. The Company has never declared or paid a dividend, and one of the reasons for this policy has been to save money for the physical expansion of the business. Over the years the Company has in fact expanded and recently purchased property to accommodate its continuing growth. Paul F. Ryan has been the certified public accountant for the Company since 1947 and has been paid on a fee basis for his services. During 1960 and 1961 he made all the ledger entries, prepared the tax returns, and, in general, was personally familiar with the financial transactions of the Company. During the taxable years in issue the Company employed two distinct methods for the payment of expenses incurred by its officers and other employees for travel, entertainment, and gifts, in addition to certain expenses for other miscellaneous items. Some of these expenses were paid directly by the Company, usually when the expenses were large or when the employee had used a credit card bearing the Company's name. The other expenses were paid by the employees, who were later reimbursed by the Company pursuant to the system set 186 forth below. In 1959 the Company established a system for the reimbursement of employees for their expenses under which the employees were required to submit "vouchers" before 838 receiving payment from the Company. The "vouchers" were printed forms on which the employee was asked to supply the following information: 2 the item for which the expense; the applicable category of the expense (the stated categories included both "Travel" and "Entertainment"); and the name of the customer to whom the expense was attributable, if applicable. Each "voucher" was submitted to the Company's accountant, who subsequently checked it for mathematical accuracy. In some instances the employees also submitted documentary evidence of their expenses to the accountant. The accountant then wrote a check for the amount of the claimed expenses and submitted the "voucher" and check to Glenn, the secretary - treasurer, for his approval. At no time during the years in question were any questions raised by the accountant, Glenn, or either 187 one of the other officers of the corporation with respect to the legitimacy or propriety of the expenses claimed for reimbursement on any of the "vouchers" submitted by the petitioner-officers. The following schedule 3190 sets forth the amounts deducted as traveling and entertainment expenses by the Company and disallowed by the respondent with respect to each of the petitioner-officers during the years in issue: 10 HERBERT BRADT 10 1960Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals$361.50Train$30.00Car Expense104.26Misc.36.16Entertainment$2,525.24B. Direct:Gulf Oil Corp.563.87Atlantic Refg. Co.17.35Car License 10.00Total $725.48$2,525.24$397.66Total Amount Claimed $3,648.38Amounts Disallowed:1/5 Travel$145.09Entertainment$2,525.241/3 Meals $120.50Total $145.09$2,525.24$120.50Total Amount Disallowed $2,790.83 10 HERBERT BRADT 10 1961Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals$422.00Car Expense$159.15Xmas Liquor211.37Entertainment$735.00B. Direct:Gulf Oil Corp.528.11Car License10.00Car Insurance139.94Amal. Litho. Assn.10.00Atlantic Refg. Co. 11.17Total $848.37$735.00$643.37Total Amount Claimed $2,226.74Amounts Disallowed:1/5 Travel$169.67Entertainment$735.00Xmas Liquor$211.371/3 Meals 141.00Total $169.67$735.00$352.37Total Amount Disallowed $1,257.04188 10 JAMES J. GLENN 10 1960Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals$ 489.54Tolls, Parking, Phone$ 205.19Train13.85Litho Club210.05Ink Production Club151.75Prtg. Ink Makers Assoc.131.53Air Travel305.55Hotel257.09Taxi6.40Tips50.80Misc.9.50Car Rental151.23Entertainment$1,567.80B. Direct:Atlantic Refining Co.582.07J. E. Caldwell Co.27.50Esso Oil Co.9.00Calif. Oil Co.2.56Koelle-Greenwood Ford390.75Mobil Oil Co.105.96Auto License14.00Car Rental16.46Gulf Oil Corp.42.54Air Line144.32Sears & Co.3.94Dick & George 20.34Total $2,297.77$1,588.14$1,023.81Total Amount Claimed $4,909.72Amounts Disallowed:1/5 Travel$ 459.55Entertainment$1,588.141/3 Meals$ 163.18Total $ 459.55$1,588.14$ 163.18Total Amount Disallowed $2,210.87 840 10 james j. glenn 10 1961Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals$ 397.65Tolls$ 42.50Parking45.89Telephone26.90Misc.26.05Litho Club202.65Prtg. Ink Makers Assoc.166.38Ink Production Club167.00Tips53.35Car Wash32.92Notary Fees4.00Xmas Liquor160.81Xmas Cards10.00Entertainment$478.55Gasoline5.00B. Direct:Esso Std. Oil67.37Mobil Oil Corp.44.34Atlantic Refg. Co.948.26Car License10.00Dick & George (Beer)50.96Koelle-Greenwood Ford352.62Gulf Oil Corp.61.20Spaeth Motor Co.290.87American Oil Co.26.88Air Line19.53Car Insurance129.12M.I.T. Club5.00Human Events (Gift Sub.) 142.50Total $2,129.85$478.55$1,359.90Total Amount Claimed $3,968.30Amounts Disallowed:1/5 Travel$ 425.97Entertainment$478.55Xmas Liquor$ 160.81Xmas Cards10.00Human Events (Gift Sub.)142.501/3 Meals132.55Total $ 425.97$478.55$ 445.86Total Amount Disallowed $1,350.38189 841 10 JAMES T. KILLIAN 10 1960Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals985.84"Just One Break"75.00Car Wash$ 7.66Telephone8.45Parking5.90Tolls8.95Tips4.00Hotel35.74Car Repair11.02Misc.5.26Air Insur.7.50Bus5.00Taxi15.40Xmas Liquor308.71Xmas Cigars37.21Entertainment$2,066.84B. Direct:Esso Std. Oil Co.168.26Atlantic Refg.922.00Emerson Hotel104.18Litho Club230.00Dick & George (Beer)15.31Koelle-Greenwood Ford909.06Car License10.00Gulf Oil Corp.29.21American Oil Co.311.97Air Line297.00Craftsmen Club87.50Xmas Cards100.00Xmas Gifts --Friendl iness, Inc. 95.93Total $2,845.35$2,066.84$1,956.71Total Amount Claimed $6,868.90Amounts Disallowed:TravelEntertainmentSelling ExpensesTotal1/5 Travel1 $509.67Entertainment$2,066.84Xmas Liquor$308.71Xmas Cigars37.21Xmas Gifts95.931/3 Meals 328.61Total $509.67$2,066.84$770.46Total Amount Disallowed $3,346.97 842 10 JAMES T. KILLIAN 10 1961Items Claimed:TravelEntertainmentSelling ExpensesTotalA. Vouchers:Meals$ 878.36Car Expense$ 124.51Tolls23.90Parking45.20Telephone9.10Railroad103.69Hotel209.67Tips9.00Taxi10.05Litho Club56.60Golf Outing$ 34.58Entertainment3,539.23B. Direct:Atlantic Refg. Co.$958.35Car License10.00Hotel32.20American Oil Co.710.61Koelle-Greenwood Ford596.83Litho Club20.00Esso Std. Oil274.29Air Line201.14Mobil Oil Co.6.55Gulf Oil Corp.54.27Car Ins.126.12Xmas Liquor389.48Gifts - Friendliness, Inc.243.71Craftsmen Club35.00Entertainment 228.00Total $3,496.38$3,801.81$1,632.25Total Amount Claimed $8,930.44Amounts Disallowed:TravelEntertainmentSelling ExpensesTotal1/5 Travel$699.27Entertainment$3,573.81Xmas Liquor$389.48Xmas Gifts243.711/3 Meals 292.79Total $699.27$3,573.81$925.98Total Amount Disallowed $5,199.06 843 Due to a high degree of competition in the ink industry during the years in question, the Company found that it was necessary to entertain its customers. In most cases, one of the petitioner-officers would take one or more individuals, who were responsible for buying ink for a particular customer, to lunch or dinner. In this way it was possible to talk to the customer's representative about the Company's ink products for a couple of hours without being disturbed. During the years in issue, the Rexford Company, a competitor mentioned previously, spent an amount equal to between four and five percent of total sales on traveling and entertainment 191 expenses. The Rexford Company has, on occasion, spent as much as six percent. Petitioner-Company claimed a total of $26,613.15 and $22,040.89 for travel and entertainment expenses on its income tax returns for 1960 and 1961, respectively. These amounts represented about 4.6 percent and 3.7 percent of total sales in the respective years. The portion representing the amount claimed solely for officers' expenses was $15,427 in 1960, and $15,125.48 4 in 1961. In August 1961, Bradt informed the Company that he would like to have his shares of stock redeemed but that he wanted to stay with the Company as an employee. The Company then employed an independent certified public accountant, Harry K. Cohen and Company, to make an audit as of September 30, 1961, for the purpose of placing a valuation upon the stock. Subsequently, Killian also indicated a desire to sell his stock back to the corporation and also remain an employee. The audit established that the fair value of each share of common stock was $5,286.60. At some undetermined time soon after 1961 192 all of the shares of Bradt and Killian were redeemed. It has been previously stated that the respondent disallowed the deduction by the petitioner-Company of traveling and entertainment expenses paid to or for Killian, Glenn, and Bradt, in the amounts of $3,346.97, $2,210.87, and $2,790.83, respectively, in 1960, and $5,199.06, $1,350.38, $1,257.04, respectively, in 1961. Likewise, in his notices of deficiency to each of the petitioners Killian, Glenn, and Bradt, for the taxable years 1960 and 1961, respondent increased the gross income of each by the above respective amounts. In his notice of deficiency with respect to the petitioner-Company respondent also disallowed the deduction of $30,000 in 1960, and $7,800 in 1961, representing a portion of the total amounts paid as compensation to Killian, Glenn, and Bradt in the respective years. It was determined that payments made to each of these three petitioner-officers, to the extent of $10,000 in 1960, and $2,600 in 1961, "[did] not constitute a reasonable allowance for salaries or other compensation for personal services actually rendered within the purview of section 162(a)(1)" of the 1954 Code. In his income tax returns for the years 193 1960 and 1961, petitioner Glenn deducted $1,025.50 and $1,001, respectively, for charitable contributions. In his notice of deficiency, respondent disallowed the deduction to the extent of $666.50 in 1960, and $459 in 1961. In addition to amounts conceded by respondent to have been given to charity, Glenn made the following contributions in both 1960 and 1961. During these years Glenn and his family attended a Sunday service at the Mother of Divine Providence Church almost every week. Each week Glenn made a cash contribution of $3.25 as follows: Glenn put $2 in the plate and gave his wife 50 cents, and each of his three sons 25 cents, to put in the plate. Also, in each of the years in issue, Glenn's wife provided round trip automobile transportation five days each week for one month for a group of nuns who were conducting a summer 844 program for children at the church. There is no evidence of record as to the number of miles traveled. Glenn also contributed $25 each year for liquor and cakes to be used as prizes in church raffles. In his income tax return for 1961, Glenn deducted as a casualty loss $112.32, representing the cost of a new rotating television antenna to replace his 194 old antenna which was blown down in a windstorm. Respondent disallowed this deduction in full. Glenn estimated that the original antenna had been bought and attached to his house about two years prior to his purchase of the house in 1955. While Glenn owned the house, the antenna had blown down on one or two occasions prior to its final destruction in 1961. Glenn estimated that the destroyed antenna had originally cost in excess of $100. Ultimate Findings of Fact 1. The amounts paid by the Company in 1960 and 1961 as salaries and bonuses to each of the petitioners Bradt, Glenn, and Killian constituted reasonable compensation for services rendered. 2. Traveling, entertainment, and gift expenses paid by the Company which were attributable to Bradt, Glenn, and Killian represented personal expenses not proximately related to the business to the extent of $770.64, $940.35, and $1,399.41, respectively, in 1960, and to the extent of $499.94, $716.89, and $1,833.46, respectively, in 1961. 3. Glenn made contributions to charity in 1960 and 1961 in the total amounts of $569 and $752, respectively. Opinion The first issue which we must consider is whether certain amounts paid by the petitioner-Company 195 to its officers (petitioners Glenn, Killian, and Bradt) during the taxable years 1960 and 1961 are deductible by the Company under section 162(a)(1), I.R.C. 1954, as reasonable compensation for services rendered. Petitioner has the burden of showing that these amounts were in fact reasonable and, thus, ordinary and necessary expenses. Botany Mills v. United States, 278 U.S. 282">278 U.S. 282 (1929). The issue is factual. During each of the taxable years 1960 and 1961 the Company paid a salary of $15,600 to each of the three petitioner - officers. In December of each of these years, the board of directors, which consisted of Glenn, Killian, and Bradt, resolved that the Company should pay them bonuses in the amounts of $11,069, $12,538.54, and $10,000, respectively in 1960, and $7,695.14, $5,434.36, and $2,600, respectively in 1961. Respondent has taken the position that the bonuses paid to each officer, to the extent of $10,000 in 1960 and $2,600 in 1961, did not constitute reasonable compensation and were more in the nature of year-end distributions of dividends on the stock held by these officers. Bonus payments are governed by the rules generally applying to other compensation payments, and are 196 deductible to the extent the entire compensation, including the bonus, represents reasonable payment for services actually rendered. Section 1.162-9, Income Tax Regs.Bearing in mind that each of the officers mentioned above owned 32 percent of the outstanding stock in the corporation, we have subjected the facts relevant to the reasonableness of their compensation to close scrutiny. We have concluded that the total amounts paid to these individuals as compensation were reasonable, and were in fact payments purely for services. Section 1.162-7(a), Income Tax Regs. We see no need to set forth in detail the analysis which led us to the ultimate finding of fact which we have made. The factors which are discussed below represent only some of those which we considered. All three of the petitioner-officers were well qualified to perform their duties during the years in question. Glenn and Killian had both graduated from M.I.T. in 1935 after collaborating on an important thesis concerning the physical measurement of color. During the ensuing 11-year period Glenn continued to work with color measurement, and Killian worked for several companies where he gained a considerable amount of experience 197 in making and selling inks. In 1946, Glenn and Killian started the petitioner Glenn-Killian Color Company. In 1952, they were joined by petitioner Bradt, a lithograph printing specialist who had been the superintendent of one of the largest offset printing plants in Philadelphia, Pennsylvania. During the taxable years 1960 and 1961, Killian, Bradt, and Glenn each owned 32 percent of the common stock of the Company and held the offices of president, vice president, and secretary-treasurer, respectively. Although Killian, Bradt, and Glenn were primarily responsible for sales, 845 research and development, and production, respectively, each of these men was involved to some extent in all of these areas of work in a supervisory capacity. The ability to perform successfully in all of these areas of work represented a unique combination of skills. It appears that very few "technical" men in the ink business are also good salesmen. Our Findings demonstrate that the Company was highly successful. The gross receipts increased from $31,832.05 in 1946 to $594,461.25 in 1961. A large part of the Company's success after 1955 was directly attributable to the invention of the "Offset Color Formulator" 198 by Glenn and Killian, a unique combination of a color catalogue and color matching system which has since been substantially adopted by most ink companies. When the history of compensation paid to officers is viewed in the light of the Company's high degree of financial success resulting from their efforts, it appears that the amount of compensation paid to the officers during the first decade of operations was relatively low. Furthermore, we find that the increases in compensation paid thereafter, including the taxable years in issue, do not appear to have been unwarranted when contrasted with the significant increases in gross receipts in those years. At the trial, Alfred W. Rexford, the president of one of the Company's competitors, testified with respect to the reasonableness of the compensation in issue herein. He was generally familiar with both the operations of the petitioner-Company and capabilities of the petitioner-officers. Rexford, who performed essentially the same duties for his company as the petitionerofficers performed during the taxable years, received a salary of $30,000 plus a bonus amounting to 10 percent of his company's profits before taxes. The gross receipts 199 of Rexford's business were approximately half of those received by the petitioner-Company during the years in issue. Rexford was of the opinion that reasonable compensation (including a bonus) during each of these years for Glenn, Killian, and Bradt, would have been $30,000, $28,000, and $26,000, respectively, which amounts were equal to or in excess of the amounts actually paid by the Company. It should also be pointed out that one of the Company's salesmen, who owned no stock in the corporation, received a salary in the approximate amount of $13,000 in each of the taxable years in issue. We have found that his contribution to the business was small in comparison to the services performed by each of the officers. We cannot agree with the respondent's determination, which would allow the Company to deduct as compensation amounts only a few thousand dollars higher than $13,000 for each of the petitioner-officers in each year in question. Respondent's contention is that the amounts disallowed did not represent reasonable compensation but were more in the nature of distributions of dividends upon the stock held by the officers. Respondent places great emphasis on the fact that the Company 200 has never paid a dividend. We have found, however, that since its inception, the Company has grown rapidly, and generally has not had enough physical space in which to operate the business, and it appears that the money which might have been available for dividends has been spent or set aside for physical expansion. Respondent also emphasizes the fact that a large part of the total compensation paid to the officers in each year was in the form of a year-end bonus, contending that this is indicative of a mental disposition on the part of the officer-directors toward a distribution of profits. We note, however, that the corporate minutes state that the bonuses were authorized not only after a detailed review of the financial statements, but after consideration of the services performed. Furthermore, the parties have in fact stipulated that the Company's method of compensation for each of the individual officers was a system of basic yearly salary payments determined near the beginning of the year and a bonus, determined at the end of the year. The officers each owned 32 percent of the Company's stock, yet neither the bonuses nor the salaries were in equal amounts in the years before 201 us. We are unable to conclude that the bonuses were, in part, distributions of dividends merely because they were determined at the end of the year. In light of the factors discussed above, and after a careful review of all the evidence of record with respect to this issue, we are unable to agree with respondent's contentions. We conclude and hold that the total amounts paid as compensation, including salaries and bonuses, to each of the petitioner-officers during the years in question represented reasonable compensation for services rendered. 846 We turn now to the question of whether the respondent properly disallowed the deduction by the Company of a portion of certain amounts paid during 1960 and 1961 for traveling, entertainment, and gift expenses incurred by each of the petitioners Bradt, Glenn, and Killian. Respondent claims that the amounts disallowed with respect to each of these petitioner-officers represent personal expenses and are therefore includable in the gross income of each officer. The petitioners have the burden of proving these were ordinary and necessary business expenses within the meaning of section 162(a), I.R.C. 1954. 5202 The expenses in issue were either paid directly by the Company, or paid by the individual officers, who were then reimbursed by the Company. In order to obtain reimbursement for the latter expenses the officers were required to submit certain information on a printed form called an "expense voucher" to the accountant for the Company. These "vouchers" provided spaces in which the officers and other employees were supposed to indicate the item for which the expense was incurred, the amount of the expense, the applicable category (e.g., "Travel", "Entertainment"), and the name of the customer to whom the expense was attributable, if applicable. Before reimbursement was made, the "vouchers" were checked by the accountant for mathematical accuracy and "approved" by Glenn, who was secretary-treasurer of the Company; however, neither ever question the legitimacy or propriety of any expense claimed for reimbursement by an officer. At the trial petitioners introduced a sample "expense voucher" for each of the officers, but they were introduced for the sole 203 purpose of showing the form of the "vouchers." The petitioners chose not to introduce any "vouchers" for the purpose of substantiating the expenses in issue herein. Furthermore, the petitioners did not introduce any bills, receipts, or canceled checks which might have helped to substantiate either the reimbursed expenses or the expenses which were paid directly by the Company. Instead, at trial petitioners merely submitted an itemized list of expenditures for each officer. The items contained in these lists are set forth in our Findings of Fact. The lists were prepared by the Company's accountant from the books and records of the Company. With a few minor exceptions, no evidence was introduced to prove whether any individual expense item was attributable to a particular customer, when the expenditure was made, or whether any specific expenditure was made for a business purpose. At the trial, each officer simply made a blanket statement to the effect that the accountant's list represented an accurate statement of his expenses. In determining the deficiencies herein, respondent listed all of the items of expense which he considered to be connected with "travel", and took the position 204 that one-fifth of the total amount represented personal expenses of the officers. He also took the position that one-third of the items categorized by petitioners as "meals" were personal expenses. The evidence presented with respect to these items was so general and of such a summary and conclusory nature that, in our opinion, petitioners have wholly failed to carry their burden of proof. Reginald G. Hearn, 36 T.C. 672">36 T.C. 672 (1961), affirmed 309 F. 2d 431 (C.A. 9, 1962), certiorari denied 373 U.S. 909">373 U.S. 909 (1963). We therefore sustain the respondent's determination with respect to these items. Respondent also determined that all but one of the items listed by petitioners simply as "entertainment", 6205 and certain Christmas gifts, were wholly personal in nature. Petitioners have convinced us, however, that it was necessary to entertain and give Christmas presents to their customers during the years in question. Applying the rule of Cohan v. Commissioner, 39 F. 2d 540 (C.A. 2, 1930), we have concluded that 80 percent of these expenses were ordinary and necessary business expenses of the company and did not constitute personal expenses of the officers.In light of the above, we conclude and hold that the petitioner-Company is entitled to deduct traveling, entertainment, and gift expenses of the petitioner-officers in the amounts of $12,316.60 in the taxable year 1960, and $12,065.19 in 1961, and that the following amounts represent personal expenses paid by the Company which are 847 includable in the gross income of the petitioner-officers: 19601961Bradt$ 770.64$ 499.94Glenn940.35716.89Killian1,399.411,833.46Another issue which we must decide is whether respondet properly disallowed deductions for charitable contributions claimed by petitioner Glenn under section 170, I.R.C., 1954 to the exent of $666.50 in 1960, and $459 in 1961. We find that, in addition to amounts already allowed by respondent, Glenn made regular cash contributions in the amount of $3.25 per week to his church, and contributed $25 each year for liquor and cakes to be used as prizes in church raffles. Also, in each of the years in issue, Glenn's wife provided round-trip automobile transportation 206 five days each week for one month for a group of nuns who were conducting a summer program for children at the church. No evidence was presented to show the precise number of miles traveled by Glenn's wife. Applying the rule of Cohan, supra, we conclude and hold that, in addition to amounts already allowed by respondent, petitioner Glenn is entitled to a deduction of $210 for the above-mentioned contributions in each of the taxable years 1960 and 1961. The final issue for our decision is whether respondent properly disallowed petitioner Glenn's deduction of $112.32 as a casualty loss in 1961, representing the cost of a new television antenna to replace his old antenna which was blown down and totally destroyed in a windstorm. The proper measure for the amount of this particular casualty loss would have been the difference between the fair market value of the old antenna immediately before and immediately after the windstorm. Section 1.1677(b), Income Tax Regs. Although Glenn did not originally purchase the old antenna, which was on his house when he bought the latter, he estimated that it had originally cost in excess of $100 and that it was approximately seven years old when it was 207 destroyed in 1961. The old antenna had been blown down on two occasions prior to the windstorm in 1961, however no evidence was presented to show the extent of damage on those occasions. Further, no evidence was introduced for the purpose of establishing the fair market value of the property immediately before the windstorm. On the basis of this information alone, we cannot determine the extent of damage in 1961. We therefore conclude and hold that the respondent's determination on this issue should be sustained. Decisions will be entered under Rule 50. Footnotes1. Cases of the following petitioners are consolidated herewith: Glenn-Killian Color Company, Docket No. 838-67; Herbert Bradt and Irene P. Bradt, Docket No. 847-67; and James T. Killian and Marjorie A. Killian, Docket No. 888-67.↩*. Commission2. In some instances the employees merely submitted handwritten or typewritten notations which were later transcribed on to the printed "vouchers" by the Company's accountant.↩3. The subheadings "Vouchers" and "Direct" represent the two aforementioned methods employed by the Company in paying the expenses of employees. The former was a method of reimbursement, whereas, under the latter method the Company made a "direct" payment to the creditor, e. g. when the employee used a credit card bearing the Company's name. The categories "Travel," "Entertainment," and "Selling Expenses" are those used by the respondent in making his determination of deficiency and are included herein only to show the method of his determination.↩1. It appears that respondent incorrectly computed 1/5 of $2,845.35 as $509.67, instead of $569.07, in determining the amount of "travel" expense disallowed.↩4. The petition in Docket No. 838-67 and certain exhibits of the parties contain a miscalculation and show this total figure to be $15,115.48.↩5. Petitioners are not required to satisfy the strict substantiation requirements of section 274 (d), I.R.C. 1954↩, which applies only to taxable years ending after December 31, 1962.6. Respondent also included in the "entertainment" category an expense in 1960 attributable to Glenn which petitioners listed as "Dick & George", and an expense in 1961 attributable to Killian which was listed as "Golf Outing."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621488/	Robert T. Ely and Jeanne M. Ely v. Commissioner.Ely v. CommissionerDocket No. 60483.United States Tax CourtT.C. Memo 1958-86; 1958 Tax Ct. Memo LEXIS 146; 17 T.C.M. (CCH) 422; T.C.M. (RIA) 58086; May 13, 1958William Braham Washabaugh, Jr., Esq., and Enoch C. Filer, Esq., Ariel Building, Erie, Pa., for the petitioners. Donald W. Howser, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The Commissioner determined a deficiency in income tax of $8,057.74 and additions to tax of $717.23 under section 294(d)(1)(A) and $478.16 under section 294(d)(2) for the year 1950. The questions for decision are (1) whether a deduction of $36,945.36 was properly claimed as a partially worthless business bad debt under section 23(k)(1) of the Internal Revenue Code of 1939, and (2) the propriety of the determination of additions to tax for failure to file a timely estimate of tax and for substantial underestimation of estimated tax. Findings of Fact Some of the facts are stipulated, are147 so found, and the stipulation of facts together with the pertinent exhibits are included herein by this reference. Robert T. Ely (hereinafter called petitioner) and Jeanne M. Ely, are husband and wife. They filed a joint income tax return for 1950 with the collector of internal revenue for the 23rd district of Pennsylvania, at Pittsburgh, Pennsylvania. Petitioner was honorably discharged as a Captain in the Armed Services of the United States in January of 1946 and had inherited a substantial amount of money from his grandfather who died in 1945. On his discharge, petitioner began to look for investment opportunities for his funds. On the tax returns for 1948 and 1949, petitioner described his occupation as "Executive". On the 1950 return, he described his occupation as "Business venture". Acorn Plastic Engineers, Inc., hereinafter referred to as Acorn, is a corporation organized on March 14, 1946, under and by virtue of the laws of the Commonwealth of Pennsylvania, with an authorized capital of $75,000 divided into 750 shares of common stock having par value of $100 each. The Articles of Incorporation of Acorn state that it was incorporated for the purpose or purposes: to148 design, develop, manufacture and sell at wholesale and retail, plastics, electrical and mechanical equipment and products, to render engineering services, and to purchase, lease, and acquire such real estate as is necessary and convenient for the operation of said business and to mortgage and convey title to the same. Shortly after its incorporation, 150 shares of capital stock of the par value of $15,000 were issued to petitioner, 20 shares of the par value of $2,000 were issued to his uncle, F. W. Ely, whom petitioner hoped would manage the business, and 2 shares of the par value of $200 were issued to George P. Marshall. After Acorn was organized, petitioner's uncle lost interest in the venture and declined to put in further money. He withdrew in August 1946 and petitioner purchased the 20 shares of stock held by him. Subsequent to such time and prior to May 8, 1947, Acorn issued to petitioner 450 additional shares of the par value of $45,000. In 1949 petitioner purchased from George P. Marshall the remaining 2 shares of stock outstanding, making his total holdings of Acorn 622 shares with an aggregate par value of $62,200. He retained ownership of said stock at all times subsequent149 to his aquisition thereof and no other person acquired ownership of Acorn stock. Petitioner was elected treasurer on organization of Acorn and upon purchase of his uncle's stock he was elected president, remaining president and treasurer at all subsequent times pertinent to this case. On various dates during the period from August 31, 1946, to March 31, 1952, petitioner purchased and paid for machinery for Acorn, paid various expenses of Acorn, and paid to Acorn various sums of money, and on various dates during such period Acorn paid to and on behalf of petitioner various amounts of money. Such payments were entered on the books of Acorn by a system of debits and credits on a running account nominated "Advances from Officer" and "Amounts Due Officer". Petitioner first began to make the advances to Acorn after his uncle's withdrawal, and at a time when only $17,200 had been paid in to capital. He continued to make the advances from time to time as Acorn needed money to buy equipment, to pay expenses, and "to fulfill some obligations we got into several times as a result of anticipated new business or new personnel". No interest was charged on the advances and the money so advanced150 was to be repaid "as the corporation was in a position to do so". The advances were reflected on Acorn's balance sheets for the years 1947, 1948, and 1949 under "Long Term Liabilities". By March 31, 1947, petitioner had been credited on such account with the total sum of $76,933.33 for payments made to or on behalf of Acorn, with a debit of $114.40 made to the account, leaving a balance in petitioner's favor of $76,788.93. On such date, the account was debited "to transfer to Capital Stock (R.T.E.) 18,500.00" and "To transfer R.T.E. monies to Notes Payable Account, 50,000.00", leaving a balance of $8,288.93 credited to petitioner. Payment for the balance of the $62,200 of capital stock issued to petitioner was made by him directly to the corporation. On March 31, 1947, Acorn executed and delivered to petitioner a promissory note in the sum of $50,000 payable on demand without interest. The note was executed on behalf of Acorn by petitioner as president. Entry of said note was made on the books of Acorn on a notes payable account. On March 31, 1948, the notes payable account of Acorn was debited by the amount $34,019.99 for the net book value of assets transferred to petitioner151 to apply on the $50,000 note. The note payable account bears the notation that the balance of $15,980.01 was written off on March 31, 1952. Acorn sustained net losses from its operation for the fiscal years ended March 31, 1947in the total amount of $30,187.14March 31, 1948in the total amount of26,192.34March 31, 1949in the total amount of11,730.93March 31, 1950in the total amount of10,973.64March 31, 1951in the total amount of25,424.98March 31, 1952in the total amount of31,369.53 as reflected on its income tax returns duly filed. For the nine months period ended December 31, 1950, Acorn sustained a net operating loss of $7,212.54. Petitioner transferred machinery which he had received with other assets from Acorn to Perry Plastics Corporation in exchange for $30,000 capital stock, a minority interest. Acorn ceased manufacturing operations and thereafter operated largely as a sales agency of plastic tile manufactured by Perry Plastics. Petitioner became vice president and a director of Perry Plastics and continued as such until 1949 or 1950 when he withdrew from participation in that concern. The record does not show who organized152 Perry Plastics. In 1949 petitioners formed a partnership named Ely Enterprises to operate as a sales agency and supply, on petitioner's personal credit, the customers whom Acorn did not have sufficient credit to supply, and for the further purpose of separating that type of operation from Acorn's sales through commission agents. Acorn's balance sheet dated December 31, 1950, reflects assets totaling $60,192.08, including an item nominated "Deferred Motion Advertising Costs and Income" in the amount of $13,643.87. The liabilities aggregated $83,493.57, which included a balance of $55,822.19 shown on the "Amount Due Officer" account at such date, the $15,980.01 balance of the $50,000 note payable to petitioner, and $11,691.37 owing to others, giving a minus net worth of $23,301.49. Between the dates of March 31, 1949, and December 31, 1950, during which time Acorn was insolvent, petitioner made net advances to Acorn to increase the "Advances from Officer" account by about $40,000. During the last nine months of the calendar year 1950, the "Amount Due Officer" account was increased by about $15,000. The total advances during the year 1950 amounted to $38,899.50. During the last153 nine months of the calendar year 1951, the account was increased by $3,000. Subsequent to December 31, 1950, Acorn continued to do business and expended a substantial sum of money for merchandise to be sold. Acorn ceased doing business in the spring of 1952. Aside from his interest in Ely Enterprises, Acorn, and Perry Plastics, petitioner was a licensed real estate and insurance salesman and invested $30,000 with members of a real estate firm in connection with building 12 houses; purchased a building and dwelling in 1946, renting part of the building to Acorn and the dwelling to third parties; purchased 3 multiple tenancy properties in 1952; erected an apartment house in 1953, and purchased houses in 1950 and 1955 in Florida. He loaned $1,500 to a Club Carr and $3,000 and $6,000 to Gordon Lindsey, a close personal friend, all without taking notes. He loaned $1,900 to Byron Mac-Intosh, an employee of Acorn, to buy a house, and $5,000 to LaMarque Restaurant, taking non-interest bearing notes in each instance. He sold 2 lots to Albert Pope, taking a $2,200 non-interest bearing and unsecured note for part of the purchase price. Ely Enterprises sold $58,000 of plastic products to Penny-King154 and $680 of plastic products to a City Club, both on open account. Acorn sold $13,000 of products to Styron-BriTile on open account. Petitioner personally sold $2,600 of molds and products to Universal Marc-A-Plot on open account, and personally endorsed several of Acorn's bank loans and guaranteed Perry Plastic's credit to the extent of $13,000. The amount of $36,945.36 was deducted on petitioners' joint income tax return for the calendar year 1950, with the explanation that it constituted the portion of a bad debt, owing to petitioner Robert T. Ely by Acorn Plastic Engineers, Inc., which became worthless in 1950. In the statutory notice of deficiency mailed by respondent to petitioners, it was determined by respondent that such deduction was not allowable. Petitioner's income tax returns for 1949 and 1950 disclosed no taxable income. In 1949 petitioner reported income from a trust in the amount of $9,314.41. In 1950 he reported income from the same trust in the amount of $7,824.88. A certified public accountant prepared petitioner's income tax returns as well as those of Acorn. Petitioner relied on the accountant's advice in tax matters during the taxable year. Petitioners155 did not file any declaration of estimated tax for the calendar year 1950. Opinion The Commissioner's contentions in support of disallowing the deduction claimed for partial worthlessness of the debt may be summarized as follows: first, the advances constituted contributions to capital and not indebtedness; second, if a debt existed it was a non-business debt and no deduction for partial worthlessness can be claimed under the statute; and, third, that petitioner has not proved worthlessness in 1950. Petitioner, on the other hand, makes one primary contention, i.e. that he was in the trade or business of engaging in business ventures and that the indebtedness of Acorn to him was proximately related to his activities in "promoting, organizing, financing and loaning funds to customers of enterprises and businesses in the management and business of which (he took) an active part and (devoted) a substantial part of his time and energy." The burden of proving the propriety of the claimed deduction is on petitioner. He relies on Foss v. Commissioner, 75 Fed. (2d) 326 (C.A. 1), (reversing a Memorandum Opinion of this Court, Commissioner v. Stokes' Estate, 200 Fed. (2d) 637156 (C.A. 3), (affirming a Memorandum Opinion of this Court [10 TCM 1111]), Tony Martin, 25 T.C. 94">25 T.C. 94, Vincent C. Giblin v. Commissioner, 227 Fed. (2d) 692 (C.A. 5), (reversing a Memorandum Opinion of this Court [13 TCM 1009; T.C. Memo 1954-186">T.C. Memo. 1954-186]) and several Memorandum Opinions of this Court. It is recognized that whether the activities of a taxpayer add up to engaging in a trade or business is largely a question of fact and "requires an examination of the facts in each case." Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212. Here petitioner had participated in the organization of but a single corporation - Acorn, to which the advances in question were made. He later became an officer in another - Perry Plastics - for which he guaranteed credit to the extent of $13,000. He was a member of a partnership operating as a sales agency for some customers whom Acorn did not have sufficient credit to supply. He supplied his personal credit to the partnership. In addition, he was a real estate broker, entered into a few transactions involving real estate and made the few loans otherwise detailed in our findings of fact. None157 of the loans carried interest and petitioner does not claim to have been in the business of lending money or of financing corporations. On the facts we hold that the advances made to Acorn, even if they were loans rather than contributions to capital, were not business debts. We are of the opinion that the activities of petitioner were not extensive enough to bring his case within the ambit of the cases on which he relies. See Higgins v. Commissioner, supra, A. Kingsley Ferguson, 16 T.C. 1248">16 T.C. 1248, Fred A. Bihlmaier, 17 T.C. 620">17 T.C. 620, and Estate of William P. Palmer, Jr., 17 T.C. 702">17 T.C. 702. Even if we are in error in so holding, petitioner must lose on another ground. He has not proven that the debt became worthless to the extent claimed in the year 1950. The findings of fact show that in each year beginning with the fiscal year ending March 31, 1947 through the fiscal year ending March 31, 1952, Acorn operated at a loss. Nevertheless, petitioner continued to advance moneys, and part of the advances were made when Acorn was insolvent. Even during the year 1950, the year in which the worthlessness is claimed, total advances were $38,899.50, more158 than the claimed deduction. The claim of worthlessness in that year, despite the attempted explanation that the Korean War was curtailing operations, is certainly inconsistent with the advances made, Janet McBride, 23 T.C. 926">23 T.C. 926. We find no identifiable event in 1950 which would justify petitioner in claiming the worthlessness of a substantial portion of his indebtedness in that year. As a matter of fact, the stipulated "Advances from Officer" account shows that during 1950 petitioner was debited in this account for amounts totaling around $42,000. We find no justification for allowing the claimed deduction in 1950 and sustain the Commissioner's determination in this respect. It thus becomes unnecessary for us to decide whether or not the advances constituted an indebtedness or contributions to capital. With reference to the additions to tax for failure to file a timely estimate and for substantial underestimate, petitioner contends that the failure to file was due to reasonable cause, in that the advice of a certified public accountant was relied on, and that no additional penalty for substantial understimation can properly be determined in any event. We have found159 as a fact that petitioner relied on the advice of a certified public accountant in not filing an estimate of tax. But this is not sufficient to show that the failure to file was "due to reasonable cause and not to willful neglect." Rene R. Bouche, 18 T.C. 144">18 T.C. 144, John T. Potter, 27 T.C. 200">27 T.C. 200. Furthermore, there is no evidence in the record to show that the accountant was a competent tax advisor. The accountant himself testified that he was aware petitioner would receive between $7,000 to $10,000 from an estate and that, "if it is a reason," he advised no estimate need be filed for 1950 because petitioner's 1949 return showed no taxable income. It may be pointed out that the statute requires the filing of a return of estimated tax if the taxpayer's gross income from sources other than wages can reasonably be expected to exceed $100 for the taxable year and his gross income to be $600 or more. Sec. 58, Internal Revenue Code of 1939, as amended. As said in Marvin Maxey, 26 T.C. 992">26 T.C. 992, 996, "the expectation of little or no net taxable income does not excuse a taxpayer's failure to file a declaration where the amount of his gross income satisfies the statutory160 requirements for filing." We hold that petitioner has not shown that his failure to file a return of estimated tax was due to reasonable cause and not to willful neglect. On this record the determination of an addition to tax for substantial underestimation must also be held to be proper. Since the petitioners failed to file a declaration of estimated tax, their estimated tax was zero. G. E. Fuller, 20 T.C. 308">20 T.C. 308, affd. 213 Fed. (2d) 102. The statute contains no provision for excusing substantial underestimation for "reasonable cause" and petitioners cannot escape the addition to tax on that ground. Harry Hartley, 23 T.C. 353">23 T.C. 353. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621489/	NANCY L. CAFARELLI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; RICHARD A. CAFARELLI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCafarelli v. CommissionerDocket Nos. 20309-93, 23498-93United States Tax CourtT.C. Memo 1994-265; 1994 Tax Ct. Memo LEXIS 266; 67 T.C.M. (CCH) 3077; June 9, 1994, Filed 266 Nancy L. Cafarelli, pro se. For petitioner Richard A. Cafarelli: John J. Morrison. For respondent: Terri L. Parrott. COUVILLIONCOUVILLIONMEMORANDUM OPINION COUVILLION, Special Trial Judge: These consolidated cases were heard pursuant to section 7443A(b)(3) 1 and Rules 180, 181, and 182. In separate notices of deficiency, respondent determined deficiencies, respectively, in petitioners' 1989 Federal income taxes as follows: Docket No.PetitionerDeficiency20309-93Nancy L. Cafarelli$ 90223498-93Richard A. Cafarelli1,680The sole issue for decision is whether petitioner Richard A. Cafarelli or petitioner Nancy L. Cafarelli is entitled to the dependency exemptions under section 151 for Richard M. Cafarelli, Danel L. Cafarelli, and Nicholas V. Cafarelli for the 1989 tax year. The three dependents are267 petitioners' children. Some of the facts were stipulated and are found accordingly. The stipulation and attached exhibits are incorporated herein by reference. Petitioners, Nancy L. Cafarelli (Ms. Cafarelli) and Richard A. Cafarelli (Mr. Cafarelli), were residents of Chicago, Illinois, and Hanover Park, Illinois, respectively, at the time they filed their petitions. Petitioners were divorced on April 13, 1987. The Judgment for Dissolution of Marriage, with a marital settlement agreement incorporated therein (hereinafter the divorce decree), was rendered by the Circuit Court of Cook County, Chicago, Illinois (hereinafter the Illinois Circuit Court). In the divorce decree, Ms. Cafarelli was granted custody of the three children, and Mr. Cafarelli was accorded visitation rights on approximately every other weekend and on Wednesday evenings. Child support in the amount of $ 676 per month was to be paid by Mr. Cafarelli until each child reached 18 years of age, at which time there would be a pro rata reduction in the amount of child support. The dependency exemptions of the three children for income tax purposes were addressed as follows in the divorce decree: That Husband [Mr. 268 Cafarelli] shall be entitled to claim the income tax exemption for the minor children. That each party will sign whatever documents are necessary to enable the other party to claim the child as that party's income tax exemption based upon the circumstances in effect at that time, including necessary waiver forms as required by the Internal Revenue Service. Husband is entitled to such exemptions based on the present financial status of the parties; such entitlement being subject to further review.No additional documents relating to the dependency exemptions were signed by Ms. Cafarelli at the time the divorce decree was executed. Both petitioners claimed dependency exemptions for their three children on their 1987 and 1988 Federal income tax returns. Subsequently, on July 24, 1989, Ms. Cafarelli filed with the Illinois Circuit Court a motion to enforce the divorce decree. The motion addressed the issues of child support, school tuition payments, and insurance, and asked the Illinois Circuit Court to "Allow * * [Ms. Cafarelli] to claim children on federal and state income taxes." On January 5, 1990, the Illinois Circuit Court issued an order disposing of the motion in which269 Ms. Cafarelli was "ordered to execute the necessary documents for * * [Mr. Cafarelli] to claim the minor children of the parties as exemptions." Pursuant to the order, Ms. Cafarelli, while in the Illinois Circuit Court courtroom, reluctantly signed Internal Revenue Service (IRS) Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. The Form 8332 signed by Ms. Cafarelli is divided into two parts. Part I is labeled "Release of Claim to Exemption for Current Year", and part II is labeled "Release of Claim to Exemption for Future Years". Part I of the form was not completed. Part II was completed and stated: "I agree not to claim an exemption for RICHARD M., DANEL L., NICHOLAS V. for tax years ALL FUTURE YEARS." It was signed and dated by Ms. Cafarelli on January 5, 1990. On February 5, 1990, Ms. Cafarelli filed with the Illinois Circuit Court a motion for reconsideration and other relief and asked that Mr. Cafarelli not be allowed to claim the children as exemptions for income tax purposes. On March 28, 1990, Ms. Cafarelli filed with the Illinois Circuit Court an emergency motion to reset the hearing date from June 1990 to April 1990. The emergency270 motion, which focused on the issues of school tuition and the dependency exemptions, detailed the additional amounts that Ms. Cafarelli would be required to pay in 1989 Federal income tax if she were not entitled to the exemptions. As of the date of trial in this case, the Illinois Circuit Court had not modified its January 5, 1990, order that Mr. Cafarelli was entitled to the dependency exemptions. Other than the IRS Form 8332 signed by Ms. Cafarelli on January 5, 1990, there is no other written declaration by Ms. Cafarelli regarding the dependency exemption of her three children for 1989. Both petitioners claimed the three children as dependents on their respective 1989 Federal income tax returns. On the returns, both petitioners provided the names and Social Security numbers of the three children. In response to the query on the return of "No. of months * * [the dependents] lived in your home in 1989", Ms. Cafarelli answered 12 months, and Mr. Cafarelli answered 0 months. Mr. Cafarelli attached to his 1989 income tax return the IRS Form 8332 described earlier. In respective notices of deficiency, respondent determined that neither petitioner proved entitlement to dependency271 exemptions in 1989 for the three children because the Form 8332 did not specify that it was applicable to the 1989 taxable year. It is Mr. Cafarelli's position that the Form 8332 attached to his 1989 income tax return is a valid "written declaration" as required by section 152(e), and that the reference to "ALL FUTURE YEARS" included the year 1989 and thereafter because neither petitioner had prepared or filed a 1989 income tax return when the Form 8332 was signed on January 5, 1990. Ms. Cafarelli argues that she did not intend the waiver to apply for their 1989 tax year. The determinations by the Commissioner 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 (1933). Section 151(c) allows taxpayers an annual exemption amount for each "dependent" as defined in section 152. Under section 152(a), the term "dependent" means certain individuals, such as a son, daughter, stepson, or stepdaughter, "over half of whose support for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer272 (or is treated undersubsection (c) or (e) as received from the taxpayer)". The support test in section 152(e)(1) applies if: (1) A child receives over half of his support during the calendar year from his parents; (2) the parents are divorced under a decree of divorce; and (3) such child is in the custody of one or both of his parents for more than one-half of the calendar year. If these requirements are satisfied, as in the present case, "such child shall be treated, for purposes of subsection (a), as receiving over half of his support during the calendar year from the parent having custody for a greater portion of the calendar year (* * * referred to as the custodial parent)", thus allowing the dependency exemption to be claimed by the "custodial parent". To decide who has "custody", section 1.152-4(b), Income Tax Regs., provides that custody "will be determined by the terms of the most recent decree of divorce" if there is one in effect. Since petitioners' divorce decree grants custody and physical possession of the three children to Ms. Cafarelli, she is considered the children's "custodial parent" under section 152(e). Mr. Cafarelli, as the "noncustodial parent", is allowed273 to claim a child as a dependent only if one of three statutory exceptions in section 152(e) is met. Under these exceptions, the "noncustodial parent" is treated as providing over half of a child's support if: (1) Pursuant to section 152(e)(2), the custodial parent signs a written declaration that such custodial parent will not claim such child as a dependent, and the noncustodial parent attaches such written declaration to the noncustodial parent's return for the taxable year; (2) pursuant to section 152(e)(3), there is a multiple support agreement between the parties as provided in section 153(c); or (3) pursuant to section 152(e)(4), there is a qualified pre-1985 instrument providing that the noncustodial parent shall be entitled to any deduction allowable under section 151 for such child, provided that certain other requisites, not pertinent here, are met. In the present case, the exceptions in section 152(e)(3) and (4) do not apply. There was no multiple support agreement and no pre-1985 instrument. Therefore, Mr. Cafarelli is entitled to the dependency exemptions only if the requirements of section 152(e)(2) are met. Section 152(e)(2) was amended by the Deficit Reduction274 Act of 1984, Pub. L. 98-369, sec. 423(a), 98 Stat. 494, 799. Prior to this amendment, in the case of children of divorced parents, an additional exception was provided under which the noncustodial parent was entitled to the dependency exemption if the noncustodial parent provided $ 1,200 or more for support of each child, and the custodial parent did not "clearly establish" that he or she provided more than the noncustodial parent for such child's support. Sec. 152(e)(2)(B). As a result, when the dependency exemption of a child of divorced parents was in dispute, the IRS was compelled to examine conflicting factual evidence to determine which of the parties was entitled to the dependency exemption. See McGuire v. Commissioner, 77 T.C. 765">77 T.C. 765 (1981). The actual support test is no longer provided for the case of a child of divorced parents by virtue of the amendment to section 152(e)(2). The purpose of the amendment to section 152(e)(2) is explained in H. Rept. 98-432 (Part I), at 197-198 (1983). In that report, it is stated that the prior statutory framework for awarding dependency exemptions for children of divorced parents was: often subjective275 and [presented] difficult problems of proof and substantiation. The Internal Revenue Service became involved in many disputes between parents who both claim the dependency exemption based on providing support over the applicable thresholds. * * The Committee [wished] to provide more certainty by allowing the custodial spouse the exemption unless that spouse waives his or her right to claim the exemption. Thus, dependency disputes between parents will be resolved without the involvement of the Internal Revenue Service.In other words, in enacting the current version of section 152(e), Congress sought to eliminate the role of the IRS as mediator in disputes over which parent was entitled to the dependency exemptions. The present statutory scheme eases or was intended to ease the administrative burden of the IRS. In order for the noncustodial parent to meet the statutory exception of section 152(e)(2), section 152(e)(2)(A) specifically requires that the custodial parent sign "a written declaration (in such manner and form as the Secretary may by regulations prescribe) that such custodial parent will not claim such child as a dependent". Pursuant to this congressional directive, 276 temporary regulations were promulgated that provide that "The written declaration may be made on a form to be provided by the Service for this purpose. Once the Service has released the form, any declaration made other than on the official form shall conform to the substance of such form." Sec. 1.152-4T, Q&A-3, Temporary Income Tax Regs., 49 Fed. Reg. 34459 (Aug. 31, 1984). Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, was available in revised form as of December 1987. The regulations also provide that: The exemption may be released for a single year, for a number of specified years (for example, alternate years), or for all future years, as specified in the declaration. If the exemption is released for more than one year, the original release must be attached to the return of the noncustodial spouse and a copy of such release must be attached to his/her return for each succeeding taxable year for which he/she claims the dependency exemption. [Emphasis added.]Sec. 1.152-4T, Q&A-4, Temporary Income Tax Regs., 49 Fed. Reg. 34459 (Aug. 31, 1984). In this case, the Court 277 must address whether the written declaration of the custodial parent's release of the dependency exemptions for the taxable year of 1989 was "specified in the declaration" contained in Form 8332, which was signed and dated by Ms. Cafarelli on January 5, 1990, and attached to Mr. Cafarelli's 1989 income tax return. The Court considers this issue in light of the congressional intent reflected by the amendment of section 152(e) and its legislative history that dependency disputes between parents should be resolved without the involvement of the IRS. Mr. Cafarelli attached to his 1989 income tax return an appropriate written declaration, IRS Form 8332, signed by Ms. Cafarelli, the custodial parent, which, on its face, did not state that it applied to the 1989 taxable year. Part I of the form was unmistakably designated as a "Release of Claim to Exemption for Current Year" and was clearly left blank by both parties. (Emphasis added.) Therefore, it cannot be said that anywhere on the face of the written declaration is it evident that it is applicable to 1989. Whether this part of the form was left blank by inadvertence or not, the Court does not find a valid "written declaration" 278 in which Ms. Cafarelli, as the custodial parent, released the claim to the dependency exemptions for the 1989 taxable year. Therefore, the Court holds that the statutory requirements entitling Mr. Cafarelli to the dependency exemptions for 1989 have not been fulfilled. Mr. Cafarelli's argument that IRS Form 8332 was intended to apply to 1989 because it was signed on January 5, 1990, when neither petitioner had filed a 1989 income tax return, is without merit. Such an interpretation would make useless the statute's "written" declaration requirement and would not provide the certainty required by the statute. If Mr. Cafarelli's argument is correct, it would impose upon the IRS a duty to determine the true intention behind any such written waiver in order to enforce section 152(e)(2), which clearly would not further the congressional intent to ease administrative burdens. In addition, basing the effective date of a written waiver on whether or not the parties' income tax returns had been prepared, when on the face of the writing another effective date is evident, would, likewise, require the IRS and the courts to look behind the written declaration to determine what was intended. 279 In this instance, the Court does not find it proper to determine the intent behind the written declaration. The Court notes that, if the parties had simply completed part I of Form 8332 or executed another written declaration to the same effect, it would have been clear to the IRS and this Court what year the release was "intended" to cover. Therefore, the Form 8332 filed with Mr. Cafarelli's 1989 income tax return is not an effective release of the custodial parent's dependency exemption claims for 1989. Thus, Ms. Cafarelli, as the custodial parent, is entitled to the dependency exemptions for 1989. Although petitioners' divorce decree and the subsequent orders issued by the Illinois Circuit Court provide that Mr. Cafarelli is entitled to the dependency exemptions for the three children, State courts, by their decisions, cannot determine issues of Federal tax law. Commissioner v. Tower, 327 U.S. 280">327 U.S. 280 (1946); Kenfield v. United States, 783 F.2d 966 (10th Cir. 1986); Nieto v. Commissioner, T.C. Memo. 1992-296. Thus, the Court concludes that, pursuant to section 152(e), Mr. Cafarelli is*280 not entitled to claim the three children as dependents for 1989. His remedy, if any, lies in the State court for enforcement of the divorce decree. Decision will be entered for petitioner in docket No. 20309-93.Decision will be entered for respondent in docket No. 23498-93.Footnotes1. Unless otherwise indicated, 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.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621490/	Muzaffer ErSelcuk and Rolande ErSelcuk, Petitioners, v. Commissioner of Internal Revenue, RespondentErselcuk v. Comm'rDocket No. 65013 United States Tax Court30 T.C. 962; 1958 U.S. Tax Ct. LEXIS 112; July 31, 1958, Filed 112 Decision will be entered under Rule 50. 1. Held, contributions made by petitioners to various organizations in Burma are not deductible as charitable contributions under sec. 23 (o) (2), I. R. C. 1939, or as contributions to or for the use of the United States under sec. 23 (o) (1), or as a business expense under sec. 23 (a) (1).2. Held, the question of the taxability of funds received by petitioner pursuant to the provisions of a United States educational exchange grant was not properly pleaded and is not before this Court. Muzaffer ErSelcuk, pro se.George H. Becker, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 962 Respondent determined a deficiency of $ 393.20 in petitioners' income tax for the taxable year 1953.There is only one question at issue: Whether amounts contributed by petitioners to certain organizations in Burma are deductible for income tax purposes.A second question concerning the taxability of funds received by petitioner Muzaffer ErSelcuk pursuant to a United States educational exchange grant was not properly pleaded and is not in issue.An issue concerning a dependency credit was conceded by the respondent at the trial. 113 FINDINGS OF FACT.Some of the facts are stipulated and are so found, the stipulation being incorporated herein by this reference.Petitioners are husband and wife. Their principal place of residence is Lafayette, Indiana.Petitioners' 1953 joint Federal income tax return was timely filed and was processed by the district director of internal revenue, Baltimore, Maryland. This return was filed by petitioners while they were in Mandalay, Burma. Subsequently, on September 15, 1954, petitioners filed a second Form 1040 with the district director of internal revenue at Indianapolis, Indiana.Muzaffer ErSelcuk will hereinafter be referred to as petitioner.In December 1952 petitioner, a member of the faculty of Purdue University, received a United States educational exchange grant, authorized under the Fulbright Act, for work to be accomplished in Burma. Petitioner was to be paid only in Burmese currency. If he went to Burma alone he was to receive the equivalent of $ 4,478.40; if his wife accompanied him he was to receive the equivalent of $ 5,374.40.963 On the basis of strong urging from the president of Purdue University and the dean of the Science School, who indicated that114 the fellowship would aid petitioner's professional and academic career and the fact that the State Department found a job for his wife in Mandalay, petitioner accepted the award.Petitioner was in Mandalay 6 months of the taxable year 1953. During that time he taught 6 to 8 hours per week as visiting lecturer in economics at University College of Mandalay. The remainder of his time was devoted to research.It was part of petitioner's job in Burma to act as an emissary of the United States and to sell "the American way of life." In order to be on the same level with the Burmese he lived in a bamboo hut as they did, even though his funds would have allowed him to have better accommodations.On their original joint income tax return for 1953 petitioner and his wife, Rolande ErSelcuk, claimed deductions for contributions, including the following:Religious organizations in Burma$ 149.50Orphanages and charity hospitals in Burma140.00University College of Mandalay in Burma700.00Various contributions in Burma27.501 1,017.00115 Respondent disallowed these deductions and determined the deficiency here in issue.OPINION.The only question in issue is whether amounts contributed by petitioner to certain organizations in Burma are deductible as charitable contributions, or as contributions to or for the use of the United States, or as business expenses incurred by petitioner in carrying on his employment.Respondent asserts that these contributions are not deductible as "charitable or other contributions" under section 23 (o) (2) of the Internal Revenue Code of 1939 since they were made to foreign corporations or organizations located in Burma and not to domestic institutions or institutions in any possession of the United States. We agree.964 Section 23 (o) of the Internal Revenue Code of 1939 provides, inter alia, as follows:SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions: * * (o) Charitable and Other Contributions. -- In the case of an individual, contributions or gifts payment of which is made within the taxable year to or for the use of: (1) The United States, any State, Territory, or any political subdivision thereof or the District116 of Columbia, or any possession of the United States, for exclusively public purposes;(2) A corporation, trust, or community chest, fund, or foundation, created or organized in the United States or in any possession thereof or under the law of the United States or of any State or Territory or of any possession of the United States, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation. * * The report of the House Ways and Means Committee relating to section 23 (o), H. Rept. No. 1860, 75th Cong., 3d Sess., pp. 19, 20 (1939-1 C. B. (Part 2) 728, 742), contains the following statement:Under the 1936 Act the deduction of charitable contributions by corporations is limited to contributions made to domestic institutions (section 23 (q)). The bill provides that the deduction allowed to taxpayers other than corporations be117 also restricted to contributions made to domestic institutions. The exemption from taxation of money or property devoted to charitable and other purposes is based upon the theory that the Government is compensated for the loss of revenue by its relief from financial burden which would otherwise have to be met by appropriations from public funds, and by the benefits resulting from the promotion of the general welfare. The United States derives no such benefit from gifts to foreign institutions, and the proposed limitation is consistent with the above theory. If the recipient, however, is a domestic organization the fact that some portion of its funds is used in other countries for charitable and other purposes (such as missionary and educational purposes) will not affect the deductibility of the gift.Although the contributions here at issue undoubtedly were made to worthy causes, the intent of Congress is clear that for contributions to charitable and other indicated organizations to be deductible the donee must be organized in the United States or in a possession thereof, or under the law of the United States, or a State, territory, or possession. Dora F. Welti, 1 T.C. 905">1 T.C. 905 (1943).118 Since petitioner has not shown that the organizations to which the contributions in issue were made come within the above classification, no deduction under section 23 (o) (2) is allowable.Petitioner's alternate contentions, that the contributions to the University College of Mandalay are deductible as gifts or contributions 965 to or for the use of the United States under section 23 (o) (1), or donations essential for the performance of his duties, are also without merit.The words "for the use of" employed in section 23 (o) (1) have been held to convey a meaning similar to that of "in trust for." John Danz, 18 T.C. 454">18 T.C. 454, 464 (1952), affd. 231 F.2d 673">231 F.2d 673 (C. A. 9, 1955), certiorari denied 352 U.S. 828">352 U.S. 828.Conceivably the contributions here at issue may ultimately benefit the Government and people of the United States in some intangible way by helping to spread the ideals of Western democracy in the land of Burma; however, they were not made to or "in trust for" the United States or any political subdivision thereof. They are, therefore, not deductible under section 23 (o) (1).Treasury Regulations*119 118, section 39.23 (o)-1 (e), provide as follows:Sec. 39.23 (o)-1 Contributions or gifts by individuals.(e) A donation made by an individual to an organization other than one referred to in section 23 (o) which bears a direct relationship to his business and is made with a reasonable expectation of a financial return commensurate with the amount of the donation may constitute an allowable deduction as business expense.Here there is no evidence that petitioner stood to gain in any way from his gifts to the University College of Mandalay. They, therefore, cannot be classed as business expenses.On his amended return for the year 1953 petitioner reported as income the funds received under his educational grant, less deductions for certain travel, food, and lodging expenses. At the trial he questioned, for the first time, the accuracy of including these funds in gross income. This question was not raised in the notice of deficiency, the petition, or the answer, and no motion was made so to amend the petition. The question is, therefore, not before this Court. Mutual Lumber Co., 16 T.C. 370">16 T.C. 370 (1951).Decision will be entered under Rule 50. Footnotes1. On their amended joint income tax return for 1953 petitioner and Rolande ErSelcuk claimed deductions for contributions as follows:↩Tuberculosis, heart, community, Red Cross, etc$ 89.00Kutkai Baptist Mission Church40.00Father LeFons and Tiokeok Orphanages100.00Namkhan Charity Hospital40.00Mandalay State Teachers College and Kalemyo Schools27.50United States Educational Foundation in Burma48.10University College of Mandalay700.001,154.10[sic]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621491/	Estate of Emma Earle, G. Harold Earle and Stewart E. Earle, Former Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent. G. Harold Earle, Petitioner, v. Commissioner of Internal Revenue, Respondent. Stewart E. Earle, Petitioner, v. Commissioner of Internal Revenue, RespondentEarle v. CommissionerDocket Nos. 4257, 4258, 4259, 4260, 4261United States Tax Court5 T.C. 991; 1945 U.S. Tax Ct. LEXIS 52; October 26, 1945, Promulgated 52 Decisions will be entered under Rule 50. 1. Decedent's husband died in 1923, leaving the residue of his estate in trust. He provided that the income accruing to the trust estate should be distributed at such times and in such amounts as the trustees should deem best, said income to be paid one-third to his wife and one-third to each of his two sons or their heirs, the trust to terminate at the death of the wife and the corpus to go to the two sons or their heirs. The trustees made some distributions of income, but accumulated a considerable portion thereof. Decedent, when asked in 1935 whether she wanted any more distributions from trust income, told the trustees that she did not. Held, that decedent had a vested interest in one-third of the income of the trust; that there had been no waiver or disclaimer; and that one-third of the undistributed income of the trust is includible in her gross estate under section 811 (a) of the Internal Revenue Code.2. On the facts, held, that the income accruing during the period of executorial administration of the estate of decedent's husband is to be included in computing the amount of undistributed income; held, further, that53 capital gains and losses of the trust are not to be taken into account in the computation of the undistributed income.3. No deduction is allowable for the amount paid by decedent's executors in settlement of seven notes (plus accrued interest) given by decedent to her grandchildren without consideration, because of the provisions of section 812 (b) (3) of the Internal Revenue Code. George E. H. Goodner, Esq., for the petitioners.Charles J. Munz, Esq., for the respondent. Arundell, Judge. ARUNDELL992 These consolidated proceedings involve estate tax deficiencies and fiduciary and transferee liability therefor in the amount of $ 55,606.06. It has been stipulated that petitioners G. Harold Earle and Stewart E. Earle, either as fiduciaries or transferees, or both, are liable for any taxes that may be found due from the estate of Emma Earle, who died November 1, 1940. Petitioners claim an overpayment of estate tax. The issues before us are three: Whether any of the undistributed55 income of the George W. Earle testamentary trust is includible in the gross estate of decedent, Emma Earle; the correct amount of the undistributed income of the trust; and whether the estate is entitled to a deduction of $ 35,606.69 representing the face amount and accrued interest on seven notes given by decedent and paid by her executors.FINDINGS OF FACT.Petitioners G. Harold Earle and Stewart E. Earle are the sons and only children of Emma Earle, deceased, and George W. Earle, deceased. Emma Earle died November 1, 1940, a resident of Hermansville, Michigan. She left a will under which her sons, the petitioners, were appointed executors of her estate. They filed an estate tax return with the collector for the district of Michigan and paid the tax shown therein to be due. Thereafter they distributed to themselves as residuary beneficiaries the corpus of the estate remaining after the payment of debts, expenses, etc.George W. Earle died testate on October 10, 1923, a resident of Hermansville, Michigan. His will was admitted to probate by the 993 Probate Court of Menominee County, Michigan, on November 27, 1923. The will reads in part as follows:After the payment of56 my just debts, liabilities and funeral expenses, I give, devise and bequeath all of my estate, both real and personal and wherever situate, unto G. Harold Earle, Stewart Earle and Charles M. Case, as trustees, and the survivor of them and his successor thereto, and his heirs, executors and administrators, respectively, according to the nature thereof, upon trust, to sell, convey or mortgage such parts of the trust property upon such terms as they may deem advisable, and to invest the proceeds thereof, or any moneys belonging to said trust estate, in such securities or in the carrying on of any business in which I may be interested at the time of my death, or to engage in any other business or enterprise of any nature whatsoever, as they may from time to time deem advantageous, with power to employ at such salaries as they shall think fit, such persons as may be necessary to carry on such business or enterprises, and generally to act in all matters relating thereto as if they were beneficially entitled to the same.In case of the death of any trustee I direct that such vacancy shall be filed within thirty days from the death of such trustee by appointment to be made by the surviving57 trustees.I hereby direct that thirty days after the birth of a grandson of mine, there shall be paid to the mother, if such child shall be then living, the sum of One Thousand Dollars ($ 1000), and in case of a granddaughter, Five Hundred Dollars ($ 500).I hereby direct that there shall be paid to each of my nieces, Myra Watson and Cora L. Earle, the sum of Five Hundred Dollars ($ 500) a year during the life of each, in equal quarterly instalments. If they or either shall be living at the time of the death of my wife, there shall be paid to each of them a sum sufficient to yield to each Five Hundred Dollars ($ 500) a year for such number of years as the mortality table adopted by the State of Michigan shall show the expectancy of the life of each to be, at the time of the death of my wife.I further direct that the income accruing to said trust estate shall be distributed at such times and in such amounts as said trustees shall deem best; said income to be paid to my wife, Emma Earle, one-third, to G. Harold Earle, his heirs, executors or administrators, one-third, and to Stewart Earle, his heirs, executors or administrators, one-third.Said trust to continue until the death of58 my said wife, Emma Earle, at which time said trust estate shall be closed and divided equally between my sons, G. Harold Earle and Stewart Earle.In case of the death of either of my said sons before the death of my wife, I hereby direct that the income that would have been payable to such deceased son shall be paid to his heirs, share and share alike, and upon distribution of said trust estate the share of said deceased son shall be distributed among his heirs in equal proportions.* * * The will also nominated Harold and Stewart Earle as executors, and they were appointed, qualified, and served as such until the administration of the estate was concluded on August 16, 1926. At that time they were discharged as executors, and the residue of the estate, consisting of both real and personal property, was transferred to them and to Charles M. Case as trustee of the testamentary trust provided for in the will. Case served as cotrustee until his death in 1940, and Chris H. Gribble was then appointed as his successor. The order 994 of the probate court assigning the residue of the estate to the trustees stated its value to be $ 2,109,049.01.The following schedule shows, for59 the George W. Earle estate and trust, the income, charges against income, capital gains and losses, legacies paid, and distributions made to Emma Earle:The estateThe trustTotal income$ 278,207.28$ 807,159.52 Charges against income5,176.0848,328.59 Net capital gains235,049.5036,634.38 Net capital losses(647,039.40)Cash distribution to Emma Earle20,000.0079,100.00 Other distribution to Emma Earle1,554.817,989.78 Legacies paid3,500.0022,570.00 George W. Earle, at the time his will was drafted, instructed his attorney that he wanted his entire estate, with the exception of a few specific legacies, to go to his two sons, but that he wanted a provision for his wife during her lifetime so that she would be amply provided for and could have anything she wished.The trustees accumulated a large part of the income of the trust, believing that the will granted them discretion not to distribute it all and that they were carrying out the testator's intent. They reinvested the accumulated income. They were never criticized for their acts in administering the trust. Whenever cash distributions were made to Emma Earle, like amounts were distributed60 to Harold and Stewart.In his lifetime George W. Earle was in the lumber business and had very extensive investments in land, timber, and securities. He owned considerable stock in the Wisconsin Land & Lumber Co. and was actively engaged in managing the company. Stewart Earle looked after his father's personal affairs and also worked at the lumber company. Some time prior to his death George W. Earle transferred to his sons a great deal of property outside Michigan and also some stocks.Stewart Earle kept the books of the George W. Earle estate and trust. The Wisconsin Land & Lumber Co. performed some accounting services for the trust, paying bills, etc., which would be charged to the trust. Some of the bills paid were on behalf of Emma Earle, and such amounts were treated as additional distributions to Emma Earle from the trust income. For the purpose of determining capital gains and losses, two bases were used. In the case of securities purchased by the trust, the cost to the trust was the basis. In the case of the property assigned from the estate to the trust, the value at the date of death of George W. Earle was used as the basis, that value being determined from the 61 court order and from the estate tax return.995 From a time prior to her husband's death until her own death, Emma Earle owned and lived in a large home in Hermansville. She had her own car, chauffeur, and household servants. She often spent the winter in the South or in California, and in the summertime she took automobile trips, sometimes alone and sometimes with a companion. Commencing at about the time of her husband's death, Emma Earle had her own bank account. She received interest on her savings and dividends on certain stock she owned, and by the time of her death she had accumulated over $ 92,000 in savings. At no time did she ask the trustees for money, and she was not required to do without anything she needed or desired. The trustees urged her to spend whatever money she wished and to buy anything she wished.After 1935 Stewart Earle asked his mother whether she wanted any more money to be distributed to her, and she said on several occasions that she did not. The money she had already accumulated was a responsibility and a concern to her, and she did not want the burden to increase. She did not, however, file with the trustees any written waiver of her interest62 under the trust, and she made no oral statement to them that she waived any rights. If she had at any time asked for extra money from the trust income the trustees would have given it to her.On December 25, 1936, Emma Earle gave each of her seven grandchildren, as a Christmas present, a demand note in the face amount of $ 5,000, bearing interest at the rate of 2 percent per annum. The interest was paid each Christmas until her death. On March 11, 1941, the executors of the estate of Emma Earle paid the face amount of the notes, plus accrued interest, pursuant to an order entered March 10, 1941, by the probate court having jurisdiction of the estate, after a hearing at which the claimants appeared personally and the estate was represented by Stewart Earle as executor and by Raymond Turner as attorney. The notes were given to the respective payees without consideration.The respondent determined that one-third of the undistributed income of the George W. Earle estate and trust was includible in the gross estate of Emma Earle. He determined that one-third of said income was $ 268,417.51. He also refused to allow a deduction claimed in the amount of $ 35,606.69 representing the63 total of the seven demand notes and accrued interest paid by the executors in 1941.OPINION.Respondent has determined that one-third of the undistributed income of the George W. Earle trust (stated in the deficiency notice to be $ 268,417.51) is includible in the gross estate of decedent, Emma Earle, under the provisions of section 811 (a) of 996 the Internal Revenue Code. 1 The reasons for his action were expressed in the deficiency notice as follows:In view of the failure of the testator [George W. Earle] to provide for an accumulation and his failure to provide for the disposition of any accumulation, it is held, that his wife, this decedent, acquired an absolute vested interest in one-third of the income which accrued during her lifetime and that her right to such income vested in her immediately upon the death of the testator. Accordingly, one-third of the accumulated income as of the date of the decedent's death has been included as part of her gross estate.64 Petitioners contend that under the terms of their father's will the trustees were given discretion to distribute or to withhold the income accruing to the trust estate and that the decedent had no vested interest in the accumulated income within the meaning of section 811 (a). The pertinent language of the will is as follows:I further direct that the income accruing to said trust estate shall be distributed at such times and in such amounts as said trustees shall deem best; said income to be paid to my wife, Emma Earle, one-third, to G. Harold Earle, his heirs, executors or administrators, one-third, and to Stewart Earle, his heirs, executors or administrators, one-third.From this language and the other provisions of the will and from the surrounding circumstances, we are to determine what the testator intended.The petitioners and their cotrustees interpreted the will as allowing them discretion to accumulate income. They contend that the only limit on the trustees' discretion was a provision that the distributions be divided equally among them and their mother as beneficiaries; that "said income" can refer only to the income which the trustees determined to distribute. It appears65 that the trustees administered the trust throughout the years in accordance with that interpretation; but the ultimate question is whether their action was authorized by the will. If it was not, what the trustees have done can not affect the result here.The testator first directed that the income accruing to the trust estate be distributed at such times and in such amounts as the trustees should deem best. If he had stopped at that point, there would perhaps be a stronger basis for the interpretation contended for by the petitioners. It is observed, however, that the testator did not say that so much of the income as the trustees deemed best should be distributed. He stated that "the income" should be distributed. Then he went on to provide that "said income" should be distributed in the proportions stated. As a matter purely of grammar, it would seem 997 that the antecedent of "said income" is "the income accruing to said trust estate" rather than such income as the trustees might determine to distribute, as is contended by petitioners. The fact that one-third of the income was to be payable to the heirs, executors, or administrators of Harold Earle and one-third to66 those of Stewart Earle, in view of the fact that the trust was to terminate upon the death of Emma Earle and the provision that in case of the death of either of the sons the "income that would have been payable" to him should be paid to his heirs, is further indication of an intent on the part of the testator that all the income of the trust was to be distributed. Furthermore, nowhere in the will did the testator make any provision for the accumulation of income or for the disposition of any accumulations -- a fact which, it would seem, tends to negative an intent on the part of the testator that the trustees should have discretion not to distribute all the income. Cf. Mary Pyne Filley, 45 B. T. A. 826; F. T. Bedford, 2 T. C. 1189; affd., 150 Fed. (2d) 341.Petitioners contend that under such a construction no meaning is given to the provision that distributions should be made at such times and in such amounts as the trustees deem best. It seems to us, however, that under respondent's construction of the will those words are not necessarily meaningless. They could mean merely that the trustees67 were not required to distribute the income monthly, e. g., or quarterly, or at any other regular intervals in equal amounts throughout a given year. The mere giving of discretion as to time and amounts of the distributions is by no means necessarily an indication that not all of the income is to be distributed.Conceding that there may be some ambiguity in the language used by the testator, so as to warrant a consideration of the extrinsic evidence as to the testator's statements at or about the time his will was executed, nevertheless we find nothing in such statements indicating an intent that the trustees were to have discretion to distribute less than all of the income and to accumulate the surplus. The testator's instructions to his attorney were that he wished to give his estate ultimately to his two sons, but that he wanted a provision which would adequately and amply provide for his wife during the remainder of her life. Doubtless he thought that one-third of the income of the trust estate provided for in his will would be adequate to care for her in every way, and there is no reason to believe that he intended that his wife should receive nothing from the trust if the 68 trustees should choose to give her nothing.The cases of Roebling v. Commissioner, 78 Fed. (2d) 444; Elizabeth W. Shelden, B. T. A. memorandum opinion entered Feb. 20, 1942; and Estate of Gertrude Leon Royce, 46 B. T. A. 1090, relied upon by petitioners, are clearly distinguishable on the facts and need not be reviewed here.998 From all the evidence, we conclude that it was the testator's intent that Emma Earle should have a vested right to one-third of the income of the trust.Petitioners next contend that, even if it be held that Emma Earle was entitled to one-third of the income, she waived or disclaimed her rights or interests under the trust. It is well settled trust law that the beneficiary of a trust may disclaim his interest under the trust before acceptance. However, since Emma Earle had accepted benefits under the trust she was not in a position thereafter to disclaim. See 1 Bogert, Trusts and Trustees, § 173. Having once accepted and become the equitable owner of an interest in the trust, she could divest herself of such ownership only by a transfer to another. Michigan law requires that a 69 conveyance by the beneficiary of any trust be in writing. Michigan Stat. Ann., § 26.972; 1 Bogert, Trusts and Trustees, § 190; cf. 1 Scott on Trusts, § 139. All that Emma Earle did was to tell the trustees in 1935, when asked whether she wanted any more money to be distributed to her, that she did not. We think, therefore, that petitioners' contention in this regard can not be sustained.We conclude that one-third of the undistributed income of the trust is properly includible in the decedent's gross estate. The next issue requires a determination of the correct amount of the undistributed income.Petitioners contend that the charges against income are first to be deducted, which respondent apparently now concedes. They contend also that the capital losses of the trust are to be deducted before determining distributable income, and that only the income of the trust (excluding the income to the estate during the period of administration) is to be included, because of the fact that the will provides only for the distribution of income accruing to "said trust estate."We shall consider first the question whether the income of the estate during the period of administration is to be70 included. According to the Restatement of the Law of Trusts, § 234, where a will provides for the creation of a trust the income of which is payable to one beneficiary for life or a designated period and thereafter the principal to another beneficiary, in the absence of a contrary indication the income beneficiary is entitled to income from the date of the death of the testator. See also 2 Scott on Trusts, § 234.3, and 4 Bogert, Trusts and Trustees, § 811, which indicate that the rule of the Restatement is the majority rule. It appears also that that is the law of Michigan. See Detroit Trust Co. v. Detroit Trust Co., 258 Mich. 386">258 Mich. 386; 242 N. W. 738; Poole v. Union Trust Co., 191 Mich. 162">191 Mich. 162; 157 N. W. 430. We find no indication in the will or elsewhere that Emma Earle should be entitled to 999 nothing during the period of administration of the testator's estate. On the contrary, all the circumstances point the other way. The testator's obvious intent was to provide for her from the date of his death. The income during the period of administration therefore71 should be included in the computation of the undistributed income.Petitioners' contention with respect to the capital gains and losses appears to be that, since those items are taken into account in determining the net income of a trust for income tax purposes, they should likewise be included in computing the income distributable to the beneficiary. The net income of a trust for income tax purposes and the amount of income distributable to a beneficiary, however, may be two quite different things. It is only with the latter, that is, the determination of the amount of distributable income, that we are concerned here. As between an income beneficiary and a remainderman, capital gains and losses generally fall on the principal or corpus of the trust, 4 Bogert, Trusts and Trustees, § 823, and ordinarily do not affect the computation of the income of the beneficiary, 6 Mertens, Law of Federal Income Taxation, § 36.51. Cf. Baltzell v. Mitchell, 3 Fed. (2d) 428. Of course, the general rule may be varied by the terms of the trust instrument or the will establishing the trust, but the instrument before us is silent with respect to the treatment of 72 capital gains and losses. Furthermore, we have been cited to no statute or case law of Michigan, nor have we found any, to indicate a contrary rule in that state.Shortly before his death George W. Earle transferred to his two sons extensive properties outside the State of Michigan and also some stocks. From all the circumstances it would appear that his primary concern with respect to the trust was for the protection of his widow during her life, and, since there is no mention in the will of the treatment to be accorded capital losses, we find no reason to believe he intended that they should be charged to income. We conclude, therefore, that capital gains and losses are not to be taken into account in determining the distributable income of the trust.The correct amount of Emma Earle's share of the undistributed income is $ 235,309.45, computed as follows:Income of the estate$ 278,207.28Income of the trust807,159.52Total income1,085,366.80Income charges, estate$ 5,176.08Income charges, trust48,328.5953,504.67Total distributable income1,031,862.13Emma Earle's share, one-third343,954.04 Distributions to Emma Earle:Estate:Cash$ 20,000.00Other1,554.81Trust:Cash79,100.00Other7,989.78$ 108,644.59Emma Earle's share of undistributed income includible in her estate235,309.4573 1000 As for the third issue, respondent has determined that no deduction is allowable for the amount of $ 35,606.69 paid by the executors of Emma Earle's estate in settlement of the seven notes given by decedent to her grandchildren, because of the provisions of section 812 (b) (3) of the Internal Revenue Code. 2 Petitioners contend that under the Michigan negotiable instruments law failure of consideration is a matter of defense; that Emma Earle did not in her lifetime raise the defense; and that after her death the probate court ordered payment of the notes. They further contend that the sum in question did not pass at the death of Emma Earle, and that the estate tax law imposes a tax upon the passing of property at death.74 The issue before us is not the includibility of the sum of $ 35,606.69 in the gross estate of the decedent, but rather the deductibility thereof as a claim against the estate, and the statute expressly denies the deduction, because concededly there was no consideration in money or money's worth for the notes. The statute fully recognizes that certain claims may be allowable against an estate under state law, but the deductibility of such claims for Federal estate tax purposes is expressly limited to those contracted in good faith and for full and adequate consideration.On the authority of Estate of Julius C. Lang, 34 B. T. A. 337; affirmed on this issue, 97 Fed. (2d) 867, we hold that no deduction is allowable in respect of the seven notes.Decisions will be entered under Rule 50. Footnotes1. SEC. 811. GROSS ESTATE.The value of the gross estate of the decedent 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 --(a) Decedent's Interest. -- To the extent of the interest therein of the decedent at the time of his death.↩2. SEC. 812. NET ESTATE.For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate --* * * (b) Expenses, Losses, Indebtedness, and Taxes. -- Such amounts -- * * (3) for claims against the estate, * * as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered * . The deduction herein allowed in the case of claims against the estate * * or any indebtedness shall, when founded upon a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621494/	Estate of Otis E. Byrd, Deceased, Jimmie Lou Byrd, Administratrix, Petitioner, v. Commissioner of Internal Revenue, RespondentByrd v. CommissionerDocket No. 3848-64United States Tax Court46 T.C. 25; 1966 U.S. Tax Ct. LEXIS 120; April 6, 1966, Filed 120 Decisions will be entered for the respondent, The decedent at the date of his death owned 32.4 percent in value of the stock of A corporation, 66 percent of B corporation, 26.67 percent of C corporation, and 88.9 percent of D corporation, which values were included in computing the value of the gross estate. D corporation, in turn, owned stock of A, B, and C corporations. The estate of the decedent, the petitioner herein, received distributions from A, B, and C corporations in redemption of part of the stock of such corporations which it held. The value of the stock of each of the redeeming corporations held directly by the estate and included in determining the value of the gross estate was less than 35 percent of the gross estate and less than 50 percent of the taxable estate. Held, that the value of 88.9 percent of the stock of A, B, and C corporations held by D corporation may not be combined with the value of the stock of the A, B, and C corporations held by the estate for the purpose of determining whether, under section 303(b)(2)(B) of the Internal Revenue Code of 1954, there was included in determining the value of the decedent's gross estate more than 75 percent121 in value of the outstanding stock of any of the redeeming corporations; that therefore the value of the stock of the three redeeming corporations held by the estate may not be treated as the stock of a single corporation for the purpose of determining whether the value of all of the stock of a redeeming corporation included in determining the value of the decedent's gross estate constituted more than 35 percent of the value of the gross estate or more than 50 percent of the taxable estate as required by section 303(b)(2)(A) of the Code; and that therefore the distributions received by the petitioner may not, under section 303(a) of the Code, be treated as distributions in full payment in exchange for the redeemed stock. W. G. Hardwick, for the petitioner.Robert W. Goodman, for the respondent. Atkins, Judge. ATKINS26 OPINIONThe respondent determined a deficiency in income tax of $ 64,856.64 against the petitioner-estate for its taxable year 1959. The only issue presented is whether distributions received by the estate upon the redemption of stock of three corporations should be treated, under section 303 of the Internal Revenue Code of 1954, as distributions in exchange for the stock so redeemed, as contended by the petitioner, or whether the amounts received upon the redemptions constituted dividends, as determined by the respondent.All of the facts have been stipulated and are incorporated herein by this reference.The petitioner filed its Federal income tax return for its taxable year 1959 with the district director of internal revenue at Birmingham, Ala.The decedent died on August 21, 1957. His gross estate was valued125 for estate tax purposes at $ 728,624.85 and the taxable estate was $ 314,512.19.On the date of the decedent's death there were issued and outstanding 50,000 shares of common stock of the Peoples Savings Life Insurance Co. (hereinafter referred to as Peoples) having a total value of $ 175,000. At the time of his death the decedent owned 44,450 shares 27 of the outstanding common stock of Peoples which had a value of, and was included in his gross estate at, $ 155,575. This represented 88.9 percent of the total value of the outstanding capital stock of such company.On the date of the decedent's death there were issued and outstanding 700 shares of common stock of the Hub City Finance Co., Inc. (hereinafter referred to as Hub City), having a total value of $ 140,000. At the time of his death the decedent owned 227 shares of such stock which represented 32.4 percent of the total value of the outstanding shares of such company. The total value of the decedent's 227 shares for Federal estate tax purposes was $ 45,400.On the date of the decedent's death Peoples owned 471 shares of the outstanding common stock of Hub City. The value of the 88.9 percent of the 471 shares of Hub126 City owned by Peoples valued in the decedent's estate was $ 83,743.80.The total value of the stock of Hub City owned by the decedent individually at the date of his death was $ 45,400 and the 88.9 percent of the 471 shares of stock of Hub City owned by Peoples was valued at $ 83,743.80 or a total valuation in the estate of $ 129,143.80, which constituted 92.24 percent of the total value of all the outstanding capital stock of Hub City at date of decedent's death.On the date of the decedent's death there were issued and outstanding 290 shares of class A nonvoting common stock and 10 shares of class B voting stock of the Alabama Banking Co., Inc. (hereinafter referred to as Alabama Banking). The total value of both classes of stock was $ 150,000. At the time of his death, the decedent owned 190 shares of the outstanding class A nonvoting common stock and 8 shares of the outstanding class B voting stock, which had a total value for Federal estate tax purposes of $ 99,000, which represented 66 percent of the total value of the outstanding capital stock of such company.On the date of the decedent's death Peoples owned 99 shares of the outstanding class A common stock of Alabama Banking127 which had a value at the date of the decedent's death of $ 49,500. The value of the 88.9 percent of the 99 shares of Alabama Banking owned by Peoples valued in the decedent's estate was $ 44,005.50.The total value of the stock of Alabama Banking owned individually by the decedent at the date of his death was $ 99,000 and the 88.9 percent of the stock of Alabama Banking owned by Peoples was valued at $ 44,005.50 or a total valuation in the estate of $ 143,005.50, which constituted 95.33 percent of the total value of all the outstanding capital stock of Alabama Banking at the date of decedent's death.On the date of the decedent's death there were issued and outstanding 1,000 shares of class A nonvoting common stock and 275 shares 28 of class B voting common stock of the Rock Finance Co., Inc. (hereinafter referred to as Rock Finance), having a total value of $ 56,250. At the time of his death the decedent owned all of the 1,000 shares of the outstanding class A nonvoting common stock of Rock Finance, which had a value for Federal estate tax purposes of $ 15,000, which represented 26.67 percent of the total value of the outstanding capital stock of such company.On the date128 of the decedent's death Peoples owned 221 shares of the outstanding class B voting stock of Rock Finance. The value of the 88.9 percent of the 221 shares of class B voting stock of Rock Finance owned by Peoples valued in the decedent's estate was $ 29,470.35.The total value of the stock of Rock Finance owned by the decedent individually at the date of his death was $ 15,000 and the 88.9 percent of the stock of Rock Finance owned by Peoples was valued at $ 29,470.35 or a total valuation in the estate of $ 44,470.35, which constituted 79.05 percent of the total value of all the outstanding capital stock of Rock Finance at the date of the decedent's death.On November 17, 1959, Alabama Banking redeemed 100 shares of class A nonvoting common stock from the petitioner for $ 50,000. On November 21, 1959, Rock Finance redeemed 900 shares of class A nonvoting common stock from petitioner for $ 13,500. On the same day Hub City redeemed 127 shares of its common stock from the petitioner for $ 25,400. The price at which Alabama Banking, Rock Finance, and Hub City redeemed such shares was the same as the amount at which they were valued in the Federal estate tax return filed by the petitioner. 129 The petitioner has paid the following estate taxes and administration expenses:Federal estate tax$ 86,343.90Alabama estate tax5,984.39Funeral and administration expense8,615.80Total100,944.09In its income tax return for the taxable year 1959 the petitioner did not report any income from the above stock redemptions, treating the amounts received as distributions in exchange for the stock under the provisions of section 303 of the Internal Revenue Code of 1954.In the notice of deficiency the respondent determined that the redemptions of stock did not meet the requirements of section 302 and/or 303 of the Internal Revenue Code of 1954, and that the distributions totaling $ 88,900 constituted dividend income which is to be included in gross income under section 301 of the Code.There are set forth in the margin pertinent provisions of section 29 303 of the Code. 1Section 303(a) sets forth the general rule that a distribution in redemption of all or part of the stock of a corporation which is included in the decedent's gross estate shall be treated as a distribution in full payment in exchange for the stock redeemed to the extent that the amount of 130 the distribution does not exceed the sum of all taxes imposed because of the decedent's death and the funeral and administration expenses deductible by the estate in computing the value of the taxable estate. However, section 303(b)(2)(A) limits the application of the general rule to the situation where the value for estate tax purposes of all of the stock of the redeeming corporation included in determining the value of the decedent's gross estate is either more than 35 percent of the value of the gross estate or more than 50 percent of the taxable estate. Section 303(b)(2)(B) provides that, for purposes of the application of the 35-percent and 50-percent requirements, stock of two or more corporations, with respect to each of which there is included in determining the value of the decedent's gross estate more than 75 percent in value of the outstanding stock, shall be treated as the stock of a single corporation.131 The total amount of the distributions received by the petitioner did not exceed the sum of the tax imposed because of the decedent's death and the amount of the funeral and administration expenses allowable 30 as deductions in computing the taxable estate. Nor is there any question that the distributions were made within the time limitations provided by the statute. The only controversy is whether the percentage requirements of section 303(b)(2) have been met.The value of the gross estate was $ 728,624.85 and the taxable estate was $ 314,512.19. The value ($ 45,400) of the stock of Hub City which the decedent owned directly and which was included in determining the value of his gross estate obviously does not amount to more than 35 percent of the value of the gross estate or to more than 50 percent of the taxable estate. The same is true with respect to the value ($ 99,000) of the stock of Alabama Banking and the value ($ 15,000) of the stock of Rock Finance which the decedent owned directly and which was included in determining the value of the gross estate. Furthermore, the decedent did not own directly as much as 75 percent of the outstanding stock of any one of such132 corporations (owning directly only 32.43 percent of Hub City, 66 percent of Alabama Banking, and 26.67 percent of Rock Finance), and therefore the amount included in the gross estate representing such direct ownership did not amount to as much as 75 percent of the value of the outstanding stock of any of those corporations. Thus, if we consider only the value of the stock of those corporations included in the gross estate on account of the stock which the decedent directly owned, it is readily apparent that none of such stock may, under section 303(b)(2)(B), be treated, along with stock of any other corporation, as stock of a single corporation for the purpose of determining whether either the 35-percent or the 50-percent requirement has been met.The petitioner contends that in determining whether more than 75 percent in value of the outstanding stock of any of the redeeming corporations was included in determining the value of the gross estate there should be taken into consideration the value of 88.9 percent of the stock of those corporations which was owned by Peoples, since such value was included in the gross estate by virtue of there having been included in the gross estate133 the value of the decedent's 88.9 percent of the stock of Peoples. It argues that the statute is concerned only with whether the value of stock of a corporation included in determining the value of the gross estate meets the percentage requirement, and that such value should be construed as encompassing "direct valuation and indirect valuation and all valuations of any capital stock of any corporation which was included in any manner in the estate of the decedent." It points out that the stipulation of facts, which has been set forth hereinabove almost verbatim, states that the value of the stock of the redeeming corporations owned by the decedent individually at the date of his death as well as the value of 88.9 percent of the stock of such corporations owned by Peoples, or a total of 92.24 percent of the value of the outstanding stock of Hub City, 95.33 31 percent of the value of the outstanding stock of Alabama Banking, and 79.05 percent of the value of the outstanding stock of Rock Finance, was included in the decedent's estate. It therefore contends that the provisions of section 303(b)(2)(B) have been met.If the petitioner is correct in its interpretation of the statute134 then it must be considered that there was included in determining the value of the decedent's gross estate more than 75 percent in value of the outstanding stock of each of Hub City, Alabama Banking, and Rock Finance; that therefore the stock of those three corporations is to be treated as the stock of a single corporation; and that the value of the stock of such single corporation included in determining the value of the decedent's gross estate was $ 316,619.65 (composed of $ 129,143.80 for Hub City, $ 143,005.50 for Alabama Banking, and $ 44,470.35 for Rock Finance), which is more than 35 percent of the value of the gross estate of the decedent and more than 50 percent of the taxable estate of the decedent.The respondent, on the other hand, contends that only the value of the stock owned directly by the decedent at date of death can be utilized in determining whether the 75-percent requirement of section 303(b)(2)(B) has been met. It is his position that Congress did not intend for the phrase "included in determining the value of the decedent's gross estate" to encompass stock held as an underlying asset by a corporation the stock of which has been directly valued in the gross135 estate. He points out that in those sections of the Code where indirect ownership as well as direct ownership is intended to apply this has been specifically stated in the Code section or there has been a cross-reference to section 318, which deals with constructive ownership of stock, whereas section 303 contains no provision allowing the combining of stocks directly owned and those indirectly owned in order to meet the 75-percent requirement of section 303(b)(2)(B).We agree with the respondent that for the purpose of determining whether the 75-percent requirement set forth in section 303(b)(2)(B), and hence the 25-percent or 50-percent requirement of section 303(b)(2)(A), has been met there is to be taken into consideration only the value of the stock of the redeeming corporation which has been directly included in determining the value of the decedent's gross estate -- that is, the value of the stock of such corporations which the decedent owned directly at the date of his death and which was included in his gross estate. It is clear that section 303 must be interpreted in the light of the other sections of the Code dealing with the estate tax, since it specifically refers to136 the value, for Federal estate tax purposes, of stock included in determining the value of the decedent's gross estate.Section 2031 of the Code provides that "The value of the gross estate of the decedent shall be determined by including to the extent 32 provided for in this part [pt. III, ch. 11], the value at the time of his death of all property * ." Section 2033 sets forth the basic provision that the "value of the gross estate shall include the value of all property * * to the extent of the interest therein of the decedent at the time of his death." There are, in addition, other provisions in part III requiring that the value of the gross estate shall include the value of property transferred in contemplation of death (sec. 2035), property the transfer of which is to take effect at death (sec. 2037), etc. Part III does not provide for the inclusion in determining the value of the gross estate of the value of property owned by a corporation of which the decedent is a stockholder. Thus, we think that section 303(b)(2)(B) must be interpreted as having reference to only the stock actually owned by the decedent at the date of his death or otherwise required to be included137 in his gross estate, and not to stock in which he has only an indirect interest through ownership of stock of another corporation. 2 In the instant case there was not included in determining the value of the decedent's gross estate, within the contemplation of the statute, the stock of the redeeming corporations which was owned by Peoples. It was the value of the decedent's stock of Peoples which was included in the decedent's gross estate. 3138 In view of the foregoing, we hold that the respondent properly determined that the distributions in question are not to be treated as distributions in full payment of the stock redeemed within the contemplation of section 303 of the Code. The respondent also determined that such distributions did not qualify as distributions in part or full payment in exchange for the stock within the contemplation of section 302 of the Code, and that therefore such distributions constituted dividends. These latter determinations of the respondent have not been put in issue.Decisions will be entered for the respondent, Footnotes1. Section 303 of the Code provides in part as follows:(a) In General. -- A distribution of property to a shareholder by a corporation in redemption of part or all of the stock of such corporation which (for Federal estate tax purposes) is included in determining the gross estate of a decedent, to the extent that the amount of such distribution does not exceed the sum of -- (1) the estate, inheritance, legacy, and succession taxes (including any interest collected as a part of such taxes) imposed because of such decedent's death, and(2) the amount of funeral and administration expenses allowable as deductions to to the estate under section 2053 * * *,shall be treated as a distribution in full payment in exchange for the stock so redeemed.(b) Limitations on Application of Subsection (a). -- (1) Period for distribution. -- Subsection (a) shall apply only to amounts distributed after the death of the decedent and -- (A) within the period of limitations provided in section 6501(a) for the assessment of the Federal estate tax (determined without the application of any provision other than section 6501(a)), or within 90 days after the expiration of such period, or(B) if a petition for redetermination of a deficiency in such estate tax has been filed with the Tax Court within the time prescribed in section 6213, at any time before the expiration of 60 days after the decision of the Tax Court becomes final.(2) Relationship of stock to decedent's estate. -- (A) In general. -- Subsection (a) shall apply to a distribution by a corporation only if the value (for Federal estate tax purposes) of all of the stock of such corporation which is included in determining the value of the decedent's gross estate is either --(i) more than 35 percent of the value of the gross estate of such decedent, or(ii) more than 50 percent of the taxable estate of such decedent.(B) Special rule for stock of two or more corporations. -- For purposes of the 35 percent and 50 percent requirements of subparagraph (A), stock of two or more corporations, with respect to each of which there is included in determining the value of the decedent's gross estate more than 75 percent in value of the outstanding stock, shall be treated as the stock of a single corporation. For the purpose of the 75 percent requirement of the preceding sentence, stock which, at the decedent's death, represents the surviving spouse's interest in property held by the decedent and the surviving spouse as community property shall be treated as having been included in determining the value of the decedent's gross estate.↩2. In this connection it should be noted that the only exception to this provided in sec. 303(b)(2)(B)↩ is that provided in the last sentence thereof which states that a surviving spouse's interest in stock held by the decedent and the surviving spouse as community property shall be treated as having been included in determining the value of the decedent's gross estate.3. The parties have, in effect, stipulated as a fact that in the instant case the circumstances are such that the value of the stock of Peoples is measured by the value of the stock of the redeeming corporations which it owned. However, that fortuitous circumstance is not determinative of the question here presented.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621498/	MARY C. MARSHALL REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mary C. Marshall Realty Co. v. CommissionerDocket No. 56358.United States Board of Tax Appeals29 B.T.A. 241; 1933 BTA LEXIS 973; October 31, 1933, Promulgated 973 Abraham Lowenhaupt, Esq., and Stanley S. Waite, Esq., for the petitioner. George D. Brabson, Esq., for the respondent. TRAMMELL241 OPINION. TRAMMELL: This proceeding is for the redetermination of a deficiency in income tax of $8,371.02 for 1927. The only matter in controversy is the correctness of the respondent's action in including in taxable income the amount of $56,596.91 as representing profit realized from the sale of real estate. The petitioner is a Missouri corporation, organized in 1907, and has its office at St. Louis. Although empowered by its charter to engage in the real estate business generally, it was organized primarily to hold and manage the real estate belonging to the estate of Mary C. Marshall, who had died in 1905. From time to time the petitioner sold some of the real estate which had been transferred to it from the estate. It never bought or dealt in other real estate nor held any in connection with any other person. The corporation was regarded as a family affair and its business was conducted very informally. No stockholders' or directors' meetings were held between April 15, 1918, and April 16, 1927. 974 The capital stock of the petitioner consisting of 500 shares was neld as follows during the year 1927: SharesJohn D. Marshall125Merritt H. Marshall125Cora B. Pullis125Collier M. Berry62 1/2Leslie W. Berry62 1/2During 1927 and until his death in 1928 John D. Marshall was president of the petitioner. Collier M. Berry was elected treasurer in 1927. Merritt H. Marshall was secretary in 1927 and had held that office since 1907. For a number of years John D. Marshall was the stockholder most active in the management of the corporation's business. The other stockholders permitted him to negotiate sales and to confer with them separately and informally respecting their consent thereto. After Collier M. Berry was elected treasurer in 1927 he began to take an active interest in the sale of certain of the corporation's property. 242 About October 1926 John D. Marshall, president of the petitioner, advised William M. Stites, a real estate agent through whom the petitioner had previously sold several pieces of property, that certain property of the petitioner known as the Marshall Building, situated in Maplewood, Missouri, was for975 sale and asked Stites to obtain an offer from a purchaser. In April 1927 Stites obtained such an offer from one Aufrichtig, representing the Lesser Goldman Cotton Co., to purchase the building for $132,500 cash. A contract of sale combined with a receipt for $10,000 earnest money made out in the name of the petitioner was submitted to John D. Marshall. This receipt was returned to Stites on June 24, 1927, approved and signed by John D. Marshall, as president, and C. M. Berry, as treasurer, for the petitioner. Between August 1914 and January 1927 Stites had acted for the corporation in making all its sales and had sold several pieces of real estate. When the contract and receipt for earnest money was signed on June 24, 1927, he believed he was acting for the petitioner. On all previous sales the documents had been signed by John D. Marshall as president and Merritt H. Marshall as secretary of the petitioner. On the same date the contract of sale and receipt for earnest money was executed a statement of rentals and expenditures with respect to the Marshall Building was executed in the name of the petitioner, John D. Marshall signing as president and C. M. Berry as treasurer. 976 Also on the same date John D. Marshall, signing as president of the petitioner, and C. M. Berry, as treasurer, executed an instrument with Aufrichtig whereby Aufrichtig granted to the petitioner an easement in one of the walls of the Marshall Building for the benefit of an adjoining building owned by petitioner. Some time between June 24, 1927, and August 1, 1927, Collier M. Berry consulted one Wilson, an attorney, "to see that this thing was put through in a proper manner" and to see if the transaction might be handled in some manner so as to save the petitioner taxes. Wilson advised him that this could be done by having the petitioner distribute the property in question to the stockholders as a dividend in kind, then place the property in the hands of a trustee, who then could pass title to the purchaser. Acting upon the advice of Wilson a special joint meeting of the stockholders and directors, who were the same persons, was held on August 1, 1927, at which time a resolution was adopted purporting to distribute to the stockholders the Marshall Building, subject to a first and a second trust, and as a dividend in kind, their interests therein to be in proportion to their stockholdings977 in the petitioner. Upon request of the stockholders the petitioner on August 1, 1927, executed a deed to the Marshall Building to Collier M. Berry, who on the same date executed with 243 respect thereto a declaration of trust in favor of the respective stockholders and an agreement with them whereby they empowered him to sell and convey the property for $132,500 within 90 days from date. The dividend was recorded in the petitioner's journal by the following entry: 1927Aug. 3. Surplus$20,476.14Bills Pay #415,000.00Bills Pay #4623,000.00Bills Pay #5310,000.00Bills Pay #5611,386.43Bills Pay #575,211.43To Maplewood Real Estate$75,074.00To record dividend in kind of this date.The attorney for the Lesser Goldman Cotton Co., in making his examination of the title to the Marshall Building, found it to be in the name of Collier M. Berry, who held it for the benefit of himself and the other stockholders of the petitioner as their respective interests might appear. The attorney also found that the east wall of the building was seven or eight inches over on property still held by the petitioner and which was not included in the978 deed to Collier M. Berry. Under these circumstances the attorney refused to approve the title unless the petitioner gave the purchaser an easement in the other property with respect to the wall and unless all the stockholders and their respective husbands or wives joined in the deed. A special joint meeting of the stockholders and directors of the petitioner was held on August 5, 1927, at which time the officers of the petitioner were empowered to join with the stockholders in the execution of a general warranty deed conveying the Marshall Building to the purchaser and granting the easement desired. Thereupon on the same date the stockholders of the petitioner and their respective spouses and the petitioner, by its president and secretary, executed a general warranty deed to the Marshall Building, together with the easement referred to above. While Collier M. Berry signed the deed, he did not purport to do so in his capacity as trustee for the other stockholders, nor was the deed signed by anyone as trustee. The earnest money receipt having provided that the amount paid in connection therewith should constitute a part of the purchase money, a cashier's check dated August 10, 1927, for979 $121,239.34 and drawn to the order of the attorney for the purchaser was endorsed by him over to the order of Collier M. Berry, who in turn endorsed it and delivered it to the Stites Realty Co., which used part of the 244 proceeds thereof for the payment of certain deeds of trust or mortgages outstanding on the Marshall Building and in payment of certain expenses and turned the balance back to Berry. Berry thereupon opened an account in a bank in Maplewood in his name as trustee and issued checks against it to each of the stockholders for the amount finally ascertained to be due them. This brought the transaction to a close. Certain expenses paid by the purchaser, plus the earnest money and the amount of the cashier's check, all totaling $132,500, constituted the consideration paid by the purchaser for the property. In its income tax return for 1927 the petitioner made no reference to the sale of the Marshall Building with the exception that the balance sheet at the end of the year showed building and land at $81,316.25 less than at the beginning of the year. In determining the deficiency here involved the respondent included in the petitioner's taxable income the980 amount of $59,596.91 as a profit realized by it on the sale of the Marshall Building. The petitioner contends that the earnest money receipt and contract of sale executed by its president and treasurer on June 24, 1927, was a nullity so far as the petitioner was concerned because it was neither authorized nor approved by petitioner's directors or stockholders; that the fact that it joined in the deed with the stockholders and their wives does not establish a sale of the property by the petitioner; that the petitioner's action in conveying the property to a trustee for its stockholders pursuant to the resolution adopted at the special joint meeting of the stockholders and directors on August 1, 1927, effectually transferred from the petitioner any title or interest in the property and therefore it could not have derived any profit from the sale of the property. The respondent contends that the sale negotiated on behalf of the petitioner by its president and treasurer, as evidenced by the earnest money receipt and contract of sale executed on June 24, 1927, was carried out in accordance with its original terms and was consummated by the execution of a deed by the corporation and981 stockholders on August 5, 1927; that the intermediate transaction conveying the property to C. M. Berry as trustee was merely a device or subterfuge indulged in in an attempt to avoid taxation and did not affect the terms and conditions of the original contract of sale and that the sale was in effect one by the petitioner, which is subject to tax on the profits therefrom. There is no controversy between the parties as to the correctness of the amount of the profit from the transaction as computed by the respondent, the controversy being only as to whether the petitioner is taxable on such profit. 245 The burden of a great deal of the petitioner's argument, as well as some of its evidence, is to the effect that under its bylaws neither its president nor its treasurer had any authority to execute the earnest money receipt and contract of sale executed by them on June 24, 1927; that when they (the president and treasurer) discovered that a large income tax would result from the sale of the property by the petitioner they conferred with counsel and sought a means of avoiding such tax and, without letting the other stockholders know that the instrument of June 24, 1927, had982 been executed and the earnest money paid pursuant thereto, they permitted the adoption of the resolution of August 1, 1927, distributing the property to the stockholders in kind; that this action and resolution were bona fide in every respect and that the property in question was on that date effectively transferred from the petitioner to the stockholders. The petitioner further urges that the stockholders never ratified or approved the action of its president and treasurer in executing the instrument of June 24, 1927. While three of the stockholders, Merritt H. Marshall, Cora B. Pullis and Leslie W. Berry, testified as to having no knowledge prior to or on August 1, 1927, of the contract of sale, the payment of the earnest money and the earnest money receipt executed on June 24, 1927, they testified as to knowing prior to August 1 that a sale was pending with respect to the property and that the purpose of the meeting was to consider matters relating thereto. There is some other testimony indicating that Leslie W. Berry was aware of all that had been done. Cora B. Pullis testified that Merritt H. Marshall, secretary of the petitioner, in advising her that the meeting was to983 be held, informed her that the object of it was to declare the property as a dividend to the stockholders. The record also shows that attorneys were present at the meeting and explained to the stockholders and directors that if the transaction were handled as originally planned - that is, by the petitioner making the sale and deed directly to the purchaser or its agent - there would be an income tax to be paid by petitioner, but that if the property were first distributed as a dividend and the sale and deed not made directly by the petitioner, there would be no tax to it. The record also clearly shows that the stockholders all knew that the meeting on August 1, 1927, was for the purpose of attempting to handle the property in such a way as to reduce the taxes to the petitioner. Most, if not all, of the stockholders knew prior to August 1 that the selling price of $132,500 for the property had been agreed upon. The purchaser through its agent acquired title to the property upon final payment of the consideration agreed upon in the instrument 246 of June 24, 1927. While none of the stockholders and directors other than John D. Marshall and Collier M. Berry may have known984 on August 1 or August 5, 1927, of the execution of the instrument of June 24 and the payment of the earnest money, there is nothing in the record to indicate that when they did learn of these facts they took any steps to repudiate the agreement or to have the execution of the deed to the property set aside or that they in any wise proceeded against John D. Marshall and Collier M. Berry for failing to disclose such information to them prior to the execution of the deed. Considering the foregoing and the other facts in the case in connection with the fact that the purchaser acquired title to the property within the time, and for the consideration specified in the contract of sale and receipt for purchase money of June 24, 1927, we are unable to conclude that the roundabout method selected for transferring title to the purchaser operated to relieve petitioner of the tax on the income from the sale of the property. The petitioner lays much stress on the action taken at the joint meeting of the stockholders and directors on August 1, 1927, in distributing the property to the stockholders and thereby divesting petitioner of all interest therein. While the resolution purporting to declare985 the distribution indicates that such distribution was to be from the petitioner's surplus, there is nothing to indicate that the stockholders of petitioner considered or treated such distribution as a part of their income. So far as the record discloses the matter was handled by them as if they were a mere conduit, as contended by respondent, through which the title passed from the petitioner to the purchaser. The record is clear that the only purpose for which the property was transferred out of the petitioner's name was to start it on its way to the purchaser or its agent. Had the instrument of June 24, 1927, not been executed, there is nothing in the record to indicate that any attempt to distribute the property to the stockholders would have been made either in 1927 or at any other time. The purported distribution of the property was, in our opinion nothing but an attempt on the part of the stockholders and directors, a majority of whom were no doubt fully acquainted with the situation, to avoid the consequence of the acts of its president and treasurer in entering into the contract of sale and accepting the earnest money in connection therewith. 986 The respondent has included the profit from the sale of the property in the taxable income of the petitioner. From the facts before us we are unable to hold that he erred in so doing. Cf. ; ; . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621499/	Estate of Pauline E. Strickland, Deceased, Della Rose Schwartz, Personal Representative, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Strickland v. CommissionerDocket No. 41553-85United States Tax Court92 T.C. 16; 1989 U.S. Tax Ct. LEXIS 3; 92 T.C. No. 3; January 10, 1989; As amended January 18, 1989 January 10, 1989, Filed 3 Decision will be entered under Rule 155. Decedent died on Jan. 3, 1982. Petitioner attempted to elect sec. 2032A, I.R.C. 1954, special use valuation on an amended Federal estate tax return timely filed on Oct. 4, 1982. In the notice of election, petitioner failed to supply the information and documentation necessary to substantiate the special value based on use pursuant to sec. 2032A(e)(7)(A) and sec. 20.2032A-4, Estate Tax Regs. Held, petitioner has not "substantially complied" with the regulations under sec. 2032A(d)(3)(B). Charles N. Woodward, for the petitioner.Juandell D. Glass, for the respondent. Goffe, Judge. GOFFE16 The Commissioner determined a deficiency in petitioner's Federal estate tax in the amount of $ 34,814.42.After concessions by petitioner, the sole issue remaining for decision is whether petitioner is entitled to value real property in the decedent's estate at its special use value pursuant to section 2032A. 14 FINDINGS OF FACTSome of the facts of this case have been stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated by this reference.Della Rose Schwartz, personal representative of the Estate of Pauline E. Strickland (the decedent), was a resident of Edmond, Oklahoma, at the time the Federal estate tax returns and the petition were filed in this case.The decedent, Pauline E. Strickland, died on January 3, 1982, owning seven tracts of land which were being used for farming. At the time of her death, decedent was a resident and citizen of the United States.17 Petitioner timely filed a Federal estate tax return, Form 706, on September 8, 1982. On October 4, 1982, petitioner filed an amended Federal estate tax return, Form 706. The applicable box was not checked on either return signifying that section 2032A special use valuation was elected. On the amended Federal estate tax return, Schedule A -- Real Estate, petitioner elected to value five tracts of land owned by the decedent at her death at their special use value under section 2032A. Tract I consists of 20 acres of cultivated land, tract II consists of 54 acres of cultivated 5 land and 26 acres of pasture land, tract III consists of 90 acres of cultivated land and 70 acres of pasture land, tract IV consists of 220 acres of pasture land, and tract V consists of 160 acres of pasture land. Tracts I and II are located in Grant County, Oklahoma, and tracts III, IV, and V are located in Logan County, Oklahoma.A separate notice of election to value the above-described real property under section 2032A was submitted with the amended Federal estate tax return. The notice of election contained the following information:Election and Agreement to Have CertainProperty Valued Under Section 2032Afor Estate Tax Purposes1. DECEDENT:Pauline E. StricklandSSAN 445-48-14672. QUALIFIED USE:Decedent operated the real propertysubject to election as a farm.3. REAL PROPERTY:This election applied to Tract I, TractII, Tract III, Tract IV and Tract Von Schedule A.4. VALUATION:Market2032A Tract I16,0008,489Tract II80,00024,786Tract III138,80038,684Tract IV99,00016,823Tract V77,40012,495Total411,200101,27718 5. ADJUSTED VALUE:The adjusted value of all realproperty used in Qualified Use andpassing to qualified heirs is $ 405,155.The adjusted value of all realproperty to be specially valued is$ 405,155.6. PERSONAL PROPERTY:Personal property passing toqualified heirs and used in a qualifieduse includes only an undivided onehalf interest in Item 3, Schedule F,and the adjusted value thereof is$ 4,077.7. ADJUSTED GROSS ESTATE:The adjusted value of the grossestate, as defined in Section 2032A(b)(3)(A) is $ 752,420.8. METHOD OF VALUATION:The method of valuation was thatmethod prescribed in section 2032A(e)(7). The subject real property hasan established annual cash rentalvalue of $ 45.00 per acre for cultivated(wheat) land and $ 9.375 per acre forpasture land. Real property averagetaxes were determined by averagingactual assessments for the years1979, 1980, & 1981. The interest ratefactor was provided by I.R.S.,Oklahoma City, Oklahoma, to-wit:10.26%.9. APPRAISALS:Written appraisals of Fair market ofreal property are attached toSchedule A.10. OWNERSHIP:Decedent owned all specially valuedreal property for at least 5 of the 8years immediately preceding the dateof decedent's death.11. QUALIFIED USE:During the entire eight yearsimmediately preceding decedent'sdeath, Decedent owned and operatedthe specially valued property as afarm, and materially participated inthe operation thereof.12. QUALIFIED HEIRS:The following persons, both of whomare daughters of the decedent, willreceive the following specially valuedproperty:6 19 Della Rose Schwartz 505 N. Blvd. Edmond, Oklahoma 73034 SSAN: 444-28-9285 TractMarket value2032A valueOne-half Tract I8,000 4,245 One-half Tract II40,000 12,393Tract III138,80038,684Willa Mae Abercrombie Rt. 1, Box 16 Crescent, Oklahoma 73028 SSAN: 444-28-8963 TractMarket value2032A valueOne-half Tract I8,000 4,245 One-half Tract II40,00012,393Tract IV99,00016,823Tract V77,40012,49513. AFFIDAVITS:Attached hereto are affidavits to theeffect that decedent materiallyparticipated in the operation of herfarm. Alos [sic], attached are Forms4835 of decedent for years 1979 and1980 (most recent available).14. LEGAL DESCRIPTION:The legal description of speciallyvalued property is reflected as TractsI, II, III, IV and V on Schedule A.15. AGREEMENT:WILLA MAE ABERCROMBIE,with respect to Tracts I, II, IV and Vof Schedule A, and DELLA ROSESCHWARTZ, with respect to TractsI, II and III of Schedule A, being theonly persons having an interest insaid tracts, hereby agree and consentto the application of I.R.C. Section2032A (c) in the event of certain earlydispositions of the property or earlycessation of the qualified use; consentto personal liability for taxes imposedthereunder; and designatethemselves, at the addresses above,as agents in all dealings with InternalRevenue Service on matters arisingunder Section 2032A.7 20 With respect to the method of valuation, petitioner submitted, with the amended Federal estate tax return, a lease for a period of June 1, 1982, through May 31, 1983, covering comparable pasture land adjoining tract III. Petitioner submitted an opinion letter from the vice president of Farmers & Merchants Bank in Crescent, Oklahoma, setting forth a cash rental value of $ 40 to $ 45 per acre per year for the cultivated land for a period subsequent to decedent's death. Other comparable cultivated and pasture land existed in the geographical area of the respective tracts, but petitioner did not submit evidence of them. Taxes paid on tracts III, IV, and V for the years 1979, 1980, and 1981 were submitted by petitioner in a letter from the Logan County treasurer's office. In addition, copies of receipts were submitted from the Grant County treasurer's office for taxes paid on tracts I and II for the years 1979, 1980, and 1981.The agreement as to special use valuation was filed with the amended Federal estate tax return and was signed by all the required parties.On March 8, 1984, and again on May 30, 1984, petitioner was notified by letter from respondent, that the information8 and documentation submitted with respect to the special use valuation was not sufficient and a request was made for the required information. Petitioner responded on October 3, 1984, stating that petitioner was determining whether or not to contest the disallowance of the section 2032A election.On October 23, 1986, petitioner was informed by letter that respondent had not yet received the required information and documentation to support the special use value. On January 7, 1987, petitioner submitted two documents in response to respondent's request. One document was the same cash lease submitted with the notice of election from comparable property adjoining tract III, the only difference being that the lease covered a period from June 1978 through 1984. The second document was a statement from the Logan County treasurer setting forth the taxes paid in 1981 on this comparable parcel.On February 17, 1987, petitioner was notified that it failed to qualify for the special use valuation provided under section 2032A, even after taking into account the two 21 documents previously submitted by letter dated January 7, 1987. No further documentation was submitted by petitioner. 9 In the statutory notice of deficiency, the Commissioner determined that petitioner was not entitled to the special use valuation under section 2032A because of petitioner's failure to properly document and substantiate the section 2032A election.OPINIONThe value of property included in the gross estate of a decedent is usually the fair market value of the property interest as of the date of death of the decedent. Sec. 2031. Prior to 1976, there were no provisions in the Internal Revenue Code that permitted any other valuation. Section 2032A, which was adopted as part of the Tax Reform Act of 1976, provides an alternative means for valuing real property used in farming operations or other closely held businesses. Tax Reform Act of 1976, Pub. L. 94-455, sec. 2003(a), 90 Stat. 1856. The purpose in adopting section 2032A was to provide an alternative to "highest and best use" for valuing real property used in family farming operations or closely held businesses. Estate of Johnson v. Commissioner, 89 T.C. 127">89 T.C. 127, 129 (1987); Estate of Coon v. Commissioner, 81 T.C. 602">81 T.C. 602, 608 (1983).Under section 2032A(a)(1)(B), the executrix10 must elect this special use valuation on a Federal estate tax return. Sec. 2032A(d)(1); sec. 20.2032A-8, Estate Tax Regs. A notice of election must be filed with the Federal estate tax return setting forth 14 items of information. In addition, an agreement must be filed, signed by each person in being who has an interest in any property designated in such agreement, consenting to the application of an additional estate tax under subsection (c) with respect to such property. Sec. 2032A(d)(2). The estate must also meet a number of other conditions to be eligible for special use valuation. 2 We must first decide whether a proper election has been filed.11 22 A section 2032A election need not be made as to all real property in the estate, but only sufficient property to satisfy the threshold requirements of section 2032A(b)(1). 312 Sec. 20.2032A-8(a)(2), Estate Tax Regs. The election is to be made on the Federal estate tax return in the manner prescribed by the regulations. Sec. 2032A(d)(1). Section 1025 of the Deficit Reduction Act of 1984 retroactively amended section 2032A(d)(3) to provide that the Secretary shall prescribe procedures that give the executrix of the estate of a decedent dying after 1976 a reasonable time within which to cure defects in a section 2032A election. Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 1025(a), 98 Stat. 1030. 4 In any case in which the executrix timely files an election in "substantial compliance" with the regulations but which does not contain the required information, the executrix will have a reasonable time, not to exceed 90 days after notification of such failures, to provide all of the information. Sec. 2032A(d)(3).Section 20.2032A-8(a)(3), Estate Tax Regs., delineates 14 items of information that petitioner must submit with the Federal estate tax return:(i) The decedent's name and taxpayer identification number as they appear on the estate tax return;(ii) The relevant qualified use;(iii) The items of real property shown on the estate tax return to be specially valued pursuant to the election (identified by schedule and item number);(iv) The fair market value of the real property to be specially valued under section 2032A and its value based on its qualified13 use (both values determined without regard to the adjustments provided by section 2032A(b)(3)(B));23 (v) The adjusted value (as defined in section 2032A(b)(3)(B)) of all real property which is used in a qualified use and which passes from the decedent to a qualified heir and the adjusted value of all real property to be specially valued;(vi) The items of personal property shown on the estate tax return that pass from the decedent to a qualified heir and are used in a qualified use under section 2032A (identified by schedule and item number) and the total value of such personal property adjusted as provided under section 2032A(b)(3)(B);(vii) The adjusted value of the gross estate, as defined in section 2032A(b)(3)(A);(viii) The method used in determining the special value based on use;(ix) Copies of written appraisals of the fair market value of the real property;(x) A statement that the decedent and/or a member of his or her family has owned all specially valued real property for at least 5 years of the 8 years immediately preceding the date of the decedent's death;(xi) Any periods during the 8-year period preceding the date of the decedent's death during which the decedent14 or a member of his or her family did not own the property, use it in a qualified use, or materially participate in the operation of the farm or other business within the meaning of section 2032A(e)(6);(xii) The name, address, taxpayer identification number, and relationship to the decedent of each person taking an interest in each item of specially valued property, and the value of the property interests passing to each such person based on both fair market value and qualified use;(xiii) Affidavits describing the activities constituting material participation and the identity of the material participant or participants; and(xiv) A legal description of the specially valued property.We must decide whether petitioner "substantially complied" with the regulations in submitting a notice of election which did not contain all of the required information. If we find that petitioner has "substantially complied" with the regulations, then, in determining whether petitioner completed the notice of election, we will take into account any documents submitted by petitioner within 90 days after notification by the Internal Revenue Service. If petitioner has not "substantially complied" with15 the regulations, section 2032A will not apply to the valuation of the respective properties and petitioner must value the five tracts of land listed in the amended Federal estate tax return, Schedule A -- Real Estate, at the fair market value on the date of decedent's death.It is well established that the Commissioner's determination is presumed to be correct and that the taxpayer has 24 not only the burden of proving error in that determination, but the burden of producing evidence from which a proper determination can be made. Most of the information required under section 20.2032A-8(a)(3), Estate Tax Regs., can be ascertained from petitioner's amended Federal estate tax return and the notice of election submitted with the return. However, with respect to the section 20.2032A-8(a)(3)(viii), Estate Tax Regs., method of determining special value based on use, petitioner failed to supply the information and documentation necessary to substantiate the special value based on the use of the property.In determining special value based on use, section 2032A provides several methods for valuing farms. Sec. 2032A(e)(7); sec. 2032A(e)(8); sec. 20.2032A-4, Estate Tax Regs. The first16 method, capitalization of rents, measures the present value of the future cash-flows from the real property by using cash rent figures for the last 5 years. Sec. 2032A(e)(7)(A). The capitalization of rents formula is the excess of the average annual gross cash rental for comparable land used for farming purposes and located in the locality of such farm over the average annual State and local real estate taxes for such comparable land divided by the average annual effective interest rate for all new Federal Land Bank loans. 5 Each average annual computation shall be made on the basis of the 5 most recent calendar years ending before the date of decedent's death. Sec. 2032A(e)(7)(A); sec. 20.2032A-4(a), Estate Tax Regs.17 Gross cash rental is the amount of cash received during the year for the use of actual tracts of comparable farmland in the same locality, undiminished by any expenses or liabilities associated with the farm operation. Sec. 20.2032A-4(b)(1), Estate Tax Regs. In using this method, the executrix must identify to the Internal Revenue Service actual comparable property for all specially valued property and cash rentals from that property. Sec. 20.2032A-4(b)(2)(i), Estate Tax Regs. If it is established that there is no comparable land from which the annual gross cash rentals 40 may be determined, then the average-net-share-rental method may be used. Sec. 2032A(e)(7)(B)(i).The second method of valuation under section 2032A is prescribed under section 2032A(e)(8). This method may be used when it is established that there is no comparable land from which the average annual gross cash rental may be determined, and no comparable land from which the average net share rental may be determined, or where the executor elects to value the farmland under this method. Sec. 2032A(e)(7)(C)(i) and (ii).Petitioner elected to value the respective property under section 2032A(e)(7)(A). 618 In the notice of election, petitioner stated that the cultivated land had an annual cash rental value of $ 45 per acre and the pasture land $ 9.375 per acre. However, petitioner did not provide any substantiation with respect to the cultivated land price. Petitioner bases the cash rental value of the respective property on an opinion letter from a vice president of the Farmers & Merchants Bank of Crescent, Oklahoma. Section 20.2032A-4(b)(2)(iii), Estate Tax Regs., prohibits the use of appraisals in this manner. In addition, petitioner does not state the time period involved. The letter relates to the year subsequent to decedent's death, rather than the preceding 5 years. With respect to the pasture land, petitioner produced a lease from a comparable parcel in Logan County; however, the annual gross cash rental values also relate to the year subsequent to the decedent's death. Section 2032A(e)(7)(A) requires this computation to be made on the basis of the 5 years preceding the decedent's death. Sec. 20.2032A-4(a), Estate Tax Regs.19 Petitioner submitted tax statements for only 3 of the prescribed 5 years preceding the decedent's date of death. The tax statements were those taxes paid on tracts I, II, III, IV, and V. Petitioner was required to submit tax 26 figures with respect to comparable real property, not on the tracts themselves. Sec. 20.2032A-4(a)(1), Estate Tax Regs.Petitioner has failed to identify comparable real property, annual gross cash rentals, and State and local taxes therefrom for the requisite 5 calendar years preceding the decedent's date of death. It is impossible for the Court to ascertain from petitioner's amended Federal estate tax return and notice of election the special use value of the respective properties under section 2032A(e)(7)(A).We must now decide whether petitioner's failure to properly document and substantiate the method used in determining the special value based on use is fatal under the "substantial compliance" language of section 2032A(d)(3)(B).Neither party has cited any authority addressing this specific point. We are aware of a Memorandum Opinion of this Court in which almost none of the required information of section 20.2032A-8(a)(3), Estate Tax Regs., 20 was submitted in a timely filed original or amended Federal estate tax return in which special use valuation was elected.7 In the present factual situation, however, 13 of the 14 items have been submitted in the notice of election in a timely filed amended Federal estate tax return. We must therefore decide whether by omitting the one item which is essential to substantiate the special value based on use of the respective property, petitioner's notice of election has failed to "substantially comply" with the regulations under section 2032A. 821 In Estate of Gunland v. Commissioner, 88 T.C. 1453 (1987), we found that a failure to attach an agreement of the type referred to in section 2032A(d)(2) to an original Federal estate tax return defeated an attempted election of section 2032A special use valuation because the taxpayer did not "substantially comply" with the regulations. Although petitioner, in the instant case, filed an agreement as referred to in section 2032A(d)(2), our discussion of the 27 "substantial compliance" language in Estate of Gunland is instructive. In applying the "substantial compliance" language of section 2032A, we found that:The test for determining the applicability of the substantial compliance doctrine has been the subject of a myriad of cases. The critical question to be answered is whether the requirements relate "to the substance or essence of the statute." Fred J. Sperapani, 42 T.C. 308">42 T.C. 308, 331 (1964). If so, strict adherence to all statutory and regulatory requirements is a precondition to an effective election. Lee R. Dunavant, 63 T.C. 316 (1974). On the other hand, if the requirements22 are procedural or directory in that they are not of the essence of the thing to be done but are given with a view to the orderly conduct of business, they may be fulfilled by substantial, if not strict, compliance. See Lee R. Dunavant, supra;Georgie S. Cary, 41 T.C. 214 (1963); Columbia Iron & Metal Co., 61 T.C. 5 (1973). [Estate of Gunland v. Commissioner, supra at 1458-1459 (quoting Taylor v. Commissioner, 67 T.C. 1071">67 T.C. 1071, 1077-1078 (1977)).]We found that section 20.2032A-8(a)(3), Estate Tax Regs., is not a "procedural" or "directory" regulation. "Moreover, the substantial compliance doctrine is not applicable where, as here, the statute or regulation provides with detailed specificity the manner in which an election is to be made." Estate of Gunland v. Commissioner, supra at 1459 (citing Taylor v. Commissioner, 67 T.C. at 1080; Thorrez v. Commissioner, 31 T.C. 655 (1958), affd. 272 F.2d 945">272 F.2d 945 (6th Cir. 1959)). 23 Based upon this analysis, we found that "substantial compliance" was insufficient to secure the benefits of special use valuation.9Estate of Gunland v. Commissioner, supra at 1459.With respect to the method of valuation under section 2032A, section 20.2032A-8(a)(3)(viii), Estate Tax Regs., provides that the method used in determining the special use valuation shall be set forth in the notice of election. Section 2032A(e)(7)(A)(i) and (ii), provides the 24 formula for determining the value of a farm under the gross cash rental method. Section 20.2032A-4, Estate Tax Regs., further defines each requirement in the formula in detail. Not only do section 2032A(e)(7)(A) and section 20.2032A-8(a)(3), Estate Tax Regs., provide specificity in the manner in which an election 28 is to be made, i.e., the method used in determining the special value based on use; but, section 20.2032A-4, Estate Tax Regs., further delineates those elements which must be used in valuing a farm under section 2032A(e)(7)(A). Just as the "requisite agreement is an integral part of the statutory scheme in that it subjects all qualified heirs to potential recapture liability" ( Estate of Gunland v. Commissioner, supra at 1459), so too is the method of valuation under section 2032A an integral part of the statutory scheme. It is the method of valuation which underlies the purpose of the statute -- to permit a method of special valuation of property based on actual use, rather than fair market value, for estate tax purposes.Petitioner submitted, with the timely amended Federal estate tax return, one lease from a comparable parcel, 25 for a period subsequent to the decedent's date of death. The only tax information submitted was those taxes paid on the respective tracts themselves and not on comparable property. Thus, we find that petitioner cannot avail itself of the "substantial compliance" language of section 2032A because it has failed to "substantially comply" with the detailed specificity of section 20.2032A-8(a)(3), Estate Tax Regs., in failing to substantiate the method used in determining the special value based on use, as set forth in section 2032A(e)(7)(A) and section 20.2032A-4, Estate Tax Regs.We are aware that Congress believed, in enacting section 2032A(d)(3), that the Internal Revenue Service was being too strict in applying the regulations to disallow elections on the basis of technical mistakes in the agreements or notice of election information. Senate Floor Amendment, Deficit Reduction Act of 1984, 130 Cong. Rec. S4318 (daily ed. Apr. 11, 1984) (statement of Sen. Dixon). Section 2032A(d)(3) provided that the Secretary of the Treasury was to develop procedures to permit estates to perfect election notices which "substantially complied" with the regulations. H. Rept. 98-861 (Conf.) (1984), 26 1984-3 C.B. (Vol. 2) 494. However, in the present factual situation, we are not dealing with a technical mistake or omission in the notice of election. The omission of the method used in determining the special value based on use, and the elements used in 29 calculation of such is not the type of minor omission or mistake addressed in section 2032A(d)(3).Illustrations of the type of information that may be supplied after the initial filing of a notice of election are omitted social security numbers and addresses of qualified heirs and copies of written appraisals of the property to be specially valued. This provision does not, however, permit such appraisals to be obtained only after the estate tax return is made. Rather, the provision simply permits the submission of previously obtained appraisals. Likewise, a notice of election which does not provide a legal description of the property to be specially valued may not be perfected unless the notice, as initially filed with the estate tax return, described the property with reasonable clarity, even though the full legal description was not provided. [H. Rept. 98-861 (Conf.) (1984), 1984-3 C.B. (Vol. 2) 495.]27 We do not hold that the failure to submit 1 out of 14 items in a notice of election will never meet the "substantial compliance" standard of section 2032A(d)(3). Although section 20.2032A-8(a)(3), Estate Tax Regs., is not a "procedural" or "directory" regulation, there are certain informational items that do not relate to the substance or essence of the statute. We have set some of them out in our discussion of the legislative history above. We hold that the estate has not "substantially complied" with the regulations under section 2032A because of its failure to supply the information and documentation necessary to determine the special value based on use as found in section 2032A(e)(7)(A) and section 20.2032A-4, Estate Tax Regs.Petitioner contends that there was no comparable land from which the average annual gross cash rental values could be determined. It argues that the net-share-value method under section 2032A(e)(7)(B) should be used. In support of this, petitioner contends that testimony by petitioner's witnesses demonstrated a lack of comparable land from which average annual gross cash rental values could be determined. We find that this testimony does not corroborate28 petitioner's contentions.Petitioner contends that Mr. Ben Abercrombie testified that he had attempted to locate written cash leases for property in the area, but was unable to locate any leases other than the one which was submitted to the Internal Revenue Service (Mr. Abercrombie refers to this lease as "leases to the pasture land to the west of us" in his 30 testimony). As we noted, this lease was for a period subsequent to the decedent's death, June 1, 1982, through May 31, 1983. We read Mr. Abercrombie's testimony differently.Q. Mr. Abercrombie, did you make an effort to locate cash leases on both cultivated land and pasture land in preparation, not only for this case, but all through this proceeding?A. Yes. On the land that surrounded our land.Q. Okay. Were you able to locate any cash leases?A. The cash leases I knew about, I was unable to get any documents on.Q. Okay. Did you actually talk to people and see if they had cash -- had written cash leases?A. Yes. We contacted our neighbor to the north there. She has a cash lease, and we could not get papers from her. But I did get copies of leases on pasture land to the west of us. * * Q. Mr. Abercrombie, 29 did you -- were you able to locate any other cash leases?A. I also tried to check on the quarter east of us which belonged to a real estate man in Enid, and he has sold that, and I couldn't complete my check on that because the new owner doesn't live there.Q. You were not able to find a cash lease in this instance.A. On him, no.From Mr. Abercrombie's testimony, cash leases existed on both cultivated land and pasture land, but he was not able to obtain any documents on them. In addition, it appears that Mr. Abercrombie visited neighboring farms that bordered the cultivated land and the pasture land, but he never investigated other properties. 10Section 20.2032A-4(d), Estate Tax Regs., specifically authorizes the factors to be taken into account in locating comparable land. There exists no provision limiting the scope of comparable property to those lands adjoining the land(s) in question.30 Petitioner's second witness, Mr. Dwayne Johnson, was a farmer who participated in the operation and management of the cultivated land and pasture land in question. Petitioner contends that Mr. Johnson testified that it was not common for cultivated land to be leased on a cash 31 basis, and that such leases are rare. We read Mr. Johnson's testimony differently.Q. Is it common to lease pasture land on a cash rental basis?A. Yes. Mostly. All of the leases, nearly, from August 1 until August 1 on pasture.Q. Okay. How about cultivated land? What is the common method of leasing or renting cultivated land?A. I would say the majority is leased on a crop one-third or two-thirds share, but some is rented for cash, too.Q. Do you have any personal knowledge of any cash rental leases that either existed or have existed concerning cultivated land?A. Well, I know of some. Yes.Q. Okay. What are those that you know of? Can you recall?A. I really couldn't tell you what price they paid because I am not that familiar with them. It varies, the type of ground and location, and so forth.Although cash leases may not be the most common method for leasing cultivated land, Mr. Johnson31 was aware of the existence of some of these cash leases, which petitioner has failed to produce.It is apparent that there were cash leases for comparable cultivated land and pasture land from which average annual gross cash rental values could be computed. Petitioner failed to produce evidence of them in her notice of election filed with the amended Federal estate tax return. We hold, therefore, that because comparable land from which average annual gross cash rental values could be submitted, petitioner, in electing to use section 2032A(e)(7)(A), may not now choose to value the respective tracts under section 2032A(e)(7)(B).In an effort to substantiate the values reflected in the notice of election, item 8, petitioner has devised a formula to value the respective tracts based upon "average production" in bushels per acre and in price per bushel. We need only point out that section 20.2032A-4(b)(2)(iii), Estate Tax Regs., prohibits the use of appraisals or other statements regarding rental value and area-wide averages in determining the value of real property under section 2032A(e)(7).Petitioner argues that information pursuant to section 2032A(e)(7) was submitted and to the32 extent such information is not available, section 2032A(e)(7)(C) provides that such information as is available can be used to establish 32 special use value. We do not agree with petitioner's interpretation of section 2032A(e)(7)(C).(C) Exception. -- The formula provided by subparagraph (A) shall not be used -- (i) where it is established that there is no comparable land from which the average annual gross cash rental may be determined and that there is no comparable land from which the average net share rental may be determined, or(ii) where the executor elects to have the value of the farm for farming purposes determined under paragraph (8).The statute provides that, if it can be demonstrated that no comparable property exists for either method, section 2032A(e)(7)(A) or (B) shall not be used. Furthermore, neither of these valuation methods shall be used if the executor elects to use section 2032A(e)(8). Petitioner has not elected to value the respective tracts under section 2032A(e)(8). In addition, we find that comparable property existed from which the average annual gross cash rental values could have been determined. Petitioner's contentions belie the statute. 33 It is important to note that there is an apparant inconsistency between the statute, at section 2032A(e)(7)(C)(i), and the regulations, at section 20.2032A-4(b)(2), Estate Tax Regs. The statute suggests that the executrix must make an affirmative showing that there is no comparable land from which the average annual gross cash (or net share) rental may be determined (sec. 2032A(e)(7)(C)(i)), and that the executrix may value the respective property under section 2032A(e)(8) only if such an affirmative showing is made. 11 Under the regulations, the executrix may, by "default," use section 2032A(e)(8) to value the respective property. Under the regulations, "If the executor does not identify such [comparable] property and cash rentals, all specially valued real property must be valued under the rules of section 2032A(e)(8)." Sec. 20.2032A-4(b)(2), Estate Tax Regs. Our holding rests upon the interpretation of the statute at section 2032A(e)(7)(C)(i). However, if we were to follow the regulations at section 20.2032A-4(b)(2), Estate Tax Regs., the result would not be 33 different. 12 Under the regulations, petitioner would be allowed to value the respective property under 34 section 2032A(e)(8) because it failed to identify comparable property and cash rentals therefrom. In this case, the only evidence available to value the respective property is the fair market value of the property as reported in the original Federal estate tax return. Thus, a valuation pursuant to section 2032A(e)(8) will equal the fair market value of the property on the date of decedent's death.35 We hold that petitioner has not "substantially complied" with the regulations under section 2032A in attempting to value the property of the decedent under section 2032A(e)(7)(A). Petitioner failed to identify comparable property, annual gross cash rentals, and State and local taxes therefrom for the requisite 5 years prior to the decedent's date of death. Thus, it is impossible to compute average annual gross cash rentals under section 2032A(e)(7)(A). In addition, the evidence establishes that comparable tracts of land, from which gross cash rental values could be ascertained, existed in the geographical area of the respective tracts. Petitioner is, therefore, precluded from utilizing the net share rental method of valuing the respective tracts. Sec. 2032A(e)(7)(B). Because petitioner has not "substantially complied" with the regulations, section 2032A will not apply to the valuation of the respective tracts and petitioner must value the five tracts of land listed in the amended Federal estate tax return, Schedule A -- Real Estate, at the fair market value on the date of decedent's death.In order to allow the deduction of any administration expenses occasioned by this litigation, 36 Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section numbers refer to the Internal Revenue Code as in effect as of the date of death of decedent.↩2. The decedent must have been a citizen or a resident of the United States, and the subject property must be located in the United States. Sec. 2032A(a)(1)(A); sec. 2032A(b)(1). The real property must have been used as a farm or in a trade or business by the decedent or by a member of the decedent's family, and the decedent or a member of the decedent's family must have materially participated in the operation of the farm or the business. Sec. 2032A(b)(1)(A)(i) and (ii). In addition, the property must pass to a qualified heir, who must be a member of the decedent's family. Ownership and use requirements must be satisfied as set forth in the statute to avoid recapture of part of the tax savings resulting from special use valuation. Sec. 2032A(c)↩.3. In addition to the requirements listed above, sec. 2032A includes requirements regarding the makeup of the estate, as set forth in sec. 2032A(b)(1)(A) and (B)↩. These percentage requirements limit tax relief to those situations where the family farm or business is a major asset, in terms of value, in the decedent's estate. We need not address this issue for this information was sufficiently set forth in petitioner's notice of election.4. Petitioner erroneously contends on brief that because the passage of sec. 1025(a) of the Deficit Reduction Act of 1984 was subsequent to the date of the amended Federal estate tax return, the 90-day requirement has no application because it was not in existence at the time of the filing or auditing of the amended Federal estate tax return. Petitioner has failed to take notice of the fact that sec. 1025(a) was made retroactive to apply to decedents dying after Dec. 31, 1976. Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 1025(b)(1), 98 Stat. 1030.↩5. The Internal Revenue Service issues an annual revenue ruling setting forth the effective interest rate for each of the 12 regional Federal Land Bank Districts. The effective interest rate for the Federal Land Bank District in which the respective property is located, for 1982, was 10.26 percent. Rev. Rul. 82-104, 1 C.B. 129">1982-1 C.B. 129↩, 130.6. Petitioner has presented an utterly confusing picture as to which method of valuation is being elected. In the notice of election, petitioner merely states that an election is being made under sec. 2032A(e)(7). On brief, petitioner argues that sec. 2032A(e)(7)(A) valuation was elected, then contends that evidence was submitted to the Internal Revenue Service regarding net share rental under sec. 2032A(e)(7)(B)↩. Petitioner then submits a formula based upon "average production" in bushels per acre and in price per bushel. Finally, petitioner contends that "every effort was made to value the land in accordance with the formula contained in [sec. 2032(e)(7)] (A)."7. Estate of Killion v. Commissioner, T.C. Memo. 1988-244↩.8. This is not a case in which no election was attempted on a timely original Federal estate tax return and an amended return was filed after the due date of the original return, including extensions containing a sec. 2032A notice of election. Carmean v. United States, 4 Cl. Ct. 181">4 Cl. Ct. 181 (1983); Estate of McCoy v. Commissioner, T.C. Memo. 1985-509, affd. 809 F.2d 333">809 F.2d 333 (6th Cir. 1987); Estate of Williams v. Commissioner, T.C. Memo. 1984-178; Estate of Young v. Commissioner, T.C. Memo. 1983-686; Estate of Boyd v. Commissioner, T.C. Memo. 1983-316↩.9. We are aware of other decisions which generally hold that strict compliance with sec. 2032A is required to receive statutory relief. Estate of Cowser v. Commissioner, 736 F.2d 1168 (7th Cir. 1984), affg. 80 T.C. 783">80 T.C. 783 (1983); Estate of Abell v. Commissioner, 83 T.C. 696">83 T.C. 696 (1984); Estate of Coon v. Commissioner, 81 T.C. 602 (1983); Estate of Geiger v. Commissioner, 80 T.C. 484↩ (1983).10. We are unable to ascertain what tract of land Mr. Abercrombie was referring to when he referred to "our land." However, for purposes of this analysis, it is not relevant which specific tract is referred to, as no evidence of comparable property was produced.↩11. This assumes that the executrix has not initially made an election under sec. 2032A(e)(7)(ii) to value the property under sec. 2032A(e)(8)↩.12. If sec. 2032A(e)(8) is used for valuation purposes, none of the documentation requirements of sec. 2032A(e)(7)(A) would be required. Therefore, the only disputed issue remaining would be whether there was "material participation" by the decedent in the operation of the farm as required by sec. 2032A(b)(1)(C)(ii)↩. We assume that this standard would have been met for purposes of this analysis only. We express no opinion as to whether petitioner "materially participated," as our holding does not require us to reach this issue.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621500/	Estate of Robert Driscoll, Clara Driscoll, Sole Beneficiary v. Commissioner.Estate of Driscoll v. CommissionerDocket No. 112199.United States Tax Court1943 Tax Ct. Memo LEXIS 227; 2 T.C.M. (CCH) 336; T.C.M. (RIA) 43312; June 28, 1943227 J. P. Jackson, Esq., for the petitioner. Stanley B. Anderson, Esq., for the respondent. LEECHMemorandum Opinion LEECH, Judge: Respondent has determined a deficiency in income tax of $6,534.93 for the period January 1 to November 2, 1938, and notified petitioner thereof by letter addressed to it at 801 Leopard Street, Corpus Christi, Texas. We find the facts as stipulated by the parties. [The Facts] Robert Driscoll died in July 1929. Clara Driscoll was named as sole beneficiary in his will. The administration of his estate was finally completed on November 2, 1938 and all assets thereof were then distributed to Clara Driscoll. During the period of administration of the estate the executors granted oil and gas leases on certain properties jointly owned by the estate and Clara Dricoll and received cash bonuses thereon of $185,758.50. The estate and Clara Driscoll each reported one-half of this amount as income and each deducted one-half of the 27 1/2 per cent depletion allowance of $51,083.57. On November 2, 1938, when final distribution of the estate was effected, the leases were in full force and effect and none of them had produced oil. In determining the deficiency the 228 respondent restored to income of the estate for the period January 1 to November 2, 1938 the depletion theretofore deducted by and allowed to the estate in the sum of $25,541.79 as above detailed. The propriety of that action is the only issue. [Opinion] The question is ruled by our decisions in Estate of Emma Louise G. Seeligson, 1 T.C. 736">1 T.C. 736, and Mary F. Waggoner, 47 B.T.A. 699">47 B.T.A. 699, holding that under such conditions the amount of depletion theretofore taken and allowed did not constitute income. We accordingly hold respondent's action to be erroneous. Since certain other adjustments made by respondent in determining the deficiency are not disputed. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621501/	ESTATE OF NORMAN D. WEEDEN, DECEASED, WILLIAM F. WEEDEN, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Weeden v. CommissionerDocket No. 4815-75.United States Tax CourtT.C. Memo 1979-498; 1979 Tax Ct. Memo LEXIS 27; 39 T.C.M. (CCH) 699; T.C.M. (RIA) 79498; December 12, 1979, Filed 27 John M. Hammerman,Robert M. Winokur, Leland H. Faust, for the petitioner. Gerald J. Beaudoin, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $23,240 deficiency in decedent's 1969 income tax. The issue for decision is whether decedent realized gain upon the gift of stock to his nephews when the gift was conditioned on the nephews' paying the resulting gift tax liability. FINDINGS OF FACT Substantially all the facts have been stipulated and are found accordingly. Norman D. Weeden ("decedent") died a resident of California on May 22, 1970, at the age of 71. William F. Weeden (sometimes referred to as petitioner) is duly appointed, qualified, and acting as executor of the Estate of Norman D. Weeden. On the date the petition was filed, william F. Weeden resided in Oakland, California. In 1965, decedent retired as vice president of Weeden and Company, a corporation engaged in the stock brokerage business. In the summer of 1968, decedent transferred 12,075 shares of stock in Weeden and Company to his four nephews, Alan, Donald, John and William F. Weeden. Alan, Donald, John and28 William F. Weeden are brothers. At the time of the transfer and at all relevant times, decedent owned the 12,075 shares of stock free and clear of any encumbrances and there were no borrowings against the stock. This transfer was made on the express written condition that the four nephews each pay "all Federal and State Gift or Transfer Taxes due which are attributable to this gift." This condition was acknowledge in writing by each of the four nephews. At the time of the transfer decedent was a widower and had no children, alive or deceased. The Last Will and Testament of decedent dated June 7, 1968, left the residue of his estate equally to his four nephews, Alan, Donald, John and William F. Weeden. The gross estate of decedent reported for estate tax purposes, valued at the date of death, was $644,042 of which $6,683 was in the form of bank deposits and cash. The cash position of decedent at the time of the gift was similar to his cash position at the time of his death. The fair market value of the 12,075 shares of stock in Weeden and Company was $422,625 on July 1, 1968, the date that the gifts were accepted by the nephew-donees. Decedent's basis for the stock was $7,404.49. 29 On January 24, 1969, each nephew-donee paid his respective share of Federal and State gift taxes attributable to the transfers of stock made to him by decedent. The Federal gift tax paid by the donees was $68,963.66, and the State gift tax paid was $39,764.68. Following respective audits, the Federal Government refunded $10,850.32 to the donees and the State Government refunded $5,939.78. Thus, the net gift tax paid in 1969 by the four donees, rounded off to the nearest dollar, was $91,911. Decedent desired and intended to make a gift of the Weeden and Company stock to his nephews. He did not desire or intend to make a part-sale, part-gift of the stock. The gift was made by decedent on condition that the nephews pay the applicable gift taxes because decedent felt his cash position was such that he would have difficulty paying the gift tax. On March 5, 1975, respondent mailed to petitioner a notice of deficiency for decedent's 1969 taxable year in which he determined that decedent realized income of $84,507 in 1969 as a result of the transfer to his nephews of 12,075 shares of common stock of Weeden and Company, subject to their payment of all Federal and State gift or transfer30 taxes attributable to the transfers. OPINION Inasmuch as the facts and legal questions presented here are indistinguishable from those of , on appeal (6th Cir., May 5, 1978), we hold that decedent did not realize income as a result of his gifts of stock conditioned upon the donees' payment of the resulting Federal and State gift taxes. 1Decision will be entered for the petitioner. Footnotes1. Petitioner claims that he is entitled to attorney's fees; this request is denied because this Court lacks jurisdiction to award attorney's fees. See , on appeal (5th Cir., August 15, 1977).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621503/	APPEAL OF ALICE M. CLEMSON.Clemson v. CommissionerDocket No. 6256.United States Board of Tax Appeals5 B.T.A. 594; 1926 BTA LEXIS 2833; November 23, 1926, Decided 2833 The evidence is insufficient to show that the Commissioner's valuation of property acquired by inheritance in 1918 was erroneous. R. Lester Moore, Esq., for the petitioner. Bruce A. Low. Esq., for the Commissioner. LITTLETON594 The deficiency involved is $2,747.89. The petitioner acquired certain real estate by inheritance on August 5, 1918. The Commissioner determined its value at that time to have been $83,000. This property was sold in 1920 for $123,863. The petitioner claims that the value of the property in 1918 was in excess of the amount for which it was sold. FINDINGS OF FACT. The petitioner is the widow of Ralph E. Clemson, who, at the time of his death on August 5, 1918, was a resident of Pittsburgh, Pa. Ralph E. Clemson died testate, leaving surviving him his widow and one child, a son. The pertinent part of his will, so far as this case is concerned, is as follows: FIRST: I give, devise and bequeath all my estate, real, personal and mixed, of whatever kind and description and wheresoever the same may be situated, unto John G. Clemson, Gibson D. Packer and Hallock C. Sherrard, their successors 595 and assigns, 2834 in trust nevertheless to hold, manage, invest, re-invest and keep invested the same and pay out of the net income therefrom, without deduction for any tax, the sum of one hundred dollars ( $100) per month during her life to Edith G. Smith, who has cared for my son, Richard E. Clemson; the balance of said net income, to an amount not exceeding twelve thousand dollars ($12,000) per annum shall be paid by said Trustees, without deduction for any tax, to my wife, Alice M. Clemson, quarterly during her life or so long as she remains my widow * * . EIGHTH: Said Trustees shall have power to make and change investments from time to time, and full power and authority is hereby given the them to sell, and convey any of my real estate upon such terms as they deem proper, and to make, execute, acknowledge and deliver a deed or deeds therefor without liability on the part of the purchaser to see to the application of the purchase money. NINTH: I nominate and appoint John G. Clemson, Gibson D. Packer and Hallock C. Sherrard executors of this my last will and testament, and full power and authority is given unto them to sell and convey any real estate of which I may die seized, and to make, 2835 execute, acknowledge and deliver a deed or deeds therefor, without liability on the part of the purchaser to see to the application of the purchase money. * * * On January 3, 1919, the petitioner elected under the laws of Pennsylvania to take against the will of her husband, and claimed one-half of the estate under the Wills and Intestate Acts of Pennsylvania in lieu of the annuity of $12,000 provided for her in the will. Her written election, under oath, to take under the intestate laws was filed in the Orphans' Court of Allegheny County, Pennsylvania, and is as follows: I, Alice M. Clemson, widow of Ralph E. Clemson, late of Allegheny County, deceased, do hereby waive, the devise and bequest to me by his last will and testament, and do elect to take my share of his estate under the intestate laws of the Commonwealth of Pennsylvania. Section 23(a) of the Wills Act of June, 7, 1917, P.L. 403; Pa. St. 1920, section 8335, is as follows: When any person shall die testate, leaving a surviving spouse who shall elect to take against the will, such surviving spouse shall be entitled to such interests in the real and personal estate of the deceased spouse as he or she would have2836 been entitled to had the testator died intestate: Provided, That nothing herein contained shall affect the right or power of a married woman, by virtue of any authority or appointment contained in any deed or will, to bequeath or devise any property held in trust for her sole and separate use. Section 1(a) of the Intestate Act of June 7, 1917, P.L. 429; Pa. St. 1920, section 8342, provides as follows: The real and personal estate of a decedent, whether male or female, remaining after payment of all just debts and legal charges, which shall not have been sold, or disposed of by will, or otherwise limited by marriage settlement, shall be divided and enjoyed as follows; namely, - Where such intestate shall leave a spouse surviving and one child only, or shall leave a spouse surviving and no children, but shall leave descendents of 596 one deceased child, the spouse shall be entitled to one-half part of the real and personal estate. The deceased, Ralph E. Clemson, at the time of his death owned considerable property, real and personal. Included in such property was a country home on Woodland Road, near Pittsburgh, known as "Oak Gables," acquired by him in 1909, which2837 was valued for Federal estate-tax purposes, as well as for State inheritance tax purposes, at $83,000. The Commissioner determined that the value of the property on August 5, 1918, was $83,000. This property was sold in 1920 for $123,863 net, and this petitioner under her election to take against the will received one-half of the proceeds thereof. The Commissioner held that petitioner's one-half interest was acquired under her election on August 5, 1918. He determined that, upon the sale in 1920 for $123,863, the petitioner realized a taxable profit. OPINION. LITTLETON: The evidence before the Board in support of the claim of the petitioner that the residence in question had a value on August 5, 1918, in excess of the amount for which it was sold in 1920 consisted of the testimony of four witnesses. A member of the firm which constructed the building in 1909 and 1910 testified that, with the exception of electric work, plumbing, heating, finishing hardware, painting, glazing, furnishings and decorating, and title work, the building cost $53,366.31. Another witness, an officer of a construction company, testified that in his opinion, from the measurements of the cubical2838 contents of the house, the cost of reproduction new in 1920, less depreciation at 2 per cent per annum, was $127,624, and that this cost was considerably in excess of such cost in 1918. Another witness, an employee of the appraisal company which had made an appraisal on April 23, 1913, of the personal property in the house at that time, such as furniture, carpets, tapestries, clothing, etc., upon the basis of replacement cost, identified the appraisal as one made by that company. He had nothing to do with the making of the appraisal. The appraisal was not offered or received in evidence. The petitioner testified that a portion of the personal property in the house in 1918 and 1920 was sold with it. This evidence is insufficient to warrant the Board in finding that the Commissioner's determination of value was erroneous. Judgment will be entered for the Commissioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621506/	LYNCHBURG COLLIERY CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lynchburg Colliery Co. v. CommissionerDocket No. 3998.United States Board of Tax Appeals7 B.T.A. 282; 1927 BTA LEXIS 3201; June 14, 1927, Promulgated 3201 DEDUCTION FOR LOSS. - The taxpayer breached a contract in 1917; settled its liability therefor in 1918; kept its books on the accrual basis; did not admit its liability to the injured party during 1917; did not accrue on its books any reserve to meet the damages during 1917, but did charge off the loss in 1918 when paid and took a deduction therefor in its 1918 tax return. Held, return was made in accordance with taxpayer's method of accounting as required by section 212(b) of the Revenue Act of 1918 and it can not now claim the loss as a deduction for 1917. A. T. Henderson, C.P.A., for the petitioner. Shelby S. Faulkner, Esq., for the respondent. TRUSSELL 282 This proceeding is for the redetermination of a deficiency in the amount of $18,501.27 in income and profits taxes for the calendar year 1917. The deficiency letter appealed from determined deficiencies for the years 1917 and 1918, but this proceeding involves only the year 1917. The petitioner alleges that the Commissioner erred in refusing to permit the petitioner to take as a deduction in the year 1917 a loss sustained by reason of the breaching of a contract upon the part3202 of the petitioner. FINDINGS OF FACT. The Lynchburg Colliery Co. is a West Virginia corporation organized in 1902 and engaged in the business of mining and selling bituminous coal. Its mines and general offices are located at Vanetta, W. Va. J. T. Noell, Jr., the president, resides at Lynchburg, Va., and T. A. Deitz, treasurer and general manager, resides at Charleston, W. Va.The officers of the petitioner are also the president and manager, respectively, of the Deitz Colliery Co., the mines of which are located about two miles from those of the petitioner. In June, 1916, J. T. Noell, Jr., as president of the petitioner and of the Deitz Colliery Co., entered into a contract with the West Virginia Coal Co. of Richmond, Va., for the sale of 50,000 tons of coal at a rate of 90 cents per ton for 25,000 tons and 95 cents per ton for 25,000 tons. The petitioner and the Deitz Colliery Co. were to ship 25,000 tons each, shipments to commence on July 1, 1916, and to continue in approximately equal monthly quantities until June 30, 1917. 283 In July, 1916, a second contract between the parties was entered into which contract called for the shipment of 30,000 tons of3203 coal (the petitioner and the Deitz Colliery Co. to ship 15,000 tons each) at a rate of $1.05 per ton. Shipments under the terms of this contract were to commence on August 1, 1916, and continue in approximately equal monthly quantities until August 1, 1917. The shipments under the second contract were to be made immediately after the shipments under the first contract. Under the terms of both of the said contracts, the West Virginia Coal Co. was to make payment for the coal shipped during the month succeeding the month of shipment. Neither of the two contracts made any provision for strikes, lockouts, labor difficulties or car shortages. Monthly shipments on the two contracts were made regularly until December, 1916, when a fire in the mine of the Deitz Colliery Co. caused that company to cease shipments altogether. The petitioner continued monthly shipments of coal from January, 1917, to and including June, 1917, but in smaller quantities than called for by the contracts due to its difficulty in securing labor and cars. During this period from January to June, 1917, the West Virginia Coal Co. continually demanded more coal from the petitioner, threatened suit from time3204 to time and withheld the payment of money due the petitioner for coal already shipped during 1917. In June, 1917, J. T. Noell, Jr., went to Richmond, Va., and had a conference with the officers of the West Virginia Coal Co. and endeavored to secure a guarantee of the payment for all coal shipped, but that company refused to give the guarantee. Noell desired to ship as much coal as the petitioner could to the end of the contract and receive a guarantee of payment therefor. He did not desire to be the plaintiff in an action to recover the money due the petitioner, but would rather have been the defendant, if the West Virginia Coal Co. deisred to bring action on account of the undelivered coal. On June 28, 1917, two days after the above-mentioned conference, Noell sent the following telegram to the West Virginia Coal Co.: Having had no definite answer to may letter June seventh or to my personal request of day before yesterday. I have wired Deitz today to cease shipping you any coal. On the same day Noell wired Deitz as follows: Cease shipping coal to West Virginia Coal Company. Am writing. At the time the petitioner stopped shipping coal to the West Virginia Coal Co. 3205 there were still 13,404 tons of coal due the latter company under the contracts, which required the petitioner to ship 40,000 tons, but the petitioner did not ship any more coal at any subsequent date under those contracts. 284 Noell testified that he knew that the petitioner was liable on the contracts which it breached, but never formed an opinion as to the extent of its liability because of the conditions surrounding the breach and because he thought the matter could be compromised. During July and October, 1917, T. A. Deitz, treasurer and general manager of the petitioner, had a conference with E. S. Simpson, president of the West Virginia Coal Co., and tried to effect a settlement, but made no definite offiers. On one occasion Simpson offered to take 17,700 tons of coal as settlement and on another occasion Deitz offered Simpson $5,000 but merely to feel him out. No basis for compromise was effected during 1917. In August, 1917, the West Virginia Coal Co. brought attachment proceedings in Chancery Court, Richmond, Va., against the petitioner, the Deitz Colliery Co., and several of the petitioner's debtors located in that city. In the suit the West Virginia Coal3206 Co. claimed damages in the sum of $59,000 against each of the two companies, the petitioner and the Deitz Colliery Co. A motion to dismiss this suit was filed by the two defendant companies on the ground that the attachment was invalid. The defendant's answer was prepared and depositions of the plaintiff's witnesses were taken, but the case never came to trial. During the fall of 1917, Deitz wrote Noell many letters urging him to compromise and in December, 1917, Deitz wrote Noell that he thought the West Virginia Coal Co. would get judgment if the case was tried, but that he also thought they could settle for about $20,000. Also, Deitz suggested to Noell that the liability should be compromised and settled prior to the close of the year 1917, so that a deduction for the amount of the loss could be taken for that year. However, it appears that Noell had hopes of having the suit dismissed. No evidence has been submitted to the effect that the petitioner actually admitted liability to the West Virginia Coal Co. during 1917. Some time during 1918 the attorney for the petitioner and the Deitz Colliery Co. convinced the West Virginia Coal Co. that the Deitz Colliery Co. was not3207 liable for the breach of its contracts because the fire in its mines rendered it impossible to make delivery of coal and, also, that the petitioner was not liable for the Deitz Colliery Co.'s breach of contract as had been claimed by the West Virginia Coal Co. In November, 1918, the petitioner's liability, for its failure to ship the full 40,000 tons of coal required under the two contracts, was compromised for $25,000, which amount the petitioner paid by check; the suits were dismissed, and the West Virginia Coal Co. paid the petitioner by check $2,190.77, which amount stood on 285 the petitioner's books on December 31, 1917, for coal shipped to the West Virginia Coal Co. under the contracts but not paid for. The petitioner kept its books and made its tax returns on the accrual basis. In the year 1917, the petitioner did not accrue on its books any approximately accurate estimate of its liability as a reserve to meet the damages, but it did charge off $2,190.77, the amount owed it by the West Virginia Coal Co. for coal shipped, and in its 1917 tax return deducted the said amount as a bad debt. In 1918 the petitioner entered upon its books as a loss the difference between3208 $2,190.77 and the $25,000 paid in 1918 in settlement of its liability under the breached contracts and deducted that amount as a loss in its 1918 tax return. The Commissioner disallowed the deduction of $2,190.77 as a bad debt deduction for 1917 and allowed the petitioner a deduction of the full $25,000 as a loss for the year 1918. No amended returns for the years 1917 and 1918 have been filed. OPINION. TRUSSELL: Under the facts set forth in this proceeding, the petitioner claims it is entitled to a deduction of $25,000 as a loss for the year 1917 and the Commissioner's position is that the said deduction has been properly allowed by him for the year 1918. While the liability to respond in damages for the breach of two coal contracts may have attached during the year 1917, the petitioner corporation id not appear to recognize such liability in any amounnt. @ It did not set up upon its books any liability on account of such breach of contracts or recognize the same in any way in its accounting system until the year 1918, when it settled its liability by the payment of the sum of $25,000. At that time it entered the amount so paid as an expense for the year 1918. In*3209 the audit of this petitioner's income and profits-tax returns for the years 1917 and 1918, the respondent has allowed the deduction of the $25,000 as and when claimed by the petitioner in accordance with its books of account. The petitioner now claims a deduction corporation did not appear to recognize such liability in any amount. the same deduction for the year 1918. The $2,190.77 originally claimed by petitioner as a bad debt for the year 1917 was not ascertained to be worthless during that year and was properly restored to gross imcome for the year 1917 and the full amount of $25,000 appears to have been allowed for the year 1918. The deficiency for the year 1917 is $18,501.27. Judgment will be entered accordingly.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621507/	ORVILLE G. HICKS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; ELSIE M. HICKS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHicks v. CommissionerDocket Nos. 20241-91, 20242-91United States Tax CourtT.C. Memo 1992-80; 1992 Tax Ct. Memo LEXIS 85; 63 T.C.M. (CCH) 2026; T.C.M. (RIA) 92080; February 10, 1992, Filed 85 Orders and decisions will be entered for respondent. Orville G. Hicks and Elsie M. Hicks, pro se. John Altman, for respondent. DAWSON, BUCKLEYDAWSONMEMORANDUM OPINION DAWSON, Judge: These cases were assigned to Special Trial Judge Helen A. Buckley pursuant to the provisions of section 7443A(b)4 and Rules 180, 181, and 183. 1 After a review of the record, the Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE BUCKLEY, Special Trial Judge: The Court heard these cases on respondent's motions to dismiss for failure to state a claim upon which relief can be granted, as well as respondent's motions for penalties. We will grant respondent's motions. Petitioners are part of a group of petitioners in the Seattle area who filed identical86 petitions and read identical statements to this Court at the hearings on respondent's motions to dismiss. See . Respondent determined deficiencies in and additions to petitioners' Federal income taxes as follows: Additions to TaxPetitionerDocket No.YearDeficiencySec.6651(a)(1)Sec.6653(a)(1)Orville G.20241-911988$ 44,714$ 11,179$ 2,236HicksElsie M.20242-911988$ 42,458$ 10,577$ 2,123HicksPetitioners, who are husband and wife, resided at Sumas, Washington, when they filed their petitions herein. The petitions are identical in nature. Each requests "dismissal of illegal assessment of fraudulent or understatement tax return penalties without a taxpayers return, and for lack of subject matter jurisdiction, for the years ending December 31, 1988". The gist of petitioners' argument is that a notice of deficiency can only be issued to taxpayers who file Federal income tax returns, and that a taxpayer's own return is required to invoke the jurisdiction of this Court. Petitioners further contend that they were not required to and did not file a Federal income tax return87 for 1988, or an estimated tax return for that year. Petitioners do not contest that they received income for 1988. Their sole argument appears to be based upon the discreditable theory that the system of income taxation in this country is voluntary in nature. Prior to the hearing herein, the Court held a chambers conference with both petitioners in order that they might be fully informed that the Court considered their petitions to be frivolous, and that, if they persisted in such arguments, the Court would be inclined to impose sanctions under the provisions of section 6673. Petitioners acknowledged, in open Court, that they were duly warned that their petitions were frivolous and failed to state a cause of action. Nevertheless, they persisted in their frivolous arguments that our system is voluntary, that self-assessment is required before a notice of deficiency can be issued, and that they had not chosen to self assess their taxes. Petitioners further argued that there can be no deficiency in tax until there has been an assessment. Petitioners' arguments are no more than stale tax protestor contentions long dismissed summarily by this Court and others which have heard such88 contentions. Our system of taxation is not voluntary in nature. See, e.g., . Petitioners were required to file Federal income tax returns for 1988, and their failure to do so does not serve to insulate them from the issuance of a notice of deficiency by respondent. See, e.g., . There is simply no point to an extended discussion of the law in this regard. As we stated in , affd. : 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.Respondent's motions to dismiss for failure to state a claim are well taken. We note in particular that petitioners do not contest that they earned the income in question, and they admit that they did not file Federal income tax returns. Rule 34(b) provides in pertinent part that89 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". Neither petitioner has satisfied these requirements. The facts upon which they rely are not facts, but rather their mistaken theory of the basis for their claim. Neither petitioner has asserted any justiciable errors of law or fact in respondent's determinations. We further note that Rule 34(b)(4) provides that "Any issue not raised in the assignment of errors shall be deemed to be conceded". The notices of deficiency in these two cases are based upon Forms 1099-S indicating the receipt of capital gains from the sale of real estate in the amount of $ 143,375. The Court was concerned that petitioners, who did not strike us as sophisticated persons, had been influenced by outside persons to make their tax protestor arguments and did not recognize the consequences of their arguments. Thus, we discussed with them at some length in chambers the fact90 that the taxation system was not voluntary; that if they had sold real estate, the amount realized on the sale was subject to reduction for their cost basis in the property; that if they had sold their principal residence and purchased a replacement residence they might be entitled to roll over the gain or some portion thereof and delay taxation; and, lastly, that if they were over 55 years of age and had sold their residence they might be entitled to exclude a substantial portion of the gain. The Court repeated these comments on the record. Nevertheless, despite the Court's best efforts, petitioners chose to pursue their tax protestor arguments. There comes a time when the Court cannot protect litigants from the folly of their ill-taken arguments. Therefore, because respondent's determinations in the notices of deficiency are presumed correct and petitioners have the burden of proving that the determinations are incorrect, we hold that they have failed to meet this burden. Rule 142(a); ; , affg. . Consequently, *91 there are no justiciable issues for trial in these cases, and petitioners have failed to state claims upon which relief can be granted. We now turn to respondent's motions for penalties under the provisions of section 6673. We went to pains to advise petitioners prior to the hearing that their positions were frivolous in nature, and that if they persisted in their arguments we would impose sanctions. Petitioners, however, chose to adhere to their preconceived but incorrect view of the law. "Fere libenter homines id quod volunt credunt." 2 Accordingly, we will grant respondent's motions and require each petitioner to pay a penalty to the United States in the amount of $ 4,000. To reflect the foregoing, Orders and decisions will be entered for respondent. Footnotes1. All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩2. "Men willingly believe what they wish." Julius Caesar, "De Bello Gallico", I. iii. 18.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621508/	The Bolta Company v. Commissioner.Bolta Co. v. CommissionerDocket No. 5638.United States Tax Court1945 Tax Ct. Memo LEXIS 31; 4 T.C.M. (CCH) 1067; T.C.M. (RIA) 45360; November 28, 194531 1. Upon the evidence, held, the salvage value of certain machines determined by the respondent for depreciation purposes is sustained. 2. Upon the evidence, held, petitioner is entitled to a deduction for obsolescence of certain machinery and equipment which its officers during the taxable year determined would become obsolete at the close of the next taxable year. 3. Upon the evidence, held, petitioner is not entitled to a deduction for obsolescence of a certain machine, the cost of which was not proven. J. N. Welch, Esq., and Edward J. Keelan, Jr., Esq., 60 State St., Boston, Mass., for the petitioner. J. T. Haslam, Esq., for the respondent. BLACKMemorandum Findings of Fact and Opinion This proceeding involves deficiencies in income tax, declared value excess-profits tax and32 excess profits tax determined by the respondent against petitioner for the fiscal year ended November 30, 1941 in the amounts of $14,082.60, $2,744.97 and $13,992.40, respectively. The deficiencies result from 17 adjustments to the net income as disclosed by petitioner's return. Petitioner does not contest 14 of the adjustments and has consented to the assessment of approximately one-half of the deficiencies. By appropriate assignments of error petitioner does contest three of the adjustments, the first two of which are explained in a statement attached to the deficiency notice, as follows: (a) Loss from abandonment disal-lowed$ 1,451.98The deduction of $1,451.98 claimed on line 23 of your 1941 fiscal year return on account of alleged abandonment of an Automatic Cutting Machine has been disallowed for the reason that the said asset had not been abandoned or discarded at the close of the fiscal year ended November 30, 1941 as contended in the affidavit of Harold F. Houston, Treasurer, which is attached to the return. (b) Loss from obsolescence disal-lowed$13,987.33The deduction of $13,987.33 claimed on line 24 of your 1941 fiscal year33 return, and explained in Schedule L (attached to the return) as due to "Obsolescence of Hard Rubber Comb Machinery and Equipment caused by the Office of Production Management's curtailment order of July 1941 and stoppage order of December 11, 1941, regarding the use of Rubber in the Manufacture of combs" is disallowed for the reason that the factors upon which a claim for obsolescence may be based did not exist during the fiscal year ended November 30, 1941. Relative to adjustment (a), petitioner now concedes that the respondent did not err in disallowing one-half of this adjustment in the amount of $725.99. Effect will be given to this concession under Rule 50. Petitioner still contests the remaining one-half. The third contested adjustment is "(h) Excessive depreciation disallowed $30,497.64." Petitioner, however, contests only $14,102.75 of this adjustment, which contested part is explained in a statement attached to the deficiency notice, in part, as follows: Depreciation claimed by you on injection machinery and incidental equipment in the amount of $41,555.76 is reduced to $27,453.01 reflecting a disallowance of $14,102.75. In determining the depreciation allowable on34 this asset classification, a 25% salvage value has been determined on the basis of the history of your sales of discarded machines after having been in use for five years. The rate of depreciation has been based on an estimated five-year life pending the development of the machine units to the stage of efficiency demanded in your business. Findings of Fact Petitioner was incorporated under the laws of Massachusetts on May 6, 1929, with its principal place of business in Lawrence, Massachusetts. The returns for the period here involved were filed with the collector of internal revenue at Boston, Massachusetts. Adjustment (h). During the taxable year petitioner was the manufacturer of plastic products and its chief products of manufacture were combs and serving trays. The combs were made out of hard rubber and plastics. Prior to 1935 the combs were made by a socalled compression molding press (referred to further under adjustment (b)) but beginning in 1935, the so-called injection method of manufacturing plastics was introduced, and both methods were used until January of 1942 when the compression method was abandoned. In the injection method of manufacture a plunger forces35 the heated plastic into a closed die and the heated material is immediately chilled, as the molds are cooled with refrigerated water. Some twenty to thirty seconds after the plastics enter the mold, the die is opened and the molding of the plastic into a comb is complete. The injection machine has a large capacity and the manufacture of combs by this process is considerably cheaper than their manufacture by the compression molding press, as it has but one finishing operation as against 20 for the older method. When operated at full capacity each injection machine was capable of turning out from 150 up to 250 gross of combs per day. The machines are operated 24 hours a day, six days a week. Efficient manufacture requires that they be kept in continuous operation so that they will retain a constant high temperature. The use of the injection process enabled petitioner to greatly reduce the selling price of its combs so that it was able to compete with its closest competitors. The manufacture of combs requires that the injection machines be accurate and exact within thousandths of an inch. A slight inaccuracy will result in imperfections in the combs. Because of the speed, the36 strains, and the continuous operation of injection machines, inaccuracies develop; and it has been found that they will retain the necessary accuracy for use in manufacturing combs for only about five years. As yet, no method of completely correcting inaccuracies resulting from usage has been found. Products which do not require the high degree of accuracy called for in the petitioner's business can be manufactured in injection machines which, through usage, have lost the accuracy needed for comb manufacture. One use to which such machines can be put is in the manufacture of novelty items from metals. Some of petitioner's used machines have been sold to manufacturers in that field. From the time it began to use them until the close of the taxable year petitioner had disposed of a total of 11 of its injection machines. These machines had been purchased by it during the fiscal years 1936 to 1939, inclusive, at an aggregate cost of $81,402.98. Depreciation of $48,666.97 had been claimed and allowed, leaving unrecovered cost of $32,736.01. The machines were sold during the fiscal years 1937 to 1941, inclusive, at prices which aggregated $34,781.31, resulting in a net gain of $2,045.30. 37 The history of each of the 11 machines is shown by the petitioner's Exhibit 1, as follows: CostMachineFiscal YearDeprecia-No.PurchasedAmounttionNet111/30/364,197.501,679.002,518.50211/30/369,499.949,499.94311/30/369,499.949,499.94411/30/366,822.136,822.13511/30/379,950.305,223.914,726.39)611/30/377,612.305,328.612,283.692011/30/375,528.133,547.191,980.942311/30/375,752.802,588.763,164.041611/30/389,137.382,132.057,005.331011/30/396,701.281,451.945,249.341111/30/396,701.28893.505,807.7881,402.9848,666.9732,736.01Sales PriceMachine(Loss)No.DateAmountor Gain11937 50.00(2,468.50)210/20/41310/20/416,505.006,505.00 410/20/4151/16/402,000.00(2,726.39)611/30/412,876.31592.62 208/14/404,200.002,219.06 238/21/404,500.001,335.96 161/31/406,300.00(705.33)106/28/403,250.00(1,999.34)111/31/405,100.00(707.78)34,781.312,045.30 38 Machine No. 1 was the first machine bought, and it quickly developed certain deficiencies. It was abandoned and sold for scrap the year after it was purchased. Machines Nos. 2, 3 and 4 were sold on October 20, 1941 for a total of $6,505 after they had served their usefulness to petitioner and after petitioner had claimed and been allowed the entire cost thereof as depreciation. This selling price was slightly in excess of 25 percent of the total cost of the machines of $25,822.01. They were sold at a time when equipment was getting scarce and in normal times they could not have been sold for that high a price. Machines Nos. 5 and 6 were a complete failure and never produced a commercial product. Petitioner sent both machines back to the company from which it purchased them. For No. 5 petitioner obtained a cash refund and for No. 6 a merchandise credit. Machines Nos. 20 and 23 were purchased from a different concern than the others, and were not satisfactory as far as accuracy was concerned. Petitioner experienced much breakage of parts with these machines. It considered them useless for its purposes and for that reason it sold them. Machines Nos. 16 and 11 were sold to petitioner's39 Canadian company at a loss to petitioner. Machine No. 10 is a machine which petitioner purchased from a third concern during the fiscal year 1939. At the time petitioner sold the machine in 1940, its usefulness to petitioner had ended. Not included in petitioner's Exhibit 1, above, is machine No. 41 which petitioner purchased in 1941 for $15,541.87 and sold in 1944 for $7,500, after it had taken depreciation thereon of $8,777.86, thus realizing a gain of $735.99 on the sale. This represented a machine which had broken due to overstrain and had become useless to petitioner. Petitioner has about eight or ten of this type of machine. On its return for the fiscal year ended November 30, 1941, petitioner claimed depreciation on its injection machinery and incidental equipment in the amount of $41,555.76. This amount was computed on the basis of cost spread over a five-year life with no consideration given to any salvage value. The respondent determined that the depreciation on this property should be computed on the basis of cost spread over a five-year life with consideration given to a salvage value of 25 percent. He thus determined that instead of an allowance of $41,555.76, petitioner40 was only entitled to an allowance of $27,453.01, which he computed as follows: SalvageDepreciableAccum.RemainingYearCost25%CostDepreciationYrs.Cost1936$29,176.42$29,176.52$24,082.271/2$ 5,094.15193713,302.35$ 3,325.599,976.769,090.831 1/2885.93193865,742.5016,435.6249,306.8832,771.152 1/216,535.73193936,576.139,144.0327,432.1010,956.973 1/216,475.13194026,403.856,600.9619,802.892,582.384 1/217,220.51194188,266.6022,066.6566,199.955 66,199.95Total AllowedAllowableYearDepreciation1936$ 5,094.151937590.6219386,614.2919394,707.1819403,826.7819416,619.99Total Allowed$27,453.01The salvage value of petitioner's injection machines and incidental equipment was, as determined by the respondent, 25 percent of cost. Adjustment (b). Petitioner manufactured combs out of hard rubber as well as from plastics. The hard rubber combs were manufactured through open presses in which there were two die halves into which the material was loaded and the press was closed. The method of manufacturing41 hard rubber combs referred to as the older method in the testimony needed about 20 additional operations to complete it, in excess of the operations used to manufacture plastic combs by the injection method. It was also necessary in manufacturing the rubber combs to cut tooth after tooth in the rubber blank. The ordinary compression press used for the manufacture of hard rubber combs operates from two to five minutes and frequently up to a half hour, in comparison with the injection method used which shortens the cycle to 12 to 30 seconds. The injection method discussed under adjustment (h) is much cheaper than the method used in the manufacture of hard rubber combs. In the manufacture of hard rubber combs, it was first necessary to cut out the rubber blank and then place the blank into a vulcanizer from 12 to 15 hours. The blank was then placed in a cutting machine to cut out the teeth and after that, some 12 to 15 more operations were necessary to round the comb, join it, grind it and polish it. Hard rubber is very difficult to work with as it scratches very easily. In comparison with the manufacture of the hard rubber, the manufacture of plastic combs by the injection method is42 performed in one operation, as no hand touches the material after it is put into the hopper. In 1941, petitioner was manufacturing combs out of plastics through the injection molding machines and out of hard rubber through the old fashioned method of manufacture with compression presses and cutting machines. In July 1941, petitioner was advised by the United States government that there was a restriction on the purchase of rubber. Petitioner's representatives were advised also that they could not use more than 50 percent of their normal supply of rubber after July 1, 1941. Petitioner had sufficient rubber to continue the manufacture of hard rubber combs through the end of the fiscal year November 30, 1941 and manufactured some in the early part of the fiscal year ended November 30, 1942. In the summer of 1941, the president of New York Merchandise Company, petitioner's largest comb customer, advised petitioner that in his opinion rubber combs would never come back again, first, because they were too expensive and, second, because the new comb petitioner was producing with the injection machines was in many respects better than the hard rubber combs produced by the compression43 presses and cutting machines. Petitioner's chairman of the board of directors was of the same opinion. In the same year, 1941, injection molds were developed to produce rubber injected combs so if rubber combs were never again manufactured they would be produced by the far cheaper injection method and the compression presses would not be used in the manufacture of combs. During the taxable year ended November 30, 1941, petitioner concluded that the compression presses used to manufacture combs would become completely obsolete by the close of the fiscal year ending November 30, 1942 because (1) there was very little likelihood of ever again manufacturing combs of hard rubber, and (2) if combs were manufactured from rubber, the injection method would be the method used. Petitioner ceased the manufacture of hard rubber combs sometime in January of 1942. On November 30, 1941, the depreciated cost of the compression presses which petitioner owned, was $27,974.65. One-half of this sum or $13,987.33, was claimed by petitioner in its return as a deduction for obsolescence for the fiscal year ended November 30, 1941. The respondent disallowed the deduction. In November, 1943, petitioner44 sold the above mentioned compression presses together with the cutting machine mentioned under adjustment (a) below for the total amount of $429. Adjustment (a). In its return for the fiscal year ended November 30, 1941, petitioner claimed a deduction of $1,451.98 on account of the alleged abandonment of an automatic cutting machine. This machine was used in sawing out teeth in the hard rubber combs manufactured by the compression holding presses. This machine was used in the summer of 1941, but it was not used after January 1942. The machine was sold in November 1943, along with the compression presses mentioned in adjustment (b) above. The sale price of this machine was included in the above-mentioned amount of $429. Opinion BLACK, Judge: As previously stated, petitioner assigned errors as to only three of the 17 adjustments lettered (a) to (q), inclusive, made by the respondent to the net income as disclosed by petitioner's return. The contested adjustments are (a), (b) and (h). We will first consider adjustment (h). On its return petitioner had claimed depreciation on its injection machinery and incidental equipment in the amount of $41,555.76. The respondent determined45 that the allowable depreciation on this property was $27,453.01 and that the $14,102.75 claimed by petitioner in excess thereof should be disallowed. The reason for respondent's action has been set out in our preliminary statement. The applicable statute is section 23 (1) of the Internal Revenue Code, the material portion of which is in the margin. 1 The applicable regulation is section 19.23(1)-1 of Regulations 103, as amended by T.D. 5196, Cumulative Bulletin 1942-2, p. 96, the material portion of which is also in the margin. 246 Petitioner and the respondent are agreed upon the cost of the property and upon the rate of depreciation. They disagree only upon the "salvage value" to be used in making the computation. Petitioner in its return did not take into consideration any salvage value but simply spread the cost over a period of five years. The respondent determined that the cost should first be reduced by a salvage value equal to 25 percent of the cost, and that, therefore, only 75 percent of the cost should be spread over a period of five years. Although petitioner in its return did not take into consideration any value for salvage, it apparently now concedes that at least 5 percent of the cost should be so considered, for in its brief it says "The petitioner contends that salvage value of not over 5% of the gross cost of the machinery should be used in determining the depreciation deduction; whereas, the respondent has determined that the salvage value of this machinery should be 25% of its cost." Notwithstanding this apparent concession, petitioner later in its brief states that what it did in its return "was in compliance with the instructions issued by the Bureau of Internal Revenue, as issued in47 Bulletin F." This is a special bulletin on depreciation and obsolescence, first issued by the Treasury Department in 1920 and revised in January, 1942. Petitioner brings to our attention the following quotation from page 7 of the revised edition: Salvage. - Salvage value is the amount realizable from the sale or other disposition of items recovered when property has become no longer useful in the taxpayer's business and is demolished, dismantled, or retired from service. When reduced by the cost of demolishing, dismantling, and removal, it is referred to as net salvage. In principle, the estimated net salvage should serve to reduce depreciation, either through a reduction in the basis on which depreciation is computed or a reduction in the rate. In either instance the amount of net salvage should actually, or in effect, be a credit to the depreciation reserve. Where the basis or rate for depreciation is not reduced for estimated salvage, all net receipts from salvage should be considered income. Petitioner emphasizes the last sentence of the above quotation as representing authority for the manner in which it computed the depreciation allowance on its return and says that "If this48 Court should find that salvage value should not be considered, the depreciation deducted by the petitioner in its return for injection machinery in the sum of $41,555.76 was correct." We think, however, that this is a case where salvage value can reasonably be estimated and should, therefore, be considered. The sentence from Bulletin "F" specifically relied upon by petitioner was intended to cover those cases where the probable salvage value could not reasonably be estimated. Obviously such a provision is necessary in order to prevent the recovery, tax free, of more than cost. In determining the annual depreciation allowance where it is possible to estimate the salvage value, the cost should first be reduced by such estimated value before applying thereto the rate of depreciation. See Terminal Realty Corporation, 32 B.T.A. 623">32 B.T.A. 623, wherein we said: * * The annual allowance may be computed by dividing the cost of the property by the number of years of its estimated life. If the probable salvage value can be estimated, it should be first deducted from cost, but if it can not be reasonably estimated, adjustment may be made for it later. Some later adjustment may also be49 necessary to make up for errors in the estimate. A reasonable allowance is thus merely the equitable share of the expense of ultimate retirement of the plant assignable to each year. See also section 19,23(1)-1 of Regulations 103, as amended, supra, and United States v. Ludey, 274 U.S. 295">274 U.S. 295, wherein the Supreme Court said: * * The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost. * * * What was the salvage value of the injection machinery in question? This is a matter of proof. The respondent determined it was 25 percent of cost. Petitioner contends it was not in excess of 5 percent of cost. Up to some time in 1944 petitioner had disposed of 12 injection machines. The cost of these machines, the depreciation claimed and allowed, the year of acquisition and sale, and the sales price thereof are all set out in our findings of fact. Petitioner contends that because the net profit from the sale of the 11 machines set out in50 Exhibit 1 was less than 3 percent of their original cost, and because the net profit from the sale of machine No. 41 was slightly over 4.73 percent of its cost, that this is sufficient proof by itself to support petitioner's contention that a salvage value of not more than 5 percent should be considered. We do not agree with this contention. These machines, with the exception of machines Nos. 2, 3 and 4, had not been held for five years and therefore had not fully depreciated at the time of sale and were sold for the most part because of special defects. We think that because of those facts the gain or loss from the sale of such machines under special circumstances can have little bearing on determining the salvage value of machines that have been used for five years. The situation is entirely different with respect to machines Nos. 2, 3 and 4. Those machines cost $25,822.01. Petitioner had used them for five years and had claimed and had been allowed their full cost as depreciation. They were then sold for $6,505, which was slightly in excess of 25 percent of their original cost. The respondent contends that the sale of these three machines tends to support his determination. Petitioner51 offered testimony to show that when these three machines were sold on October 20, 1941, equipment was becoming scarce and that in "normal times" they could not have been sold for that high a price. We think the world situation at the end of 1941 was such that one could reasonably expect that the manufacture of civilian goods and the production of machinery therefor would be more and more seriously curtailed over the years to follow. Experience has fully justified such expectations. The injection machines had only five years of useful life for petitioner's purposes, but they could be used and were used in other businesses. It is for these reasons that we think the evidence relating to machines Nos. 2, 3 and 4 is the best evidence in the record as to the probable salvage value of petitioner's injection machines upon which it is now claiming a depreciation allowance. Petitioner's president who had graduated from the University of Darmstadt in Germany with a bachelor's certificate testified that "as engineers we place no value on the machine after five years except their scrap value. The motor is the only part that has a useful life after five years" and that "We figure that five per52 cent is about all we can recover of the value after five years." This testimony, however, does not coincide with the actual facts. The only machines that were sold by petitioner after they had been used by petitioner for the normal period of five years were the above mentioned machines Nos. 2, 3 and 4, and these machines were sold for slightly more than 25 percent of their original cost. We sustain the respondent's determination upon this issue. We will now consider adjustment (b). The issue here is whether the respondent erred in disallowing $13,987.33 claimed by petitioner as a deduction for obsolescence of its hard rubber comb machinery and equipment. As to when property will become obsolete is a question of fact. Crooks v. Kansas City Title & Trust Co., 46 Fed. (2d) 928, 930. The applicable statute is section 23(1), I.R.C., the material portion of which is in footnote 1 above. The applicable regulation is section 19.23(1)-6 of Regulations 103, which is in the margin. 353 In Real Estate-Land Title & Trust Co. v. United States, 309U.S. 13, the Supreme Court in passing upon an essentially similar statute and regulation, among other things, said: * * * the term "allowance for obsolescence" as used in the Act and in the Treasury Regulations has a narrower or more technical meaning than that derived from the common, dictionary definition of obsolete. The Treasury Regulations state the circumstances under which an allowance for obsolescence of physical property may be allowed, viz., where such property is "being effected by economic conditions that will result in its being abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions alone are insufficient to return the cost (or other basis) at the end of its economic term of usefulness." This Court, without undertaking a comprehensive definition, has held that obsolescence for purposes of the revenue acts "may arise from changes in the art, shifting of business centers, loss of trade, inadequacy, supersession, prohibitory laws, and other things which, apart from physical deterioration, operate to cause plant elements or the plant as a whole to suffer diminution54 in value." * * Such specific examples illustrate the type of "economic conditions" whose effect on physical property is recognized as obsolescence by the Treasury Regulations. Others could be mentioned which similarly cause or contribute to the relentless march of physical property to the junk pile. * * * obsolescence under the Act requires that the operative cause of the present or growing uselessness arise from external forces which make it desirable or imperative that the property be replaced. What those operative causes may be will be dependent on a wide variety of factual situations. "New and modern methods" appear to have been one of the real causes of abandonment of the title plant in Crooks v. Kansas City Title & Trust Co., supra.* * * In the instant proceeding "new and modern methods" of manufacturing combs had convinced the officers of petitioner in the summer of 1941 that the machines it was using under the old compression method were headed for the junk pile. The evidence proves this beyond all doubt. The new injection process was much faster, made better combs and was far less expensive than the old compression method. In his brief the respondent states55 his position as follows: The petitioner says in effect that in 1941 two factors had rendered the manufacture of combs by the compression method obsolescent. The two factors are said to be (1) restrictions placed by the Government on the use of rubber, and (2) the advancement of the cheaper and more efficient method of the manufacture of combs out of plastic by injection machines. The respondent takes the position that the first factor has no bearing whatsoever on the obsolescence of the machines, and that with respect to the second factor the proof fails to show the extent, if any, to which it resulted in obsolescence in the taxable year. It may be true that the restriction placed by the Government on the use of rubber had a tendency to bring this factual obsolescence situation to a head in the taxable year 1941, but we are convinced from the evidence that the situation existed in fact irrespective of the restrictions placed on rubber. The president of petitioner's largest customer told petitioner's chairman of the board, John Bolten, in 1941: "John, rubber combs will never come back again. First, they are too expensive, and second, the new vinalite combs you are producing now56 are in many respects even better than your hard condirubber combs were." Bolten testified that he "* * * wanted to have the whole machinery taken off our books because they were no good to us; there was no future. As far as I was concerned it was nothing but a junk pile. But Harold Houston, our treasurer, said it is better, for some reasons, to divide it into two years." Subsequent events have proved the correctness of petitioner's belief in 1941 that the economic term of usefulness of its hard rubber comb machinery and equipment would not extend beyond the next fiscal year. Petitioner ceased the manufacture of hard rubber combs sometime in January of 1942 and sold its hard rubber comb machinery and equipment for a fraction of its cost in 1943. It is clear from the evidence that by the end of 1941 petitioner knew its supply of hard rubber would be exhausted in early 1942 and if it ever resumed the manufacture of hard rubber combs at a later date it would be by the injection method and not the compressed method. The parties have agreed that the depreciated cost of the machinery involved on November 30, 1941 was $27,974.65. We hold that petitioner is entitled to a deduction of one-half57 of this amount as obsolescence in the fiscal year ended November 30, 1941. The respondent's determination on this issue is reversed. Crooks v. Kansas City Title & Trust Co., supra, and cases there cited. Adjustment (a). In its return petitioner claimed a deduction of $1,451.98 as a loss from abandonment of an automatic cutting machine. The respondent disallowed the deduction for the reasons given in a statement attached to the deficienc0 notice which we have set out above in our opening statement. Petitioner assigned error "In the determination that the loss * * should be disallowed in its entirety." In its petition petitioner also alleged that "In May, 1941, the petitioner purchased an automatic cutting machine at a cost of $1,451.98 * * "; and that In the tax return filed by the petitioner for the year ended November 30, 1941, the total cost of this machine, namely, $1,451.98, was claimed as a deduction from taxable income. The petitioner now believes that this should be amortized over the fiscal years ended November 30, 1941 and November 30, 1942; one-half being allowed as a deduction from taxable income for the fiscal year ended November 30, 1941 in the sum58 of $725.99. The respondent in his answer admitted "that in the tax return filed by the petitioner for the fiscal year ended November 30, 1941, the sum of $1,451.98 was claimed as a deduction from taxable income" but for lack of information denied all the remaining allegations relative to this issue. In its brief petitioner says "The same argument relates to this machine as relates to the obsolescence of the compression machinery and it is the contention of the petitioner that one-half the cost of this machine should be charged off in the fiscal year ended November 30, 1941 and the balance in the year ended November 30, 1942." Petitioner offered no proof as to the cost of this machine and the respondent specifically relies upon this lack of proof as one of his reasons why no deduction may be allowed in respect of this machine. Even if we disagreed with all of the respondent's other reasons as to why no deduction may be allowed relative to this machine, we could not sustain petitioner's contentions without proof of cost. In this respect this issue differs from the preceding issue. In the trial of that issue the parties stipulated the remaining undepreciated cost of the machines59 there in question. No such stipulation or other evidence was offered as to the cost of the automatic cutting machine here involved. We therefore, sustain the respondent's determination as to this issue. 160 Decision will be entered under Rule 50. Footnotes. Junked and sold with other junk. Estimated portion of total sales price attributable to this machine $50.↩1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * (1) Depreciation. - A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - (1) of property used in the trade or business. * * ↩2. Sec. 19.23(1)-1. Depreciation. - A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business * * * may be deducted from gross income. For convenience such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan (not necessarily at a uniform rate), whereby the aggregate of the amounts so set aside, plus the salvage value, will, at the end of the useful life of the depreciable property, equal the cost or other basis of the property determined in accordance with section 113. * * *↩3. Obsolescence. - With respect to physical property the whole or any portion of which is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions alone are insufficient to return the cost or other basis at the end of is economic term of usefulness, a reasonable deduction for obsolescence, in addition to depreciation, may be allowed in accordance with the facts obtaining with respect to each item of property concerning which a claim for obsolescence is made. No deduction for obsolescence will be permitted merely because, in the opinion of a taxpayer, the property may become obsolete at some later date. This allowance will be confined to such portion of the property on which obsolescence is definitely shown to be sustained and cannot be held applicable to an entire property unless all portions thereof are affected by the conditions to which obsolescence is found to be due.↩1. Motion of the Commissioner striking from the opinion the sentence which appeared at this point is reproduced herein: "MOTION" "Comes now the Commissioner of Internal Revenue, by his attorney, J. P. Wenchel, Chief Counsel, Bureau of Internal Revenue, and moves that the Tax Court amend its Memorandum Findings of Fact and Opinion entered herein on November 28, 1945, by striking from the opinion the last sentence appearing on page 18 thereof. "As grounds for the motion, respondent states that the Court is without jurisdiction to decide matters which will enter into the determination of the petitioner's income tax and excess-profits tax liability for the taxable year 1943 since the only taxable year involved in this proceeding is the fiscal year ended November 30, 1941. "WHEREFORE, it is prayed that this motion be granted. (SIGNED) J. P. WENCHEL, CPR, J. P. Wenchel, Chief Counsel, Bureau of Internal Revenue. "OF COUNSEL: Charles P. Reilly, Division Counsel, A. J. McDowell, Special Attorney, Bureau of Internal Revenue The Tax Court of the U.S., GRANTED, Dec. 13, 1945, (Signed) Eugene Black↩, Judge"	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621509/	Appeal of MILTON H. BICKLEY.Bickley v. CommissionerDocket No. 297.United States Board of Tax Appeals1 B.T.A. 544; 1925 BTA LEXIS 2909; January 31, 1925, decided Submitted December 15, 1924. 2909 A corporation preparing to reorganize under the laws of another state transferred all of its assets to its four stockholders by resolution passed December 31, 1918. The stockholders agreed to hold such assets as trustees for the corporation to be organized and to transfer the same to it when it came into being. The new corporation was formed in February, 1919, and the assets were transferred to it by the old corporation and the trustees. Held, that the transfer of its assets by the old corporation to its stockholders as trustees did not constitute a distribution in liquidation of their interests therein, but was merely a step in the reorganization of the old corporation, and any gain which may have been derived by the stockholders through the reorganization is taxable for the year 1919 and not as a gain on liquidation of their interests in 1918. Debts ascertained to be worthless and charged off during the year 1918, and a loss sustained on stock which became worthless, held to have been properly deducted in that year. James L. Rankin, Esq., for the taxpayer. A. H. Fast, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. 2910 MARQUETTE 544 Before IVINS, KORNER, and MARQUETTE. This is an appeal from a proposed assessment of income tax for the year 1918. From the evidence submitted at the hearing the Board makes the following FINDINGS OF FACT. Prior to and during the year 1918, the Baldt Anchor Company was a New Jersey corporation with an authorized capital stock of $100,000 divided into 2,000 shares of a per value of $50 each. At the end of 1918 all of the stock of said company was held in equal shares by Norris D. Powell, Edward O. Hall, Richard J. Bennett, and the taxpayer herein, and it was decided that the company should be reorganized as a Pennsylvania corporation. At a meeting of the stockholders on December 31, 1918, the following resolution was passed: The president announced that the meeting had been called for the purpose of considering the question of the sale and disposal of all of the assets of the Company and also the question of the dissolution of the Company as now incorporated under the laws of the State of New Jersey. Mr. Bickley moved that the President and Secretary of the Company be and they are authorized and empowered to enter into an agreement to sell2911 and to sell all of the assets of the Company, of all kinds and wherever situate, including all patents, accounts and bills receivable, machinery and other equipment, and stock of all and every character, to Norris D. Powell, Richard 545 J. Bennett, Edward A. Hall and Milton H. Bickley, at a price equal to the net value or worth of the Company, and all of its assets, this amount to be determined by the books of the Company as of this date, and further the said President and Secretary are authorized to agree upon all terms of the sale as to times and method of payment and to execute and deliver on behalf of the Company, any and all agreements, bills of sale and other assurances of which they may in their discretion approve. The motion was seconded by Mr. Bennett and unanimously adopted. Mr. Bickley moved that the Company wind up the Company's affairs as of December 31, 1918, and to dissolve as soon as can be readily done, that the President and Secretary be and they hereby are authorized and empowered to have taken all necessary steps to precure the legal dissolution and final winding up of the affairs of the Company and further to make full and final distribution of the2912 assets of the Company among all of the stockholders (after all proper debts and obligations are paid or otherwise cared for) in proportion to their several holdings or shares in the Company. The motion was seconded by Mr. Bennett and unanimously adopted. Contemporaneously with the passage of the above resolution, the four stockholders above named executed a declaration acknowledging that they held title to the assets of the corporation as trustees for the benefit of the Pennsylvania corporation to be organized and agreeing to transfer such assets to the Pennsylvania corporation when formed. Steps were at once taken to secure a charter under the laws of Pennsylvania, and in February of 1919 the Baldt Anchor Co. was chartered as a Pennsylvania corporation with an authorized capital stock of $500,000. When the new corporation was organized the Baldt Anchor Co. of New Jersey executed a bill of sale transferring all of its assets to the Baldt Anchor Co. of Pennsylvania as the nominee of the said trustees and at their direction. No part of the assets of the Baldt Anchor Co. of New Jersey was ever transferred to or received by the said stockholders as such, but they joined with the2913 corporation in executing the bill of sale of its assets. At December 31, 1918, the books of the Baldt Anchor Co. of new Jersey showed a surplus of approximately $193,000, and when the stock of the new company was issued in February, 1919, there was credited to the account of this taxpayer the sum of $25,000, par value of the capital stock of the New Jersey corporation held by him, one-fourth of the surplus account, and an item of $18,000 owing to him upon a loan to the Baldt Anchor Co. of New Jersey, and new stock was issued to him to the extent of the credit thus established in his favor upon the books of the new company. The Commissioner proposes to assess a tax upon an alleged gain received by the taxpayer in liquidation of the Baldt Anchor Co. of New Jersey in the year 1918. The Cassada Manufacturing Co. was a Delaware corporation, organized in 1913, for the purpose of manufacturing talcum powder and other similar products. At the time of its organization the taxpayer herein purchased $2,500 of the capital stock of the said company for cash. During the years 1914 and 1915, the taxpayer, as an accommodation indorser, indorsed two notes of the Cassada Manufacturing Co. 2914 in the sum of $10,000 and $5,000, respectively, and said notes were discounted by the First National Bank of Chester, Pa. These notes were extended from time to time, and during the years 1915 and 1916 the company was unable to secure further 546 extensions and the taxpayer was required to pay the amount of these notes to the bank. The Cassada Manufacturing Co. continued to do business up to and including the year 1918, and all of its business activities were managed and directed by John B. Cassada, its president. During this time it appeared that the company would eventually become a success but late in 1918 all activities ceased and the president of the company left for a point in the South and shortly thereafter died. At this time the company had no assets of any value or any funds with which to pay any of its debts and was entirely insolvent. There was no market for the sale of the capital stock and the testimony shows that nothing could have been obtained for it from any source. At the end of the year 1918 the taxpayer charged off his books, as worthless debts, the amount of the two notes paid during the years 1915 and 1916 of $15,000, and deducted as a loss in that2915 year the item of $2,500 representing the purchase price of the stock. DECISION. The determination of the Commissioner is disapproved and the tax should be computed in accordance with the following opinion. The amount of the deficiency to be assessed will be settled by the Board on consent or on 10 days' notice under Rule 50. OPINION. MARQUETTE: Two questions are presented for decision in this appeal. First, whether the taxpayer herein is taxable for the year 1918 upon an alleged gain received in liquidation of the Baldt Anchor Co. of New Jersey, and second, the deductibility of certain items claimed to have been worthless debts, and a loss on stock alleged to have become worthless. The Commissioner has proposed a assess a tax for the year 1918 upon the theory that the taxpayer derived a gain from the liquidation of his interest in the Baldt Anchor Co. of New Jersey. This action was based upon the language of the resolution passed at the stockholders' meeting of December 31, 1918. Standing alone, the resolution undoubtedly gives color to a determination that there was a distribution in liquidation to the stockholders, but when taken in connection with the facts preceding, 2916 contemporaneous with, and following the adoption of such resolution, it assumes a different hue. The facts disclose that the assets of the Baldt Anchor Co. of New Jersey were received by the stockholders as trustees for a corporation to be formed, and to be known as the Baldt Anchor Co., a Pennsylvania corporation; that when the Pennsylvania corporation was formed, the entire assets of the Baldt Anchor Co. of New Jersey were transferred to it by that company at the direction of the said trustees, who joined in the execution of the bill of sale. No part of the assets of the original company were transferred to or received by the said stockholders in virtue of their several interests in the old company, and they acted as a mere conduit to pass the title of the assets to the new corporation when formed. It is quite apparent from the disclosed facts that there was not a distribution in liquidation by the Baldt Anchor Co. of New Jersey547 to its stockholders on December 31, 1918, but that the stockholders' resolution of that date was merely a step in the reorganization of the Baldt Anchor Co., a New Jersey corporation, into the Baldt Anchor Co., a Pennsylvania corporation, 2917 and that this taxpayer is not taxable in the year 1918 as upon a gain received in liquidation of the old company. Any gain which may have been derived by the taxpayer in the reorganization of the Baldt Anchor Co. of New Jersey is properly to be accounted for in the year 1919 and not in 1918. The taxpayer has deducted as debts ascertained to be worthless and charged off during the year 1918, the amount of two notes of the Cassada Manufacturing Co. aggregating $15,000, upon which he was accommodation indorser, and which he was compelled to pay in the years 1915 and 1916, and $2,500, representing a loss of the purchase price of stock of said company acquired at its organization for cash, and alleged to be worthless. The Cassada Manufacturing Co. was a small corporation organized to manufacture talcum powder and similar products. Its president was John D. Cassada, who had the entire management of the business of the concern. The company was never a financial success, and during the years 1914 and 1915 this taxpayer indorsed two of its notes for $10,000 and $5,000, respectively, as an accommodation indorser, and the notes were discounted at a bank. The two notes were extended2918 from time to time and, the company being unable to meet them, demand was made upon the taxpayer, and during 1915 and 1916 the notes were paid by him. The evidence discloses that during 1917 and 1918 the company had prospects of becoming a success, but late in 1918 its president left for a point in the South and shortly thereafter died. The business entirely ceased when the president left, and the company had no assets or funds with which to meet its obligations and was entirely insolvent. The stock of the company was closely held and had no market value; and nothing was ever received by the stockholders from the company. The contention in respect of the worthlessness of these debts is as to when they became worthless. It is the contention of the Commissioner that they were worthless in 1915 and 1916. We think the taxpayer properly determined their worthlessness in the year 1918, when he wrote them off his books. While, as shown by the facts, the company was not a financial success, the testimony produced at the hearing shows there was reasonable ground for the belief on the part of the stockholders and others that an era of prosperity was in prospect for the company, and that*2919 it would eventually be able to pay. This belief, however, was dissipated when the president, who was the sole guiding factor of the corporation, departed for a point in the South, leaving the corporation without assets or funds with which to meet its obligations and hopelessly insolvent. As the corporation had no funds or assets of any kind and entirely ceased to do business in 1918, and as the stock had no value and could not be disposed of at any price, it was entirely worthless at that time. We are of opinion that the deduction of the amount of the two notes as worthless debts, and of the loss in the stock should be allowed in the year 1918.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621510/	NEW FAITH, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentNew Faith, Inc. v. CommissionerDocket No. 42902-85XUnited States Tax CourtT.C. Memo 1992-601; 1992 Tax Ct. Memo LEXIS 631; 64 T.C.M. (CCH) 1050; October 8, 1992, Filed 631 Decision will be entered for respondent. For Petitioner: Joseph Daniel Seckelman. For Respondent: William H. Quealy Jr.FAYFAYMEMORANDUM OPINION FAY, Judge: In 1985, after examining the records and activities of New Faith, Inc., for the period ended December 31, 1982, respondent revoked petitioner's tax-exempt status for the tax year ended December 31, 1982, and all subsequent years. Petitioner challenges respondent's determination and has invoked the jurisdiction of this Court for a declaratory judgment pursuant to section 7428. 1This case was submitted for decision on the stipulated administrative record under Rule 122. The stipulated administrative632 record is incorporated herein by this reference. The issue presented to us is whether petitioner is operated exclusively for charitable purposes within the meaning of section 501(c)(3). At the time of filing its petition herein, petitioner had its principal place of business in Bonita, California. BackgroundPetitioner is a nonprofit public benefit corporation organized under the laws of the State of California on January 30, 1981. Petitioner's articles of incorporation provide that petitioner's specific purpose is "to supply money, goods, and services for the poor." The articles of incorporation further declare that "This corporation is organized and operated exclusively for charitable purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code." On March 3, 1981, petitioner filed a Form 1023, Application for Recognition of Exemption under Section 501(c)(3) of the Internal Revenue Code (application), with respondent's District Director in Los Angeles, California. In its application, petitioner represented that its "sole source of financial support will be its fund-raising activities" which petitioner described as "raffles, bingo and donations." In its633 application, petitioner further described its charitable activities as follows: Essentially, the programs and activities of the corporation will be to supply money, goods and services to the poor. The corporation intends to keep a supply of such necessities as food and clothing in stock so that when a qualified person comes to New Faith he can be supplied with such necessities immediately. If a person needs a place to sleep, we want to be able to immediately provide a place to sleep. There will be no cost for these services. In this way the corporation hopes to provide immediate assistance to the poor without forcing them to spend money they either do not have or cannot afford to spend. Additionally, the corporation has as its goal the construction of a camp to house and care for poor people. The camp will not only house and feed these people, but provide an opportunity for these people to get on their feet and gain renewed confidence in themselves. At this time it is not possible to provide more details about the camp. Rev. Joseph is still exploring the possibilities of the camp and has made no firm decisions as to where it will be located, when it will be opened or 634 the details of its operations. The corporation also plans on conducting such "social" activities as picnics for the poor. Food would be provided free of charge. The key to any activity planned by the corporation would be its ability to immediately assist, without cost, the truly poor people.Petitioner also represented in its application that there would be no cost for these services, and that services would be limited to persons with referrals from ministers or lawyers certifying the individual's need for assistance. On May 22, 1981, based on the information supplied in petitioner's application, respondent issued an advance letter ruling to petitioner recognizing it as an exempt organization. For the years at issue, petitioner's primary activity and source of income was the operation of several lunch trucks, which provided food items to the general public in exchange for scheduled "donations". Petitioner reported $ 114,080 in donations from this activity and expenses for food and produce of $ 96,642 on Form 990, Return of Organization Exempt from Income Tax, for the year ended December 31, 1982. Petitioner made a contribution in 1982 of $ 100 to the campaign fund of a candidate635 who was running for Mayor of San Diego. Respondent conducted an examination of petitioner's activities for the period ended December 31, 1982, and on March 30, 1984, respondent advised petitioner that petitioner did not qualify as an exempt organization since petitioner's primary purpose or activity was determined to be the conduct of a trade or business. On September 3, 1985, following consideration of a protest filed by petitioner, respondent issued a final determination revoking petitioner's status as an exempt organization described under section 501(c)(3). The final adverse determination letter stated as grounds for revocation: The organization failed to meet the requirements of I.R.C. section 501(c)(3) and related Treasury Regulations, in that: 1) It was not operated exclusively for a tax-exempt purpose. 2) (a) A primary purpose of the organization was a trade or business (lunch truck) which constituted a substantial part of its operations, and (b) this business was carried on for profit, and was not in furtherance of nor related to the organization's tax exempt purposes. 3) The organization made a contribution to a political campaign on behalf of a local mayoral candidate. 636 4) The organization failed to keep records and books adequate to substantiate its purported charitable activities.DiscussionUnder section 501(c)(3), an organization which is organized and operated exclusively for an exempt purpose (and meets the other requirements of the provisions) qualifies as a tax-exempt organization. In order for an organization to be exempt from Federal income taxes under section 501(a) and (c)(3), it must satisfy both the organizational and operational tests of section 1.501(c)(3)-1(b) and (c), Income Tax Regs. If an organization fails to meet either test, it is not ex empt. Sec. 1.501(c)(3)-1(a)(1), Income Tax Regs. Respondent, on brief, focuses her argument on petitioner's failure to satisfy the operational test. Petitioner has the burden of proving that respondent's adverse determination is erroneous. Greater United Navajo Enterprises, Inc. v. Commissioner, 74 T.C. 69">74 T.C. 69, 76 (1980), affd. 672 F.2d 922">672 F.2d 922 (9th Cir. 1981). Section 1.501(c)(3)-1(c)(1), Income Tax Regs., provides: (c) Operational test -- (1) Primary activities. An organization will be regarded as "operated exclusively" 637 for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. The word "exclusively" as used in section 501(c)3) does not mean "solely" or "without exception." Church in Boston v. Commissioner, 71 T.C. 102">71 T.C. 102, 107 (1978). An organization which engages in nonexempt activities can obtain and maintain exempt status so long as such activities are only incidental and insubstantial. Manning Association v. Commissioner, 93 T.C. 596">93 T.C. 596, 603-604 (1989). The purpose toward which an activity is directed, rather than the nature of the activity itself, determines whether the operational test is satisfied. The fact that an organization's activity constitutes a trade or business does not, in itself, disqualify that organization under section 501(c)(3). Junaluska Assembly Housing, Inc. v. Commissioner, 86 T.C. 1114">86 T.C. 1114, 1121 (1986); see also sec. 1.501(c)(3)-1(e)(1), Income Tax638 Regs. The critical inquiry is whether petitioner's activity encompasses a substantial nonexempt purpose irrespective of the presence of other exempt purposes. This determination is a question of fact to be ascertained under the facts and circumstances of each individual case. See Manning Association v. Commissioner, supra.Petitioner's main activity is the operation of a number of canteen-style lunch trucks. This type of activity is normally carried on by commercial profit-making enterprises. Petitioner's practice of collecting cash in exchange for food items is indistinguishable from the commercial activities of other for-profit commercial ventures engaged in the food retailing business. 2 The extent of petitioner's commercial activities is reflected in petitioner's Form 990 for 1982. During 1982, petitioner's commercial activity accounted for approximately 80 percent of its gross expenditures and nearly 100 percent of its gross revenues. It is incumbent on petitioner to show that this activity somehow furthered an enumerated exempt purpose. 3639 Petitioner's sole argument, on brief, is that food items were routinely provided to needy travelers on California highways on a donation or "love offering" basis and that the needy traveler could determine what amount, if any, he could pay. We find, however, that the evidence stipulated in the administrative record does not support petitioner's argument. At the outset, we find no credible evidence in the record to support the position that food items were routinely offered to anybody for free or at below-cost prices. See Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687">72 T.C. 687, 692 (1979), affd. 625 F.2d 804">625 F.2d 804 (8th Cir. 1980). Furthermore, there is no evidence in the record showing that the people, if any, who received food items from petitioner for free or at below-cost prices were impoverished or needy persons. Petitioner provided no evidence that the alleged charitable activities were tailored to serve the poor, nor did petitioner limit its alleged assistance to those with referrals from ministers or lawyers, as was represented in petitioner's application filed with respondent. There is no reliable evidence in640 the administrative record from which we could determine whether the number of fair market value exchanges was insubstantial. Furthermore, the administrative record does not support a finding that amounts received from the fair market value exchanges furthered any exempt purpose. In short, petitioner could not explain how its activity, essentially commercial in nature, furthered its charitable exempt purpose. See Greater United Navajo Enterprises, Inc. v. Commissioner, 74 T.C. 69 (1980). Petitioner's submission of a newspaper article that contains its founder's own statements relating to petitioner's activities does not substitute for specific documentation in the form of checks, invoices, receipts, contemporaneous journals, and other documentation necessary to substantiate petitioner's alleged charitable activities. Accordingly, based on all the evidence contained in the administrative record, we hold that petitioner has not carried its burden of proof in showing that petitioner's lunch trucks were operated exclusively in furtherance of one or more exempt purposes. 4*641 Decision will be entered for respondent. Footnotes1. All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. Sec. 7428↩ specifically confers jurisdiction on this Court to make a declaration with respect to the continuing qualification of certain tax-exempt organizations.2. On brief, respondent alleges that petitioner posted prices for the different food items offered by the lunch trucks. Petitioner does not contest this claim. ↩3. Exempt purposes include religious, charitable, scientific, literary, and educational, among others. Petitioner, on brief, characterizes its activities simply as charitable. The term "charitable" is used in sec. 501(c)(3) in its generally accepted legal sense. Sec. 1.501(c)(3)-1(d)(2), Income Tax Regs.↩ Although it would be impossible to list all purposes held to be charitable, the relief of poverty is certainly recognized as a charitable purpose.4. In so holding, we need not reach respondent's alternative arguments for revocation of petitioner's tax-exempt status. We also want to make clear that our holding does not question the sincerity or motivation of petitioner or its founders in the operation of the lunch trucks at issue. We simply find that there is not enough evidence in the administrative record to enable us to conclude that petitioner has carried its burden of proof.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621512/	HENRY JENNY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentJenny v. CommissionerDocket No. 7703-75.United States Tax CourtT.C. Memo 1977-142; 1977 Tax Ct. Memo LEXIS 296; 36 T.C.M. (CCH) 607; T.C.M. (RIA) 770142; May 12, 1977, Filed Michael Antin, for the petitioner. Marion Westen, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined a deficiency in petitioner's Federal income tax in the amount of $4,208 for the taxable year 1972. The sole issue remaining for our determination is the amount of unreimbursed theft loss which petitioner is entitled to deduct under section 165. 1297 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner, Henry Jenny (Jenny), resided in Palm Springs, California at the time the petition was filed in this case.Petitioner filed a Federal income tax return for the taxable year 1972 with the Office of the Internal Revenue Service at Ogden, Utah. On December 1, 1972, Jenny returned from a short trip to Los Angeles to find that, in his absence, someone had robbed his home of several valuable items. Jenny alerted the police who filed a report describing the robbery and listing 16 items which were stolen. Fifteen of these items were valued at $7,295 with the value of a sixteenth item, "miscellaneous clothing," listed as unknown. Jenny's property was insured against theft with the State Farm Fire and Casualty Company (State Farm). A proof of loss claim dated December 27, 1972 valued the stolen items at $10,015, and an itemized list of stolen property, submitted to State Farm on Jenny's stationary lists four items in addition to all the items previously given on the police report. State Farm paid Jenny the maximum amount under the policy, $4,200 in early 1973. On Schedule A of his298 1972 Federal income tax return, Jenny claimed a $7,295 casualty loss but did not indicate whether or not he had received any insurance reimbursement. OPINION Respondent concedes that petitioner sustained a loss during 1972 due to theft. Petitioner concedes that he received $4,200 from State Farm reimbursing him for at least part of that loss. What the parties dispute is the value and basis of the stolen property for purposes of determining the theft loss under section 165. Section 165(c)(3) permits individuals to deduct losses caused by the theft of nonbusiness property only to the extent that the loss from each theft exceeds $100 and is not reimbursed by insurance or otherwise. The proper measure of the loss sustained is the lesser of (1) the fair market value of the property immediately before the theft or (2) the adjusted basis of the property. Sections 1.165-7 and 1.165-8, Income Tax Regs.Ternovsky v. Commissioner, 66 T.C. 695">66 T.C. 695, 697-98 (1976). The basis of Jenny's property for this purpose is the cost of such property. Section 1012. We have been presented with three sets of figures concerning the value of the stolen property. Jenny gave the police299 department a tentative property list on the day he discovered the theft. A little while later he gave the insurance company a list containing some changes from the list given the police and adding items which he subsequently discovered stolen. Jenny also testified in court as to the cost and value of the stolen property including property which he discovered stolen only after the insurance company list had been presented. Listed below are the three sets of figures: In Court TestimonyPoliceInsuranceYearReportList ItemPurchasedCostF.M. ValueValuesValues2 speakers1969$ 350$ 350$ 190$ 1903 statues197218006000150015002 1/4 X 2 1/4camera1966525525+52552516mm motion pic-ture camera19702000200020002000tuner & amplifier1968900900900900tape recorder1969850850700850casette recorder1969369369450450record player1969430430450450suede coat1968150150150suede suit1971350350350350bag197010101025U.S. passport196735-503535Swiss passport35-503535Misc.500-1000500leather coat200bedcover75jewelry1971150025001500silk robe1008mm camera1801 3/4 X 1 3/4camera1969150150+150camera acces-sories850850"Elmo" projector1967180165slide projector1967125100Kodak projector1972125125pictures750750other (est.)3500300 Despite his lack of supporting documentation we find the evidence as to the cost of the stolen property to be generally credible and sufficient. However, we have strong reservations as to his estimates of fair market value. While the owner of property is competent to testify as to its value, the weight to be given his testimony will depend upon his knowledge, experience, method of evaluation, and other relevant considerations. Biddle v. United States, 175 F. Supp. 203">175 F. Supp. 203, 204 (E.D. Pa. 1959); Harmon v. Commissioner, 13 T.C. 373">13 T.C. 373 (1949). With but two exceptions, Jenny's estimates of present value equalled or exceeded the original cost of the property. While the statues and jewelry may indeed have appreciated in value because of the nature of the items and the unique circumstances under which they were purchased, we find his conclusion as to the other items unacceptable. In particular, items such as the suede coat and the tuner and amplifier, all purchased in 1968, must have depreciated in value by December 1972 when they were stolen. It appears that Jenny's estimates are high because he based them on the replacement cost of new rather than used items. *301 This is not an appropriate standard. After having carefully reviewed and considered all the testimony and evidence, we conclude that petitioner's loss amounted to $8,200.We feel that this figure fairly reflects the value of the stolen property. From this amount must be deducted the $4,200 insurance reimbursement received by petitioner and the $100 required by section 165(c)(3). Accordingly, petitioner is entitled to a deduction of $3,900. Decision will be entered Under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621513/	N. Gordon Phillips, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lauretta M. Phillips, Petitioner, v. Commissioner of Internal Revenue, RespondentPhillips v. CommissionerDocket Nos. 58561, 58562United States Tax Court29 T.C. 47; 1957 U.S. Tax Ct. LEXIS 64; October 16, 1957, Filed 64 Decisions will be entered for the respondent. Held, petitioner received all of the proceeds from the 1951 sale of stock under a claim of right so as to be taxable thereon in that year, despite the fact he was obliged in a later year to pay back the proceeds received from the sale of a portion of the stock, pursuant to the mandate of a State court decree. Sidney R. Reed, Esq., for the petitioners.Mark Townsend, Esq., for the respondent. Mulroney, Judge. MULRONEY 48 OPINION.The respondent determined a deficiency in the income tax of the petitioners in these consolidated cases for the calendar year 1951 in the amount of $ 15,525.59. The sole issue in controversy here is whether the proceeds from the sale of certain stock, reported as income in the 1951 joint return of petitioners, can be included in that year's income65 when it appeared petitioners were obliged to pay back such proceeds to a claimant in a later year.Most all of the facts were stipulated and the stipulated facts are found accordingly. N. Gordon Phillips and Lauretta M. Phillips, petitioners in these consolidated cases, are husband and wife residing in Beverly Hills, California. They filed a joint income tax return for 1951 with the then collector of internal revenue for the sixth district of California at Los Angeles, California. Petitioner, N. Gordon Phillips, will hereafter sometimes be referred to as petitioner, as Lauretta is only interested in the case by virtue of the community property laws of California and her liability under the joint income tax return for 1951.Petitioner organized and promoted the Gordon Oil Company, a California corporation organized on January 30, 1949. For his services and for the transfer of certain leasehold interests, he was to receive one-half of the stock of the said company. A permit was issued by the corporation commissioner for the State of California in March 1949, authorizing the issuance of 13,000 shares of stock to petitioner and the sale of an additional 13,000 shares at a par value66 of $ 10, and providing that all shares should be held in escrow and that petitioner should receive no dividends on his shares until the purchasers of shares for cash had been reimbursed for the full purchase price.Petitioner sold 1,790 shares of stock to other parties, and in March 1949 the corporation commissioner consented to the transfer of said 1,790 shares within escrow to the names of such purchasers. In August 1949 a written instrument was executed by petitioner and G. W. Raichart under the terms of which petitioner purportedly agreed to give "[for] promotional services rendered," when received by petitioner from escrow, 320 shares of the capital stock of the Gordon Oil Company.G. W. Raichart died on December 27, 1950, and shortly thereafter petitioner put through a transaction with a man named Kline wherein the latter agreed to purchase all of the stock of the Gordon Oil Company. On March 21, 1951, petitioner received 11,210 shares out of escrow (13,000 shares less 1,790 shares previously transferred) and 49 on or about the same date sold them to Kline for $ 1,689,347. In August 1951 the Gordon Oil Company was dissolved, thereby extinguishing all of its outstanding67 shares.Petitioner treated all of the shares of stock and the proceeds received from the sale of stock as his own, reporting the gain from the sale on his 1951 income tax return.In February 1952 the widow of G. W. Raichart, as executrix of his will, brought an action in the Superior Court of California against petitioner for breach of contract and for conversion with respect to the 320 shares of stock which was the subject of the aforementioned instrument executed by petitioner and Raichart. Petitioner resisted the claim, asserting that the instrument executed by him and Raichart was never intended to be an agreement and was void; that it was executed without consideration; and in the alternative that the written agreement had been canceled and extinguished by an oral agreement between the parties. In December 1952 the Superior Court rendered a decision and judgment in favor of the plaintiff holding the defendant in that action, petitioner here, was guilty of conversion of 320 shares of the Gordon Oil Company stock. Since the stock had been disposed of, a money judgment was awarded the plaintiff in that action. The District Court of Appeals, Fourth District of California, affirmed68 the judgment and an appeal to the Supreme Court of California was denied. Petitioner paid the judgment, together with interest, in the amount of $ 56,755.73 in 1953.In his 1953 return Phillips did not claim a deduction for the payment of the judgment. In 1953 his operations, without regard to the payment of the judgment, resulted in a loss and he had no taxable net income for that year.The deficiencies set forth in the statutory notices are due to the reduction in the basis of the 11,210 shares of Gordon Oil Company stock sold and reported by petitioner. Petitioner does not contest this reduction in basis but contends that he is entitled to reduce the sales proceeds reported in his 1951 return by the amount of money received for the 320 shares of stock, which money he was obliged to refund in 1953, pursuant to the judgment of the California courts.Respondent contends that the proceeds were received by petitioner under a claim of right without restriction as to their disposition, and they are taxable to petitioner in 1951, the year they were received and retained, even though in a later year, 1953, the petitioner was obliged to refund them.We agree with the respondent that the69 portion of the proceeds received from the sale of the 320 shares in 1951 was taxable income to the petitioner for that year even though he was later obliged to return the 50 portion of the proceeds received from such sale. The "claim of right" doctrine, which supports respondent, had its origin in . The opinion explains the doctrine as follows ():If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. * There is no need to go into a general discussion of the claim of right doctrine. It has been applied many times. See ; ; and , affd. .The facts of this case70 bring it clearly within the claim of right doctrine. Petitioner treated all 11,210 shares of stock which he received from escrow as his own and he sold the stock in 1951 and treated the entire proceeds from such sale as his own. It was not until 1952 that a claim was filed against the portion of these proceeds representing the 320 shares claimed by Raichart's estate. Petitioner continued to claim his right to the proceeds from the sale of these 320 shares of stock. In what petitioner terms a "hotly contested adversary proceeding" it was ultimately decided that petitioner's claim of right was invalid.Since petitioner retained the proceeds from the sale of the 320 shares of stock under claim of right without restriction as to the disposition of said proceeds, he is taxable in the year of sale, regardless of any infirmity in his title and despite the fact that he was obliged to refund the proceeds of said sale in 1953.Petitioner argues that judgments of State courts in matters of title to property must be respected and here the California State court ruled the 320 shares belonged to Raichart's estate and no income tax can be exacted from petitioner on the proceeds of the sale of71 that stock. But petitioner realized income from the sale of this stock in 1951, which he claimed as his own and which he retained at the close of the year. The force of the California judgment compelling the payback is recognized and petitioner's complying with the mandate of the judgment will give him a deduction from income in the year it is made.Petitioner's real argument is in effect an equitable appeal. Petitioner's operations were such that in 1953 when he paid the $ 56,755.73, he had no taxable income, and, he argues, unless he prevails here, he will be without remedy and respondent will be exacting a tax on income which he reported but was not allowed to retain. But a cardinal principle of Federal income taxation requires annual returns and accounting. . This principle requires the determination of income at the close of the taxable 51 year without regard to the effect of subsequent events. One can admit the equities of the situation favor petitioner but this Court must decide the case according to the applicable law for the taxable year. 1*72 Decisions will be entered for the respondent. Footnotes1. It is to be observed that Congress granted some relief in this area by providing, in section 1341 of the 1954 Code, that where a taxpayer is required to restore an amount, in excess of $ 3,000, which was included in his income in a prior year under a claim of right, he may either (1) claim a deduction in the current year for the amount so restored, or (2) eliminate the amount so restored from the income of the prior year and decrease his current year's tax by the resulting decrease in tax for the prior year, with special rights for credits and refunds in certain situations.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4537553/	Nebraska Supreme Court Online Library www.nebraska.gov/apps-courts-epub/ 05/29/2020 08:07 AM CDT - 868 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 William Sellers, appellee, v. Reefer Systems, Inc., appellant. ___ N.W.2d ___ Filed May 22, 2020. No. S-19-082. 1. Statutes: Appeal and Error. Statutory interpretation presents a ques- tion of law, for which an appellate court has an obligation to reach an independent conclusion irrespective of the decision made by the court below. 2. Judgments: Statutes: Rules of the Supreme Court: Appeal and Error. Because Nebraska Supreme Court rules are construed in the same manner as statutes, an appellate court does so independently of the conclusion of the lower court. 3. Attorney Fees: Appeal and Error. A court’s decision awarding or denying attorney fees will be upheld absent an abuse of discretion. 4. Attorney Fees: Statutes: Rules of the Supreme Court: Affidavits: Appeal and Error. In order to recover statutory “reasonable” attor- ney fees under Neb. Rev. Stat. § 48-125(4)(b) (Cum. Supp. 2018), the details of the attorney-client agreement is not a necessary component of the affidavit submitted pursuant to Neb. Ct. R. App. P. § 2-109(F) (rev. 2014) for justification of appellate attorney fees. 5. Statutes: Legislature: Intent. The intent of the Legislature may be found through its omission of words from a statute as well as its inclu- sion of words in a statute, and courts are not permitted to read addi- tional words into a clear and unambiguous statute. 6. Workers’ Compensation: Attorney Fees. When Neb. Rev. Stat. § 48-125(4)(b) (Cum. Supp. 2018) of the Nebraska Workers’ Compensation Act does not specify that reasonable attorney fees must have been “incurred,” it is improper for a court to add it. 7. Workers’ Compensation. The Nebraska Workers’ Compensation Act should be construed liberally to carry out its spirit and beneficent pur- pose of providing compensation to employees injured on the job. - 869 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 8. Attorney Fees: Legislature: Public Policy. The Legislature determined as a matter of public policy that the “reasonable attorney’s fee” man- dated by Neb. Rev. Stat. § 48-125(4)(b) (Cum. Supp. 2018) does not depend on the terms of any fee agreement. 9. Attorney Fees. Statutory “reasonable” attorney fees taxed as costs do not go directly to the attorney. 10. ____. In order to determine proper and reasonable attorney fees, a court considers several factors, including the nature of the litigation, the time and labor required, the novelty and difficulty of the questions raised, the skill required to properly conduct the case, the responsibility assumed, the care and diligence exhibited, the result of the suit, the character and standing of the attorney, the customary charges of the bar for similar services, and the general equities of the case. Petition for further review from the Court of Appeals, Riedmann, Bishop, and Arterburn, Judges, on appeal thereto from the Workers’ Compensation Court, J. Michael Fitzgerald, Judge. Judgment of Court of Appeals reversed and remanded with directions. Tanya J. Hansen, of Smith, Johnson, Allen, Connick & Hansen, for appellant. Joel D. Nelson, of Keating, O’Gara, Nedved & Peter, P.C., L.L.O., for appellee. Heavican, C.J., Miller-Lerman, Cassel, Stacy, Funke, Papik, and Freudenberg, JJ. Freudenberg, J. NATURE OF CASE In an appeal of a workers’ compensation case, wherein the award to the employee was affirmed, the Nebraska Court of Appeals denied the employee’s motion for attorney fees for his counsel’s appellate work, despite the statutory mandate under Neb. Rev. Stat. § 48-125(4)(b) (Cum. Supp. 2018) that reason- able attorney fees shall be allowed to the employee by the appellate court if the employer files an appeal from a workers’ compensation award and fails to obtain any reduction in the - 870 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 amount of such award. We hold that the affidavit submitted by the employee’s attorney, which mentioned a contingency fee agreement, presented the total number of hours worked on the appeal with a couple of examples of tasks performed, set forth an hourly rate, averred that the total hours claimed were calculated from business records itemizing the same, and averred in the attorney’s expert opinion that the hours and rate were reasonable, sufficiently justifies under Neb. Ct. R. App. P. § 2-109(F) (rev. 2014) reasonable attorney fees to which the employee has a statutory right. We reverse the judgment and remand the matter to the Court of Appeals to determine the amount of the fee. BACKGROUND William Sellers was injured while working for Reefer Systems, Inc., in 2007. In 2019, the Workers’ Compensation Court awarded him permanent total disability benefits. Reefer Systems appealed the award to the Court of Appeals. The Court of Appeals affirmed the award in all respects in a memo- randum opinion issued on October 8, 2019. 1 Sellers timely filed a motion in the Court of Appeals for an award of reasonable attorney fees pursuant to § 48-125(4)(b) for the reason that the employer appealed the trial court deci- sion and there was no reduction in the amount of the award on appeal. Attached to the motion is the affidavit of Sellers’ counsel who worked on the appeal. Counsel avers that he spent 37.8 hours in total on the appeal, beginning April 18, 2019, and end- ing May 7, and opines that was “a reasonable amount of time for the work involved.” Counsel describes that he has been an attorney since 1997 and that since 1999, a substantial por- tion of his practice has been workers’ compensation cases. He avers that his hourly rate ranges from $140 to $245 per hour, that he is generally familiar with hourly rates charged by other 1 Sellers v. Reefer Systems, No. A-19-082, 2019 WL 4940200 (Neb. App. Oct. 8, 2019) (selected for posting to court website). - 871 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 litigation attorneys in this geographic area, and that an hourly rate of $200 per hour for his work on Sellers’ appeal would be reasonable and consistent with fees charged in this area for attorneys of similar background and skill. Counsel avers, further, that he derived the number of hours spent on the appeal from an audit of records maintained by his law firm’s staff and himself, consistent with their regular and established business practices. He notes that the audit revealed its first entry on April 18, 2019, as reviewing the bill of excep- tions, and, as its last entry, revising Sellers’ brief. The hours assigned to these particular tasks is not set forth. No other tasks are specifically delineated. The referenced records were not attached to the affidavit. Counsel notes in the affidavit that he represented Sellers “on a contingent fee.” The details of that arrangement are not otherwise described. The Court of Appeals denied the motion for attorney fees on the ground that counsel’s affidavit did not provide suffi- cient information to justify the reasonableness of the attorney fees sought. The Court of Appeals issued the following minute entry: [Sellers’] motion for attorney fees denied. Affidavit fails to justify amount of attorney fees sought. See Neb. Ct. R. App. P. § 2-109(F). See also St. John v. Gering Public Schools, 302 Neb. 269, 923 N.W.2d 68 (2019) (in seeking attorney fee[s], lawyer has burden of proving not only extent and value of services provided, but also exis- tence and terms of fee contract). We granted Sellers’ petition for further review of this order of the Court of Appeals which overruled his motion for attor- ney fees. ASSIGNMENTS OF ERRORS Sellers assigns that the Court of Appeals erred in (1) over- ruling Sellers’ motion for statutory attorney fees and (2) impos- ing a burden of proof regarding attorney fees derived from fee disputes between attorneys or between an attorney and client. - 872 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 STANDARD OF REVIEW [1] Statutory interpretation presents a question of law, for which an appellate court has an obligation to reach an inde- pendent conclusion irrespective of the decision made by the court below. 2 [2] Because Nebraska Supreme Court rules are construed in the same manner as statutes, an appellate court does so inde- pendently of the conclusion of the lower court. 3 [3] A court’s decision awarding or denying attorney fees will be upheld absent an abuse of discretion. 4 ANALYSIS Section 48-125(4)(b) provides for mandatory attorney fees for appellate work in circumstances where the employer appeals and fails to obtain any reduction in the award: If the employer files an appeal from an award of a judge of the compensation court and fails to obtain any reduc- tion in the amount of such award, the Court of Appeals or Supreme Court shall allow the employee a reasonable attorney’s fee to be taxed as costs against the employer for such appeal. (Emphasis supplied.) Section 2-109(F) of the Supreme Court rules sets forth the general procedure by which an employee must request the attorney fees allowable under § 48-125(4), 5 inasmuch as it sets forth the procedure for any litigant seeking from our appellate courts attorney fees to which there is a right under law or cus- tom. Section 2-109(F) provides in relevant part: Any person who claims the right under the law or a uni- form course of practice to an attorney fee in a civil case appealed to the Supreme Court or the Court of Appeals 2 Saylor v. State, 304 Neb. 779, 936 N.W.2d 924 (2020). 3 See Hotz v. Hotz, 301 Neb. 102, 917 N.W.2d 467 (2018). 4 See State ex. Rel. Peterson v. Creative Comm. Promotions, 302 Neb. 606, 924 N.W.2d 664 (2019). 5 See Escobar v. JBS USA, 25 Neb. Ct. App. 527, 909 N.W.2d 373 (2018). - 873 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 must file a motion for the allowance of such a fee sup- ported by an affidavit which justifies the amount of the fee sought for services in the appellate court. (Emphasis supplied.) Sellers’ motion for attorney fees pursuant to § 48-125(4)(b) was timely under § 2-109(F), but the parties dispute whether the supporting affidavit adequately justifies “reasonable” attorney fees. In denying Sellers’ motion, the Court of Appeals concluded that the affidavit submitted under § 2-109(F) was inadequate because it did not provide the details of the fee agreement between Sellers and his attorney. This was in error. We have never held that in order to recover statutory “reasonable” attorney fees, the attorney must submit the details of the attorney-client agreement. Neither is such evidence specified in § 2-109(F) as a necessary component to the justification of an appellate attorney fees. We have affirmed allowances of statutory attorney fees for trial work despite a lack of proof as to any fee agreement. In Dale Electronics, Inc. v. Federal Ins. Co., 6 we held under a statute setting forth the right to “reasonable” attorney fees that the attorney-fee allowance for the work of in-house counsel should be for the time actually engaged in the work to the same extent as outside counsel; evidence of counsel’s annual salary was not required. And in Black v. Brooks, 7 we affirmed the lower court’s award of statutory “reasonable attorney’s fees” 8 to which the successful tenant was entitled under Nebraska’s Uniform Residential Landlord and Tenant Act (URLTA), 9 even though the tenant was represented on a pro bono basis without any provision under the agreement for payment to the attorney in the event of an award of statutory fees. 6 See Dale Electronics, Inc. v. Federal Ins. Co., 205 Neb. 115, 286 N.W.2d 437 (1979). 7 Black v. Brooks, 285 Neb. 440, 827 N.W.2d 256 (2013). 8 Neb. Rev. Stat. § 76-1425(2) (Reissue 2009). 9 Neb. Rev. Stat. §§ 76-1401 to 76-1449 (Reissue 2009). - 874 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 In Black, we indicated that the tenant “need only present some evidence to the trial court upon which the court can make a meaningful award.” 10 We observed, “We have never said a fee agreement or any other agreement showing an obligation of the client to pay the attorney fees to the attorney is part of the proof that must be proffered in order to support an award of statutory attorney fees.” 11 We reasoned in Black that the amount of the statutory attorney fees under URLTA is not directly tied by the statute to the amount due under a fee agreement and that the public policy goals of encouraging compliance with laws serving the public interest and encouraging settlements are effectively furthered only when the statutory attorney fees under URLTA are awarded for fee-based and pro bono work alike. A land- lord who violates URLTA should not “reap the benefits of free representation to the other party.” 12 There was nothing in the statutory language of “reasonable attorney’s fees” in URLTA that made the recovery of such fees dependent upon a billing obligation, and we held it would be improper to insert the addi- tional term “incurred” into the statute. 13 [4-6] We now hold that in order to recover statutory “rea- sonable” attorney fees under § 48-125(4)(b), the details of the attorney-client agreement is not a necessary component of the affidavit submitted pursuant to § 2-109(F) for justification of appellate attorney fees. The intent of the Legislature may be found through its omission of words from a statute as well as its inclusion of words in a statute, and we are not permitted to read additional words into a clear and unambiguous statute. 14 Several attorney fee statutes, such as the one recently addressed 10 Black, supra note 7, 285 Neb. at 451, 827 N.W.2d at 264. 11 Id. 12 Id. at 454, 827 N.W.2d at 266. 13 See Black, supra note 7. 14 See Stewart v. Nebraska Dept. of Rev., 294 Neb. 1010, 885 N.W.2d 723 (2016). - 875 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 in TransCanada Keystone Pipeline v. Nicholas Family, 15 spec- ify that to be recoverable, the reasonable attorney fees must have been “incurred.” 16 When § 48-125(4)(b) of the Nebraska Workers’ Compensation Act does not specify that reasonable attorney fees must have been “incurred,” it is improper for us to add it. [7,8] We have repeatedly said that the Nebraska Workers’ Compensation Act should be construed liberally to carry out its spirit and beneficent purpose of providing compensation to employees injured on the job. 17 It is apparent that the Legislature determined as a matter of public policy that the “reasonable attorney’s fee” mandated by § 48-125(4)(b) does not depend on the terms of any fee agreement. Thus, the affi- davit submitted under § 2-109(F) in support of attorney fees pursuant to § 48-125(4)(b) does not need to set forth the exis- tence and terms of a fee contract between the employee and the attorney in order to “justify” statutorily mandated “reasonable” attorney fees for the appeal. The Court of Appeals’ reliance on St. John v. Gering Public Schools 18 to conclude otherwise is misplaced. St. John did not involve attorney fees taxed as costs under a statute or custom. Instead, it involved the question of the attorneys’ entitlement under their attorneys’ liens for services rendered pursuant to their fee agreements. In an analysis centered around the profes- sional responsibility rules, we held that “while a lawyer with a valid fee agreement is entitled to recover from a client what a 15 TransCanada Keystone Pipeline v. Nicholas Family, 299 Neb. 276, 908 N.W.2d 60 (2018). 16 See, e.g., Neb. Rev. Stat. § 1-148 (Reissue 2012); Neb. Rev. Stat. § 21-281 (Cum. Supp. 2018); Neb. Rev. Stat. § 30-4020 (Supp. 2019); Neb. Rev. Stat. § 50-1515 (Cum. Supp. 2018); Neb. Rev. Stat. § 53-223 (Reissue 2010); Neb. Rev. Stat. § 76-726 (Reissue 2018); Neb. Rev. Stat. § 81-3537 (Reissue 2014); Neb. Rev. Stat. § 85-1510 (Reissue 2014). 17 Bortolotti v. Universal Terrazzo & Tile Co., 304 Neb. 219, 933 N.W.2d 851 (2019). See Neb. Rev. Stat. § 48-101 (Reissue 2010). 18 St. John v. Gering Public Schools, 302 Neb. 269, 923 N.W.2d 68 (2019). - 876 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 fee agreement allows to the extent that amount is reasonable, a lawyer is not entitled to recover from a client more than a fee agreement allows.” 19 Neb. R. of Prof. Cond. § 3-501.5 provides in part that “[a] lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses.” In so holding in St. John, we cited to Hauptman, O’Brien v. Turco 20 for the proposition which states: In a suit to recover an unpaid fee, “the lawyer has the burden of persuading the trier of fact, when relevant, of the existence and terms of any fee contract, the making of any disclosures to the client required to render a con- tract enforceable, and the extent and value of the lawyer’s services.” Like St. John, Hauptman, O’Brien did not involve statutory “reasonable” attorney fees to be taxed as costs in favor of the litigant-client. It was an action to enforce an attorney lien in an amount computed in accordance with the contingent fee agree- ment. The client asserted that recovery under the contingent fee agreement was excessive for the amount of work actually done, and we held that because the law firm failed to present any evidence in support of its motion for summary judgment as to the “extent and value of the professional services which it performed” during the period of its representation, there was “no factual basis upon which to determine whether or not the claimed fee computed pursuant to the contingent fee agreement is reasonable.” 21 This was because collection by the attorney of attorney fees computed pursuant to a contingent fee agreement is still subject to the ethical principle embodied in § 3-501.5 of the professional conduct rules that prohibits a 19 Id. at 277, 923 N.W.2d at 75. 20 See Hauptman, O’Brien v. Turco, 273 Neb. 924, 931, 735 N.W.2d 368, 374 (2007) (emphasis supplied), quoting Restatement (Third) of the Law Governing Lawyers § 42(2) (2000). 21 Hauptman, O’Brien, supra note 20, 273 Neb. at 932, 735 N.W.2d at 374. - 877 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 lawyer from making an agreement for, charging, or collecting an unreasonable fee. [9] But, as we pointed out in Black, statutory “reason- able” attorney fees taxed as costs do not go directly to the attorney. 22 The award of fees for an unsuccessful appeal by an employer in a workers’ compensation case is “for the ben- efit of the claimant employee.” 23 Within constitutional limits, the Legislature is free to set statutory attorney fees under the Nebraska Workers’ Compensation Act in any amount it deems fit to further the public policy of the act. Attorney fees under § 48-125(4)(b) shall be allowed in an amount that is reasonable. That determination depends on the extent and value of services provided and is not dependent upon a fee agreement. [10] We find that the affidavit submitted on Sellers’ behalf contains sufficient justification of the extent and value of the attorney services provided on appeal to make a meaningful determination of the amount of “reasonable” attorney fees to which Sellers is entitled. In order to determine proper and reasonable attorney fees, a court considers several fac- tors, including the nature of the litigation, the time and labor required, the novelty and difficulty of the questions raised, the skill required to properly conduct the case, the responsibility assumed, the care and diligence exhibited, the result of the suit, the character and standing of the attorney, the customary charges of the bar for similar services, and the general equities of the case. 24 Sellers’ affidavit did not need to set forth a detailed log of all tasks and the amount of time spent on each task in order to be considered under § 2-109(F) in determining reason- able attorney fees. The affidavit by Sellers’ attorney stated 22 See Black, supra note 7. 23 Neeman v. Otoe County, 186 Neb. 370, 376, 183 N.W.2d 269, 273 (1971). 24 See, Pan v. IOC Realty Specialist, 301 Neb. 256, 918 N.W.2d 273 (2018); Kercher v. Board of Regents, 290 Neb. 428, 860 N.W.2d 398 (2015). - 878 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports SELLERS v. REEFER SYSTEMS Cite as 305 Neb. 868 the total number of hours and the applicable rate, and it presented an expert opinion that both were reasonable. The attorney noted a couple of tasks performed and stated that the number of hours claimed had been carefully logged in his law firm’s business records. We also note that the evidence supporting a meaningful determination of reasonable attorney fees on appeal is not lim- ited to the affidavit required under § 2-109(F). It also includes the court’s general experience in matters of litigation and what has been produced by the attorney for the appellate court’s direct consumption. 25 The Court of Appeals abused its discretion in concluding that it could not meaningfully determine a “reasonable attor- ney’s fee” pursuant to § 48-125(4)(b), because Sellers’ affi- davit failed to adequately “justify” one. We reverse the denial of Seller’s motion for appellate attorney fees and remand the matter with directions for the Court of Appeals to determine the amount of reasonable attorney fees. Nothing in this opinion should be read as expressing an opinion as to what the amount of attorney fees should be. CONCLUSION For the foregoing reasons, we reverse the judgment and remand the matter to the Court of Appeals with directions. Reversed and remanded with directions. 25 See, e.g., Rinderknecht v. Rinderknecht, 204 Neb. 648, 284 N.W.2d 569 (1979); Lippincott v. Lippincott, 152 Neb. 374, 41 N.W.2d 232 (1950); Specht v. Specht, 148 Neb. 325, 27 N.W.2d 390 (1947); Yost v. Yost, 143 Neb. 80, 8 N.W.2d 686 (1943).	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474980/	OPINION Gustafson, Judge: This case is an appeal by petitioner Ron Lykins, Inc. (RLI), under section 6330(d).1 RLI seeks our review of the determination by the Internal Revenue Service (IRS) to uphold a proposed levy on RLl’s assets. The levy is intended to recapture income tax refunds for tax years 1999 and 2000 which the IRS tentatively allowed as a result of RLl’s claimed net operating loss (NOL) carryback from 2001 but later concluded was improper. This case is submitted to the Court fully stipulated under Rule 122. The parties’ primary contentions focus on the doctrine of res judicata. Therefore, the dispositive issue is whether RLl’s favorable decision in a prior deficiency case—Ron Lykins, Inc. v. Commissioner, T.C. Memo. 2006-35 — either bars RLI from disputing, or bars the IRS from collecting, the liability now asserted. We hold that res judicata neither bars RLI from asserting the NOL carryback nor bars the IRS from recapturing the tentative refunds allowed on account of the NOL carryback. Background The facts are derived from the parties’ stipulations of March 18, 2008 (as amended January 5, 2009), and those stipulations are incorporated herein by this reference. RLI is currently an S corporation, see sec. 1361, though in the tax years at issue — 1999 and 2000 — it was a C corporation, see secs. 301 et seq. RLl’s principal place of business was in Ohio at the time the petition was filed. Activity Before Litigation For the years 1999 and 2000, RLI filed its Forms 1120, U.S. Corporation Income Tax Return, reporting taxable income and a tax liability for each year that was satisfied by quarterly estimated tax payments. For the year 2001, however, RLI filed a Form 1120 reporting a net operating loss (NOL) of about $135,000. RLI filed that 2001 Form 1120 in June 2002; and on November 5, 2002, it filed a Form 1139, Corporation Application for Tentative Refund, in order to carry that 2001 loss back to the years 1999 and 2000 (pursuant to section 172), reduce its tax liability for those earlier years, and obtain the resulting refunds. In this instance, the IRS made the tentative refunds very promptly on December 16, 2002, allowing $24,113 for 1999 and $6,337 for 2000. However, while the IRS personnel responsible for the tentative refunds had been processing RLl’s Form 1139, IRS examination personnel were examining RLl’s returns for 1999 and 2000. On February 6, 2003 — less than 2 months after RLI had received tentative refunds for 1999 and 2000 — the IRS issued to RLI, for those very same years, a statutory notice of deficiency (pursuant to section 6212), determining that RLI owed more tax than it had originally reported and paid for those years. The notice of deficiency did not make any reference to the NOL carrybacks from 2001, nor did it take into account the recent refunds in its computation of RLl’s liability. Rather, the notice made unrelated adjustments that are not at issue. The Prior Deficiency Case, Docket No. 6795-03 RLI filed a timely petition in this Court on May 6, 2003, which commenced docket No. 6795-03. The petition stated in part, in paragraph 4: I disagree with the deficiency for the following reasons: * * * 4) Form 1139 to claim an NOL deduction of $135,748 was filed on, or about, November 5, 2002, for the years 1999 and 2000. Thus, although RLI had already received the 1999 and 2000 refunds resulting from the 2001 NOL carryback, RLI initially believed that the 2001 NOL was relevant to its 1999-2000 deficiency case. Thereafter, at least as early as March 1, 2004, respondent requested that RLI “substantiate the deductions on the 2001 return” so as to verify RLl’s entitlement to the NOL carryback to 1999 and 2000, the years in the deficiency case. Respondent’s litigating attorneys were aware of the dispute about the tentative refunds allowing the NOL carryback. In March 2004 the Court granted a continuance upon the parties’ joint representation that they “currently are not able to stipulate the amount of any loss in taxable year 2001 to which the petitioner is entitled.” By letter dated August 4, 2004, an Appeals officer offered RLI a conference at which the IRS Office of Appeals would consider “the allowance of the net operating loss deduction (nold) carryback to 1999 and 2000.” Thereafter correspondence was exchanged between RLI and the Office of Appeals on the subject of the NOL.2 In pretrial activity throughout 2004, the parties explicitly disputed whether the NOL was properly included in the deficiency case, with RLI eventually contending that it was not in the case and respondent contending that it was in the case. By December 2004, the Appeals officer who was considering the matter determined that the 2001 NOL should be disallowed. However, respondent did not amend the answer or assert an increased deficiency to take account of this development. Rather, on January 18, 2005, RLI moved for leave to file an amendment to its petition3 in docket No. 6795-03. The motion explained that the reference in the original petition to the carryback of the 2001 NOL “was inadvertent and unnecessary as to why the Petitioner disagreed with the Notice of Deficiency”, and it requested that the “petition be amended to strike (eliminate) the statement from the petition”. The attachment to the motion restated the original petition verbatim, except that it omitted the original reference to the NOL (i.e., in paragraph 4, the subparagraph “4) Form 1139 to claim an NOL deduction of $135,748 was filed on, or about, November 5, 2002, for the years 1999 and 2000”) by excluding subparagraph “4)” of the original petition in its entirety. RLl’s motion was granted on January 24, 2005, and its amendment to paragraph 4 of the petition was filed. On February 1, 2005, the parties and the Court held a telephone pretrial conference in which respondent’s counsel stated respondent’s position that res judicata would thereafter bar RLI from litigating the NOL, and RLI stated its position that there would have to be another trial on the NOL issue. As respondent’s brief explains, the Court did not decide the res judicata issue but made “sure that petitioner understood the respondent’s position.” RLl’s understanding was that its amendment had “eliminate[d] the NOL” from consideration in the deficiency case. Notwithstanding the amendment that had been made to the petition, respondent did not move to amend the answer.4 As a result, respondent’s answer remained silent as to the 2001 NOL and its having been carried back to 1999 and 2000, the tax years at issue in the deficiency case. Respondent never alleged in the answer (and never moved to amend the answer to allege) that, as a result of the refunds, the deficiencies were greater than had been determined in the notice of deficiency. Nor did respondent ever ask the Court to hold that the tentative carryback was excepted from the effect of the Court’s decision.5 On February 17, 2005, at the one-day trial of RLl’s deficiency case (docket No. 6795-03), neither party put on any evidence as to the 2001 NOL or the carrybacks to 1999 and 2000. After the trial concluded, the case remained pending and awaiting decision for slightly more than a year. The Court then issued an opinion—Ron Lykins, Inc. v. Commissioner, T.C. Memo. 2006-35 — in RLl’s favor and, on March 3, 2006, entered decision “that there is no deficiency in tax due from petitioner for its 1999 and 2000 tax years.” Neither party appealed the decision and, pursuant to sections 7481 and 7483, it became final on June 1, 2006. The Summary Assessment On March 8, 2005 — i.e., two and a half weeks after the trial for years 1999 and 2000 in docket No. 6795-03 but a year before the Court’s entry of its decision — the IRS made summary assessments against RLI for 1999 and 2000, pursuant to section 6213(b)(3), in the amounts of the December 2002 refunds. By this means, the IRS sought to recapture those refunds. The IRS then issued to RLI Notices of Tax Due for 1999 and 2000. The CDP Proceedings RLI did not pay the amounts that the IRS demanded, and on October 8, 2005, the IRS issued to RLI, pursuant to section 6330(a), a Final Notice of Intent to Levy and Notice of Your Right to a Hearing regarding the unpaid taxes for 1999 and 2000.6 On October 26, 2005, RLI timely submitted a request for a collection due process (CDP) hearing by way of a letter substitute for Form 12153, Request for a Collection Due Process Hearing. At its CDP hearing, RLI made three arguments against the proposed levy: First, RLI argued that the summary assessment and the levy were the result of bad faith and the desire for revenge on the part of the IRS. The hearing officer dismissed RLl’s allegation of a bad-faith or revenge assessment after reviewing the case file. According to the attachment to the notice of determination, “the administrative case file * * * show[s] that Appeals first began considering the NOL issue as early as 10/27/2003 * * . The meeting between [IRS attorney] Mr. Neubeck, Mr. Lykins and Appeals Officer Jones took place well after this.” Moreover, the hearing officer did not find RLl’s allegation against Mr. Neubeck, even if true, “to be materially relevant to the tax issues in [RLl’s] case.” Second, RLI proposed to dispute its underlying liabilities for the 1999 and 2000 tax by showing that it was entitled to the carryback of its 2001 NOL to 1999 and 2000. RLI did not undertake to prove that it actually realized a loss in 2001; rather, RLI argued that it was entitled to the carrybacks because (i) the IRS had accepted without dispute RLl’s return for 2001 showing the NOL and had issued the refunds resulting from the carryback of that NOL, and (ii) the period of limitations for assessments for 2001 had expired, so that the IRS could make no further adjustments to 2001. The Office of Appeals declined to consider RLl’s challenge to the underlying liabilities for 1999 and 2000 because it concluded that in 2004 RLI had had a prior “opportunity”, see sec. 6330(c)(2)(B), for Appeals’s consideration of the issue when the deficiency case had still been pending. Third — and most significant here — after the Tax Court’s decision in docket No. 6795-03 was entered on March 3, 2006, RLI raised in the CDP hearing (by letters of March 8 and September 11, 2006) the then-“new issue” that the IRS should not proceed with the levy because the Tax Court’s decision “that there is no deficiency in tax due from the petitioner for its 1999 or 2000 tax years” barred the IRS from asserting any other liabilities for those years. On April 10, 2007, the Office of Appeals rejected RLl’s arguments and issued a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330, determining that the IRS could proceed with levy to recapture the refunds issued to RLI for 1999 and 2000. The Petition in This Case On May 7, 2007, RLI timely petitioned this Court to review that notice of determination. RLl’s petition raised five issues: 1. The statute of limitation had expired for 2001 and IRS had not issued an Intent to Levy (IRC § 6330(a)(1) and 26 C.F.R. § 301.6330~l(a)(l)[)]. Thus, the NOL carryback to 1999 and 2000 are correct mathematical calculations and the tax assessments of 3/8/05 were not legal or valid. 2. A valid statutory Notice of Deficiency, or 90-day letter, was not issued for these tax assessments, or denial of NOL. 3. The additional tax assessments were pursued solely under a bad-faith revenge motive of IRS Counsel * . 4. On 3/3/06 a US Tax Court Decision (No. 6795-03): was entered . . that there is no deficiency in tax due from petitioner for its 1999 or 2000 tax years.” Thus, the doctrine Res Judicata applies, and the 1999, and 2000 tax years are closed to further IRS challenges. 5. IRS was not authorized, in this case, to make changes to the taxpayer’s account (IRC § 6213(g)(2.)[)] RLI has abandoned the first and third of these five issues.7 The second and fifth issues — that no statutory notice of deficiency was issued for the reassessments or for the disallowance of the NOL, and that the reassessments are invalid because they do not correct mathematical errors as defined in section 6213(g)(2) — are addressed in part II.B below as “verification” issues under section 6330(c)(1). The fourth of these issues — res judicata — is the principal issue in the case, discussed below in part III. (It should be noted that the petition does not state, and RLI has not undertaken in this case to prove affirmatively, that it actually incurred in 2001 a loss that it was entitled to carry back to 1999 and 2000. Rather, RLl’s contentions are to the effect that the IRS is procedurally barred from denying the carrybacks.) The parties stipulated the facts and submitted the case for decision without a trial under Rule 122. Discussion I. Collection Due Process Principles A. CDP Procedures If a taxpayer fails to pay any Federal income tax liability after notice and demand, section 6331(a) authorizes the IRS to collect the tax by levy on the taxpayer’s property. However, Congress has added to chapter 64 of the Internal Revenue Code certain provisions (in subchapter D, part I) as “Due Process for Collections”, and those provisions must be complied with before the IRS can proceed with a levy: Before proceeding, the IRS must issue a final notice of intent to levy and notify the taxpayer of the right to an administrative hearing before the Office of Appeals. Sec. 6330(a) and (b)(1). B. Issues Considered At that so-called CDP hearing, the taxpayer may raise issues relevant to the proposed collection of tax: Pursuant to section 6330(c)(2)(A) a taxpayer may raise collection issues (including collection alternatives, such as offers-in-compromise), but RLI did not raise such issues. Pursuant to section 6330(c)(2)(B) a taxpayer may, under certain circumstances, challenge the underlying tax liability. In this instance, by asserting that res judicata bars the IRS’s collection of the tax at issue, RLI raised a “challenge[ ] to the existence * * of the underlying tax liability”, which it could do if previously it “did not * * * have an opportunity to dispute such tax liability.” Sec. 6330(c)(2)(B). From the information presented at that CDP hearing, the Appeals officer must make a determination whether the proposed levy action may proceed. The Appeals officer is required to take into consideration: (1) “verification from the Secretary that the requirements of any applicable law and administrative procedure have been met”, see sec. 6330(c)(3)(A) (citing sec. 6330(c)(1)); (2) relevant issues raised by the taxpayer, see sec. 6330(c)(3)(B) (citing sec. 6330(c)(2)); and (3) “whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary”, see sec. 6330(c)(3)(C). If the Office of Appeals then issues a notice of determination to proceed with the proposed levy, the taxpayer may appeal the determination to this Court within 30 days, as RLI has done, and we now “have jurisdiction with respect to such matter”. Sec. 6330(d)(1). C. Standard of Review Respondent does not dispute rli’s right to contend in the CDP hearing and in this case that res judicata bars collection of the tentative refunds. We assume that this contention is a challenge to underlying liability under section 6330(c)(2)(B);8 and we assume that this liability challenge is permitted because res judicata arising from the Tax Court’s prior decision could not have been raised as an issue before that decision was entered in March 2006, so that RLI did not have a prior opportunity to assert this issue.9 Where the underlying tax liability is properly at issue in a section 6330 hearing, the Court will review the matter not for abuse of discretion but de novo, Davis v. Commissioner, 115 T.C. 35, 39 (2000), so we review de novo RLl’s res judicata contention. However, the facts are fully stipulated, and if the Appeals officer was in error, it was an error of law, so the sometimes vexing standard- and scope-of-review issues do not affect the outcome here. II. Verification Under Section 6330(c)(1) A. The Verification Obtained by the Office of Appeals In March 2005 the IRS summarily assessed each tentative refund amount “as if it were due to a mathematical or clerical error”, as permitted by section 6213(b)(3). For an assessment made pursuant to section 6213(b)(3), the IRS is not required to issue a notice of deficiency before making the assessment. Sec. 6213(b)(1). As a result, the legal and procedural requirements that the Appeals officer was required to verify under section 6330(c)(1) were (i) that a valid assessment was made, (ii) that notice and demand was issued, (iii) that the liability was not paid, and (iv) that the Final Notice of Intent to Levy and Notice of Your Right to a Hearing was issued to the taxpayer. These requirements were recited in the attachment to the notice of determination, and the hearing officer concluded that “[t]hese requirements have been met.” The record contains transcripts showing these administrative actions and copies of the notice and demand for 1999 and 2000, as well as the final notice of intent to levy. B. RLI’s Verification Disputes However, RLI disputes the validity of the March 2005 summary assessment on two grounds: (1) failure to issue notices of deficiency, and (2) the absence of a mathematical error. Although RLI raised neither of these arguments in its CDP hearing, a challenge to the verification requirement of section 6330(c)(1) is properly before the Court “without regard to whether the taxpayer raised * * * [any verification issues] at the Appeals hearing.” Hoyle v. Commissioner, 131 T.C. 197, 202-203 (2008). Therefore, any argument in rli’s petition asserting infirmities with the notice of deficiency or the assessment procedure are section 6330(c)(1) verification issues that RLI may raise here for the first time. 1. Lack of a Notice of Deficiency rli’s petition asserts: “2. A valid statutory Notice of Deficiency, or 90-day letter, was not issued for these tax assessments, or denial of NOL.” It is well settled that the IRS has three remedies to recover an “abatement, credit, refund, or other payment” erroneously allowed under section 6411: (i) to summarily assess the deficiency attributable to the tentative carryback adjustment as if due to a mathematical error; (ii) to institute an erroneous refund suit under section 7405; or (iii) to issue a notice of deficiency under section 6212.10 Baldwin v. Commissioner, 97 T.C. 704, 710 (1991) (and cases cited thereat). Furthermore, none of these remedies is exclusive, so that the IRS may freely choose which remedy to pursue. Id.; sec. 301.6213-l(b)(2)(ii), Proced. & Admin. Regs. (26 C.F.R.). In RLl’s case the IRS chose, pursuant to section 6213(b)(3), to summarily assess the deficiency attributable to the tentative carryback adjustment as if the deficiencies were due to a mathematical error. Since the IRS opted to pursue that remedy, there was no requirement that the IRS issue a notice of deficiency with respect to the assessments. Sec. 301.6213— l(b)(2)(i), Proced. & Admin. Regs, (“the district director or the director of the regional service center may assess such amount without regard to whether the taxpayer has been mailed a prior notice of deficiency”). In fact, in order to make summary assessment under section 6213(b)(3), the IRS needed only to “notify the taxpayer that such assessment has been or will be made.” Sec. 301.6213-l(b)(2)(i), Proced. & Admin. Regs. The IRS did so by issuing to RLI notices of tax due for 1999 and 2000 on March 8, 2005, which showed the reassessed amounts. RLI argues, however, that the notices failed to include any explanatory information as to the basis for the IRS’s actions as is required by section 6213(b)(1). However, that section requires that “[e]ach notice under this paragraph shall set forth the error alleged and an explanation thereof.” (Emphasis added.) The assessment in this case was made not under section 6213(b)(1) but under section 6213(b)(3), which does not require such an explanation. See Midland Mortgage Co. v. United States, 576 F. Supp. 101, 106 (W.D. Okla. 1983) (“This Court does not find that * * * [section] 6213(b)(3) requires that the taxpayer be notified of the error alleged and be given an explanation thereof as required by * * * [section] 6213(b)(1)”). With respect to RLl’s complaint that no notice of deficiency was issued for the disallowance of the NOL in the loss year itself, RLI is correct that, as far as our record shows, the IRS never formally disallowed the NOL in 2001 or issued any notice of deficiency for 2001 in that regard. While it may not be intuitive to some taxpayers, the IRS does have the authority to disallow an NOL carryback in a year to which the NOL was carried back without issuing any notice of adjustment for the year in which the NOL was generated. It is well settled that the IRS and the courts may recompute taxable income from one year — even a closed year — in order to determine tax liability in another year. See sec. 6214(b); Barenholtz v. United States, 784 F.2d 375, 380-381 (Fed. Cir. 1986); Springfield St. Ry. Co. v. United States, 160 Ct. Cl. 111, 312 F.2d 754, 757-759 (1963); Robarts v. Commissioner, 103 T.C. 72, 78 (1994), affd. without published opinion 56 F.3d 1390 (11th Cir. 1995); Angell v. Commissioner, T.C. Memo. 1986-528, affd. without published opinion 861 F.2d 723 (7th Cir. 1988). As a result, RLl’s argument that the IRS erred in some manner by not issuing a notice of deficiency for 2001 with respect to the NOL has no merit. 2. Absence of a Mathematical Error RLl’s petition also asserts: “5. IRS was not authorized, in this case, to make changes to the taxpayer’s account (IRC § 6213(g)(2.)[)]” That is, RLI argues that there must be a mathematical error, as defined in section 6213(g)(2), in order for the IRS to assess taxes under section 6213(b)(3) to recover refunds tentatively allowed under section 6411. However, this argument ignores the actual language of the statute. Section 6213(b)(3) provides that assessments for refunds that are tentatively allowed under section 6411 may be made “as if* * * [the amount] were due to a mathematical or clerical error appearing on the return.” (Emphasis added.) Nowhere does section 6213(b)(3) provide that there must be an actual mathematical or clerical error, as defined in subsection (g), before the IRS may assess taxes to recover a section 6411 tentatively allowed refund. As a result, subsection (g), which defines “mathematical or clerical error”, has no impact on subsection (b)(3). We find no defect in the verification by the Office of Appeals, under section 6330(c)(1), that the IRS had met the requirements of applicable law and administrative procedure. We therefore turn to the principal question in this case, i.e., whether the prior deficiency case forecloses either party from its contentions about the NOL carrybacks. III. Res Judicata and Collateral Estoppel A. Res Judicata Precludes Relitigation of “claims”; and Collateral Estoppel Precludes Relitigation of “issues”. Res judicata and the related doctrine of collateral estoppel “have the dual purpose of protecting litigants from the burden of relitigating an identical issue and of promoting judicial economy by preventing unnecessary or redundant litigation.” Meier v. Commissioner, 91 T.C. 273, 282 (1988). Res judicata, or claim preclusion, was developed by the courts to bar repetitious suits on the same cause of action and is applicable to tax litigation. As the Supreme Court explained: [W]hen a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound “not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose.” * * * ***** * * * * * Income taxes are levied on an annual basis. Each year is the origin of a new liability and of a separate cause of action. Thus if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year. * * * [Commissioner v. Sunnen, 333 U.S. 591, 597—598 (1948) (quoting Cromwell v. County of Sac, 94 U.S. 351, 352 (1876); emphasis added).] That is, each tax year is a separate cause of action, and res judicata makes a final judgment on that cause of action truly final. Where the cause of action of a taxpayer’s liability in a given tax year has been litigated (as RLl’s tax liabilities for 1999 and 2000 were litigated in docket No. 6795-03), the parties are thereafter barred from relitigating that liability— whether by reference either to a “matter which was offered” in that prior suit (such as the adjustments on the notice of deficiency) or to a “matter which might have been offered” in the prior suit — unless there is an applicable exception that prevents the application of the doctrine of res judicata. Collateral estoppel, or issue preclusion, prevents the relitigation of an identical issue, even in connection with a different claim or cause of action. Unlike res judicata, which binds the parties as to any matter that “might have been offered”, whether or not that matter was actually litigated, collateral estoppel applies only to issues that were actually litigated in the first suit. The rule of collateral estoppel provides that “[w]hen an issue of fact or law is actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment, the determination is conclusive in a subsequent action between the parties, whether on the same or a different claim.” 1 Restatement, Judgments 2d, sec. 27 (1982) (emphasis added); see also Montana v. United States, 440 U.S. 147, 153-154 (1979). Simply stated, Under res judicata, a final judgment on the merits of an action precludes the parties or their privies from relitigating issues that were or could have been raised in that action. * * * Under collateral estoppel, once a court has decided an issue of fact or law necessary to its judgment, that decision may preclude relitigation of the issue in a suit on a different cause of action * * . [Allen v. McCurry, 449 U.S. 90, 94 (1980).] B. Collateral Estoppel Does Not Apply Here. Respondent briefly invokes the doctrine of collateral estop-pel in support of his position;11 but the doctrine has no application here. In arguing against the prior case’s decision having any preclusive effect against the collection of the carryback refunds, respondent points out that “the court did not rule on whether the tentative refunds for 1999 and 2000 were proper in the deficiency proceeding”. And respondent is correct in so stating. The merits of the 2001 NOL were not “actually litigated” in the prior deficiency case for tax years 1999 and 2000. Because the 2001 NOL was not “actually litigated”, neither party would be barred under collateral estop-pel from litigating the 2001 NOL in this case. C. Res Judicata Bars Neither Party to This Case. For the following reasons, we hold that, even assuming that either party could have litigated the NOL in the prior deficiency case, neither RLI nor respondent is now barred by res judicata from disputing the 2001 NOL carryback and its tax effect upon the 1999 and 2000 liabilities. 1. Deficiency Jurisdiction Extends to “the entire subject matter of the correct tax”. When rli filed its petition in docket No. 6795-03, the Tax Court acquired jurisdiction, pursuant to section 6213(a), “in respect of the deficiency that is the subject of such petition.” In the case of income tax, section 6211(a) provides that— the term “deficiency” means the amount by which the tax imposed by subtitle A * * exceeds the excess of— (1) the sum of (A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus (B) the amounts previously assessed (or collected without assessment) as a deficiency, over— (2) the amount of rebates, as defined in subsection (b)(2), made. [Emphasis added.] That is, the equation for calculating a deficiency begins with “the tax imposed”, i.e., the taxpayer’s actual liability. It follows, then, that once a petition is properly filed, the Tax Court has jurisdiction to adjudicate not only the particular adjustments in the statutory notice of deficiency but also both the irs’s claim of a greater deficiency than is stated in the notice, see sec. 6214(a), and the taxpayer’s claim of an overpayment of tax, see sec. 6512(b)(1). Moreover, the Code is explicit that the Tax Court’s authority to redetermine a deficiency in one year allows it to address NOL carrybacks from another year — i.e., to “consider such facts * * * for other years * * * as may be necessary correctly to determine the amount of such deficiency”. Sec. 6214(b). Tax Court precedent is clear that “[w]e acquire jurisdiction when a taxpayer files with the Court and that jurisdiction extends to the entire subject matter of the correct tax for the taxable year”, Naftel v. Commissioner, 85 T.C. 527, 533 (1985) (emphasis added),12 and other courts hold the same.13 The res (Latin for “thing”) that is judicata (“adjudicated”) in a deficiency case is the taxpayer’s entire tax liability for each year in issue. Once the Tax Court’s decision has become final, the thing has been adjudicated. Res judicata. 2. The NOL Carrybacks Could Have Been Litigated in the Prior Deficiency Case. Respondent could have litigated the 1999 and 2000 carryback refunds in the deficiency case. The IRS issued the refunds in December 2002 and then 7 weeks later issued a notice of deficiency that failed to take those recent refunds into account. The IRS was put on notice of this failure in May 2003 when RLI commenced that deficiency case by filing a petition that explicitly mentioned its prior filing of the Form 1139. The issue of the NOL carryback was a subject of frequent discussion in pretrial proceedings, and respondent’s litigators knew before the February 2005 trial of docket No. 6795-03 that respondent wanted to retrieve those refunds. Section 6214 allows the IRS to assert an additional deficiency at or before the hearing or a rehearing and to allege and demonstrate in the pending suit a deficiency greater than that determined in the notice of deficiency. By amending his answer to plead that the carryback allowance was improper and that the deficiency was therefore greater than the notice had stated,14 respondent could have brought the additional deficiencies resulting from the carryback refunds into the deficiency case for 1999 and 2000, making them part of the res that was to be judicata there; but he did not do so. RLI did mention the NOL from 2001 in its petition in docket No. 6795-03, but the Court later granted it leave to amend the petition to delete that reference, and RLI never undertook to prove the NOL or to validate the carrybacks. Like respondent, we assume15 that RLI could have pressed in docket No. 6795-03 its position as to its actual tax liabilities in 1999 and 2000 — “the tax imposed” — taking into account the asserted NOL carrybacks from 2001 and could have asked the Court to rule on the validity of those carrybacks in redetermining RLl’s deficiencies, as defined in section 6211(a), for 1999 and 2000. But RLI did not do so. Rather, RLI does seem to have attempted to invoke the IRS’s allowance of the refunds as if those refunds estopped the IRS from later reconsidering and disallowing the NOL.16 If that was RLl’s belief, then it was mistaken. See secs. 6411, 6213(b)(3). Even a regular refund claimed on Form 1120X, Amended U.S. Corporation Income Tax Return, is subject to the IRS’s later contention that it was erroneous, see secs. 6532(b), 7405(b); and the same is certainly true under the “tentative” refund procedure that RLI chose.17 A Form 1139 is an “application for a tentative carryback adjustment” (emphasis added) under section 6411(a); and under section 6411(b) the IRS is supposed to make only a “limited examination of the application” and then give the appropriate refund within 90 days. The system thus sets a deadline for the IRS to rule on these applications, and then gives it the special mechanism of the so-called summary assessment, see secs. 6212(c)(1), 6213(b)(3), to quickly reassess the amount if the refund is later found to have, been improper, see Midland Mortgage Co. v. Commissioner, 73 T.C. 902, 909-911 (1980). As a result, the IRS’s right hand that examines returns and determines deficiencies may not always know what its left hand that allows tentative refunds is doing; but the agency’s compliance with the strict timetable of section 6411 does not estop it from taking subsequent corrective action. Apparently because of its erroneous belief about the supposed binding effect of the tentative refunds, RLI never undertook in the prior deficiency case to substantiate its 2001 loss and to prove the validity of the carrybacks; and it moved to amend its petition to delete any reference to the NOL. The Court granted that motion, and the parties never litigated the carrybacks in the deficiency case. We thus assume that either party could have raised the 2001 NOL in the prior case — a circumstance that would implicate res judicata — but we find that, for the following reasons, res judicata does not apply here. 3. The NOL Carrybacks Were Not Litigated, but Neither Party Is Bound by Res Judicata. The doctrine of res judicata does admit exceptions, and we now explain the exception to res judicata that applies in this case. As the Restatement instructs: When any of the following circumstances exists, the general rule * * * does not apply to extinguish the claim, and part or all of the claim subsists as a possible basis for a second action by the plaintiff against the defendant: ******* (d) The judgment in the first action was plainly inconsistent with the fair and equitable implementation of a statutory or constitutional scheme, or it is the sense of the scheme that the plaintiff should be permitted to split his claim * * . [1 Restatement, supra sec. 26.] As we will show, the Internal Revenue Code incorporates a “statutory * * scheme” for refunds attributable to NOL carrybacks, in sections 6411, 6511(d)(2)(B), 6212(c)(1), and 6213(b)(3); and it is “the sense of the scheme” that both the taxpayer and the IRS are permitted to “split” NOL carrybacks from the rest of a liability. a. RLI Is Not Bound. Respondent contends: “Because the petitioner permitted the Court to render a final judgment in the deficiency proceeding without considering the merits of the NOL claim, it should be precluded from raising that issue in this proceeding”. But assuming RLI could have used its deficiency case to litigate the NOL, the question is whether RLI must have used the deficiency case. The answer is no. The Code includes exceptions to the operation of res judicata,18 and one of them applies here. Section 6511(d)(2)(B) explicitly permitted RLI to pay the summary assessments and pursue an overpayment remedy for its NOL carrybacks to 1999 and 2000, without the bar of res judicata. Section 6511(d)(2)(A) provides a special period of limitation for claims attributable to an NOL (i.e., a period measured not from the carryback year but from the generating year), and subsection (d)(2)(B) provides: (i) In GENERAL. — If the allowance of a credit or refund of an overpayment of tax attributable to a net operating loss carryback * * * is otherwise prevented by the operation of any law or rule of law * * , such credit or refund may be allowed or made, if claim therefor is filed within the period provided in subparagraph (A) of this paragraph. * * * * ❖ * (iii) Determination by courts to be conclusive. — In the case of any such claim for credit or refund or any such application for a tentative carryback adjustment, the determination by any court, including the Tax Court, in any proceeding in which the decision of the court has become final, shall be conclusive except with respect to— (I) the net operating loss deduction and the effect of such deduction * * * [Emphasis added.] That is, under subsection (d)(2)(B)(i) a refund claim attributable to NOL carrybacks may be allowed even if it “is otherwise prevented by the operation of any law [such as the statute of limitations in section 6511(b)] or rule of law” (emphasis added) — with the “rule of law” being res judicata.19 And under subsection (d)(2)(B)(iii) the court determination that would otherwise bar the refund is conclusive “except with respect to” the NOL carryback. Section 6511(d)(2) relates specifically to a taxpayer’s refund claim and not to a taxpayer’s prepayment challenge to liability at a CDP hearing under section 6330(c)(2)(B). However, the sense of the Code’s scheme is that the NOL carryback contention survives the deficiency case and may be maintained thereafter by the taxpayer, notwithstanding a prior deficiency case. A taxpayer who has paid the tax may claim an overpayment, litigate its carryback in a refund suit, and prove (if it can) that it had a loss in the generating year, that it was entitled to the carryback, and that its tax liability was therefore less than it had paid. If instead that taxpayer is in a CDP case and is otherwise entitled under section 6330(c)(2)(B) to “raise * * * challenges to the existence or amount of the underlying tax liability”, res judicata similarly should not operate as a bar.20 For an Appeals officer to consider only the admitted procedural validity of the summary assessment, and to refuse to consider whether res judicata bars the IRS from collecting that assessment, would deprive the taxpayer of his statutory right to challenge “liability” in the CDP hearing.21 Respondent’s position essentially ignores the taxpayer prerogative that is embodied in section 6511(d)(2)(B). That statute relieves RLI of the bar of res judicata. b. Respondent Is Not Bound. Section 6511(d)(2)(B) grants relief to the taxpayer and not to the IRS; but that provision is a part of the statutory scheme that does grant equivalent latitude to the IRS. We have already noted that section 6411 is the part of that scheme that effectively requires the IRS to allow tentative refunds from NOL carrybacks after only a cursory examination of the taxpayer’s application. However, the Code includes compensating accommodations to the IRS, in sections 6212(c)(1) and 6213(b)(3): Section 6212(c)(1) generally bars the IRS from issuing a second notice of deficiency after a taxpayer has filed a petition in the Tax Court in response to a first such notice.22 However, the statute explicitly allows the IRS to determine an additional deficiency that results from a tentative carryback refund — even if the IRS has previously issued a notice of deficiency for the carryback year and the taxpayer has filed a petition in the Tax Court. The statute makes this allowance by including an “exception] as provided in * * * section 6213(b)(1) (relating to mathematical or clerical errors)” and then providing (in section 6213(b)(3)) that a tentative carryback refund may be assessed “as if it were due to a mathematical or clerical error”. Thus, these three sections — 6411, 6212(c)(1), and 6213(b)— create a unique regime for the IRS’s allowance and recapture of carryback refunds. As the legislative history for section 6411 (formerly section 3780) explains: In recognition of the fact that, due to the short period of time allowed [generally 90 days], the Commissioner necessarily will act upon an application for a tentative carry-back adjustment only after a very limited examination, subsection (c) of section 3780 [now section 6213(b)(3)] provides a summary procedure whereby the Commissioner and the taxpayer each may be restored to the same position occupied prior to the approval of such application. Subsection (c) provides that if the Commissioner determines that the amount applied, credited, or refunded with respect to an application for a tentative carry-back adjustment is in excess of the overassessment properly attributable to the carry-back upon which such application was based, he may assess the amount of the excess as a deficiency as if such deficiency were due to a mathematical error appearing on the face of the return. * * * [H. Rept. 849, 79th Cong., 1st Sess. (1945), 1945 C.B. 566, 583; emphasis added.] That is, the IRS may determine an additional deficiency (pursuant to section 6212(c)(1)) and may assess it without deficiency procedures as if it arose from a mathematical or clerical error (pursuant to section 6213(b)(3)). It is this constellation of provisions — sections 6411, 6212(c)(1), and 6213(b)(3), in conjunction with the taxpayer’s prerogative enacted in section 6511(d)(2)(B) — that (in the words of the Restatement) constitutes the “statutory * * * scheme” that permits a party to “split his claim”. That is, we do not hold simply that section 6213(b) by itself trumps res judicata, and that the IRS avoids res judicata whenever it is permitted by section 6213(b) to make a summary assessment to correct a mathematical or clerical error.23 Rather, sections 6411, 6212(c)(1), and 6213(b)(3) create a unique procedure for tentative carryback refunds, and we do not have before us the question whether there is any analog for this procedure in the case of these other corrections. Moreover, unlike the other summary assessments the IRS may make under section 6213(b), the summary assessment under subsection (b)(3) to recapture a tentative refund is not subject to subsection (b)(2), which (outside the tentative refund context) provides a routine under which the IRS must abate the assessment upon a taxpayer’s request but then may issue a notice of deficiency, as a prelude to a probable deficiency case in which the taxpayer will have the burden of proof. By excepting carryback recaptures from this subsection (b)(2) routine,24 subsection (b)(3) provides that the NOL carryback recapture will not ordinarily be the subject of a taxpayer’s petition in a deficiency case. One effect of section 6213(b)(3) bears special mention. RLI effectively contends that respondent was required to plead the recapture in his answer in docket No. 6795-03 or thereafter be barred by res judicata. However, the means for respondent to do so was to plead the tentative refund as an increased deficiency under section 6214(a). Had he done so, respondent would have borne the burden of proof on the NOL carryback. See Rule 142(a)(1). If instead respondent had denied the application for a tentative refund, prompting RLI to plead in the deficiency case (pursuant to section 6512(b)(1)) the overpayment resulting from the carryback or to file a claim for refund and litigate the claim in a refund suit, then RLI would have had the burden to prove the NOL carryback. If respondent was required to plead the recapture as an increased deficiency, then sections 6411 and 6213(b)(3) would have failed in their congressionally intended purpose to “provide! ] a summary procedure whereby the Commissioner and the taxpayer each may be restored to the same position occupied prior to the approval of such application”. H. Rept. 849, supra, 1945 C.B. at 583 (emphasis added). If the law were as RLI maintains, then the summary assessment would not restore the IRS to the position it was in before making the tentative refund; rather, the IRS would now be forced to the choice of either bearing an unaccustomed burden of proof or else being bound by res judicata. That was manifestly not Congress’s intention, and it is not “the sense of the scheme”. Likewise, we do not hold simply that section 6212(c)(1) by itself trumps res judicata, and that the IRS avoids res judi-cata whenever it is permitted by section 6212(c)(1) to determine an additional deficiency. Again, it is the combination of sections 6411, 6212(c)(1), and 6213(b)(3) that creates a unique scheme for tentative carryback refunds. Section 6212(c)(1) makes exceptions for additional deficiency determinations in five circumstances — i.e., except in the case of fraud, and except as provided in section 6214(a) (relating to assertion of greater deficiencies before the Tax Court), in section 6213(b)(1) (relating to mathematical or clerical errors), in section 6851 or 6852 (relating to termination assessments), or in section 6861(c) (relating to the making of jeopardy assessments) —and the recapture of tentative refunds fits into one of those exceptions (i.e., mathematical or clerical errors). But whether any other additional deficiency determination permitted by section 6212(c)(1) involves an exception to res judicata would turn not just on its appearance in this section but on the overall “sense of the scheme” that the Code does or does not provide for that additional deficiency determination.25 Sections 6411, 6213(b)(3), and 6511(d)(2)(B) — important to our holding here — would have no application to these other determinations allowed by section 6212(c)(1). For that reason, we need not revisit our holding in Zackim v. Commissioner, 91 T.C. 1001 (1988), revd. 887 F.2d 455 (3d Cir. 1989), which involved the interplay between res judicata and a different exception in section 6212(c)(1) — in that case, the exception “in the case of fraud”. We held in Zackim v. Commissioner, supra at 1010, that in spite of the IRS’s ability to issue a second notice of deficiency under section 6212(c)(1), res judicata “precluded [respondent] from litigating, assessing, and collecting” the additional tax for 1979. The fraud assessment in Zackim and the summary assessment of RLl’s tentative refunds have in common their allowance in section 6212(c)(1), but our holding that res judicata does not preclude the IRS’s recapture of the tentative refunds depends on statutes that have no application to tax assessments attributable to fraud. For that reason, we have no occasion here to reconsider Zackim, but rather we distinguish it as we did in Burke v. Commissioner, 105 T.C. 41 (1995). In this case, under a statutory scheme different from the one at issue in Zackim, we find an exception to the doctrine of res judicata, and we hold that the IRS, like the taxpayer, may dispute an NOL carryback after prior deficiency litigation. IV. Non-litigation of the Merits of the 2001 NOL We hold today that RLI is not barred by res judicata from contending that it incurred a net operating loss in 2001 and contending that it is entitled for 1999 and 2000 to NOL carryback deductions. RLI had hoped to establish that entitlement simply by showing that the IRS was barred by res judi-cata from disputing the carrybacks. RLI was entitled under section 6330(c)(2)(B) to make that res judicata challenge at the CDP hearing (and in this appeal therefrom), because it did not have a prior opportunity to press that issue. However, that challenge lacks merit, and we have upheld the determination by the Office of Appeals that res judicata did not bar the IRS from disputing the NOL. That holding leaves RLI with the burden of proving its loss in 2001 and establishing the validity of the carrybacks to 1999 and 2000. The Office of Appeals determined that RLI was not entitled in its CDP hearing to “challenge liability” by proving the NOL carrybacks, because it had had a prior opportunity, during the pendency of its prior deficiency case, to present to Appeals the issue of its 2001 NOL and the carrybacks to 1999 and 2000. In its petition in this case, RLI did not dispute that aspect of the determination. As a result, if RLI ever had any contention that the Office of Appeals abused its discretion in the CDP hearing by declining to address the actual merits of RLl’s 2001 loss, that contention has been conceded, see Rule 331(b)(4), and we do not address it. The merits of the 2001 loss is not an issue that was litigated in this case. The proposed levy to collect the summary assessments must therefore be upheld. Conclusion Although its reasoning on the doctrine of res judicata was in error, the Office of Appeals did not abuse its discretion in determining to proceed with a levy to collect the summary assessments by which it recaptured the 1999 and 2000 NOL carrybacks. To reflect the foregoing, Decision will be entered for respondent. Except as otherwise noted, all section references are to the Internal Revenue Code (Code) (26 U.S.C.), and all Rule references are to the Tax Court Rules of Practice and Procedure. In addition to the August 4, 2004, Letter from Appeals Officer Jones to ELI stating that Appeals was considering the validity of the NOL, the correspondence regarding the NOL included a November 2, 2004, letter from RLI to Appeals Officer Jones where in RLI provided Appeals with some substantiation for the NOL; a November 8, 2004, letter from Appeals Officer Jones to RLI requesting more substantiation from RLI; and a December 7, 2004, letter from RLI to Appeals Officer Jones wherein RLI stated its refusal to provide any further documentation to substantiate the NOL. The motion, filed by RLI pro se, was styled “Motion for Leave to File Amended Answer”, and it asked the Court to file an attached “Amended Answer” (because it was “in answer to the Notice of Deficiency5’); but the relief the motion requested pertained to the petition, not the answer. The Court filed it as a “Motion for Leave”, granted the motion, and filed the “Amended Answer” as a “Reply”. But see IRS Field Service Advisory (May 9, 1997) (warning IRS attorneys that “the Service may not be able to collect a summarily assessed deficiency once the Tax Court redetermines unrelated deficiencies”). Cf. Nestle Holdings, Inc. v. Commissioner, T.C. Memo. 2000-374 (the parties stipulated that “the decision of the Court would not serve as res judicata” as to tentative carryback refunds); 1 Restatement, Judgments 2d, sec. 26(1) (1982) (“When any of the following circumstances exists, the general rule of § 24 does not apply to extinguish the claim, and part or all of the claim subsists as a possible basis for a second action by the plaintiff against the defendant: (a) The parties have agreed in terms or in effect that the plaintiff may split his claim, or the defendant has acquiesced therein; or (b) The court in the first action has expressly reserved the plaintiffs right to maintain the second action”); IRS Field Service Advisory (July 14, 1997) (“The decision and computation should specify which carrybacks were not at issue in the Tax Court proceeding. It should also provide that if those carrybacks are placed at issue in a later proceeding, petitioner will not assert the defense of res judicata or contest the ability of the Commissioner to make an assessment under I.R.C. § 6213(b)(3)”). The record contains only the first page of the final notice of intent to levy issued to RLI on October 8, 2005. While this page does not contain the amount of unpaid tax as required by section 6330(a)(3), it indicates that the amount due is “shown on the back of [the] page.” Furthermore, RLI has never asserted that the amounts due were not provided, and in a letter dated October 26, 2005, submitted in response to the notice of intent to levy, RLI clearly lists the amounts due for 1999 and 2000. Therefore, we are satisfied that a proper Final Notice of Intent to Levy and Notice of Your Right to a Hearing was issued to RLI for 1999 and 2000. The Rule 122 stipulation does not include facts to support these contentions — the statute of limitations argument and the bad-faith/revenge argument — and RLI failed to present or argue these matters on brief. As a result, we find these arguments to have been abandoned in this litigation. See Rule 149(b); Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001); Rybak v. Commissioner, 91 T.C. 524, 566 n.19 (1988); Cerone v. Commissioner, 87 T.C. 1, 2 n.1 (1986); Rockwell Intl. Corp. v. Commissioner, 77 T.C. 780, 837 (1981), affd. 694 F.2d 60 (3d Cir. 1982). When a taxpayer alleges that the IRS is barred from collecting his Federal income tax, e.g., because of the expiration of the period of limitations on collection, we review that matter as a challenge to the underlying liability. See Boyd v. Commissioner, 117 T.C. 127, 130 (2001). RLI’s right under section 6330(c)(2)(B) to challenge its underlying liability on the grounds of res judicata, which RLI never had a prior opportunity to assert before Appeals, is distinct from RLI’s right (or lack of right) to challenge its underlying liability on the merits (i.e., by proving the 2001 NOL and its carrybacks to 1999 and 2000), which issue RLI did have a prior opportunity to raise before Appeals. See infra pp. 111 — 112. However, pursuant to Rev. Rul. 88-88, 1988-2 C.B. 354, 355, the “Service may not mail a second notice of deficiency to the taxpayer with respect to the amount attributable to disallowance of the carryback [where] s * * a notice of deficiency for amounts unrelated to the carryback had previously been mailed and the taxpayer had petitioned the Tax Court for a rede-termination of that deficiency.” See also Midland Mortgage Co. v. Commissioner, 73 T.C. 902 (1980). Respondent argues that “petitioner is barred by the doctrines of res judicata andlor collateral estoppel” (emphasis added), but his principal contention appears to be res judicata, presumably because it is clear that the 2001 NOL was not “actually litigated” in the prior case. See also Cornick v. Commissioner, T.C. Memo. 1985-513 (“Judicial economy requires that all issues raised in a case be tried and settled in one proceeding; this has long been our policy. Cf. Estate of Baumgardner v. Commissioner, 85 T.C. [445] (filed Sept. 11, 1985) [estate tax]; Markwardt v. Commissioner, 64 T.C. 989, 998 (1975) (where we denied taxpayer’s request for a second trial when he attempted to raise a new issue not raised at the first trial); Robin Haft Trust v. Commissioner, 62 T.C. 145, 147 (1974) * * . When we are presented with a case over which we have jurisdiction and in which we possess the necessary and usual powers to resolve the dispute, we must consider all the issues raised by the case. See Kluger v. Commissioner, 83 T.C. 309, 314 (1984)”); Powerstein v. Commissioner, 99 T.C. 466, 472-473 (1992); Rosenberg v. Commissioner, T.C. Memo. 1985-514. See Russell v. United States, 592 F.2d 1069, 1072 (9th Cir. 1979) (“There can be no question that when the taxpayer petitioned the Tax Court to redetermine the asserted deficiency, the Tax Court acquired jurisdiction to decide the entire gamut of possible issues that controlled the determination of the amount of tax liability for the year in question” (emphasis added)); Erickson v. United States, 159 Ct. Cl. 202, 309 F.2d 760, 767 (1962) (“the Tax Court’s jurisdiction, once it attaches, extends to the entire subject of the correct tax for the particular year. The cause of action then before the court encompassed all phases of the taxpayer’s income tax for 1942” (emphasis added; fn. ref. omitted)). Rule 41(a) provides that leave to amend pleadings “shall be given freely when justice so requires.” Cf. Fed. R. Civ. P. 15(a)(2) (to the same effect). Respondent did not dispute that RLI had the option to bring the NOL carrybacks into docket No. 6795-03 but rather insisted that it had brought them into the case. Because we hold that RLI is not bound by res judicata in any event, we do not need to resolve the question whether, before summary assessment had been made and paid, there was any impediment to RLI’s pleading the carrybacks. As respondent put it in his brief: “The petitioner believed the NOL issue should be removed [from the petition in the deficiency case] * * because the respondent accepted the petitioner’s 2001 corporate income tax return and issued the refunds on December 16, 2002. The petitioner considered the acceptance of the return and issuance of the refunds as evidence that the respondent had previously, and permanently, allowed the NOL and the carrybacks.” See Zarnow v. Commissioner, 48 T.C. 213, 215 (1967) (“if the respondent allows an adjustment [under section 6411] which he later determines was in error, he may subsequently correct such error”). The difference between the filing of a claim for a tentative refund on Form 1139, see sec. 6411, versus the filing of a formal refund claim on Form 1120X, see secs. 6401-6402, 6501, 7422(a), is explained in the Instructions for Form 1139. See also Saltzman, IRS Procedural Forms and Analysis, pars. 5.06 and 5.10 (2001). For an exception not relevant here, see, e.g., sec. 6015(g)(2) (“(2) Res Judicata— * * * if a decision of a court in any prior proceeding for the same taxable year has become final, such decision shall be conclusive except” etc.). See Mar Monte Corp. v. United States, 503 F.2d 254, 257 (9th Cir. 1974); Birch Ranch & Oil Co. v. Commissioner, a Memorandum Opinion of this Court dated Mar. 24, 1948 (res judi-cata is a “rule of law” that was intended to be overridden by sec. 322(g), the predecessor statute to sec. 6511(d)(2)(B)(i)); see also Wiltse v. Commissioner, 51 T.C. 632, 633 (1969) (“res judicata is * * * a settled rule of law”). By way of analogy, when the IRS duly mails a statutory notice of deficiency and the taxpayer does not file a petition in the Tax Court to commence a deficiency case, the IRS properly assesses the tax pursuant to section 6213(c). However, if the taxpayer did not actually receive the notice and therefore did not have an opportunity to file a deficiency case, the taxpayer will be entitled to challenge the liability in a CDP case when the IRS attempts to collect the tax. See Kuykendall v. Commissioner, 129 T.C. 77, 80 (2007). In that CDP context, the taxpayer will not be limited to attempting to show that the assessment was procedurally invalid; he is not forced to pay the assessment and make his liability challenge in a later refund suit. Rather, the CDP provisions allow him to make a postassessment, prepayment challenge to liability. A CDP petitioner is limited to making challenges to liability for which he did not have a prior opportunity. See sec. 6330(c)(2)(B). In part IV below we show that, under this rule, RLI is entitled to press its res judicata claim but is not entitled to attempt to prove the fact of the 2001 loss and the validity of the carrybacks to 1999 and 2000. Section 6212(c)(1) provides in pertinent part: “If the Secretary has mailed to the taxpayer a notice of deficiency as provided in subsection (a), and the taxpayer files a petition with the Tax Court within the time prescribed in section 6213(a), the Secretary shall have no right to determine any additional deficiency of income tax for the same taxable year, * * * except as provided in * * * section 6213(b)(1) (relating to mathematical or clerical errors)”. Section 6213(g)(2) provides, in subparagraphs (A) through (M), a wide variety of circumstances that constitute “mathematical or clerical” errors. In addition, other circumstances are treated as if they were mathematical or clerical errors, pursuant to sections 1400S(d)(5)(C), 6034A(c)(3), 6037(c)(3), 6201(a)(3), 6227(c)(1), 6241(b), 6428(f)(1), and 6429(d)(1). Section 6213(b)(3) provides that “the Secretary * * * may assess without regard to the provisions of paragraph (2) the amount of the excess as a deficiency”. (Emphasis added.) The U.S. Court of Appeals for the Eighth Circuit reached the same result that we reach today in Jefferson Smurfit Corp. v. United States, 439 F.3d 448 (8th Cir. 2006), overruling Bradley v. United States, 77 AFTR 2d 96-1255, 96-1 USTC par. 50,195 (D. Minn. 1996), affd. without published opinion 106 F.3d 405 (8th Cir. 1997). Like the Court of Appeals for the Third Circuit’s opinion in Zackim v. Commissioner, 887 F.2d 455 (3d Cir. 1989), revg. 91 T.C. 1001 (1988), Jefferson Smurfit appears to rely on broad grounds: “By excluding fraud from the general bar against successive deficiencies in 26 U.S.C. § 6212(c)(1), ‘Congress dealt explicitly with the policy of finality, and plainly excepted claims of fraud from the general policy.’” 439 F.3d at 453 (quoting Zackim v. Commissioner, supra at 458-459). We do not decide whether there is a broad exception to res judicata in any circumstance in which additional deficiency determinations are permitted by section 6212(c)(1). Rather, we decide this case on the narrower basis of the statutory scheme in sections 6411, 6212(c)(1), 6213(b)(3), and 6511(d)(2)(B) that is applicable only to tentative refunds and that excepts the operation of res judicata in that specific circumstance.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621553/	AMERICAN GAS & ELECTRIC COMPANY AND SUBSIDIARY COMPANIES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.American Gas & Elec. Co. v. CommissionerDocket Nos. 67368, 67369, 69800.United States Board of Tax Appeals33 B.T.A. 471; 1935 BTA LEXIS 745; November 15, 1935, Promulgated 745 1. A corporation which retires an outstanding issue of bounds at a callable price above par in accordance with the trust agreement is entitled to a deduction for the unexhausted discount and expense on the old bond issue and for the difference between par and the amount paid to retire them, even though it had borrowed money to retire the bonds and promptly repaid the amount borrowed from the proceeds of a new bond issue. 2. Where the assets and liabilities of a corporation, including its liability on outstanding bonds, were transferred for the stock of another corporation, which transferred them to a third corporation for its stock, and the latter was thereafter merged with a fourth corporation, and the first and second corporations continued their corporate existence, the fourth corporation is not entitled to amortize over the remaining life of the bonds the unamortized discount and the expense incidental to the original issuance of the bonds. J. Marvin Haynes, Esq., for the petitioner. Chester A. Gwinn, Esq., for the respondent. MURDOCK 471 OPINION. MURDOCK: The Commissioner determined deficiencies in income tax of the petitioner746 as follows: Docket No.YearAmount673681928$2,154,726.146736919291,077,216.706980019301,459,842.74472 The parties have filed an "Agreed Statement of Facts", wherein they have settled a number of the issues originally raised and have stated the facts relating to the two questions upon which they ask a decision by the Board. The one question has been decided against the Commissioner in a number of cases. He concedes that the facts here bring this case within those prior decisions. The question is whether a corporation which retires an outstanding issue of bonds at a callable amount above par in accordance with the trust agreement, is to be denied a deduction for the unexhausted discount and expense on the old bond issue and for the difference between par and the callable price because it borrowed new money to retire those bonds and promptly repaid the amount just borrowed from the proceeds of the sale of a new bond issue. The deduction is proper. ; 747 ; ; ; ; ; ; . The present case is distinguishable from , because here the old bonds were not retired by an exchange for the new bonds. The other question is whether a corporation which acquires all of the assets and assumes the liabilities of another, including the liability on outstanding bonds, in exchange for its capital stock may amortize over the remaining life of the bonds the unamortized discount and expense incidental to the original issuance of the bonds under the circumstances here present. The petitioner is the parent of an affiliated group of corporations, which included in 1928, 1929, and 1930 the Appalachian748 Electric Power Co. The books of the corporations in the group were kept on an accrual basis and the returns were filed on that same basis. The Virginian Power Co. (hereinafter called Virginian) was organized in 1912 under the laws of Massachusetts. It was engaged, until 1925, in the manufacture and sale of electricity. It was not affiliated with the petitioner, although the latter owned a large part of its stock. It had sold certain bonds at a discount. The discount and expense of issuing the bonds were shown on its books as prepaid interest. Each year a part of this item was charged to expense. The petitioner organized the Appalachian Securities Corporation (hereinafter called Securities) in 1924 under the laws of New York. Securities issued 82,000 shares of its first preferred stock to Virginian in January 1925 in exchange for all of the assets of the latter and it 473 also assumed all of the liabilities of Virginian. The first preferred stock of Securities had voting rights. The stock issued to Virginian was the only stock outstanding after that transfer. Virginian continued its corporate existence and later exchanged its stock in Securities for stock in749 the petitioner. The Appalachian Power & Light Co. (hereinafter called Power & Light) was organized on February 14, 1925, under the laws of Virginia. It then transferred all of its stock to Securities in exchange for the assets and liabilities which Securities had just acquired from Virginian. The American Gas & Electric Co. and Securities were consolidated on February 17, 1925, to form the petitioner. The Appalachian Electric Power Co. was organized on March 4, 1926, under the laws of Virginia and on April 1, 1926, Power & Light and the Appalachian Power Co. (a Virginia corporation organized in 1911) were merged with it. The petitioner owned 95 percent or more of the stock of each at the date of the merger. The balances of discount and expense on the Virginian bonds after each transfer were placed upon the books of the transferee as prepaid interest. The interest on the bonds was paid by the Appalachian Electric Power Co. after it assumed the liability on the Virginian bonds. It also amortized the balance of discount and expense in the same way as Virginian had done and claimed deductions therefor. The Commissioner disallowed the deductions. 750 Virginian was entitled to an annual deduction representing amortization of the original expense of issuing its bonds and of the discount at which its bonds were issued. . But the question here is whether the right to such annual deductions persisted without interruption in the various other corporate taxpayers which, in turn, assumed payment of the Virginian bonds. The last taxpayer in the chain was the Appalachian Electric Power Co. and it has no right to the deductions unless each of its predecessors in liability on the bonds had a similar right. The Board has held that deductions for unamortized bond discount and expenses are personal to the corporation issuing the bonds and do not persist in a successor which assumes liability on the bonds. , et seq; ; ; Michigan Central railroad 751 . The Board has applied this rule in all cases, regardless of whether the liability had been assumed in connection with a sale or whether it had been assumed as a result of a consolidation, merger, or other reorganization from which no gain or loss would be recognized. The application of such a rule here would deny the deductions claimed. 474 The Board's decisions in three cases on this subject have been appealed. The Circuit Court of Appeals for the Fourth Circuit reversed the Board in the Western Maryland Railway Co. case, supra. . The Western Maryland Railway Co. issued the bonds in that case. The court there stated that The Western Maryland Railway Co. owned all of the stock of seven subsidiary corporations whose property it operated in all respects as its own. That company and its subsidiaries were consolidated to form the taxpayer in that case, Western Maryland Railway Co. The court recognized that the consolidated corporation was a distinct legal entity from those whose places it had taken, but held that the new corporation752 was entitled to the same deductions on account of unamortized discount that the old corporation would have been entitled to if the reorganization had not taken place, because, for all practical intents and purposes, the new corporation was a mere continuation of the old. Judge Northcott dissented on the ground that since the two corporations were separate legal entities, the new corporation acquired no right to charge off a proportionate part of the discount at which the bonds were originally sold. The present case is distinguishable from the Western Maryland Railway Co. case since here the corporation issuing the bonds was not one of the subsidiaries of a single operating system and never merged or consolidated with the corporation claiming the deduction. Cf. . 1Virginian did not merge with Securities, but continued as a separate corporation and taxpayer. 753 The Court of Appeals for the Second Circuit has recently reversed a decision of the Board on the discount question. . There the bondissuing corporation was later consolidated with others to form the taxpayer corporation. That case is likewise distinguishable form the present case on its facts, since here the bond-issuing corporation never consolidated with any other to form the corporation claiming the deduction. The court said in the New York Central case: In (C.C.A. 4) it was held that a consolidated corporation steps into the place of the constituent corporations and is entitled to deduct amortized discount on bonds issued by them. We think this decision is sound and should be followed in the case at bar. * * The assets of the consolidated corporation 475 have the same cost basis as they had when held by the old companies and are subject to the lien of the bond issues. * * As already stated the subject of amortization is the difference between the cash realized on the bonds and their par value. 754 This difference the consolidated corporation will pay when the bonds mature, and this expenditure it should be allowed to anticipate by yearly amortization during the life of the bonds in order more clearly to reflect its income. Cases denying deductions for losses sustained by a predecessor in prior years were distinguished in the opinion in the New York Central case. The court said that the difference between the cash realized on the bonds and their par value is not sustained as a loss by the issuing corporation at the time of the issuance of the bonds. The difference between the issuing price and the amount later paid to retire the bonds, the court said, was a loss sustained at the time of the retirement by the corporation retiring the bonds. It held that a corporation succeeding to another by a consolidation and assuming payment of the other's bonds, was entitled to deductions for amortization to absorb the loss, which it would have to pay when it retired the bonds, to the extent that this loss had not been recovered previously. It pointed out that the consolidation was a reorganization and that the successor had to take the same bases on its property which the predecessor755 had had. The reasoning of the court might apply with equal force to all reorganizations where the old bases carried over. However, the facts in that case showed that there had been a true consolidation. The court did not mention the decision of the Court of Appeals for the District of Columbia in the case of , affirming an unpublished decision of the Board. The facts in the present case are in all essentials like the facts in Turner-Farber-Love Co. The taxpayer, in the latter case, exchanged its stock for the assets and liabilities of three companies. One of the three companies had issued its bonds at a discount and the Turner-Farber-Love Co. assumed the payment of those bonds as a part of the liabilities of that company. The appellate court, like the Board, held that the corporation which assumed payment of the bonds was not entitled to deductions representing unamortized discount. Cf. . The court said: There was obviously no merger or consolidation of the two companies, but an outright sale of the assets of the one756 to the other. The vendor, until dissolved, continued to be a corporation. The sale of its assets did not destroy its identity, and it might have continued legally thereafter to do any business its corporate charter authorized. It might have filed a tax return and claimed a loss on the sale of its bonds or on the sale of its other assets. Granted it had the right to amortize its bond discount, petitioner, in purchasing its assets, did not succeed to this right any more than it would have succeeded to the 476 right to set up its losses occurring prior to the purchase. athol . What we have just said is true because the tax laws treat separate corporations as separate taxpayers. Here petitioner is a distinct and separate corporation from the Darnell Company. The court could find no justification in the statute for allowing the Turner-Farber-Love Co. deductions to which the Darnell Co. would have been entitled. The Turner-Farber-Love Co., case was cited by the Supreme Court with apparent approval in 757 , whereas the case of the Fourth Circuit, (which, the Circuit Court said, was governed by its decision in the Western Maryland Railway case) was disapproved by the Supreme Court. The petitioner argues that the prior Board decisions are not in point because they arose under acts which contained no "reorganization" and "non-recognition" provisions. However, the cases can not be distinguished on that basis, since the acts which were applicable to the exchanges in those cases did contain some such provisions. It is no doubt true, however, that Virginian could not have claimed a loss for 1925 on the unamortized discount on its bonds or on the exchange of its other assets. The gain or loss from the exchange which took place in 1925 would not have been recognized under section 203(b) of the Revenue Act of 1926. The assets transferred would have the same bases in the hands of Securities as they had had in the hands of Virginian. The Board has never been reversed in disallowing deductions to a successor corporation on account of expenses758 of the predecessor in issuing its bonds. The theory of the Second Circuit Court decision would not apply to such expenses since the successor does not pay them. The Appalachian Electric Power Co. is not entitled to deduct amortized expenses and discount on the bonds issued by Virginian. Expenses and discount on other bonds are also involved in this case. The facts relating to those bonds, although somewhat different from those outlined above, are nevertheless similar in all essential details, and the decision of the Board is the same in regard to all such deductions claimed in this case. Reviewed by the Board. Decision will be entered under Rule 50.BLACK BLACK, dissenting: I dissent on the second point. This point is stated in the majority opinion as follows: The other question is whether a corporation which acquires all of the assets and assumes the liabilities of another, including the liability on outstanding 477 bonds, in exchange for its capital stock may amortize over the remaining life of the bonds the unamortized discount and expense incidental to the original issuance of the bonds under the circumstances here present. The majority759 opinion gives a negative answer to that question and disallows the amortization deduction claimed. I agree that where one corporation purchases outright the assets of another and as a part of the purchase price assumes and agrees to pay prior issued bonds of the selling corporation, the purchasing corporation is not entitled to set up on its books the remaining unamortized discount and expenses incurred in the original issuance of the bonds and take an annual deduction of unamortized discount spread ratably over the remaining life of the bonds. The reason for this is because a transaction whereby assets are sold by one corporation to another is one in which gain or loss is recognized and the selling corporation is then and there entitled to take a deduction of its remaining unamortized discount and expenses connected with the previous issuance of its bonds. That seems to be the main ground upon which the court based its decision in , and , both cases cited by the majority opinion in support of the conclusion therein reached. 760 The court emphasized this point in the Turner-Farber-Love case, wherein it said: There was obviously no merger or consolidation of the two companies, but an outright sale of the assets of the one to the other. The vendor, until dissolved, continued to be a corporation. The sale of its assets did not destroy its identity, and it might have continued legally thereafter to do any business its corporate charter authorized. It might have filed a tax return and claimed a loss on the sale of its bonds or on the sale of its other assets. Granted it had the right to amortize its bond discount, petitioner, in purchasing its assets, did not succeed to this right any more than it would have succeeded to the right to set up its losses occurring prior to the purchase. . So, where there has been a sale of the assets of one corporation to another and the purchasing corporation assumes the bonded indebtedness of the debtor corporation as a part of the consideration for the assets purchased, I agree that the purchasing corporation has no right to avail itself as a deduction from its own gross income, of the unamortized761 discount of the selling corporation. If the facts in the instant case showed an outright sale of assets of one corporation to the other, I would agree to the result reached in the majority opinion. But I think the situation is altogether different where there is a nontaxable exchange under the reorganization provisions of the applicable revenue acts. In that sort of a situation no gain or loss is recognized in the transaction and the corporation to which 478 the assets are transferred takes the same basis of cost for depreciation and gain or loss on the subsequent disposal of the assets as the transferor corporation had. In a very real sense the transferee corporation steps into the shoes of the transferor corporation. Speaking on this point, the court in New York Central Railroad Co. v. Commissioner (a case involving facts somewhat akin to those we have here), , said: In , (C.C.A. 4) supra, it was held that a consolidated corporation steps into the place of the constituent corporations and is entitled to deduct amortized discount on bonds issued by them. 762 We think this decision is sound and should be followed in the case at bar. The consolidated corporation does not succeed to the rights by operation of law. See [11 Am. Fed. Tax Rep. 857] (C.C.A. 2); [14 Am. Fed. Tax Rep. 311] (C.A.A. 2). The assets of the consolidated corporation have the same cost basis as they had when held by the old companies and are subject to the lien of the bond issues. Hence the consolidated corporation will suffer a loss when it pays the bonds at par, and the regulations as to spreading this loss over the life of the bonds should apply. They do not in terms confine discount deductions to the issuing corporation, and should not be construed to do so. If the new corporation cannot take the deduction, no one can, for the old companies sustained no loss when the consolidation was effected. As already stated the subject of amortization is the difference between the cash realized on the bonds and their par value. This difference the consolidated corporation will pay when the bonds mature, and this*763 expenditure it should be allowed to anticipate by early amortization during the life of the bonds in order more clearly to reflect its income. Therefore, under the facts stated in the majority opinion and the law applicable thereto, I think petitioner is entitled to prevail on the second issue as well as the first. SMITH, TRAMMELL, ARUNDELL, and VAN FOSSAN agree with this dissent. Footnotes1. The court in its opinion in Brandon Corporation made the following statement in regard to its earlier case: "Had there been here a merger in which an existing corporation continued its existence, the other corporation or corporations, being subsidiaries of the main corporation and being merged into it, such as was the case in ,↩ a different question might be presented."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621554/	John D. Thompson, Petitioner v. Commissioner of Internal Revenue, Respondent; Westward, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentThompson v. CommissionerDocket Nos. 4396-77, 4397-77United States Tax Court73 T.C. 878; 1980 U.S. Tax Ct. LEXIS 187; February 25, 1980, Filed 187 Decisions will be entered under Rule 155. 1. During 1973 and 1974, petitioner Westward, Inc., purchased tax refund claims from taxpayers filing Form 1040 or 1040A Federal income tax returns. Westward, Inc., would pay a taxpayer an amount equal to two-thirds of the refund due the taxpayer in exchange for the right to receive any refund made by the IRS. Held, the discount income Westward, Inc., derived on the receipt of taxpayers' refund checks does not constitute "interest" within the meaning of sec. 1372(e)(5), I.R.C. 1954. Held, further, Westward, Inc.'s election under sec. 1372(a) to be treated as a small business corporation remained in effect in 1973 and 1974.2. During 1974, Cable Vision, Inc., rented recorded video cassettes to cable television stations. In July of 1974, Cable Vision, Inc., entered an agreement with G.E. Corp. under which G.E. Corp. paid Cable Vision, Inc., $ 3,004.80 for the right to use Cable Vision, Inc.'s recorded cassettes for one year. Held, the $ 3,004.80 Cable Vision, Inc., received from G.E. Corp. in 1974 constituted "rent" within the meaning of sec. 1372(e)(5). Held, further, petitioner did not render "significant services" 188 in connection with the receipt of this rental income. Held, further, Cable Vision, Inc.'s election under sec. 1372(a) to be treated as a small business corporation terminated in 1974 and, therefore, petitioner Thompson is not entitled to deduct the amount he claimed as his share of Cable Vision, Inc.'s 1974 loss.3. Held, advances petitioner Thompson made to Cable Vision, Inc., in 1974 constituted contributions to capital and, therefore, petitioner Thompson is not entitled to a bad debt deduction under sec. 166 in 1974 for these advances. George Constable, for the petitioners.Matthew W. Stanley, for the respondent. Fay, Judge. FAY879 Respondent determined deficiencies in petitioners' Federal income taxes and additions to taxes as follows:Addition to taxDocket No.PetitionerYearDeficiencysec. 6653(a) 14396-77John D. Thompson1973$ 5,752$ 28819746,8143414397-77Westward, Inc.197311,92519745,338These cases have been consolidated for purposes of trial, briefing, and opinion.Concessions having been made, 2 the remaining issues for decision are:(1) Whether more than 20 percent of the gross receipts of petitioner Westward, Inc., for its taxable year 1973 was "interest" 190 and therefore passive investment income within the meaning of section 1372(e)(5), so as to terminate its election under section 1372(a) to be treated as a small business corporation for 1973 and 1974.(2) Whether more than 20 percent of the gross receipts of I-Cable Vision Programmers, Inc., for its taxable year 1974 was "rent" and therefore passive investment income within the meaning of section 1372(e)(5). If so, then I-Cable Vision Programmers, Inc.'s election under section 1372(a) to be treated as a small business corporation terminated in 1974 with the result that petitioner John Thompson is not entitled to deduct the amount that he claimed as his share of I-Cable Vision Programmers, Inc.'s 1974 loss.(3) Whether petitioner John Thompson is entitled to a bad debt deduction under section 166 in 1974 for advances made to I-Cable Vision Programmers, Inc. 3191 880 FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.At the time of filing his petition herein, petitioner John D. Thompson resided in Seattle, Wash. Petitioner Westward, Inc., maintained its principal office in Seattle, Wash., at the time of filing its petition herein.WestwardWestward, Inc. (Westward), was incorporated on January 1, 1971. John D. Thompson (John) and his brother, Robert M. Thompson (Robert), each owned 49.5 percent of Westward's stock, and their mother, Ethyle M. Thompson, owned the remaining 1 percent. Robert was president and John was secretary-treasurer of Westward.John and Robert each operated an income tax consulting and return preparation service in Seattle. John's office was in a building located at 5215 Ballard Ave., N.W. Westward's office was located in this same building across the hall from John's office. Robert's office was approximately one-half mile away from the offices of John and Westward in a building located at 1141 Northwest Market St.On December 1, 1970, John, on behalf of Westward, filed an election to be taxed pursuant to the provisions of subchapter S of the Internal Revenue Code. The election192 was effective for Westward's first taxable year beginning January 1, 1971.During 1973 and 1974, Westward was in the business of acquiring tax refund claims at a discount from taxpayers filing Form 1040 and Form 1040A Federal income tax returns. Beginning in January of each of these years, Westward would circulate flyers in various taverns advertising that it would provide an immediate cash refund to taxpayers who filed Form 1040A returns. The advertisements instructed the taxpayer to bring his or her W-2 Form into Westward's office in Seattle.When a taxpayer would come into Westward's office, one of the three Westward employees would prepare the taxpayer's 1040A return and calculate the amount of any refund due. 4 If the taxpayer was entitled to a refund, a Westward employee 881 would fill out one of Westward's forms labeled "Tax Claim Refund & Sale Computation." The purpose of the form was to compute the amount of cash Westward would pay for the taxpayer's refund claim. The amount of cash to be paid to the taxpayer was calculated on this form by reducing the refund due the taxpayer by a "discount charge" of 33 1/3 percent. Thus, Westward would acquire the right to receive193 a taxpayer's entire refund in exchange for two-thirds of the total amount of the refund due the taxpayer.In addition, the taxpayer was required to fill out a form provided by Westward labeled "Refund Application." On this "Refund Application," the taxpayer was asked to provide the following information: various biographical data, the amount of any tax refund received the previous year, whether returns were filed, and whether taxes were owed for the years 1967 through 1972. This form also included a statement to be signed by the taxpayer authorizing the Internal Revenue Service (IRS) to mail the taxpayer's refund check to Westward's office in Seattle.Westward also required the taxpayer to sign two power of attorney forms. The first was a form prepared by Westward labeled "General Power of Attorney" which gave John and Robert the power to receive, endorse, and collect194 the taxpayer's refund check. The second was IRS Form 2848 which gave John and Robert the power to act as attorneys in fact for the taxpayer and to receive the taxpayer's refund check.When the taxpayer's return had been prepared and all the other forms completed, the Westward employee would take these documents, and a check made out to the taxpayer for two-thirds the amount of the refund, across the hall to John's office for approval. John would then review the documents in an effort to determine the validity of the taxpayer's W-2 Form and to make sure the refund was computed correctly. If John approved the transaction, he would sign the check which would then be given to the taxpayer.John reviewed each transaction to ensure that Westward did not acquire refund claims based on false or fraudulent W-2 Forms. Although the taxpayer was required to sign an affidavit stating under penalty of perjury that the information on the W-2 Form was accurate, once Westward paid a taxpayer for his refund claim, the taxpayer had no obligation to repay Westward even if the IRS did not honor the taxpayer's refund claim. 882 Hence, when a refund was not made by the IRS, Westward sustained195 a loss on the transaction. For this reason, Westward refused to acquire the refund claims of all taxpayers who brought W-2 Forms into its office. Westward rejected approximately 15 percent of the 600 applications it received from taxpayers each year.During 1973 and 1974, Westward began acquiring tax refund claims on January 15 and ceased acquiring refund claims on April 15. As refund checks were received, they were endorsed and deposited in Westward's bank account. All of Westward's gross receipts in 1973 and 1974 were derived from its business of acquiring and processing customers' tax refund claims. In 1973, Westward reported $ 224,122 as gross receipts, $ 179,737 as cost of operations, and $ 64,385 as gross income. In 1974, Westward reported $ 152,854 as gross receipts, $ 113,478 as cost of operations, and $ 39,376 as gross income.Although John conducted his own tax consulting business, he spent several hours a day supervising Westward's activities. John also prepared Westward's income tax returns each year and arranged for Westward to borrow $ 80,000 from private investors in January of 1973 and 1974 to obtain the initial capital necessary to acquire refunds from taxpayers. 196 Robert took no part in the day-to-day activities of Westward. Robert's only duties involved the auditing of Westward's books. Robert would regularly go to Westward's office in the evenings and audit all of the corporation's books and records. In 1973, Westward paid John and Robert $ 17,767, each, as compensation, and in 1974 Westward paid John $ 10,706 and Robert $ 11,121 as compensation.Cable VisionI-Cable Vision Programmers, Inc. (Cable Vision), was incorporated on January 26, 1974. John owned 59 percent of the Cable Vision stock, his brother Robert owned 40 percent of the stock, and the remaining 1 percent was owned by Alan Morrow. Robert was president and John was secretary-treasurer of Cable Vision. On the same day Cable Vision was incorporated, it made an election effective in 1974 to be taxed pursuant to the provisions of subchapter S of the Internal Revenue Code.Cable Vision was organized for the purpose of renting recorded video cassettes to cable television stations. During 1974, 883 Cable Vision contacted companies owning the film rights to old movies and acquired licenses to record these movies onto video cassettes. Cable Vision then purchased blank197 video cassettes and with rented equipment, Robert and Cable Vision's only employee, Lawrence Dawson, recorded these old movies onto the cassettes. The licensing agreements that Cable Vision entered into with the film companies also provided that Cable Vision was entitled to distribute the recorded cassettes for a fixed period of time. Thus, using a brochure prepared by Robert, Cable Vision contacted cable television stations by mail in an effort to rent these recorded cassettes.In April 1974, Cable Vision acquired a license from the King Brothers in New York to record onto video cassettes the complete film library of the Little Rascals "Our Gang" comedy series. The King Brothers also gave Cable Vision the right to distribute the recorded cassettes for 1 year.In June 1974, Hal Green (Green), a representative of General Electric Cable Vision Corp. (G.E.) contacted Robert about obtaining Cable Vision's video cassettes of the Little Rascals series for broadcast on one of G.E.'s cable television stations. Thereafter, Robert and Green entered an oral agreement whereby Cable Vision agreed to provide G.E. with video cassettes of 80 episodes of the Little Rascals "Our Gang" comedy series198 for a fee of $ 3,004.80. The billing invoices prepared by Cable Vision in connection with this transaction show that 29 episodes were shipped to G.E. on June 26, 1974, 15 episodes were shipped on July 16, 1974, and 7 were shipped thereafter. All 51 of these cassettes were shipped by Cable Vision to G.E.'s cable television station in Anderson, Ind. On July 26, 1974, Robert and a representative of G.E. signed a "Program License Agreement" that clarified the earlier oral agreement and provided that Cable Vision was granting G.E. a license to broadcast the 80 episodes for 1 year only. The pertinent provisions of this written agreement were as follows:PROGRAM LICENSE AGREEMENTAGREEMENT made this 26th day of July, 1974, by and between I Cable-Vision Programmers, Inc., 1141 N. W. Market Street, Seattle, WA 98107 (herein called "ICV") and [General Electric Cable Vision Corp.] (herein called "Licensee").ICV hereby grants to Licensee and Licensee hereby accepts, a license to make the following local television broadcasts during the term hereof in 884 accordance with the provisions set forth herein and in the Terms and Conditions on pages 2 through 4 attached hereto and hereby made199 a part hereof:I.PROGRAM SERIES: LITTLE RASCALSII.NUMBER OF PROGRAMS: 80III.NUMBER OF BROADCASTS: UNLIMITED FOR 12MONTHSIV.FREQUENCY OF BROADCASTS: not more than UNLIMITEDbroadcasts per week.V.STATION: G.E. CABLE VIS. VI. CITY: ANDERSON IND.VII.METHOD OF BROADCAST C.A.T.V.VIII.OTHER LIMITATIONS:IX.STARTING DATE: JULY 9th.X.TERM: ONE YEAR.XI.NET LICENSE FEE: $ 3,004.80, payable in $ 1,001.60with delivery and two consecutive monthly installments of $ 1,001.60each commencing on the first day of AUGUST, AND SEPTEMBER1974.PRINTS TO BE DELIVERED TO: G.E. CABLE VISION CORP. 633 JACKSON ST. ANDERSON IND. 46016* * * TERMS AND CONDITIONS1. USE OF PRINTS AND PROGRAMS. Licensee shall not make, authorize or permit any use of the "prints" [video cassettes] or programs other than as specified on page 1 hereof, including, without in any way being limited to, copying, duplicating, or sublicensing the use of, any program, print, or portion thereof, or authorizing or permitting the exhibition, whether by way of television broadcasting or otherwise, or any program, print, or portion thereof, in any theater, auditorium or other place to which an 200 admission fee is charged, or doing anything which may impair the copyright in any program or portion thereof, or ICV title to the print thereof.* * * 3. DELIVERY AND RETURN OF PRINTS. * * (c) Licensee will return each print, prepaid, substantially in the same condition as received by Licensee, normal wear and tear excepted, to I Cable-Vision Programmers, Inc., 1141 N. W. Market Street, Seattle, WA 98107, or to such address as ICV may specify to Licensee: within twenty-four (24) hours, excluding Sundays and holidays, after the broadcast thereof or immediately upon termination or suspension of this Agreement. Delivery of the prints by Licensee to ICV, ICV agent or specified addressee, or a common carrier shall be deemed to be delivery by Licensee to ICV hereunder. * * 15. OWNERSHIP. All rights and title in and to the programs and program 885 series, including but not limited to, prints thereof and the title or titles, names, stories, plots, incidents, ideas, formulas, formats, general content of the programs and any other literary, musical, artistic or creative material included therein (other than material in the public domain) shall, as between ICV and Licensee, remain201 vested in ICV. * * Pursuant to this agreement, G.E. made its three payments of $ 1,001.60 to Cable Vision on August 6, 1974, August 22, 1974, and October 1, 1974.Although G.E. was obligated to return the video cassettes to Cable Vision, it did not do so. In a letter dated November 16, 1978, addressed to respondent's counsel in Seattle, K. C. Wilkes, a manager for G.E., explained why the video cassettes were not returned to Cable Vision:This letter is in further reply to your letter of October 19, 1978 regarding the Little Rascals program license agreement between I-Cable Vision and General Electric Cablevision Corporation. As a result of my conversation with our cable TV system manager in Anderson, Indiana, it appears that the tapes [video cassettes] we received were not returned. Eighty (80) episodes were contracted for in this license agreement, however we received only fifty-one (51). Since we had paid for 80 episodes, byt [sic] only received 51, we kept the tapes of the 51 episodes as a bargaining tool. However, at some time during the disagreement over the 29 episodes I-Cable Vision apparently went out of business. Therefore, the tapes with the 51 episodes were 202 not returned and are therefore still in Anderson, Indiana.Cable Vision was not successful in its efforts to rent its recorded video cassettes to cable television stations. Consequently, it ceased doing business at the close of 1974. Cable Vision prepared its petition in bankruptcy on December 20, 1974, and subsequently filed this bankruptcy petition on January 10, 1975. On April 10, 1975, Cable Vision was discharged in bankruptcy.On its 1974 Federal income tax return, Cable Vision reported $ 4,838 in gross receipts. This sum included $ 3,004.80 from the license agreement with G.E. and $ 190 from other rentals of video cassettes. Cable Vision also reported $ 17,053 as cost of goods sold and $ 48,736 in deductible expenses. The expenses included amounts for equipment rental, depreciation, advertising, telephone, and video taping. As a result of its large expenditures, Cable Vision reported a loss of $ 60,951 in 1974. However, the total amount advanced to Cable Vision by all three shareholders during 1974 was only $ 33,750. As a shareholder in a subchapter S corporation, John, on his individual return for 1974, 886 reported his share of the loss as $ 19,913, which represented203 59 percent of $ 33,750. 5Advances to Cable VisionWhen Cable Vision was incorporated in January 1974, the total capital contribution made by the three shareholders, John, Robert, and Alan Morrow, was $ 500. Between January 25, 1974, and July 23, 1974, John personally advanced $ 12,331.25 to Cable Vision, and through Westward, he advanced an additional $ 5,768.01 to Cable Vision 6 during this same period. Robert advanced in excess of $ 5,000 to Cable Vision in 1974. A schedule attached to Cable Vision's 1974 Federal income tax return indicated that John's share of the amounts advanced to Cable Vision in 1974 was proportionate to his ownership of the corporation and that such amounts represented his "invested money." Cable Vision executed two demand promissory notes, dated June 1, 1974, one in the amount of $ 18,275 payable204 to John and the other in the amount of $ 9,200 payable to Robert.In the statutory notice sent to Westward, respondent determined that Westward's subchapter S election terminated for 1973 and 1974 because it received excessive passive investment income in those years. Respondent accordingly treated Westward as a separate taxable entity for 1973 and 1974 and completely disallowed the amounts Westward paid to John and Robert during these 2 years as unreasonable compensation.In the statutory notice sent205 to John Thompson, respondent determined that Cable Vision's subchapter S election terminated in 1974 because it received excessive passive investment income in that year. Respondent consequently disallowed the $ 19,913 loss John had claimed on his 1974 return as his share of Cable Vision's loss for the year.887 OPINIONWestwardThe first issue we must decide is whether more than 20 percent of Westward's gross receipts in 1973 was "interest" and therefore passive investment income within the meaning of section 1372(e)(5), so as to terminate its election under section 1372(a) to be treated as a small business corporation.Section 1372(e)(5)(A) states the general rule that a corporation's subchapter S election shall terminate for any year in which the corporation has passive investment income in excess of 20 percent of its gross receipts. Section 1372(e)(5)(C) specifically includes "interest" as one type of "passive investment income." 7 We believe Congress intended the word "interest" in section 1372(e)(5)(C) to be used in its usual and commonly accepted sense. Old Colony R.R. Co. v. Commissioner, 284 U.S. 552">284 U.S. 552, 560 (1932); Marshall v. Commissioner, 60 T.C. 242">60 T.C. 242, 251 (1973),206 affd. 510 F.2d 259">510 F.2d 259 (10th Cir. 1975); Buhler Mortgage Co. v. Commissioner, 51 T.C. 971">51 T.C. 971, 978 (1969), affd. per curiam 443 F.2d 1362">443 F.2d 1362 (9th Cir. 1971). Nothing in the legislative history of section 1372(e)(5) indicates the word "interest" was to be construed otherwise. 8207 Interest is commonly defined as the amount paid per unit of time for use of borrowed money. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488, 497 (1940); Old Colony R.R. Co. v. Commissioner, supra;Wilkerson v. Commissioner, 70 T.C. 240">70 T.C. 240, 253 (1978). The regulations under section 1372 also adopt this definition of the term "interest." 9 Thus, for an amount to constitute interest, it must 888 be paid or received on an existing, valid, and enforceable obligation and such amount must also be computed according to the passage of time. Meilink v. Unemployment Comm'n., 314 U.S. 564">314 U.S. 564, 570 (1942); Christensen v. Commissioner, 40 T.C. 563">40 T.C. 563, 578 (1963); Intercounty Operating Corp. v. Commissioner, 4 T.C. 55">4 T.C. 55, 63-65 (1944). Moreover, whether a given amount constitutes interest is a question of fact. Wilkerson v. Commissioner, supra;L-R Heat Treating Co. v. Commissioner, 28 T.C. 894">28 T.C. 894, 897 (1957). See also Green v. Commissioner, 367 F.2d. 823, 825 (7th Cir. 1966),208 affg. a Memorandum Opinion of this Court.In the present case, respondent takes the position that Westward in effect made loans to taxpayers when it advanced money to them with the expectation of repayment in the form of tax refund checks. Respondent therefore maintains that all of Westward's income on these transactions was interest because Westward was being paid for the use of its money. Respondent concludes that Westward's subchapter S election was terminated for 1973 and 1974 because Westward's passive investment income in the form of interest exceeded 20 percent of its gross receipts in 1973 and 1974. 10209 Petitioner Westward, on the other hand, argues that it did not make loans to taxpayers but instead purchased tax refund claims at a discount. Petitioner Westward points out that after it paid a taxpayer for his refund claim, the taxpayer had no obligation to repay Westward even if the refund was not forthcoming. Thus, petitioner Westward contends that the income it derived on the subsequent receipt of a refund check was discount income, not interest on loans, and, therefore, Westward did not have excessive passive investment income in 1973 or 1974.Considering all the facts and circumstances, we conclude that the income Westward derived from the acquisition of tax refund claims at a discount does not constitute "interest" within the meaning of section 1372(e)(5).The primary reason for our conclusion is that the requirement that interest be paid on indebtedness is lacking here. Once 889 Westward paid a taxpayer for his refund claim, the taxpayer had no obligation to repay Westward, even if the refund was not forthcoming. In other words, the taxpayer was simply not indebted to Westward as a result of the transaction. Thus, we believe Westward purchased the rights to receive210 tax refunds at a discount rather than made loans with tax refunds as security. See Thompson v. Commissioner, 66 T.C. 1024">66 T.C. 1024, 1047 (1976). Compare Elk Discount Corp. v. Commissioner, 4 T.C. 196">4 T.C. 196, 201-202 (1944), and Southeastern Finance Co. v. Commissioner, 4 T.C. 1069">4 T.C. 1069, 1083-1084 (1945), affd. 153 F.2d 205">153 F.2d 205 (5th Cir. 1946). Since interest is a payment for the use of borrowed money, Westward's income was not interest because its income was not received on a valid, enforceable obligation but was instead derived from Westward's discount purchase of tax refund claims. See Christensen v. Commissioner, supra.In addition, another element of interest is lacking in this case. The amount of the discount Westward received on each transaction was not computed according to the passage of time. See Intercounty Operating Corp. v. Commissioner, supra. On the contrary, Westward received a 33 1/3-percent "discount charge" from each taxpayer regardless of when the refund might be received. We believe such a discount reflects211 Westward's estimate of the fair market value of a potential tax refund rather than a payment for the use of money.Since we have found that the income Westward derived from the purchase of tax refund claims does not constitute "interest" within the meaning of section 1372(e)(5), we hold that Westward did not have passive investment income in excess of 20 percent of its gross receipts in 1973 or 1974 and was therefore a valid subchapter S corporation during 1973 and 1974. 11Cable VisionThe second issue we must decide is whether more than 20 percent of Cable Vision's gross receipts in 1974 was "rent" and therefore passive investment income within the meaning of section 1372(e)(5). If so, 212 then Cable Vision's election under section 1372(a) to be treated as a small business corporation 890 terminated in 1974 with the result that petitioner Thompson is not entitled to deduct the $ 19,901.36 that he claimed as his share of Cable Vision's 1974 loss.As set out above, section 1372(e)(5)(A) provides that a corporation's subchapter S election will terminate in a year in which the corporation has passive investment income in excess of 20 percent of its gross receipts. 12 Under section 1372(e)(5)(C), "rents" are included within the term "passive investment income." Section 1.1372-4(b)(5)(vi), Income Tax Regs., provides that "the term 'rents' as used in section 1372(e)(5) means amounts received for the use of, or right to use, property (whether real or personal) of the corporation." However, this same section of the regulations excludes certain payments from the definition of the term "rents":The term "rents" does not include payments for the use or occupancy of rooms or other space where significant services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels, boarding houses, or apartment houses furnishing hotel213 services, or in tourist homes, motor courts, or motels. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. * * Thus, if a corporation leases personal property and it renders services primarily for the convenience of the lessee other than those "usually or customarily" rendered in connection with such a lease and such services are "significant" in nature, then the income received by the lessor will not constitute "rents" for purposes of section 1372(e)(5). Winn v. Commissioner, 67 T.C. 499">67 T.C. 499, 514 (1976), affd. in part and revd. in part 595 F.2d 1060">595 F.2d 1060 (5th Cir. 1979); Bramlette Building Corp. v. Commissioner, 52 T.C. 200">52 T.C. 200, 204 (1969), affd. 424 F.2d 751">424 F.2d 751 (5th Cir. 1970); Feingold v. Commissioner, 49 T.C. 461">49 T.C. 461, 467 (1968).214 Moreover, in determining whether income should be treated as rent or as payment for the sale of property, the substance of the transaction and not the form is controlling. Smith v. Commissioner, 51 T.C. 429">51 T.C. 429, 437-438 (1968); Martin v. Commissioner, 44 T.C. 731">44 T.C. 731, 740 (1965), affd. 379 F.2d 282">379 F.2d 282 (6th Cir. 1967).In the present case, since Cable Vision only had $ 4,838 in gross receipts for 1974, including $ 3,004.80 from the "Program License 891 Agreement" with G.E., if we find that the $ 3,004.80 constituted "rent," then Cable Vision's subchapter S election terminated in 1974 because its passive investment income would be in excess of 20 percent of its gross receipts for that year.Petitioner Thompson asserts that although Cable Vision initially intended to rent the recorded cassettes to G.E., when Cable Vision determined that there was no rental market for its cassettes, the transaction with G.E. evolved into a sale. He maintains the fact that G.E. did not return the cassettes demonstrates that the transaction had evolved into a sale by the end of 1974. In the alternative, petitioner Thompson215 claims that Cable Vision engaged in substantial business activity in preparing the cassettes for shipment to G.E., including rental of equipment, advertising, and recording of cassettes, and that these activities constitute "significant services." He therefore concludes that the amounts Cable Vision received from G.E. did not constitute "rents."Respondent argues that under the terms of the "Program License Agreement," G.E. was only entitled to the use of the cassettes for 1 year and, thus, it is clear that the amounts G.E. paid Cable Vision constitued "rents." With respect to petitioner's alternative argument, respondent's position is that petitioner has not proven what, if any, "significant services" Cable Vision rendered to G.E. in connection with the license agreement and, consequently, that the exception provided by section 1.1372-4(b)(5)(vi), Income Tax Regs., is inapplicable.We disagree with petitioner Thompson's argument that Cable Vision's transaction with G.E. evolved into a sale. The evidence in the record indicates that the parties structured the transaction as a rental agreement and then performed according to the terms of such rental agreement.Under the "Program License216 Agreement" signed by Robert and a representative of G.E. on July 26, 1974, G.E. as "licensee" agreed to pay Cable Vision a "net license fee" of $ 3,004.80 for the right to broadcast the recorded cassettes containing 80 episodes of the Little Rascals "Our Gang" comedy series for 1 year beginning July 9, 1974. Also, paragraph 15 of the agreement specifically provided that all rights and title in the cassettes and programs thereon, as between Cable Vision and G.E., remained vested in Cable Vision. Pursuant to this agreement, Cable Vision shipped cassettes containing 51 episodes to 892 G.E.'s station in Anderson, Ind., and G.E. paid Cable Vision the "net license fee" of $ 3,004.80 in three equal installments.In addition, the fact that G.E. did not return the cassettes to Cable Vision does not demonstrate, as petitioner contends, that the transaction evolved into a sale by the end of 1974. In a letter dated November 16, 1978, addressed to respondent's counsel in Seattle, K. C. Wilkes, a manager for G.E., explained why the cassettes were not returned. In the letter, Wilkes stated that G.E. contracted with Cable Vision for 80 episodes, but Cable Vision delivered only 51, so G.E. 217 kept the cassettes of the 51 episodes as a bargaining tool, and because Cable Vision went out of business during the dispute over the 29 remaining episodes, the cassettes of the 51 episodes were never returned. Considering this explanation, we do not believe that G.E.'s retention of the cassettes proves that the parties intended the transaction to be a sale.In light of the clarity of the terms of the "Program License Agreement" and the actions of the parties in connection with this agreement, we conclude that, in substance as well as form, the transaction between Cable Vision and G.E. was not a sale but rather a rental agreement in which G.E. paid Cable Vision for the use of the recorded cassettes for 1 year.We also reject petitioner Thompson's alternative argument that the amounts G.E. paid to Cable Vision did not constitute "rents" because Cable Vision rendered "significant services" to G.E. in connection with the license agreement. Although Cable Vision engaged in various activities in its rental business including equipment rental, advertising, and recording of cassettes, the only service Cable Vision rendered to G.E. was the shipment of the cassettes to G.E.'s cable television218 station in Anderson, Ind. Petitioner Thompson offered no evidence to prove that this service of shipping the cassettes was in any way "significant." Moreover, it is clear to the Court that this shipping service rendered by Cable Vision is a service that is "usually and customarily" rendered in similar rental businesses. Thus, we conclude that Cable Vision did not render "significant services" to G.E. in connection with the license agreement.Accordingly, we hold that the $ 3,004.80 Cable Vision received from G.E. in 1974 constituted "rent" within the meaning of section 1372(e)(5) and, therefore, Cable Vision's subchapter S election terminated in 1974 because its passive investment 893 income exceeded 20 percent of its gross receipts for that year. Consequently, petitioner Thompson is not entitled to deduct the $ 19,901.36 that he claimed as his share of Cable Vision's 1974 loss.Advances to Cable VisionThe third and final issue we must decide is whether petitioner John Thompson is entitled to a bad debt deduction under section 166 13219 in 1974 for advances he made to Cable Vision during 1974. 14Petitioner Thompson claimed that between January 25, 1974, and July 23, 1974, he personally loaned Cable Vision $ 19,901.36, and that through Westward he loaned Cable Vision an additional $ 5,826.28 during this same period. 15 As evidence of these loans, petitioner points to the demand promissory note Cable Vision executed on June 1, 1974, in the amount of $ 18,275 payable to petitioner. Petitioner concludes that since Cable Vision prepared its bankruptcy petition in December 1974 and was discharged in bankruptcy in April 1975, the220 loans he made to Cable Vision in 1974 became worthless in 1974 and, therefore, petitioner is entitled to a bad debt deduction in 1974 for these amounts.894 Respondent, on the other hand, argues as follows: First, the advances made by petitioner are contributions to the capital of Cable Vision and are not deductible. Second, if a valid debtor-creditor relationship existed between Cable Vision and petitioner with respect to the amounts in question, then any loss is not deductible in 1974 because the debts were not worthless in that year. Finally, respondent maintains that if the debts were worthless in 1974, they were nonbusiness rather than business bad debts.The determination of whether advances made by a stockholder to a corporation create a true debtor-creditor relationship or actually represent contributions to capital depends on the particular facts of each case. John Kelly Co. v. Commissioner, 326 U.S. 521">326 U.S. 521 (1946); A. R. Lantz Co. v. United States, 424 F. 2d 1330, 1334 (9th Cir. 1970).221 In making the determination of whether advances of the type in the present case constitute debt or equity, the courts have considered a number of factors including the following: the relationship between the parties; whether the corporation is adequately capitalized; whether the advances are made in proportion to shareholder's interest in the corporation; whether interest was payable on the amounts advanced; whether a debt instrument was executed; whether an outsider would have made similar advances without security; and whether such advances were placed at the risk of the business and thus constituted investment capital. A. R. Lantz Co. v. United States, supra at 1333; Davis v. Commissioner, 69 T.C. 814">69 T.C. 814, 836 (1978); Litton Business Systems, Inc. v Commissioner, 61 T.C. 367">61 T.C. 367, 376 (1973); Family Group, Inc. v. Commissioner, 59 T.C. 660">59 T.C. 660, 669 (1973). The burden of proving that amounts advanced to a corporation constitute loans rather than capital contributions is on the taxpayer. Baumann & Co. v. Commissioner, 312 F.2d 557">312 F.2d 557, 558 (2d Cir. 1963),222 affg. a Memorandum Opinion of this Court; Yale Avenue Corp. v. Commissioner, 58 T.C. 1062">58 T.C. 1062, 1074 (1972).After taking into account the above factors, we conclude that the amounts petitioner Thompson advanced to Cable Vision during 1974 constituted contributions to capital. 16To begin with, when Cable Vision was incorporated in early 895 1974, the total capital contribution by all three shareholders was only $ 500. The advances in excess of $ 20,000 made by petitioner and his brother, Robert, during 1974 were apparently Cable 223 Vision's only other source of capital. When the small amount of initial capital is compared with the large amount of alleged loans, it is evident Cable Vision was undercapitalized. In addition, a schedule attached to Cable Vision's 1974 return clearly indicates that petitioner's share of the amounts advanced to Cable Vision in 1974 was proportionate to his ownership of the corporation and that such amounts represented his "invested money." Moreover, there is no evidence in the record to show that petitioner's advances were secured and considering Cable Vision's meager financial success throughout 1974, we do not believe an outsider would have made similar advances without security. Finally, although Cable Vision executed a demand promissory note payable to petitioner, petitioner offered no evidence as to whether demand for repayment had ever been made or when such repayment was contemplated. Nor did he offer any evidence to prove that the note was actually executed on June 1, 1974. Also, there is no explanation as to why no note was executed with respect to the advances made to Cable Vision after June 1, 1974. Thus the existence of this note, by itself, is insufficient evidence224 to prove that the advances made by petitioner to Cable Vision were loans. See A. R. Lantz Co. v. United States, supra.Accordingly, because we have found that the $ 12,331.25 petitioner Thompson personally advanced to Cable Vision and the $ 5,768.01 he advanced to Cable Vision through Westward in 1974 constituted contributions to capital, we hold that petitioner Thompson is not entitled to a bad debt deduction under section 166 in 1974 for such advances. 17 However, nothing herein is to be construed as preventing such amounts from being added to the basis of petitioner's stock in Cable Vision. See sec. 1.118-1, Income Tax Regs.896 To reflect the foregoing,Decisions will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, and in force during the years in issue.↩2. The parties settled a number of issues including the sec. 6653(a) addition to tax in the case of petitioner John Thompson, docket No. 4396-77.↩3. Petitioner Thompson, in an amendment to his petition filed after trial, claimed that if Cable Vision's subch. S status terminated in 1974, then in the alternative he was entitled to a bad debt deduction in 1974 for the amounts he advanced to Cable Vision in 1974. Respondent, in his answer to this amendment, denied each and every allegation made by petitioner.↩4. When it was necessary for the taxpayer to file a Form 1040 return, John or Robert would prepare the return and then bill Westward for his services.↩5. On brief, petitioner John Thompson stated that his share of the total amount advanced to Cable Vision in 1974 was actually $ 19,901.36, and this amount constituted his deductible loss.↩6. Petitioner Thompson claimed to have personally advanced $ 19,901.36 to Cable Vision in 1974. However, the evidence petitioner Thompson introduced substantiates a personal advancement of only $ 12,331.25. In addition, petitioner Thompson claimed that he advanced $ 5,826.28 to Cable Vision in 1974 through Westward which was 50 percent of the total amount advanced to Cable Vision by Westward. Since petitioner actually owned 49.5 percent of Westward, his share of Westward's advances to Cable Vision is only $ 5,768.01.↩7. SEC. 1372(e)(5). Passive investment income. --(A) Except as provided in subparagraph (B), an election under subsection (a) made by a small business corporation shall terminate if, for any taxable year of the corporation for which the election is in effect, such corporation has gross receipts more than 20 percent of which is passive investment income. Such termination shall be effective for the taxable year of the corporation in which it has gross receipts of such amount, and for all succeeding taxable years of the corporation.* * * (C) For purposes of this paragraph, the term "passive investment income" means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities * ↩8. S. Rept. 1983, 85th Cong., 2d Sess. (1958), 3 C.B. 922">1958-3 C.B. 922, 1010; S. Rept. 1007, 89th Cong., 2d Sess. (1966), 1 C.B. 527">1966-1 C.B. 527, 532; S. Rept. 91-1535 (1970), 1 C.B. 614">1971-1 C.B. 614↩.9. Sec. 1.1372-4(b)(5)(viii), Income Tax Regs., provides as follows:"The term 'interest' as used in section 1372(e)(5)↩ means any amounts received for the use of money (including tax-exempt interest and amount treated as interest under section 483)."10. Under sec. 1.1372-4(b)(5)(iv), Income Tax Regs., amounts constituting loan repayments are not included in gross receipts. Consequently, if Westward's 1973 and 1974 gross receipts consist of only loan repayments and interest thereon as respondent contends, then the portion attributable to loan repayments must be eliminated leaving Westward's interest income equal to 100 percent of its gross receipts. See Marshall v. Commissioner, 60 T.C. 242">60 T.C. 242, 250, affd. 510 F.2d 259">510 F.2d 259↩ (10th Cir. 1975).11. Since we have held that Westward was a valid subch. S corporation during 1973 and 1974 rather than a separate taxable entity, we do not reach the issue raised by respondent in his statutory notice to Westward, whether the amounts Westward paid to John and Robert during 1973 and 1974 constituted unreasonable compensation.↩12. See n. 7 supra↩.13. SEC. 166. BAD DEBTS.(a) General Rule. -- (1) Wholly worthless debts. -- There shall be allowed as a deduction any debt which becomes worthless within the taxable year.(2) Partially worthless debts. -- When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * * *(d) Nonbusiness Debts. -- (1) General rule. -- In the case of a taxpayer other than a corporation -- (A) subsections (a) and (c) shall not apply to any nonbusiness debt; and(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.(2) Nonbusiness debt defined. -- For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than -- (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩14. Under sec. 1376(b)(2), a shareholder's basis in any debt owed to him by his subch. S corporation must be reduced by the amount of the shareholder's portion of the corporation's net operating loss for the taxable year to the extent that such amount exceeds the shareholder's basis in his stock. Hence, in the present case, if Cable Vision had been a valid subch. S corporation in 1974 we would not need to consider this bad debt issue because petitioner Thompson's share of Cable Vision's 1974 loss would have apparently reduced his basis in the alleged loans to zero.↩15. See n. 6 supra↩.16. We note that because petitioner Thompson raised this bad debt issue for the first time in an amendment to his petition filed after trial, there is very little documentary evidence and even less testimony in the record to explain the circumstances surrounding the making of these advances. While petitioner Thompson's brother, Robert, testified that these advances were loans, the Court found his testimony vague, inconsistent, and lacking in credibility.↩17. Due to our conclusion that petitioner's advances were capital contributions, we need not consider respondent's second and third arguments.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621558/	E. E. Carroll v. Commissioner.Carroll v. CommissionerDocket No. 25570.United States Tax Court1951 Tax Ct. Memo LEXIS 343; 10 T.C.M. (CCH) 84; T.C.M. (RIA) 51022; January 25, 1951343 Held, respondent is not barred by the statute of limitations from determining a deficiency for the year 1943. Z. W. Koby, 14 T.C. 1103">14 T.C. 1103, followed. Paul A. Sayre, Esq., for the petitioner. John H. Pigg, Esq., for the respondent. VAN FOSSAN Memorandum Opinion VAN FOSSAN, Judge: The respondent determined deficiencies in petitioner's income tax as follows: YearDeficiency1943$12,434.60194418,894.20194525,259.85All but one of the errors originally alleged have been settled by the parties, leaving only the issue as to the applicability of the statute of limitations to the year 1943. The parties entered into a "Stipulation of Facts and of Deficiencies" in which they agreed: - That there are deficiencies in Federal income tax due from this petitioner for344 the taxable (calendar) years 1944 and 1945 in the respective amounts of $11,587.17 and $15,045.86, and that the Court may enter its decision accordingly. That if the Court should determine and hold that the assessment of a deficiency in respect of petitioner's taxable (calendar) year 1943 is not barred by the applicable statute of limitations, then, and in that event, there is a deficiency in Federal income tax due from the petitioner for the taxable year 1943 in the amount of $7,216.10, and that the Court may enter its decision accordingly. That by reason of the foregoing, all the assignments of error contained in petitioner's petition have been satisfactorily disposed of by and between the parties hereto, except that contained in paragraph 4 (g) of the petition, relating to the statute of limitations. [The determination of the additional taxes as set forth in the said notices of deficiency is based upon the following errors: * * * (g) The respondent erred in giving notice of a deficiency and in asserting a deficiency for the year 1943 for the reason that the time limited by law for making an assessment for said year has expired and the assesment should not be made either under345 Section 275-a or 275-c of the Internal Revenue Code.] That with respect to the assignment of error so contained in paragraph 4 (g) of the petition, the following facts are true and may be so taken and considered by the Court as offered in evidence by the parties in this proceeding: [The Facts] (a) Petitioner's returns for the years 1942 and 1943 were filed with the collector for the district of Oregon. (b) On March 15, 1943, petitioner filed his income tax return for the year 1942, reporting thereon gross income of $23,637.08. On April 15, 1944, petitioner filed his income tax return for the year 1943, reporting thereon a gross income of $12,960.49. (c) The deficiency in income tax for the year 1943 as set forth and referred to above, was arrived at and agreed upon by and between the parties hereto upon the basis that petitioner's correct gross income for the year 1942 is $35,300.97, and that his correct gross income for the year 1943 is $15,091.39. For the purposes of this proceeding such amounts may be considered and accepted by the Court as correct. (d) During the month of February 1949, the petitioner and the respondent entered into a certain written agreement346 captioned "Consent Fixing Period of Limitation Upon Assessment of Income and Profits Tax," reading as follows: "In pursuance of the provisions of existing Internal Revenue Laws E. E. Carroll, a taxpayer of 5329 N. E. Sandy Boulevard, Portland, Oregon, and the Commissioner of Internal Revenue hereby consent and agree as follows: "That the amount of any income, excess profits, or war-profits taxes due under any return (or returns) made by or on behalf of the above-named taxpayer for the taxable year ended December 31, 1943 under existing acts, or under prior revenue acts, may be assessed at any time on or before June 30, 1950, except that, if a notice of a deficiency in tax is sent to said taxpayer by registered mail on or before said date, then the time for making any assessment as aforesaid shall be extended beyond the said date by the number of days during which the Commissioner is prohibited from making an assessment and for sixty days thereafter. Provided, however, that the taxpayer does not waive hereby any statute of limitations which has run heretofore in favor of the taxpayer." The above-quoted agreement was duly executed by petitioner on February 1, 1949, and on behalf347 of respondent on February 8, 1949. (e) The involved notice of deficiency covering petitioner's taxable year 1943 was sent by respondent to petitioner by registered mail on August 9, 1949. To summarize the critical dates, petitioner's return for 1943 was filed April 15, 1944. The "waiver" as to 1943 was executed by petitioner on February 1, 1949, and by respondent on February 8, 1949. The notice of deficiency was mailed August 9, 1949. [Opinion] Petitioner contends that respondent may not consider 1942 income in his determination of the 1943 deficiency, it being necessary for respondent to look to 1942 income to make up the 25 per cent of the "gross income stated in the return" for 1943. (Section 275 (c).) Petitioner concedes that if respondent may so look to the 1942 return, the 5-year statute of limitations had not run and decision should be against him. The respondent relies on the 5-year limitation provided by section 275 (c), section 6 of the Current Tax Payment Act of 1943, and cites (on appeal CA-6), and cases cited and considered therein, notably . Petitioner admits that the Koby348 case is probably against him. We are of the opinion that the principles and considerations on which the Carpenter and Koby cases rest are equally applicable here and, accordingly, it must be held that the statute of limitations did not bar respondent's action for the year 1943. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621559/	PASCAL G. REDFERN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRedfern v. CommissionerDocket No. 13562-89United States Tax CourtT.C. Memo 1990-406; 1990 Tax Ct. Memo LEXIS 425; 60 T.C.M. (CCH) 382; T.C.M. (RIA) 90406; August 2, 1990, Filed 425 Decision will be entered for the respondent. Pascal G. Redfern, pro se. Thomas E. Ritter, for the respondent. PARR, Judge. PARRMEMORANDUM OPINION This matter is before the Court on respondent's motion to dismiss under Rule 104 1 and for damages under section 6673. Respondent determined the following deficiencies in and additions to petitioner's Federal income tax: Additions To Tax Under SectionsYearDeficiency6651(a)(1)6653(a)(1)6653(a)(2)665466611982$ 9,179$ 2,295$ 459 $ 894$ 2,29519839,0442,2614525532,26119849,7172,4294866102,429198511,2802,820564*6472,820426 On January 19, 1990, the Court served a Notice Setting Case for Trial at the trial session in Helena, Montana, on June 18, 1990. A Standing Pre-Trial Order was also served upon the parties. The Notice Setting Case for Trial states in part: The calendar for that Session will be called at 10:00 A.M. on that date and both parties are expected to be present at that time and be prepared to try the case. YOUR FAILURE TO APPEAR MAY RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU. The Notice Setting the Case for Trial and the Standing Pre-Trial Order similarly required the parties to cooperate and to stipulate facts to the maximum extent possible. As early as January 30, 1990, respondent sought to meet with petitioner on an informal basis, avoid formal discovery, and fully stipulate mutually agreed facts and evidence. As early as February 6, 1990, respondent advised petitioner of427 his obligation to cooperate and warned him if he failed to do so, respondent would seek dismissal of the case and request penalties under section 6673. Petitioner refused to meet with respondent's counsel. On March 2, 1990, respondent served interrogatories upon petitioner pursuant to Rule 71, and on March 22, 1990, respondent served a request for admissions and a request for production of documents upon petitioner pursuant to Rules 90 and 72, respectively. Petitioner did not respond. On May 4, 1990, respondent filed a motion to dismiss and for damages (motion) with the Court. On May 14, 1990, the Court issued the following order: ORDERED that petitioner shall, on or before May 25, 1990, serve on counsel for respondent answers to each interrogatory served on petitioner on March 2, 1990. An evasive or incomplete answer will be treated as a failure to answer. It is further ORDERED that petitioner shall, on or before May 25, 1990, produce to counsel for respondent those documents requested in respondent's request for production of documents served on petitioners on March 22, 1990. An evasive or incomplete response will be treated as a failure to respond. It is further 428 ORDERED that petitioner shall, on or before May 25, 1990, file any motion to withdraw or modify the matters deemed admitted by petitioner's failure to timely respond to respondent's request for admissions served on petitioners on March 22, 1990, pursuant to Rule 90(f). A denial shall fairly respond to the substance of the requested admission. It is further ORDERED that the Court may impose sanctions upon petitioner pursuant to Rule 104, including dismissal of this case, if petitioner fails to timely obey this Order. Respondent's motion to dismiss and for damages will be held in abeyance pending any response by petitioner to this Order.At petitioner's request, a telephone conference between the Court, respondent's counsel, petitioner, and petitioner's wife, Mona Redfern, took place on May 23, 1990. (Mona Redfern is a petitioner in a separate case for the years 1982 through 1985.) Respondent agreed to mail petitioner a copy of everything in petitioner's case file after eliminating any written mental impressions of the revenue agent. The Court reiterated that petitioner must respond to respondent's discovery requests on or before May 25, and informed petitioner of his obligations429 and duties pursuant to the trial on June 18, 1990. On May 29, 1990, the Court received a number of meritless motions signed jointly by petitioner and Mona Redfern. Also included were "answers" to respondent's discovery requests, which were signed by petitioner. Petitioner answered the interrogatories by either asserting Fifth Amendment privilege, that the answer to the question was obvious to the IRS, and/or that the question was duplicative. Petitioner responded to the document request by asserting the Fifth Amendment privilege with respect to each and every item. As to the requested admissions, petitioner asserted Fifth Amendment privilege and/or that the request was duplicative, or that he was "not required" to file Federal income tax returns for the years in issue. Petitioner stated that his responses to the deemed admissions and interrogatories were made under duress and under the time limitation imposed by the Court. Petitioner indicated that he would reveal to the Court in camera requested documents and answers to certain interrogatories (but apparently not others). On June 18, 1990, the case was called from the trial calendar. No appearance was made by or on behalf430 of petitioner. Respondent filed written motions to dismiss and for damages with the Court at that time. The Court may dismiss a case for failure to properly prosecute if a party unexcusably fails to appear when the case is called for trial. Rule 149(a). Petitioner was notified of this fact in the Notice Setting the Case for Trial, and the telephone conference between the Court, respondent's counsel, petitioner, and Mona Redfern. Furthermore, on June 11, 1990, in an order denying petitioner's "Motion for a Phone Conference to Set Up Trial Date on June 18," we ordered petitioner to appear at the time and place set forth in the Notice Setting Case for Trial. Nevertheless, no appearance was made by or on behalf of petitioner when the case was called for trial. Therefore, dismissal is warranted in this case for failure to properly prosecute. Since we have dismissed this case for failure to properly prosecute under Rule 149(a), respondent's motion to dismiss under Rule 104 is moot. We next consider that part of respondent's motion which seeks the imposition of damages under section 6673. Whenever it appears to the Court that proceedings before it have been instituted or maintained431 by the taxpayer primarily for delay, that the taxpayer's position in such proceeding is frivolous or groundless, or that the taxpayer unreasonably failed to pursue available administrative remedies, the Court may require the taxpayer to pay to the United States a penalty not in excess of $ 25,000. Sec. 6673(a). 2Respondent repeatedly advised petitioner that if he failed to cooperate respondent would seek dismissal of his case and penalties under section 6673. Nevertheless, petitioner continued to stonewall with the objective of delaying discovery and the ultimate resolution of this case. We warned petitioner in our discovery order that an evasive432 or incomplete answer to respondent's interrogatories would be treated as a failure to answer. Nevertheless, petitioner refused to answer questions on the grounds that the answer was obvious and/or duplicative. Furthermore, petitioner's failure to appear at trial convinces us that petitioner is maintaining this proceeding primarily for delay. Accordingly, we hold that petitioner has maintained this case primarily for delay, and require petitioner to pay a penalty to the United States under the authority of section 6673 of $ 2,000. To reflect the foregoing, Decision will be entered for the respondent. Footnotes1. 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, as amended and in effect for the years in issue.↩. 50 percent of the interest due on $ 9,163.↩*. 50 percent of the interest due on the deficiency.↩2. The Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7731(a), 103 Stat. 2106, changed the term "damages" to "penalty" and increased the amount which can be awarded to the United States from $ 5,000 to $ 25,000. These changes are applicable to positions taken after December 31, 1989, in proceedings which are pending or commenced after such date.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621560/	PRESTON W. CARROLL and DOROTHY CARROLL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCarroll v. CommissionerDocket No. 1221-75.United States Tax CourtT.C. Memo 1978-173; 1978 Tax Ct. Memo LEXIS 340; 37 T.C.M. (CCH) 736; T.C.M. (RIA) 780173; May 10, 1978, Filed Ervin M. Entrekin, for the petitioners. John B. Harper, for the respondent. TANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: YearDeficiency1969$293,044.941970406,237.791971432,503.02341 The issues remaining for decision are: (1) whether payments made to a corporation wholly owned by Preston W. Carroll are deductible rental expenses and (2) whether state franchise and excise taxes paid by the corporation are deductible by petitioners. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners, Preston W. Carroll (Preston or petitioner) and Dorothy Carroll, are husband and wife who resided in Clifton, Tennessee, at the time of the filing of the petition herein. For 1969 and 1970, they filed joint U.S. Individual Income Tax Returns with the Internal Revenue Service Center at Chamblee, Georgia. For 1971, they filed an original and two amended joint U.S. Individual Income Tax Returns with the Internal Revenue Service Center at Memphis, Tennessee. Since 1952, Preston has operated, as a sole proprietorship, Preston Carroll Construction Company (hereinafter the construction company or the proprietorship), which, during the years in issue, was engaged primarily in the construction of sewer lines and sewage treatment plants. 342 In the latter part of 1968, the construction company had a performance bonding capacity of $6,000,000 for all projects and $2,000,000 for any single project. Petitioner wished to bid on jobs which, if the bids were accepted, would require additional bonding capacity, and he discussed this matter with Continental Casualty (his bonding company at that time), which indicated that it would increase the construction company's bonding limit if it could obtain long-term financing of at least $600,000. Initially, petitioner was unable to secure long-term financing. However, in December 1968, he secured a loan with an interest rate of at least 6-1/2 percent due in 18 months in the amount of $1,005,597.22 from First American National Bank, Nashville, Tennessee (First American). Although petitioner placed $1,000,000 of the proceeds in a 4-percent certificate of deposit in the construction company's name at First American, the certificate did not serve as security for the loan. Continental Casualty still refused to increase the bonding limit. Petitioner's bonding agent approached three other insurance companies, none of which was willing to issue performance bonds in the amounts requested343 by petitioner. The limitation imposed on petitioner's bonding capacity was due to the inadequate accounting methods employed by the construction company and the lack of working capital. A new accountant, Thomas Smith, was hired so that more current and complete financial information could be obtained. In January 1969, Preston Carroll Company, Inc. (hereinafter the corporation), was incorporated pursuant to the laws of the State of Tennessee. The business purposes stated in the certificate of incorporation covered a wide range of activities involving construction and real estate. Petitioner has always been president, treasurer, and sole shareholder of the corporation. Among the reasons for forming the corporation were to make provision for centralized control and limitation of personal liability and eventually to conduct the construction business. In February 1969, United States Fidelity and Guaranty Co. (USF&G) authorized the issuance of performance bonds on two individual projects, but it was unwilling to commit itself to a firm bonding program. USF&G though that it was in its best interests for the certificate of deposit to be cashed in on maturity and used to pay off344 the First American loan. In or about April 1969, petitioner informed USF&G that, instead of cashing in the certificate of deposit, he would transfer certain heavy equipment and the First American loan to the corporation. The corporation would rent the equipment to the construction company and would use the rental payments to pay off the loan. It was estimated that, due to the lower corporate income tax rates, there would be a net reduction in Federal income tax liability in excess of $70,000 per year on the amounts involved. Such reduction in taxes would help to improve the corporation's working capital position and would thereby assist it in obtaining an increased bonding ceiling. On August 1, 1969, petitioner transferred the construction equipment theretofore used by the construction company to the corporation. The unadjusted basis in the equipment at that time was $2,414,498.95, and accumulated depreciation amounted to $1,613,429.87. In exchange for the equipment, the corporation assumed payment of the balance on three notes of the sole proprietorship, in the aggregate amount of $60,986.02, and executed a note in the amount of $700,000 in partial satisfaction of an obligation345 owed by petitioner to First American. Petitioner personally guaranteed the $700,000 note. The corporation's net book equity in the equipment, after depreciation, amounted to $40,083.06. Immediately after this transfer, petitioner and the corporation entered into a lease agreement, under which the construction company leased all of the corporation's equipnent. The lease provided as follows: The term of this lease shall be from the date hereof through December 31, 1971 and the LESSEE shall have an option to renew the lease under the same terms and conditions for an additional year and from year to year until and unless the LESSOR within ninety (90) days from the end of the term of any renewal notifies LESSEE that the lease shall no longer be renewable. The rental for the full term of this Agreement shall be $2,500,148, payable at the rate of $86,212 per month, except that LESSEE may skip payments; provided, however, LESSEE may not skip more than eight (8) monthly payments during the term of the Lease. If LESSEE desires to skip more than eight (8) monthly payments, LESSEE shall notify LESSOR and shall agree to pay an interest penalty of one (1%) percent per month skipped in346 excess of eight months; and, in no event, may LESSEE skip more than eleven (11) months. In addition, the LESSEE shall place all equipment in the best possible operating condition. Rental for the option period shall be as mutually agreed to between the LESSOR and the LESSEE at the time the option is exercised. If the parties cannot agree, rental shall continue at the same annual rate with the LESSEE allowed three monthly skips plus one monthly skip with penalty. In order to exercise its option all LESSEE must do is forward notice in writing deposited in the mail and addressed to the LESSOR, Box 1, Clifton, Tennessee. Maintenance and operation: LESSEE will, at all times and at its own expense keep the Leased Equipment in good working order and operating condition and LESSEE will furnish all replacement parts and maintenance required to preserve the Lease Equipment according to good standards of operation during this lease. The operation and maintenance of the Leased Equipment shall be under the sole and exclusive control of LESSEE and the personnel operating and maintaining the Leased Equipment shall be the agents and employees of LESSEE and not LESSOR. Return of Equipment:347 Upon the termination of this Lease in any manner whatsoever, or upon any default by LESSEE hereunder, LESSEE shall forthwith deliver and return the Leased Equipment to LESSOR at LESSEE's expense, in as good order and operating condition as when initially delivered to LESSEE and brought up to good working condition by said LESSEE as a part of this lease agreement, ordinary and reasonable wear and tear alone excepted. If LESSEE fails to return said equipment, LESSOR may take such steps as are necessary to repossess same and LESSEE shall be liable to pay all reasonable expenses, including attorney fees. Liability of LESSEE: @LESSEE assumes full responsibility for damage, loss or destruction of the Leased Equipment from the date of delivery until returned to LESSOR. LESSEE assumes full responsibility for and indemnifies LESSOR against and will save LESSOR harmless from any and all loss, liability, damage and expense in connection with any injury to person or property arising from or in connection with the use or operation of the Leased Equipment. Insurance: LESSEE will carry, at its own expense, public liability insurance and property insurance to protect the LESSOR in348 the amount of not less than Three Hundred Thousand and 00/100 Dollars ($300,000.00) per accident and the equipment shall be insured at its cost or fair market value for replacement purposes. Taxes: LESSEE will pay all taxes, fees and other charges which may be imposed on this transaction or in connection with the use of the Leased Equipment during the term of this Lease. Title and Possession: The Leased Equipment shall at all times, remain and be the sole and exclusive personal property of LESSOR and LESSEE shall have only the right to possession and use of the same under the terms of this lease. It is specifically understood by and between the parties that LESSEE shall acquire no equity in or right of ownership to the equipment and shall have no rights of any description other than those specifically granted herein. Default: This Lease Agreement may be terminated at the election of the LESSOR if the LESSEE is not maintaining the equipment or otherwise complying with the terms and conditions hereof, then LESSOR may take possession of said equipment. In the event of any default by LESSEE, the entire rental provided herein through the term of the lease then in effect349 shall become immediately due and payable. Assignment : The LESSEE may not assign any of its right, title and interest in and to this lease or any equipment covered thereby without the consent of the LESSOR which consent will not be unreasonably withheld.Non-Waiver: None of the terms, convenants or conditions of this lease shall be deemed waived by any act of LESSOR unless same is specified in writing. The rent to be charged under the lease was 50 percent of the rentals specified in "AED Rentals," an industry publication showing rental rates for heavy construction equipment. The 50-percent adjustment was made to reflect the age and capabilities of the particular equipment involved and the expected wear and tear on the equipment over the term of the lease. The parties have stipulated that "[the] $86,212 monthly rentals payable by the construction company under the August 1, 1969 equipment lease * * were reasonable for those items of equipment transferred to the corporation and leased back on that date." On January 2, 1972, the corporation and the construction company executed a First Written Amendment to the Lease Agreement, which provided as follows: 1. The350 parties agree to follow the terms and conditions of the original Lease Agreement.2. The parties agree that where the Lessor has replaced worn out equipment or acquired new equipment such replacement and/or new acquisitions are satisfactory for purposes of maintaining the fixed dollar rental at the amount provided in the original lease. 3. The parties further agree to continue the lease on the same terms and conditions with the understanding however that either party may upon 90 days written notice to the other cancel the lease. 4. The parties further agree that the Lessor may at any time and from time to time notify the Lessee that the Lessor elects to demand interest payments on delinquent rentals. Thirty days from and after the date of such demand interest at the rate of ten (10%) percent per annum on the delinquent portion of the rental then due and payable shall accrue. If such a demand is made the parties further [agree] that the Lessee may cancel the Lease effective as of the date interest is to accrue, provided however, that in all events the arrearages shall be paid by the Lessee to the Lessor with interest thereon at the rate of ten (10%) percent per annum plus351 attorney fees if the Lessor must resort to the courts for collection. The lease continued in effect from August 1969 until January 1975, at which time all of the construction company's assets were transferred to the corporation. During this period, rental payments due the corporation totaled $5,603,780. For each fiscal year ending July 31, the rentals paid and received were as follows: Fiscal yearRental dueRental received1970$1,034,544$ 1,034,54419711,034,544681,69619721,034,544788,49719731,034,544718,96019741,034,544628,5271975431,060173,510$4,025,734At no time did the corporation demand, nor did the construction company pay, interest on the delinquent rentals. In purchasing equipment from independent dealers, petitioner had fallen behind as much as four to six months in making scheduled payments; in such instances, petitioner was able to rearrange and delay the times of payment. Prior to 1975, the business of the corporation consisted solely of renting equipment to the construction company, purchasing new equipment, and disposing of old equipment. The rental income was used to satisfy its loan obligations352 and to purchase new heavy construction equipment. When equipment was purchased on credit, petitioner personally guaranteed the notes given for the purchases. During the period August 1, 1969 to January 1975, petitioner also purchased heavy construction equipment in his own name; such equipment was later transferred to the corporation when it was in a financial position to pay any balance due on the purchase price. Petitioner incurred expenses for repair of construction equipment and vehicles in the following amounts: YearCost of Repairs1969$689,4271970695,7371971862,6741972769,5071973891,585A substantial portion of these expenses was incurred in repairing equipment rented from the corporation. It is not unusual for the sole shareholder of a corporation to be required to guarantee the obligations of the corporation. The corporation's books and records were maintained in the construction company's office by construction company personnel. For the fiscal year ending July 31, 1970, the corporation paid the construction company $1,200 for these services. Prior to 1975, the corporation had no employees other than its officers and directors. 353 The corporation has never paid dividends. In the notice of deficiency, respondent determined that the transfer of equipment to the corporation in 1969 and the subsequent leaseback lacked economic reality and a business purpose and that the amount claimed as rental payments was not deductible under section 162. 1 He further determined that the income purportedly realized and expenditures purportedly incurred by the corporation should be treated as if realized and incurred by petitioner; in so doing, respondent did not allow as a deduction by petitioner state franchise and excise taxes paid by the corporation. OPINION Prior to August 1, 1969, petitioner operated his construction business as a sole proprietorship. On that date, he purportedly transferred the construction equipment used by the proprietorship to a newly formed corporation in exchange (presumably nontaxable under section 351) for its stock and the assumption of certain liabilities of the proprietorship. Simultaneously with this transfer, the corporation354 purportedly leased the equipment back to the sole proprietorship, which continued to use the equipment in the same manner as it had prior thereto. In his deficiency notice, respondent determined that the corporation should not be accorded recognition for Federal income tax purposes, i.e., it was a sham, and that all of its income and deductions (except for state franchise and excise taxes) should be attributable to petitioner. 2 The issue as to whether the corporation should be treated as a sham was the centerpiece of the trial and of the original briefs filed by the parties. Recognition of the transfer and leaseback for tax purposes constituted at best a secondary issue, and even then it was intertwined with the question of recognition of the existence of the corporation. 3 However, in his reply brief, respondent conceded that the corporation was not a sham and that its separate legal identity should be recognized, and he directed his fire to the issue previously treated as secondary, namely, that "the sale and leaseback arrangement lacked any economic substance and * * petitioner should be treated as the owner of the construction equipment for Federal tax purposes." 3355 In so doing, respondent has framed the issue in all-or-nothing terms, making no suggestion or argument that the instant situation falls within the ambit of cases involving the disallowance of a portion of claimed rental payments. E.g., Midland Ford Tractor Co. v. Commissioner,277 F. 2d 111 (8th Cir. 1960), affg.T.C. Memo 1958-213">T.C. Memo. 1958-213; Ray's Clothes, Inc. v. Commissioner,22 T.C. 1332">22 T.C. 1332 (1954). Consequently, as is the situation with respect to the application of section 482 (see footnote 2, supra), the question of partial disallowance is not before us and the frame of reference is that established by the respondent (to which the petitioner has not objected), namely, whether the transfer and leaseback should be recognized for income tax purposes so that petitioners should be allowed the claimed deductions on the ground that they were "required to be made as a condition to the continued use or possession * * of property," as provided in section 162(a)(3). 356 Before addressing this issue, a few preliminary observations are in order. The bulk of the leaseback cases have arisen in the area of intra-family transfers to trusts, either by way of sale or gift, followed by a leaseback to the transferor. E.g., Mathews v. Commissioner,520 F. 2d 323 (5th Cir. 1975), revg. 61 T.C. 12">61 T.C. 12 (1973); Butler v. Commissioner,65 T.C. 327">65 T.C. 327 (1975); Wiles v. Commissioner,59 T.C. 289">59 T.C. 289 (1972), aff. per curiam 491 F. 2d 1406 (5th Cir. 1974); Penn v. Commissioner,51 T.C. 144">51 T.C. 144 (1968); Furman v. Commissioner,45 T.C. 360">45 T.C. 360 (1966), affd. 381 F. 2d 22 (5th Cir. 1967). Both parties herein have directed a great deal of attention to these cases on brief, petitioners arguing that they have no applicability in a business context involving a corporation and its shareholdrs and respondent maintaining that the principles articulated, particularly with reference to retention of control by the transferor, are clearly relevant to the issue before us. Although the transfer and leaseback cases in the intr-family area have some relevancy to the issue357 at hand, we find it unnecessary to define the precise parameters of the intra-family trust decisions except to note that, if the element of retention of control were considered the determining factor, no transfer and leaseback between a corporation and its shareholders could be sustained. Any such tenet would raise havoc in situations that otherwise have all the elements of a normal commercial transaction and fails to recognize the realities of the use of the corporate structure in the business world, namely, that "policies and day-to-day activities are determined not as decisions of the corporation but by [the] owners acting individually." See National Carbide Corp. v. Commissioner,336 U.S. 422">336 U.S. 422, 433 (1949). See also Bass v. Commissioner,50 T.C. 595">50 T.C. 595, 601 (1968). Moreover, such an inflexible rule would automatically call into question decisions which have sustained arrangements not unlike those involved herein, e.g., L.W. Tilden, Inc. v. Commissioner,192 F. 2d 704 (5th Cir. 1951), revg. on the basis of a different view of the ultimate358 factual conclusion a Memorandum Opinion of this Court dated March 16, 1950; Vardeman v. United States,209 F. Supp. 346">209 F. Supp. 346 (E.D. Tex. 1962). At the same time, we are fully aware of the judicial precept that transactions between a corporation and its controlling shareholders should be given close scrutiny. Ingle Coal Corp. v. Commissioner,174 F. 2d 569 (7th Cir. 1949), affg. 10 T.C. 1199">10 T.C. 1199 (1948); cf. Dielectric Materials Co. v. Commissioner,57 T.C. 587">57 T.C. 587, 591 (1972). While control cannot be totally ignored, its presence in the circumstances of this case is not in and of itself determinative of unfavorable tax consequences. Thus, some additional guideline is required. The development of such a guideline should take into account the fact that the right to the use of the property is in the same person both before and after the transfer and leaseback transaction, a situation which does not obtain where property owned by one party is simply leased to another related party and where the issue is the disallowance of a portion of359 the rental payments. See footnote 5, infra. We think an appropriate guideline can be found in transfers and leasebacks outside of the family context which indicate that the transion will be recognized if there is a legitimate business purpose to be served even though a tax-saving purpose is also present. See L.W. Tilden, Inc. v. Commissioner,supra;Vardeman v. United States,supra.Where no legitimate business purpose is served and the transaction is simply motivated by a desire to minimize taxes, the transfer and leaseback will be disregarded. Armston Co. v. Commissioner,188 F. 2d 531, 533 (5th Cir. 1951), affg. 12 T.C. 539">12 T.C. 539 (1949). We emphasize that the business purpose must have substance; it cannot be one that is "conjured up" or "artificial." See Matthews v. Commissioner, 520 F.2d at 325; Shaffer Terminals, Inc. v. Commissioner,16 T.C. 356">16 T.C. 356, 364 (1951), affd. per curiam 194 F. 2d 539 (9th Cir. 1952). Cf. Ingle Coal Corp. v. Commissioner,supra.360 To the foregoing, we would add that whatever may be the boundaries of integrating or separating a transfer and leaseback in the intra-family trust situations (cf. Butler v. Commissioner,supra), we think that, in the context of this case, the continued need for the equipment by the construction company was so compelling that the transfer of the equipment and the leaseback should not be treated separately. Under these circumstances, there tends to be an overlapping in the articulation of considerations of "business purpose" and "economic reality." Compare Mathews v. Commissioner,supra;Butler v. Commissioner,supra;Furman v. Commissioner,45 T.C. at 366, n.9. And finally we note that the issue before us is ultimately factual and that its resolution depends upon our evaluation of the totality of the circumstances surrounding the transfer and leaseback of the equipment. See Furman v. Commissioner,supra at 364. Clearly, petitioner believed that, as a result of the transfer, he would be able to increase his bonding capacity by improving his working capital position. Respondent361 seeks to dismiss the transfer as a paper transaction which would "obviously" not fool anyone. Granted that the improvement in working capital appears to have been effectuated by a balance sheet shuffle and that the bonding company would still be deeply interested in the ability of the sole proprietorship to utilize the equipment in its operation, we cannot say, on the basis of the record before us, that such shuffle did not have an influence on the attitude of the bonding company. Indeed, we think it did have an influence, in the same manner as the previous shuffle in which the petitioner had incurred a long-term liability by borrowing $1,000,000 but had "improved" the working capital position of his sole proprietorship by putting the sum borrowed into a short-term certificate of deposit bearing a low interest rate, i.e., at a net out-of-pocket cost.Moreover, the following factors should not be overlooked: (1) throughout the term of the lease, substantial rental payments were made to or on behalf of the corporation, which resulted in substantial profits for the corporation, on which it paid substantial Federal income taxes (compare Wiles v. Commissioner,supra,362 and Furman v. Commissioner,supra, in which the alleged transferees received no beneficial enjoyment of the property); 4 (2) profits realized by the corporation were used by it to purchase additional equipment for use in its business; (3) all relevant third parties (i.e., the bank holding a security interest in the equipment and the bonding company) were notified of the transfer of the equipment and were given an opportunity to restructure their arrangements with petitioner and the corporation to protect their interests; and (4) petitioner retained no direct interest in the assets. Its limited range of activities during these years does not require the opposite conclusion. Van Dale Corp. v. Commissioner,59 T.C. 390">59 T.C. 390 (1972). The leaseback of the equipment to the sloe proprietorship has a variety of provisions, some of them unusual, which must be considered. The rent was fixed at $86,212 per month, or $2,500,148 over a two-year-and-five-month term. The parties have stipulated that363 this rental was "reasonable for those items of equipment transferred to the corporation and leased back on that date," and we think it a fair inference from the stipulation that it was intended to apply at least to the extremely short initial term. Moreover, the rental payments were geared to a 50-percent adjustment in the industry rental rates for heavy construction equipment. 5 Cf. Vardeman v. United States,supra;Felix v. Commissioner,21 T.C. 794">21 T.C. 794, 804 (1954). Under these circumstances, we do not consider the fact that the rents to be paid over the initial lease period were approximately equal to the original cost of the equipment and far in excess of its adjusted basis to the sole proprietorship at the time of transfer to the corporation sufficient to cause us to make the mathematical comparisons which this Court and the court of appeals considered significant in Southeastern Canteen Co. v. Commissioner,410 F. 2d 615 (6th Cir. 1969), affg. on this issueT.C. Memo. 1967-183, and in Shaffer Terminals, Inc. v. Commissioner,supra.364 Petitioner was responsible for all replacement parts and maintenance, taxes, insurance, etc. In short, the lease was a net lease. The payments for such items were substantial and we are not prepared to hold that these amounts are necessarily encompassed within respondent's stipulation as to the reasonableness of the monthly rental payments. Nevertheless, the fact of the matter is that there is not the slightest indication that such net lease provisions were not customary in the construction industry insofar as heavy equipment, which is commonly known to be subjected to hard use, is concerned.6 Cf. Arkhola Sand & Gravel Co. v. United States,190 F. Supp. 29">190 F. Supp. 29 (W.D. Ark. 1960); Southern Ford Tractor Corp. v. Commissioner,29 T.C. 833">29 T.C. 833, 843 (1958). Given the posture of this case and the stipulation as to the reasonableness of the fixed monthly payment, we think it was at least incumbent upon respondent to raise the issue of the additional payments, irrespective of whether or not he would have been held to have the burden of proof thereon. In the same vein, we think it a significant consideration that, as we have previously pointed out (see pp. 15-16, 365 supra), respondent has not sought to bifurcate the claimed rental payments and to seek a partial disallowance. Nor are we impressed with respondent's argument that the same rental was maintained even though some of the equipment originally subject to the lease became unusable. The record contains evidence that such equipment was replaced by the additional equipment acquired by the corporation or by petitioner, who then transferred his acquisitions to the corporation, and that the value of the total equipment subject to the lease increased during the taxable years before us. Similarly, the fact that petitioner personally guaranteed the obligations of the corporation is of little significance in view of the customary requirement of such a guaranty by a sole shareholder. Petitioner was not a model either of punctuality or in making full payments under the lease. In addition, he was permitted to "skip" eight monthly payments, although eventually366 interest would be payable on the skipped payments (at a substantial rate of one percent per month). But these provisions did no more than make explicit arrangements for postponing payments for equipment that petitioner had been able to work out with unrelated entities. Moreover, although petitioner made irregular rental payments (a factor which lends some support to respondent's position), the fact of the matter is that petitioner did not exceed the permitted number of skippings during the taxable years before us. Finally, we take note of respondent's argument that it was petitioner's earning power, derived from the use of the equipment, which generated the funds used to pay the rentals and that this indicates that the lease was not bona fide. Whatever relevance this element may have in the area of intra-family transfers (see Kirschenmann v. Westover,225 F. 2d 69, 71 (9th Cir. 1955)), we think it of peripheral significance in the instant case. It cannot be gainsaid that, in the realities of the business world, business operations customarily generate the wherewithal to pay the rent on business premises. Our analysis must also take into account the fact367 that tax planning and minimization played a role in the transactions involved herein. Respondent has sought to convince us that the fundamental purpose of the transfer and leaseback was tax avoidance and that therefore we should strike them down. As we have previously indicated (see p. 19, supra), we would be the first to acknowledge that "the building may not be constructed entirely from the tax advantage, but if the foundation and bricks have economic substance, the economic or financial inducement of the tax advantage can provide the mortar." See McLane v. Commissioner,46 T.C. 140">46 T.C. 140, 145 (1966), affd. per curiam 377 F. 2d 557 (9th Cir. 1967). On the other hand, given the underlying business purpose of the transactions, namely, to improve petitioner's bonding capacity, 7 evidence that the transactions actually had such an impact (albeit not as great or an lasting as petitioner had hoped), the stipulation as to the reasonableness of the fixed monthly "rental" payment insofar as the years before us are concerned, and the way the trial and briefing of the case evolved, we conclude, on the basis of the entire record, that there was sufficient economic368 substance to the "foundation and bricks" of the arrangements between the petitioner and the corporation so that the tax advantage simply provided the "mortar," i.e., there was a legitimate substantive business purpose. In this connection, we think it of some significance that the tax savings involved herein had a bearing on petitioner's bonding limits because of the potential increase in his available cash. Moreover, we have not overlooked the facts that the corporation paid substantial taxes during the taxable years before us and that it was possible that the use of the corporate form might well prove disadvantageous to petitioner in the long run. Accordingly, we hold that the transfer to the corporation and the leaseback of the equipment by the sole proprietorship should be recognized for tax purposes and that the claimed rental payments by petitioner should be allowed as payments "required to be made as a condition to the continued use or possession * * of property," as provided in section 162(a)(3). Cf. Frank LyonCo. v. United States, U.S. (Apr. 18, 1978). In view of our holding, we need not decide whether petitioner is entitled to deduct the state franchise369 and excise tax paid by the corporation.One final word. Our analysis and holding herein is directed solely to petitioners' taxable years 1969, 1970, and 1971. What we have said may have only a tangential effect with respect to petitioners' right to deductions for similar payments in 1972, 1973, and 1974. The apparently increasing gap, during the latter period, between the amount of payments and the investment in the equipment, the potential impact of the possible failure of petitioner and the corporation to take into account changed conditions when the lease was renewed on January 2, 1972 (including the aging of the equipment), and a different frame of reference for any litigation that may take place370 could produce a different result.Certainly, respondent's arguments relating to the lease renewal on the same terms and conditions and the disposition of petitioner's unpaid obligations under the lease will have greater relevance to the determination of petitioners' right to the claimed deductions for those years. 8Decision 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 taxable years in issue, unless otherwise indicated.↩2. Respondent did not invoke and has not invoked the power of allocation under section 482, so the applicability of that section is not before us. Commissioner v. Transport Mfg. & Equip. Co.,478 F. 2d 731 (8th Cir. 1973), affg. on this issue Riss v. Commissioner,56 T.C. 388">56 T.C. 388, 400-401 (1971), and 57 T.C. 469">57 T.C. 469, 472 (1971). Compare Boyer v. Commissioner,58 T.C. 316">58 T.C. 316↩ (1972). 3. The two issues, i.e., whether the corporation is a sham and the recognition of the transfer and leaseback, are separate but not totally unrelated in view of the fact that the only business conducted by the corporation was the leasing and incidental buying and selling of the equipment involved herein.See Charlson v. United States,525 F.2d 1046">525 F. 2d 1046, 1057↩ (Ct. Cl. 1975).4. Compare also Southeastern Canteen Co. v. Commissioner,410 F.2d 615">410 F. 2d 615, 620↩ (6th Cir. 1969), affg. on this issueT.C. Memo. 1967-183.5. Under these circumstances, although we have recognized that the situations involving the deduction of allegedly excessive rentals are distinguishable (see p. 19, supra), the cases in that area provide some support for petitioner's position herein.Those cases recognize that a transaction between shareholders and their corporationis inherently not at arm's length and establish a guideline as to whether the transaction can be said to achieve "the same result as arm's-length dealings." See Ray's Clothes, Inc. v. Commissioner,22 T.C. 1332">22 T.C. 1332, 1337 (1954). Cf. Southeastern Canteen Co. v. Commissioner, footnote 4, supra. See also Little Carnegie Realty Corp. v. Commissioner,T.C. Memo. 1970-150↩.6. It is common knowledge that requirements that the lessee keep the property in good operating condition and insured, carry liability insurance, and pay taxes in respect of the use of the property are normal provisions of a net lease.↩7. Petitioners argue that additional business purposes were to centralize control over the business and to limit petitioner's liability from the operation of the construction business.During the taxable years involved, all construction operations were conducted by the proprietorship and petitioner was required to guarantee the corporation's indebtedness. As a result, these alleged business purposes were not furthered by the transfer and leaseback during the years before us.↩8. See Post Bros.Construction Co. v. Commissioner,T.C. Memo. 1973-257↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621561/	JACK EUGENE FLEMING and CAROLYN DELL FLEMING, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFleming v. CommissionerDocket Nos. 25460-82, 13415-83.United States Tax CourtT.C. Memo 1985-165; 1985 Tax Ct. Memo LEXIS 472; 49 T.C.M. (CCH) 1134; T.C.M. (RIA) 85165; April 2, 1985. Jack Eugene Fleming and Carolyn Dell Fleming, pro se. Barbara E. Horan, for the respondent in Docket No. 25460-82. Byron Calderon, for the respondent in Docket No. 13415-83. 473 SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge : By statutory notices of deficiency dated August 13, 1982 (for 1979) and May 19, 1983 (for 1980), respondent determined deficiencies in petitioners' Federal income tax liabilities and additions to tax as follows: Additions to TaxYearDeficiencySection 6651(a) 11979$4,769$655.08198018,4734,618.00After concessions, the issues for decision are: (1) The amounts of investment tax credit to which petitioners are entitled in 1979 and 1980; (2) whether petitioners may deduct $12,431.50 as a partnership loss in 1979; (3) whether petitioners may deduct $929.17 in legal expenses incurred in 1979; and (4) whether petitioners are liable for additions to tax under section 6651(a)(1) in 1979. FINDINGS OF FACT Some of the facts474 have been stipulated and are so found. Petitioners Jack Eugene Fleming and Carolyn Dell Fleming are husband and wife and resided in Colorado Springs, Colorado, at the time the petitions herein were filed. Petitioners filed their 1979 joint Federal income tax return late on October 16, 1980, and filed their 1980 joint Federal income tax return late on October 26, 1981. These cases were consolidated by order of this Court entered on September 5, 1984. 2 Petitioner Jack Eugene Fleming hereinafter will be referred to as "petitioner." During the years in controversy, petitioner and George Seeger (hereinafter referred to as "Seeger") each held a 50-percent partnership interest in F & S Warehouse (hereinafter referred to as "F & S"), which was formed to build and operate four commercial warehouses in Colorado Springs, Colorado. Petitioner, Seeger, and Albert475 Smith (hereinafter referred to as "Smith") also had incorporated a construction company, Tri-Pro Construction Company (hereinafter referred to as "Tri-Pro"), in which each held one-third of the outstanding shares of stock. F & S contracted with Tri-Pro to build the warehouses and Smith, acting as Tri-Pro's construction manager, Supervised the day-to-day construction of the warehouses. Two of the warehouses constructed for F & S were 10-feet wide and two of the warehouses were 25-feet wide. Each warehouse had five or six interior wood-fram walls that spanned the width of the building. The storage rooms within each warehouse were, however, separated by moveable partitions. The moveable partitions consisted of large (1" thick by 8' height by 2' width) panels of gypsum coreboard or drywall that were glued together and placed in metal channels that had been secured to the floor and ceiling of each warehouse. The coreboard was anchored in place by wedging a strip of one-half-inch plywood into the metal channel. Financing for the warehouse construction project was secured by a construction loan made to F & S by a local bank.F & S made periodic payments to Tri-Pro, and Tri-Pro then476 purchased the materials necessary for the construction of the warehouses from local building supply retailers. Those purchases apparently were made by bank check. Petitioner and Seeger were not aware that they were entitled to claim an investment tax credit for the moveable partitions in each warehouse until F & S' accountant, Larry Lowry (hereinafter referred to as "Lowry"), so informed them sometime after construction of the warehouses was completed in 1980. Upon completion of the warehouses, petitioner and Seeger had transferred to Smith their respective interests in Tri-Pro and, thus, any receipts or records that might have substantiated the cost basis of the moveable partitions were in Smith's possession. At Lowry's request, Smith and Seeger prepared an estimate of the costs incurred in constructing the moveable partitions by referring to Tri-Pro's checkbook register. Seeger gave that cost information to Lowry, and Lowry calculated the amounts of investment tax credit each partner (petitioner and Seeger) should claim on their individual Federal income tax returns for 1979 and 1980. Based on the information received from Lowry, petitioners reported on their 1979 and 1980477 Federal income tax returns a cost basis in the moveable partitions of $108,295 and $39,200, respectively. Petitioners claimed investment tax credits in the amount of $5,415 for 1979, based on a qualified investment of $54,150 (50-percent of $108,295), and in the amount of $7,375 3 in 1980, based on a qualified investment of $19,600 (50-percent of $39,200). In his notices of deficiency, respondent disallowed the investment tax credits claimed by petitioners for the moveable partitions and asserted that the partitions did not "qualify for investment credit under section 38." Upon his subsequent examination of the partitions, respondent conceded that the partitions were moveable and did qualify for the investment tax credit, but disagreed with petitioners over the cost basis of the partitions and, therefore, over the amounts of investment credit to which petitioners were entitled in 1979 and 1980. The parties agree, however, that 73.42-percent of478 the moveable partition system was placed in service in 1979 and that 26.58-percent of the moveable partition system was placed in service in 1980. In addition, respondent disallowed for lack of substantiation a partnership loss claimed by petitioners on their 1979 Federal income tax return in the amount of $12,431.50. Petitioner claims that that amount represents his share (50-percent) of the total loss incurred by F & S in 1979. The parties agree that a significant portion of the partnership loss is attributable to depreciation expenses claimed by the partnership with respect to the moveable partitions. The amount of partnership loss deducted by petitioners was based on information supplied to them by Lowry, and petitioners submitted Lowry's accounting work papers to substantiate the loss. Respondent also disallowed legal expenses in the amount of $929.17 claimed by petitioners in 1979. Respondent concedes that petitioner incurred those legal expenses but determined that the expenses represent capital expenditures relating to one of petitioner's businesses, known as Trailerville, and are not deductible. There is no evidence in the record with respect to the type of business479 Trailerville conducts or the purpose for which the legal expenses were incurred. At trial in Denver, Colorado, petitioner, Seeger, Smith, and Lowry testified for petitioners. We found petitioners' witnesses to be forthright, candid, and credible in their recitation of the facts. The testimony of Tri-Pro's construction manager, Smith, particularly was convincing because he personally was involved in the day-to-day construction of the moveable partitions, he personally purchased the materials used in the construction, be has many years of experience in the construction business, and had little interest in the outcome of the issues presented herein. Respondent's agent, Eddie Fernandez, testified for respondent as an expert in building construction and building appraisal. Fernandez' testimony also was credible, particularly with respect to measurements of the moveable partitions he calculated based on drawings of the warehouses that were provided by the warehouse manager. Apparently petitioners do not dispute the accuracy of those measurements. Documentary evidence also was received, but neither party offered sales receipts, Tri-Pro's checkbook register, or photocopies of cancelled480 checks to substantiate the cost of the materials actually used in constructing the partitions. The parties agree that, assuming any sales receipts were in fact issued, such receipts no longer exist. OPINION A credit against Federal income tax is allowed under section 38 for investments in certain types of depreciable property, as defined in Section 48(a) and (b), 4 that are placed in service by a taxpayer during the taxable year. In his notices of deficiency, respondent determined that the moveable partitions in petitioners' warehouses were not the type of property that qualifies for investment tax credit under section 38, and disallowed petitioners' credit. 5 At trial and on brief, respondent conceded that the moveable partitions did qualify for investment tax credit, but determined that the cost basis of the moveable partitions, and therefore, the amount of credit to which petitioners are entitled, had not been substantiated. 481 We first address a procedural issue raised by petitioners at trial and on brief. Petitioners contend that respondent's assertion that the cost basis of the moveable partitions has not been substantiated raises a "new matter" on which respondent bears the burden of proof under Rule 142(a). 6 Respondent argues that he has not raised a new matter because the explanations in his notices of deficiency of the disallowance of the investment credits were sufficiently broad to place in issue substantiation of the cost of the partitions. We agree with petitioners. When respondent asserts a new theory that alters the original deficiency or requires petitioners to present different evidence, respondent has introduced a new matter on which he bears the burden of proof. Achiro v. Commissioner,77 T.C. 881">77 T.C. 881, 890 (1981);482 Estate of Falese v. Commissioner,58 T.C. 895">58 T.C. 895, 898-99 (1972); Rule 142(a). The factual basis required to substantiate the costs incurred in constructing the moveable partitions is entirely different from the factual basis required to establish that the partitions are the type of property that qualifies for investment tax credit under sections 38 and 48. Although the issue of substantiation of petitioners' cost basis in the moveable partitions was tried by the consent of the parties and did not surprise or disadvantage petitioners, the placement of the burden of proof on respondent is not altered merely because petitioners were forewarned of respondent's new theory. Schuster's Express, Inc. v. Commissioner,66 T.C. 588">66 T.C. 588, 593-594 (1976), affd. 562 F.2d 39">562 F.2d 39 (2d Cir. 1977). 7 Therefore, we hold that in his determination that the cost basis of petitioners' moveable partitions is not substantiated, respondent asserted a new issue on which he bears the burden of proof, and we treat the pleadings as if the issue had been raised by respondent in his answer. Rules 142(a) and 41(b)(1). 8483 The parties agree that no receipts exist to substantiate the costs incurred in building and installing petitioners' moveable partitions. Therefore, each party presents alternative methods of estimating those costs. Essentially, the parties agree on the type of materials used to construct the partitions and on the individual price per item for those materials in 1979. The parties disagree over the quantity of materials used to construct the partitions and over the labor costs incurred to install the partitions. Petitioners present two estimates of the total cost basis in the moveable partitions, namely $147,495 and $170,887. 9 The first estimate, $147,495, was calculated by F & S' accountant Lowry, and reported to petitioners by letter dated July 31, 1980. Petitioners argue that Lowry's cost estimate is the most reliable because it is based on cost information obtained by Smith and Seeger from Tri-Pro's checkbook register. The second estimate484 presented by petitioners, $170,887, is based on complicated method of comparing the estimated cost of materials in their moveable partition system with the estimated total cost (both labor and materials) of constructing a permanent partition system. In estimating the total cost of constructing a permanent partition system, petitioners rely on a sophisticated real estate appraisal guide published by Marshall and Swift Publication Company (hereinafter referred to as "Marshall & Swift"). On the basis of that comparison, petitioners estimate their labor costs. Respondent rejects petitioners' cost estimates. Respondent asserts that Lowry's estimate is based on the unverified oral reports of an interested party, Seeger, who, as a 50-percent partner in F & S, also claimed an investment tax credit for his share of the movable partitions. In addition, respondent contends that petitioners' estimate of the cost of a permanent partition system is erroneous and, therefore, petitioners' reliance on that estimate to calculate the labor costs incurred in the installation of the moveable partitions is misplaced. Respondent offers three estimates of the cost basis of petitioners' moveable partitions,485 ranging from $47,592 to $58,482. First, respondent estimates the cost of materials used to construct the partitions to be $23,796. Respondent asserts that, generally, the cost of labor in a construction project is roughly equivalent to the cost of materials. Therefore, respondent calculates his first estimate of total cost to be $47,592, by doubling his estimate of the cost of materials ($23,796 times 2). Second, to estimate total cost, respondent uses a Marshall & Swift estimate of $ .54 per square foot, which represents the total costs (both labor and materials) of applying a one-half-inch sheet of gypsum coreboard to a preexisting wall as the interior facing thereof. Respondent multiplies that estimate by 2.5 ($ .54 times 2.5 equals $1.35 square foot) to account for the cost difference between one-inch coreboard, the type of coreboard installed by petitioners, and one-half-inch coreboard, the type of coreboard used in the Marshall & Swift estimate. Using that method, respondent estimates the total cost of the partitions to be $58,482 ($1.35 times 43,320 total square feet of partition). Third, respondent's agent, Fernandez, testified that he made an informal survey of building486 contractors in the Colorado Springs area which indicated that it would have cost approximately $1.28 per square foot in 1979 to build and install a moveable partition system similar to the system constructed in the F & S warehouses. Based on the results of that survey, respondent offers a third estimate of $55,450 (1.28 times 43,320 square feet). Respondent would allow petitioners to claim $58,482, the most generous estimate, as their cost basis in the moveable partitions. Petitioners contest the estimates offered by respondent. First, petitioners argue that the construction of the moveable partitions is "labor-intensive"; that is, that the labor costs thereof far exceed the cost of materials. Second, petitioners argue that respondent's use of the Marshall & Swift estimate of applying coreboard to a preexisting wall ($ .54 per square foot) is inapplicable herein because the estimate fails to account for the costs (both materials and labor) of the "frame" that supported the coreboard in petitioners' moveable partition system. After a thorough examination of the testimonial and documentary evidence presented, we conclude that none of the estimates offered by the parties adequately487 established the appropriate cost basis of the moveable partitions for the purpose of calculating the amount of investment tax credit to which petitioners are entitled. The following discussion briefly analyzes each estimate offered by the parties and explains the basis for our lack of confidence in those estimates. First, we accord little weight to the cost estimate in the amount of $147,495 prepared by F & S' accountant, Lowry. That estimate is based on information supplied to Lowry by Seeger and Smith, but neither Seeger nor Smith were able to specify the costs of individual items that were computed as part of the $147,495 total. Therefore, we have no basis from which to determine whether expenses in that amount actually were incurred or whether any of those expenses were incurred in the construction of the warehouses themselves, which costs are not subject to investment tax credit, rather than in the construction of the moveable partitions. Petitioners' second estimate (and respondent's second estimate as well) relies on the Marshall & Swift publication, which provides estimates of the total cost (including materials, labor, overhead, and profit) of various types of buildings488 or portions thereof. Marshall & Swift does not provide an estimate for the cost of moveable partitions such as those installed in petitioners' warehouses. Therefore, both parties have compared petitioners' moveable partition system to other types of walls for which Marshall & Swift does provide an estimate of cost. Petitioners' second estimate ($170,887) assumes that the cost of their partition system is most closely similar to the cost of constructing a permanent, immoveable frame partition. In Marshall & Swift, a permanent frame partition consists of a metal or wooden frame with vertical studs that is secured to the floor and ceiling and to which one-half-inch pieces of gypsum coreboard are applied on each side. Marshall & Swift estimates that the total cost in 1979 of such a permanent frame partition was $1.29 per square foot of floor area. Petitioners (erroneously) conclude that the Marshall & Swift estimate for a permanent frame partition ($1.29 per square foot) excludes the cost of the coreboard facing. That is, petitioner argues that the $1.29 estimate includes only the cost of the "frame." Petitioners therefore add to that figure the Marshall & Swift estimate of the489 cost of applying coreboard as the facing of a preexisting interior wall, which is $ .54 per square foot of wall space. By adding those two estimates together, petitioner calculates the total cost of a permanent frame partition to be approximately $1.83 per square foot. Petitioners' analysis from this point on becomes more complicated. Petitioners concede that the estimated cost of a permanent partition system would exceed the cost of their moveable partition system. Petitioners contend, however, that the ratio of the cost of materials to the cost of labor in both systems would be the same. Thus, petitioners endeavor to calculate the percentage of the total cost of a permanent frame partition that is attributable to the cost of materials and the percentage of total cost that is attributable to the cost of labor. Petitioners then apply those percentages to the estimated cost of materials in their moveable partition system to determine an estimate of total costs. Briefly, their analysis is as follows. Petitioners estimate the cost of materials used to construct a permanent frame partition. Petitioners then divide their estimate of the total cost of a permanent frame partition490 ($1.83 per square foot) by their estimate of the cost of materials. Petitioners conclude that the cost of materials in a permanent frame partition represents 24-percent of the total cost and, accordingly, the cost of labor represents 76-percent of the total cost. Petitioners then calculate the estimated cost of materials in their moveable partition system to be $41,013. Assuming that the same ratio of cost of materials to the cost of labor applies to the construction and installation of their moveable partitions, petitioners next divide their estimate of the cost of materials in the moveable partitions by 24-percent, and conclude that their total cost in the partition system is $170,887 ($41,013 divided by .24), of which $129,874 or 76-percent, is attributable to labor costs. In support of that analysis, petitioners contend that the construction of a moveable partition is "labor-intensive." That contention is not totally without support. Smith testified that one could purchase one-half-inch gypsum coreboard installed for approximately $ .42 per square foot, of which $ .15 per square foot would represent the cost of materials. If Smith is correct, the material costs would constitute491 36-percent of the total costs. We do not accept, however, petitioners' estimate that the cost of materials represents only 24-percent of the total cost of the moveable partitions. Petitioners' estimate of the total cost of a permanent frame partition ($1.83 per square foot), on which their estimate is based, is overinclusive in that it twice accounts for the costs (both materials and labor) of applying the gypsum coreboard. Thus, petitioners' reliance on that estimate as an indicator of the cost of their partition system is misplaced. In summary, we have little confidence in either of the estimates offered by petitioners to substantiate their cost basis in the moveable partitions. Turning next to respondent's three estimates of petitioners' costs, respondent first argues that labor costs incurred in installing a moveable partition system are equivalent to the cost of materials, resulting in an estimate of $47,592 ($23,796 times 2). In our opinion, however, respondent's first estimate, calculated by doubling his estimate of the cost of materials used in petitioners' moveable partition system, is not sufficiently substantiated to sustain his burden of proof, particularly in light492 of some evidence that the type of construction involved herein is labor-intensive. Respondent's second estimate ($58,482) assumes that the cost of petitioners' partition system is similar to the Marshall & Swift estimate of the cost of applying one-half-inch gypsum coreboard to a preexisting wall as the interior facing of the wall. Marshall & Swift estimates that cost to be $ .54 per square foot of wall space. Respondent then multiplies that figure by 2.5 to account for the difference in the cost of one-inch pieces of coreboard, resulting in an estimate of $58,482 ($ .54 times 2.5 times 43,320 square feet).We reject respondent's second estimate because it is underinclusive in that it fails to account for the costs (both materials and labor) of installing the "frame" portion of petitioners' moveable partition system, such as the metal channels and plywood strips. Respondent's third estimate ($55,450) is apparently based on an informal survey of building contractors conducted by respondent's agent. The testimony concerning the informal survey is totally unsubstantiated and, in our view, is an insufficient basis from which to conclude that respondent's third estimate is reliable. 493 That view is supported by respondent's expert witness report which evidences the expert's misconception about the construction of the partitions, particularly as to the size of the gypsum coreboard used therein. Thus, in our judgment, neither party has calculated an accurate estimate of the cost basis of petitioners' moveable partitions. We have, however, relied to some extent on each party's estimates, among other evidence, as a basis for our determination of the cost basis of the moveable partitions. We adopt respondent's measurement of 5,415 liner feet, or 43,320 square feet (5,415 linear feet times 8-foot height), in petitioners' partition system because petitioner has not presented alternative measurements and in fact has relied on respondent's measurements in their estimates. In our view, respondent's second estimate of $58,482 is the most accurate approximation of petitioners' actual cost of the moveable partitions. That estimate accounts for both material and labor costs of installing one-inch coreboard to a preexisting wall. We must, however, add to that estimate the cost incurred for materials to construct the partitions' "frame", and the cost of labor to build the494 frame and install the coreboard therein. First, with respect to the unit price of the indiviudal components in the frame, we adopt the parties' agreement as to three categories of frame components, and we adopt Smith's estimates of the remaining two categories. Second, with respect to the quantity of materials used to build the frame, we adopt Smith's estimates in the four categories in which the parties disagree. In our opinion, the most appropriate figure for the cost of materials used in the frame portion of petitioners' moveable partitions is $9,483. 10Next, we must estimate the cost of labor to build the frame and install the coreboard therein. In our opinion, and on495 the basis of the record herein, we estimate those labor costs to be approximately equal to the estimated cost of materials used to construct the frame. Thus, we add $10,000 as an estimate of the labor costs incurred in building the frame portion of the partitions at issue. In summary, the cost basis of petitioners' moveable partition system may be itemized as follows: (1) Respondent's estimate of the costs ofmaterials and labor of applying one-inchgypsum coreboard to a preexisting wall($ .54 times 2.5 times 43,320 sq. ft.)$58,482(2) Cost of materials in the "frame"9,483(3) Estimated labor costs of installing the"frame"10,000Total cost basis of moveable partitions:$77,965Therefore, we hold that the total cost basis of petitioners' moveable partition system is $77,965, of which 73.42-percent ($57,242) was placed in service in 1979 and of which 26.58-percent ($20,723) was placed in service in 1980. Thus, petitioner may claim investment tax credits based on qualified investments in the amounts of $28,621 (50-percent of $57,242) and $10,361.50 (50-percent of $20,723) in 1979 and 1980, respectively. Partnership LossRespondent disallowed496 petitioners' partnership loss in 1979 in the amount of $12,431.50 for lack of substantation. Respondent concedes that a "significant portion" of the loss is attributable to depreciation expenses claimed by petitioners with respect to the moveable partitions installed in the F & S warehouses. Neither party, however, offers any evidence that would allow the Court to determine the extent to which the partnership loss is comprised of those depreciation expenses. Petitioner submitted as evidence some of Lowry's accounting work papers, summary sheets, and correspondence to substantiate the claimed partnership loss. Lowry also testified at trial, but his testimony centered specifically on his computation of the cost basis of moveable partitions and did not explain the extent to which F & S' expenses or income, if any, had been reflected in petitioners' deduction for the partnership loss. Without some documentation in the form of receipts, or reliable testimony supporting the accounting worksheets, we cannot determine whether the amount reflected as partnership loss was properly computed and allocated to petitioner or whether any such losses were incurred. We therefore hold that petitioners497 are not entitled to deduct any portion of the $12,431.50 claimed as a partnership loss in 1979. Legal ExpensesRespondent disallowed $929.17 in legal expenses incurred by petitioner in 1979. In his opening statement at trial, respondent explained the disallowance of the claimed legal expenses in a general statement, indicating that the expenses were nondeductible capital expenditures. In his opening statement, petitioner explained that those expenses were incurred in a dispute with his partner over a business known as Trailerville. Neither side, however, offered any testimonial or documentary evidence concerning the issue. Petitioner failed to introduce any evidence on this issue, and we therefore are unable to authorize any deduction for legal expenses, on which petitioners bear the burden of proof. Rule 142(a). We therefore sustain respondent's disallowance of petitioners' legal expenses. Addition to Tax--Section 6651(a)(1)Respondent determined additions to tax under section 6651(a)(1) 11 for 1979 and 1980, and asserted that petitioners did not establish a reasonable cause for the late filing of their 1979 and 1980 Federal income tax returns. Petitioners conceded498 the addition for 1980 and presented no evidence with respect to the addition for 1979. On brief they contend that the failure to timely file was due to reasonable cause and not to willful neglect because they did not receive information from their accountant regarding the F & S warehouse partnership until July 31, 1980. Petitioners also assert that because they were under the impression that they would not owe any Federal income tax for 1979, they decided to file late, rather than to file in a timely fashion and amend their return upon receipt of the information concerning the partnership. 499 We agree with respondent that the evidence establishes that petitioners' delinquency was due to willful neglect and not due to reasonable cause. We sustain respondent's addition to tax under section 6651(a)(1). Decisions will be entered under Rule 155.Footnotes. By order of the Chief Judge, Docket No. 13415-83 was reassigned from Judge Meade Whitaker to Judge Stephen J. Swift↩.1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect in the years in dispute, and all rule references are to the United States Tax Court Rules of Practice and Procedure.↩2. After concessions, the sole issue in Docket No. 13415-83 is the amount of investment tax credit to which petitioners are entitled in 1980. The parties agree that all evidence available on that issue is contained in the record in Docket No. 25460-82 and agree to be bound with respect to that issue by our decision herein.↩3. On their 1980 Federal income tax return, petitioners erroneously claimed $5,415 as investment tax credit carry-forward. That amount was the amount of investment credit claimed by petitioners in 1979 and disallowed by respondent.↩4. Section 48 provides, in relevant part: (a) Section 38 Property.-- (1) In general.--Except as provided in this subsection, the term "section 38 property" means-- (A) tangible personal property (other than an air conditioning or heating unit), or (B) other tangible property (not including a building and its structural components) * * Such term includes only recovery property (within the meaning of section 168 without regard to any useful life) and any other property with respect to which depreciation (or amortization in lieu of depreciation) is allowable and having a useful life (determined as of the time such property is placed in service) of 3 years or more. * * * ↩5. In his notice of deficiency dated August 13, 1982, for taxable year 1979 (docket no. 25460-82), respondent offered the following explanation for his disallowance of the investment tax credit: The $5,415.00 shown as an investment credit on F & S Warehouse Property is disallowed because it has not been established that the property qualifies for the investment credit under section 38 of the Internal Revenue Code. Therefore your tax is increased $5,415.00. A similar explanation was offered in respondent's notice of deficiency for taxable year 1980, dated May 19, 1983 (docket no. 13415-83): The $7,375.00 shown as an investment credit is disallowed because (a) the property does not qualify for the investment credit under section (38) of the Internal Revenue Code, and (b)↩ there is no carry-over of credit as a result of audit adjustments to taxable year 1979.6. Rule 142(a) provides: (a) General: The burden of proof shall be upon the petitioner, except as otherwise provided by statute or determined by the Court; and except that, in respect of any new matter, increases in deficiency, and affirmative defenses, pleaded in his answer, it shall be upon the respondent. As to affirmative defenses, see Rule 39.↩7. Denman v. Commissioner,T.C. Memo. 1981-332↩. 8. Rule 41(b)(1) provides, in relevant part: (b) Amendments to Conform to the Evidence: (1) Issues Tried by Consent:↩ When issues not raised by the pleadings are tried by express or implied consent of the parties, they shall be treated in all respects as if they had been raised in the pleadings. * * 9. For simplicity, our discussion will center on calculations of the total cost basis of petitioner's moveable partition system; those total costs will then be allocated between 1979 and 1980 according to the agreement of the parties.↩10. The costs for the frame portion of the partitions may be itemized as follows: ↩TotalMaterialCategoriesUnit PriceQuantityCostGlue$4.75 per tube150 tubes$ 713Metal channel.50 per linear ft.10,830 linear ft.5,415Concrete fasteners.60 per fastener4,061 fasteners2,437Plywood14.00 per sheet57 sheets798Nails30.00 per building4 buildings120Total Cost of Materials in the Frame$9,48311. Section 6651(a)(1) provides in relevant part: (a) Addition to the Tax.--In case of failure-- (1) to file any return * * on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during with such failure continues, not exceeding 25 percent in the aggregate; * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621563/	FRANK R. AND JUDITH C. PAULSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; GERALD J. VON ALMEN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPaulson v. CommissionerDocket Nos. 21436-85, 21438-85.United States Tax CourtT.C. Memo 1995-387; 1995 Tax Ct. Memo LEXIS 381; 70 T.C.M. (CCH) 399; August 14, 1995, Filed 381 Decisions will be entered under Rule 155. Lois C. Blaesing and Chauncey W. Tuttle, Jr., for petitioners. Mary P. Hamilton, Paul Colleran, and William T. Hayes, for respondent. DAWSON, Judge. WOLFE, Special Trial Judge DAWSON; WOLFEMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: These cases were assigned to Special Trial Judge Norman H. Wolfe pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. 1 They were tried and briefed separately but consolidated for purposes of opinion. The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE WOLFE, Special Trial Judge: These cases are part of the Plastics Recycling group of cases. For a detailed discussion of the transactions involved in the Plastics Recycling382 cases, see Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without published opinion 996 F.2d 1216">996 F.2d 1216 (6th Cir. 1993). The facts of the underlying transaction in these cases are substantially identical to those in the Provizer case. Through a second tier partnership, Efron Investors (EI), petitioners Frank R. Paulson and Gerald J. Von Almen invested in the Clearwater Group limited partnership (Clearwater), the same partnership considered in the Provizer case. Pursuant to petitioners' requests at trial, this Court took judicial notice of our opinion in the Provizer case. In a notice of deficiency issued by certified mail on April 12, 1985, respondent determined deficiencies in the joint 1978 and 1981 Federal income taxes of petitioners Frank R. and Judith C. Paulson (the Paulsons) in the amounts of $ 1,666 and $ 9,854, respectively. In notices of deficiency issued by certified mail on April 12, 1985, respondent determined deficiencies in Gerald J. Von Almen's 1978, 1979, and 1981 Federal income taxes in the respective amounts of $ 6,425, $ 5,948, and $ 10,800. 2 In the notices of deficiency, respondent also determined383 that the deficiencies in the Paulsons' 1978 and 1981 Federal income taxes and Gerald J. Von Almen's 1978, 1979, and 1981 Federal income taxes were substantial underpayments attributable to tax-motivated transactions and that, as a result, interest on those deficiencies accruing after December 31, 1984, would be calculated at 120 percent of the statutory rate under section 6621(c). 3 The deficiencies for taxable years 1978 and 1979 result from disallowance of investment tax and business energy credit carrybacks from 1981. 384 In addition to the deficiencies and additions to tax described above, in amended answers, respondent asserted the following additions to petitioners' Federal income taxes: Additions to Tax UnderDocket No.PetitionersYearSec. 6653(a)Sec. 6653Sec. 6653Sec. 6659(a)(1)(a)(2)21436-85Paulson1978$ 83----$ 5001981--$ 49312,39321438-85Von Almen1978321----1,9281979297----1,784 1981--54012,079 The issues in these consolidated cases are: (1) Whether the assessments are barred by the statute of limitations; (2) whether expert reports and testimony offered by respondent are admissible into evidence; (3) whether petitioners are entitled to claimed deductions and tax credits with respect to Clearwater as passed through EI; (4) whether petitioners are liable for additions to tax for negligence or intentional disregard of rules or regulations under section 6653(a) for the years in issue; (5) whether petitioners are liable for the additions to tax under section 6659 for underpayment of385 taxes attributable to valuation overstatement; and (6) whether petitioners are liable for increased interest under section 6621(c). FINDINGS OF FACT Some of the facts have been stipulated in each case and are so found. The stipulated facts and attached exhibits are incorporated in the respective cases by this reference. Petitioners resided in Munster, Indiana, when their petitions were filed. During the years in issue Frank R. Paulson (Paulson) was a boilermaker, Judith C. Paulson was a teacher, and Gerald J. Von Almen (Von Almen) was a construction superintendent. Paulson and Von Almen are limited partners in EI, which is a limited partner in the Clearwater limited partnership. The Clearwater limited partnership is the same recycling partnership that we considered in Provizer v. Commissioner, supra. The underlying deficiencies in these cases resulted from respondent's disallowance of claimed losses and tax credits that were passed through both Clearwater and EI to Paulson and Von Almen. Petitioners have stipulated substantially the same facts concerning the underlying transactions as we found in Provizer v. Commissioner, supra.386 4 Those facts may be summarized as follows. In 1981, Packaging Industries, Inc. (PI), manufactured and sold six Sentinel expanded polyethylene (EPE) recyclers to ECI Corp. for $ 5,886,000 ($ 981,000 each). ECI Corp., in turn, resold the recyclers to F & G Corp. for $ 6,976,000 ($ 1,162,666 each). F & G Corp. then leased the recyclers to Clearwater, which licensed the recyclers to FMEC Corp., which sublicensed them back to PI. All of the monthly payments required among the entities in the above transactions offset each other. These transactions were accomplished simultaneously. We refer to these transactions collectively as the Clearwater transaction. The fair market value of a Sentinel EPE recycler in 1981 was not in excess of $ 50,000. 387 PI allegedly sublicensed the recyclers to entities that would use them to recycle plastic scrap. The sublicense agreements provided that the end-users would transfer to PI 100 percent of the recycled scrap in exchange for a payment from FMEC based on the quality and amount of recycled scrap. In 1981, EI acquired a 43.313-percent limited partnership interest in Clearwater, Paulson acquired a 1.596-percent limited partnership interest in EI, and Von Almen acquired a 3.194- percent limited partnership interest in EI. As a result of passthrough from Clearwater and EI, Paulson deducted an operating loss in the amount of $ 4,470 and claimed investment tax and business energy credits totaling $ 9,644 and Von Almen deducted an operating loss in the amount of $ 8,945 and claimed investment tax and business energy credits totaling $ 19,302. 5 Paulson used $ 7,978 of the credits claimed with respect to his investment in EI and Clearwater on his 1981 Federal income tax return and carried back $ 1,666, the unused portion of the claimed business energy credit, to 1978. Von Almen used $ 6,929 of his claimed credits on his 1981 return and carried back the unused portion of the credits to 1978 388 and 1979 in the respective amounts of $ 6,425 and $ 5,948. Respondent disallowed petitioners' claimed deductions and credits related to EI's investment in Clearwater. EI is an Indiana limited partnership that was formed in May of 1981 by Morton L. Efron (Efron) as the general partner and Real Estate Financial Corp. (REFC) as the initial limited partner. Fred Gordon (Gordon) is the president of REFC, which is owned by members of Gordon's family. EI was formed to acquire limited partnership interests in an office building in Buffalo, New York (the office building), and a shopping center in Haslett, Michigan (the shopping center). In contemplation of these ventures, EI prepared a private placement memorandum (the original 389 offering memorandum) and distributed it to potential limited partners. At some time in late 1981, EI abandoned the contemplated investment in the shopping center and substituted limited partnership interests in Clearwater and a K-Mart shopping center in Swansea, Massachusetts (the K-Mart investment). The revised investment objectives were presented in a revised offering memorandum (the revised offering memorandum). The revised offering memorandum indicated that EI intended to invest in 100 percent of the limited partnership interests in the office building (10 units), 43.75 percent of the limited partnership interests in Clearwater (7 units), and 15.625 percent of the limited partnership interests in the K-Mart investment (2-1/2 units). Potential EI limited partners were informed of the change in EI's investment objectives through informal conversations and the revised offering memorandum. MFA Corp. (MFA) is the ministerial agent for EI. Efron owns 50 percent of the stock of MFA, and REFC owns the remaining 50 percent. The revised offering memorandum states that Efron, as general partner of EI, and MFA, as the ministerial agent for EI, will receive substantial fees, compensation, 390 and profits from EI. The contemplated payments to MFA include: (1) $ 100,000 for supervisory management of the office building and ministerial fees; (2) $ 100,000 - $ 125,000 as loan commitment fees; (3) $ 25,000 for note collection guarantees; and (4) a maximum of $ 100,750 in investment advisory fees. In addition, MFA was also the ministerial agent for the office building limited partnership and, according to the revised offering memorandum, received substantial payments in that capacity. Paulson learned of EI and the Clearwater transaction from Efron. In 1981, Paulson was an acquaintance of Efron; at trial Paulson described Efron as a friend. Paulson met Efron through his brother, Wayne Paulson, who had prior investment experience with Efron. Von Almen learned of EI and the Clearwater transaction from Efron and Wayne Paulson. In 1981 Von Almen, Efron, and Wayne Paulson were acquaintances; at trial, Von Almen described them as "just mutual friends". In addition, Efron was Von Almen's attorney with respect to Von Almen's divorce proceedings. Wayne Paulson acted as Von Almen's offeree representative with respect to Von Almen's investment in EI. However, Wayne Paulson did not review391 the original offering memorandum with Von Almen, he did not aid Von Almen in completing the offeree questionnaire, and he never discussed recycling with Von Almen. Efron was the general partner of EI. In addition, Efron owned limited partnership interests in EI through Efron and Efron Real Estate, a partnership owned by Efron and his wife, and AMBI Real Estate, a partnership owned by Efron and his sister. EI was the first partnership for which Efron served as a general partner. Efron organized EI so that he could earn legal fees and fees for managing the partnership. He received compensation and fees as the general partner of EI and as a 50-percent shareholder of MFA. Efron learned of the Clearwater transaction from Gordon. In 1981 Gordon was counsel to EI, to Efron as the general partner of EI, to Efron personally, and to MFA. He and Efron have known each other since meeting at the University of Michigan in 1955. In the early 1960's Efron and Gordon began investing together in the stock market, real estate, business loans, and other investments. Gordon is an attorney who holds a master's degree in business administration and at one time was employed by the Internal Revenue Service. 392 Prior to the date of the Clearwater private placement offering, Gordon had experience involving the evaluation of tax shelters. Gordon was paid a fee in the amount of 10 percent of some investments he guided to Clearwater; however, he did not receive a fee directly from Clearwater for the EI investments. Efron was aware that Gordon received commissions from the sale of some units in recycling ventures. 6 Gordon recommended investing in the Clearwater offering to the investors in EI, as well as to some of Gordon's other clients. 393 Efron obtained financing for the EI investments through local banks. Some of the limited partners in EI made a cash downpayment to EI and then signed installment promissory notes for the remainder of the purchase price. Thereafter, Efron pledged any promissory notes received from limited partners as security for loans to EI. In addition to lending funds directly to EI, the banks also offered loans to individual limited partners for the downpayments needed with respect to the EI investments. Paulson subscribed to purchase one-fourth of a limited partnership unit ($ 25,000) in EI, and Von Almen subscribed to purchase one-half of a limited partnership unit ($ 50,000). Efron guided both Paulson and Von Almen to Donald Cassaday (Cassaday), a vice president of the First Bank of Whiting, to finance acquisition of their interests in EI. Cassaday was involved with arranging the financing for EI with Efron and arranged required financing for some of the EI limited partners. Both Paulson and Von Almen borrowed all of the funds they required to finance acquisition of their interests in EI from the First Bank of Whiting through Cassaday. The notes were secured solely by the EI investments. 394 Both Paulson and Von Almen graduated from high school and completed 1 year of college. Judith C. Paulson holds a degree in education from Indiana University. Petitioners do not have any formal training or work experience relating to investments. Petitioners do not have any education or work experience in plastics recycling or plastics materials. They did not independently investigate the Sentinel recyclers or see a Sentinel recycler or any other type of plastics recycler prior to participating in the recycling ventures. OPINION In Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without published opinion 926 F.2d 1216">926 F.2d 1216 (6th Cir. 1993), a test case involving the Clearwater transaction and another tier partnership, this Court (1) found that each Sentinel EPE recycler had a fair market value not in excess of $ 50,000, (2) held that the Clearwater transaction was a sham because it lacked economic substance and a business purpose, (3) upheld the section 6659 addition to tax for valuation overstatement since the underpayment of taxes was directly related to the overstatement of the value of the Sentinel EPE recyclers, and (4) 395 held that losses and credits claimed with respect to Clearwater were attributable to tax-motivated transactions within the meaning of section 6621(c). In reaching the conclusion that the Clearwater transaction lacked economic substance and a business purpose, this Court relied heavily upon the overvaluation of the Sentinel EPE recyclers. Although petitioners have not agreed to be bound by the Provizer opinion, they have stipulated that their investments in the Sentinel EPE recyclers were similar to the investment described in Provizer v. Commissioner, supra, and, pursuant to their request, we have taken judicial notice of our opinion in the Provizer case. Petitioners invested in EI, a tier partnership that invested in Clearwater. The underlying transaction in these cases (the Clearwater transaction), and the Sentinel EPE recyclers considered in these cases, are the same transaction and machines considered in Provizer v. Commissioner, supra.Issue 1. Statute of Limitations In their petitions, petitioners allege that the notices of deficiency were not issued within the statutory limitations period. 396 This issue appears to have been abandoned. None of the trial memoranda or briefs address the statute of limitations. Regardless of whether the issue was abandoned, the record shows that the notices of deficiency in these cases were issued within the statutory limitations period. In general, section 6501(a) requires assessment of tax to be made within 3 years after a return is filed, whether the return was filed on or after the date prescribed. Section 6501(b)(1) provides that if a return is filed before the due date, for purposes of section 6501, the return shall be considered filed on the due date. Section 6501(j) provides that deficiencies resulting from credit carrybacks may be assessed within the period applicable to the year that produced the carrybacks. The records in these cases do not show the dates that the Paulsons or Von Almen filed their 1981 Federal income tax returns; however, both the Paulsons' and Von Almen's 1981 returns were due on April 15, 1982. See sec. 6072. The earliest date that the returns are deemed filed for purposes of section 6501 is April 15, 1982. See sec. 6501(b)(1). Respondent mailed the notices of deficiency in these cases on April 12, 1985, within397 the 3-year period provided by section 6501(a). Because the deficiencies determined by respondent for 1978 in docket No. 21436-85 and for 1978 and 1979 in docket No. 21438- 85 relate solely to investment tax and business energy credit carrybacks from 1981, the period of limitations under section 6501(a) is governed by the period of limitations applicable to 1981. Sec. 6501(j). As noted above, the statutory period for assessment for 1981 had not expired when respondent issued the notice of deficiency in these cases. Therefore, the statutory period under section 6501(j) with respect to the carrybacks to 1978 and 1979 had not expired when respondent issued her notices of deficiency. Issue 2. Admissibility of Expert Reports and TestimonyBefore addressing the substantive issues in these cases, we resolve an evidentiary issue. At trial, respondent offered in evidence the expert opinions and testimony of Steven Grossman (Grossman) and Richard Lindstrom (Lindstrom). At trial and in their reply briefs, petitioners object to the admissibility of the testimony and reports. The expert reports and testimony of Grossman and Lindstrom are identical to the testimony and reports in Fine v. Commissioner, T.C. Memo. 1995-222.398 In addition, petitioners' arguments with respect to the admissibility of the expert testimony and reports are identical to the arguments made in the Fine case. For discussions of the reports and testimony, see Fine v. Commissioner, supra, and Provizer v. Commissioner, supra. For a discussion of the testimony and petitioners' arguments concerning the admissibility of the testimony and reports, see the Fine case. For reasons set forth in Fine v. Commissioner, supra, we hold that the reports and testimony of Grossman and Lindstrom are relevant and admissible and that Grossman and Lindstrom are experts in the fields of plastics, engineering, and technical information. We do not, however, accept Grossman or Lindstrom as experts with respect to the ability of the average person, who has not had extensive education in science and engineering, to conduct technical research, and we have limited our consideration of their reports and testimony to the areas of their expertise. We also hold that Grossman's report meets the requirements of Rule 143(f). Issue 3. Deductions and 399 Tax Credits With Respect to EI and ClearwaterThe underlying transaction in these cases is substantially identical in all respects to the transaction in Provizer v. Commissioner, T.C. Memo. 1992-177. The parties have stipulated the facts concerning the deficiencies essentially as set forth in our Provizer opinion. Based on these records, we hold that the Clearwater transaction was a sham and lacked economic substance. In reaching this conclusion, we rely heavily upon the overvaluation of the Sentinel EPE recyclers. Accordingly, we sustain respondent's disallowance of the deductions and credits claimed with respect to Clearwater. Moreover, we note that petitioners in both of the cases at hand have stated their concession of this issue on brief. The record plainly supports respondent's determinations regardless of such concessions. For a detailed discussion of the facts and the applicable law, see Provizer v. Commissioner, supra.Issue 4. Sec. 6653(a) NegligenceIn her first amendment to answer in docket No. 21436-85, respondent asserted that the Paulsons were liable for the negligence additions to tax under400 section 6653(a) for 1978 and under section 6653(a)(1) and (2) for 1981. In her first amendment to answer in docket No. 21438-85, respondent asserted that Von Almen was liable for the negligence additions to tax under section 6653(a) for 1978 and 1979, and under section 6653(a)(1) and (2) for 1981. Because these additions to tax were raised for the first time in respondent's amendments to answer, respondent bears the burden of proof on these issues. Rule 142(a); Vecchio v. Commissioner, 103 T.C. 170">103 T.C. 170, 196 (1994). Section 6653(a) for 1978 and 1979, and section 6653(a)(1) for taxable year 1981 provide for an addition to tax equal to 5 percent of the underpayment if any part of an underpayment of tax is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2) for taxable year 1981 provides for an addition to tax equal to 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence. Negligence is defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985).401 The question is whether a particular taxpayer's actions in connection with the transactions were reasonable in light of his experience and the nature of the investment or business. See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728">60 T.C. 728, 740 (1973). Petitioners contend that they were reasonable in claiming deductions and credits with respect to EI's investment in Clearwater. To support their contention, petitioners allege the following: (1) That claiming the deductions and credits with respect to EI's investment in Clearwater was reasonable in light of a so-called oil crisis in the United States in 1981; (2) that in claiming the deductions and credits, they relied upon qualified advisers; and (3) that they should be relieved of the negligence additions to tax for reasons set forth in Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo. 1988-408. Petitioners argue, in general terms, that they were reasonable in claiming the deductions and credits related to EI's investment in Clearwater because of an alleged oil crisis in the United States during 1981. On brief Paulson argues402 very generally that he should be relieved of the negligence additions to tax because he "was reasonably influenced by the then ongoing national energy crisis." At trial, however, Paulson testified that he did not know whether recycling had good economic potential. He did not review the revised offering memorandum and was unaware of the details of the Clearwater transaction and how Clearwater was supposed to generate income. Von Almen testified that he believed that recycling had good economic potential because of the so-called oil crisis in the United States during 1981. Von Almen explained, however, that although he "looked through * * * [the revised offering memorandum] briefly", he did not understand the recycling investment. We find petitioners' vague, general claims concerning the so-called oil crisis to be without merit. Petitioners' reliance on Krause v. Commissioner, 99 T.C. 132 (1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024">28 F.3d 1024 (10th Cir. 1994), is misplaced. The facts in the Krause case are distinctly different from the facts of these cases. In the Krause case, the taxpayers invested in limited403 partnerships whose investment objectives concerned enhanced oil recovery (EOR) technology. The Krause opinion notes that during the late 1970's and early 1980's, the Federal Government adopted specific programs to aid research and development of EOR technology. Id. at 135-136. In holding that the taxpayers in the Krause case were not liable for the negligence-related additions to tax, this Court noted that one of the Government's expert witnesses acknowledged that "investors may have been significantly and reasonably influenced by the energy price hysteria that existed in the late 1970's and early 1980's to invest in EOR technology." Id. at 177. In the present cases, however, one of respondent's experts, Grossman, noted that the price of plastics materials is not directly proportional to the price of oil, that less than 10 percent of crude oil is utilized for making plastics materials, and that studies have shown that "a 300% increase in crude oil prices results in only a 30 to 40% increase in the cost of plastic products." While EOR was, according to our Krause opinion, in the forefront of national policy and404 the media during the late 1970's and early 1980's, there is no showing in these records that the so-called energy crisis would provide a reasonable basis for petitioners' investing in recycling of polyethylene. Moreover, the taxpayers in the Krause opinion were experienced in or investigated the oil industry and EOR technology specifically. One of the taxpayers in the Krause case undertook significant investigation of the proposed investment including researching EOR technology. The other taxpayer was a geological and mining engineer whose work included research of oil recovery methods and who hired an independent geologic engineer to review the offering materials. Id. at 166. In the present cases, petitioners were not experienced or educated in plastics recycling or plastics materials. They did not independently investigate the Sentinel recyclers, and they did not hire an expert in plastics to evaluate the Clearwater transaction. We consider petitioners' arguments with respect to the Krause case inapplicable and find their arguments as to the so-called oil crisis without merit. On their 1981 Federal income tax returns alone, petitioners405 claimed investment tax and business energy credits with respect to EI's investment in Clearwater that exceeded their investment in Clearwater. The table below shows the amounts of credits related to Clearwater claimed on petitioners' 1981 Federal income tax returns and the amounts of petitioners' investments in Clearwater through EI. Investment Tax andInvestmentPetitionersBusiness Energy Creditsin Clearwater 1Paulson$ 9,644$ 5,586Von Almen19,30211,179Like the taxpayers in Provizer v. Commissioner, T.C. Memo. 1992-177, "except for a few weeks at the beginning, petitioners [Paulson and Von Almen] never had any money in the [Clearwater] deal." In light of the large tax benefits claimed on petitioners' 1981 Federal income tax returns, we conclude that further investigation of the investment clearly was required. A reasonably prudent person would have asked a qualified independent tax adviser if this windfall were not too good406 to be true. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 850 (1989). In fact, petitioners argue that they consulted qualified advisers and relied upon them in claiming the disallowed losses and tax credits. Both Paulson and Von Almen argue that their reliance on the advice of Efron and Cassaday insulates them from the negligence additions to tax. In addition, Von Almen contends that he is not liable for the negligence additions to tax because of his reliance on Paulson, his offeree representative with respect to his investment in EI. Under some circumstances a taxpayer may avoid liability for the additions to tax for negligence under section 6653(a) if reasonable reliance on a competent professional adviser is shown. Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849, 888 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868">501 U.S. 868 (1991). Such circumstances are not present in these cases. Moreover, reliance on professional advice, standing alone, is not an absolute defense to negligence, but rather a factor to be considered. Id. In order for reliance on professional advice to excuse407 a taxpayer from the negligence additions to tax, the reliance must be reasonable, in good faith, and based upon full disclosure. Id.; see Weis v. Commissioner, 94 T.C. 473">94 T.C. 473, 487 (1990); Ewing v. Commissioner, 91 T.C. 396">91 T.C. 396, 423-424 (1988), affd. without published opinion 940 F.2d 1534">940 F.2d 1534 (9th Cir. 1991); Pritchett v. Commissioner, 63 T.C. 149">63 T.C. 149, 174-175 (1974). We have rejected pleas of reliance when neither the taxpayer nor the advisers purportedly relied upon by the taxpayer knew anything about the nontax business aspects of the contemplated venture. Beck v. Commissioner, 85 T.C. 557">85 T.C. 557 (1985); Flowers v. Commissioner, 80 T.C. 914 (1983); Steerman v. Commissioner, T.C. Memo. 1993-447. The record does not show that Efron, Cassaday, or Wayne Paulson possessed any special qualifications or professional skills in the recycling or plastics industries. In addition, Efron did not hire anyone with plastics or recycling expertise to evaluate the Clearwater transaction, and the record 408 does not show that Cassaday or Wayne Paulson hired anyone to evaluate the Clearwater transaction. In evaluating the Clearwater transaction, Efron contends that he relied upon (1) the offering materials; (2) Barry Swartz, an accountant; (3) various bankers who loaned funds to EI; and (4) Gordon for his expertise in taxation, finance, and investments. Although Efron testified that when making investments he knows "enough to go get an expert or somebody that knows something", Efron did not consult any plastics engineering or technical experts with respect to EI's investment in Clearwater. Efron relied heavily upon Gordon in deciding to include Clearwater as a part of the revised EI offering. Efron was aware that Gordon was an offeree representative, and received commissions as such, from other recycling investments. Gordon testified that he did not directly receive a sales commission with respect to the EI investment in Clearwater. The record with respect to the payment of commissions on this investment is inconclusive. See supra note 6. In evaluating the Clearwater transaction, Gordon relied on the offering materials and on discussions with persons involved in the transaction. Efron409 does not suggest that Swartz or the bankers had any peculiar or specialized knowledge of the Clearwater transaction beyond that of any accountant or banker who had read the prospectus. Paulson and Von Almen first became aware of the EI investments through Efron. They contend that they relied heavily on Efron in making their investments in EI and in claiming the associated tax deductions and credits and that they should be relieved of the negligence additions to tax under section 6653(a) because of their alleged reliance on Efron. In 1981, Paulson was acquainted with Efron. He was aware of Efron's success in personal investments and in investments with Paulson's brother, Wayne Paulson. Paulson did not review any of the materials related to his investment in EI. He did not read the original offering memorandum or the revised offering memorandum. Paulson's testimony was general and vague, providing no details of his inquiry of Efron or the advice he received from Efron, if any, following the change in EI's use of funds to include the investment in Clearwater. The only evidence in the record in docket No. 21436-85 concerning Efron's advice to Paulson is Efron's testimony that he advised410 every limited partner in EI to talk to an independent adviser. Von Almen also was acquainted with Efron. In addition, Efron was Von Almen's attorney with respect to Von Almen's divorce proceedings. Von Almen testified that in 1981 he was looking for tax credits because his Federal income tax status was single and that part of his reason for investing in EI was the tax credit factor. He testified that he "briefly reviewed" both the original and revised offering memoranda. Von Almen testified that Efron explained the original offering memorandum to him but that he did not have any discussions with Efron concerning recycling. The offering memorandum and the revised offering memorandum disclosed the fact that Efron was receiving substantial compensation and fees as the general partner of EI and as a 50-percent owner of MFA. In addition, both of the EI offering memoranda specifically warned potential investors that they were "not to consider the contents of [the offering memoranda] or any communication from the partnership or its general partners as legal or tax advice", and Efron testified that he advised every limited partner in EI to talk to an independent adviser. In our view the411 purported reliance of Paulson and Von Almen on Efron was not reasonable, in good faith, and based on full disclosure. Accordingly, we hold that petitioners are not entitled to relief from the negligence additions to tax under section 6653(a) because of their alleged reliance on Efron. Paulson and Von Almen also contend that they relied on Cassaday in investing in EI and in claiming the disallowed deductions and credits. 7 During 1981 Cassaday was an officer at the First Bank of Whiting. To finance acquisition of their interests in EI, Efron directed Paulson and Von Almen to Cassaday. Cassaday arranged for the First Bank of Whiting to lend Paulson and Von Almen the entire amount of their investments in EI. The loans were secured solely by the EI investments of Paulson and Von Almen. After the introduction of Clearwater into EI's investments, Cassaday did not change the loan arrangements with Paulson or Von Almen. Von Almen testified that he did not speak to Cassaday after the change in EI's investments and that he did not know if Cassaday was aware of the change in EI's investments. The record in docket No. 21436-85 contains no evidence that petitioner spoke with Cassaday after the412 change in EI's investments. The testimony of Paulson and Von Almen was general and vague, providing no details of their inquiry of Cassaday. Petitioners do not seriously contend that Cassaday possessed the requisite expertise in recycling or the plastics industry to enable him properly to evaluate the merits of the Clearwater transaction. Moreover, petitioners offered no evidence that they even consulted Cassaday after the change in EI's investments. Paulson and Von Almen's purported reliance on Cassaday was not reasonable. Von Almen contends that he also relied on Wayne Paulson in investing in EI and claiming the disallowed tax deductions and credits. Although Wayne Paulson acted as Von Almen's offeree representative with respect to Von Almen's investment in EI, Wayne Paulson did not review413 the EI offering memoranda with Von Almen, did not aid Von Almen in completing the offeree questionnaire, and did not discuss recycling with Von Almen. With respect to Wayne Paulson's involvement in his investment in EI, Von Almen stated only that Wayne Paulson, along with Efron, introduced him to EI and that Wayne Paulson acted as his offeree representative concerning the investment in EI. Von Almen provided no evidence that he ever spoke to Wayne Paulson about his investment in EI. Von Almen's purported reliance on Wayne Paulson was not reasonable. In our view, the purported reliance of Paulson and Von Almen on Efron and Cassaday and Von Almen's purported reliance on Wayne Paulson was not reasonable, in good faith, and based on full disclosure. Accordingly, we hold that petitioners are not entitled to relief from the negligence additions to tax under section 6653(a) because of their alleged reliance on professional advice. Petitioners' reliance on Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), is misplaced. The facts in the Heasley case are distinctly different from the facts of these cases. The taxpayers in the Heasley case actively414 monitored their investment and, as the Court of Appeals for the Fifth Circuit stated, intended to profit from the investment. We cannot reach similar conclusions in the instant cases. Paulson and Von Almen failed to provide evidence of any effort to monitor their investments in EI or reliable evidence of any profit objective independent of tax savings. Both Paulson and Von Almen testified that they did not learn of the change in the nature of EI's investments to include recycling until March of 1982. Upon learning of the change in EI's investments to include recycling neither Paulson nor Von Almen asked anyone about the details of the recycling investment even though they did not understand the Clearwater investment. In the Heasley case the taxpayers read portions of the offering materials, while in docket No. 21436-85 Paulson did not read or review either the original offering memorandum or the revised offering memorandum. We consider petitioners' arguments with respect to the Heasley case inapplicable. Paulson and Von Almen entered into the EI investment without any knowledge or background with respect to plastics or recycling and without seeking the advice of anyone who415 had such knowledge. They did not examine any Sentinel EPE recyclers after learning of the change in EI's investments, and they did not seek the advice of an independent third party concerning the machines' values. Through their investments in EI, Paulson and Von Almen paid Clearwater $ 5,586 and $ 11,179, respectively, and claimed operating losses in the respective amounts of $ 4,470 and $ 8,945 and tax credits in the respective amounts of $ 9,644 and $ 19,302 with respect to those investments for the first year of the investments alone. Under the circumstances of these cases, Paulson and Von Almen should have known better than to claim the large deductions and tax credits with respect to Clearwater on their 1981 Federal income tax returns. We conclude that petitioners were negligent in claiming the deductions and credits with respect to EI's investment in Clearwater on their 1981 Federal income tax returns. We hold, upon consideration of the entire records, that the Paulsons are liable for the negligence additions to tax under the provisions of section 6653(a) for 1978 and section 6653(a)(1) and (2) for 1981, and Von Almen is liable for the negligence additions to tax under the416 provisions of section 6653(a) for 1978 and 1979 and section 6653(a)(1) and (2) for 1981. Issue 5. Sec. 6659 Valuation OverstatementIn her first amendment to answer in docket No. 21436-85, respondent asserted that the Paulsons were liable for the additions to tax for valuation overstatement under section 6659 on the underpayments of their 1978 and 1981 Federal income taxes attributable to the investment tax and business energy credits claimed with respect to EI and Clearwater. Likewise, in her first amendment to answer in docket No. 21438-85, respondent asserted that Von Almen was liable for the additions to tax under section 6659 on the underpayments of his 1978, 1979, and 1981 Federal income taxes attributable to the investment tax and business energy credits claimed with respect to EI and Clearwater. Because these additions to tax were raised for the first time in respondent's amendments to answer, respondent bears the burden of proving that petitioners are liable for the section 6659 additions to tax. Rule 142(a); Vecchio v. Commissioner, 103 T.C. at 196. The underlying facts of these cases with respect to this issue are substantially the417 same as those in Fine v. Commissioner, T.C. Memo. 1995-222. In addition, petitioners' arguments with respect to this issue are essentially identical to the arguments made in the Fine case. For reasons set forth in the Fine opinion, we hold that petitioners are liable for the section 6659 additions to tax at the rate of 30 percent of the underpayments of tax attributable to the disallowed credits claimed with respect to EI and Clearwater. 8Issue 6. Sec. 6621(c) Tax-Motivated TransactionsIn notices418 of deficiency, respondent determined that interest on deficiencies accruing after December 31, 1984, would be calculated under section 6621(c). The annual rate of interest under section 6621(c) equals 120 percent of the interest payable under section 6601 with respect to any substantial underpayment attributable to tax-motivated transactions. An underpayment is substantial if it exceeds $ 1,000. Sec. 6621(c)(2). The underlying facts of these cases are substantially the same as those in Fine v. Commissioner, supra. In addition, petitioners' arguments on brief with respect to this issue are verbatim copies of the arguments in the taxpayers' briefs in the Fine case. For reasons set forth in the Fine opinion, we hold that respondent's determinations as to the applicable interest rate for deficiencies attributable to tax-motivated transactions are sustained and the increased rate of interest applies for the taxable years in issue. To reflect the foregoing, Decisions will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code in effect for the tax years in issue, unless otherwise stated. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner Gerald J. Von Almen and Dixie Von Almen filed joint Federal income tax returns for 1978 and 1979. In 1982, Gerald J. Von Almen filed amended returns, in his name only, for 1978 and 1979 in order to carry back investment tax and business energy credits claimed on his individual 1981 Federal income tax return. The notice of deficiency issued for taxable years 1978 and 1979 in docket No. 21438-85 was issued only to Gerald J. Von Almen because the deficiencies determined for those years solely relate to the carrybacks.↩3. The notices of deficiency refer to sec. 6621(d). This section was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2744 and repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106, 2399, effective for tax returns due after Dec. 31, 1989 (sec. 7721(d) of the Act). The repeal does not affect the instant cases. For simplicity, we shall refer to this section as sec. 6621(c)↩.1. 50% of the interest payable with respect to the portion of the underpayment attributable to negligence. ↩4. The parties did not stipulate certain facts concerning the Provizers, facts regarding the expert opinions, and other matters that we consider of minimal significance. Although the parties did not stipulate our findings regarding the expert opinions, they stipulated our ultimate finding of fact concerning the fair market value of the recyclers during 1981.↩5. Von Almen claimed a regular investment tax credit with respect to EI and Clearwater in the amount of $ 9,651 on his initial 1981 Federal income tax return and claimed a business energy credit with respect to EI and Clearwater in the amount of $ 9,651 on an amended 1981 Federal income tax return.↩6. The Clearwater offering memorandum states that the partnership will pay sales commissions and fees to offering representatives in an amount equal to 10 percent of the price paid by the investor represented by such person. The offering memorandum further states that if such fees are not paid "they will either be retained by the general partner as additional compensation if permitted by applicable state law, or applied in reduction of the subscription price." EI's Schedule K-1 for 1981 shows that EI paid full price, $ 350,000 for its seven units of Clearwater, so the 10-percent commission was not applied to reduce the subscription price. Gordon specifically stated that in the case of EI he did not directly receive the sales commission. Efron expressed doubt that he individually had been an offeree representative in connection with Clearwater or any other transaction. There are suggestions that the commission might have been paid to MFA or offeree representatives of individual investors, but the record on this subject is inconclusive.↩1. Calculated as follows: EI's Investment in Clearwater $ 350,000 x Paulson's Share of EI 1.596% = $ 5,586EI's Investment in Clearwater $ 350,000 x Von Almen's Share of EI 3.194%= $ 11,179↩7. Although Von Almen testified that in investing in EI and claiming the associated tax deductions and credits he relied upon Efron 90 percent and Wayne Paulson 10 percent, on brief he asserts that he also relied upon Cassaday.↩8. Sec. 6659 applies to returns filed after Dec. 31, 1981. Although the Paulsons filed their 1978 return prior to Dec. 31, 1981, and Von Almen filed his 1978 and 1979 returns prior to Dec. 31, 1981, they are liable for the additions to tax under sec. 6659 for those years because the underpayments of tax for those years are attributable to the carryback of unused tax credits claimed on their 1981 returns. See Nielsen v. Commissioner, 87 T.C. 779↩ (1986).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621564/	ALBERT L. EAST III AND ELLA M. EAST, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEast v. CommissionerDocket No. 7616-88United States Tax CourtT.C. Memo 1989-658; 1989 Tax Ct. Memo LEXIS 658; 58 T.C.M. (CCH) 953; T.C.M. (RIA) 89658; December 18, 1989William S. Painter, Ernest G. Taylor, Jr., Alveno N. Castilla, and William B. Grete, for the petitioners. Helen C. T. Smith, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies of $ 38,376, $ 74,901, and $ 190,357 in petitioners' Federal income tax for 1981, 1982, and 1983, respectively. After concessions, the sole issue remaining for decision is whether659 monthly payments made by Albert L. East III (petitioner) to his former wife Jean Ann Smith East (Jean East) are deductible alimony payments under section 215. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the years in issue. FINDINGS OF FACT Some of the facts have been stipulated, and the facts set forth in the stipulations are incorporated in our findings by this reference. Petitioners resided in Jackson, Mississippi, when they filed the petition in this case. Petitioner and Jean East were married to each other in 1950. From 1950 to 1954, petitioner was stationed at Keesler Air Force Base, Biloxi, Mississippi. In 1954, petitioner and Jean East moved to Louisiana and lived there until 1962. While in Louisiana, petitioner worked as a car salesman and acquired a small stock interest in his father's car dealership, Nelson and East Ford Company. After moving to Jackson, Mississippi in 1962, petitioner started East Ford, Inc. (East Ford), a Ford Motor Company car dealership. During the years in issue, petitioner was the president and sole stockholder of East Ford. In 1970, petitioner started Rebel Ford Trucks,660 Inc. (Rebel Trucks), a Ford Motor Company truck dealership. From 1970 through August 1982, when the truck dealership went out of business, petitioner was an officer and stockholder of Rebel Truck. Jean East graduated from Louisiana State University and held a teacher's certificate. During her marriage to petitioner, Jean East was a full-time homemaker and mother. Jean East did not work in petitioner's automobile or truck businesses, nor was she otherwise gainfully employed at any time during the marriage. On October 23, 1977, petitioner and Jean East separated. At the time of their separation, petitioner and Jean East had three children who were all above the age of 21 years and were self-supporting. From October 1977 until March 1979, petitioner continued to provide support for Jean East. Petitioner deposited his monthly paycheck from East Ford into Jean East's checking account. During this period of time, petitioner's gross pay was $ 3,000 per month, and the net amount of his paycheck was approximately $ 2,500 per month. During their divorce proceedings, petitioner was represented by attorney Charles L. Howorth, Jr. (Howorth), and Jean East was represented by attorney661 James Becker (Becker). Preliminary negotiations, however, were conducted by petitioner and Jean East. In October 1978, petitioner requested and received advice from his certified public accountant, Arthur W. Henderson (Henderson), regarding the tax implications of various means of providing for Jean East. Henderson advised petitioner of the estimated after-tax income that would be available to Jean East at various levels of monthly payments. Henderson's advice was based on the assumption that income tax on the monthly payments would be paid by Jean East. At the time Becker began negotiating on behalf of Jean East, petitioner had offered to pay to Jean East $ 4,000 per month alimony and had offered to transfer to her certain real property. Because petitioner and Jean East had been married for approximately 28 years and because petitioner had accumulated a substantial amount of property during their marriage, Becker believed that his client would be entitled to some share of petitioner's property. He did not, however, hire an appraiser or determine the value of Jean East's interest in petitioner's personal and business assets during the divorce settlement negotiations. Becker's662 primary goal, in his own words, was "to be sure that [Jean East] would have an amount certain for the rest of her life." Because she had never worked, Jean East was concerned that she would not have any social security benefits. In order for her to retain life and health insurance benefits and earn social security credits, petitioner agreed that Jean East would be given an "employment contract" with East Ford. Pursuant to this "employment contract," Jean East was to be paid $ 1,000 per month and was to be entitled to participate in medical and life insurance plans available to the other employees of East Ford. Becker drafted a proposed alimony and property settlement agreement that he sent to Howorth and petitioner for review. Becker drafted the agreement so that the payments would not terminate on Jean East's remarriage or on petitioner's death. Becker believed that, under the laws of Mississippi in effect at the time, a property settlement could not be modified at a later date. To achieve the objective of nonmodifiability, Becker inserted into the draft agreement language that provided: That, as alimony and as further consideration for the settlement of the claim of663 Wife to Husband's properties, and as a property interest, Husband agrees to pay unto Wife the sum of * * * $ 5,000, per month, * * * said payment not to terminate upon the death of Husband, but shall constitute a charge against his Estate until the death of Wife, irrespective of her possible remarriage. * * * [Emphasis supplied.] At Howorth's request, the language "and as a property interest" set forth in Becker's draft as consideration for the payments of $ 5,000 per month was deleted from the final agreement. Also at Howorth's request, the following language was inserted: Wife understands and agrees that the aforesaid monthly payment of $ 5,000.00 shall be the only claim she shall have against the estate of the Husband and that by her acceptance thereof and agreement hereto Wife expressly waives any and all further claim to Husband's estate. On February 21, 1979, petitioner and Jean East and their respective counsel executed an Alimony and Property Settlement Agreement (the Agreement), containing the following provisions: 1. (a) Husband and Wife jointly own a certain undeveloped lot located on Dauphin Island, Alabama, which lot shall be placed for sale and the balance664 of sale proceeds shall be divided between the parties. That the parties also own jointly that certain land and property located at 1423 Roxbury Place, Jackson, Mississippi, and a house and lot located on Dauphin Island, Alabama. That in consideration of the transfer by Husband to Wife by Quitclaim Deed of his right, title and interest in and to the aforesaid two properties, with Wife assuming all balance of indebtedness thereon, Wife shall release Husband from any and all other known and unknown interests and claims that she may have acquired in the businesses, properties, and all assets developed by Husband during their marriage. * * 2. That, as alimony and as further consideration for the settlement of the claim of Wife to Husband's properties, Husband agrees to pay unto Wife the sum of Five Thousand and NO/100 Dollars, ($ 5,000.00), per month, payable on the fourth day of each and every month hereafter, said payment not to terminate upon the death of Husband, but shall constitute a charge against his Estate until the death of Wife, irrespective of her possible remarriage. It is the full intention of Husband that Wife shall receive as alimony and as a property settlement665 from him or his Estate the sum of Five Thousand and NO/100 Dollars, ($ 5,000.00), for each and every month hereafter until her death. Wife understands and agrees the aforesaid monthly payment of $ 5,000.00 shall be the only claim she shall have against the estates of the Husband and that by her acceptance thereof and agreement hereto Wife expressly waives any and all further claim to Husband's Estate. That incident to the further support of Wife, she shall be granted an employment contract with East Ford, Inc., for public relations and other services to be performed by Wife, whereupon her salary shall be One Thousand and NO/100 Dollars ($ 1,000), per month, and Wife shall remain on all profit sharing and/or insurance benefit plans for medical, life or other insurance available to other employees, and all of the premiums therefor shall be paid by East Ford, Inc. * * The Agreement did not specify an aggregate, fixed sum to be paid to Jean East and did not specify any security for the monthly payments. As of the date the Agreement was executed, petitioner believed that his net worth was $ 4,481,852. The parties to the Agreement believed that the properties transferred666 to Jean East under the Agreement had the following values: Personal residence$ 175,000 Summer home150,000 Furnishings130,000 Half interest invacant lot25,000 Less debt assumed(30,000)Total$ 450,000 At the time he executed the Agreement, petitioner intended to support his former wife for the rest of her life. It was petitioner's objective to provide Jean East with after-tax support payments of approximately $ 3,000 per month, an amount equal to her normal monthly living expenses. Petitioner also intended that the settlement allow his former wife to maintain the lifestyle that she had enjoyed during their marriage. Howorth believed that the proposed agreement was structured so that paragraph 1 would provide for a property settlement and paragraph 2 would provide for support payments. Howorth intended that the proposed periodic payments from petitioner to Jean East constitute alimony. Petitioner believed and intended that the periodic payments would be treated as alimony taxable to Jean East. Jean East and Becker received advice from her certified public accountant, Eddie DeMiller (DeMiller), regarding the tax667 implications of the Agreement. DeMiller concluded that the transfer of real property from petitioner to Jean East would not be taxable while "the alimony of $ 5,000 a month payable by Albert L. East to his wife, Jean Ann Smith East, will represent income taxable to Mrs. East as ordinary income, and will be deductible alimony payments by Mr. East for both the federal and state of Mississippi income tax returns." Notwithstanding this advice, Becker believed that his drafted language left some question as to the taxable nature of the payments. On March 28, 1979, petitioner and Jean East were divorced by final decree in the Hinds County, Mississippi, Chancery Court on the grounds of irreconcilable differences. The Agreement was attached to and incorporated as Exhibit A in the divorce decree, and the parties were ordered to abide by its terms. At the time of their divorce, petitioner was approximately 51 years old and Jean East was approximately 49 years old. Petitioner paid Jean East $ 5,000 per month for a total of $ 60,000 per year in 1981 and 1982. Petitioner deducted the monthly payments at issue on his Federal income tax returns for the years in issue. Jean East reported668 the monthly payments received in 1979, 1980, and 1981 as alimony on her original Federal income tax returns and accordingly included the payments in her adjusted gross income for those years. Beginning in 1981, petitioner's car and truck dealerships began experiencing financial difficulties. Petitioner contacted Jean East and asked her to accept reduced monthly payments until his businesses became more profitable. Jean East refused petitioner's request. Subsequently, petitioner hired an attorney to represent him in attempting to reduce his monthly payments to Jean East. On August 9, 1982, petitioner filed a complaint to modify the final decree of divorce. On August 26, 1983, the Hinds County Chancery Court issued its opinion in response to petitioner's complaint to modify the divorce decree, reducing the monthly payments to $ 4,000 per month and assessing the court costs to Jean East. Thereafter, on October 31, 1983, the chancery court entered its Judgment of Modification which incorporated by reference its prior opinion. In modifying the divorce decree, the court specifically found that the monthly payments were alimony payments and ruled that the payments of $ 5,000 per669 month should be reduced to $ 4,000 per month. Jean East appealed the Judgment of Modification reducing the monthly payments petitioner was obligated to make. Petitioner paid Jean East $ 56,000 in 1983. During 1983, petitioner paid Jean East $ 5,000 per month for the first 8 months of the year. Pursuant to the chancery court's modification of the divorce decree, petitioner paid Jean East $ 4,000 per month beginning in September 1983 and continuing for the remainder of that year. In July 1983, Jean East filed amended Federal income tax returns for 1979, 1980, and 1981 and reported the monthly payments at issue as property settlement payments rather than alimony. Subsequently, as a result of these amended returns, respondent approved Jean East's claims for refunds of income taxes paid for 1979, 1980, and 1981. On her Federal income tax returns for 1982 and 1983, Jean East did not report as alimony or include in adjusted gross income any of the monthly payments received from petitioner during those years. Respondent did not issue statutory notices of deficiency to Jean East with respect to the payments at issue, nor did respondent take any other action to extend the statutory670 period for assessment of deficiencies in tax against Jean East for 1979, 1980, or 1981. The period of limitations for such assessments expired prior to the events described below. On August 13, 1986, the Supreme Court of Mississippi issued its opinion on Jean East's appeal of the chancery court's order. The Supreme Court held that the Agreement was nonmodifiable and reversed the chancery court. Respondent determined that the payments made by petitioner to Jean East in 1981, 1982, and 1983 were property settlement payments that do not qualify as alimony and, therefore, are not deductible from gross income. OPINION For reasons indicated in our findings, no notice of deficiency was sent to petitioner's former wife, Jean East. She was, however, permitted to file an amicus curiae brief in this case. Jean East (amicus) and respondent make similar arguments and are essentially in agreement. Amicus, petitioner, and respondent all analyze the facts in relation to the factors set forth in Beard v. Commissioner, 77 T.C. 1275">77 T.C. 1275 (1981), as indicative of whether payments from one spouse to another represent deductible alimony or nondeductible payments for property. We671 agree that the Beard analysis is appropriate, and we discuss below the seven factors in that analysis. Before addressing the issue, however, we must comment on what is not an issue. This is not a case in which we decide whether Jean East received what she was entitled to under the settlement agreement entered into with petitioner. The issue before us is the intent of the parties at the time they entered into the Agreement, regardless of the fairness of the Agreement, the appropriateness of petitioner's subsequent attempt to modify the Agreement, and the bar of the statute of limitations with respect to any deficiency of Jean East for the years in issue. We have not given weight to any event subsequent to the settlement agreement other than the opinion of the Mississippi Supreme Court. Specifically, for example, we are ignoring the improper attachment to amicus' brief, consisting of a copy of a brief filed on her behalf in the Mississippi Supreme Court. Cf. Snyder v. Commissioner, 93 T.C. (filed November 2, 1989). The Mississippi Supreme Court OpinionIn East v. East, 493 So.2d 927 (Miss. 1986), the Mississippi Supreme Court stated in pertinent672 part: It was clearly the intent of these parties, each represented by eminent legal counsel, to affix unalterably their mutual responsibilities for the remainder of their lives. Moreover, their agreement was approved by the chancellor and made a part of the divorce decree. It was the obvious intent of the parties to create a non-modifiable agreement, and of the chancery court to approve and confirm it as part of a solemn court decree. The parties and the chancery judge intended to create a non-modifiable contract and court judgment. If we hold this agreement solemnized by court decree could be modified by subsequent change in circumstances of the parties, then we must also say it is impossible to draft an agreement to pay the wife a sum certain until she dies which cannot be changed, up or down. This case presents a troublesome question. Parties divorce, and as part of the decree the husband obligates himself to make future payments to his wife. Subsequent events make one or the other unhappy with the trade, and a petition is filed for modification of the final decree. [493 So.2d at 930.] Citing various Mississippi authorities, the court went on to673 explain that periodic alimony is subject to change by a court and ceases upon remarriage or death of the party entitled to receive it. The opinion continued: The parties cannot by contract deprive, and it is doubtful if any court has the authority to deprive itself of the future authority to modify ordinary periodic alimony, or make it continue beyond the remarriage of the wife or the death of the husband. * * . 2674 On the other hand we have historically recognized that alimony awarded in a lump sum, or in gross constitutes a fixed liability of the husband and his estate and cannot be modified. * * * and, so long as the decree is unambiguous that the alimony is in lump sum, or in gross, it can provide for payment in fixed, periodic installments. * * * A divorce decree may embody periodic as well as lump sum alimony. * * * Lump sum alimony in a decree may very well have some of the attributes of a property settlement. It may be given to a wife who has by her efforts in her husband's behalf enabled him to accumulate considerable wealth, and even though she might not be entitled to any periodic alimony. * * * It may be awarded to a wife who over the years has assisted her husband in accumulating considerable property by doing her part as a housewife. * * * We have also historically recognized that parties may upon675 dissolution of their marriage have a property settlement incorporated in the divorce decree, and such property settlement is not subject to modification. A true and genuine property settlement agreement is no different from any other contract, and the mere fact that it is between a husband and wife, and incorporated in a divorce decree, does not change its character. * * [493 So.2d at 931; citations omitted.] After noting the 1976 statutory change that authorized the divorce on grounds of irreconcilable differences, the Mississippi Supreme Court phrased the question before it as follows: Was the $ 5,000 monthly payment merely periodic alimony, or a form of lump sum alimony payable in fixed immutable installments until her death, or a property settlement? [493 So.2d at 932.] The opinion concluded: We find that the agreement between Mr. and Mrs. East, while using the term alimony, was in fact a property settlement or lump sum alimony, payable in fixed, unalterable installments. When the parties specifically provided in their agreement as part and parcel of their property settlement that the payments would not terminate upon either676 his death or her remarriage, and she could never ask that any of these payments be increased, which was approved by the court in the divorce decree, this removed any claim that it was no more than periodic alimony. Mr. and Mrs. East are bound by its terms and provisions. * * [493 So.2d at 932.] Petitioner contends that the Mississippi Supreme Court opinion does not discuss or ascertain the intent of the parties regarding the purpose of the payments, only their intention to create a nonmodifiable agreement. Respondent argues that "The Mississippi Supreme Court's interpretation proves that the agreement is highly ambiguous. The Court's interpretation is entitled to consideration and to deference by the Tax Court. * * * the Mississippi Supreme Court ruling does have significant relevance to the Tax Court's decision." Respondent does not, however, indicate how the opinion of the Mississippi Supreme Court is helpful or supports the argument that the payments should be determined, for Federal tax purposes, to be property settlement rather than deductible alimony. Amicus argues that the Mississippi Supreme Court "clearly held that the Death Terminating Payments were677 not payments arising from Petitioner's obligation to support Amicus." The opinion of the Mississippi Supreme Court, however, "clearly" allows for categorization of payments as lump sum alimony, having only "some of the attributes of a property settlement" -- notably nonmodifiability. The deductibility of the payments in issue here is determined under Federal law, and our independent consideration of the relevant factors raises no inference with respect to our view of application of Mississippi law to the issue of nonmodifiability. The opinion of the Mississippi Supreme Court simply does not address the factors that are relevant and determinative in this case. Property Division or SupportTo be characterized as alimony deductible by petitioner and taxable to amicus, the payments in question must be made in discharge of a legal obligation imposed because of the marital or family relationship, i.e., payments for support and not for the purpose of dividing marital assets. Sections 71(a) and 215; Beard v. Commissioner, supra. Case law has developed 678 seven factors that indicate that payments by one spouse to another are in the nature of a property settlement rather than a support allowance. No single factor is conclusive, but the absence of one or more may tend to indicate that the payments are in the nature of a support allowance. Those factors are that (1) the parties in their agreement (or the court in its decree) intended the payments to effect a division of their assets; (2) the recipient surrendered valuable property rights in exchange for the payments; (3) the payments are fixed in amount and not subject to contingencies, such as death or remarriage; (4) the payments are secured; (5) the amount of the payments and other property awarded to the recipient approximates one-half of the property accumulated by the parties during the marriage; (6) the need of the recipient was not taken into consideration in determining the amount of the payments; and (7) a separate provision for support was provided elsewhere in the agreement. Beard v. Commissioner, 77 T.C. at 1284-1285. A review of these factors does not favor the position of respondent or amicus. An inference679 as to intent of the parties to the Agreement in this case necessarily draws on the same evidence as that discussed under other factors, and there is some overlap. As the Mississippi Supreme Court stated in its opinion in East v. East, however, a prime indicator of intent, particularly where both parties to an agreement are represented by competent counsel, is the specific language of the agreement. In paragraph 1 of the Agreement here, amicus released her property rights in exchange for specific items of real property. In paragraph 2 "as alimony and as further consideration for the settlement of the claim of Wife to Husband's properties," petitioner agreed to pay to amicus $ 5,000 per month. The language in paragraph 2 was explained by the testimony at trial, specifically by the testimony of Becker, as a deliberate attempt to make the Agreement nonmodifiable with respect to the $ 5,000 per month payments. That attempt was successful. There is no testimony that the $ 5,000 per month payments were intended to constitute payments for property interests, and the evidence is to the contrary, as discussed further below. The Agreement between petitioner and amicus, by its terms, 680 resolves claims to alimony and to property. Thus all consideration paid by petitioner to amicus can be considered payment for surrender of her rights to each category. The language inserted in the Agreement at Howorth's request is consistent with this interpretation. We cannot, on the evidence in this case, conclude that the $ 5,000 per month payments were intended to be solely or primarily for property rights. Apparently amicus had claims to property held in the name of petitioner as well as to property that was jointly owned. Certainly she had claims to substantial alimony under Mississippi law in view of the length of the marriage, the disparity between earning abilities of the parties to the Agreement, and the standard of living to which she had become accustomed. See Brabham v. Brabham, 226 Miss. 165">226 Miss. 165, 84 So. 2d 147">84 So.2d 147 (1955). So far as we can determine from the evidence, amicus' rights to alimony were far clearer than her claims to property. The parties to the Agreement, and specifically counsel for petitioner's former wife, did not determine the value of her property rights before entering into the Agreement; the chancery court did not determine those values; 681 the Mississippi Supreme Court did not determine those values; and we have insufficient objective evidence from which to determine those values. The parties have merely estimated that petitioner's net worth was approximately $ 4.5 million and the property received by amicus was worth approximately $ 450,000. We cannot conclude that payments of $ 5,000 per month for the rest of the life of amicus, who was under 50 at the time, constituted payment for an undetermined amount of property. The payments in question were to terminate on the death of amicus but not on her remarriage. To the extent that the payments terminate on the death of amicus, this factor suggests that the payments are alimony. In view of the length of the marriage and the status of the parties, the provision that payments continue even in the event of remarriage is not persuasive, particularly because it was not given conclusive effect by the Mississippi Supreme Court. See Phinney v. Mauk, 411 F.2d 1196">411 F.2d 1196, 1198 (5th Cir. 1969). Addressing the absence of security for the payments, respondent argues that no682 security was necessary because of petitioner's substantial wealth. The significance of security, however, is not related to the payor's ability to make the payments in question. Security is a factor in cases where there is a specific lien on the property, because the presence of a lien suggests that the payment is made for the property. See, e.g., Widmer v. Commissioner, 75 T.C. 405">75 T.C. 405, 409 (1980). As indicated above, the total value of the property accumulated by the parties during the marriage has only been estimated, was not determined by the parties prior to the Agreement, and was not determined by the Mississippi Supreme Court. Thus, we cannot determine with any certainty whether the amount of the payments plus the other property awarded to amicus equals approximately one-half of the property accumulated by the parties during marriage. The evidence in the record, however, precludes a conclusion that the need of amicus was not taken into consideration in determining the amount of the payments. Compare McCombs v. Commissioner, 397 F.2d 4">397 F.2d 4, 7 (10th Cir. 1968), affg. a Memorandum Opinion of this Court. Respondent acknowledges that, at the683 time of the divorce, petitioner was giving amicus between $ 2,250 and $ 2,500 per month, and petitioner's accountant prepared computations that showed the after-tax effect of payments at particular levels. These computations corroborate petitioner's testimony that his intention was to provide the same level of support to amicus after the divorce as before, on the assumption that income tax on the payments would be paid by her. Although there is no evidence of what the actual needs of amicus were at the time of the divorce or were expected to be for the duration of her life, her estimated or assumed needs were apparently given much greater consideration than her actual interests in property. Becker testified that his primary interest was in securing a regular income for amicus that petitioner could not reduce or change. He testified in response to questions from respondent's counsel as follows: Q Who actually drafted the first version of that agreement before it was -- the ultimate version was finally adopted? A That is my language. Q Okay. And did you have any specific objectives for your client, Jean East, when you drafted that agreement? A Well, during the time we were684 negotiating, she wanted to be taken care of for the rest of her life. Al had a -- what we thought was property where he had the dealership -- one or both of them, I am not certain without studying real closely here -- that was worth about -- we figured about $ 650,000. And there was a discussion at one time whether he would convey those properties to her, so that she would have ample support for the rest of her life. And then during the negotiations, after I sent him my accountant's request for appraisals and income statements, profit and loss sheets, et cetera, I was advised he didn't want to consider a property transfer anymore. And so we went on into the idea that she would get this alimony, and we called it "and as a property settlement," and I phrased it that way because, in my opinion, a property settlement was not able to be changed or modified under the Court's -- Mississippi Supreme Court rulings that were in effect at that time, and I wanted to be sure that she would have an amount certain for the rest of her life. I also thought there may have been a question as to the taxable nature of it, and that that would give her a good call on it not being taxable. My accountant685 did not agree with that, but I felt like it was a good chance of that. Q So what specifically did you do in terms of specific language in the agreement to achieve those objectives for your client, if you can recall? A Well, of course he conveyed the home and the Dauphin Island property to her. And then we put in this paragraph 2 that is on page 3 of the agreement, and this is my language, "that as alimony and as further consideration for the settlement of the claim of wife to husband's property, husband agrees to pay unto wife the sum of $ 5,000 per month, said payment not to terminate upon the death of husband, but shall constitute a charge against his estate until the death of wife, irrespective of her possible remarriage." Now that is my language. I also wrote the rest of that paragraph. I think I even had it a little stronger at one time, but Charlie Howorth objected to one phrase in that first portion of the paragraph. If it had been just normal alimony, as a lot of times you have, it would have terminated upon her death or remarriage, and it of course would have terminated upon his death. But I wanted it particularly binding, so it did not terminate on his death or686 her remarriage. And I provided that it would be a charge on his estate. I have never had anybody else sign that before. Q How did the parties arrive at the amounts of $ 5,000 per month from Mr. East and $ 1,000 per month from East Ford? A Well, as I recall, and it has been ten years, the $ 5,000 a month was what Jean said she wanted every month. And that was geared to this absolutely non-negotiable, non-modifiable language. The $ 1,000 a month, as I recall, was to keep her on the payroll at East Ford, so she could be eligible for the benefits and stay on the program for the hospitalization and such as that. Q Can you tell us, if you know, why the $ 5,000 a month payments were contingent only on her life, and the $ 1,000 payments were contingent on her staying unmarried? A Well, even though -- I can't give you a clear answer on that. I just don't recall. I did want the $ 5,000 a month to continue throughout the rest of her life, whether Al predeceased her. Q When you negotiated the agreement and when you drafted it, what did you consider the $ 5,000 a month payment was: alimony which would be deductible to Mr. East and income to her, or property settlement? A It is687 really sort of a hybrid, I believe. But it definitely was taken in lieu of him transferring enough security that she could have been taken care of out of the income of that security for the rest of her life. Obviously Becker's objective related to the needs of amicus. Further, he abandoned any effort to secure reliable information about the value of petitioner's property. Petitioner's testimony and Becker's testimony persuade us that the foremost, if not only, consideration in setting the $ 5,000 per month payments was the need of amicus. Under all of the circumstances, it is extremely unlikely that the sum of $ 1,000 per month, to be paid by the auto dealership, was a separate provision for the support of amicus and was all that was allocable to support. We need not draw any inference as to the reason why the $ 1,000 payments per month were to be made from the corporation. It is probable that the payments supported maintenance of social security coverage and insurance on amicus, as suggested by petitioner and Becker, and thus logically terminated upon remarriage. There is no logical relationship between the amount of these payments, however, and the amount of support to688 which amicus was entitled. No party suggests that she was entitled to support of only $ 1,000 per month. Respondent suggests that, if we do not accept his argument that the $ 5,000 per month payments were property settlement, we determine that some part of those payments is allocable to property rights. The record does not support any allocation other than the one made by the parties at the time of the divorce. We are persuaded on the evidence that the Agreement of the parties in form and in substance specifies that $ 5,000 per month was to be alimony. Respondent suggests that we should draw a negative inference from the failure of petitioner to call amicus as a witness. Respondent's trial memorandum, not petitioner's, listed amicus as a probable witness. Obviously amicus would be a hostile witness with an adverse interest if called by petitioner. If any inference is to be drawn, it is to respondent's detriment. Decision will be entered for the petitioners. Footnotes. An amicus curiae brief was filed on behalf of Jean S. East Burrow by Steven I. Klein and Daniel J. Daigle.↩2. The reason for this lack of power is encompassed in the meaning we have placed upon "periodic alimony." "Alimony" thus defined comes from the duty of the husband to support his wife. * * If, as we have consistently stated such alimony is imposed on a husband to support his former wife in the manner to which she has been accustomed to the extent of his ability to pay, * * * then it is nonsensical to state in the divorce decree that the alimony payments cannot be changed, regardless of future circumstances of the parties. [Citations omitted.] The problem arises when one judge thinks alimony means "X," another thinks it means "Y," and an appellate court thinks it means "XY."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621565/	Irene M. Reineck v. Commissioner. Oak Park Trust & Savings Bank, Trustee of E. F. Reineck Trust under Agreement No. 21567 v. Commissioner. Frederick M. Lee v. Commissioner. Winfield S. Hevenor and Lillian F. Hevenor, Husband and Wife v. Commissioner.Reineck v. CommissionerDocket Nos. 110776, 111009, 111224, 111225.United States Tax Court1943 Tax Ct. Memo LEXIS 298; 2 T.C.M. (CCH) 108; T.C.M. (RIA) 43236; May 19, 1943298 Daniel M. Healy, Esq., and Samuel E. H1IRSCH, Esq., for the petitioners. David Altman, Esq., for the respondent. LEECHMemorandum Opinion LEECH, J.: These consolidated proceedings involve deficiencies in income taxes as follows: Docket No.Name193619371938110776Irene M. Reineck$2,243.02$1,294.26$2,343.27111009E. F. Reineck Trust838.60111224Frederick M. Lee4,368.785,195.709,041.60111225Winfield S. Hevenor and Lillian F.Hevenor, Husband and Wife1,349.561,529.122,930.49In the deficiency contested in the proceeding entered to Docket No. 110776, respondent's position is that under section 162 (b) of the Revenue Act of 1936 the petitioner Irene M. Reineck is taxable as beneficiary or income distributed to her from the Trust in the amounts of $19,773.88, $13,402.06 and $20,859.38 for the respective years involved, 1936, 1937 and 1938. These amounts were the dividend payments received by the Trust during those respective years on the Reineck stock, less disbursements for trust administration during those years. The propriety of that action is the only issue. The deficiency, the correctness of which is contested in Docket No. 111009, 299 results from the Commissioner's determination that the E. F. Reineck Trust, petitioner therein, was taxable on the Commercial stock dividends received by the Trust in 1938 and not distributed, under section 161 of the Revenue Act of 1936, because of litigation involving all the taxpayers involved in this proceeding. The correctness of that determination is the only issue. Section 161 of the Revenue Act of 1936. Respondent apparently now concedes, in effect that the distributability of the Trust income was not affected by that litigation. In determining the deficiencies which are disputed in Docket Nos. 111224 and 111225, respondent has treated the Commercial stock delivered to Lee and Hevenor in the years 1936, 1937 and 1938, respectively, by the E. F. Reineck Trust because of credits against their stock accounts on the books of the Trust of the amount of dividends received by the Trust on the Reineck stock in those years, as compensation and taxable to the respective recipients in the amount of its fair market value, under section 22(a) of the Revenue Acts of 1936 and 1938. Respondent has amended his answers in these proceedings to raise the alternative issue that, in any event, 300 the petitioners in these docket numbers are subject to income tax on the pro rata amounts of the gross dividends paid by the Commercial Company to the E. F. Reineck Trust against which payments shares of stock were issued to them. These are the only issues in the proceedings entered to these docket numbers. All the returns of the respective petitioners for the various calendar years involved were filed with the collector of internal revenue for the First District of Illinois at Chicago, Illinois. The proceedings were submitted on a stipulation and certain exhibits. The facts are so found. Summarized, they are as follows: [The Facts] On January 10, 1930, E. F. Reineck, who died December 18, 1930, executed a trust agreement conveying to the Oak Park Trust & Savings Bank as trustee, 2,149 common shares of the capital stock of Commercial Wall Paper Mill, Inc. The material provisions of that agreement are as follows: WHEREAS the business of said company is highly specialized and to be successfully conducted requires executives of long experience in dealing with its peculiar problems; and WHEREAS Frederick M. Lee (hereinafter called "Lee") and W. S. Hevenor (hereinafter called301 "Hevenor") both of La Grange, Illinois, are now and have for several years past been associated with said Reineck in the conduct of said business and the said Reineck therefore believes it to be desirable to make provision whereby said Lee and Hevenor may succeed to his interest in said company. * * * * ARTICLE ONE During Reineck's lifetime the trustee shall pay over all dividends received on said stock to Reineck and shall vote all of said shares or issue proxies to vote said shares in such manner and to such persons as Reineck shall direct. ARTICLE TWO Upon the death of Reineck the trustee shall set apart and hold for the use and benefit of Lee two-thirds of said stock and shall set apart and hold for the use and benefit of Hevenor one-third of said stock all upon the following trusts, terms and conditions: First: The said Lee and Hevenor shall have the right to purchase said stock set apart for their respective use and benefit, in the manner hereinafter provided, at the rate of Sixty dollars ($60.00) per share; provided however, that Reineck shall have and hereby expressly reserves the right to establish a new and different valuation of said stock for the purpose of purchase302 herein provided from time to time by notice in writing delivered to said trustee. Second: The dividends paid upon the respective shares of said stock set apart as above provided, shall be received and applied by the trustee upon the purchase price of said respective shares as follows: (1) From the amount of such dividends the trustee shall first deduct interest upon the balance owing upon said purchase price computed at the rate of 5% per annum, compounded from the date to which said interest was last fully paid, to the date when the dividend is received. (2) The balance, if any, of any such dividends shall be applied upon the purchase price of said stock; provided however, that said Lee or Hevenor may pay any part of the purchase price together with interest as hereinabove provided, from sources other than said dividends. Third: The trustee shall cause to be transferred to Lee or Hevenor so many of such shares of stock as such payments may be sufficient to fully pay for from time to time. Fourth: In the event the dividends upon said stock are insufficient to pay the accrued interest upon the balance of the purchase price as hereinabove provided, for three successive years, then303 the trustee may at its option terminate the rights to purchase hereinabove provided, by giving notice in writing thereof to said Lee and Hevenor. Within sixty (60) days thereafter said Lee or Hevenor shall have the right to purchase any shares to which they respectively had the right of purchase under the provisions hereof by paying to the trustee the balance owing thereon together with interest as hereinabove provided. In the event either said Lee or Hevenor shall fail to so purchase within said period, then their respective rights shall cease and determine and this agreement shall be of no further force and effect as to them respectively. Fifth: Either Lee or Hevenor may relinquish his rights hereunder at any time by giving notice in writing thereof to the trustee. Sixth: In the event any shares hereunder shall be no longer subject to the rights of said Lee or Hevenor, or of any successor, as hereinabove provided, then the said trustee shall have the power to sell all or any part of said stock for such price and upon such terms and conditions as the trustee shall deem advisable, provided however, that during the lifetime of Irene M. Reineck, wife of said Reineck, her consent to304 such sale shall be first obtained, and after her death and during the lifetime of Reineck's daughter Mary F. Reineck, the consent of said daughter shall be first obtained. Seventh: In the event of the death of either Lee or Hevenor prior to the completion of the purchase of said stock as herein provided, all rights and obligations hereunder of such person so dying shall cease and determine and thereupon all shares of stock, theretofore paid for by such decedent and not yet transferred to him, shall be transferred and delivered to the personal representative of such deceased person or if he has no personal representative, then to his heirs. Upon any such death the survivor of said Lee or Hevenor shall have the right to substitute himself or any other person in the stead of said decedent and any person so substituted shall have the same rights hereunder as such decedent so far as is consistent with the provisions and purposes hereof. Eighth: In the event of the death of the survivor of Lee and Hevenor or upon the death of any person substituted by the survivor under the provisions of Paragraph Seventh of this Article Two, then the shares set apart to be sold to such survivor of said305 other person and not paid for as herein provided shall be transferred to those who would then be entitled to share in a distribution under the provisions of Paragraph Tenth of this Article Two in the proportions therein provided, it being the intention hereof that all rights to purchase any such shares not paid for at the death of any such decedent shall terminate upon such death. Ninth: The Trustee, with the written consent of those entitled to purchase said stock under the provisions hereof and of such of the beneficiaries provided in Paragraph Tenth of this Article Two, as shall then be of legal age, may sell any stock held hereunder or any part hereof for such price and upon such terms and conditions as may be deemed advantageous, irrespective whether such price is more or less than the price provided herein. In the event of any such sale, or for any consolidation, merger, or liquidation of said company before the completion of the purchase of said stock as herein provided, the rights of Lee and Hevenor and of their successors shall thereupon cease and determine as to all stock not then fully paid for. Any such stock not then paid for, or the proceeds thereof in case of sale, 306 shall thereupon be distributed to those who would then be entitled to share in the distribution under the provisions of Paragraph Tenth of this Article Two. Tenth: All amounts collected by the trustee under this agreement shall, after the deduction of its reasonable charges and expenses hereunder, be distributed as follows: (1) To Irene M. Reineck, wife of Reineck, if she is then living, to hold in her sole and absolute right. (2) If said Irene M. Reineck is not living, then to Margaret F. Reineck, daughter of said Reineck, to hold in her sole and absolute right. (3) If neither said Irene M. Reineck nor Margaret F. Reineck are then living, then to the issue of said Irene M. Reineck per stirpes and not per capita. ARTICLE THREE In effectuating the purpose of this agreement the trustee upon the death of Reineck shall have the following powers and authority. First: The trustee shall have sole and absolute power to vote in person or by proxy shares of said stock which shall not have been delivered under the provisions hereof in accordance with its best judgment and discretion. Said trustee may however, in its discretion, accept the judgment of said Lee and Hevenor in 307 all matters arising in the conduct of said business and shall be wholly free from any and all liability whatsoever in accepting and acting upon the judgment or advice of said Lee and Hevenor in such matters. * * * ARTICLE FOUR Said Reineck hereby expressly reserves the right to revoke this agreement at any time prior to his death by written notice to the trustee. The trustee shall notify said Lee and Hevenor of such revocation. The death of either Lee or Hevenor prior to the death of Reineck shall immediately terminate this agreement as to all parties in interest and render the same of no further force and effect. In the event of any such revocation the trustee shall immediately cause said shares of stock to be transferred back to Reineck. The trustee hereby accepts the trusts of this agreement declared and provided, and agrees to perform the same upon the terms and conditions herein set forth. The execution of this agreement by said Reineck shall be a revocation of an agreement heretofore executed by and between the parties hereto dated the 26th day of December 1929 pursuant to the provisions of Article Four thereof. The petitioner Irene M. Reineck is the widow of E. F. 308 Reineck, deceased. The petitioner Oak Park Trust & Savings Bank, a corporation organized and existing under the Banking Laws of the State of Illinois, is the trustee of the E. F. Reineck Trust, and duly qualified and acted as such trustee throughout. Petitioners Frederick M. Lee and Winfield S. Hevenor are individuals. Lee became associated with the business of E. F. Reineck, deceased, in 1911; Hevenor, a brother-in-law of decedent, became associated in 1914. On June 26, 1922, the business conducted by the decedent was incorporated under the name of Commercial Wall Paper Mill, Inc. Decedent, until his death, was the president and treasurer; Lee was vice president in charge of the production phase of the business and Hevenor was Secretary in charge of sales and the office administration. All three were directors and stockholders of said corporation. Prior to 1930 decedent held all the outstanding 200 shares of the preferred stock and approximately 90 per cent of the common shares; the remaining common shares were held by Lee and Hevenor. Prior to and at the time of his death the salary paid decedent by the corporation was $15,000 per annum. Lee and Hevenor were each paid $7,500 per309 annum until 1932 when they each voluntarily reduced their salaries to $5,000, which amounts they received in 1932, 1933, 1934 and part of 1935. During 1935 the salary of each was increased to $6,500 per annum and subsequent to 1936 the salary of each was increased to $7,500 per annum. After the death of E. F. Reineck one Holland C. Pile, a representative of the trustee, was elected to the board of directors of the Commercial Wall Paper Mill, Inc., and served throughout. In September 1934, George A. Gaunt and Jack Horlock were elected directors, the latter serving throughout and the former serving until his resignation on June 30, 1938. From 1930 to June 30, 1934 the Commercial Wall Paper Mill, Inc., had outstanding 200 shares of preferred stock and 2,450 shares of common; from June 30, 1934 to December 31, 1938 it had outstanding 200 shares of preferred stock and 2,356 shares of common stock. The gross receipts by the trustee under the E. F. Reineck Trust for the years involved were: 1936$20,862.50193719,759.25193832,260.00During the year 1930 and particularly on December 18, 1930, the fair market value of the common stock of the Commercial Wall Paper Mill, Inc., 310 was not in excess of $60 per share. The fair market value of the common stock during the years in question was as follows: 1936 $140 per share1937145 per share1938150 per shareFor approximately one year prior to his death on December 18, 1930, E. F. Reineck was largely confined to his home with a heart ailment. He left surviving him his wife, Irene M. Reineck, a petitioner here, and one daughter, Margaret F. Reineck. During the year 1930 and particularly on December 18, 1930, the Commercial Wall Paper Mill, Inc., was in financial difficulty, primarily due to the fact it was unable to meet matured obligations of approximately $32,000 because the Hanmond Bank, where most of its cash funds were deposited, had closed. To enable the said corporation to meet these obligations, Mrs. Reineck advanced $11,000 and Lee and Hevenor advanced together $11,000, and the corporation obtained an extension for the payment of the balance. In June 1936 Irene M. Reineck, petitioner in Docket No. 110776, filed a complaint in the Circuit Court of Cook County, Illinois, seeking to have the aforesaid agreement declared invalid and set aside on various grounds. The Oak Park Trust & Savings311 Bank, as trustee, and petitioners Lee and Hevenor were made parties defendant and all filed answers. The matter was referred to a Master in Chancery who rendered a report setting forth his findings and conclusions. By a decree of the Circuit Court entered on June 26, 1939, on consent of all parties, the Court, inter alia, overruled all exceptions to the Master's Report and approved the same. The decree further found and adjudged that the trust agreement, dated January 10, 1930, was "at the time of its execution and has continued to be a valid and effectual agreement and that the trust created thereunder is valid and effectual according to law and according to its full tenor and import," and we adopt such finding. Immediately after the death of Reineck, the trustee set up on its books accounts receivable from Lee and Hevenor, respectively, and charged Lee thereon for 1,432 2/3 shares of Commercial stock at $60 per share and Hevenor for 716 1/3 shares at the same price. As and when dividends were declared and paid to the Trust by the Commercial Company on this stock, as well as when moneys were received directly from Lee and Hevenor for the stock, these accounts were first credited312 with the unpaid interest from the date of Reineck's death and stock at $60 per share for any balance was delivered to Lee and Hevenor. In 1936, 1937 and 1938 Commercial declared and paid dividends on the stock thus held by the trustee in the respective amounts of $20,862.50, $19,759.25 and $32,260. The amounts thus received in 1936 and 1937 were, after deducting administration expenses, paid to petitioner Irene M. Reineck in the years when received. That for 1938 was withheld by the trustee because of the litigation involving her and the other parties in this proceeding but was paid to her in 1939, less administration expenses. All of the stock so charged by the Trust to the accounts of Lee and Hevenor beginning prior to 1936 was delivered by the Trust to Lee and Hevenor before July 1939. The books of the Trust record payment for the same as follows: Lee, $46,659.69 from his funds, directly, and $39,300.31 from dividends to the trust; Hevenor, $18,749.78 from his own funds, directly, and $24,230.22 from dividends to the trust. [Opinion] It is not seriously contended otherwise and we have found that the petitioner E. F. Reineck Trust was, during the tax years, a valid trust. 313 The purpose of section 161 of the Revenue Act of 1936, controlling here, was to tax the whole income of all trust estates unless definitely exempted, no claim of which is made here. But, as such income it is taxable only once. . Corpus, a prerequisite of any trust, of course is not income and its receipt is therefore not taxable. The intention of the creator of the Trust is decisive. That intent is a fact to be ascertained from the trust instrument read as an entirety. So read, we have no doubt of what Reineck intended to and did accomplish by the Trust. That intention is confirmed by the circumstances surrounding the execution of the Trust. We think no one will gainsay the fact that one's family is the natural object of his bounty. In accomplishing that natural result, one may think it necessary to grant an incidental benefit to another. Cf. . That, we think, is basically the situation here. The primary consideration of Reineck in creating the present Trust was that his wife, petitioner assured - so far as possible - that they would receive the value of 314 his Commercial stock. Unless the stock was sold to Lee and Hevenor under their option, the Trust could not sell it without the consent of the wife or, if she were dead, the daughter. That stock, subject to an irrevocable option to buy in Lee and Hevenor, effective for three years, was the corpus of the Trust. As and when that option was exercised and the stock purchased, the proceeds, except interest in an agreed amount on the unpaid balance which petitioner Irene M. Reineck concedes is taxable to her under section 162 (b), became corpus and were distributed as such to her, the widow, under the trust. See particularly Article Two, paragraph "Tenth" of the Trust. Respondent erred in taxing them to her as income. Revenue Act of 1936, section 161. Since a trust can have but one corpus and that corpus was, as we have held, distributed to petitioner Irene M. Reineck, the other distributions, if any except the conceded interest income, could not have been corpus. The Commercial stock on which the dividends involved here were paid then belonged to the Trust. . The dividends were income to it. See315 ; affd., . The segregated Commercial stock, during the tax years, was subject to the Lee and Hevenor option to purchase. The option was exercised when the stock was sold by the Trust to Lee and Hevenor. This occurred when the dividends on the stock were paid to the Trust and, under its terms, were concurrently constructively distributed as trust income to Lee and Hevenor by a credit on the books of the Trust against interest and purchase price of the stock and the stock thus paid for was delivered to Lee and Hevenor. See . Lee and Hevenor were employed by the Commercial Company and not the decedent. That company was a separate entity which cannot be disregarded here. . The Trust did not purport to compensate them for anything. Cf. , and cases there cited. They were given an option, the value of which is not in question. Its exercise depended316 upon no service, past, present or future, to be rendered by either Lee or Hevenor to anybody. Cf. Reineck clearly did not intend that Lee and Hevenor should have the stock as a gift. The stock in the form of proceeds from its sale was given to his wife, petitioner Irene M. Reineck. Reineck intended that Lee and Hevenor should have an option to purchase it and to help them do so he made them beneficiaries of the Trust income if they exercised the option. They bought all the stock and used their "other sources" of income to pay for approximately half. Article Two of the Trust agreement leaves no doubt of the decedent's intention. In paragraph "First" of that Article it is provided, inter alia, "The said Lee and Hevenor shall have the right to purchase said stock set apart for their respective use and benefit, in the manner hereinafter provided, at the rate of Sixty Dollars ($60.00) per share * * ": then follow the two methods by which the purchase may be made, i.e., the income of the Trust in the form of dividends paid to it on the respective shares of stock and from other sources. The trustee is then directed to transfer to317 them "so many of such shares of stock as such payments may be sufficient to fully pay for from time to time" after deducting interest on the unpaid balance. The wording of these provisions is in pointed contrast to that in the "Tenth" paragraph of Article Two providing, inter alia, that "All amounts collected by the trustee under this agreement shall, after the deduction of its reasonable charges and expenses hereunder, be distributed as follows: "To Irene M. Reineck, wife of Reineck, if she is then living, to hold in her sole and absolute right * * ." It is our conclusion that Lee and Hevenor, having exercised their option to buy the stock, under the Trust became entitled to and did receive the distribution of the Trust income as and when received from the corporation in the form of dividends. It follows that they are taxable with the same. Section 162(b), supra. No other result would be consistent with the intention of the decedent. , Cf. , affirming . From the foregoing318 it necessarily follows, for present purposes, the Trust was in receipt of no taxable income during the tax year in dispute except that which was currently distributed or distributable and is here taxed to the recipients. Therefore, the respondent erred in taxing the Trust with the receipt of any income in that year. Section 162(b), Revenue Act of 1936. . Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621566/	DWIGHT E. PARKS AND PEGGY J. PARKS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentParks v. CommissionerDocket No. 4368-84United States Tax CourtT.C. Memo 1990-281; 1990 Tax Ct. Memo LEXIS 300; 59 T.C.M. (CCH) 803; T.C.M. (RIA) 90281; June 5, 1990, Filed 300 Decision will be entered under Rule 155. Held: Deficiencies redetermined; fraud addition found under doctrine of collateral estoppel. Michael P. Carnes, for the petitioner Peggy J. Parks. W. V. Dunnam, for the petitioner Dwight E. Parks. Richard D. Ames, for the respondent. WHITAKER, Judge. WHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies and additions to tax against petitioners for the calendar years 1978 and 1979 in the following amounts: Addition to TaxYearDeficiencySection 6653(b) 11978$ 166,477.22$ 83,238.61197969,858.0034,929.00 Both the deficiencies and the additions to tax for fraud are in issue. In addition, if we hold against respondent on the fraud issue, we will be required to decide whether the 6-year statute of limitations under section 6501(e)(1) is applicable. The deficiencies are predicated upon respondent's determination that petitioners diverted funds from Cin- Lynn Properties, Inc. (Cin-Lynn) for their own benefit. 301 FINDINGS OF FACT BackgroundSome of the facts have been stipulated and they are so found. During the years 1978 and 1979 petitioners Dwight Parks and Peggy Parks were husband and wife and resided in Waco, Texas. They were married in 1975. For these years they filed joint Federal income tax returns. Mrs. Parks has only a high school education. Mrs. Parks has a son by a prior marriage who during these years resided with her. Mr. Parks' two daughters by his prior marriage did not reside in the Parks' household. In October 1981, Mrs. Parks filed a petition for divorce which was ultimately withdrawn, although Mr. and Mrs. Parks were not living together at the time of trial. On May 28, 1978, Mr. Parks was convicted of a Federal drug-related offense. He was incarceratedfrom that date until February 9, 1981, in several different prisons including Leavenworth. While there, as a result of a prisoner strike, Mr. Parks received death threats. In February 1983, petitioners were both indicted for evasion of income tax under section 7201 for each of the calendar years 1978 and 1979. Mr. Parks was found guilty as charged and Mrs. Parks was acquitted. Mr. Parks' conviction was upheld on 302 appeal. During 1971, apparently in connection with his divorce from his former wife, Mr. Parks caused Cin-Lynn to be incorporated with all of the capital stock issued to Mr. Parks' daughters, Cindy Parks and Lynn Parks. Apparently through the years involved, Mr. Parks served as president of Cin-Lynn and up to his incarceration exercised exclusive management control. Cin-Lynn was used by Mr. Parks as a vehicle for conducting many, if not most, of his business affairs, including the acquisition, development, rental, and sale of real estate. Notwithstanding the ownership of stock by his daughters, who had reached adulthood prior to 1978, Mr. Parks appears to have treated Cin-Lynn as though wholly owned by him. There is no evidence that either daughter objected. At somepoint prior to the years in issue Mrs. Parks was appointed secretary of Cin-Lynn. She became employed by Cin-Lynn in 1971, continuing to perform secretarial and clerical duties which she had been doing for Mr. Parks since the 1960's. Cin-Lynn's offices were from time to time in various buildings owned by Cin-Lynn. When Mr. Parks was incarcerated, sole responsibility for handling the businesses of Cin-Lynn fell on 303 Mrs. Parks, assisted by her husband's attorney Mike Beard. Mr. Parks had complete confidence in both Mrs. Parks and Mr. Beard and left to their discretion the handling of Cin-Lynn's business affairs, with such infrequent policy directions as he was able to give. In general, but with certain minor exceptions as noted herein, Mrs. Parks and Mr. Beard used their best judgment to handle these business affairs for the benefit of Cin-Lynn. While in jail Mr. Parks directed Mrs. Parks to file necessary Federal tax returns and to report correctly all transactions. Following this direction, Mrs. Parks delivered to Cameron Talbert, Mr. Parks' certified public accountant, information used for tax return preparation of Cin-Lynn's returns for the years 1978 and 1979. She alsoprepared certain schedules attached to those returns. The 1978 return was signed by Mrs. Parks as secretary of Cin-Lynn and by Mr. Talbert as preparer. The 1979 return was signed by Mr. Parks as president and by Mr. Talbert. The individual returns of Mr. and Mrs. Parks were similarly prepared by Mr. Talbert for 1978 and 1979. Of immediate concern to Mrs. Parks in June 1978 was the completion of a building on 901-917 Lake 304 Air Drive, construction of which had been begun by Mr. Parks through Cin-Lynn as owner of the property. (See below under heading "901-917 Lake Air Drive.") Shortly after her husband was incarcerated, Mrs. Parks received Cin-Lynn monies which required depositing into a Cin-Lynn bank account. In the course of preparing to make the deposit into an account at Central National Bank, Mrs. Parks was told by a bank official that the money could be deposited but that she could not withdraw it because she did not have signature authority over that account. Therefore, on July 31, 1978, Mrs. Parks established a checking account in Central National Bank styled "Peggy Parks Commercial Account" (the Commercial Account). This account was used primarily for the deposit ofthe proceeds of the Hewitt Mobile Home sale (see below under heading "Mobile Home Park") and income received from 901-917 Lake Air Drive property. During 1978, all disbursements from the Commercial Account were made for the benefit of Cin-Lynn. However, during 1979 the aggregate sum of $ 1,823.83 was expended from the account for the personal benefit of Mrs. Parks and her son. A television set purchased in 1979 with funds from 305 the Commercial Account was used exclusively in Cin-Lynn's offices and was not a personal expenditure for Mrs. Parks' benefit. Also in 1979, Mrs. Parks caused Cin-Lynn to lend $ 4,600 to her mother which was used to pay the balance of a mortgage on her mother's residence. A demand promissory note was given to reflect the loan but up to the time of trial no interest had been paid on the note. Prior to the time of Mr. Parks' incarceration, Mrs. Parks drew money from Cin-Lynn for her personal needs from time to time, although Mr. Parks provided the principal support for the family, presumably from his Cin-Lynn compensation. After his incarceration Mrs. Parks withdrew funds from various Cin-Lynn businesses for her own support. Respondent has not questionedthese withdrawals. Thus we assume that they were properly reported for tax purposes. The deficiencies in this case arise principally out of respondent's determinations that petitioners diverted or converted to their own use properties and funds of Cin-Lynn. These include the Parks' residence at 2453 Charboneau in Waco, Texas; a mobile home park, legal title to which apparently was in Mr. Parks' name as trustee for his daughters, 306 although the property was treated as an asset of Cin-Lynn; real property known as 901-917 Lake Air Drive upon which a building was under construction in May 1978; $ 80,000 of the sale proceeds of a motel known as Motel 11; the proceeds of the sale of a Cessna aircraft; and part of the proceeds of the sale of the properties known as Parkstown Apartments. With the exception of the residence, these properties were sold by Mrs. Parks to unrelated third parties with Mr. Beard's help in 1978 and 1979, in part at the general direction of Mr. Parks. In addition Cin-Lynn was caused to pay the attorney fees incurred by Mr. Parks in his criminal trial. 2453 CharboneauIn 1975 Cin-Lynn purchased a lot known as 2453 Charboneau in Waco, Texas, on which a housewas constructed during 1975 and 1976. Cin-Lynn paid all the costs of purchasing the lot and constructing the house. Some of these disbursements for construction costs were charged to other businesses owned by Cin-Lynn. Upon completion of construction Mr. and Mrs. Parks used this property as their joint residence until Mr. Parks' incarceration. Mrs. Parks continued to reside in the house during 1978 and 1979 and was still residing there 307 at the time of trial. Prior to 1978 this property had been used by Cin-Lynn as security for a loan made by Marlin National Bank. In April 1978 the loan was renewed in the amount of $ 65,699.46 and again secured by deed of trust on this property. In April 1979 the loan was again renewed for $ 54,996.78 and a new deed of trust executed by Cin-Lynn and petitioners individually. During the period 1976 to August 1981, the dwelling was insured for $ 72,000 with the insurance reduced in August 1981 to $ 70,000. However, financial statements prepared for Cin-Lynn as of June 1, 1976, and June 1, 1977, showed the house and lot as having a value of $ 125,000. When Mr. Parks went to jail in 1978, he wanted Mrs. Parks to obtain title to the residence sothat she would have that much financial security. Mr. Parks had already arranged with his two daughters to cause Cin-Lynn to deed the residence to Mrs. Parks free and clear of the lien if Mr. Parks died in prison. Shortly after going to prison Mr. Parks signed in blank and gave to Mr. Beard two deeds, one to be used to deed the residence to Mrs. Parks and the other the mobile home park. Mr. Beard was given complete discretion to handle both 308 transactions. By deed dated July 25, 1978, Mr. Beard caused the residence to be deeded to Mrs. Parks as her separate property. The deed was recorded on September 8, 1978. At that time, the property was still subject to the lien of the April 19, 1978, deed of trust. On September 5, 1978, at the direction of Mr. Beard, Mrs. Parks executed a promissory note in favor of Cin-Lynn in the amount of $ 50,000 with interest at 6 percent. The note was intended to be consideration for the transfer of the property to Mrs. Parks. On December 12, 1978, she paid $ 500 to Cin-Lynn on account of the note. No other payments were made on the note. Mrs. Parks was unable to pay the $ 50,000 note or the balance due on the secured loan, payments on which weremade by Cin-Lynn. Demands were made upon Mrs. Parks in 1982 for payment. Whether these demands were made in connection with the divorce proceedings filed by Mrs. Parks or for other reasons, we do not know. On May 2, 1983, the property was deeded back to Cin-Lynn by Mrs. Parks in consideration of the assumption of the secured indebtedness then owed to the Waco branch of Central Texas Savings and Loan Association (Central Texas) 2 and the cancellation 309 of the $ 50,000 note. For the years 1977 and 1978, Cin-Lynn paid the property taxes on this property. It is unclear whether Cin-Lynn or Mrs. Parks paid these taxes in 1979 and later years. Mrs. Parks paid the utilities. No rent was paid to Cin-Lynn on the residence prior to 1978 or after May 2, 1983. However, atthe time of trial and apparently for some period prior to that, Mrs. Parks paid the maintenance cost of the residence. Respondent treated the residence as having a value of $ 125,000 with the entire value diverted by petitioners to their benefit during the year 1978. Although no appraisal testimony was presented, during July and September 1978, we find that the value of the Charboneau property was in the range of $ 110,000 to $ 125,000. Mobile Home ParkSometime prior to 1978 a trust of which Mr. Parks was trustee for the benefit of his two daughters, Cindy and Lynn Parks, acquired or developed a mobile home park described as Hewitt 310 Mobile Home. It is unclear on this record whether the mobile home park was constructed on land then owned by Cin-Lynn or how or why the property was treated as belonging to Cin-Lynn. However, Cin-Lynn's financial statement dated June 1, 1977, includes a mobile home park valued at $ 59,000. Cin-Lynn's corporate returns for the years 1976, 1977, and 1978 include the income and expenses of a mobile home park. The second deed previously signed by Mr. Parks in blank was completed by Mr. Beard, dated July 18, 1978, and used to effect the transferof title to the mobile home park to Mrs. Parks. Mr. Parks believed that operation of the mobile home park was more than Mrs. Parks could handle by herself and that the property should be sold. It was to facilitate that sale that the property was transferred into her name. Why the deed was not used to transfer title to the purchaser is unclear. By deed dated November 24, 1978, Mrs. Parks sold the mobile home park to one Glidden O'Connor for $ 40,000 with a $ 10,000 down payment and a $ 30,000 installment note made payable to Mrs. Parks. The note was secured by a deed of trust which designated Mr. Beard as trustee. Mrs. Parks actually received 311 $ 8,837.72 out of the down payment, the remainder being consumed by selling expenses. It is unclear when the sale to Mr. O'Connor was actually closed. The deed of trust securing the unpaid balance was not recorded until the end of December 1978. On January 10, 1979, Mrs. Parks purchased a certificate of deposit in her name at Central Texas in the amount of $ 10,000. Funds for the purchase of a certificate of deposit came from a check in the amount of $ 8,837.72 drawn by Abstract and Title Company, reflecting the net portion of the downpayment from the sale of the mobile home park. The date of this check is illegible on the exhibit. The balance came from a check dated January 10, 1979, in the amount of $ 1,062.28 written on Cin-Lynn's account at Texas National Bank. On July 10, 1979, that certificate of deposit was rolled over into another certificate of deposit also in the name of Peggy Parks at Central Texas. On January 7, 1980, the proceeds of the certificate of deposit plus accrued interest was transferred to an account at Central Texas styled "Peggy Parks Tax and Escrow Account." Funds in that account were used to pay taxes and other expenses with respect to Cin-Lynn properties. 312 During the year 1979 Mr. O'Connor made note payments to Mrs. Parks, aggregating $ 3,759.36, all of which were deposited in the Commercial Account. (No payments were made on the note during the year 1978.) Cin-Lynn's 1978 corporate return reported the sale of the mobile home park, including the receipt of the $ 10,000 down payment. During 1980 Mr. O'Connor made monthly payments to Mrs. Parks in the amount of $ 3,759.36. Cin-Lynn's returns for the years 1979 and 1980 reflect the interest received from Mr. O'Connor on the installmentnote. We cannot from this record ascertain the disposition of the installment note payments received by Mrs. Parks in 1980 or of the balance of principal and interest due on the installment sale, on the assumption that it was paid. Respondent treated the $ 40,000 value of the mobile home park as diverted to petitioners in 1978. 901-917 Lake Air DrivePrior to Mr. Parks' conviction in May 1978, Johnny Whiteside acquired from Wallace Cox land at 901-917 Lake Air Drive for $ 80,500 of which $ 500 was paid in cash. A short-term promissory note for $ 80,000 was given by Mr. Whiteside. Thereafter through his attorney who was Mr. Beard, Mr. Whiteside was put 313 in touch with Mr. Parks. They made an agreement pursuant to which Cin-Lynn purchased the land and assumed the $ 80,000 promissory note. Cin-Lynn further agreed to construct a building and lease space in it to Mr. Whiteside. The deed from Mr. Whiteside to Cin-Lynn was not recorded but instead was held by Mr. Beard apparently at Mr. Parks' direction. The interest rate on the Whiteside note was below the then current rate. Mr. Parks was afraid that if the deed to Cin-Lynn were recorded, Mr. Cox would find out about thattransaction and would insist upon market-rate interest on renewal. By the end of May 1978 when Mr. Parks went to prison, the building was approximately 90-percent complete. On June 1, 1978, at the request of Mr. Beard, Mr. Whiteside conveyed the property to Peggy Parks as her separate property. The deed to Peggy Parks was recorded. Mrs. Parks had no knowledge of the deeding of the property to her until October 1979 when she handled the payment to Mr. Cox of the balance due on the purchase price. Mr. Parks did not instruct Mr. Beard to cause this action to be taken and was not aware of the second deed until well after 1979. Nothing in this record explains the reason 314 for this second deed. 3Costs for the construction of the building rented to Mr. Whiteside in the amount of $ 64,699.10were paid by Cin-Lynn in 1978. Between August 1, 1978, and September 6, 1979, Peggy Parks wrote checks each month in the amount of $ 533.33, drawn on her Commercial Account, which checks were deposited into Mr. Beard's trust account to be used to pay interest to Mr. Cox. The monthly interest payments were then made by Mr. Beard. This handling of the interest payments was intended to prevent Mr. Cox from learning that this property had been purchased by Cin-Lynn. On October 11, 1979, Mrs. Parks drew a check on her Commercial Account in the amount of $ 80,159.73 payable to Mr. Cox which paid off the principal and accrued interest due on the note. It was in connection with this transaction that Mrs. Parks learned of the Whiteside deed to her. The check was funded by the proceeds of a loan from CentralTexas, with an $ 80,000 CD owned by Cin-Lynn 315 used as collateral. See discussion below under heading "Motel 11." The building constructed on the 901-917 Lake Air Drive property contained two stories. It was completed in 1978 and rented to Mr. Whiteside. All rental payments on this property were paid by Mr. Whiteside to Mrs. Parks at the direction of Mr. Beard. The building wasrented to Donald J. Dwyer from May 1979 to the early part of 1981. The monthly lease payments on this building were paid to Mrs. Parks. Aggregate lease payments received by Mrs. Parks in 1978 were $ 9,000 and in 1979 $ 19,850. All of these lease payments were deposited into Mrs. Parks' Commercial Account at Central National Bank. The income and expenses pertaining to the leasing of the 901-917 Lake Air Drive property were reported on Cin-Lynn's 1978 and 1979 Federal income tax returns. On May 15, 1981, Mrs. Parks transferred the 901-917 Lake Air Drive property to Cin-Lynn by warranty deed. Respondent taxes to petitioners for the year 1978 the sum of $ 64,699.10 as a diversion of Cin-Lynn funds used in the construction of the building. For 1979 respondent determined that $ 80,000 of Cin-Lynn funds were used to purchase the 901-917 Lake Air Drive 316 property. See discussion under heading "Motel 11." Motel 11Prior to 1979 Cin-Lynn acquired a motel known as Motel 11. On March 30, 1979, Cin-Lynn sold Motel 11 to Renchor, Inc., for $ 345,000. (We assume Mr. Parks signed the deed as president of Cin-Lynn.) After selling expenses and existing liabilities were paid, Cin-Lynnreceived $ 132,519.82. This sum as deposited by Mrs. Parks in Cin-Lynn's account at Texas National Bank on that day. Also on March 30, 1979, Mrs. Parks transferred $ 120,000 from Cin-Lynn's Texas National Bank account to Central Texas which funds were then used to purchase a savings certificate issued by that institution in the name of Cin-Lynn. On September 27, 1979, the $ 120,000 savings certificate was redeemed and out of the proceeds $ 33,299.45 was transferred to another Cin-Lynn savings account, $ 13,015.77 was transferred to a Cin-Lynn account in Central Texas and used to pay off a loan, and $ 80,000 was transferred into a savings certificate. On October 9, 1979, Mrs. Parks caused Cin-Lynn to borrow $ 80,000 from CentralTexas, using the $ 80,000 savings certificate as collateral. The proceeds of the loan were deposited into Mrs. Parks' Commercial Account 317 and on that date used principally to fund the check for $ 80,159.73 paid to Mr. Cox. The $ 80,000 loan was paid off in April 1980 with funds from the redemption of the $ 80,000 savings certificate. Although not entirely clear from the statutory notice, we assume that it is the transfer of the proceeds of the loan intothe Commercial Account which respondent deemed to be a diversion of funds. Cessna 337 AircraftIn 1977 Cin-Lynn purchased three aircraft, one of which was a Cessna 337. Income and expenses of these aircraft are reflected on Cin-Lynn's 1977 and 1978 Federal income tax returns. All three aircraft were registered in the name of United Air Services, a trade name used by Cin-Lynn. On September 25, 1978, the Cessna 337 was sold to one Carl May. Mrs. Parks as secretary of United Air Services signed the bill of sale and the sale was reported on Cin-Lynn's 1978 Federal income tax return. On September 25, 1978, Mrs. Parks or Mr. Beard received a check from Carl May in the amount of $ 24,500 as the final payment on the Cessna 337. This check was deposited into Mr. Beard's trust account. On the same date Mr. Beard purchased at First National Bank at Waco a bank money order 318 payable to Peggy Newton in the amount of $ 24,500. Peggy Newton is the maiden name of Mrs. Parks. Mrs Parks used the money order to purchase a certificate of deposit at the Central Texas branch in Temple, Texas, in the amount of $ 24,500. The certificate of deposit was issued in the name of "Peggy Newton, Trusteefor Michael Daron Rhodes," who is Mrs. Parks' son by her former marriage. The address used on the certificate was Mrs. Parks' residence. Mrs. Parks placed the $ 24,500 in her name as trustee for her son in order to conceal the money from Mr. Parks and to insure that there would be some money available for her son in the event of the death of Mr. Parks. This sum with interest was thereafter used to purchase gold Krugerrands. (See below.) Respondent treated the proceeds from the sale of the Cessna 337 as diverted to petitioners in 1978. Legal FeesBetween April and July 1978, Cin-Lynn paid $ 19,000 to the attorney who defended Mr. Parks on the Federal drug charge. There is no evidence that either Mr. or Mrs. Parks ever reimbursed Cin-Lynn for this amount. These payments were treated as additional income to petitioners. KrugerrandsOn August 16, 1979, Cin-Lynn borrowed 319 $ 39,315 from Central Texas which funds were deposited into Cin-Lynn's bank account at Lake Air National Bank. The funds were thereupon used by Mrs. Parks to purchase gold Krugerrands from Monex International Limited (Monex). The purchase was made in the names of Mr. and Mrs. Parks. (During 1981, the account was changed into the name of Cin-Lynn.) The $ 24,500 with accrued interest, then totaling $ 26,808.16, reflected in the certificate of deposit issued by the Temple Branch of Central Texas was withdrawn and combined with an additional $ 13,015.17 in funds withdrawn from Cin-Lynn's account at the Waco branch of Central Texas and was used to repay the funds borrowed on August 16, 1979. The $ 13,015.17 was a portion of the proceeds of the sale of the Motel 11. The purchase of the Krugerrands was at the direction of Mr. Parks. On receipt the Krugerrands were placed in a safety deposit box in the name of Peggy Parks. In 1981, within 30 to 40 days after Mr. Parks was released from prison, Mrs. Parks returned one half of the Krugerrands to him and later returned the remaining Krugerrands. The retention of half of the Krugerrands apparently was related to the marital controversy 320 between Mr. and Mrs. Parks. Respondent treated $ 13,015.77 used to purchase Krugerrands as diverted to petitioners in 1979, the $ 24,500 sum having already been taxed to petitioners as a 1978 adjustment. Parkstown ApartmentsSometime prior to 1979 Cin-Lynn acquired property in Waco, Texas, described as the Parkstown Apartments. On November 11, 1979, that property was sold to one Don Dwyer for $ 480,000 of which $ 5,000 was the down payment and $ 48,905.33 was paid at the closing. At the closing a promissory note in the amount of $ 54,125.31 payable to Cin-Lynn within 90 days from the date of sale was delivered, and the purchaser assumed an outstanding mortgage in the amount of $ 330,000. Mr. Dwyer dealt with Mrs. Parks in making the purchase but the deed dated October 30, 1979, was executed by Mr. Parks as president of Cin-Lynn. On November 13, 1979, Mrs. Parks used the sum of $ 48,905.53, received at the closing to purchase a cashier's check issued by Lake Air National Bank payable to Cin-Lynn. On the same day another check in the amount of $ 1,094.47 was drawn on a Cin-Lynn Account at Lake Air National Bank payable to Mike Beard as Trustee. Mr. Beard on November 13, 1979, thereupon 321 deposited the two Cin-Lynn checks 4 totaling $ 50,000 into his trust account, and immediately withdrew $ 50,000 from that account in the form of a check payable to "Peggy Parks" which check was used to acquire a $ 50,000 certificate of deposit at the First National Bank in Waco inthe name of Mrs. Parks. This certificate of deposit with accrued interest was used in part to purchase silver bullion in May 1980 through Monex. The 1980 Federal income tax return of Cin-Lynn reported a loss under the caption of "Monex Silver Speculation" in an amount in excess of $ 67,000. However, Monex records show that the silver bullion was in the names of petitioners. The parties have stipulated that on December 31, 1980, Monex paid to petitioners the sum of $ 35,565.21. On February 19, 1980, the $ 54,124.31 promissory note was paid by Mr. Dwyer to Mrs. Parks. Respondent without explanation determined that $ 50,000 was diverted in 1979 to petitioners. OPINION 322 The aggregate additional income of petitioners for 1978 as result of respondent's adjustmentsis in excess of $ 273,000. For 1979 slightly more than $ 143,000 in funds or assets is treated as diverted from Cin-Lynn to petitioners. Respondent also determined that both petitioners are liable for the addition to tax for fraud. These transactions are discussed under the headings used in our Findings of Fact. 2453 CharboneauNeither party presented any appraisal testimony with respect to the value of the residence at 2453 Charboneau on July 25, 1978, the date of the deed which conveyed the residence to Mrs. Parks. It is unclear whether the transaction should be treated as effective on that date or on September 8, 1978, the date of recordation. Neither can we determine from this record the exact amount of the outstanding loan secured by the deed of trust on the Charboneau property on this date. We do know that in April 1978 the loan was slightly in excess of $ 65,000 and one year later in April 1979 the loan had been reduced to just under $ 55,000. If we assume that the mortgage payments were level, then on the date of the deed to Mrs. Parks, the principal should have been reduced 323 by approximately one fourth of the annual reduction or approximately $ 2,500. On thisbasis, the principal balance on the date of deed as well as on the date of recordation would have been approximately $ 63,000. The value of Cin-Lynn's equity was therefore the full value on the appropriate date less the secured debt. Mrs. Parks gave her note in the amount of $ 50,000, to Cin-Lynn reflecting apparently a conclusion by Mr. Beard of an equity of approximately $ 113,000. This estimate of value was not unreasonable. By no stretch of the imagination could the transfer of the Charboneau residence to Mrs. Parks be deemed to be a conversion of corporate assets in the amount of $ 125,000, an amount probably in excess of the actual fair market value of the house and lot. Possibly the difference (if any) between the value of the equity and $ 50,000 might be income to Mrs. Parks, but respondent has not raised any alternative issues with respect to this transaction. Respondent's determination was clearly incorrect. There is no evidence of any intent on the part of either petitioner to convert corporate assets by the transfer of title of the residence to Mrs. Parks. Even though title was 324 in Cin-Lynn, Mr. Parks considered the property to be his. He had arranged with hisdaughters to deed the property to Mrs. Parks free and clear of the encumbrance, if he had died in prison. However, Mr. Beard set up the transaction as a purchase in order to protect it from possible attack by the daughters. Both he and Mr. Beard considered its value to be slightly over $ 100,000. The reasons for the transfer are obvious and understandable. In this state of the record we have no basis for concluding that this transaction resulted in any diversion of Cin-Lynn property to petitioners in 1978. We note that respondent did not seek to tax to either petitioner the rental value of the premises prior to the transfer to Mrs. Parks or to tax to her the mortgage payments which Cin-Lynn continued to make from the date of the deed to Mrs. Parks until the date of her retransfer of the property back to Cin-Lynn. Cin-Lynn itself appears to have been treated as the alter ego of Mr. Parks but respondent has not raised that as an issue. On the Charboneau residence issue we hold for petitioners. Mobile Home ParkRespondent fails to recognize the reasonableness of the action taken by Mrs. Parks with 325 Mr. Beard's advice in placing cash and properties in her name for easy disposition. There may have been other and perhaps better ways in which the businesses of Cin-Lynn might have been handled or at least ways of minimizing the parties' exposure to tax controversy. But we find the actions taken by petitioners and Mr. Beard to have been reasonable, based on the explanations given by them. We further find these three individuals to be credible witnesses. Both the Commercial Account and the Tax and Escrow Account were appropriate vehicles for the management of the businesses and properties. The funds in each account were used for Cin-Lynn with the specific exceptions noted in our Findings of Fact. Respondent argues that the return of the funds to Cin-Lynn was an afterthought, caused by respondent's initial audit inquiry in 1981. That ignores, however, the undisputed testimony as to use of the funds in the two bank accounts starting in 1978. Respondent's determination with respect to the conversion of the mobile home park in the amount of its sale price in 1978 is again incorrect. We hold for petitioners on this issue. 901-917 Lake Air DriveThe statutory notice treats the sum 326 of $ 64,699.10 which was used in 1978 for the purchase of "901-917 Lake AirDrive" as used for "the purchase of personal assets." Respondent ignores the fact that this property was purchased by Cin-Lynn from Mr. Cox and deeded to it. It was at all times treated as an asset of Cin-Lynn. Neither Mr. nor Mrs. Parks was aware at the time of its execution that Mr. Beard for reasons not adequately explained on this record caused a second deed to be executed by Mr. Whiteside to Mrs. Parks covering this property. However, at least between the parties, the prior deed to Cin-Lynn was effective and we deem the second deed to have been a nullity. Mrs. Parks and Mr. Beard simply handled this property for Cin-Lynn as best they could. We hold for petitioners on this issue. Motel 11The sale of Motel 11 generated funds which in part were used in 1979 to repay an $ 80,000 loan by Cin-Lynn from CentralTexas. The loan was used to fund the final installment payment to the seller of the purchase price of the 901-917 Lake Air Drive property. For the reasons discussed under that heading, the $ 80,000 payment benefited Cin-Lynn. Respondent's determination is incorrect. We hold for petitioners on 327 this issue. Cessna 337The proceeds of the sale of the Cessna337 aircraft in the amount of $ 24,500 were in September 1978 diverted by Mrs. Parks to her own use, although ultimately returned in the following year either to Cin-Lynn or to Mr. Parks. Even if we agreed with petitioners that the purchase of gold Krugerrands was for the benefit of Cin-Lynn, that action taken in 1979 does not cure the 1978 problem. The setting aside of the $ 24,500 for the benefit of Mrs. Parks' son in a manner calculated to conceal that action from Mr. Parks shows an appropriation of this sum by Mrs. Parks for her own benefit. Whether Mrs. Parks' action should be characterized as akin to embezzlement is unclear but at the least the sum is taxable to Mrs. Parks in 1978. We hold for respondent on this issue. Legal FeesPetitioners' remaining 1978 adjustment is $ 19,000 in legal fees paid by Cin-Lynn for Mr. Parks. Petitioners seek to treat this payment of legal fees either as a mistake on the part of the accountant who prepared the 1978 corporate income tax return or as a proper corporate disbursement to protect Cin-Lynn's chief executive officer. Whether or not a mistake the payment was a diversion 328 of Cin-Lynn assets to the use of Mr. Parks. The criminaltrial on a drug offense has no relation to any legitimate Cin-Lynn business. Respondent's determination to tax that amount to petitioners is correct. KrugerrandsThere is also a second issue which arose out of use of the proceeds from the sale of Motel 11. The sum of $ 13,015.77 was combined with the $ 24,500 and interest on that amount (derived from the sale of the aircraft and deposited by Mrs. Parks in an account for the benefit of her son) and used to repay a loan from CentralTexas. This loan had been made to purchase Krugerrands at Mr. Parks' direction. Mrs. Parks testified that she made the purchase for Cin-Lynn's benefit. However, there is simply no evidence other than the testimony of petitioners to show that the Krugerrands were ever treated as Cin-Lynn property. Documentary evidence is to the contrary. The Monex account was in the names of petitioners until 1981. The Krugerrands were delivered to and kept by Mrs. Parks in a bank box apparently in her name. At least there is nothing in the record to indicate the box was in the name of Cin-Lynn. She delivered them to Mr. Parks. There is no evidence that Mr. 329 Parks treated the gold as property of Cin-Lynn. Accordingly the sum of $ 13,015.77 is taxable to petitioners in 1979. Parkstown ApartmentsRespondent determined that $ 50,000 out of the proceeds of the Parkstown Apartments sale was diverted from Cin-Lynn to petitioners in 1979. However, the actions taken by Mrs. Parks and Mr. Beard during 1979 do not support respondent's position. While there is no explanation for the apparently circuitous route by which the $ 48,905.53 check drawn on Lake Air National Bank and given by Mr. Dwyer to Mrs. Parks was transferred into an interest-bearing certificate of deposit in the amount of $ 50,000 issued by First National Bank of Waco, the end result was simply an investment of excess Cin-Lynn funds under Mrs. Parks' control. That is entirely consistent with other actions taken by Mrs. Parks and Mr. Beard during 1978 and 1979 with respect to Cin-Lynn's assets and properties. Use of the proceeds of this certificate of deposit in May 1980 to purchase silver through Monex in an account in petitioners' names may well have been a diversion of Cin-Lynn assets but the year 1980 is not before the Court. Through the end of 1979, there is no basis for concluding 330 that the investment of thesefunds in the certificate of deposit was an appropriation by petitioners of Cin-Lynn assets. We, therefore, hold for petitioners on this issue. Diversion from Commercial AccountIn 1979, we have found, Mrs. Parks expended the sum of $ 1,823.83 in payment of doctor bills and other items personal to herself and her son. These funds belonged to Cin-Lynn; at least the Commercial Account has been explained as a mechanism for handling Cin-Lynn business. Hence, this use was a diversion, the amount should be taxable to Mrs. Parks and should have been included in petitioners' 1979 income tax return. We note also that funds from this account were loaned to Mrs. Parks' mother for her use but were reflected in an interest-free note. Respondent has not argued that interest should be imputed to Cin-Lynn and its tax years are not before us. While the loan may not have served any business purpose, we see no basis for increasing petitioners' income by this amount. Respondent has not raised either of these issues and we see no reason why we should do so. Redetermined Unreported IncomeOn the basis of the foregoing we hold that additional income is taxable to petitioners 331 for 1978in the amount of $ 43,500 and for 1979 in the amount of $ 13,015.77. Fraud AdditionUnder section 6653(b) respondent has the burden of proving fraud by clear and convincing evidence. Section 7454(a); Rule 142(b). To meet this burden, respondent must show that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Stoltzfus v. United States, 398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968); Rowlee v. Commissioner, 80 T.C. 1111 (1983). 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); Estate of Pittard v. Commissioner, 69 T.C. 391">69 T.C. 391 (1977). Fraud is not to be imputed or presumed. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970); Otsuki v. Commissioner, 53 T.C. 96 (1969).However, fraud may be proven by circumstantial evidence because direct proof of the taxpayer's intent is rarely available. Rowlee v. Commissioner, supra.The taxpayer's entire course of conduct may be examined to establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 223-224 (1971); 332 Otsuki v. Commissioner, supra at 105-106. The intent to conceal or mislead may be inferred from a pattern of conduct. See Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943). A pattern of consistent underreporting of income, especially when accompanied by other circumstances showing an intent to conceal, justifies the inference of fraud. See Holland v. United States, 348 U.S. 121">348 U.S. 121, 137 (1954); Otsuki v. Commissioner, supra.However, the mere failure to report income is not sufficient to establish fraud. Merritt v. Commissioner, 301 F.2d 484">301 F.2d 484, 487 (5th Cir. 1962). Fraud may not be found under "circumstances which at most create only suspicion." Davis v. Commissioner, 184 F.2d 86">184 F.2d 86, 87 (10th Cir. 1950);Katz v. Commissioner, 90 T.C. 1130">90 T.C. 1130, 1144 (1988). Other badges of fraud which may be taken into account include: the making of false and inconsistent statements to revenue agents, Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 20 (1980); the filing of false documents, Stephenson v. Commissioner, 79 T.C. 995">79 T.C. 995, 1007 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984); understatement of income, inadequate records, failure to file tax returns, implausible or inconsistent explanations of behavior, concealment 333 of assets, and failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303 (9th Cir. 1986), affg. a Memorandum Opinion of this Court. On this record, there is simply no basis for a finding that Mrs. Parks is liable for the fraud addition. She was forced into taking action on and with the advice of Mr. Beard under most difficult circumstances. The most one can conclude from this record is (i) that for a period of time $ 24,500 of Cin-Lynn's assets was set aside for the benefit of Mrs. Parks' son and ultimately and somewhat indirectly used to purchase Krugerrands; (ii) $ 1,823.83out of the Commercial Account was spent on personal items for Mrs. Parks and her son but respondent did not raise the issue; (iii) an aggregate of $ 63,015.77 of Cin-Lynn's funds was used to purchase gold and silver in 1979 and 1980; and (iv) attorneys fees aggregating $ 19,000 were paid in 1978 for Mr. Parks.From this record we cannot determine specifically whether the facts pertaining to all of these items were fully disclosed by Mrs. Parks to the tax return preparer. The attorney fees were so disclosed. Moreover, Mrs. Parks was acting during 1978 and 1979 and thereafter on and with 334 the advice of Mr. Beard, except for the gold and silver investments. While there is no indication that she received tax advice from Mr. Beard or that he was knowledgeable in Federal tax, the $ 24,500 diversion was intended to be a protection against Mr. Parks' death while in prison. Mr. Beard in his capacity as attorney assisted. Later use of the $ 24,500 to purchase Krugerrands, at Mr. Parks' direction, but apparently before he became aware of the temporary diversion for Mrs. Parks' personal benefit, effected a return of the funds to the family unit although not to Cin-Lynn. We have concluded that use of Cin-Lynn moneys by Mrs. Parks to purchase gold and silver in the names of petitioners was not for the account of Cin-Lynn but those actions are not sufficient to show fraudulent intent on the part of either petitioner. There is simply an insufficient basis on this record for finding fraud on the part of Mrs. Parks or, except for collateral estoppel, against Mr. Parks. Respondent contends that Mr. Parks is collaterally estopped from denying that the underpayment of income tax for the years 1978 and 1979 is due to fraud. Collateral estoppel is based upon Mr. Parks' conviction of 335 income tax evasion for the years 1978 and 1979 in violation of section 7201. The law is clear that a criminal conviction based upon an indictment charging a wilful attempt to evade or defeat tax necessarily carries with it the ultimate factual determination that the underpayment was due to fraud. Amos v. Commissioner, 43 T.C. 50">43 T.C. 50 (1964), affd 360 F.2d 358">360 F.2d 358 (4th Cir. 1965).Thus, Mr. Parks is estopped from denying the existence of fraud for the years1978 and 1979. As to Mr. Parks, we hold for respondent. We further note that although petitioners filed joint returns, our finding of fraud against Mr. Parks, based solely upon collateral estoppel,does not warrant finding fraud against Mrs. Parks. Rodney v. Commissioner, 53 T.C. 287">53 T.C. 287 (1960); Quantz v. Commissioner, T.C. Memo 1990-39">T.C. Memo. 1990-39.Accordingly the fraud addition is found against Mr. Parks but not against Mrs. Parks. Statute of LimitationsRespondent raises the 6-year statute of limitations under section 6501(e)(1)(A) as an alternative to fraud. Since we have found fraud against Mr. Parks under the doctrine of collateral estoppel, the statute is open as to him. Sec. 6501(c)(1). We consider this issue as to Mrs. Parks only. See Rodney v. Commissioner, 53 T.C. 287">53 T.C. 287, 310-311 (1969).336 The burden of proof is upon respondent. The parties have not stipulated as to the actual dates of filing of petitioners' 1978 and 1979 income tax returns. The returns themselves do not show filing dates but the signature appear to have been affixed prior to April 15 of the years 1979 and 1980. The preparer's signature on the 1978 returnis dated March 30, 1979, and on the 1979 return Mr. Parks' signature has the date "4-12-80" inserted next to it. Therefore, under section 6501(b)(2), both returns are deemed filed on April 15 (or the next business day) of each year. The 3-year statute would have expired on April 15 of the years 1982 and 1983. The statutory notice is dated November 23, 1983. Thus it was issued more than 3 years but less than 6 years after the filing date of both returns. As redetermined by us, the unreported income for 1978 is $ 43,500 and for 1979 is $ 13,015.77. The gross receipts reported on the returns for the years are respectively, $ 14,318.35 and $ 5,249.16. Twenty-five percent of each of these sums is respectively $ 3,709.90 and $ 1,312.29. Hence, the 6-year statute (section 6501(e)(1)) is applicable. The statutory notice is, therefore, timely as to 337 Mrs. Parks. Income AveragingPetitioners have raised in their petition the issue of income averaging, but none of the parties has commented on the matter on brief. We, therefore, deem petitioners to have abandoned the issue. Decision will be entered under Rule 155. Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. In the stipulation and exhibits, this banking institution is also described as "Central Texas Savings and Loan" and as "Central Texas Savings Association." With one exception noted herein, transactions appear to have been with the Waco branch.↩3. Mr. Beard gave a deposition which is in the record. However, as a result of injuries received in an accident, Mr. Beard's memory was impaired. Consequently, many details which only he could have supplied are unavailable.↩4. We assume that the cashier's check was endorsed by Mrs. Parks to Mr. Beard. The copy of this exhibit is so illegible that we can only recognize the words "Peggy Parks" on the reverse side where an endorsement might be expected to have been made.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621568/	Gilt Edge Textile Corporation, Formerly Gilt Edge Silk Mills of New Jersey, Petitioner, v. Commissioner of Internal Revenue, RespondentGilt Edge Textile Corp. v. CommissionerDocket No. 10447United States Tax Court9 T.C. 543; 1947 U.S. Tax Ct. LEXIS 86; September 30, 1947, Promulgated 86 Decision will be entered for the petitioner. In 1929 petitioner made a loan of $ 30,000 to an estate of which petitioner's president was a coexecutor. In 1931 the estate was in a precarious financial condition and, in order to enable petitioner to collect its debt, its president arranged for the purchase by petitioner from the estate of certain shares of stock, with the debt to be credited against the purchase price. Several years later the heirs and legatees and the other executors of the estate brought suit against petitioner's president, claiming mismanagement rendered the estate insolvent and alleging that the $ 30,000 payment in 1931 was a preference. The chancery court entered its final decree in the action in 1942, ordering the defendant to repay the $ 30,000 as an alleged preference. Petitioner issued its check for $ 30,000 to its president, and he endorsed and delivered it to the estate. Held, petitioner is entitled to deduct $ 30,000 as a loss under section 23 (f), I. R. C.William Surosky, Esq., for the petitioner.John E. Mahoney, Esq., for the respondent. Arundell, Judge. Hill, J., dissenting. Turner, Disney, Kern, and Opper, JJ., agree with this dissent. ARUNDELL543 The respondent determined a deficiency of $ 13,348 in petitioner's income tax for 1942. On brief, respondent has conceded error on his part as to two minor adjustments made in determining the deficiency. That leaves for consideration the question whether petitioner is entitled to a deduction under section 23 of the Internal Revenue Code for an amount of $ 30,000 paid out by it in the taxable year under the circumstances hereinafter appearing.FINDINGS OF FACT.The petitioner, Gilt Edge Textile Corporation, formerly Gilt Edge Silk Mills of New Jersey, is a corporation of the State of New Jersey, with88 principal office at Paterson. Its return for the year involved was filed with the collector of internal revenue for the fifth district of New Jersey.On June 15, 1929, Minnie Spitz, Jacob Spitz, and Philip Dimond became duly qualified executors of the estate of Louis Spitz, deceased. Philip Dimond served as such executor until July 31, 1942, when by a decree of the Orphans' Court of the County of Passaic, New Jersey, he was discharged as such executor, leaving Minnie Spitz and Jacob Spitz as remaining executors and trustees after that date.Dimond was at all times from June 8, 1929, to June 8, 1943, president, treasurer, and a director of the petitioner. In the taxable year he owned 53.58 per cent of the stock of petitioner.544 In 1929 petitioner made a loan of $ 30,000 to the estate of Louis Spitz and received the estate's note in that amount, dated October 31, 1929, payable one month from date. The note was not paid at maturity, but a renewal note dated November 30, 1929, and payable on demand, was substituted. Interest was paid on the note from time to time.In February 1931 the estate of Louis Spitz was experiencing some financial difficulties, and petitioner was worried89 about the collection of its loan. Dimond and another officer of petitioner discussed the matter; and Dimond, acting on behalf of petitioner, arranged for it to purchase certain shares of stock from the estate at an agreed price, with the loan to be collected as part of the transaction. On or about February 16, 1931, petitioner gave its check to the estate in the amount of $ 91,927.50 in payment for 1,313 1/4 shares of stock in Quebest Investing Co. at $ 70 a share, and at the same time the estate gave petitioner its check for $ 31,140 in payment of the $ 30,000 note and accrued interest of $ 1,140 thereon.Several years later the heirs and legatees of Louis Spitz and the other executors of the Spitz estate commenced a suit against Dimond, alleging, among other things, that the estate was rendered insolvent by Dimond's mismanagement and that the payment of $ 30,000 in 1931 constituted a preferential payment. Six separate causes of action were set forth in the complaint, alleging various acts of mismanagement. The $ 30,000 item here involved was covered in the first cause of action. The second cause of action claimed a loss to the estate of $ 250,000 through Dimond's failure to90 allow the sale of pledged stock to pay debts of the estate. In the third cause of action claim was made for a loss of $ 231,312.04 as a result of Dimond's involving the estate in certain stock-trading pools. The fourth cause of action alleged a loss of $ 1,500,000 through Dimond's failure to liquidate marketable securities in the declining stock market. In the fifth cause of action complainant Jerome Spitz, one of the heirs of Louis Spitz, claimed conversion of trust funds in the amount of $ 48,997.13 held by the estate for his benefit. Complainant Minnie Spitz, in the sixth cause of action, made claim for $ 15,000 of insurance proceeds due to her and allegedly used by Dimond to pay debts of the estate.Although the petitioner was not made a party defendant in the suit, it was named in the bill of complaint as one of the parties who had gained; and petitioner employed counsel to represent its interests in the outcome of the litigation, paying him a fee of $ 5,000 for legal services in that connection. Dimond also employed other counsel to represent him.After the suit had been pending for some time, the several parties entered into a stipulation in settlement and, pursuant thereto, 91 on 545 July 31, 1942, the New Jersey Chancery Court entered its final decree in the suit, ordering Dimond, inter alia, to:* * * pay or cause to be paid in cash to Minnie Spitz and Jacob Spitz, as remaining executors and trustees under the last will and testament of Louis Spitz, deceased, over, above and in addition to any commissions to which he, as executor of said Estate, might be entitled, the following amounts, namely:(a) $ 30,000.00, by way of return to the Estate of Louis Spitz, deceased, of, and in payment of any liability by reason of, the allegedly preferential repayment by defendant as Executor, in February, 1931, of a loan to the Estate in that amount, as complained of in paragraph 13 of the first cause of action of the amended amended bill of complaint.(b) $ 20,000.00, in payment of any liability to the Estate of Louis Spitz, deceased, predicated on any careless or negligent action of the defendant in connection with any matters or things (other than those referred to in succeeding subsection (c)) alleged or referred to in the second cause of action of the amended amended bill of complaint.(c) $ 20,000.00, in payment of any obligation to the Estate 92 of Louis Spitz, deceased, by reason of the acquisition by defendant from Linray Investment Co. of 6,300 shares of Hahn Department Stores, Inc. stock, complained of in paragraphs 12, 13 and 14 of the second cause of action of the amended amended bill of complaint, and his retention, as owner thereof, of said shares and any present or future proceeds thereof, and any right or interest of the Estate of Louis Spitz, therein and thereto.(d) $ 10,000, in payment of any liability to the Estate of Louis Spitz, deceased, predicated on any careless or negligent action by the defendant in connection with any matters or things alleged or referred to in the third cause of action of the amended amended bill of complaint.(e) $ 20,000.00, in payment of any liability to the estate of Louis Spitz, deceased, predicated upon careless or negligent action by defendant in connection with any matters or things alleged or referred to in the fourth cause of action of the amended amended bill of complaint, and also in satisfaction and discharge of any other possible claim of any kind or nature of the estate of Louis Spitz, deceased, and of the executors and trustees thereof, and of all of the complainants, 93 against defendant, except as limited in paragraph 3 hereof.The fifth and sixth causes of action were dismissed with prejudice.The decree also ordered all the complainants in the suit to execute general releases in favor of Dimond, Gilt Edge Silk Mills, and Quebest Investing Co., and ordered Dimond, individually, to execute general releases to all the complainants and to cause to be executed and delivered general releases from Gilt Edge Silk Mills and Quebest Investing Co. to the complainants.With respect to the $ 30,000 involved in paragraph (a) of the decree, petitioner's officers believed that, since Dimond had acted in its interests in securing payment of the debt due it from the estate and had received no personal benefit therefrom, petitioner was obligated either to repay the money or to reimburse Dimond. On July 30, 1942, with 546 the consent and approval of Irving Abrash, the secretary and a director of petitioner since 1929, petitioner issued its certified check to Dimond in the amount of $ 30,000; and he in turn endorsed and delivered it to the remaining executors of the estate of Louis Spitz and their counsel.Dimond paid the remaining $ 70,000 ordered by the court94 with respect to the other causes of action and fully satisfied the provisions of the decree. The releases called for by the decree, running from the petitioner to the estate and the other complainants, were duly executed and delivered.In its return for the taxable year petitioner claimed deduction for the $ 30,000, which respondent disallowed.OPINION.Respondent disallowed the claimed deduction of $ 30,000 on the ground that it was a payment made to satisfy a personal liability of Philip Dimond. It appears from the evidence before us, however, that the item in question originated as an interest-bearing loan from petitioner to the estate of Louis Spitz in 1929. Philip Dimond, petitioner's president, was also a coexecutor of the estate. In 1931, when it appeared that the estate was having financial difficulties, Dimond, acting in petitioner's behalf, sought to obtain repayment of the loan from the estate to petitioner by arranging for the petitioner to purchase from the estate certain shares of stock in Quebest Investing Co. Although separate checks were exchanged, the net effect of the transaction was that petitioner took credit upon the purchase price of the stock for the debt95 owing to it from the estate and paid the estate the cash difference. Later, in the suit brought against Dimond by the heirs and legatees of Louis Spitz and the other executors of the Spitz estate, it was alleged that the $ 30,000 payment constituted a preference. The final decree of the chancery court entered pursuant to a stipulation of the parties in settlement of the suit ordered Dimond, among other things, to repay or cause to be paid in cash the $ 30,000 by way of return to the estate of Louis Spitz. Petitioner thereupon issued its check to Dimond in that amount and he in turn endorsed it to the estate. Dimond paid the remaining $ 70,000 called for by the decree in connection with the second, third, and fourth causes of action.In view of these circumstances, we think respondent's disallowance of the deduction of $ 30,000 claimed by petitioner was improper. Two of the complainants in the suit were contending that they were preferred creditors of the estate. If all the facts alleged in the complaint could be proved, it may well be that petitioner, as the recipient of a preferential payment, could have been legally compelled to make 547 direct restitution to the estate. 96 It may also be that other liabilities could have been asserted directly against the petitioner, based on its transactions with the estate. Apparently, petitioner considered that its risks of incurring losses were substantial, because it retained separate counsel and paid him a $ 5,000 fee to represent its interests in the outcome of the litigation.But whether petitioner could have been proceeded against directly and compelled to return the money to the estate is not, we think, controlling of the right to the deduction. Petitioner contends that it was legally obligated to reimburse Dimond for his loss when it later developed that he was answerable to the estate for the money he had collected for petitioner's benefit. There appears to be considerable merit in the contention, for, under the general principles of the law of agency, an agent is entitled to reimbursement from his principal for expenses and losses incurred in the course of the principal's business and to indemnity from liability to third parties arising from the agent's acts where the principal has received the benefit of such acts. See Bibb v. Allen, 149 U.S. 481">149 U.S. 481, 498; Admiral Oriental Line v. United States, 86 Fed. (2d) 201, 202;97 Irving Trust Co. v. Townsend, 1 Fed. Supp. 837; Restatement Agency, § 439; C. J. S., Agency, §§ 196, 197. Dimond was no less petitioner's agent in arranging for the collection of petitioner's debt merely because the same act, in his other capacity as executor, formed the basis of one of the liabilities asserted against him in the suit. And petitioner received the benefit of that act.Nevertheless, we need not rest our decision on a holding that petitioner, as principal, was legally liable to indemnify Dimond, as its agent. We have said before that even a moral obligation arising out of a business transaction will suffice to support a loss deduction. Herschel V. Jones, 1 B. T. A. 1226; Abraham Greenspon, 8 T. C. 431. The petitioner here was no mere volunteer. In equity and good conscience it was obliged to satisfy that part of the decree against Dimond calling for the repayment of the $ 30,000 to the estate. After making the payment, there was no possibility for petitioner to recover any part of it from the estate or the heirs, because, in exchange for releases from all the complainants, 98 petitioner executed cross releases to them.The payment in the taxable year marked the ultimate conclusion of the transaction entered into in 1929 and fixed the petitioner's loss. We think it fully qualifies for deduction as a loss under section 23 (f) of the code, and we so hold.Decision will be entered for the petitioner. HILL 548 Hill J., dissenting: It is my opinion that the record in this case discloses neither a legal nor a moral obligation on the part of petitioner to release its claim for debt against the Spitz estate.If it be assumed that petitioner was either legally or morally obligated to refund the $ 30,000 paid to it in 1931 in full settlement of its debt against the Spitz estate because such payment was improperly preferential to it as a general creditor, petitioner by such refundment was restored to its former status of a general creditor of the Spitz estate. As a general creditor, it had the legal right to payment of its debt proportionately with other general creditors out of assets of the estate available for payment to general creditors. It does not appear that there were no such assets. In fact, the contrary is indicated. After such refundment99 was made by petitioner, neither the Spitz estate nor the creditors thereof, nor the heirs of Louis Spitz, deceased, had any claim or claims whatever against petitioner. The general releases by petitioner of claims against the above named parties were executed solely for the purpose of enabling Dimond, petitioner's president, treasurer, and controlling stockholder, to settle on a compromise basis for $ 100,000 actions for damages against him in the claimed aggregate amount of more than $ 2,000,000 for alleged negligence and mismanagement as executor of the Spitz estate.The pending action against Dimond did not involve any alleged liability of the petitioner to the complainants therein. Petitioner was not a party to the action and there is nothing in the record to indicate any obligation or duty, legal or moral, on the part of petitioner either to Dimond or to the complainants in the action to execute such releases. It does not appear that it was within the scope of petitioner's business to contribute to the payment or settlement of Dimond's obligations, nor does it appear that such contribution was a nonbusiness transaction entered into for profit.It does not appear that petitioner100 was to be reimbursed by Dimond for releasing its claim of debt against the Spitz estate. If, however, a claim for such reimbursement did arise out of the transaction, there is no showing that Dimond was not financially able to discharge such obligation.Therefore, as I see it, under the facts of the case and the law applicable thereto, petitioner is not entitled either to the deduction claimed for a business or nonbusiness loss or to a deduction for bad debt.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621569/	LLOYD E. WILLIAMS, JR. AND MILDRED A. WILLIAMS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilliams v. CommissionerDocket No. 36698-87United States Tax CourtT.C. Memo 1992-269; 1992 Tax Ct. Memo LEXIS 292; 63 T.C.M. (CCH) 2959; May 11, 1992, Filed 292 Decision will be entered under Rule 155. P entered into an agreement to purchase a vacation condominium for a stated purchase price in excess of $ 1.5 million. P executed an installment note calling for two payments of the stated purchase price, the first installment due in just over 6 months and the second due in 30 years. P claims that the first installment is a payment to which sec. 483, I.R.C., applies and that unstated interest is allocated to such first installment pursuant to sec. 1.483-1(a)(1), Income Tax Regs.Held: P has failed to show that the benefits and burdens of ownership of the condominium were acquired more than 6 months prior to the due date of the first installment; accordingly, no unstated interest is allocated to the first installment pursuant to sec. 1.483-1(a)(1), Income Tax Regs.J. Gordon Hansen, David E. Leta, and Stuart A. Fredman, for petitioners. James R. McCann and James C. Lanning, for respondent. HALPERNHALPERNMEMORANDUM OPINION HALPERN, Judge: By notice of deficiency dated August 21, 1987, respondent determined a deficiency in petitioners' Federal income tax in the amount of $ 29,015, for the taxable year 1983, together with an addition293 to tax under section 6661. In an amended answer filed on September 26, 1988, respondent increased the deficiency to $ 61,011.50 and conceded that section 6661 was inapplicable. The deficiency at issue derives from respondent's disallowance of a deduction for unstated interest claimed by petitioner Lloyd E. Williams, Jr., in connection with his purchase of a one-half interest in a Utah condominium unit. We focus here on whether the sale to him of the one-half interest in the condominium occurred in June 1983. Petitioners claim that it did, such that the interest component of an installment payment of the purchase price made on December 30, 1983, is computed pursuant to section 1.483-1(a)(1), Income Tax Regs.Some of the facts have been stipulated and are so found. The stipulation of facts filed by the parties and attached exhibits are incorporated herein by this reference. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954 in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. BackgroundAt the time the petition in this case was filed, petitioners Lloyd E. Williams, Jr., and Mildred294 A. Williams resided in Kenilworth, Illinois. Hereinafter, the term "petitioner", when used in the singular, will refer to petitioner Lloyd E. Williams, Jr. Purchase AgreementThe Pinnacle at Deer Valley (The Pinnacle) is a condominium project located in Deer Valley, Park City, Utah. Deer Valley contains a ski resort. RDG Associates, a Utah limited partnership, is the developer of The Pinnacle and, during all times here relevant, marketed condominium units in The Pinnacle. 1 On June 22, 1983, petitioner, a lawyer, and C. Barry Montgomery, one of petitioner's law partners (together, Buyers), entered into a condominium purchase agreement (the Purchase Agreement) with RDG Associates (Seller) to purchase a condominium unit in The Pinnacle. 295 Among other terms, the Purchase Agreement provides that the Buyers are purchasing, and the Seller is selling, Unit 37, a residential condominium, in The Pinnacle (the Condominium). The stated purchase price is $ 1,514,000. The Purchase Agreement requires the Buyers immediately to pay $ 10,000, as a downpayment, with the balance of the purchase price, or $ 1,504,000, to be paid in installments, in accordance with the terms of a promissory note (the Installment Note), to be described. The Purchase Agreement requires certain documents to be placed in escrow, to be delivered by the escrow agent (Escrow Agent) on December 30, 1983, the "Settlement Date" (Settlement Date). The Seller was to place in escrow a warranty deed conveying to the Buyers title to the Condominium (Warranty Deed). The Buyers were to place in escrow a deed of trust, along with a rider to the deed (together, Second Deed of Trust), and a quitclaim deed reconveying the Condominium from the Buyers to the Seller (Quitclaim Deed). The Warranty Deed, Second Deed of Trust, and Quitclaim Deed were executed by the appropriate persons on June 23, 1983, and placed in escrow. The Purchase Agreement states further that the296 Buyers entered into possession of the Condominium as of June 22, 1983, and that the parties would enter into a Memorandum of Condominium Purchase Agreement (Memorandum of Purchase Agreement). The Memorandum of Purchase Agreement is described as "evidencing Buyer's purchase of, and equitable title to, the Condominium". The memorandum was executed on June 23, 1983, and recorded on June 27, 1983. Upon recordation of the Memorandum of Purchase Agreement, the Seller was obligated to deliver to the Buyers a commitment to issue a title insurance policy. The Purchase Agreement provides that real estate taxes are to be prorated as of June 22, 1983, to reflect that the benefits and burdens of ownership have transferred to the Buyers. Further, the Buyers have no right to assign or transfer the Purchase Agreement or their rights under that agreement without the Seller's prior written consent. The Purchase Agreement requires the Condominium to be completed and equipped according to certain specifications reviewed by the Buyers, but it grants the Seller the right to make certain changes provided that such changes do not materially diminish the Condominium's value. The Purchase Agreement 297 obligates the Seller to use reasonable efforts to have the Condominium fully constructed and ready for occupancy by December 30, 1983, and requires the Seller to complete the Condominium, and the entire building of which the Condominium is a part, within 200 or fewer days, or by early January 1984. On June 23, 1983, the Buyers paid the sum of $ 10,659.72 to the Seller, which sum included the downpayment ($ 10,000), an estimated proration of taxes ($ 259.72), and a homeowner's capitalization fee ($ 400). Petitioner paid one-half of that sum. On June 23, 1983, the residential unit of the Condominium had not yet been constructed. On that date, excavation for the building containing the residential unit had been completed and a few supports and beams had been placed. The residential unit was not completed until after January 1, 1984. Installment Note and Judgment NoteThe Installment Note, dated June 23, 1983, has a stated face amount of $ 1,504,000. It calls for two payments. The first payment (first installment), in the amount of $ 477,000, is due on the Settlement Date, December 30, 1983, and the second payment (second installment), in the amount of $ 1,027,000, is due298 on July 24, 2013. The Installment Note states: "No interest shall be charged on the face amount owed hereunder during the term thereof." To secure partially their obligation to make the first installment (due on the Settlement Date), the Buyers executed contemporaneously with the Installment Note a judgment note, in the amount of $ 50,000 (Judgment Note). Upon payment of the first installment, the Seller was to return the Judgment Note to the Buyers. The Installment Note contemplates that the Buyers might finance the first installment ($ 477,000). It provides that the obligation to pay the second installment on July 24, 2013, would be subordinate to such financing. Default Prior To Settlement DateThe Purchase Agreement provides the Seller with two remedies in the event of a default by the Buyers prior to the Settlement Date (Pre-Settlement Default): (i) Seller may be released from all obligations in law and equity to convey fee simple title to the [Condominium] and Buyer shall become at once a tenant at will of Seller. Upon written notification from Seller, Escrow Agent shall record the Quit-Claim Deed from Buyer to Seller deposited with Escrow Agent herewith, and 299 all payments which have been made previously under this agreement by Buyer, together with the Judgment Note, shall be retained by Seller as liquidated and agreed damages for breach of this Agreement, and Seller shall be entitled in connection therewith to make demand for payment of the proceeds of the Judgment Note; or (ii) Seller may, upon written notice to Buyer, declare the entire amount under the Installment Note at once due and payable and may elect to treat this Agreement as a note and mortgage, and tender title to Buyer subject thereto, and proceed immediately to foreclose the same in accordance with the laws of the State of Utah, and have the * * * [Condominium] sold and the proceeds applied to the payment of the balance owing, and Seller's costs and attorneys' fees; provided, however, that Seller's sole remedy in such an event shall be to foreclose Buyer's rights under this Agreement, and Buyer shall not be liable for any deficiency between the amounts owed under the Installment Note and the proceeds from such foreclosure. [Emphasis added.] The Purchase Agreement provided the Buyers with one remedy in the event of the Seller's default prior to Settlement Date: In the300 event Seller defaults under this Agreement prior to the Settlement Date, Buyer's sole and exclusive remedy shall be to terminate and rescind this Agreement, whereupon Seller shall return to Buyer all sums previously paid by Buyer to Seller hereunder and any prior reservation agreement, together with interest thereon at the rate of six percent (6%) per annum, and Seller shall cancel and return to Buyer the Judgment Note, the [Installment] Note, and the Trust Deed [i.e., Second Deed of Trust]. Upon such termination, Escrow Agent shall record with the Summit County, Utah, Recorder the Quit-Claim Deed to the Condominium deposited with Escrow Agent herewith, and Seller and Buyer shall have no further obligations to each under this Agreement or any other agreement with respect to this transaction. Side AgreementThe Seller and the Buyers signed a letter dated June 23, 1983, containing handwritten revisions and additions that modified the terms of the transaction. Later, that letter was retyped, and a few other revisions and additions were made. The retyped letter, dated September 15, 1983, was then executed by the parties. We shall refer to those two letters collectively as 301 the "Side Agreement". Under the Side Agreement, the Seller could not sell the Installment Note for 5 years and could not exercise any right to demand payment of the second installment under the Installment Note prior to July 24, 2013. The Side Agreement further provided that the Seller was willing to sell the Installment Note back to the Buyers at a present-value price (determined by a 10-percent semiannual compounding of interest). Also, the Side Agreement obligated the Seller to deliver to the Buyers a commitment from a financial institution to finance the first installment. Under the Side Agreement, if the Condominium was not ready for occupancy by December 31, 1983, the Seller was obligated to lease the Condominium from the Buyers until its completion, at a rent equal to the interest incurred on the Buyers' financing of the first installment. In turn, the Buyers agreed that the Seller would not be deemed in default under the Purchase Agreement unless the Condominium were not completed by March 15, 1984. Co-Ownership AgreementOn August 1, 1983, the Buyers executed a co-ownership agreement (the Co-Ownership Agreement): "to memorialize their agreement that each will 302 be liable to the other to pay one-half of the purchase price and any debts incurred by them in the course of paying the purchase price". The Co-Ownership Agreement provided that each Buyer owned an undivided one-half interest in the Condominium as a tenant-in-common and in any income earned with respect to the Condominium. Under the Co-Ownership Agreement, each Buyer granted the other a lien on the other's interest in the Condominium to secure repayment of any excess payments with respect to the Condominium's ownership and operation. The lien was subject to foreclosure if a Buyer failed to reimburse the other Buyer for an excess payment within 60 days following demand by the other Buyer for reimbursement. Buyers' Financing of the First Installment PaymentThe Buyers obtained partial financing from Columbia Savings and Loan Association, Irvine, California (Lender), for payment of a portion of the first installment. Before financing the Buyers' payment of the first installment, the Lender obtained an appraisal of the Condominium. The appraisal report estimated that, as of November 11, 1983, the Condominium's market value was $ 500,000, with a range of $ 471,500 to $ 538,500. 303 On December 15, 1983, the Buyers borrowed $ 400,000 from the Lender and executed a Balloon Payment Fixed Rate Note payable to Lender, with a face amount of $ 400,000 (Fixed Rate Note), and with joint and several liability. The Fixed Rate Note was secured by a Deed of Trust, with the Lender as the beneficiary (First Deed of Trust). Settlement DateOn the Settlement Date, the Buyers paid to the Seller the first installment of $ 477,000. The Escrow Agent returned to the Buyers the Quitclaim Deed and delivered to the Buyers, and recorded in the appropriate land records, the Warranty Deed and the Second Deed of Trust. In turn, pursuant to the Purchase Agreement, the Seller returned to the Buyers the Judgment Note and delivered to the Buyers an owner's title insurance policy insuring the Buyers' title to the Condominium. The title insurance policy was issued by the Escrow Agent in the amount of $ 519,200. Buyers' Default After Settlement DateThe Purchase Agreement provides that, if the Buyers default after the Settlement Date either in the payment of any amounts owing under the Installment Note or in performing any obligation under the Second Deed of Trust (Post-Settlement304 Default), the Seller may exercise any and all remedies in the Installment Note or the Second Deed of Trust. The Installment Note provides that, in the event of a Post-Settlement Default, the Seller may declare to be immediately due and payable all amounts under the Installment Note. Consistent with the Installment Note, the Second Deed of Trust provides that, upon a Post-Settlement Default, the Seller "may execute or cause * * [the trustee under the Second Deed of Trust] to execute a written notice of default and of election to cause * * * [the Condominium] to be sold to satisfy the obligations hereof, and * * * [said trustee] shall file such notice for record in each county" in which the Condominium is located. The Second Deed of Trust also provides that, in the event of a default, the Seller could "declare all sums secured hereby immediately due and payable and foreclose this Trust Deed in the manner provided by law for the foreclosure of mortgages on real property." Petitioners' 1983 Federal Income Tax ReturnOn their 1983 tax return, petitioners claimed an interest deduction in the amount of $ 145,075 arising in part from the Buyers' payment in December 1983 of the305 first installment of $ 477,000. 2Procedural HistoryBy notice of deficiency dated August 21, 1987, respondent determined a deficiency for the taxable year 1983 in petitioners' Federal income tax in the amount of $ 29,015, together with an addition to tax under section 6661. The sole adjustment giving rise to the deficiency at issue is respondent's disallowance of the interest expense of $ 145,075, computed by petitioners pursuant to section 1.483-1(a), Income306 Tax Regs., and claimed by petitioners on account of their payment of the first installment. In an amended answer filed on September 26, 1988, respondent increased the deficiency to $ 61,011.50, but conceded that petitioners were entitled to deduct $ 630 as interest paid to the Lender during 1983 and that section 6661 was inapplicable. In March 1990, this Court issued an opinion in response to the parties' cross-motions for partial summary judgment. Williams v. Commissioner, 94 T.C. 464 (1990). In that opinion, this Court focused on whether section 446(b) or 461(g) limited petitioners' interest deduction to the amount of interest that economically accrued rather than to the amount of interest determined under section 483. We held that neither section so limited petitioners' deduction. Id. at 472. Because involving factual disputes and, thus, inappropriate for summary judgment, we did not address certain other issues raised by respondent. Id. at 472-473. Later, in August 1990, respondent filed a motion for leave to file a second amendment to answer. We granted that motion, and respondent's second amendment to answer307 was filed. That amendment raised formally two additional issues: whether section 189 or 163 limits the amount of interest deductible by petitioners. Since that amendment, however, respondent has conceded that section 163(d) is not applicable. DiscussionAre We Precluded From Considering Section 483's Applicability?At trial, we asked the parties to address in their briefs the question of whether our opinion in Williams v. Commissioner, 94 T.C. 464">94 T.C. 464 (1990) (Williams I), precludes us from considering whether the provisions of section 483 govern the first installment. Petitioners argue that, as a result of Williams I, the doctrines of res judicata and the law of the case prevent us from considering the applicability of section 483. Respondent disagrees, arguing that the issue of the applicability of section 483 was not considered in Williams I. We agree with respondent. In Williams I, we considered the parties' cross-motions for partial summary judgment, filed under Rule 121. We specifically noted that unresolved issues of fact precluded final resolution of the case. 94 T.C. at 465. We treated the parties' motions as motions for308 partial summary judgment on what we styled "the section 483 issue". That issue was whether either section 446(b) or 461(g) limits petitioners' interest deduction to the amount of interest that economically accrued rather than to the amount of interest determined by section 483. 94 T.C. at 465, 467, 472. Sections 446(b) and 461(g) were two of the grounds cited by respondent in her notice of deficiency as grounds for the disallowance of petitioners' interest deduction. In Williams I, we concluded that neither section 446(b) nor section 461(g) limits petitioners' interest deduction to the amount of interest that economically accrued. 94 T.C. at 472. We granted petitioners' cross-motion for partial summary judgment that neither such section so limits petitioners' interest deduction and denied respondent's motion for partial summary judgment. Petitioners' res judicata argument has no merit. Res judicata is a common-law doctrine that serves to promote judicial economy and the repose of disputes. Gustafson v. Commissioner, 97 T.C. 85">97 T.C. 85, 91 (1991). In Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 597 (1948), the Supreme309 Court explained res judicata as follows: The general rule of res judicata applies to repetitious suits involving the same cause of action. * * The rule provides that when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound "not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose." The judgment puts an end to the cause of action, which cannot again be brought into litigation between the parties upon any ground whatever, absent fraud or some other factor invalidating the judgment. [Citations omitted.] The application of res judicata requires a final judgment. Gustafson v. Commissioner, supra, at 91-92; Shaheen v. Commissioner, 62 T.C. 359">62 T.C. 359, 363-364 (1974). In the cause of action before us, however, we have only granted petitioners' cross-motion for partial summary judgment that neither section 446(b) nor section 461(g) limits the interest deduction at issue to the amount that economically accrued. 310 See Williams I, 94 T.C. at 472. We have issued no final judgment here. Sec. 7481(a). See Russell v. Commissioner, 678 F.2d 782">678 F.2d 782, 786 (9th Cir. 1982). Each tax year is the origin of a new income tax liability and a separate cause of action. Commissioner v. Sunnen, supra at 598; Johnson v. Commissioner, 1 T.C. 1041">1 T.C. 1041, 1050 (1943). We have yet to redetermine petitioners' income tax liability for the tax year at issue and have issued no final judgment regarding that liability. Further, petitioners' law-of-the-case argument is also not successful. See 1B Moore, Moore's Federal Practice, par. 0.404[1], [4.-1] at 117, 124 (2d ed. 1991). Although in Williams I we styled the issues that we were dealing with as the "section 483 issue," our description of the section 483 issue clearly shows that we were, in essence, dealing only with certain technical issues that, had respondent prevailed, would have foreclosed any further inquiry into the application of section 483 to the first installment. Those technical issues concerned whether section 446(b) or 461(g) limits the interest deduction at issue to the amount311 that economically accrued, rather than to the amount of interest determined under section 483. Our opinion in Williams I is too narrowly focused to be generalized into a plenary rejection of any further argument by respondent concerning the requirements of section 483 under the doctrine of law of the case. Finally, on brief, petitioners also argue that they have been caught by surprise by respondent's claim that the first installment is not a payment for which unstated interest is determined under section 483. Petitioners fault respondent for failing to have pled that issue. Petitioners may somewhat misunderstand the workings of this Court. Our job is to redetermine deficiencies determined by respondent. See sec. 6214(a). Respondent's notice of deficiency is not a pleading. See Rule 30. Respondent's notice is sufficient if (1) it fairly advises the taxpayer that respondent has in fact determined a deficiency and (2) specifies the year and amount. Stevenson v. Commissioner, T.C. Memo. 1982-16. Nevertheless, we understand petitioners' objection to be that respondent did not raise the section 483 issue either in her notice of a deficiency or in her answer, 312 and thus we ought to consider respondent's present stance as a surprise to petitioners. See, e.g., Riss v. Commissioner, 57 T.C. 469">57 T.C. 469, 470-474 (1971), affd. Commissioner v. Transport Manufacturing and Equipment Co., 478 F.2d 731">478 F.2d 731, 734-736 (8th Cir. 1973). We think that petitioners' own pleadings belie their arguments that the section 483 issue was not raised in respondent's notice of deficiency and that they are surprised by respondent's present stance and have no fair warning of such stance. The notice of deficiency makes only one adjustment to petitioners' return and describes in part that adjustment as: "Item Changed: -Schedule E Rental, Condo Pinnacle, Expense, IRC § 483-$ 145,075." In her notice, respondent further describes that adjustment, as follows: "Full disallowance of interest expense of IRC § 483 for violating provisions of IRC § 461(g), for not clearly reflecting income under Sec. 446, and for lacking economic substance and reality as cited by the courts as being required by the Code." In their petition, petitioners did not restrict their assignment of errors, and statement of facts in support of those errors, to the three particular313 reasons described in the above quoted explanation. In full, paragraph 4 of the petition provides as follows: The determination of tax set forth in the said notice of deficiency is based upon the following errors: a. The Commissioner erred in disallowing as interest expense the sum of $ 145,075, which sum was deducted pursuant to I.R.C. section 483 on the petitioner's 1983 income tax return. b. The Commissioner erred in alleging the petitioner violated the provisions of I.R.C. section 461(g). c. The Commissioner erred in alleging the petitioners income was not clearly reflected as required by I.R.C. section 446. d. The Commissioner erred in alleging that the transaction which gave rise to the disallowed deduction lacked economic substance and reality. As facts in support of the first assignment of error, petitioners continue for over three pages, explaining in detail the transaction in question. After quoting a portion of section 483(c)(1) (describing payments to which section 483 applies), petitioners add: "Therefore, the total of all payments to which section 483 applies is $ 1,504,000, comprised of the first installment of $ 477,000 which was due December314 30, 1987[3], and the second installment of $ 1,027,000 which is due 30 years from the date of the purchase agreement." In her answer, respondent denied that she erred, as alleged by petitioners in paragraph 4(a)-(d) of the petition. We think that whether or not respondent's notice raises adequately the issue of section 483, beyond the particulars set out in her explanation (and we are not saying that it does not), petitioners responded in their petition as if respondent's notice did so adequately raise, and as if they had fair warning of, the issue of section 483's applicability. See Pagel, Inc. v. Commissioner, 91 T.C. 200">91 T.C. 200, 210-213 (1988); William Bryen Co. v. Commissioner, 89 T.C. 689">89 T.C. 689, 704-709 (1987). Thus, we dismiss petitioners' claim of surprise as unfounded. Questions PresentedHaving disposed of what might be termed preliminary, procedural matters, we now turn to the substantive aspects of this case. Respondent presents nine questions to be answered, which can be distilled into three assertions: 1. The first installment is due 6 months or less after the date of sale or exchange of the condominium. 2. The transaction315 was a tax avoidance scheme devoid of economic substance. 3. Because construction period interest must be amortized, petitioners' interest deduction is limited. Since we agree with the first assertion, we need not reach either of the second two, and respondent's determination must be sustained. We will begin our analysis by exploring in some detail the workings of section 483. Section 483Section 483(a) states that in certain designated transactions: for the sale or exchange of property there shall be treated as interest that part of a payment to which this section applies which bears the same ratio to the amount of such payment as the total unstated interest under such contract bears to the total of the payments to which this section applies which are due under such contract. Section 1.483-1(d), Income Tax Regs., provides tests to determine whether unstated interest exists. Under provisions applicable to the period at issue, the test rate is 9-percent per annum simple interest. Sec. 1.483-1(d)(1)(ii)(C), Income Tax Regs. Failing that test, the imputed interest rate is 10-percent per annum compounded semiannually. Sec. 1.483-1(c)(2)(ii)(C), Income Tax Regs.316 After the imputed interest is determined, it is allocated to the principal payments of the debt on a pro rata basis. Sec. 483(a). Section 1.483-1(a)(1), Income Tax Regs., provides: Thus, the amount to be treated as interest under section 483 is determined by multiplying each payment to which such section applies by a fraction, the numerator of which is the total unstated interest under the contract, and the denominator of which is the total of all payments to which section 483 applies * . The effect of this ratio is to allocate the total unstated interest on a pro rata basis among the total payments to which section 483 applies. Section 483 and the relevant regulations provide specific rules for the deduction of imputed interest by a buyer under the cash and accrual methods of accounting. Any allocable amount treated as unstated interest under section 483 by a cash method purchaser would be deductible as interest in the taxable year in which the payment is made. Accrual method taxpayers must claim the unstated interest deduction in the taxable year in which the payment becomes due. 3Sec. 1.483-2(a)(1)(ii), Income Tax Regs.317 Section 483(a) states that it applies "for purposes of this title" (i.e., the entire Internal Revenue Code), and section 1.483-2(a)(1), Income Tax Regs., provides that amounts treated as unstated interest under section 483 shall be treated as interest "for all purposes of the Code." Pursuant to section 483(c), section 483 applies only to payments for the sale or exchange of property due more than 6 months after the date of such sale or exchange under a contract both containing unstated interest and calling for payments to be made more than 1 year after the date of such sale or exchange. Section 1.483-1(b)(1), Income Tax Regs., provides that: "The term 'sale or exchange' includes any transaction treated as a sale or exchange for purposes of the Code." Respondent argues that the sale of the Condominium occurred after June 1983, so that the first installment, due on the Settlement Date (December 30, 1983), was due less, not more, than 6 months after the sale. Petitioners' position is to the contrary. We agree with respondent that a sale of the Condominium did not occur prior to the end of June 1983. Therefore, the first installment is not a payment to which section 483 applies. 318 Sec. 483(c). Accordingly, no portion of the first installment can be treated as unstated interest under section 483(a). Benefits and Burdens of OwnershipThe term "sale" is not used in any unusual sense in section 483. See sec. 1.483-1(b)(1), Income Tax Regs. For Federal income tax purposes, the term "sale" normally is given its ordinary meaning and generally is defined as a transfer of property for money or a promise to pay money. Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 570-571 (1965); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221, 1237 (1981). We do not doubt that, at some point, the Buyers purchased the Condominium. The question is when. When a sale is complete for tax purposes is essentially a question of fact to be ascertained from the intention of the parties as evidenced by the written agreements read in light of the attendant facts and circumstances, no single one of which is controlling. Paccar, Inc. v. Commissioner, 85 T.C. 754">85 T.C. 754, 777 (1985); Derr v. Commissioner, 77 T.C. 708">77 T.C. 708, 724 (1981). The applicable test is a practical one. Derr v. Commissioner, supra at 724;319 Baird v. Commissioner, 68 T.C. 115">68 T.C. 115, 124 (1977). The economic substance of a transaction, rather than its form, governs for Federal tax purposes. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 469-470 (1935); Grodt & McKay Realty, Inc. v. Commissioner, supra at 1236. In examining the circumstances surrounding a conveyance of property to determine when it occurred, the focus is on when the "benefits and burdens" of ownership shifted to the buyer. Paccar, Inc. v. Commissioner, supra at 777; Grodt & McKay Realty, Inc. v. Commissioner, supra at 1237. Consequently, we consider whether the Buyers acquired the benefits and burdens of ownership of the Condominium in June 1983. Baird v. Commissioner, supra at 124-125. Petitioners bear the burden of proving that they did. Rule 142(a). In Grodt & McKay Realty, Inc. v. Commissioner, supra at 1237-1238, we noted some of the factors that courts have considered in determining when a sale occurs. Those factors are as follows: (1) Whether legal title passes; (2) how the parties treat the transaction; 320 (3) whether an equity was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (5) whether the right of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. * * [Citations omitted.] We consider those factors that are relevant in light of petitioner's situation. -- Legal TitleA warranty deed in favor of the Buyers was executed on June 23, 1983. Nevertheless, the Buyers did not receive legal title to the Condominium in June 1983, as the Warranty Deed was placed in escrow at that time. While passage of legal title is not the determinative factor in deciding when ownership has passed, it is certainly an important consideration. Harmston v. Commissioner, 61 T.C. 216">61 T.C. 216, 228-229 (1973). Legal title to the Condominium did not transfer to the Buyers until the Escrow Agent delivered the Warranty Deed to them on the Settlement Date. See Roberts v. Osburn, 589 P.2d 985">589 P.2d 985, 989 (Kan. Ct. App. 1979);321 28 Am. Jur. 2d, Escrow, sec. 10 (1966).4 Under Utah law, the Buyers obtained at best some equitable, not legal, interest in the property at the time the Purchase Agreement was executed; recordation of the Memorandum of Purchase Agreement had no effect on the passage of legal title. Bekins Bar V Ranch v. Beryl Baptist Church, 642 P.2d 371">642 P.2d 371, 373 (Utah 1982); Estate of Willson v. State Tax Commission, 499 P.2d 1298">499 P.2d 1298, 1300 (Utah 1972); Lach v. Deseret Bank, 746 P.2d 802">746 P.2d 802, 805 (Utah Ct. App. 1987). -- Equity in the CondominiumIn the absence of legal title, the acquisition of an322 equity interest in property generally signifies ownership for tax purposes. See Haggard v. Commissioner, 241 F.2d 288">241 F.2d 288, 289 (9th Cir. 1956); Oesterreich v. Commissioner, 226 F.2d 798">226 F.2d 798, 803 (9th Cir. 1955). Petitioners have failed to carry their burden of showing that the Buyers, in June 1983, acquired any equity in the Condominium. In June 1983, the Buyers paid $ 10,659.72 to the Seller. Pursuant to the Purchase Agreement, however, that amount was refundable, with interest at 6 percent, if the Seller defaulted prior to the Settlement Date. Also, upon default of the Seller prior to the Settlement Date, the Judgment Note would be canceled and returned to the Buyers, as would be the Installment Note and the Second Deed of Trust. The meager penalty (restitution plus the payment of apparently below-market-rate interest) is inconsistent with any practical obligation on the part of the Seller and, in substance, supports the conclusion that the Seller had no more than an option to sell the Condominium, which it, of course, might decline to exercise. 5 Thus, until the Seller were to choose to exercise its option, the Buyers had no definite risk323 of loss associated with nonpayment of the Installment Note. Similarly, until then, the Buyers had no definite opportunity to benefit from their approximately $ 10,000 investment. Until the Settlement Date, that investment was, at best, only a potential equity in the Condominium, which would ripen into an actual equity interest only if the Seller were to exercise its option, and if, at that time, it made economic sense for the Buyers not to default. 6 Thus, as of June 1983, the Buyers' equity interest in the Condominium could not be ascertained. Petitioners have failed to show that, as of then, the Buyers had acquired an equity interest in the Condominium. 324 -- Present ObligationsIn June 1983, neither the Buyers nor the Seller had any unconditional obligations under the Purchase Agreement. See Major Realty Corp v. Commissioner, 749 F.2d 1483">749 F.2d 1483, 1486-1487 (11th Cir. 1985), affg. in part and revg. in part T.C. Memo. 1981-361. The Purchase Agreement was in the nature of an executory contract, as each party had several substantive obligations to fulfill before the sale was complete. See Westrom v. Commissioner, T.C. Memo 1966-198">T.C. Memo. 1966-198. Under the Purchase Agreement, while the Seller was obligated to perform several tasks prior to Settlement Date, the Buyers had one very limited remedy in the event the Seller defaulted prior to Settlement Date. The Buyers' sole and exclusive remedy under the Purchase Agreement was to terminate the Purchase Agreement and to receive back from the Seller all sums previously paid by the Buyers, together with interest at 6 percent per annum. Any ownership interest that the Buyers had would, by Quitclaim Deed, be transferred back to the Seller. As we have described previously, the Seller had, in essence, the option, but not the obligation, to complete325 the sale of the Condominium to the Buyers. Further, under the Side Agreement, the Seller was obligated to deliver to the Buyers, prior to Settlement Date, a commitment from a financial institution to finance the Buyers' payment of the first installment. That provision of the Side Agreement appears to be a condition of sale, such that the Buyers' obligation was not fixed or unconditional in June 1983. In sum, petitioners have failed to carry their burden of showing that, in June 1983, the parties to the Purchase Agreement had unconditional present obligations to fulfill. -- Right to PossessionThe Purchase Agreement provides that the Buyers entered into possession of the Condominium as of June 1983. Petitioners have not, however, met their burden of producing evidence that would support that conclusion. Possession of real property serves to place all persons on constructive notice of the rights of the possessor and serves to charge all such persons with the duty to inquire as to the rights of the possessor. 77 Am. Jur. 2d, Vendor and Purchaser, sec. 671 (1975). Such possession must be actual, open, definite, and unambiguous. Holmgren Brothers, Inc. v. Ballard, 534 P.2d 611">534 P.2d 611, 614 (Utah 1975);326 77 Am. Jur. 2d, Vendor and Purchaser, sec. 675 (1975). No deed had been delivered to the Buyers in June 1983. The recordation of a deed to them as grantees would have signified their possession. The Buyers have not shown that they were otherwise in possession in June. They were not in physical possession of the Condominium in the sense that they were living (or could live) in the residence that the Seller was to construct.7 In June, only the excavation work and the placement of a few beams had been completed. Petitioners argue that the Buyers may have had some equitable interest in the Condominium under the doctrine of equitable conversion. See, e.g., Estate of Willson v. State Tax Commission, 499 P.2d 1298">499 P.2d 1298, 1300 (Utah 1972). That may be so. Nevertheless, such equitable interest does not necessarily imply possession. See 77 Am. Jur. 2d, Vendor and Purchaser, secs. 371 and 352 (1975). Petitioners have not shown that they were in possession in June 1983. 327 -- Payment of Property TaxesAlthough the Purchase Agreement required the real estate taxes to be prorated as of June 1983, and although the Seller and the Buyers apparently did prorate those taxes as of that date, we do not give great weight to that fact. The real estate taxes for the second half of 1983 were only slightly more than $ 200, and that amount is insignificant in comparison to the Condominium's purchase price of $ 1,514,000 (respondent's view) or roughly $ 520,000 (petitioners' view). -- Profits from Operation or Sale of PropertyIn June 1983, petitioner was in no position to receive the profits from the operation of the Condominium. As we have stated, petitioner's interest in, and the benefits of ownership of, the Condominium derived at least in part from its potential rental value, and the Condominium was not completed until 1984. The Side Agreement required the Seller to pay rent to the Buyers if the Seller failed to complete the Condominium on time. The obligation to pay rent to the Buyers, however, arose only if the Condominium was not ready for occupancy by December 31, 1983. Further, petitioner lacked in June 1983 an unrestricted right to sell328 the Condominium because, under the Purchase Agreement, the Buyers could not assign or transfer, voluntarily or involuntarily, the Purchase Agreement or their rights under that agreement without the Seller's prior written consent. We thus conclude that the Buyers did not own the Condominium in June 1983 in the sense that, realistically, they could profit from its operation or sale. ConclusionWe find that, in June 1983, the Seller did not transfer to the Buyers the benefits and burdens of ownership of the Condominium and that any sale of the Condominium occurred thereafter. Accordingly, the first installment, due on December 30, 1983, was due less than 6 months after the date of such sale. The first installment is not a payment to which section 483 applies, and section 1.483-1(a)(1), Income Tax Regs., does not apply to determine the interest component of the first installment. To reflect concessions made by respondent Decision will be entered under Rule 155.Footnotes1. Pursuant to Utah law, the term "condominium unit" includes a unit (here a residence) together with an undivided interest in the common areas and facilities appertaining to that unit. Utah Code Ann. sec. 57-8-3(6) (1990). Each unit, together with its undivided interest in the common areas and facilities, constitutes real property under Utah law. Utah Code Ann. sec. 57-8-4↩ (1990).2. A schedule attached to petitioners' tax return calculates the interest component of that first installment paid by Buyers pursuant to sec. 483, as follows: PRESENT VALUEINTERESTPAYMENT% INTERESTDOWN$ 10,000$ $ 10,000FIRST PAY.454,28522,715477,0004.762%SECOND PAY.54,986972,0141,027,00094.646%TOTAL$ 519,271$ 994,729$ 1,514,00066.1389%1983 INTEREST $ 477,000 x 66.138907% = 315,483FIRST MORTGAGE INTEREST 630CONST. PERIOD INTEREST $ 519,271 x 5.00% = (25,964) NET DEDUCTION $ 290,149[Petitioner's share of the net deduction is one-half, or $ 145,075.]↩3. An opinion from Arthur Andersen & Company purporting to describe the tax consequences of the transaction in question illustrates those consequences as follows: Hypothetical Illustration of Imputed Interest under IRC Sec. 483Assume a cash basis taxpayer enters into the proposed transaction. On the date the agreement is executed a $ 10,000 down payment and $ 100,000 irrevocable standby letter of credit are received by RDG. Further assume that a $ 450,000 noninterest-bearing cash payment is made 186 days after the date the agreement is executed and a second noninterest-bearing payment of $ 1,000,000 is made 30 years after the agreement is executed. The following illustrates the interest deductions pursuant to Reg. Sec. 1.483-1(c)(3): Total payments to which IRC Sec. 483applies$ 1,450,000Less: Present value of $ 450,000due in 186 days.Reg. Sec. 1.483-1(g).($ 450,000 x .95238)$ 428,571Present value of $ 1,000,000due in 30 years. Reg. Sec.1.483-1(g) ($ 1,000,000 x.05354)53,540482,111Total Unstated Interest$ 967,889The total unstated interest, as illustrated above, is allocated pro rata to each installment. Consequently, a cash basis buyer would deduct $ 300,379 ((450,000 divided by 1,450,000) x 967,889) of interest in the year the first installment is paid and $ 667,510 ((1,000,000 divided by 1,450,000) x 967,889) in the year the second installment is paid.↩4. We note that, while the Warranty Deed was recorded on Dec. 30, 1983, recordation of the Warranty Deed is not relevant for determining when the Seller transferred legal title to the Buyers. Recording laws are designed to provide third parties with notice of real property interests. Bekins Bar V Ranch v. Beryl Baptist Church, 642 P.2d 371">642 P.2d 371, 373↩ (Utah 1982).5. The Seller would have an economic incentive not to exercise that option if another buyer were willing to pay more than the Buyers had agreed to pay. ↩6. It would make economic sense for the Buyers to default if their potential net loss on any resale of the Condominium exceeded the sum of the amount they already had paid plus the amount of the Judgment Note.↩7. Respondent has not suggested that a portion of the consideration the Seller received from the Buyers pursuant to the Purchase Agreement was for the construction of improvements on property owned by the Buyers and not for the purchase of property. Since respondent has not raised that point, we will accept, without deciding, that the Purchase Agreement was not to any extent a contract for services.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621571/	H. ROTHSCHILD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. J. JACOBSTEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Rothschild v. CommissionerDocket Nos. 35140, 35141, 37629, 40244.United States Board of Tax Appeals26 B.T.A. 345; 1932 BTA LEXIS 1323; June 9, 1932, Promulgated 1323 Phil D. Morelock, Esq., for the petitioners. T. M. Mather, Esq., for the respondent. LANSDON 345 OPINION. LANSDON: At Docket Nos. 35141 and 40244 the respondent asserts deficiencies in income tax against H. Rothschild for the years 1925 and 1926 in the respective amounts of $2,125.27 and $935.52, and at Docket Nos. 35140 and 37629 against J. Jacobstein for the same years in the respective amounts of $2,066.85 and $916.29. The same issue is involved in each proceeding, all of which were consolidated for hearing. There are no disputed facts and each of the proceedings was submitted on the pleadings. The petitioners are individuals who were partners in the Union Clothing Company of Kansas City, Missouri, in the taxable years. The deficiencies result from the respondent's increase of the distributable 346 net profits of such partnership for each of the years involved, which converted reported losses for 1925 and 1926 into profits for each of such years and resulted in the deficiencies here in controversy. Prior to 1925 the Union Clothing Company kept its books and rendered its income-tax returns on the accrual basis. At January 1, 1925, in1324 conformity with the law and pursuant to the regulations of the Commissioner it changed its method of accounting for and reporting income to the installment basis. During the year 1925 it collected accounts receivable on merchandise sold in the amount of $161,716.53 and in 1926 it made similar collections in an amount not clearly disclosed in the record. All of such collections in the two years under review had been included in the partnership's returns of gross income made on the accrual basis in years prior to 1925. The petitioners contend that the procedure proposed by the respondent results in double taxation. This may be true, but, if so, it is not a unique situation and is not in violation of any law. . This identical question has been before this Board and the courts in many instances and decisions have been consistently adverse to the contentions here. If there is any infirmity in the law which taxes the income here involved a second time, it can be cured only by legislation, which is not the province of this Board. The determinations of the respondent are approved. *1325 . Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621514/	ESTATE OF LULU K. FLANDREAU, DECEASED, RICHARD KNIES, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Flandreau v. CommissionerDocket No. 22448-89.United States Tax CourtT.C. Memo 1992-173; 1992 Tax Ct. Memo LEXIS 184; 63 T.C.M. (CCH) 2512; March 24, 1992, Filed 184 Decision will be entered under Rule 155. John O'Shea, for petitioner. William J. Gregg, for respondent. CLAPPCLAPPMEMORANDUM OPINION CLAPP, Judge: Respondent determined a deficiency in estate tax in the amount of $ 38,756.35. After concessions by the parties, the issue for consideration is whether petitioner is entitled to claim deductions for notes in the amount of $ 102,000 executed by decedent in favor of her children. We hold that petitioner is not entitled to such deductions. All section references are to the Internal Revenue Code in effect at the date of decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure. We incorporate by reference the stipulation of facts and attached exhibits. Petitioner is the Estate of Lulu K. Flandreau (decedent). Decedent was a resident of Munsey Park, New York, when she died on February 20, 1986. On September 13, 1989, the date the petition in this case was filed, the executor resided in Manhasset, New York. Petitioner timely filed a Form 706, United States Estate Tax Return. During 1970, January 1971, and January 1972, decedent transferred $ 102,000 in cash to her two sons, Richard A. 185 Knies and Donald A. Knies, and their wives: Date ofGiftPaid ToAmount1970Donald A. Knies$ 21,0001970Maureen Knies6,0001970Richard A. Knies21,0001970Constance D. Knies6,0001/71Donald A. Knies6,0001/71Maureen Knies6,0001/71Richard A. Knies6,0001/71Constance D. Knies6,0001/72Donald A. Knies6,0001/72Maureen Knies6,0001/72Richard A. Knies6,0001/72Constance D. Knies6,000The cash transfers described above were reported on Forms 709, United States Gift Tax Returns, filed by decedent. Decedent's son, Richard, and his wife, Constance, transferred funds totaling $ 51,000 to decedent during December 1970, January 1971, and January 1972: DateFunds Provided ByAmount12/10/70Richard A. Knies$ 6,00012/10/70Constance D. Knies6,00012/17/70Richard A. Knies15,0001/8/71Richard A. Knies6,0001/8/71Constance D. Knies6,0001/5/72Richard A. Knies6,0001/5/72Constance D. Knies6,000Decedent's son, Donald, and his wife, Maureen, transferred funds totaling $ 51,000 to decedent during December 1970, January 1971, and January 1972: DateFunds Provided ByAmount12/10/70Maureen Knies$ 6,00012/10/70Donald A. Knies6,00012/17/70Donald A. Knies15,0001/8/71Donald A. Knies6,0001/8/71Maureen Knies6,0001/10/72Donald A. Knies6,0001/10/72Maureen Knies6,000186 Respondent disagrees due to lack of hard evidence that Donald or Maureen ever transferred funds to decedent. However, such transfers are consistent with the rest of the transactions, and we so find. Decedent executed several notes in which she promised to pay both of her sons and their wives the following amounts: Date of NotePayment AmountPayment to12/10/70$ 6,000Richard A. Knies12/10/706,000Constance D. Knies12/17/7015,000Richard A. Knies1/8/716,000Richard A. Knies1/8/716,000Constance D. Knies1/5/726,000Richard A. Knies1/5/726,000Constance D. Knies12/10/706,000Maureen Knies12/10/706,000Donald A. Knies12/17/7015,000Donald A. Knies1/8/716,000Donald A. Knies1/8/716,000Maureen Knies1/10/716,000Donald Knies1/10/716,000Maureen KniesRespondent contends that the dates of the notes between decedent and Donald and Maureen, although dated January 10, 1971, should be January 10, 1972. This would be consistent with the transfers by and notes to Richard and Constance. We find that January 10, 1972, is the correct date for these transfers and notes. The amounts of these notes equal the amounts of the funds decedent187 had transferred to her sons and their wives. The dates of the transfers and the notes were contemporaneous. Decedent was 70 years old when she executed the first notes. All of the notes were due during December 1995 -- at which time decedent would have been 95 years old -- or upon decedent's death, whichever occurred first. The notes were noninterest bearing, and there was no collateral or security given in exchange for them. No repayments were ever made by decedent during her lifetime on these notes. Respondent disallowed the deduction by petitioner of the alleged debts of decedent represented by the notes in issue. Respondent contends that the transfers of funds by decedent to her children constituted incomplete gifts because the amounts were immediately returned, and that the notes did not represent "bona fide debts contracted for adequate and full consideration under Section 2053 of the Internal Revenue Code." Petitioner argues that because respondent previously accepted as valid the gift tax returns filed by decedent during her lifetime, respondent is barred by the statute of limitations from now adjusting or disputing the value of such gifts, and thus the gifts must be188 treated as complete and unconditional. Therefore, the notes from decedent were in exchange for cash transfers and do represent bona fide debts of decedent and, thus, a valid claim against petitioner. Section 2053(a) provides that the value of the taxable estate shall be determined by deducting from the gross estate, among other things, claims against the estate. Section 2053(c)(1)(A) provides that any deduction allowed for claims against the estate be limited "to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth". The question in the instant case is whether decedent's alleged debts were contracted bona fide and for full consideration in money or money's worth. We find that the notes executed by decedent in favor of her children do not represent debts of decedent. The succession of events indicates that decedent never intended to make completed gifts, but instead to arrange to receive estate tax deductions without parting with control of her money. The gifts, transfers back, and notes were exchanged contemporaneously; they were for identical amounts; the notes were accepted without collateral; they were noninterest189 bearing; and they stipulated that repayment would not be made until the earlier of 1995, when decedent would be 95 years of age, or upon her death. It is clear that these were merely circular transfers of money from decedent to her children and back to decedent. Further, as indicated by the exceedingly liberal terms of the notes, there was no expectation of eventual repayment. Decedent's notes to her children did not represent debts, as the notes were nothing more than unenforceable gratuitous promises to make a gift, based upon neither money nor money's worth. In these circumstances, the payment to decedent of money which she herself supplied to her children cannot be loans to her or furnish consideration for her notes. Accordingly, decedent's notes were not given to her children for full consideration in money or money's worth, and the claims based upon them are not deductible claims against the estate under section 2053. Guaranty Trust Co. v. Commissioner, 98 F.2d 62">98 F.2d 62 (2d Cir. 1938); Estate of Connell v. Commissioner, 20 T.C. 917 (1953). Finally, petitioner contends that because the statute of limitations for assessment has expired *190 with respect to the gifts reported by decedent on her previously filed Forms 709, respondent is barred from challenging these gifts in determining estate tax liability. However, in Guaranty Trust Co. v. Commissioner, supra at 66, the Second Circuit stated: There could be no estoppel in the present case even if one were ever possible against the government because it had accepted payment of taxes that were theoretically inconsistent with a liability for others. Here there is no reason to suppose that the government officials knew anything about the circumstances under which the alleged gifts were made or that they did more than take the representations of the taxpayer that he had made gifts and was liable for taxes thereon, at their face value.Our conclusion is not based on whether or not these gifts were valid. Our holding looks to the exact relationship in time and amount between the gifts, the transfers back, and the notes. Treating them all as component parts of single transactions, we conclude that there were no valid debts which could serve as bases for estate tax deductions. Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621550/	CONSOLIDATED FREIGHT LINES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Consolidated Freight Lines, Inc. v. CommissionerDocket No. 88246.United States Board of Tax Appeals37 B.T.A. 576; 1938 BTA LEXIS 1022; March 29, 1938, Promulgated 1938 BTA LEXIS 1022">1022 Prior to 1934 the petitioner purchased certificates of public convenience and necessity permitting transportation of freight by truck over certain highways in the State of Washington, which certificates meterially restricted competition over the routes covered. Legislation effective in 1934 removed the monopolistic character of the certificates, but did not destroy the petitioner's right to operate its truck lines. Held, that the change in legislation did not result in a deductible loss. Robert R. Rankin, Esq., for the petitioner. John H. Pigg, Esq., for the respondent. ARUNDELL37 B.T.A. 576">576 In this proceeding the respondent determined a deficiency in income and excess profits taxes for the year 1934 in the amount of $11,927.19. The only issue is whether the petitioner is entitled to a loss on its investment in certain certificates of public convenience and necessity covering freight transportation by truck in the State of Washington which allegedly became worthless in 1934, due to certain legislation. FINDINGS OF FACT. The petitioner was incorporated under the laws of the State of Washington in August 1929, as the Federal Auto Freight1938 BTA LEXIS 1022">1023 Co. In 1931 its name was changed to Consolidated Freight Lines, Inc. This corporation under both of its successive names will be referred to herein as the petitioner. During the year 1934 petitioner was engaged in the operation of trucking transportation service as a common carrier over the highways within the State of Washington, as well as carrying some interstate trucking business. 37 B.T.A. 576">577 Petitioner in 1934 was the owner of certain certificates of convenience and necessity permitting the operation of trucking lines over certain routes in the State of Washington, as follows: Certificate No.Route289 (316)Yakima-Prosser via Sunnyside289 (533)Yakima-Easton via Cle Elum496Spokane-Ephrata-Wenatchee526Spokane-Yakima570Seattle-WenatcheeInterests in these certificates were transferable, subject to the approval of the Department of Public Service of the State of Washington; and the practice was to approve transfers as a matter of course without a hearing. Petitioner's interest in the certificates enumerated above was acquired as follows: No. 289 (316). - A. E. Birum, one of the incorporators of the petitioner, had acquired the original1938 BTA LEXIS 1022">1024 certificate No. 289 and had purchased certificate No. 316 from E. J. Miller for $15,000. The fee paid for issuance of the original certificate No. 289 was $25. At the time of petitioner's incorporation the combined certificate No. 289 (316) was turned in to the petitioner at an agreed value of $30,000, along with the other assets owned by Birum individually. The petitioner assumed the liabilities of Birum and the excess of assets over liabilities transferred was $27,000. In exchange, Birum received $2,000 in cash and 250 shares of stock of the petitioner of a par value of $100 per share. The fair market value of the stock was equal to its par value. There was a contemporaneous sale of 250 shares of stock to George Youell, another incorporator, for $25,000 cash. No. 289 (533). - Birum and another person were coowners of this certificate and turned it in to a corporation organized by them under the name of Yakima-Seattle Auto Express Co. The petitioner on January 26, 1932, acquired the certificate from the Yakima-Seattle Auto Express Co. in exchange for the issuance of $5,000 par value of the petitioner's stock. The fair market value of the petitioner's stock at this time1938 BTA LEXIS 1022">1025 was equal to its par value. No. 496. - This certificate was owned by the North Central Freight Co. In order to acquire it the petitioner purchased all of the stock of that company for $38,000 and discharged its liabilities in an amount which brought the petitioner's total expenditure up to $60,184.28. Petitioner liquidated the North Central Freight Co., receiving assets of a book value (based on their depreciated cost) of $16,795.30 in addition to this certificate No. 496. The certificate therefore cost the petitioner the difference between its total expenditure and the value of the physical assets received, or $43,388.98. No. 526. - This certificate was originally issued to the Portland Spokane Auto Freight Lines, Inc., an Oregon corporation, which 37 B.T.A. 576">578 was merged into the Consolidated Truck Lines, another Oregon corporation, which in turn was merged into the petitioner. The Portland Spokane Auto Freight Lines, Inc., paid $1,000 to a Washington resident, who was a rival applicant for the certificate to operate on the Spokane-Yakima route, to obtain the withdrawal of his application, which was considered a serious threat to the corporation's application. As1938 BTA LEXIS 1022">1026 part of the transaction by which the petitioner acquired the properties of the Consolidated Truck Lines, in the early part of 1931, the petitioner paid for this certificate its capital stock having a fair market value of $1,000. No. 570. - This certificate was purchased by the petitioner from the Hamilton Auto Freight, Inc., in 1931 for $20,000 cash. The purchase price was advanced by Youell, Inc., and repaid by the petitioner in installments during 1931. The filing fee paid by the Hamilton Auto Freight, Inc., in originally obtaining the certificate was $25. Prior to 1934 the certificates of convenience and necessity were mortgagable, had a substantial sale value, and a substantial value for state personal property tax purposes. Also, the petitioner had no competition on any of its routes prior to 1934. In 1934 the certificates lost their sale value, were no longer mortgagable, and the assessed value for personal property taxes was removed by the state tax commission. This change was brought about by legislation enacted in 1933, which abolished the exclusive character of the certificates and permitted operation in competition with existing lines. From 1934 on, many1938 BTA LEXIS 1022">1027 competing common carriers by truck began operating over the routes served by petitioner, petitioner's rates were reduced, and its tonnage decreased. OPINION. ARUNDELL: In its income tax return for 1934 the petitioner claimed losses on account of the worthlessness of the franchises acquired under the above certificates in the following amounts: Yakima-Prosser$15,025.00Yakima-Easton5,000.00Spokane-Ephrata-Wenatchee36,388.98Spokane-Yakima1,000.00Seattle-Wenatchee20,025.00By amended pleadings in this proceeding the petitioner claims the loss on the Spokane-Ephrata-Wenatchee certificate should be increased by $7,000 to $43,388.98. By the same pleading petitioner concedes the correctness of the Commissioner's disallowance of the loss of $4,500 claimed on the return for a certificate covering an interstate route from Yakima, Washington, to Portland, Oregon. 37 B.T.A. 576">579 The question for decision here is whether or not the petitioner suffered a deductible loss by reason of legislation which was enacted by the State of Washington in 1933 and took effect January 17, 1934. The successive legislative acts of the State of Washington referred to by1938 BTA LEXIS 1022">1028 the parties may be briefly described. It appears that regulation of motor carriers began with an enactment in 1921. Laws of 1921, ch. 111. That act gave the Department of Public Works (subsequently, the Department of Public Service) authority to regulate motor carriers operating "for the transportation of persons and, or, property for compensation between fixed termini or over a regular route in this state * ." The regulation was to be accomplished through the medium of granting or withholding certificates of "public convenience and necessity." The statute contained a mandatory provision, commonly called the "grandfather clause", requiring issuance of such certificates to carriers operating on January 15, 1921. Certificates for competitive lines could be issued, after hearing, only when the existing line failed to provide satisfactory service. By statutory provision, certificates could be "sold, assigned, leased, transferred or inherited as other property, only upon authorization of the Commission." Sec. 4, ch. 111, Laws of 1921. The purpose of section 4 of the 1921 statute is described in 1938 BTA LEXIS 1022">1029 , as follows: * * * Its primary purpose is not regulation with a view to safety or to conservation of the highways, but the prohibition of competition. It determines not the manner of use, but the persons by whom the highways may be used. It prohibits such use to some persons while permitting it to others for the same purpose and in the same manner. * * * The effect of the 1921 statute was to grant monopolies to those carriers in operation on January 15, 1921, and the first comers thereafter in other territory, and to perpetuate the monopolies in successors who acquired the certificates of public convenience and necessity by purchase or otherwise. Thus the certificates, by reason of granting the right of operation to their holders to the exclusion of others, came to have considerable value. The certificates acquired by the petitioner, as described in the findings of fact, were certificates issued under the 1921 statute. The 1921 statute limited regulation to motor carriers operating "between fixed termini or over a regular route." Statutes enacted in 1933 (ch. 166, Session Laws of 1933) extended the regulatory power1938 BTA LEXIS 1022">1030 of the Department of Public Service to other classes of motor carriers, designated "contract haulers", "for hire carriers", and "private carriers." These classes of carriers were required to procure permits from the Department of Public Service in order to engage in motor transportation. This legislation did not affect the certificates of convenience and necessity issued under the 1921 statute. 37 B.T.A. 576">580 Chapter 55 of the Extraordinary Session Laws of 1933, which became effective January 17, 1934, and are herein for convenience called the 1934 statute, elaborated the provisions of the earlier statute of the year 1933. The particular provision added by the Extraordinary Session Laws which is of interest here is as follows: Nothing herein contained shall be construed to confer upon any person the exclusive right or privilege of transporting property for compensation over the public highways of the State of Washington. The 1934 statute, like the old, required carriers like the petitioner to procure certificates of public convenience and necessity which, as under the 1921 statute, could be "assigned, sold, leased, transferred or inherited as other property only upon authorization1938 BTA LEXIS 1022">1031 of the department." The 1934 statute did not, like the 1921 statute, limit the power of the department to authorize competing lines only in case of inadequacy of service, but could, after hearing, issue or refuse in whole or in part, certificates authorizing competing service in the same territory. Section 18 of the 1934 statute provided that operators under certificates issued under the 1921 statute "shall continue to operate under said certificates in the same manner and to the same effect as if such certificates were granted under the provisions of this act." The substance of the changes wrought by the 1934 statute is succinctly stated in ; , where the court said that the changes established "the principle of regulated competition * * ." With this resume of the successive statutes before us, we face the question of whether the statutory changes that became effective in 1934 so affected petitioner's certificates of public convenience and necessity as to result in a deductible loss. Petitioner's view is that under its certificates issued under the 1921 statute it had monopolistic1938 BTA LEXIS 1022">1032 rights which were destroyed by the 1934 statute; that such rights had been acquired at substantial cost and had considerable value; and that the destruction of them resulted in a deductible loss. A comparison of the statutes and the description of them in the court cases cited above leaves no doubt that the 1921 statute granted monopolistic rights and that the 1934 statute destroyed the monopolistic character of those rights. It does not follow, however, that a deductible loss was sustained. When the petitioner acquired the certificates such certificates were a prerequisite to the conduct of the business of transporting property over state highways between fixed termini or over a regular route. They were obviously acquired by the petitioner for the purpose of engaging in that business, as it thereafter did operate such a business. The monopolistic character of the certificates is not, as far as the record shows, a thing separate and apart from the right to carry on a business under them. In other words, there is no showing that the certificates were bought and sold like 37 B.T.A. 576">581 shares of stock or bonds which are so often held by the owner for income or appreciation without1938 BTA LEXIS 1022">1033 thought of his engaging in the business that gives value to the securities. Such monopolistic features as the certificates had were, in fact, effective only if the holder engaged in the business to which the certificate related. If he did not conduct the business authorized and did not do it in such a way as to furnish service satisfactory to the issuing department, certificates could be issued to others to serve the same territory and thus destroy the petitioner's monopoly. Thus, the monopoly granted by the certificates can not be viewed as a thing separate and distinct from the other rights granted and duties imposed by them. The monopoly was only one element that gave them value. The complete enmeshing of the monopolistic and operating aspects of the certificates distinguishes this case from those in which the right to operate a business is lost or destroyed. Petitioner cites , as authority for its claim. In that case the taxpayer paid some $10,000 to an operator of bus lines in California for what he thought were rights to operate over certain highways in California. In 1921 the California Railroad Commission decided that the1938 BTA LEXIS 1022">1034 vendor had no operative rights over the particular highways. The result of this was, as we found, that the taxpayer "had paid a purchase price for certain operative rights, but had acquired nothing." We allowed a loss deduction. That decision does not support the petitioner's case. There, upon conclusion of the proceedings before the local regulatory body, the taxpayer had no operative rights - his business was completely obliterated. Here, the petitioner's operative rights and its business carried on in virtue of its certificates continue, they have neither been lost nor in any way hampered. On like ground there must be distinguished the cases allowing obsolescence and loss deductions where businesses were affected by prohibition legislation. See ; ; ; (Ct. Cls., Dec. 6, 1937). The last three cited cases involved deductions for liquor or saloon licenses, and the facts, particularly in the Elston case, concerning the acquisition and holding of1938 BTA LEXIS 1022">1035 licenses are quite close to the facts here. In the Elston case the taxpayer had purchased a number of saloon licenses which, because of an ordinance limiting the number thereof on the basis of population but containing a grandfather clause, were valuable and were bought and sold and for some purposes were treated as property. With the advent of prohibition legislation in 1919 the licenses became worthless and were abandoned by the taxpayer in that year. The Court of Claims allowed a deduction in the amount of the cost to the taxpayer 37 B.T.A. 576">582 of its licenses. The court, citing the above mentioned Board cases, said: * * * The renewal rights of saloon licenses is those cases, as in the instant case, were income producing assets, subject to purchase, sale and assignment, separate from the business itself. They were assignable assets distinct from the business. In this respect they were in the same category with patents, contracts and franchises. * * * At first glance this language would seem to support the petitioner's position here. However, it must be borne in mind that the court was speaking in the light of the factual situation of the destruction of the business1938 BTA LEXIS 1022">*1036 to which the licenses related. When so considered it can not be said that the Elston case, or the others cited, stand for the allowance of deductions in respect of licenses where the business goes on despite a change in some feature or characteristic of the license. Assuming in the present case that the monopolistic features of the certificates issued under the 1921 statute had some value apart from the operative rights, and that the monopolistic features were destroyed by the 1934 legislation, the petitioner has not shown what part of cost is attributable separately to those features. Hence it has not established its basis for gain or loss. We find no error in the respondent's determination. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621551/	MARSHALL FIELD & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Marshall Field & Co. v. CommissionerDocket No. 15279.United States Board of Tax Appeals14 B.T.A. 755; 1928 BTA LEXIS 2916; December 17, 1928, Promulgated 1928 BTA LEXIS 2916">2916 Reduction of opening inventory of a business purchased by reason of assigning a part of the purported purchase price of the stock of merchandise to cost of good will of the business held error, where the evidence established that no good will asset in fact existed, or was considered in appraising the stock in trade. Lyle T. Alverson, Esq., for the petitioner. John F. Greaney, Esq., for the respondent. SIEFKIN14 B.T.A. 755">755 This proceeding results from respondent's determination of a deficiency in income taxes for the calendar year 1923 in the amount of $151,345.31, of which $117,374.74 is contested. The sole error alleged is respondent's action in treating a part of the purported purchase price of a stock of goods as payment for good will of the seller, thereby reducing opening inventory of an affiliated corporation organized to carry on the acquired business. FINDINGS OF FACT. Petitioner is, and was during 1923, an Illinois corporation with principal offices at Chicago. During the year in question negotiations were begun between petitioner and another corporation, Rothschild & Co., which was then conducting a retail drygoods department1928 BTA LEXIS 2916">2917 store, looking to the purchase of Rothschild & Co. by petitioner. When the negotiations were begun, petitioner informed the sellers that the negotiations might as well stop if they had in mind petitioner's paying anything for good will, as petitioner thought there was no good will. Respecting the merchandise petitioner agreed to buy on the basis of cost or market, whichever was lower. The effective date of the sale was October 1, 1923, though the actual selling price was not determined until December 18, 1923. The last physical inventory taken by the seller, prior to the agreed effective date of the sale, was July 1 of that year. The stock sheets of the seller were represented as showing cost or market, whichever was lower, to date, and were used as a basis or starting point for determining the agreed purchase price without actual physical inventory. The stock sheets showed an estimated inventory of $3,324.633, which was reduced to $2,918,034 by adjustments made by representatives of both parties to bring the estimate down to the purchase basis. No item-for-item examination of the merchandise was made, but petitioner's merchandise 14 B.T.A. 755">756 men made a general survey of the1928 BTA LEXIS 2916">2918 store to ascertain the condition of the goods. The assets taken over by petitioner and their respective values, as determined by the parties to the sale, were as follows: Cash on hand$ 50,434Building3,500,000Fixtures470,779Motor trucks40,742Warehouse elevator478Jackson Blvd. Bldg. improvements107,475Bonds:Market value 10/1/23$107,556At R. & Co13,000120,556U.S. Treasury cert. of ind.250,000Inventory of merchandise2,918,034Inventory of supplies90,639Advances on leases28,224Unexpired insurance31,048Unexpired licenses1,283Regular and furniture install. accts. rec1,451,604C.O.D. in transit17,121Will call in transit11,5239,089,940Mortgage assumed1,000,0008,089,940$ 5,000100,000105,0007,984,940In appraising the assets, each asset was separately valued and the sum of such values was determined to be the total sale price. The petitioner conducted the business taken over during the remainder of 1923 through a subsidiary, the Davis Dry Goods Co. Business was not interrupted at the time of the transfer. Most of the employees1928 BTA LEXIS 2916">2919 (including departmental heads) of the seller were retained for a time. The process of weeding out such employees, which was begun immediately, lasted over a period of a year or two. The merchandise purchased from Rothschild & Co. was included in the Davis Company's opening inventory at the agreed sale price of $2,918,034. In the report submitted by a revenue agent which was adopted as a basis for the deficiency, this amount was reduced by $938,997.97, which was treated as the cost of good will, a capital item. Rothschild & Co. had not been successful in conducting the business. The business had been able to continue only because its stockholders 14 B.T.A. 755">757 made additional advances to the business from time to time and converted the loans into stock or securities. Rothschild & Co. had been advertising for a number of years. There was no good will or going concern asset of value acquired by petitioner. OPINION. SIEFKIN: The single issue in controversy in this proceeding is whether the $2,918,034 fixed as the purchase price of the stock of goods, appraised on the basis of cost or market value, whichever was lower, included any sum paid for good will of Rothschild & Co. 1928 BTA LEXIS 2916">2920 We think the evidence is clear that such value was fixed as the value of the merchandise only. It was reached by the representatives of the parties to the sale after a careful check of the various elements marking up the total current inventory value as shown by the seller's stock sheets. The evidence likewise is clear that no good will or going-concern asset of value was purchased. We have found as a fact that Rothschild & Co. had not been successful. Petitioner refused to negotiate on any basis assigning a value to good will. Petitioner did not think Rothschild & Co. had any good will. Such opinion is evidenced by testimony and by the fact that the business was conducted after purchase under a new name. The total purchase price was determined by adding together the value fixed in the separate preliminary appraisal of the several assets. Neither good will nor going-concern value was considered as an asset. The deficiency is $33,970.57. Decision will be entered accordingly.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621552/	ESTATE OF R. R. RUSSELL, AND J. L. BORROUM, T. P. RUSSELL AND O. H. JUDKINS, EXECUTORS AND TRUSTEES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Russell v. CommissionerDocket No. 59226.United States Board of Tax Appeals34 B.T.A. 715; 1936 BTA LEXIS 658; June 25, 1936, Promulgated 1936 BTA LEXIS 658">658 Decedent, in life, was a stockholder and officer in two corporations and carried on a cattle business individually and in a partnership. He endorsed notes of the corporations, and of an individual who purchased cattle from him. He also paid debts of one of the corporations and endorsed a note of an individual. The estate continued the cattle business conducted by the decedent before his death. In winding up the affairs of the partnership the executors received a note from the surviving partner for his share of the firm's liabilities. In the administration of the estate of the decedent the executors were required to satisfy the endorsed notes, and they ascertained the note of the surviving partner to be worthless. Held, that the losses are not attributable to any trade or business regularly carried on by the executors and the estate, and, the individual not being the same taxpayer the petitioner may not use the losses in computing a net loss of the estate. A. J. Lewis, Esq., for the petitioner. Hunter B. Linton, Esq., and Dean P. Kimball, Esq., for the respondent. SEAWELL34 B.T.A. 715">715 This proceeding involves the redetermination of a deficiency1936 BTA LEXIS 658">659 of $19,894.56 in income tax for 1928 determined against the estate of R. R. Russell, deceased. The issue is whether certain losses sustained in 1926 were attributable to the operation of a trade or business regularly carried on by the petitioner. Substantially all of the facts were stipulated. FINDINGS OF FACT. All of the property of R. R. Russell, who died June 28, 1922, a resident of San Antonio, Texas, consisted of community property of himself and wife. In his last will and testament he appointed O. H. Judkins, T. P. Russell, and J. L. Borroum independent executors of his estate, directed that all of his debts be paid, and authorized his executors to "borrow monies, make sales of property as in 34 B.T.A. 715">716 their judgment would be to the best interest of the Estate, and to lease for an unnamed number of years, such real estate as it was not deemed advisable or found necessary to sell in connection with the administration of the estate." The will further provided that in all of such matters the consent of the decedent's wife, Mattie E. Russell, "should first be obtained." The will was duly probated and ever since the estate has been in the process of administration. At1936 BTA LEXIS 658">660 the request of the widow, at all times important the executors retained possession and control of her one-half community interest in the community property and managed and operated the entire estate as a unit. The executors kept books of account and filed income tax returns of the estate on the accrual basis. During his lifetime the decedent was regularly extensively engaged in the business of raising, buying, selling, and exchanging livestock, including horses, cattle, sheep, and goats. At the time of his death he owned several ranches comprising about 145,000 acres of land in Texas, approximately 26,000 head of cattle, and about 8,000 sheep and goats. He was also director of four or five banks and two or three loan companies, including the Stockyards Loan Co. of Kansas City, Kansas, and had an interest in some partnerships engaged in the livestock business. The petitioner continued to operate the ranches which the decedent owned at the time of his death. Prior to June 28, 1922, the decedent sold some steers to W. J. Rutledge for $304,407. The cattle were paid for by the buyer with money borrowed from the Cassidy Southwestern Commission Co. upon notes bearing the seller's1936 BTA LEXIS 658">661 endorsement. The notes were further secured by a chattel mortgage on the cattle sold. There was a perceptible drop in the cattle market between the time the cattle were sold and the date of the decedent's death. In the estate tax return filed by the executors of the estate in 1924, the sum of $157,248.74 was claimed as a deduction from gross estate on account of the decedent's liability as an endorser of the Rutledge note. The deduction was allowed by the Commissioner. In 1924 Rutledge was adjudicated a bankrupt, but neither the petitioner nor the Commission Co. ever filed a claim against the bankrupt estate for the unpaid amount of the note. Thereafter the bankrupt estate surrendered to the Commission Co. such steers covered by the chattel mortgage as were on hand and unsold, and authorized the mortgagee to gather the remaining steers and apply the proceeds of sale of any cattle recovered to discharge the debt. The bankrupt estate never declared or paid a dividend. The bankrupt was discharged in 1925. Thereafter in 1925 the petitioner was called upon to pay, and did pay, to the Commission Co. the sum of $198,708.11 on account of the decedent's liability as an endorser1936 BTA LEXIS 658">662 of 34 B.T.A. 715">717 the Rutledge note. In 1926 the petitioner, upon demand, made the following additional payments to the Commission Co. on account of such liability: January 30, 1926, interest$3,088.89May 1, 1926818.76August 10, 1926, note35,030.75The note for $35,030.75 was given to satisfy the balance due on the Rutledge note after application of the proceeds derived from the sale of the cattle. The petitioner made no payment on the note until after 1928. The sum paid on the note in 1925 was charged to profit and loss for that year. On December 31, 1926, it charged to the same account the additional amount of $37,509.59, a figure reached by deducting from the payments made and the note given in 1926, credit allowed for cattle sold, and a refund. It is stipulated that "Neither in 1925 nor in 1926 did W. J. Rutledge have any assets or prospects of paying his debts, and his condition then continued throughout all subsequent years material to this appeal." On June 1, 1921, the decedent sold to R. H. Martin & Co., a partnership composed of R. H. Martin and the decedent, and engaged in the business of buying, raising, and selling livestock of all kinds, 1936 BTA LEXIS 658">663 certain livestock for $74,359.62, evidenced by three notes of the buyer executed on June 1, 1921, in the amount of $24,786.54 each. Thereafter the decedent endorsed one of the notes to the City National Bank of San Antonio without recourse. The bank owned and held the note at the time of the decedent's death. The partnership was dissolved by the death of the decedent. A short time thereafter the petitioner purchased the assets of the partnership for $30,313.70. Martin's unpaid liability on the two partnership notes held by the petitioner, after making allowance for his interest in partnership assets and other liabilities, was $19,904.08, for which on August 12, 1924, he gave petitioner his individual note. The note was ascertained to be worthless and charged off by the petitioner in 1926. Between August 12, 1924, and the close of 1925 the petitioner paid debts of the partnership in the amount of $3,625.06, of which one-half was chargeable to the surviving partner. These debts were in existence but not ascertained at the time the partnership was dissolved. In July 1926 the petitioner was required to and did pay the partnership note of $24,786.54 held by the City National1936 BTA LEXIS 658">664 Bank of San Antonio, plus interest, a total of $35,162.30, by giving the bank its own note. On the same day it was required to and did pay in a like manner an individual note of Martin in the amount of $4,984.28, 34 B.T.A. 715">718 including accrued interest. The note bore the endorsement of the decedent. At the time of his death the decedent and his wife owned the following stock in the corporations shown: CapitalizationPar value of stock ownedRussell-Coleman Oil Mill Co$300,000$285,000Beeville Oil Mill Co100,00027,000Winters Oil Mill Co150,00037,500Ballinger Oil Mill Co150,00037,500Runnels County Gins150,00037,500Kennedy Oil Mill Co90,50050,000They also had an investment of $9,300 in the San Angelo Cotton Oil Co., a partnership. The Russell-Coleman Oil Mill Co. was organized in 1915 by the decedent and one Coleman, a ranchman. At the time of his death the decedent was president of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co. and an endorser on and guarantor of notes of "certain" of the organizations listed above. The amount of the notes of the Russell-Coleman Oil Mill Co. which the decedent endorsed1936 BTA LEXIS 658">665 varied from year to year, and was $300,000 one year. When the decedent died his liability arising out of his endorsement of notes of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co. "was so much greater than the realizable value of the assets of the aforementioned corporations that it was definitely known that the executors would ultimately be forced to pay substantial amounts out of the funds of the Estate in satisfaction of such liability." The executors estimated the probable loss from the decedent's endorsement of notes of the Beeville Oil Mill Co. would be $50,000 and from the Russell-Coleman Oil Mill Co. $70,000. One-half of these amounts was claimed by the executors and allowed by the respondent in the estate tax return as claims against the estate of the decedent. The executors and the decedent's wife reendorsed notes of the foregoing corporations that had been endorsed by the decedent. The "executors, with R. F. Spencer, who represented them in all matters, attended all annual meetings of the corporations, were consulted in the selection of the local managers and other representatives of the mills, and, generally, by virtue of the stockholdings of the estate1936 BTA LEXIS 658">666 and of Mrs. Russell, had a dominant voice in the management of the various corporations." Spencer was also president of the Beeville Oil Mill Co. after the decedent's death. Lacking funds with which to operate them, during the latter part of 1922 the Russell-Coleman Oil Mill Co. leased its properties until June 1, 1923, with an option to buy if a price could be agreed upon. 34 B.T.A. 715">719 An offer of $125,000 made for the property upon the termination of the lease was declined. The corporation's plant remained idle until 1925, when it was sold for $60,000 and the proceeds of the sale were used to liquidate notes of the corporation held by the City National Bank of San Antonio. In 1926 like disposition was made of the sum of $20,000 received from the sale in that year of all the properties of the Beeville Oil Mill Co., which had been idle since 1922. In or about July 1926 the principal and accrued interest on notes of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co., originally guaranteed by the decedent and continued by the executors, amounted to $107,208.81 and $101,062.74, respectively. The City National Bank of San Antonio, due to the sale of all of the assets1936 BTA LEXIS 658">667 of these corporations, with some insignificant exception, was unwilling to continue to hold the notes of the corporations, R. H. Martin, and R. H. Martin & Co., and demanded payment by the petitioner under its liability as guarantor. The petitioner satisfied its liability by giving the bank its note dated July 22, 1926, in the amount of $356,622.93 in full payment of the notes of the corporations, the individual and the partnership, together with "certain other items." The obligations of the two corporations, Martin, and the partnership were worthless in 1926, when the petitioner gave its note to the bank in satisfaction of its endorser liability. The debts were ascertained to be worthless and charged off in 1926. In 1928 the petitioner made a cash payment of $164,967.37 on the note. In 1926 the petitioner paid the sum of $4,358.29 on behalf of the Beeville Oil Mill Co. in clearing title to the property of the corporation so that it could be sold. The petitioner sustained a statutory net loss of at least $1,146.97 in 1926 and a like loss of $14,561.57 in 1927. Its taxable net income in 1928 was $71,470 without any deduction for prior net losses. OPINION. SEAWELL: 11936 BTA LEXIS 658">668 The petitioner claims that its 1926 net loss should be increased by the following alleged losses: 1. W. J. Rutledge note$37,509.59R. H. Martin note19,904.08R. H. Martin & Co. note$24,786.54Interest10,375.7635,162.302. R. H. Martin & Co. debts1,812.53Russell-Coleman Oil Mill Co. note107,208.81Beeville Oil Mill Co. note101,062.74Beeville Oil Mill Co. debts4,358.29R. H. Martin note4,984.2834 B.T.A. 715">720 The petitioner concedes that the amount of the losses arising out of the decedent's endorsement of notes of the corporations should be decreased by $120,000 on account of deductions taken in the estate tax return, and it is agreed that the remaining amounts of such items, together with the other losses, should be reduced one-half to reflect the widow's community property interest in the estate. Deductions from gross income, including net losses, are allowable only when clearly provided for by statute. 1936 BTA LEXIS 658">669 New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435. The statutes allow, as deductions in the computation of a net loss, losses "attributable to the operation of a trade or business regularly carried on by the taxpayer." Sec. 206, Revenue Act of 1926; secs. 117 and 169, Revenue Act of 1928. The amount of the several claimed losses is not in controversy. The petitioner's contention is that all of the losses are attributable to trades or businesses regularly carried on by the decedent during his lifetime, and, having continued such trades or businesses after his death, it is entitled to the benefits of the statute. The respondent's position on the point is that the petitioner was regularly engaged in only the ranching business, and, as none of the losses are attributable to such business, the items form no part of the petitioner's net loss in 1926. The thing of importance respecting the items in group one is whether they are attributable to a trade or business regularly carried on by the decedent before his death, or his executors, the petitioner. The Rutledge note was endorsed and the note of R. H. Martin & Co. was acquired by the decedent during his lifetime. 1936 BTA LEXIS 658">670 The Martin note for $19,904.08 was acquired by the petitioner in settling the affairs of R. H. Martin & Co. and the remaining claimed losses in group one resulted from the payment of debts of that partnership after the settlement with Martin, the surviving partner. During his lifetime the decedent was regularly engaged in the ranching business, including the purchase and sale of livestock, in his individual capacity and as a member of partnerships. He endorsed the Rutledge note and received the partnership note in the ordinary course of operating his individual ranching business, and had the losses occurred prior to his death, undoubtedly the amount thereof would have been available to him in the computation of a net loss. His liability as an endorser existed at the time of his death and the losses resulting from it would have been sustained if the executors had not engaged in any line of business. The activities of the executors consisted of administering the estate of the individual, including the liquidation of liabilities thereof, and operating the ranches formerly owned and operated by the decedent 34 B.T.A. 715">721 in his individual capacity. Russell's death worked a dissolution1936 BTA LEXIS 658">671 of the partnership of R. H. Martin & Co., and the activities of the executors as to it related only to settling its affairs as required by law. The ordinary duties of an executor, such as the executors here were performing in settling the liabilities of the estate on the notes and winding up the affairs of R. H. Martin & Co., do not constitute a trade or business regularly carried on. O. A. Refling, Executor,17 B.T.A. 327">17 B.T.A. 327; affd., 47 Fed.(2d) 859; Charles Lesley Ames, Executor,14 B.T.A. 1067">14 B.T.A. 1067; affd., 49 Fed.(2d) 853; People's Pittsburgh Trust Co. v. United States,6 Fed.Supp. 447; Eli Strouse,24 B.T.A. 748">24 B.T.A. 748; affd., 59 Fed.(2d) 600. Thus the losses referred to were not attributable to any trade or business regularly carried on by the petitioner unless under the statute it and the decedent are one and the same taxpayer. In our opinion they are not. A new corporation formed to acquire the assets and business of an existing corporation in exchange for its stock may not obtain the benefit of a net loss of the old corporation in the computation of its net income. 1936 BTA LEXIS 658">672 292 U.S. 435">New Colonial Ice Co. v. Helvering, supra. Under a ruling of the Commissioner of long standing a net loss of an individual may not be carried forward in determining net income of his estate, the theory of the principle being that the two are not a single taxpayer. I.T. 1562, C.B. II-1, p. 33. The statutes classify the estate of a decedent as a taxpayer. Sec. 2, 1926 Revenue Act; sec. 701, 1928 Revenue Act. The taxable net income of an individual and an estate are not computed in the same manner. Certain specified contributions made by an estate pursuant to the terms of the will are deductible from gross income without limitation, whereas in the case of an individual the amount of the deduction is limited. Contributions to a public cemetery may be deducted by an estate, but not by an individual. In the case of an estate, the credit allowed is the same as that for a single person, with no allowance for dependents. Sections 214(a) and 219(b), Revenue Act of 1926, which contain other provisions peculiar to estates. No credit is available to an estate for earned income. Sec. 209, 1926 Revenue Act. A further distinction is that property of the decedent acquired1936 BTA LEXIS 658">673 a new basis when it was acquired by the estate. Sec. 113(5), 1928 Revenue Act. In Hartley v. Commissioner,295 U.S. 216">295 U.S. 216, the Court, in holding that under the 1924 and 1926 Acts the basis for property in the hands of the executor acquired from the decedent was the fair market value thereof at the time of the decedent's death, rather than the decedent's basis, said: "The revenue acts consistently treat the estate of a decedent in the hands of an administrator or executor as a separate taxpayer." 34 B.T.A. 715">722 The fact of continuity of the business was stressed by the petitioner in 292 U.S. 435">New Colonial Ice Co. v. Helvering, supra, but the Court did not regard it as controlling, saying: * * * Besides, the matter of importance here, as will be shown presently, is not continuity of business alone but of ownership and tax liability as well. Had the transfer from one company to the other been effected by an unconditional sale for cash, there would have been continuity of business, but not ownership or tax liability. The losses contained in group one were not attributable to any trade or business regularly carried on by the petitioner, but to businesses1936 BTA LEXIS 658">674 regularly carried on by the decedent prior to his death, and, the estate being a taxable entity separate from the individual, the petitioner is not entitled to include the items in the computation of its net loss for 1926. The decedent and Martin had equal interests in the partnership of R. H. Martin & Co. In closing up the affairs of the firm it was determined that Martin owed the estate the sum of $19,904.08 on the two partnership notes it held, each in the face amount of $24,786.54. Whether the third note of a like sum, held by the City National Bank of San Antonio, was taken into the reckoning is not shown by the record. If the decedent's investment in the partnership resulted in taxable gain or deductible loss, the amount thereof should have been reflected in the return of the estate for 1924, the year in which the settlement was made between Martin and the estate. The loss on the note given by Martin did not result from any partnership activity of the decedent or his executors, but was due to the failure of Martin to pay the obligation. 1936 BTA LEXIS 658">675 Lewis G. Carpenter,33 B.T.A. 1">33 B.T.A. 1. The partnership debts of $3,625.06 were paid after the settlement was entered into between the partners but prior to 1926, and can not on any ground be allowed as a deduction in 1926. The items in group two relate to losses resulting from endorsement of notes of two corporations, debts paid for the account of one of the corporations, and an individual note of R. H. Martin. In Burnet v. Clark,287 U.S. 410">287 U.S. 410, the taxpayer at various times endorsed notes of a corporation of which he was a majority stockholder and president, and to the affairs of which he devoted a large part of his time. He was not regularly engaged in endorsing notes or buying and selling securities. From these basic facts the Court refused to allow, in the computation of net losses, amounts the taxpayer paid out to satisfy his liability as endorser of the corporation's notes. Neither the decedent nor the petitioner was regularly engaged in the business of endorsing or guaranteeing notes, making advances to, or paying debts of corporations. Under the rule announced in the Clark case, supra, the losses sustained on the corporate notes1936 BTA LEXIS 658">676 and debts paid for one of them would not have been deductible by the decedent 34 B.T.A. 715">723 in the computation of a net loss had they occurred during his lifetime. His estate, a separate taxpayer, acquired no greater rights. The loss sustained on the individual note of R. H. Martin has no relation to any trade or business regularly carried on by the estate or by the decedent prior to his death, and, like the other losses, may not be used in the computation of a net loss of the petitioner for 1926. Decision will be entered under Rule 50.Footnotes1. This decision was prepared during Mr. Seawell's term of office. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/748939/	131 F.3d 144 NOTICE: Eighth Circuit Rule 28A(k) governs citation of unpublished opinions and provides that they are not precedent and generally should not be cited unless relevant to establishing the doctrines of res judicata, collateral estoppel, the law of the case, or if the opinion has persuasive value on a material issue and no published opinion would serve as well.UNITED STATES of America, Appellee,v.PREMISES KNOWN AS, with any and all appurtenances theretoand any and all proceeds from its sale ortransfer, Defendant. No. 97-2697. United States Court of Appeals, Eighth Circuit. Submitted: November 21, 1997.Filed: December 2, 1997. Appeal from the United States District Court for the District of Minnesota. Before McMILLIAN, BEAM, and MORRIS SHEPPARD ARNOLD, Circuit Judges. PER CURIAM. 1 Gary Lloyd Bruce appeals from the district court's1 denial of his Federal Rule of Civil Procedure 60(b)(4) motion challenging a 1991 forfeiture judgment entered in favor of the United States and against his real property. Upon review of the record and the parties' submissions on appeal, we conclude that the judgment of the district court is correct. Accordingly we affirm. See 8th Cir. R. 47B. 1 The Honorable Paul A. Magnuson, Chief Judge, United States District Court for the District of Minnesota	01-04-2023	04-17-2012
https://www.courtlistener.com/api/rest/v3/opinions/4537562/	Nebraska Supreme Court Online Library www.nebraska.gov/apps-courts-epub/ 05/29/2020 08:07 AM CDT - 747 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 Richard K. Bonness, appellant, v. Joel D. Armitage, M.D., appellee. ___ N.W.2d ___ Filed May 8, 2020. No. S-19-393. 1. Rules of the Supreme Court: Pleadings: Waiver: Appeal and Error. When a question concerning the waiver of an affirmative defense involves the interpretation of rules of pleading, it is a question of law reviewed de novo. 2. Limitations of Actions: Pleadings. A challenge that a pleading is barred by the statute of limitations is a challenge that the pleading fails to allege sufficient facts to constitute a claim upon which relief can be granted. 3. Motions to Dismiss: Appeal and Error. A district court’s grant of a motion to dismiss on the pleadings is reviewed de novo, accepting the allegations in the complaint as true and drawing all reasonable infer- ences in favor of the nonmoving party. 4. Appeal and Error. As a general rule, a Nebraska appellate court does not consider an argument or theory raised for the first time on appeal. 5. Waiver: Estoppel. Ordinarily, to establish a waiver of a legal right, there must be a clear, unequivocal, and decisive act of a party showing such a purpose, or acts amounting to an estoppel on his or her part. 6. Limitations of Actions: Words and Phrases. “Discovery,” in the con- text of statutes of limitations, refers to the fact that one knows of the existence of an injury and not that one has a legal right to seek redress. It is not necessary that a plaintiff have knowledge of the exact nature or source of the problem, but only that a problem existed. 7. Limitations of Actions: Malpractice: Words and Phrases. In a profes- sional negligence case, “discovery of the act or omission” occurs when the party knows of facts sufficient to put a person of ordinary intel- ligence and prudence on inquiry which, if pursued, would lead to the knowledge of facts constituting the basis of the cause of action. - 748 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 8. Malpractice: Damages: Words and Phrases. In a cause of action for professional negligence, legal injury is the wrongful act or omission which causes the loss. Legal injury is not damage; damage is the loss resulting from the misconduct. Appeal from the District Court for Douglas County: James T. Gleason, Judge. Affirmed. Patrick J. Cullan and Joseph P. Cullan, of Cullan & Cullan, L.L.C., for appellant. David A. Blagg, Brien M. Welch, and Kathryn J. Cheatle, of Cassem, Tierney, Adams, Gotch & Douglas, for appellee. Heavican, C.J., Cassel, Stacy, Funke, Papik, and Freudenberg, JJ. Papik, J. Richard K. Bonness appeals the district court’s dismissal of his medical malpractice action against Joel D. Armitage, M.D., on statute of limitations grounds. Bonness contends that Armitage waived the statute of limitations defense and that even if he did not, his complaint should not have been dismissed. We disagree and affirm the decision of the dis- trict court. BACKGROUND Commencement of Action and Initial Procedural History. This case began on June 20, 2017, when Bonness filed his initial complaint against Armitage. The initial complaint generally alleged that Armitage had failed to timely diagnose Bonness with prostate cancer. The attorney who filed the initial complaint on behalf of Bonness later moved to withdraw, and new counsel entered an appearance. The district court subsequently granted Bonness leave to file an amended complaint. Bonness did so in January 2018. The amended complaint contained additional factual - 749 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 allegations, but also generally alleged that Armitage had failed to timely diagnose Bonness with prostate cancer. Armitage filed an answer later that month in which he denied negligence and also asserted that the claims alleged were barred by the professional negligence statute of limitations. After the filing of the first amended complaint, the par- ties engaged in discovery for some time. In November 2018, Bonness filed a motion for leave to file a second amended complaint. In the motion, he asserted that the proposed second amended complaint would reflect new information learned dur- ing discovery. Armitage did not object to the motion for leave to file a second amended complaint. The district court granted the motion, and Bonness filed the second amended complaint. Because the second amended complaint is the operative com- plaint for purposes of this appeal, we summarize its allegations in greater detail below. Second Amended Complaint. In the second amended complaint, Bonness alleged that he had a family history of prostate cancer and that his father had died of prostate cancer at the age of 68. Following his father’s death in 1995 until 2010, Bonness underwent “Prostate‑Specific Antigen” (PSA) tests several times while he was seen by physi- cians other than Armitage. According to the second amended complaint, a PSA test measures the level of PSA in the blood- stream and can serve as an early indicator of prostate cancer, because the level of PSA in the blood is often elevated in men with prostate cancer. In 2007, one of those other physicians referred Bonness to a urologist because of an elevated PSA test and a hardened area on his prostate. The urologist determined that there was no cancer. In late 2010, Armitage became Bonness’ physician. The sec- ond amended complaint alleged that “based on . . . Bonness’ desire to do everything necessary to screen for prostate can- cer,” Bonness and Armitage “agreed to a health plan that entailed utilizing the most effective preventative cancer care for the early detection of prostate cancer.” Armitage allegedly - 750 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 told Bonness that he would implement the plan in accordance with protocols in place at a university medical center. Bonness alleged that during his initial visit with Armitage, Bonness informed Armitage that Bonness had a family his- tory of prostate cancer, that he had been taking the medica- tion commonly known as Avodart for many years, that he had undergone PSA testing earlier in the year, and that his PSA at that time was 3.0 ng/mL. Armitage noted in his records that he would perform PSA testing on Bonness on a yearly basis, but would not perform the testing that day, because Bonness had already been tested that year. Armitage also continued to pre- scribe Avodart for Bonness. Bonness alleged that at the time of his first appointment with Armitage, the federal Food and Drug Administration was warning physicians that if taken for more than 6 months, Avodart decreases an individual’s PSA level by about 50 per- cent. According to the second amended complaint, Avodart’s effect on PSA levels requires physicians to double the value of PSA levels for purposes of testing for the presence of prostate cancer. Accordingly, Bonness alleged that his PSA test of 3.0 ng/mL in 2010 should have been interpreted as 6.0 ng/mL. Bonness also alleged that a patient with an adjusted PSA value of 6.0 ng/mL should be referred to a urologist, presumably for further testing. Bonness alleged that he relied on Armitage’s representation that there was no need to perform additional PSA testing in 2010. Bonness further alleged that Armitage affirmatively rep- resented to him in 2011 that PSA testing was not immediately necessary and that he relied on that representation. Bonness also alleged that in 2013, Armitage affirmatively represented to him that PSA testing was “deemed unreliable” and that it was not necessary to perform the test and that Bonness relied on those representations as well. Bonness alleged that he spe- cifically inquired of Armitage whether PSA testing should be performed in 2010, 2011, and 2013. - 751 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 Armitage later claimed that Bonness refused to undergo PSA testing in 2010, 2011, and 2013, but Bonness denied refusing and also alleged that Armitage should have known that he desired testing. He asserted that Armitage should have known he wished to be tested based on Bonness’ family history of prostate cancer, the death of his father from prostate cancer, Bonness’ concerns regarding friends who had been diagnosed with prostate cancer, his “repeated, express concerns about the risk to himself of having prostate cancer,” and his “expressed willingness to do, or have done, whatever was necessary” to detect and treat prostate cancer. Bonness alleged that in 2014, Armitage reversed course and affirmatively represented to him that PSA testing was now warranted. Bonness then underwent PSA testing. His PSA level was over 5.0 ng/mL, a level the second amended com- plaint characterized as “elevated.” In 2015, Bonness under- went additional PSA testing and his PSA level was more than 6.0 ng/mL, a level the second amended complaint also characterized as “elevated.” Bonness alleged that as a result of his elevated PSA levels, he underwent a prostate biopsy on January 9, 2015, which revealed the presence of cancer. In March 2015, Bonness then underwent a radical prostatectomy. Bonness alleged that after this procedure, he was told he was cancer free. Bonness had additional PSA testing performed in April, May, and June 2016. Based on PSA testing performed in June 2016, Bonness was informed that his prostate cancer had recurred. Based on these facts, Bonness alleged that Armitage was liable for negligence and for failure to obtain his informed consent to the treatment provided. With respect to his claim of negligence, Bonness alleged that the most effective preventa- tive cancer care for prostate cancer would have included PSA testing in 2010, 2011, and 2013. He also alleged that because he was taking Avodart, his PSA test results in 2010 should have been doubled. He contended that given his PSA test results in 2010 and Bonness’ family history of prostate cancer, - 752 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 Armitage should have immediately referred him to a urologist. With respect to his claim of failure to obtain informed consent, he also alleged that Armitage should have provided him with information regarding the risks to Bonness of not having regu- lar PSA tests in light of his family history of prostate cancer and the effect of Avodart on PSA test results. Bonness alleged that it was only after the recurrence of his prostate cancer that he learned of facts that led to the discovery of his claims against Armitage. Dismissal by District Court. Armitage moved to dismiss the second amended complaint pursuant to Neb. Ct. R. Pldg. § 6‑1112(b)(6). The motion to dismiss asserted that the second amended complaint failed to allege facts indicating that it was timely filed. Following a hearing, the district court entered a written order granting the motion to dismiss. The district court found that Bonness’ claims were barred by the 2‑year professional negligence statute of limitations set forth in Neb. Rev. Stat. § 25‑222 (Reissue 2016). The district court concluded that Armitage’s allegedly deficient treatment would have been known to Bonness by January 2015, when his prostate cancer requiring surgical intervention was first discovered. The dis- trict court wrote that by that date, Bonness would have known that Armitage had been unable to prevent Bonness from get- ting prostate cancer. Based on its determination that Bonness discovered his claims in January 2015, the district court found that he did not timely file his action. Bonness timely appealed. ASSIGNMENTS OF ERROR Bonness assigns two errors on appeal, both concerning the district court’s dismissal of his suit on statute of limitations grounds. According to Bonness, the district court erred by dismissing the suit, (1) because Armitage waived the statute of limitations defense and (2) because Bonness did not discover his claims until his cancer recurred in June 2016. - 753 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 STANDARD OF REVIEW [1] When a question concerning the waiver of an affirmative defense involves the interpretation of rules of pleading, it is a question of law reviewed de novo. See SFI Ltd. Partnership 8 v. Carroll, 288 Neb. 698, 851 N.W.2d 82 (2014). [2,3] A challenge that a pleading is barred by the statute of limitations is a challenge that the pleading fails to allege sufficient facts to constitute a claim upon which relief can be granted. Carruth v. State, 271 Neb. 433, 712 N.W.2d 575 (2006). A district court’s grant of a motion to dismiss on the pleadings is reviewed de novo, accepting the allegations in the complaint as true and drawing all reasonable inferences in favor of the nonmoving party. Rutledge v. City of Kimball, 304 Neb. 593, 935 N.W.2d 746 (2019). ANALYSIS Did Armitage Waive Statute of Limitations Defense? [4] We begin our analysis by considering Bonness’ argu- ment that Armitage waived the statute of limitations defense. Initially, we note that nothing in our record indicates that Bonness raised this argument in the trial court, and it is thus not clear that it is properly preserved for appellate review. See, e.g., State v. Kruse, 303 Neb. 799, 808, 931 N.W.2d 148, 155 (2019) (“[a]s a general rule, an appellate court will not consider an argument or theory that is raised for the first time on appeal”). But even assuming the argument is prop- erly before us, we find that it lacks merit for reasons we will explain. A party can waive a statute of limitations defense. See, e.g., McGill v. Lion Place Condo. Assn., 291 Neb. 70, 864 N.W.2d 642 (2015). For example, a party waives a statute of limita- tions defense if it fails to plead it. See id. In this case, however, Bonness concedes that Armitage did not fail to plead a statute of limitations defense. Armitage asserted in his answer to the first amended complaint that Bonness’ claims were barred by the statute of limitations. And although Armitage did not file an - 754 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 answer to the second amended complaint, he filed a motion to dismiss on statute of limitations grounds. Unable to liken this case to those in which a party fails to plead a statute of limitations defense and thereby waives it, Bonness argues that Armitage waived the statute of limita- tions defense by not immediately moving to dismiss the first amended complaint. According to Bonness, as soon as the first amended complaint was filed, Armitage had all of the information necessary to file a motion to dismiss on statute of limitations grounds but instead engaged in discovery for sev- eral months. This, Bonness contends, led him to believe that Armitage was defending the case solely on its merits and thus amounts to a waiver of the defense. [5] Bonness acknowledges that he is unable to direct us to any cases in which we or another court has held that a party waived a statute of limitations defense by not immediately filing a motion to dismiss on statute of limitations grounds. Instead, Bonness relies on cases in which we have discussed waiver in a general sense and said that “[o]rdinarily, to estab- lish a waiver of a legal right, there must be a clear, unequivo- cal, and decisive act of a party showing such a purpose, or acts amounting to an estoppel on his or her part.” See, e.g., Eagle Partners v. Rook, 301 Neb. 947, 959, 921 N.W.2d 98, 108 (2018). Bonness asserts that Armitage’s engaging in discov- ery after the first amended complaint was filed qualifies as a waiver under that standard. We find Bonness’ contention that Armitage waived the stat- ute of limitations defense unsound. As we noted in recounting the standards of review applicable to this appeal, a challenge to a pleading on statute of limitations grounds is a challenge that the complaint fails to state a claim upon which relief can be granted. Carruth v. State, 271 Neb. 433, 712 N.W.2d 575 (2006). This is relevant because our rules of pleading in Nebraska state that “[a] defense of failure to state a claim upon which relief can be granted . . . may be made in any pleading permitted or ordered under § 6‑1107(a), or by motion - 755 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 for judgment on the pleadings, or at the trial on the merits.” § 6‑1112(h)(2). Our rules of pleading thus make clear that a party does not waive the right to contend that a complaint fails to state a claim upon which relief can be granted by not filing a motion under § 6‑1112(b)(6). Rather, the defense is preserved through trial. Accordingly, Armitage’s decision not to file a motion to dismiss the first amended complaint could not have amounted to an act showing an intention to waive the statute of limitations defense. Neither could it amount to an estoppel. Bonness’ estop- pel theory is that he was led to believe that Armitage would not seek to dismiss on statute of limitations grounds when he did not immediately move to dismiss. For reasons we have explained, however, Bonness could not reasonably conclude from Armitage’s choice to engage in discovery that Armitage would not later seek to contend that the pleading failed to show it was filed in accordance with the statute of limitations. We see no basis to find that Armitage waived the statute of limita- tions defense. Was Dismissal on Statute of Limitations Grounds Proper? Having found that Armitage did not waive the statute of lim- itations defense, we turn to Bonness’ contention that the district court erred by dismissing the case on statute of limitations grounds. As we have discussed, a defendant may, as Armitage did here, raise the statute of limitations as part of a motion to dismiss for failure to state a claim upon which relief can be granted. If such a motion is made but the complaint does not disclose on its face that it is barred by the statute of limitations, dismissal is improper. See Lindner v. Kindig, 285 Neb. 386, 826 N.W.2d 868 (2013). However, if the face of the complaint does show that the cause of action is time barred and the plain- tiff does not allege facts to avoid the bar of the statute of limi- tations, dismissal is proper. See Chafin v. Wisconsin Province Society of Jesus, 301 Neb. 94, 917 N.W.2d 821 (2018). The - 756 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 task before us is thus to review the second amended com- plaint and determine whether, accepting the factual allegations therein as true, it shows that the cause of action is barred by the applicable statute of limitations. For the reasons discussed below, we conclude that it does. There appears to be some disagreement between the parties as to whether the applicable statute of limitations is the profes- sional negligence statute of limitations set forth in § 25‑222 or the statute of limitations in the Nebraska Hospital‑Medical Liability Act set forth in Neb. Rev. Stat. § 44‑2828 (Reissue 2010). The parties agree, however, that those statutes of limita- tions are identical as they relate to this case. Accordingly, we will consider the case under § 25‑222, which provides: Any action to recover damages based on alleged pro- fessional negligence or upon alleged breach of warranty in rendering or failure to render professional services shall be commenced within two years next after the alleged act or omission in rendering or failure to render professional services providing the basis for such action; Provided, if the cause of action is not discovered and could not be reasonably discovered within such two‑year period, then the action may be commenced within one year from the date of such discovery or from the date of discovery of facts which would reasonably lead to such discovery, whichever is earlier; and provided further, that in no event may any action be commenced to recover damages for professional negligence or breach of warranty in ren- dering or failure to render professional services more than ten years after the date of rendering or failure to render such professional service which provides the basis for the cause of action. Under the statute, an action must be commenced within 2 years of the date the limitations period began to run unless the action was not or could not reasonably be discovered within that 2‑year period, in which case, it must be commenced within 1 year after it is discovered or should be discovered. - 757 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 See Guinn v. Murray, 286 Neb. 584, 837 N.W.2d 805 (2013). As we will explain, the parties disagree in this case, both as to when the statute of limitations began to run and when Bonness discovered or reasonably could have discovered his claims against Armitage. Bonness argues that Armitage committed several isolated acts of negligence and that a separate statute of limitations period began to run upon each such act. Specifically, Bonness contends that Armitage was negligent in 2010, 2011, and 2013, when he saw Bonness, but did not perform PSA testing, did not properly interpret Bonness’ earlier PSA test results, and did not refer him to a urologist. Bonness acknowledges that under his theory, the 2‑year statute of limitations would have expired as to his claims unless § 25‑222’s discovery exception applies. But Bonness argues the discovery exception does apply. He contends that he did not discover and could not reasonably have discovered his claims until he learned his prostate cancer had recurred on June 24, 2016. He thus argues that he timely filed this action by filing it within 1 year of that date. Armitage disagrees with Bonness, as to both when the stat- ute of limitations began to run and when he could have rea- sonably discovered his claims. Armitage argues that under the continuing treatment doctrine, see, e.g., Carruth v. State, 271 Neb. 433, 712 N.W.2d 575 (2006), the statute of limitations did not begin to run on Bonness’ claims until January 2015, when the professional relationship between Bonness and Armitage concluded. Based on his contention that the statute of limita- tions began to run in January 2015, Armitage asserts that even if Bonness is correct that he could not reasonably have dis- covered his claims until June 2016, his claims are nonetheless barred, because the 1‑year discovery extension does not apply if a plaintiff discovered or reasonably could have discovered his or her claims prior to the expiration of the 2‑year statute of limitations. See, e.g., Egan v. Stoler, 265 Neb. 1, 653 N.W.2d 855 (2002). Alternatively, Armitage argues that the district - 758 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 court was correct to conclude that based on the facts alleged in the operative complaint, Bonness discovered or reasonably could have discovered his claims in January 2015, and that thus, his claims are barred even if the statute of limitations began to run as early as Bonness contends. [6‑8] We will begin our analysis by considering whether the district court was correct to conclude that under the facts alleged in the operative complaint, Bonness discovered or reasonably could have discovered his claims in January 2015, when he first learned of the presence of prostate cancer. Several principles govern when a party discovers a claim for statute of limitations purposes. “Discovery,” in the context of statutes of limitations, refers to the fact that one knows of the existence of an injury and not that one has a legal right to seek redress. Guinn v. Murray, supra. It is not neces- sary that a plaintiff have knowledge of the exact nature or source of the problem, but only that a problem existed. Id. In a professional negligence case, “discovery of the act or omission” occurs when the party knows of facts sufficient to put a person of ordinary intelligence and prudence on inquiry which, if pursued, would lead to the knowledge of facts constituting the basis of the cause of action. Id. In a cause of action for professional negligence, legal injury is the wrongful act or omission which causes the loss. Id. Legal injury is not damage; damage is the loss resulting from the misconduct. Id. Given these governing principles, we must consider what Bonness knew in January 2015 and whether a reasonable per- son in his position with that knowledge would have pursued an inquiry that would have led to knowledge of facts constituting the basis of his claims. The first and most obvious fact that Bonness knew at that time was that he had been diagnosed with prostate cancer. The district court seemed to conclude that Bonness had discovery of his claims based on his diag- nosis alone. It reasoned that as soon as Bonness knew that he had prostate cancer, he would have known that “the treatment - 759 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 provided by [Armitage] had not been effective in precluding [Bonness’] development of prostate cancer.” Although this statement of the district court is unquestion- ably true, we find it does not shed much light on the question at hand. Bonness does not allege that Armitage was negli- gent because he failed to prevent prostate cancer; he alleges that Armitage was negligent because he should have detected prostate cancer earlier. It is not so clear to us that based on a diagnosis of a condition alone, a patient is on inquiry notice of a claim that his or her physician should have diagnosed the condition earlier. We need not, however, decide whether Bonness discovered his claims against Armitage based on a diagnosis alone. As we will discuss below, the second amended complaint disclosed that at the time of his diagnosis, Bonness was aware of other information relevant to the discovery of his claims. At the time he was diagnosed with cancer in January 2015, Bonness not only knew that he had been diagnosed, he also knew what Armitage had done and not done with respect to testing for prostate cancer before that diagnosis. As noted above, Bonness alleged that before Armitage became his doc- tor in 2010, he had undergone PSA testing for several years at the direction of other physicians and, on one occasion, was referred to a urologist for an elevated PSA result. Bonness alleged Armitage did not direct PSA testing for several years and represented to him in those years that PSA testing was not immediately necessary and that it was “deemed unreli- able.” Bonness also alleged, however, that elevated results on PSA testing ordered by Armitage in 2014 and 2015 led to the referral of Bonness to a urologist in early 2015 and his prostate cancer diagnosis. By the time of his diagnosis, then, Bonness would have known his diagnosis occurred as a result of elevated levels on a test that he had previously received regularly at the direction of other physicians, but that Armitage had declined to perform for several years and had claimed was unreliable. - 760 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 We also note that the second amended complaint con- tains several other allegations regarding Bonness that suggest a person in his position would have questioned Armitage’s detection efforts as soon as a diagnosis was made. As noted above, Bonness alleged that because members of his family and friends had been diagnosed with prostate cancer, Bonness repeatedly expressed concerns to Armitage about prostate can- cer and made it clear that he wanted to do whatever was neces- sary to detect it. In addition, in the years in which Armitage did not order PSA testing, Bonness inquired about whether testing should be performed. In our view, once Bonness was diagnosed with cancer, a reasonable person in his position would have known of facts sufficient to put a person of ordinary intelli- gence and prudence on inquiry which, if pursued, would lead to the knowledge of facts constituting the basis of the cause of action. We are not persuaded by Bonness’ argument that the fact that he was told he was cancer free following surgery in March 2015 is relevant to the discovery analysis. The fact that Bonness was told the cancer had been removed following surgery may have affected the extent of damages available for Armitage’s alleged negligence in failing to detect prostate cancer. The focus, how- ever, in deciding when a plaintiff discovered a cause of action for statute of limitations purposes is when the plaintiff knows of the existence of an injury. See Guinn v. Murray, 286 Neb. 584, 837 N.W.2d 805 (2013). Injury, for these purposes, is the wrongful act or omission which causes the loss, not damage. See id. One need not know the extent of his or her damages to have discovery. See Gering ‑ Ft. Laramie Irr. Dist. v. Baker, 259 Neb. 840, 612 N.W.2d 897 (2000). Because we find that the face of the second amended complaint shows that Bonness discovered his claims against Armitage upon learning of his prostate cancer diagnosis in January 2015, it is not necessary for us to pinpoint exactly when the statute of limitations period began to run. Whether the statute of limitations began running in January 2015, as - 761 - Nebraska Supreme Court Advance Sheets 305 Nebraska Reports BONNESS v. ARMITAGE Cite as 305 Neb. 747 Armitage contends, or earlier, as Bonness claims, the action was not commenced within 2 years of accrual or within 1 year of discovery. CONCLUSION Because the face of the complaint shows that the action is barred by the statute of limitations, the district court did not err in granting Armitage’s motion to dismiss. Affirmed. Miller‑Lerman, J., not participating.	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4475017/	OPINION Wherry, Judge: The sole issue before this Court is whether we have subject matter jurisdiction. Petitioner argues we do not; respondent argues we do. We agree with respondent. Background The following recitation of facts is drawn primarily from Mary Helen Norberg’s (Ms. Norberg) motion to dismiss for lack of subject matter jurisdiction (motion to dismiss) and responses filed by both parties. We note that our recitation of “facts” is solely for the purpose of ruling on the motion to dismiss and is not a finding of facts. Jane H. Gudie (decedent), a resident of California, died on June 14, 2006. Decedent had no children but was survived by two nieces, Ms. Norberg and Patricia Ann Lane (Ms. Lane). Decedent’s will did not nominate either niece as her executrix. Part of decedent’s estate consisted of property held in the “Jane Henger Gudie Living Trust” (decedent’s trust), created July 17, 1991. The trust document originally named Ms. Nor-berg and Ms. Lane (the nieces) as the remainder beneficiaries. Decedent retained for her life the right to revoke or amend the trust in whole or in part. On April 1, 1995, the terms of decedent’s trust were amended to name the nieces as the primary beneficiaries. On January 19, 1999, the terms of decedent’s trust were amended to appoint Ms. Norberg cotrustee and the nieces as successor cotrustees upon decedent’s death. On February 9, 1999, decedent and the nieces entered into a transaction where, in form, the nieces each agreed to pay decedent an annuity of $937,483 per year, with the first payment due in 4 years. In return, decedent, as trustee, issued a note to each niece, due in 4 years or upon decedent’s death, in the face amount of $3 million with 6 percent interest, secured by the assets of decedent’s trust. Neither note was recorded, and no payments were made. On February 9, 2003, the unpaid annuity amounts were rolled over into new annuities and the annuity commencement date and the due date of the notes deferred for another 4 years. Again, no payments were made. On or about March 14, 2007, a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, was filed for decedent’s estate (estate tax return). At the time the estate tax return was filed, no one was formally appointed, qualified, or acting as executor or administrator of decedent’s estate. Ms. Norberg signed the estate tax return as executor but refuses to be formally appointed executrix of decedent’s estate under California law. The estate tax return reported a total gross estate less exclusion of zero and estate taxes owed of zero. Schedule G, Transfers During Decedent’s Life, attached to the estate tax return listed assets including real estate totaling $1,890,000, furniture and furnishings totaling $100,000, and securities and bank accounts totaling $5,080,515. The real estate, securities, and bank accounts were titled in the name of decedent’s trust. The assets of decedent’s trust were listed subject to the outstanding debt owed to the nieces ($6 million principal plus $2,643,300 accrued interest). As a result, the estate tax return reported total assets transferred during decedent’s life of negative $1,572,785. As the sole beneficiaries of decedent’s trust, the nieces received equal shares of the trust property. According to correspondence between the nieces, Ms. Norberg’s husband, and Robert P. Hess (Mr. Hess), decedent’s estate planner, the nieces each received $3,404,343.63 upon decedent’s death. Respondent audited the estate tax return, determining (1) decedent had made $2,983,437 of adjusted taxable gifts in 1992 that were not reflected on the estate tax return; (2) claimed gifts of $279,000 decedent made in 2005 and 2006 were invalid for estate and gift tax purposes; and (3) the deduction of $8,643,300 claimed on Schedule G is not deductible because it was not a bona fide loan and was not for full and adequate consideration. On January 11, 2010, respondent issued a notice of deficiency to “Estate of Jane H. Gudie, c/o Mary Helen Norberg, Executor”, showing a deficiency in estate tax of $3,833,157.92 and a section 6662(a) accuracy-related penalty of $766,631.58.1 On February 17, 2010, a petition was filed with this Court by Mr. Hess, who is an attorney admitted to practice before this Court, on behalf of “Jane H. Gudie, Deceased; Mary Helen Norberg, Executor”. At the time the petition was filed, Ms. Norberg resided in California. In the petition, Ms. Norberg alleged that respondent erred in determining that the decedent did not receive full and adequate consideration in money or money’s worth for promissory notes that represented bona fide claims against decedent’s living trust dated September 16, 1981. There was no evidence that gifts made in 2005 and 2006 were not valid for Estate and Gift Tax purposes. Respondent filed his answer on April 8, 2010. On January 3, 2011, respondent’s motion for leave to file amendment to answer, filed December 23, 2010, was granted. In the motion respondent alleged that the gifts made in 1992 were made to “skip persons” under section 2613 and accordingly were subject to the generation-skipping transfer tax under section 2601. The motion asserted an increased deficiency in estate tax of $4,972,876.30 and an increased section 6662(a) accuracy-related penalty of $994,575.26. On June 9, 2011, Ms. Norberg filed a motion to dismiss. On June 17, 2011, respondent was ordered to file any response to the motion to dismiss on or before July 25, 2011. Respondent’s objection to the motion to dismiss was filed on July 22, 2011, with six exhibits, denominated A through F, attached. On August 26, 2011, Ms. Norberg filed two documents: (1) A reply memorandum in support of objections to respondent’s objections to motion to dismiss and (2) Mary Helen Norberg’s evidentiary objections to respondent’s objections to motion to dismiss. Discussion I. Evidentiary Objections Ms. Norberg asserts that “In ruling on a motion for summary adjudication, a trial court can only consider admissible evidence” and that because respondent’s “factual allegations and exhibits in support of * * * [respondent’s objection]” are inadmissible, they “must be stricken”, citing rule 56(e) of the Federal Rules of Civil Procedure, Orr v. Bank of Am., 285 F.3d 764, 773 (9th Cir. 2002), and Beyene v. Coleman Sec. Servs., Inc., 854 F.2d 1179, 1181 (9th Cir. 1988), as her authorities. In Orr v. Bank of Am., supra at 773, the Court of Appeals for the Ninth Circuit, the court to which this case is appeal-able absent stipulation to the contrary, stated: “A trial court can only consider admissible evidence in ruling on a motion for summary judgment.” Beyene v. Coleman Sec. Servs., Inc., supra at 1181, and rule 56(e) of the Federal Rules of Civil Procedure stand for the same proposition. But we are not ruling on a motion for summary judgment. We are ruling on a motion to dismiss for lack of subject matter jurisdiction.2 The U.S. Supreme Court has held where, as here, “there is no statutory direction for procedure upon an issue of jurisdiction, the mode of its determination is left to the trial court.” Gibbs v. Buck, 307 U.S. 66, 71-72 (1939). When an issue of jurisdiction is raised, either by a party or on our own initiative, we “may inquire by affidavits or otherwise, into the facts as they exist.” Land v. Dollar, 330 U.S. 731, 735 n.4 (1947), overruled by implication on other grounds by Larson v. Domestic & Foreign Commerce Corp., 337 U.S. 682 (1949); see also Stevens v. Redwing, 146 F.3d 538 (8th Cir. 1998). None of respondent’s exhibits will be stricken, and the Court will examine all the facts before us in determining whether we have jurisdiction over this case. II. Subject Matter Jurisdiction A. Introduction The Tax Court is a court of limited jurisdiction and may exercise jurisdiction only to the extent authorized by Congress. Adkison v. Commissioner, 592 F.3d 1050, 1052 (9th Cir. 2010), affg. on other grounds 129 T.C. 97 (2007). Our jurisdiction to redetermine a deficiency depends upon the issuance of a valid notice of deficiency and a timely filed petition. Rule 13(a), (c); Monge v. Commissioner, 93 T.C. 22, 27 (1989). Section 6212(a) expressly authorizes the Commissioner, after determining a deficiency, to send a notice of deficiency to the taxpayer. In the instance of an estate tax deficiency, once the Commissioner is notified of the existence of a fiduciary relationship, the fiduciary steps into the shoes of the taxpayer for tax purposes, and the notice of deficiency is to be sent to the fiduciary. Sec. 6212(b)(3); Rule 60(a); Estate of McElroy v. Commissioner, 82 T.C. 509, 512 (1984); Estate of Kisling v. Commissioner, T.C. Memo. 1993—119; sec. 301.6212-1(b)(3), Proced. & Admin. Regs. The taxpayer (or fiduciary) in turn has 90 days from the date the notice of deficiency is mailed (150 days if the notice is mailed to a taxpayer outside of the United States) to file a petition in this Court for a redetermination of the deficiency. Sec. 6213(a); Rule 60(a); Estate of Moffat v. Commissioner, 46 T.C. 499, 501 (1966). B. Ms. Norberg’s Argument Ms. Norberg, relying on Hulburd v. Commissioner, 296 U.S. 300 (1935), argues that “the notice was issued and mailed to the wrong taxpayer”.3 Although unclear, we surmise Ms. Norberg’s argument is that she was not a fiduciary within the meaning of section 6212(b)(3). She states that she was never appointed executrix of decedent’s estate by a California probate court and no action of any kind seeking her appointment as executrix will be taken. According to Ms. Norberg, the notice of deficiency should have been addressed to “Jane Henger Gudie Living Trust dated July 17, 1991, Mary Helen Norberg and Patricia Ann Lane successor co-trustees, or to Norberg as a transferee”. C. Respondent’s Argument Respondent argues that Ms. Norberg was in actual or constructive receipt of property of decedent and thus “as statutory executor within the meaning of section 2203, was the proper person to whom to issue the notice of deficiency pursuant to section 6212(b)(3) and the proper party to bring the instant case pursuant to Tax Court Rule 60(a)”. D. Analysis Our conclusion, explained below, is that Ms. Norberg, because she was in actual or constructive possession of property of decedent, was a statutory executor. As such, she had the responsibility and authority to file the estate tax return. By filing the estate tax return, she notified respondent of a fiduciary relationship and was the proper person to receive the notice of deficiency. Section 2203 defines “executor” for purposes of the Federal estate tax as “the executor or administrator of the decedent, or, if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent.” In her objection, Ms. Norberg states she “was never in possession of any assets of the probate estate of Jane H. Gudie, or of other estates, with respect to any and all times relevant to our motion to dismiss.” Ms. Norberg attached to her objection the signed declaration of Mr. Hess, who also states that “Norberg was not ever in possession of any assets of the probate estate of Jane H. Gudie”. Ms. Nor-berg and Mr. Hess carefully confine their statements to the “probate estate”. The fact that the property Ms. Norberg received did not pass through probate is immaterial to this discussion. This Court has previously held in situations like this that “the fact that * * * property interests passed * * * directly rather than as part of decedent’s probate estate is immaterial.” Estate of Guida v. Commissioner, 69 T.C. 811, 813 (1978); see also Estate of Wilson v. Commissioner, 2 T.C. 1059, 1083-1084 (1943) (stating that if taxpayers could distinguish between probate and nonprobate property to defeat the estate tax, “the law would soon be a nullity”). On the facts before us, Ms. Norberg was in actual or constructive possession of decedent’s property at the time the estate tax return was filed.4 At the time the estate tax return was filed, there was no one appointed, qualified, or acting as executor or administrator of decedent’s estate. Therefore Ms. Norberg qualified as a statutory executor of decedent’s estate for purposes of the Federal estate tax.5 See sec. 2203; Huddleston v. Commissioner, 100 T.C. 17, 30-31 (1993); Estate of Guida v. Commissioner, supra at 813; New York Trust Co. v. Commissioner, 26 T.C. 257, 261-262 (1956); Allen v. Commissioner, T.C. Memo. 1999-385. Section 6018(a)(1) directs the executor in cases where the decedent’s gross estate exceeds the applicable exclusion amount to file an estate tax return. See also sec. 20.6018-2, Estate Tax Regs. Therefore, as statutory executor, Ms. Nor-berg had the responsibility and authority to file the estate tax return. Section 6036 provides in part: “every executor (as defined in section 2203), shall give notice of his qualification as such to the Secretary in such manner and at such time as may be required by regulations of the Secretary.” Section 6903(a) provides: SEC. 6903(a). Rights and Obligations of Fiduciary. — Upon notice to the Secretary that any person is acting for another person in a fiduciary capacity, such fiduciary shall assume the powers, rights, duties, and privileges of such other person in respect of a tax imposed by this title (except as otherwise specifically provided and except that the tax shall be collected from the estate of such other person), until notice is given that the fiduciary capacity has terminated. Ms. Norberg’s filing of the estate tax return gave respondent notice for purposes of sections 6036 and 6903 that she was to be treated as the executor and fiduciary of decedent’s estate. Section 20.6036-2, Estate Tax Regs., provides in relevant part: “The requirement of section 6036 for notification of qualification as executor of an estate shall be satisfied by the filing of the estate tax return required by section 6018”. Section 301.6036-l(c), Proced. & Admin. Regs., provides: “When a notice is required under § 301.6903-1 of a person acting in fiduciary capacity and is also required of such person under this section, notice given in accordance with the provisions of this section shall be considered as complying with both sections.” Hence, filing the estate tax return as executor was adequate notice for purposes of both sections 6036 and 6903.6 Ms. Norberg never gave respondent a notice of termination. Therefore she was never relieved of her powers, rights, duties, and privileges as a fiduciary of decedent’s estate for Federal estate tax purposes. She was the proper individual to receive the notice of deficiency under section 6212 and had the capacity to contest the notice of deficiency upon which this case is based. See Rule 60(a)(1); Huddleston v. Commissioner, supra at 30-31; Estate of Sivyer v. Commissioner, 64 T.C. 581 (1975); Allen v. Commissioner, supra; see also Estate of Kisling v. Commissioner, T.C. Memo. 1993-119 (stating that the fiduciary of the estate was required to look after its interests). Respondent properly mailed a notice of deficiency to “Estate of Jane H. Gudie, c/o Mary Helen Nor-berg, Executor”, and Ms. Norberg’s timely petition gave this Court jurisdiction. See also Estate of Callahan v. Commissioner, T.C. Memo. 1981-357 (stating: “The function of a statutory notice of deficiency is to afford * * * [the taxpayer] a full and fair opportunity to present its case in this Court.”). In conclusion, the notice of deficiency was appropriately addressed to Ms. Norberg and she had the authority to file the petition in this case. Her timely petition in response to the valid notice of deficiency gives this Court jurisdiction. III. Statute of Limitations Although the argument is unclear, in her motion to dismiss Ms. Norberg appears to argue that the period of limitations on assessment has expired. In her objection to respondent’s objection, Ms. Norberg states she “did not and is not asserting in this motion any issue regarding statute of limitations” and asks us not to rule on this issue. We need not analyze this issue here but do note two things. First, pursuant to sections 6503(a)(1) and 6213(a), the period of limitations on assessment, if open when a notice of deficiency was sent, would generally be suspended if a timely petition was filed until such time as the Secretary is no longer prohibited from assessing the tax. Second, the statute of limitations is an affirmative defense, not a jurisdictional matter. See Rule 39; Freytag v. Commissioner, 110 T.C. 35, 41 (1998). To reflect the foregoing, An appropriate order will be issued denying petitioner’s motion to dismiss for lack of subject matter jurisdiction. All section references are to the Internal Revenue Code of 1986, as amended and in effect for the date of decedent’s death. All Rule references are to the Tax Court Rules of Practice and Procedure. Ms. Norberg, in her objection, states: This Court should treat this motion as a motion for summary judgment seeking an order ruling that this Court lacks subject matter jurisdiction, pursuant to Tax Court Rules 40 and 121. This is due to the fact that the motion to dismiss is supported by a declaration under penalty of perjury under 28 U.S.C. 1746, which authorizes declarations in lieu of affidavits. We view Ms. Norberg’s position as an attempt to circumvent established precedent and bring evidentiary rules not applicable in jurisdictional questions into play. In deciding whether we have jurisdiction, we are not bound by evidentiary rules applicable in deciding motions for summary judgment. Hulburd v. Commissioner, 296 U.S. 300 (1935), did not involve the validity of a deficiency notice, but rather the personal liability of the executor and legatee of a shareholder in a dissolved corporation. Thus, contrary to Ms. Norberg’s assertion, Hulburd has little, if any, relevance to the case at hand. Decedent was considered the owner of the trust property pursuant to sec. 676(a), which provides: “The grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under any other provision of this part, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both.” We are not appointing Ms. Norberg executor for purposes of State law or providing her the authority that comes with being appointed executor under State law. Nor are we concluding that Ms. Norberg is potentially liable for the entire deficiency. This Court has previously stated: “It is clear that a determination of deficiency against an estate, even though the executor or personal representative is named as the person to receive the notice, is not a determination of deficiency against the executor or personal representative in his or her personal capacity.” Estate of Walker v. Commissioner, 90 T.C. 253, 257 (1988). Ms. Norberg argues that “the filing of an estate tax return does not constitute notice for liability purposes” or apparently in Ms. Norberg’s views, to the Commissioner of a fiduciary relationship entitling the filer of the estate tax return to act for the estate pursuant to sec. 6903(a). She argues Form 56, Notice Concerning Fiduciary Relationship, is necessary for adequate notice. We disagree. The instructions on Form 56 state: “You must notify the IRS of the creation or termination of a fiduciary relationship under section 6903 and give notice of qualification under section 6036. You may use Form 56 to provide this notice to the IRS”. While filing a Form 56 provides adequate notice, as explained above, it is not the exclusive method by which a person can inform the IRS that he or she is acting in a fiduciary capacity. Sec. 301.6036-l(c), Proced. & Admin. Regs.; sec. 20.6036-2, Estate Tax Regs.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621575/	METRO LEASING AND DEVELOPMENT CORPORATION, EAST BAY CHEVROLET COMPANY, A CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMetro Leasing & Dev. Corp. v. Comm'rNo. 8054-99United States Tax Court119 T.C. 8; 2002 U.S. Tax Ct. LEXIS 39; 119 T.C. No. 2; July 17, 2002., Filed Metro Leasing & Dev. Corp. v. Comm'r, T.C. Memo 2001-119">T.C. Memo 2001-119, 2001 Tax Ct. Memo LEXIS 146">2001 Tax Ct. Memo LEXIS 146 (T.C., 2001)39 Petitioner not entitled to deduct tax on post-1995 installment sale income from taxable income in arriving at accumulated taxable income for 1995. No part of petitioner's paid, but contested, income tax deficiency should be reduced from its taxable income in arriving at accumulated taxable income. Respondent correctly computed adjustment for net capital gains. In an earlier opinion, we decided that P permitted its 1995 earnings to accumulate beyond the reasonable needs of its business. Secs. 531- 537, I.R.C. There remains, however, a dispute concerning the computation of the accumulated earnings tax. P contends, alternatively, that R failed to reduce P's accumulated earnings tax base by the following amounts: (1) "Deferred" tax attributable to installment sale proceeds to be received by P in tax years after 1995; (2) the amount of the income tax deficiency determined by respondent which remains contested by P and for which P has made payment after filing its petition; and (3) the difference between the amount of tax liability reported on P's return and the amount of tax that would have been due on P's net capital gain. All three reductions proposed by P require our interpretation of sec. 535(b), I.R.C. Proposed reductions (1) and (2) involve the interpretation of sec. 535(b)(1), I.R.C.40 , and sec. 1.535-2(a)(1), Income Tax Regs. Reduction (3) involves sec. 535(b)(6), I.R.C. Reductions (1) and (3) present questions of first impression. With respect to reduction (2), this Court's decision on the issue was reversed by the Court of Appeals for the Fifth Circuit in J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275">853 F.2d 1275 (5th Cir. 1987), revg. on this point T.C. Memo 1987-296">T.C. Memo 1987-296. If we follow the holding of the Court of Appeals, P would be entitled to a reduction for the paid, but still contested, income tax deficiency. R urges this Court not to follow the holding of the Court of Appeals. Held: This Court will not follow the holding of Court of Appeals on this point in Rutter Rex. Held, further, sec. 535(b), I.R.C., and underlying regulations are interpreted, and R's computation of P's accumulated earnings tax liability is correct. William L. Raby, for petitioner.Kathryn K. Vetter, for respondent. Gerber, Joel, opinion;Halpern, James S.41 , concurrence GERBER; WELLS; HALPERN; SWIFT9 SUPPLEMENTAL OPINION 1GERBER, Judge: In an earlier opinion, we decided that petitioner permitted its 1995 earnings to accumulate beyond the reasonable needs of its business. See secs. 531-537; 2Metro Leasing & Dev. Corp. v. Commissioner, T.C. Memo 2001-119">T.C. Memo 2001-119. We also decided the amount of reasonable compensation for petitioner's officers. To reflect our holding and to adjust for agreed items, the parties were required to compute the amount of resulting income tax and accumulated earnings tax liabilities pursuant to Rule 155 computation procedures.42 The parties, in docket No. 8054-99, disagree about the computation of the accumulated earnings tax liability. That tax liability is computed by applying the accumulated earnings tax rate to a corporation's accumulated taxable income. Accumulated taxable income is computed by making certain adjustments to taxable income. Respondent computed a proposed accumulated earnings tax liability of $ 56,248, and petitioner disagreed, contending that three additional adjustments should be made to respondent's computation. If any of petitioner's proposed adjustments are sustained, the resulting accumulated earnings tax liability would be within a range of amounts from zero to $ 51,074.Petitioner argues that, in computing accumulated taxable income, respondent failed to reduce taxable income by the following items: (1) Income tax attributable to unrealized and unrecognized installment sale proceeds (if correct, this adjustment would result in no accumulated earnings tax liability); (2) the amount of the income tax deficiency either determined by respondent or decided by this Court (resulting in no liability or $ 13,666 in accumulated earnings tax, 10 respectively); and (3) an increased reduction43 under section 535(b)(6), if any accumulated earnings tax liability results after our consideration of proposed adjustments (1) and (2).I. Tax Liability on Installment Sale Income To Be Received in Years After 1995Section 531 imposes a tax on a corporate taxpayer's accumulated taxable income. Accumulated taxable income is computed by making certain adjustments to a corporate taxpayer's taxable income. Sec. 535(a). In particular, section 535(b)(1) permits a deduction for Federal income tax "accrued during the taxable year". In approaching this deduction, petitioner argues that its tax liability on unrealized and unrecognized installment sale income had accrued. This issue is one of first impression in the context of computing accumulated taxable income.During its 1995 tax year, petitioner sold improved real property. The gross profit from the sale was $ 1,569,211. Petitioner reported the sale under the installment method. 3Under that method, a taxpayer reports the taxable portion of each installment in the year received. Petitioner received $ 28,376 in installments for 1995, of which only $ 20,303 was included in income by petitioner on its 1995 Federal income tax return. Petitioner44 "deferred" the inclusion in income of the remainder of the $ 1,569,211 installment sale gross profit until future installments were paid/received. 4In arguing that the tax on future installment income had "accrued", petitioner relies on section 1.535-2(a)(1), Income Tax Regs.That regulation contains the following45 elaboration on the deduction as being "for taxes accrued during the taxable year, regardless of whether the corporation uses an accrual method of accounting, the cash receipts and disbursements method, or any other allowable method of accounting."According to petitioner, the quoted phrase changes all taxpayers' methods of reporting income for purposes of section 535(b)(1)11 to the accrual method. Petitioner contends that the phrase "regardless of whether the corporation uses an accrual method of accounting, the cash receipts and disbursements method, or any other allowable method of accounting" modifies the statutory phrase "taxes accrued during the taxable year". In other words, petitioner argues that the taxes that accrued during the 1995 year should include future years' installment sale income as though petitioner had reported the entire sale under the accrual method for 1995. Computing the accrued tax in the manner proposed by petitioner would result in no accumulated taxable income and, therefore, no accumulated earnings tax liability.Respondent disagrees with petitioner and points out that the language of section 1.535-2(a)(1), Income Tax Regs., was46 not intended to change petitioner's method for reporting income from the installment to the accrual method. In that regard, respondent contends that section 535(b)(1) and the underlying regulation concern the amount of tax that "accrued during the taxable year". Respondent also contends that petitioner's post-1995 installment sale income does not meet the well-established standard for accrual of the income and/or tax during petitioner's 1995 Federal tax year.We agree with respondent. The regulation permits petitioner to deduct its tax liability which had accrued but had not been paid by the end of 1995. The regulation does not change petitioner's tax accounting method for reporting income. Respondent's interpretation of the regulation would result in equal treatment for corporate taxpayers with respect to the accrual of a tax liability for the year(s) under consideration. 5 Petitioner's interpretation, for purposes of computing accumulated taxable income, would place all taxpayers on the accrual method for reporting income. 647 We find petitioner's approach to be inherently inconsistent with and contradictory to the statutory scheme, especially when considered in the factual context of this case. In that regard, petitioner seeks the benefit of a reduction attributable 12 to tax on unrealized installment sale income in computing accumulated taxable income. Petitioner, however, has not included any portion of that same income in its tax base for 1995. 7Petitioner's48 interpretation of the subject regulation does not comport with the section 535 statutory phrase "accrued during the taxable year". In addition, the modification of a taxpayer's overall tax accounting method does not appear to fit within the regimen of section 535(b). "The adjustments prescribed by section 535(a) and (b) are designed generally to assure that a corporation's 'accumulated taxable income' reflects more accurately than 'taxable income' the amount actually available to the corporation for business purposes." Ivan Allen Co. v. United States, 422 U.S. 617">422 U.S. 617, 626, 45 L. Ed. 2d 435">45 L. Ed. 2d 435, 95 S. Ct. 2501">95 S. Ct. 2501 (1975).The adjustments provided for in section 535(b) increase or decrease taxable income, on an annualized basis, to arrive at a base against which to apply the accumulated earnings tax of section 531. For example, section 535(b)(1) provides for a reduction for taxes accrued during the taxable year and section 535(b)(4) requires that net operating loss deductions from other years must be added back. The purpose of these adjustments is to find the amount by which income has been allowed to accumulate beyond the needs of the business for a particular tax year. Respondent's interpretation of the regulatory49 phrase accomplishes that end. Petitioner's interpretation, on the other hand, addresses the question of future tax liability. 8Under established tax accounting principles for accrual, a liability is incurred and/or taken into account in the year in which all the events have occurred that establish the fact of the liability. See sec. 1.461-1(a)(2), Income Tax Regs. All the events have occurred when the amount of the liability can be determined with reasonable accuracy and economic performance has occurred with respect to the liability. Id. All of the 13 events have not occurred with respect to petitioner's tax liability on future years' installment sale income. Accordingly, petitioner is not entitled to deduct tax on post-1995 installment50 sale income from taxable income in arriving at accumulated taxable income for 1995.II. Whether a Contested Income Tax Deficiency That Has Been Paid Is Deductible From Taxable Income in Arriving at Accumulated Taxable IncomeHere again, we focus on section 535(b)(1) and the underlying regulation in considering whether a contested income tax deficiency is a tax that "accrued during the taxable year". Petitioner reported an income tax liability of $ 2,674 on its 1995 corporate Federal income tax return. The $ 2,674 was remitted by petitioner during March 1996, when it filed its 1995 return. Thereafter respondent determined a deficiency in petitioner's income tax and, in addition, that petitioner was subject to the accumulated earnings tax. After the petition was filed and before we issued our opinion, petitioner tendered payment of the income tax deficiency to respondent. Although petitioner tendered payment, it continues to contest the income tax deficiency. The parties disagree with respect to whether any part of the income tax deficiency should be deducted from taxable income to arrive at accumulated taxable income, the base for the accumulated earnings tax.In making the adjustments51 to taxable income to arrive at accumulated taxable income, respondent deducted the $ 2,674 tax liability reported by petitioner, even though the $ 2,674 was not paid until after the close of the 1995 tax year. In addition to the $ 2,674, petitioner argues that the income tax deficiency, either in the amount determined by respondent or decided by the Court, should also be deducted from taxable income to reduce the accumulated earnings tax base. 9 Respondent disagrees, contending that the income tax deficiency did not accrue during the taxable year as required by section 535(b)(1) because petitioner continues to contest it. In support of his argument, respondent relies on the well- established 14 standards for accrual (the "all events test"), contending that a contested tax liability does not meet that test.52 Petitioner relies on the holding in J.H. Rutter Rex Manufacturing. Co. v. Commissioner, 853 F.2d 1275">853 F.2d 1275 (5th Cir. 1988), revg. T.C. Memo 1987-296">T.C. Memo 1987-296 (Rutter Rex). 10 The rationale of that case focuses on the word "unpaid" in section 1.535-2(a)(1), Income Tax Regs., 11 to reach the conclusion that a contested 12 income tax deficiency that has been paid is deductible within the meaning of section 535(b)(1). Rutter Rex, supra at 1296. We note that the Court of Appeals for the Fifth Circuit did not invalidate section 1.535-2(a)(1), Income Tax Regs., in the process of reaching its holding. The factual predicates for the taxpayer in Rutter Rex and petitioner are substantially identical. 1353 The Court of Appeals for the Fifth Circuit emphasized in its rationalethat the accumulated earnings tax is a penalty tax and thus is to be strictly construed. Ivan Allen Co., 422 U.S. 617">422 U.S. 617 at 626, 95 S. Ct. 2501">95 S. Ct. 2501 at 2506, 45 L. Ed. 2d 435">45 L. Ed. 2d 435. Due to the special nature of the accumulated earnings tax and its focused examination of a earnings accumulated in a given year, it would be inequitable and inconsistent not to allow a corporation to deduct taxes assessed 15 and attributable for the year at issue, even though the corporation may be contesting the taxes, as long as the corporation has paid the taxes prior to the final computation of its accumulated earnings tax liability. * * * [Rutter Rex, supra 853 F.2d 1275 at 1296.]We respectfully disagree with the interpretation of the Court of Appeals for the Fifth Circuit of section 1.535-2(a)(1), Income Tax Regs. That regulation, in its amplification of the language "tax accrued during the taxable year", is designed to permit a reduction from taxable income in arriving at accumulated taxable income for a tax liability that had accrued during the taxable54 year, but had not been paid (is "unpaid"). That final caveat of the regulation simply explains that an accrued but unpaid tax liability may not be used to reduce the base for the accumulated earnings tax, if the tax is contested. The focus of that final caveat is that no deduction is permissible where the liability is contested. The Court of Appeals, however, interpreted the term "unpaid" as the focus of the regulation's caveat and its controlling condition.Petitioner argues that the result fashioned by the Court of Appeals in Rutter Rex is more equitable. We observe, however, that it is inconsistent in that it treats a paid but contested deficiency differently from one that is unpaid and contested. In either situation, there is no way to know whether a taxpayer's earnings will ultimately bear the burden of the contested deficiency determination. The payment of a contested income tax deficiency does not overcome the requirement that the obligation be fixed or final for accrual. 1455 Petitioner argues that traditional accrual concepts (" all events test") should not be employed for determining income tax accrued in the computation of accumulated taxable income. Petitioner's argument is based on the appellate court's rationale in Rutter Rex that it would be inequitable to prohibit a reduction for a paid, but contested, tax deficiency. Petitioner, however, has not provided a policy reason to treat taxpayers who contest an unpaid income tax deficiency differently from taxpayers who choose or are able to pay a contested deficiency.16 Our holding in Rutter Rex, T.C. Memo 1987-296">T.C. Memo 1987-296, was consistent with our holding in Doug-Long, Inc. v. Commissioner, 73 T.C. 71">73 T.C. 71 (1979), which, in turn, followed the Supreme Court's reasoning in Dixie Pine Prods. Co. v. Commissioner, 320 U.S. 516">320 U.S. 516, 88 L. Ed. 270">88 L. Ed. 270, 64 S. Ct. 364">64 S. Ct. 364 (1944), and related precedent. See also Estate of Goodall v. Commissioner, 391 F.2d 775">391 F.2d 775 (8th Cir. 1968). Those cases follow traditional accrual principles holding that a contested tax liability is not deductible because it has not accrued.In Doug-Long, Inc. v. Commissioner, supra, we held that the questioned phrase in the regulation56 was a valid interpretation of section 535 when determining a corporation's Federal income tax that had accrued during the taxable year. The Commissioner has also provided guidance on this point, consistent with his position that contested deficiencies may not be reduced from the accumulated earnings tax base. See Rev. Rul. 72-306, 1 C.B. 166">1972-1 C.B. 166. Moreover, the rationale employed in the Rutter Rex appellate opinion rests upon perceived inequities and varies from the requirements of section 461(f) and traditional accrual principles. 15 In that regard, the Court of Appeals for the Eighth Circuit, relying on Dixie Pine Prods. Co. v. Commissioner, 320 U.S. 516">320 U.S. 516, 88 L. Ed. 270">88 L. Ed. 270, 64 S. Ct. 364">64 S. Ct. 364 (1944), held that the all events test applied in deciding "what may be regarded as Federal income taxes of the corporation properly 'paid or accrued during the taxable year'". Estate of Goodall v. Commissioner, supra 391 F.2d 775 at 800.57 Significantly, Congress in section 535(b) has specifically provided for adjustments that cause the accumulated earnings tax to be applied or not to be applied to various items. There is no indication that Congress intended that the term "accrual" have a different meaning for purposes of section 535(b) and section 1.535-2(a)(1), Income Tax Regs., than its traditional and well- established meaning. In that context, we interpret the last line of section 1.535-2(a)(1), Income Tax Regs., as simply explaining that an accrued but unpaid tax 17 liability may not be used to reduce the base for the accumulated earnings tax, if the tax is contested. 16 Accordingly, in a situation where a taxpayer contests the Commissioner's determination and may continue to contest it after our decision is entered, the "all events test" has not been met. Our prior holdings and those of the Supreme Court support that result.58 For those reasons, we disagree with the holding and rationale of the Court of Appeals for the Fifth Circuit and continue to adhere to our established precedent. We hold that no part of petitioner's paid, but contested, income tax deficiency should be reduced from its taxable income in arriving at accumulated taxable income under section 535(b)(1).III. Whether the Amount of the "Tax Attributable" Adjustment to Capital Gains That Is Used To Arrive at the Accumulated Earnings Tax Base Should Be Limited to Petitioner's Reported Tax Liability for the YearPetitioner argues, as its third and final alternative, that respondent's computation of the adjustment for capital gains is understated. Petitioner argues that the tax attributable adjustment should be limited to the actual overall tax liability reported or a duplication of tax burden would result. Respondent contends that his adjustment follows the literal requirements of section 535(b)(6)(A).Section 535(b)(6)(A) provides for a deduction from taxable income in arriving at accumulated taxable income of "the net capital gain * * reduced by * * * the taxes attributable to such net capital gain." Section 535(b)(6)(B) defines "the59 taxes attributable to the net capital gain" as the difference between "the taxes imposed by this subtitle (except the tax imposed by this part) for the taxable year, and * * such taxes computed for such year without including in taxable income the net capital gain for the taxable year".The section 535(b)(6)(B)(i) language "the taxes imposed by this subtitle", is the focus of the parties' dispute. Petitioner 18 contends that the "taxes imposed" should be limited to the amount of tax liability it reported on its 1995 return or $ 2,674. On the other hand, respondent's computation is based on "taxes imposed" of $ 110,203, the amount of income tax this Court decided is imposed under the statute.In applying the above-quoted adjustment in his Rule 155 computation, respondent computed the accumulated earnings tax as follows: 1760 Accumulated Earnings Tax-1995Taxable income per Form 5278$ 325,000Less sec. 535(b) adjustments:1. Federal income taxes accured(2,674)2. Net capital gains 40,354less: income tax attributable thereto15,738(24,616)300,384Less dividends paid:Compensation treated as dividend(150,250)Other expenses paid for benefitof shareholders(8,094)Accumulated taxable income142,040x 39.6%56,248In the above61 computation, respondent has interpreted section 535(b)(6) to mean that the net capital gain should first be reduced by the full amount of tax on the capital gain and that it is not limited by the amount of combined tax liability reported by petitioner for 1995. Accordingly, respondent has taken the net capital gain of $ 40,354, applied the 35-percent maximum rate under section 1201 and arrived at $ 15,738 of income tax attributable to the net capital gain. 18 After making the "tax attributable" adjustment, respondent reduced 19 taxable income by the $ 24,616 difference in the process of arriving at accumulated taxable income.Petitioner argues that if the "total amount of Federal income62 tax attributable to the year 1995 for purposes of the section 535(b)(1) calculation is determined to be $ 2,674, * * then the total amount of income tax attributable to the capital gain cannot logically exceed $ 2,674." In other words, petitioner contends that respondent's net capital gain deduction from taxable income in the process of arriving at accumulated taxable income is $ 13,064 too small. 19The question raised by petitioner's argument is whether the amount of tax, in the context of the section 535(b)(6) phrase tax "attributable to the net capital gain", is limited by the amount of a taxpayer's total combined income tax liability 20 that was reported for the year. This is a question of first impression.63 In order to understand better the distinctions between the parties' positions, we review petitioner's 1995 Form 1120, U.S. Corporation Income Tax Return. Petitioner reported "Total Income" of $ 898,479, of which $ 35,884 was reported as "Capital gain net income". The remainder of the income reported appears to be from sources of "ordinary income", such as rents, royalties, etc. After ordinary deductions of $ 844,327 and a $ 36,326 net operating loss deduction, petitioner reported taxable income of only $ 17,825.The $ 17,825 of taxable income reported by petitioner resulted in a $ 2,674 tax liability. It is that $ 2,674 which petitioner argues should limit the "tax attributable" to net capital gains within the meaning of section 535(b)(6). We note that the $ 2,674 of tax liability reported by petitioner has already been deducted from taxable income in the process of arriving at accumulated taxable income. 21The problem64 with petitioner's position is that $ 2,674 is not the "tax imposed" on petitioner's 1995 taxable income. The tax imposed on petitioner's 1995 taxable income is $ 110,203, the amount decided by this Court in our earlier opinion 20 Metro Leasing & Dev. Corp. East Bay Chevrolet Co. v. Commissioner, T.C. Memo 2001-119">T.C. Memo 2001-119, which concerned the underlying tax issues. The $ 110,203 amount decided by this Court is the tax imposed under section 535(b)(6)(B)(i). If $ 110,203 is used as the tax imposed in the section 535(b)(6) calculation, respondent's computation of accumulated taxable income is correct.Section 535(b) contains several adjustments, some of which are intended to remove certain items from the accumulated earnings tax base. In that regard, section 535(b)(5),(6), and (7) provides for adjustments pertaining to capital gains. In general, section 535(b)(5) permits a reduction for net capital losses for the taxable year. Section 535(b)(6) provides for a reduction for net capital gains, less tax attributable to said gains. Finally, section 535(b)(7) makes inapplicable the ordering rules for capital losses under section 1212 and provides for the carryover of the prior year's65 net capital loss.The net effect of the provisions regarding capital gains and losses is to remove them from the accumulated earnings tax base, irrespective of whether they resulted in gain or loss. Respondent has removed the net capital gains in accord with the statute. The limitation argued for by petitioner does not comport with the statute, because the amount of tax liability reported by petitioner is not, ultimately, the "tax imposed" by the statute.A similarly worded adjustment and computation for removing net capital gains from the computation of the personal holding company tax is provided for in section 545(b)(5). Like the accumulated earnings tax, the personal holding tax is considered a "penalty" tax. Taxpayers, in the context of the personal holding tax, have made arguments similar to those made by petitioner in this case. They argued that the tax imposed should equal the tax accrued for purposes of the capital gain adjustment. This Court rejected those arguments, holding that Congress was aware that taxpayers would not be able to deduct contested taxes in connection with the adjustment for "taxes accrued during the year", whereas the tax imposed would include the deficiency66 decided by a court. See Kluger Associates, Inc. v. Commissioner, 69 T.C. 925">69 T.C. 925, 940-941 (1978), affd. 617 F.2d 323">617 F.2d 323, 333 (2d Cir. 1980); Ellis Corp. v. Commissioner, 57 T.C. 520">57 T.C. 520, 523 (1972).21 We are aware of the paradox that has been occasioned by petitioner's choice to continue contesting the income tax deficiency. That choice has resulted in petitioner's inability to treat the income tax deficiency, decided by this Court, as accrued during the taxable year for purposes of the section 535(b)(1) adjustment. Conversely, petitioner may not use the $ 2,674 tax liability it originally reported in its computation of the section 535(b)(6) adjustment. Although the two items are conceptually related, by definition they are not interdependent. For the section 535(b)(1) adjustment, the tax must have accrued. Whereas the section 535(b)(6)(B)(i) aspect of the capital gain adjustment is dependent upon the amount of the tax imposed. The tax "imposed" and the tax "accrued" for a particular year could be the same amount. But where the tax "imposed" is contested, it is not treated as "accrued".We therefore hold that respondent correctly computed the adjustment67 for net capital gains under section 535(b)(6) and that respondent's approach to the Rule 155 computation is not in error.To reflect the foregoing,Decision will be entered under Rule 155.Reviewed by the Court. WELLS, COHEN, SWIFT, WHALEN, COLVIN, HALPERN, BEGHE, CHIECHI, FOLEY, VASQUEZ, GALE, THORNTON, and MARVEL, JJ., agree with the majority opinion. WELLS, COHEN, SWIFT, WHALEN, COLVIN, HALPERN, BEGHE, CHIECHI, FOLEY, VASQUEZ, GALE, THORNTON, and MARVEL, JJ., agree with the majority opinion.RUWE and LARO, JJ., did not participate in consideration of this case.HALPERN, J., concurring: Although I have joined in the majority's opinion, I write separately to set forth more fully why I believe petitioner may not accrue the contested tax liability in question.I. Application of the All Events TestThe majority notes: "Our holding in J.H. Rutter Rex Manufacturing Co. v. Commissioner, T.C. Memo 1987-296">T.C. Memo 1987-296, was consistent with our holding in Doug-Long, Inc. v. Commissioner, 73 T.C. 71">73 T.C. 71 (1979), which, in turn, followed the Supreme Court's reasoning in Dixie Pine Prods. Co. v. 22 Commissioner, 320 U.S. 516">320 U.S. 516, 88 L. Ed. 270">88 L. Ed. 270, 64 S. Ct. 364">64 S. Ct. 364 (1944), and related precedent." Majority op. p. 15. It is upon Dixie Pine Prods. Co. and the "related precedent" that I wish to focus.The seminal case establishing the basic rule for68 when a liability is incurred and, thus, is taken into account under the accrual method of accounting for Federal income tax purposes is United States v. Anderson, 269 U.S. 422">269 U.S. 422, 70 L. Ed. 347">70 L. Ed. 347, 46 S. Ct. 131">46 S. Ct. 131 (1926), which holds that a liability is incurred in the year in which occur all the events needed to create an unconditional obligation to pay such liability. That test (the all events test) is now embodied in section 1.446-1(c)(1)(ii)(A), Income Tax Regs., which provides that, under an accrual method of accounting (in addition to the requirement of "economic performance", added in 1984), a liability is incurred for income tax purposes "in the taxable year in which all the events have occurred that establish the fact of the liability, [and] the amount of the liability can be determined with reasonable accuracy". See also sec. 1.461-1(a)(2), Income Tax Regs.In Dixie Pine Prods. Co. v. Commissioner, supra, the Supreme Court amplified the all events test by holding that all of the events to establish a liability have not occurred if the liability is contingent and is contested by the supposed obligor. 320 U.S. at 519; accord69 Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281, 88 L. Ed. 725">88 L. Ed. 725, 64 S. Ct. 596">64 S. Ct. 596 (1944). 1 In Dixie Pine Prods. Co. v. Commissioner, supra, the taxpayer had contested a State excise tax that, otherwise, would have been due for the taxable year in question. The Supreme Court held that the taxpayer could claim a deduction only for the taxable year in which its liability for the tax was finally settled. 320 U.S. at 519.In United States v. Consol. Edison Co., 366 U.S. 380">366 U.S. 380, 6 L. Ed. 2d 356">6 L. Ed. 2d 356, 81 S. Ct. 1326">81 S. Ct. 1326 (1961),70 the Supreme Court applied the all events test to a situation in which a contested real estate tax liability was paid in order to stay the seizure and sale of the property (in satisfaction of the tax lien) during the pendency of the contest. The Court held that such payment did not satisfy the 23 all events test so long as the contest was still pending. Id. at 391-392.The result in United States v. Consol. Edison Co., supra, was overruled (retroactively to the effective date of the 1954 Code) by section 223 of the Revenue Act of 1964, Pub. L. 88-272, 78 Stat. 19, 76, which added section 461(f), which permits a deduction for contested items in the year of payment, even though the contest is not resolved until a later year. S. Rept. 830, 88th Cong., 2d Sess. (1964), 1964-1 C.B. (Part 2) 505, is the report of the Committee on Finance that accompanied H. R. 8363, 88th Cong., 1st Sess. (1963), which, when enacted, became the Revenue Act of 1964. The report explains the general reasons for section 461(f) (which originated in the Senate) as follows:Although your committee does not question the legal doctrine laid down by the Supreme71 Court in the Consolidated Edison case, it believes that it is unfortunate to deny taxpayers a deduction with respect to an item where the payment has actually been made, even though the liability is still being contested either as to amount or as to the item itself. * S. Rept. 830, 88th Cong., 2d Sess. (1964), 1964-1 C.B. (Part 2) 505, 604. (Emphasis added.)Thus, under well-established principles of tax accrual laid down by the Supreme Court, it is clear that, for income tax purposes, the all events test is not satisfied with respect to a contested tax liability, and the contested tax liability may not be "accrued", until the year in which the contest is terminated. If the contested liability is paid before the contest is terminated, the liability is deductible in the year of payment pursuant to section 461(f). If the same tax accrual principles apply for purposes of section 535(b)(1), there is no basis in law for the holding of the Court of Appeals for the Fifth Circuit in J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275">853 F.2d 1275 (5th Cir. 1988), revg. T.C. Memo 1987-296">T.C. Memo 1987-296, that a taxpayer's payment72 of a contested tax liability entitles the payor to treat the contested liability as "accrued" during the prior taxable year to which the accumulated earnings tax relates.II. Relevance of Sec. 1.535-2(a)(1), Income Tax Regs.The Court of Appeals for the Fifth Circuit, in J.H. Rutter Rex Manufacturing Co. v. Commissioner, supra at 1297, noted that the last sentence of section 1.535-2(a)(1), Income Tax Regs., 24 does not prohibit an accrual deduction for paid contested taxes prior to termination of the contest because the sentence provides only that "an unpaid tax which is being contested is not considered accrued until the contest is resolved." (Emphasis added.) In reaching that conclusion, the Court of Appeals overlooked the fact that, at the time the cited regulation was promulgated, pursuant to T. D. 6377, 1 C.B. 125">1959-1 C.B. 125, the Internal Revenue Service's published position with respect to paid contested taxes was that such taxes are deductible in the year of payment, even though they continue to be contested. See G. C. M. 25298, 2 C.B. 39">1947-2 C.B. 39, 44, which followed Chestnut Sec. Co. v. United States, 104 Ct. Cl. 489">104 Ct. Cl. 489, 62 F. Supp. 574">62 F. Supp. 574 (1945).73 2 Under those circumstances, the general accrual rule applicable to contested taxes, contained in section 1.535-2(a)(1), Income Tax Regs., could only have applied to unpaid taxes because its extension to paid taxes would have been inconsistent with G. C. M. 25298. Since 1964, an extension of that provision to paid contested taxes would be inconsistent with section 461(f), which, in effect, codified and reinstated the Commissioner's position in G. C. M. 25298. Therefore, petitioner's payment of the contested taxes could serve only to accelerate a deduction to the year of payment pursuant to section 461(f). There is no basis under either the all events test or section 461(f) for the Court of Appeals for the Fifth Circuit's suggestion, J.H. Rutter Rex Manufacturing Co. v. Commissioner, supra at 1297, that the payment itself somehow justifies an accrual of such taxes in the earlier year for which the taxpayer is subject to tax imposed by section 531.We are left, then, to determine whether the test of a section 535(b)(1) tax accrual is the all events test.III. Validity of Sec. 1.535-2(a)(1), Income Tax Regs.74 The final sentence of section 1.535-2(a)(1), Income Tax Regs., reads: "In computing the amount of taxes accrued, an unpaid tax which is being contested is not considered accrued until the contest is resolved." That sentence leaves little doubt that the Secretary of the Treasury intended the test of a section 535(b)(1) tax accrual to be the all events test. See 25 Doug-Long, Inc. v. Commissioner, 73 T.C. at 81 (" The last sentence of this regulation is consistent with the definition of accrued taxes which has been set forth in Dixie Pine Products Co. v. Commissioner, supra; Great Island Holding Corp. v. Commissioner, * * * [5 T.C. 150">5 T.C. 150, 160 (1945)]; and sec. 1.461-2(b)(2), Income Tax Regs."). The only question is whether that is a valid interpretation of the statutory command of section 535(b)(1) that, in computing accumulated taxable income, taxable income be adjusted by subtracting certain taxes "accrued" during the taxable year. In Doug-Long, Inc. v. Commissioner, supra at 82, we held that the last sentence of section 1.535-2(a)(1), Income Tax Regs., validly75 interprets the statute. In J.H. Rutter Rex Manufacturing Co. v. Commissioner, supra at 1296, the Court of Appeals for the Fifth Circuit made a cogent argument that the accumulated earnings tax, a penalty tax, should not be based on earnings "that may not exist at all depending on the deficiency claimed." Taken to its logical conclusion, the Court of Appeals' argument is an argument to read the term "[taxes] accrued during the taxable year" in section 535(b)(1) as meaning "[taxes] finally determined for the taxable year". 3 That is a rule that Congress easily could have stated. Congress, however, used the term "taxes accrued", and the term "accrued" has a settled meaning, incorporating the all events test, for Federal income tax purposes. See, e.g., sec. 1.446-1(c)(1)(ii)(A), Income Tax Regs. In Estate of Goodall v. Commissioner, 391 F.2d 775">391 F.2d 775, 800 (8th Cir. 1968), vacating and remanding T.C. Memo 1965-154">T.C. Memo 1965-154, the Court of Appeals for the Eighth Circuit gave precisely that meaning to the term "accrued" in a predecessor version of section 535(b)(1). If section 535(b)(1) is not clear on its face, the Secretary's interpretation76 is permissible, since it defines a term in a way that is reasonable in light of the legislature's revealed design. Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837">467 U.S. 837, 844, 81 L. Ed. 2d 694">81 L. Ed. 2d 694, 104 S. Ct. 2778">104 S. Ct. 2778 (1984). 4 Although policy considerations 26 may suggest a taxes-as-finally- determined rule, the use of a commonly understood term suggests the common meaning, and the legislature's design, as revealed, does not contradict such usage. 577 I conclude that section 1.535-2(a)(1), Income Tax Regs., validly interprets section 535(b)(1): The test of a section 535(b)(1) tax accrual is the all events test.SWIFT, WHALEN, and MARVEL, JJ6., agree with this concurring opinion. Footnotes1. On May 18, 2001, this Court filed a Memorandum Findings Of Fact And Opinion, Metro Leasing & Dev. Corp., East Bay Chevrolet Co., A Corporation v. Commissioner, T.C. Memo 2001-119">T.C. Memo 2001-119↩, in two consolidated cases (docket Nos. 8054-99 and 8055-99) stating that decisions would be entered pursuant to Rule 155 of the Court's Rules of Practice and Procedure in both docket numbers. On Sept. 20, 2001, in docket No. 8055-99, Respondent's Computation For Entry Of Decision (together with a proposed decision document) was filed. On Oct. 3, 2001, by order of this Court, the consolidated cases at docket No. 8054-99 and docket No. 8055-99 were severed. On Oct. 5, 2001, a decision was entered in docket No. 8055-99. 2. All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. ↩3. Petitioner's 1995 Federal return contains the notation that it uses the accrual method of accounting for tax purposes. With respect to the real estate sale, however, petitioner elected the installment method. ↩4. Petitioner reflected an amount in excess of $ 500,000 in connection with the installment sale as "deferred income taxes" (a current liability) on the balance sheet which was part of its 1995 return. In addition, for financial reporting purposes, petitioner included the "deferred" installment sale income in its 1995 income. However, no part of the income that may be realized from subsequent years' installments was included in petitioner's 1995 Federal income tax base. ↩5. For example, under the cash method a taxpayer's tax liability would not be deductible until such time as it is paid. Under respondent's interpretation, a cash basis taxpayer would be entitled to deduct unpaid, but established (" accrued"), income tax liability that, but for payment, had accrued during the taxable year. ↩6. Under petitioner's interpretation of the statute, its sales transaction would have to be treated as an accrual method transaction as though the installment reporting method had not been elected. ↩7. For example, if petitioner had included the income in its tax base for 1995, its taxable income (the starting point for computing accumulated taxable income) would have been proportionately larger and, even after the reduction for the "accrued tax" on future installment income, would have had the potential to result in a larger accumulated earnings tax than the $ 56,248 computed by respondent. In effect, petitioner seeks to reduce the accumulated taxable income base by the future tax liability without including the future income in the income accumulation for the 1995 tax year.↩8. To the extent that petitioner receives installment income in future years, the tax and income would be matched in the same taxable year and have a direct bearing on whether that income was allowed to accumulate beyond its needs for that future year.↩9. A taxpayer's Federal income tax liability is not deductible in arriving at taxable income. See sec. 275. A Federal income tax liability that "accrued during the taxable year" is allowed as a deduction from the tax base for the accumulated earnings tax. See sec. 535(b)(1)↩.10. Our J.H. Rutter Rex Manufacturing Co. v. Commissioner opinion (T.C. Memo 1987-296">T.C. Memo 1987-296) (Rutter Rex) was reversed during 1988 ( Rutter Rex, 853 F.2d 1275">853 F.2d 1275 (5th Cir. 1988). We consider in this opinion whether we will follow the holding of the Court of Appeals for the Fifth Circuit or adhere to our established holding on this question. Since the reversal, this point has not been addressed by this Court or any other court. Any appeal of our decision in these consolidated cases would normally lie with the Court of Appeals for the Ninth Circuit because petitioner's principal place of business was in California. See sec. 7482(b)(1)(B). The Court of Appeals for the Ninth Circuit has not addressed the question we consider here. Even though this Court may disagree with an appellate court holding that is squarely on point, we shall follow the appellate court holding if that court is the venue for appeal. See Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985↩ (10th Cir. 1971). 11. The word "unpaid" appears in the last sentence of the pertinent part of sec. 1.535-2(a)(1), Income Tax Regs., as follows: for taxes accrued during the taxable year, regardless of whether the corporation uses an accrual method of accounting, the cash receipts and disbursements method, or any other allowable method of accounting. In computing the amount of taxes accrued, an unpaid tax which is being contested is not considered accrued until the contest is resolved.(Emphasis supplied.) ↩12. In its opinion, the Court of Appeals acknowledged that the income tax deficiency remained in controversy, even though payment had been proffered. Accordingly, the Court was aware that, ultimately, the taxpayer's accumulation might not have been subjected to the contested tax deficiency. ↩13. The taxpayer in Rutter Rex petitioned this Court to contest income and accumulated earning tax deficiencies determined by the Commissioner. After the filing of the petition and this Court's opinion as to the amount of the income tax deficiency, but prior to the final computation of the accumulated earning tax and the entry of a decision, the taxpayer "apparently offered to pay" the contested income tax deficiencies. See Rutter Rex, 853 F.2d 1275">853 F.2d 1275 at 1295↩. We surmise from the quoted language that the deficiency under consideration in Rutter Rex had not been assessed. Likewise, in the case we consider, respondent's computation reflects that petitioner's payment, in the amount of $ 326,932, had been paid but not assessed. 14. In addition, from the perspective of the accumulated earnings tax, payment of a contested income tax deficiency some 5 or 6 years after the accumulation in question would appear to have little relevance to the question of whether the tax "accrued during the taxable year" or whether a taxpayer allowed its income to accumulate beyond the reasonable needs of the business. The quoted statutory language and the regimen of the accumulated earnings tax address the proscribed accumulation at the time of the accumulation.↩15. The Court of Appeals for the Fifth Circuit, in a footnote, also acknowledged that their holding was contrary to cases interpreting the phrase "taxes * * * accrued during the taxable year" in the context of personal holding tax cases under secs. 541-547, a companion penalty regimen. See LX Cattle Co. v. United States, 629 F.2d 1096">629 F.2d 1096 (5th Cir. 1980); Kluger Associates, Inc. v. Commissioner, 617 F.2d 323">617 F.2d 323 (2d Cir. 1980), affg. 69 T.C. 925">69 T.C. 925 (1978); Hart Metal Prods. Corp. v. Commissioner, 437 F.2d 946">437 F.2d 946 (7th Cir. 1971), affg. T.C. Memo 1969-164">T.C. Memo 1969-164; Mariani Frozen Foods, Inc. v. Commissioner, 81 T.C. 448">81 T.C. 448 (1983), affd. sub nom. Gee Trust v. Commissioner, 761 F.2d 1410">761 F.2d 1410 (9th Cir. 1985). For additional discussion by the Court of Appeals on this point, see Rutter Rex, 853 F.2d at 1297↩ n. 37.16. Although not decisive, it is interesting to note that in the context of a prepayment forum, the income tax deficiency is not assessed and, as a technical matter, could not be paid. By contesting the deficiency, a taxpayer ensures that the tax may not be assessed or collected. Even though a deficiency is paid after the filing of a petition, if a taxpayer continues to contest it, the tax is not assessed. Normally, payment during the course of a prepayment (deficiency) forum is used to stop the running of interest and is treated more like a deposit should an income tax deficiency be ultimately decided.↩17. There appear to be two errors in respondent's computation of petitioner's accumulated earnings tax. First, there appears to be an error in subtraction. If $ 325,000 is reduced by $ 2,674 and $ 24,616, the result should be $ 297,710 and not $ 300,384. Second, the amount shown as taxable income on Form 5278, Statement -- Income Tax Changes, of respondent's computation is $ 325,522 and not $ 325,000. The parties will be asked to address these apparent discrepancies in a Rule 155 computation to be prepared in accord with this Supplemental Opinion.↩18. We note that petitioner reported $ 35,884 of net capital gain and that respondent made adjustments increasing the amount to $ 40,354. We also note that 35 percent of $ 40,354 is $ 14,123.90 ($ 14,124) and not $ 15,738. It appears that another adjustment was combined with the one discussed herein, resulting in the $ 15,738 amount.↩19. In support of its position, petitioner argues that respondent's approach results in a duplication or "doubling-up of the tax element". Essentially, respondent's computation results in removing the capital gain and its tax effect from the tax base for computing accumulated earnings tax.↩20. The liability when considering both ordinary and net capital gain income.↩21. That adjustment was made under sec. 535(b)(1)↩ as discussed earlier in this Opinion.1. It should be noted that, in the absence of a contest, the all events test is satisfied with respect to the additional tax attributable to an income tax deficiency as of the close of the deficiency year. See Dravo Corp. v. United States, 172 Ct. Cl. 200">172 Ct. Cl. 200, 348 F.2d 542">348 F.2d 542 (1965) (additional State capital stock tax paid without protest by accrual method taxpayer in year 3 with respect to year 1 properly accruable for year 1). Such additional tax is, therefore, properly accruable for the deficiency year under sec. 535(b)(1). Rev. Rul. 68-632, 2 C.B. 253">1968-2 C.B. 253↩.3. That is, finally determined before the corporation's liability for accumulated earnings tax becomes final.↩4. Petitioner suggests that the Chevron standard of review should not apply because the accumulated earnings tax is in the nature of a penalty. Even if we were to conclude that the final sentence of sec. 1.535-2(a)(1), Income Tax Regs., is invalid on that basis, it would not necessarily follow that petitioner would be entitled to deduct from its 1995 accumulated taxable income the amount of its 1995 Federal income tax deficiency as determined by this Court. That is, if we were to invalidate the final sentence of sec. 1.535-2(a)(1), Income Tax Regs., we would still be required to interpret the meaning of the term "[taxes] accrued during the taxable year" as used in sec. 535(b)(1)↩. In this regard, petitioner offers no support for the proposition that Congress intended a taxes-as-finally-determined rule as opposed to, say, a taxes-as-actually-reported rule.5. The Court of Appeals for the Fifth Circuit in J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275">853 F.2d 1275, 1297-1298 (5th Cir. 1988), cites a line of cases beginning with Stern Bros. Co. v. Commissioner, 16 T.C. 295">16 T.C. 295 (1951), in support of its position. Those cases uphold the accrual of contested taxes in the year in which the contested tax liability arises when computing accumulated earnings and profits for invested capital purposes under the excess profits tax imposed in World War II. Id. at 322-323. See also Estate of Stein v. Commissioner, 25 T.C. 940">25 T.C. 940, 966 (1956), which extends the Stern Bros. Co. rationale to permit the accrual of contested taxes in computing earnings and profits for purposes of determining whether corporate distributions are taxable dividends or nontaxable distributions from capital. In Stern Bros. Co., we were interpreting a regulation that required an accrual basis taxpayer to subtract income and excess profit taxes "for the preceding taxable year". That is not necessarily the same as allowing a deduction for any such taxes as are "accrued" during such preceding taxable year. Moreover, Stern Bros. Co. and its progeny, including Estate of Stein, specifically distinguish the computation of accumulated earnings and profits from the computation of taxable income, where Dixie Pine Prods. Co. v. Commissioner, 320 U.S. 516">320 U.S. 516, 88 L. Ed. 270">88 L. Ed. 270, 64 S. Ct. 364">64 S. Ct. 364 (1944), is acknowledged to be applicable. See, e.g., Stern Bros. Co. v. Commissioner, 16 T.C. at 322-323. The concept of taxable income is not so different from that of "accumulated taxable income", upon which the accumulated earnings tax is imposed, as to make the extension of Dixie Pine Prods. Co. to the latter an unreasonable interpretation of the term "accrued" as it is used in sec. 535(b)(1)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621576/	S. B. HEININGER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Heininger v. CommissionerDocket No. 106518.United States Board of Tax Appeals47 B.T.A. 95; 1942 BTA LEXIS 740; June 10, 1942, Promulgated 740 1. Petitioner, engaged in selling false teeth by mail, received initial deposits from customers under a written promise to refund all moneys in case of dissatisfaction after 60 days' trial. The deposits were placed, with other amounts paid, in petitioner's only bank account. The orders for false teeth had not been filled or completed at the end of the taxable years. Held, that the liability to refund was only contingent and that the deposits constituted income. 2. Petitioner expended moneys to resist issuance of a "fraud order" by the Postmaster General, barring his use of the mails, also in obtaining an injunction against the fraud order, resisting appeal therefrom, and unsuccessfully applying to the Supreme Court for certiorari after the Circuit Court had reversed the granting of the injunction. Held, such expense was not ordinary and necessary expense of trade or business. National Outdoor Advertising Bureau v. Helvering, 89 Fed.(2d) 878, followed. Samuel W. Witwer, Jr., Esq., for the petitioner. D. A. Taylor, Esq., for the respondent. DISNEY95 OPINION. DISNEY: The present proceeding involves income741 taxes for the calendar years 1937 and 1938. The Commissioner determined deficiencies in the respective amounts of $10,816.62 and $4,359.39. The 96 petitioner urges error as to the major portion of the amounts. The questions presented are whether certain amounts received by the petitioner were properly added to gross income, and whether certain attorney fees were deductible as ordinary and necessary expenses of business. The income tax returns involved were filed with the collector for the first district of Illinois at Chicago, Illinois. The greater portion of the facts have been stipulated, as follows: 1. The petitioner, S. B. HEININGER, was a resident of Chicago, Illinois, at the time of the filing of the petition herein. Petitioner now resides at Athens, Wisconsin. The returns for the periods here involved were filed with the Collector of Internal Revenue for the First District of Illinois, at Chicago, Illinois. 2. On December 3, 1940, the respondent mailed to petitioner a notice of deficiency in federal income taxes for the years 1937 and 1938, a true and correct copy of which is attached as Exhibit A to the petition herein. 3. The taxes in controversy742 are income taxes for the calendar years 1937 and 1938, and the deficiencies asserted are in the amounts of $10,816.62 and $4,359.39, respectively. 4. During the years from about 1926 to 1939, the petitioner was a licensed dentist in the State of Illinois. His principal work since about 1932 was the making of artificial dentures, commonly known as false teeth, for customers living outside of the City of Chicago who did not personally visit petitioner's office. Before said dentures were made for a customer, petitioner required from and there was forwarded to him from such customer a payment of $2.00 generally designated by the petitioner and hereinafter for convenience referred to as "deposit". Said dentures, when completed for said nonresident customers, were mailed or shipped to them, C.O.D., for the amount of petitioner's respective charges less the $2.00 "deposit". For various reasons some of the "deposits" were returned to said clients and the dentures ordered by them were not furnished by the petitioner. For years prior to the year 1937, the petitioner consistently followed the practice of entering said "deposits" in his books of account as gross receipts when received, 743 against which he entered as offsets thereto when returned the amounts of the "deposits" returned, and reflected the difference as gross income in his income tax returns for those years. 5. Petitioner's books of account for the years 1937 and 1938 recorded aforesaid "deposits" and said "deposits" returned and gross income as set forth in paragraph 4, supra. On December 31, 1937, the petitioner credited to a "deposit account" an item of $20,593.60 representing "deposits" on orders which had not been filled or completed. Of said amount, $3,656.60 represented "deposits" received during the period prior to January 1, 1937, and $16,937.00 represented "deposits" received during the year 1937. Said item of $20,593.60 was deducted from petitioner's gross income arrived at as set forth, supra, in his income tax return filed for the year 1937. On December 31, 1938 the petitioner credited to said "deposit account" an item of $6,900.63 representing "deposits" received during the year 1938. During the year 1938 the petitioner completed, mailed and/or shipped dentures on which deposits in the amount of $13,823.94 had been made in prior years and which were included in the said item744 of $20,593.60. On December 31, 1938 said "deposit account" was charged with said item of $13,823.94 and gross receipts for 1938 were increased in a like amount, leaving in said "deposit account" as of January 1, 1939 the amount of $13,670.29 ($20,593.60 minus $13,823.94 plus $6,900.63) representing deposits on 97 orders for dentures unfilled as of that date. In petitioner's income tax return for said year 1938 the aforesaid item of $13,823.94 was included in gross income and the said item of $6,900.63 was deducted from gross income. In the respondent's final determination of the petitioner's tax liability for said year 1937, as evidenced by his notice of deficiency, a copy of which is attached to the petition herein as Exhibit A, the respondent disallowed as a deduction the said item of $3,656.60 and included in gross income the said item of $16,937.00. The petitioner concedes that the respondent's action in disallowing the said deduction of $3,656.60 was proper and in the final determination herein of petitioner's tax liability for the said year, said deduction should be disallowed. In the respondent's final determination of the deficiency herein for the said year745 1938, as evidenced by his notice of deficiency, a copy of which is attached to the petition herein as Exhibit A, the respondent eliminated from gross income the said item of $13,823.94 and included in petitioner's gross income the said item of $6,900.63. 6. Petitioner's income tax returns were at all times filed on the cash receipts and disbursements basis. The petitioner never applied for nor received permission from the Commissioner of Internal Revenue to change his method of accounting or filing his income tax returns employed for years prior to 1937. 7. On September 22, 1937 a citation was issued by the Solicitor of the Post Office Department, charging that petitioner was engaged in conducting a scheme for obtaining funds through the mails by means of false and fraudulent practices, in violation of 39 U.S.C.A., Sections 259 and 732. Shortly thereafter petitioner appeared before the United States Post Office Department, answered said charges and employed attorneys to render legal services to petitioner in resisting the issuance of the so-called "Fraud Order" under said Statute. During 1937 petitioner paid attorneys' fees and other legal expenses in connection with said746 proceedings, amounting to $7,069.99; said payments were reasonable in amount. 8. On February 19, 1938, and after a hearing under the aforesaid citation, the Postmaster General of the United States issued a so-called "Fraud Order," forbidding the Postmaster at Chicago, Illinois, to pay any money orders drawn to the order of petitioner, and instructing said Postmaster to return all mail addressed to the petitioner to the senders, marked "Fraudulent". Thereafter, on February 25, 1938, petitioner filed suit in the District Court of the United States for the District of Columbia against James A. Farley, Postmaster General, and on that date said Court entered an order directing the Postmaster General to hold all mail addressed to petitioner until the further order of the Court. 9. On June 6, 1938, the District Court of the United States for the District of Columbia granted to petitioner a permanent injunction, restraining the Postmaster General of the United States from enforcing the aforesaid "Fraud Order" or otherwise proceeding in accordance with the terms of said "Fraud Order". Thereafter the Postmaster General appealed said case to the Court of Appeals for the District of747 Columbia, and on April 17, 1939 that Court reversed the Order of the District Court for the District of Columbia and remanded the cause with instructions to dissolve the injunction and to dismiss the Bill of Complaint. The opinion of the said Court of Appeals is reported at 105 Fed.2d 79, of which this Board may take judicial notice. Thereafter, in the October Term, A.D. 1939, petitioner applied to the Supreme Court of the United States for a Writ of Certiorari to review the judgment of the United States Court of Appeals, which Petition for Certiorari was denied. 10. A copy of the Bill of Complaint filed by the petitioner in said District Court including a copy of the aforesaid "Fraud Order" attached thereto as "Exhibit A"; a copy of the Answer thereto; a copy of the Restraint Order entered 98 by the said District Court; a copy of the Court's opinion; and a copy of the Court's order of permanent injunction are set forth in "Exhibit A", as labeled therein, which is attached hereto and made a part hereof. 11. Pursuant to mandate of the aforesaid Court of Appeals, the said District Court entered an order dissolving the aforesaid injunction and dismissing748 the aforesaid Bill of Complaint. Said order is now final and in full force and effect. 12. During the year 1938 petitioner paid to attorneys for legal services in prosecuting his injunction suit in the District Court of the United States for the District of Columbia, and defending the aforesaid appeal of the Postmaster General to the Circuit Court of Appeals for the District of Columbia, and in applying to the Supreme Court of the United States for Writ of Certiorari, fees and legal expenses aggregating $29,530.56; said payments were reasonable in amount. We find the facts to be as stipulated. In addition, from evidence adduced, we further find: The petitioner on receiving an inquiry by mail customarily mailed a portion of wax called "first impression" material with an order blank and catalogue of prices and instructions as to how to use the wax. The customer would return it with an impression of the teeth, and was then furnished with material for a second impression. If this was satisfactory, the upper plate was made. If not satisfactory, further material was sent to get a better impression. If upon a fourth effort a satisfactory impression was not secured the procedure749 was discontinued and the deposit mailed back to the customer. If finally satisfactory, the upper plate was finished and sent c.o.d. for the price of the upper plate only, with wax for an impression for the lower plate, which in like manner was finished and sent c.o.d. The petitioner's gross receipts from the dental business in the year 1937 were $287,582.82 and in 1938 were $150,168.27. Refunds made in 1938 were $27,349 and for the year 1937 were $38,062.08. The petitioner had only one bank account, upon which he drew to pay operating expenses and refunds which were made whenever customers asked for them, whether before or after the completion of the dentures, if the customer was not satisfied. This was pursuant to a written statement included in the order blank used, to the effect that satisfaction was guaranteed or the customer's money would be refunded after a trial of the teeth of 60 days. 1. We first consider the question whether the Commissioner erred in including in petitioner's gross income amounts received by petitioner as deposits upon dental work ordered from him by mail, under a written agreement, embodied in the order blank used by the customer, that his money750 would be refunded in case of dissatisfaction. The petitioner of course has the burden of showing respondent's action to be error. Petitioner in substance contends that there was, in each of the taxable years, when the deposits were received, no certainty that the contracts would be completed, perhaps particularly in 1938, in September of which year the Post Office citation was issued, that the money had 99 not been earned, and the deposit was earnest money held in suspense; therefore the amounts did not constitute income. The respondent on his part in effect argues that the money had been received without restriction as to disposition or use, and was therefore gross income. We note at once that one element of the petitioner's argument has no factual basis in the record: though he argues, on brief, that in the taxable year "As yet, he had done no work and performed no services whereby he earned the deposit", the record does not bear out such statement. Indeed, immediately prior to the above quoted language, he had stated that nothing had been done prior to the close of the year "other than to secure either a preliminary or final impression or to commence preparation of751 the first plate" - which shows on its face that at least some work had been done, something earned. This may well have reasonably been as much as or more than the $2 deposit here involved. The record does not tell us what proportion that amount bore to the fee for the finished product. Moreover, the evidence, by stipulation, is simply that on December 31, 1937, the deposits credited to the "deposit account" by the petitioner (and which were not returned as gross income by him) were "on orders which had not been filled or completed." Likewise the amounts left in the deposit account on December 31, 1938, were those "representing deposits on orders for dentures unfilled as of that date." An exhibit refers to the deposits on hand at the close of each year as "on orders not completed as yet." This constitutes all the evidence on the point. Obviously this is no showing that the $2 deposits had not been earned during the year, merely because orders had not been "filled" or "completed." The burden being upon the petitioner, we hold that no showing is made that the deposits had not been earned during the respective taxable years. Yet the petitioner seems to recognize this point of fact752 as decisive, for on reply brief he says: The question before this Board is whether petitioner did anything in the respective years of receipt whereby he became entitled to the deposits, as earnings. Here the facts operated to place the status of the deposits, as earnings, in suspense throughout the respective years of receipt. * * * Shortly after this appear the statements quoted above to the effect that the deposits had not been earned at the end of the year. We consider it clear that there is no showing that the deposits had not been earned. The only question, then, is the effect of an agreement to return them in case of dissatisfaction. That agreement covered not only the $2 deposits, but the entire amount received, and no claim is made that the petitioner's argument applies to more than the $2 deposits, the balance being returned as income. The argument could, when limited, as we have limited it, to the effect of the written agreement to return in case of dissatisfaction, be applied to petitioner's entire income with equal logic. 100 The petitioner cites 753 Webb Press Co., Ltd.,3 B.T.A. 247">3 B.T.A. 247. That case involved a contract for sale of a cotton compress, where title was retained until acceptance, which did not occur until the next year, so that we held the money received in advance to be income in the following year. The case is of little help here, where there is no title retention and no question of acceptance. Here the customer merely has a right to return of his money if dissatisfied. Bourne v. Commissioner, 62 Fed.(2d) 648, also cited, is a similar case, where there was advance payment or "earnest money" on a contract to sell real estate, where title did not pass and deed was not delivered until a later year, in which it was held the payment constituted income. We think such cases do not control here, where there is found only agreement to refund, not a retention of title 0r a contract not accepted. The same in effect is true of Virginia Iron, Coal & Coke Co. v. Commissioner, 99 Fed.(2d) 919; and Reginald Denny,33 B.T.A. 738">33 B.T.A. 738, involved a loan, neither paid nor received as income. Here, we think, the $2 was both so paid and received. It was deposited by754 the petitioner in his only bank account, subject to his check and disposition, and, in our opinion, it was, as we said in D. H. Byed,32 B.T.A. 568">32 B.T.A. 568, 572, "subject only to an unliquidated contingent liability." It was received "under a claim of right and without restriction as to its disposition." North American Oil Consolidated v. Burnet,286 U.S. 417">286 U.S. 417; Brown v. Helvering,291 U.S. 193">291 U.S. 193. The petitioner seeks to distinguish these two cases, cited by the respondent, by the suggestion that there was no earning in the taxable year. We have above noted that there is no such proof in the record. The contract to refund was in effect that this would be done if there was dissatisfaction after a trial of 60 days. Such agreement, in our opinion, does not demonstrate that gross income does not include money received upon the contract. That the petitioner might discontinue business because of the fraud order does not require a different conclusion. On this point the respondent is not shown to have erred. 2. Was there error in refusing deduction of attorney fees paid in connection with the fraud order issued by the Postmaster General755 and finally unsuccessful effort to obtain a permanent injunction against it? The respondent cites that line of cases which holds, in sum, that expense for attorney fees is not ordinary and necessary if paid to defend, unsuccessfully, a criminal case, where there is conviction, or expense of paying fines. The petitioner seeks to distinguish the situation herein from that involved in such cases, on the ground that here remedies afforded him by the law were asserted, and that there was no judicial determination of wrongdoing or admission of illegality. Here the Solicitor of the Post Office Department issued a citation for fraud order, under a 101 statute so authorizing if he has evidence satisfactory to him that any person is engaged in conducting any scheme or device for obtaining money or property through the mails by means of false or fraudulent pretenses, representations, or promises. Petitioner unsuccessfully expended money in 1937 for attorney fees in resisting the citation issued. The Postmaster General in 1938 issued the fraud order, the petitioner secured a permanent injunction in the United States District Court against the order, but upon appeal there was reversal, 756 the Circuit Court of Appeals specifically holding that the sole question before it was whether there was substantial evidence before the Postmaster General warranting the issuance of the fraud order, that his conclusion was presumptively correct, that the judgment of the court could not be substituted for that of the Postmaster General, and that there was substantial evidence before the Postmaster General; therefore the reversal. In 1938 the petitioner expended moneys for attorney fees to secure the injunction, and to defend the appeal and unsuccessfully apply to the Supreme Court of the United States for certiorari. The amounts expended are stipulated to be reasonable. Are they allowable as ordinary and necessary expense of trade or business? After careful consideration of this somewhat novel question we have come to the conclusion that the petitioner is not entitled to the deduction claimed. National Outdoor Advertising Bureau v. Helvering, 89 Fed.(2d) 878, in our opinion governs this case. There a bill in equity was filed by the Attorney General of the United States to enjoin certain matters which he thought unlawful. A consent decree in equity issued757 forbidding the acts, but not finding that they had been committed. The Board of Tax Appeals considered that, since there was no evidence of commission of criminal acts and since the decree had been directed to acts in the future, expenses incurred in defense of the suit should be deducted. Upon appeal the Circuit Court, reversing the Board, said: * * If it is never necessary to violate the law in managing a business, it cannot be necessary to resist a decree in equity forbidding violations, except in cases where an injunction is unjustified. * * * Herein also we find proceedings not under the criminal statutes, the first, resistance to a "fraud order" citation by the Postmaster General, and the second, an injunction puoceeding by the petitioner to enjoin such order after its issuance. Though here there was no consent involved in the fraud order or the final opinion denying injunction, nevertheless there was a holding by the Postmaster General that the practice complained of existed, and a sustention thereof by the Circuit Court. It is as if in the National Outdoor Advertising case there had been a decree of injunction on the merits, without consent. We think that opinion758 is based upon the fact of decree, 102 and not the consent. The court seems to be of the opinion that if a decree of injunction is justified where there is a contention of unlawful practice, the expense is not deductible as ordinary and necessary expense. That the practices herein complained of by the Postmaster General were unlawful is demonstrated by examination of the Federal statutes: The fraud order was issued under sections 259 and 732 of Title 39, U.S. Code Annotated. The part thereof pertinent here is: The Postmaster General may, upon evidence satisfactory to him * * * that any person or company is conducting any other scheme or device for obtaining money or property of any kind through the mails by means of false or fraudulent pretenses, representations, or promises * * * [act to bar the use of the mails or forbid payment of money orders, etc.] The language is the same in the two statutes. But the same expression is the gist of a criminal statute. Section 338 of Title 18, U.S. Code Annotated, provides that: Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent759 pretenses, representations, or promises * * shall * * * place * * * any letter * * * in any post office * * * shall be fined not more than $1,000 or imprisoned not more than five years, or both. In other words, the use of the mails in any scheme for obtaining money or property by means of false or fraudulent pretenses, representations, or promises is ground for barring from the mails, and for criminal prosecution. Though no criminal prosecution is suggested in the proceeding, it is apparent that the ground for the fraud order was the unlawful character charged to the practices of the petitioner. Use of the mails for lawful purposes would be no logical basis for a fraud order. We therefore think that injunction against unlawful practices appears here just as in the National Outdoor Advertising case. That case certainly stands for the principle that a criminal case and conviction therein is not a necessary base for denial of deduction of legal expenses involved, but that a civil proceeding involving injunction against practice forbidden by law, unsuccessfully defended, calls for such denial. The reversal of the Board's view in that case, in our ooinion, requires denial*760 of the petitioner's contention here, as is shown by the fact that deduction of expense was allowed by the court in so far as the defense was successful. We cited the National Outdoor Advertising case in Textile Mills Securities Corporation,38 B.T.A. 623">38 B.T.A. 623, 631. The proceeding in which the legal expenses are involved need be only civil, such as injunction. Such proceeding here appearing, we conclude and hold that the respondent did not err in denying the claim of deduction for legal expenses in either year. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621577/	The R. T. French Company, Petitioner v. Commissioner of Internal Revenue, RespondentR. T. French Co. v. CommissionerDocket Nos. 5026-70, 5027-70, 5028-70United States Tax Court60 T.C. 836; 1973 U.S. Tax Ct. LEXIS 63; 60 T.C. No. 89; September 6, 1973, Filed 63 Decisions will be entered under Rule 50. 1. Held: Royalty payments by T corp. to an affiliated foreign company were made pursuant to licensing arrangements such as would have been entered into by parties dealing at arm's length. The royalty expenses were therefore deductible under sec. 162(a) of the 1954 Code, and the Commissioner's disallowance of such deductions under the claimed authority of sec. 482 of the Code was improper.2. T concedes that income must be imputed to it by reason of the free use by its foreign "brother-sister" affiliates of certain intangible assets owned by T. T will never receive actual payment from the affiliates for their use of such assets. Held, the British parent of T and its affiliates did not receive a "constructive dividend" in the circumstances of this case, and T therefore was not required to "withhold" income tax on any such "dividend" under sec. 1442(a) of the Code. Frederic D. H. Gilbert, Robert B. Ross, and Donald G. Koch, for the petitioners.L. William Fishman and Bernard Goldstein, for the respondent. Raum, Judge. RAUM837 The Commissioner determined deficiencies in petitioner's income tax in the amounts of $ 60,699.15 and $ 70,594.59 for the taxable years ending December 28, 1963, and January 2, 1965, respectively, and deficiencies in petitioner's withholding (section 1442(a)) tax in the amounts of $ 5,836.50 and $ 7,059.46 for the calendar years 1963 and 1964, respectively. The only issues remaining for decision are: (1) whether the Commissioner properly allocated income to petitioner, pursuant to section 482 of the 1954 Code, by reason of its participation in certain licensing arrangements with affiliated foreign companies; and (2) whether the free use by petitioner's brother-sister foreign organizations of certain intangible assets owned by it represented constructive dividends to the foreign parent company upon which petitioner was required to withhold income tax pursuant to section 1442(a) of the Code.FINDINGS OF FACTThe parties66 have stipulated to certain facts and exhibits which are incorporated herein by this reference.R. T. French Co. (French or petitioner) is a Delaware corporation engaged in the business of manufacturing and distributing various food products and other merchandise. Its principal business office was in Rochester, N.Y., at the time of the filing of its petition herein.At all times prior to January 1, 1959, petitioner kept its books and filed its income tax returns on the basis of the calendar year. At all times on and after January 1, 1959, it has kept its books and filed its income tax returns on the basis of a fiscal year consisting of a period of 52 or 53 weeks beginning at the close of its preceding fiscal year and ending on the Saturday nearest to the 31st day of December in each calendar year. See section 441(e) and (f), I.R.C. 1954. Unless otherwise indicated by the context, reference herein to a particular tax year of petitioner after 1958 without further identification will mean that fiscal year the greater portion of which was included in the particular 838 year referred to (e.g., the "year 1964" means petitioner's fiscal year ending January 2, 1965).For a number67 of years French has distributed certain instant mashed potato products in granular form -- more fully described hereinafter -- that it has manufactured under various processes derived from one invented by Theodore Rendle, an employee of Chivers & Sons Ltd. (Chivers), a British company. Chivers had acquired Rendle's British patent from him, and during World War II it engaged in the United Kingdom in the first successful effort to develop an instant mashed potato product that was exploited commercially. Chivers applied for a U.S. patent in 1943 and was granted such a patent on August 7, 1945, but never itself produced or marketed the product in this country.Chivers had insufficient capital to put the new process fully into use on its own, and it made overtures to a British firm by the name of Reckitt & Colman Ltd., which had not only sufficient capital but also substantial overseas interests that were expected to contribute to foreign exploitation of the Rendle patents. Chivers and Reckitt & Colman Ltd. thus entered into a joint venture on or about January 1, 1946, organizing a new British company known as M.P.P. (Products) Ltd. (MPP) and to which Chivers transferred all of its 68 rights in the British and U.S. patents relating to the Rendle process and also certain of the plant facilities it had earlier used in its modest implementation of that process. Chivers took 49 percent of the shares of MPP's capital stock and assumed chief responsibility for production and technical and research aspects of the new enterprise, and Reckitt & Colman Ltd. took 51 percent of the MPP stock and became in charge of marketing. MPP never had any employees of its own; its activities were carried on in its name by its parent companies. During the continuance of their joint venture in MPP, both Chivers and Reckitt & Colman Ltd. were represented on the MPP board of directors.At all times relevant hereto until the year 1955, 55 percent of petitioner's outstanding capital stock was owned by J. & J. Colman Ltd., a British company, and the remaining 45 percent of such stock was owned by Reckitt & Sons Ltd., also a British company, or by a wholly owned subsidiary known as Reckitts (U.S.A.) Ltd. J. & J. Colman Ltd. and Reckitt & Sons Ltd. were then entirely independent of one another, and neither company possessed or exercised any control over the other through stock ownership or otherwise. 69 They did, however, own or control the stock in Reckitt & Colman Ltd., referred to above, which, together with Chivers, had organized MPP.In 1954 1 J. & J. Colman Ltd. and Reckitt & Sons Ltd. were reorganized 839 to form a single British company known as Reckitt & Colman (Holdings) Ltd., which from that time forward has controlled all of petitioner's stock either directly or through its subsidiaries. Reckitt & Colman (Holdings) Ltd. and its subsidiaries are sometimes collectively referred to hereinafter as the Reckitt & Colman group, or simply Reckitt & Colman; however, use of the term "Reckitt & Colman" in a context involving periods prior to 1954 is intended to refer to the company which, together with Chivers, had organized MPP in 1946.70 On June 20, 1960, Reckitt & Colman acquired Chivers' 49-percent interest in MPP, and in December of 1961 all of the assets and business of MPP were consolidated by merger into one of the constituents of the Reckitt & Colman group, J. & J. Colman Ltd. (which was a different entity from the previously mentioned firm of the same name). After June 20, 1960, both French and MPP were thus 100-percent-owned by Reckitt & Colman interests. None of the aforementioned British companies, including Chivers, has been engaged in the conduct of any trade or business within the United States at any time relevant to these proceedings.On August 13, 1946, French and MPP entered into a license agreement in respect of the Rendle mashed potato process. As previously indicated, all of French's stock was then owned by the two British companies which, through ownership of all of the stock in Reckitt & Colman, controlled 51 percent of the stock of MPP. Under the agreement, MPP in substance purported to grant to petitioner an exclusive license to manufacture and sell within the United States the instant mashed potato product in accordance with the so-called Rendle patent, and it undertook to provide the71 "know-how" required to work the process (including any improvements and further inventions), furnishing technical advice and assistance throughout the entire term of the agreement. The licensee agreed, without payment therefor, to make available to the licensor any improvements or further inventions which the licensee might discover. Although the U.S. patent was due to expire on August 7, 1962, the agreement was to run until June 1, 1967. The agreement required the licensee to pay a royalty of 3 percent of its net sales. It further provided that if the licensee's obligation to pay this royalty should terminate prior to June 1, 1967 (e.g., upon expiration of the patent in 1962), the licensee would be required, after such termination and until June 1, 1967, to pay a net amount of 1 percent of its net sales for the advice and assistance of the licensor relating to the production of the mashed potato product.On December 13, 1956, the foregoing agreement was amended to change the amount of the royalty to 3 percent of net sales up to net 840 sales of $ 800,000 in any calendar year plus 2 percent of net sales of any excess over that amount in any such year.On or about March 14, 72 1950, French had entered into a separate and unrelated agreement with Reckitt & Colman whereby the British firm undertook to supply French with the fruits of certain research it was conducting in areas apart from the mashed potato field and into which French was contemplating eventual expansion. French undertook to pay # 5,000 a year under that agreement, and pursuant thereto it paid $ 13,984 and $ 13,951, for the years 1963 and 1964, respectively.The Rendle process, as put into operation by French after 1946, entailed, in short, cooking and mashing of raw potatoes, admixture of the mash with "seed powder," and dehydration of the resulting material under carefully controlled conditions to yield granules that could be reconstituted into mashed potatoes suitable for consumption by the addition of water or milk. The entire process required approximately 2 hours. The "seed powder" consisted of the finished granules themselves, and the "adding back" of that powder was fundamental to the Rendle process. French obtained seed powder from MPP (or Chivers) until it produced sufficient amounts of powder to fulfill its own needs.The Rendle process could not readily be instituted without73 special equipment and technical assistance, which French obtained from Chivers through MPP. In the latter connection, a Chivers employee named Frank Diver was sent to Rochester to help French set up a pilot operation late in 1946. During Diver's stay of approximately 2 months, he assisted in the erection of the equipment and instructed French personnel in all phases of the Rendle process.French constructed a larger plant at Rochester for commercial production of potato granules during 1947, and operations at that facility commenced late in 1947 or early in 1948. Another Chivers employee, A. R. Williamson, made several brief visits to Rochester around that time to deal with matters similar to those with which Diver had been involved during his earlier visit, and a third Chivers representative, Commander William Hughes, became the permanent manager of the Rochester plant. Hughes thereafter drew no salary from Chivers; he continued to work for French until around 1958, by which time his annual salary amounted to approximately $ 12,000. After the larger plant was put into use, French sent samples weekly to be evaluated in the Chivers laboratories in order to assure that the quality74 of the French and MPP products were on a par.Production of mashed potato granules was carried on at Rochester until 1952. By then it had become apparent that the variety of potato grown in that part of the country was not particularly well suited to 841 the Rendle process and that a more acceptable product could economically be made from Idaho russet potatoes. French accordingly discontinued operations at Rochester and entered into a subcontracting arrangement with the J. R. Simplot Co. whereby Simplot would take over the manufacture of granules in Idaho with French equipment and expertise. Production was thus carried on in Idaho with Simplot personnel, although Hughes transferred to the new plant to assure that the process was being properly handled and generally to oversee matters on behalf of French. No other employee of French was continuously present in Idaho during the time the Simplot arrangement remained in effect.While production of mashed potato granules was being carried on by Simplot in Idaho, French was conducting research at Rochester that was hoped to lead to the replacement of the "batch" process then in use with a "continuous" process which would combine75 into one step the first two phases of the batch process -- that is, the cooking and mashing of the raw potatoes and the adding back of the seed powder. The continuous process would not displace the basic Rendle process, but rather was seen simply as a refinement of it. With the aid of a New York engineering firm, Henry Peck Associates, which was compensated for its work on a fee basis, and also after consultations with Chivers researchers who themselves had been engaged in a similar project, French developed an acceptable continuous process by 1956 or 1957.When it became apparent that the new process could successfully be employed, it was decided that French's contractual arrangement with Simplot would be "phased out" and that French, using the continuous process, would undertake the manufacture of instant mashed potatoes at a new plant at Shelley, Idaho, on its own behalf. During the early period of production at Shelley, A. R. Williamson of Chivers again came to the United States (his two or three visits consumed approximately 3 months in the aggregate) to contribute to the solution of certain technical problems relating to the new process and to assist generally with the transition. 76 He also acquired expertise there that contributed to the institution of a similar process by MPP. Simplot, after the final severance of its relationship with French, has continued in the instant mashed potato field and since become a major competitor of French.The development of the continuous process by French and Peck Associates in conjunction with Chivers was but one example of the continuing close cooperation between the French and Chivers research laboratories that was at least implicitly called for by the provisions of the August 13, 1946, license agreement covering the mutual exchanges of any improvements and further inventions. During its first 842 years in the instant mashed potato field, French had insufficient expertise to carry on its own research projects, and it drew instead on the efforts of Chivers researchers, whose work was done in MPP's interest. Thus, from 1946 to 1950, Dr. E. G. Williams of Chivers carried on basic research which ultimately led to the solution of certain problems that had been encountered in both England and the United States in respect of the deterioration of the packaged instant mashed potato product on the shelves of retail stores, 77 namely, tendencies to become rapidly stale and acquire a distorted flavor and also to become brown in warmer climates. Williams discovered that the "staling" and "browning" effects could be avoided by packaging the product with an inert gas instead of ordinary air with an oxygen content and by reducing the moisture content of the packages. During the course of his research, Williams regularly transmitted progress reports to French, and French ultimately made use of his studies, in conjunction with certain U.S. container manufacturers, to develop a method of packaging that gave the product a much-improved shelf life. MPP was then selling its products only to bulk consumers and not to householders, so the results of the packaging studies in the United States were of no immediate use to it.Various other research projects were undertaken by Chivers in the name of MPP during the 1940's, some of which generated results that were useful to French. French first began potato research in 1951 or 1952, and its activities in that field increased substantially throughout the 1950's. Its main research facilities were at Rochester, where, in addition to potato research, it was active in many78 other areas of inquiry related to its business.French was the only U.S. producer of instant mashed potatoes until around 1956 or 1957. Thereafter, it encountered substantial competition in the household market from a newly developed kind of instant mashed potato product known as "potato flakes." Petitioner marketed under its label a line of flakes that was produced for it by another manufacturer. It produced no flakes itself, however, although it had done some research in the field in conjunction with Chivers. French also met competition in the field of granules, which continued to be popular among bulk consumers such as restaurants, schools, and jails. At the time of the trial herein, the granule market represented approximately two-thirds of the entire instant mashed potato market, and French held approximately 25 percent of the granule market.On or about December 29, 1958, a lawsuit charging French with patent infringement was filed in the U.S. District Court for the District of Delaware by Templeton Patents, Ltd. The plaintiff was one of a number of British companies controlled by Robert Alexander Spencer Templeton, the successor in interest to certain British and U.S.79 843 potato patents that were similar to, and allegedly preemptive of, the Rendle patents. Templeton Patents alleged in its complaint that a "reasonable royalty for the right to employ the inventions of the [Templeton] patents in suit is the sum of five cents for each pound of improved reconstitutable dried potato product produced utilizing said inventions" and that a "pound of potato product produced by utilizing the inventions claimed in [Templeton's] patents sells at retail for approximately sixty cents a pound, is sold by the defendants * * * for aproximately thirty cents a pound, and costs said defendants approximately twenty cents a pound to produce." French denied the foregoing allegations and the fact of the alleged infringement in its answer, and claimed that the Templeton patents were invalid and unenforceable against French for a variety of stated reasons.The Templeton suit was settled by the parties without trial and dismissed with prejudice by court order of January 31, 1961. A written agreement entered into on January 4, 1961, between French, MPP, Templeton Patents, and Robert Alexander Spencer Templeton provided for the disposition of certain past, present, and80 future controversies (including the aforementioned litigation) between members of the Reckitt & Colman group (including French & MPP) on the one hand, and the various Templeton companies, on the other. The only monetary payment called for by the agreement was a $ 65,000 payment by French to Templeton Patents.Sometime during the pendency of the Templeton Patents suit, MPP was involved in similar litigation in England with another Templeton company. The eventual settlement of that lawsuit involved the payment of an insubstantial amount by MPP to the Templeton company, but otherwise left the parties in the same relative positions as they had been before the case was brought. Prior to the settlement of the U.S. and British suits, however, an attorney representing French in the Templeton Patents case came to the conclusion that the making of certain modifications in the August 13, 1946, license agreement between French and MPP would enable French to mount a more effective defense against certain issues that had arisen in the British litigation and were expected to be raised in the U.S. litigation. It appeared that the strength of the plaintiff's case against French depended in large81 part upon the extent to which French was in fact and in form making use of the Rendle patents. The processing methods by then practiced by French were, in fact, somewhat different from the process outlined in the Rendle patents, and counsel for French desired as well to convert the agreement with MPP into one in respect of "know-how" only and to eliminate the earlier provisions mentioning the exclusive license under the patents. A draft of a new agreement was thus prepared and submitted to an executive of Reckitt & Colman 844 under a cover letter dated March 17, 1960. The agreement was executed on December 21, 1960 -- while the Templeton Patents suit was still pending and after both French and MPP had become 100-percent-controlled by Reckitt & Colman interests. It provided, in relevant part, as follows:Whereas, the parties have previously entered into an agreement dated August 13, 1946; andWhereas, the parties desire to cancel such agreement and to enter into an agreement on the terms and conditions hereinafter set forth; andWhereas, M.P.P. is possessed of certain information, knowledge, technical data, and know-how relating to the manufacture of mashed potato powder; 82 andWhereas, FRENCH desires to obtain a license to use such information, knowledge, technical data, and know-how on the terms and conditions hereinafter set forth;Now, Therefore, it is agreed by the parties hereto as follows:1. The agreement between M.P.P. and FRENCH, dated August 13, 1946, is hereby terminated and cancelled, except for FRENCH's obligation to pay to M.P.P. royalties heretofore accrued under that agreement.2. M.P.P. hereby grants to FRENCH a nonexclusive license under M.P.P.'s information, knowledge, technical data, and know-how for the manufacture of mashed potato powder (hereinafter called "the licensed process"), and to use and sell mashed potato powder so manufactured (hereinafter called "the licensed product").3. FRENCH agrees to pay to M.P.P. a royalty at the rate hereinafter specified of the net price at which the licensed product shall be sold by FRENCH * * . The rate referred to at the beginning of this paragraph shall be 2% on sales made up to December 31, 1961 and 1% on sales thereafter made up to the expiry date as determined under paragraph 12 hereof. * * 7. M.P.P. shall at the request of FRENCH disclose or procure to be disclosed to such of 83 the directors and employees of FRENCH as FRENCH may consider necessary the whole of the licensed process and of the method of operation thereof. M.P.P. also agrees to advise and assist FRENCH in all matters relating to the method of working the licensed process, improvement of production, and generally regarding the manufacture of the licensed product.* * * 9. During the continuance of this license, M.P.P. shall forthwith disclose to FRENCH all future improvements or inventions, whether patentable or not, relating to the licensed process which M.P.P., or any employee of M.P.P. to the benefit of whose inventions M.P.P. is entitled, may discover or make, or which may be brought to M.P.P.'s knowledge and which M.P.P. shall be at liberty to disclose * 10. During the continuance of this license, FRENCH shall forthwith disclose to M.P.P. all improvements or inventions, whether patentable or not, relating to the licensed process which FRENCH, or any employee of FRENCH to the benefit of whose inventions FRENCH is entitled, may discover or make or which may be brought to FRENCH's knowledge and which FRENCH shall be at liberty to disclose * ** * * 12. This agreement shall continue84 in full force until June 1, 1967 * * *845 The U.S. patent on the Rendle process held by MPP expired on August 7, 1962. Had the original license agreement of August 13, 1946, then remained in force, the expiration of the patent upon which it was based presumably would have rendered inoperative the exclusive license provisions of that agreement and activated instead the "know-how" provisions establishing the 1-percent royalty. Thus, apart from modification of the royalty rate during the period December 21, 1960 (date of execution of the new agreement), to August 7, 1962 (date of expiration of the U.S. patent), the terms of the December 21, 1960, agreement left the relative rights and obligations of the parties substantially the same as they would have been under the prior agreement.The benefits of the potato research that had been carried on at the Chivers laboratories ceased to be available to French and MPP following Chivers' withdrawal from the MPP joint venture on June 20, 1960. Mashed potato research was taken up, however, at the British research laboratories of J. & J. Colman Ltd., the Reckitt & Colman (Holdings) Ltd. subsidiary that eventually absorbed MPP. MPP and85 French thus continued their close cooperation in potato research through J. & J. Colman Ltd. at least until June 1, 1967, when the December 21,1960, agreement was to expire.The research projects undertaken after 1960 included efforts by both the French and J. & J. Colman Ltd. laboratories to develop more easily reconstitutable products and means of preventing raw potatoes from sprouting while being stored prior to processing. In addition, French and Peck Associates pursued their studies of the continuous process, and refinements of that process were made from time to time and communicated to the British laboratories. A process for using unpeeled potatoes was developed by the J. & J. Colman Ltd. laboratories and tested by French, but was ultimately abandoned. Some further work on potato flakes was done in England, where a particular demand for products based on flakes was foreseen. Extensive cooperation between the French and J. & J. Colman Ltd. laboratories and full disclosure of results to the other typified all of the research projects undertaken by the British and U.S. laboratories.French produced approximately 1,200 tons of instant mashed potato product during each of its86 first few years of potato operations; that average increased to approximately 2,000 tons per year during the period of the Simplot subcontract. Production figures rose considerably after institution of the continuous process, and at the time of the trial herein French produced approximately 20,000 tons per year of instant mashed potato product. MPP produced about 4,000-6,000 tons per year until around 1950; its production thereafter leveled off at approximately 2,500-3,000 tons per year.846 MPP entered into one other agreement during the 1940's authorizing the exploitation of its mashed potato expertise by another organization. That agreement, with an unrelated firm based in Paris, France, known as "Produsol," was executed on February 21, 1949, and terminated approximately 4 years later after "Produsol" found itself unable to market the product in France. Like the agreement with petitioner of December 21, 1960, the "Produsol" contract was not expressly based upon any patent. As translated from the original French into English, it provided, in part, as follows:1. M.P.P. will * * * apprise the qualified representatives of "Produsol" of the secret process for manufacturing87 the product called "M.P.P.", and will thereafter keep "Produsol" advised of improvements * 2. M.P.P. will also give "Produsol" all information and technical assistance necessary to enable it to manufacture the product according to the best known methods which it uses itself * ** * * 5. "Produsol" agrees to advise M.P.P. without delay of all information * * concerning the improvements it may achieve or acquire itself in the M.P.P. production processes. * * 6. "Produsol" agrees to establish, upon signing these presents, in a factory already in existence or to be built in France, an installation for the manufacturing of the M.P.P. product with a production capacity of 400 tons (English measure) annually * ** * * 8. In return for the advantages hereinabove set forth, "Produsol" will pay to M.P.P. an advance of 5% on the net sale price of all potato products manufactured and sold during the period of the present agreement. * ** * * 10. In the event "Produsol" should decide to increase production of mashed potato powder beyond the capacity provided for the equipment established in accordance with article 6 hereinabove, this increase must be a minimum of 1,000 English88 tons per annum, and in this case "Produsol" agrees to give M.P.P. the option to participate, either itself or through any persons or companies designated by it, under the same conditions as all other subscribers and up to 50%, in the subscription of capital of any new company which may be formed to acquire the fixed assets and tangible assets of "Produsol" * * If M.P.P. exercises this option, the royalty payment hereinabove provided will be reduced by 2 1/2% as soon as the new installation has attained actual production of 1,000 English tons per annum. If the option is not exercised within a period of six months after "Produsol" has advised M.P.P. in writing of its intention to increase production, "Produsol" will continue to pay royalties at the rate of 5% on the entirety of the production.The following table reflects the annual dollar volume of mashed potato sales in respect of which petitioner made payments claimed as royalties during its taxable years 1948-64, the rate applied by petitioner (pursuant to its various agreements with MPP) in computing the amounts of those payments, and the annual payments made and 847 claimed by petitioner as deductions on its Federal income89 tax returns for each respective year:YearSalesRatePayments1948$ 524,1853%$ 15,7261949841,9823%25,2591950669,1153%20,07319511,203,8043%36,09319521,228,3933%36,8521953838,7253%25,1621954931,3783%27,94119551,838,2713%55,14819562,286,554(3% on $ 800,000)53,731(2% on excess)19573,975,249(2% on excess)87,50519588,739,878(2% on excess)182,79819594,332,076(2% on excess)94,64219608,460,103(2% on excess)177,20219618,998,9192%179,97819629,374,9671%93,75019639,805,8361%98,058196412,162,3451%121,623The Commissioner disallowed none of the deductions claimed by French in respect of the payments made during the taxable years 1948-62. In his deficiency notices to petitioner for each of the taxable years 1963 and 1964 (ending December 28, 1963, and January 2, 1965, respectively) he determined that --you engaged in transactions with your affiliate whereby you made payments to said affiliate designated on your return as "license fees" [for 1963, or "license fees and royalties," for 1964]. Said transactions were not made at arms length. Under the authority90 of Section 482 of the 1954 Code additional gross income is allocated to you in the amount of $ 98,058.00 [for 1963, and $ 121,623.00, for 1964], which allocation is necessary to clearly reflect your income and the income of your affiliate.The figures shown in the above table for payments made in fiscal 1963 and 1964 do not include any amounts paid by petitioner under its March 14, 1950, agreement with Reckitt & Colman; those items ($ 13,984 and $ 13,951 for each respective year) were separately deducted on petitioner's tax returns.For each of the years 1963 and 1964, petitioner formally declared and paid dividends of $ 1,750,000 in the aggregate to its stockholders in the Reckitt & Colman group. It duly reported those payments on its respective United States Annual Returns of Income Tax to be Paid at Source (Treasury Forms 1042) and withheld tax thereon at the rate of 5 percent. The parties are agreed that if the Commissioner's determination in respect of the claimed royalty payments for 1963 and 1964 ($ 98,058 and $ 121,623, respectively) is sustained, then those amounts, which were actually paid, are to be treated as dividends and subjected to withholding of additional tax91 at the source at the rate of 5 percent.The Commissioner also determined, under the authority of section 848 482, that petitioner received additional income of $ 18,671.90 and $ 19,566.18 in 1963 and 1964, respectively, by reason of the free use of its "trademarks, patents, know-how, etc." by its foreign "brother-sister" affiliates. The foregoing amounts represented percentages of the affiliates' net sales, as computed by the Commissioner. The affiliates do not intend ever to pay those amounts to petitioner. Such amounts and the consideration for which they were paid appear to be unrelated to the instant mashed potato business involved in the principal issue herein. Petitioner does not now contest the Commissioner's determination that it received additional income, but it does contest his further determination that the free use of the intangibles referred to gave rise to "constructive dividends" to the English parent which are subject to "the 5% withholding tax under section 1442(a) of the 1954 Code as modified by Article VI of the United States-United Kingdom Tax Treaty as then in effect." Petitioner had earned surplus at the end of each year greatly in excess of the amounts92 of the so-called "constructive dividends."OPINIONSection 482 of the 1954 Code 2 empowers the Commissioner to allocate income between or among commonly controlled organizations if he determines that such allocation "is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations." The critical inquiry for the purpose of revealing distortions in income, whether or not such distortions may have resulted from tax-avoidance considerations, is generally whether the transaction in question would have been similarly effected by parties dealing at arm's length. See Huber Homes, Inc., 55 T.C. 598">55 T.C. 598, 605, 606; L. E. Shunk Latex Products, Inc., 18 T.C. 940">18 T.C. 940, 956; secs. 1.482-1(a)(6), 1.482-1(b)(1), and 1.482-1(c), Income Tax Regs. It is by that standard that the royalty payments here in issue must be measured. See secs. 1.482-2(b)(1) and 1.482-2(d)(1)(i), Income Tax Regs. We hold that those payments were made pursuant to agreements such as would have been negotiated and entered into by parties dealing at arm's length, and that the Commissioner's contrary determination cannot stand. 93 849 The Commissioner's determination is initially subject to attack under those decisions suggesting that section 482 is not an appropriate tool for the mere disallowance of a claimed94 deduction, e.g., Hypotheek Land Co. v. Commissioner, 200 F. 2d 390, 396 (C.A. 9), reversing 16 T.C. 1268">16 T.C. 1268; Chicago & North Western Railway Co., 29 T.C. 989">29 T.C. 989, 997-998; General Industries Corporation, 35 B.T.A. 615">35 B.T.A. 615, 617; 397 for, by "allocating" to petitioner additional gross income in amounts equal to the deductions it claimed in 1963 and 1964 in respect of its royalty payments, the Commissioner has, in effect, simply disallowed the claimed deductions. However, his determination might nonetheless be supported on a different theory, namely, that the payments did not represent "ordinary and necessary" business expenses under section 162(a) of the Code. See Stearns Magnetic Mfg. Co. v. Commissioner, 208 F. 2d 849, 851-852 (C.A. 7), reversing and remanding a Memorandum Opinion of this Court; Robert Lee Merritt, 39 T.C. 257">39 T.C. 257, 269-270, reversed on another issue 330 F. 2d 161 (C.A. 4), which was in turn reversed sub nom. Paragon Jewel Coal Co. v. Commissioner, 380 U.S. 624">380 U.S. 624;95 Differential Steel Car Co., 16 T.C. 413">16 T.C. 413, 423-425; Granberg Equipment, Inc., 11 T.C. 704">11 T.C. 704, 713-714; Rev. Rul. 69-513, 2 C.B. 29">1969-2 C.B. 29. 4 It is clear from the foregoing authorities that the "arm's length" test commonly associated with section 482 is equally applicable in ascertaining the "ordinary and necessary" character of a payment to a related entity. Although the deficiency notice was explicitly founded upon section 482, petitioner, far from insisting that it has been unfairly surprised by the belated introduction of section 162 into the case, has framed a principal argument in its original brief in terms of that section. Cf. Kerry Investment Co., 58 T.C. 479">58 T.C. 479, 493; Richard Rubin, 56 T.C. 1155">56 T.C. 1155, 1163-1164, affirmed per curiam 460 F. 2d 1216 (C.A. 2). 5 It is therefore unnecessary for us to express any opinion as to the appropriate role of section 482 in the context of this case, for the substantive decisional criteria relevant to the present controversy are 850 identical in whichever96 posture the matter is viewed. 6 Cf. Sparks Nugget, Inc. v. Commissioner, 458 F.2d 631">458 F. 2d 631, 634 (C.A. 9), affirming a Memorandum Opinion of this Court, certiorari denied sub nom. Graves v. Commissioner, 410 U.S. 928">410 U.S. 928.98 The single distinction between sections 162 and 482, for present purposes, relates to the measure of proof that must be offered by the petitioner in order to overcome the presumptive correctness of the Commissioner's determination. The petitioner bears a heavier burden in seeking to overturn a determination under section 482, for it is well settled that the "Commissioner has considerable discretion in applying this section and his determinations must be sustained unless he has abused his discretion. We may reverse his determinations only where the taxpayer proves them to be unreasonable, arbitrary, or capricious." Pauline W. Ach, 42 T.C. 114">42 T.C. 114, 125-126, affirmed 358 F. 2d 342 (C.A. 6), certiorari denied 385 U.S. 899">385 U.S. 899; see also B. Forman Co. v. Commissioner, 453 F.2d 1144">453 F. 2d 1144, 1151-1152 (C.A. 2), reversing in part and affirming in part 54 T.C. 912">54 T.C. 912, certiorari denied 407 U.S. 934">407 U.S. 934, rehearing denied 409 U.S. 899">409 U.S. 899; Philipp Brothers Chemicals, Inc. (N.Y.) v. Commissioner, 435 F. 2d 53, 5799 (C.A. 2), affirming 52 T.C. 240">52 T.C. 240; Dillard-Waltermire, Inc. v. Campbell, 255 F.2d 433">255 F. 2d 433, 435-436 (C.A. 5); Grenada Industries, Inc., 17 T.C. 231">17 T.C. 231, 255, affirmed 202 F. 2d 873 (C.A. 5), certiorari denied 346 U.S. 819">346 U.S. 819. In our judgment, however, the record firmly supports the petitioner's position that its royalty payments were made in circumstances as would have existed between parties dealing at arm's length, and, assuming that the standard of review more favorable to the Commissioner is in fact applicable here, we think that his determination must nonetheless be disapproved.Petitioner first entered into a license agreement covering a process for the manufacture of an instant mashed potato product in 1946. The licensor under that agreement was a British company known as MPP; it held British and U.S. patents on the process and marketed instant mashed potatoes in Great Britain. In 1946, 51 percent of the shares of stock in MPP was owned by the British firm of Reckitt & Colman Ltd., which itself was jointly owned by two unrelated British companies100 then controlling 55 percent and 45 percent, respectively, of the outstanding capital stock in petitioner. The remaining 49 percent of MPP's stock was held by yet another independent British firm, Chivers & Sons Ltd.The 1946 agreement was to remain in force for approximately 20 years. Its provisions related to two separate periods of the 20-year 851 term, the first and principal one of which ended with the termination of the patent. Under the main part of the agreement, MPP granted to petitioner an exclusive license to work, use, and exercise the patented process and to sell the product made in accordance therewith within the United States, and MPP further agreed "to advise and assist the Licensee in all matters relating to the method of working the said process, improvement of production, and generally regarding the manufacture of cooked potato products" (punctuation supplied). In consideration of MPP's undertakings, petitioner was to pay MPP a royalty at a rate of 3 percent of petitioner's net sales of potato products manufactured under the patented process.There is no dispute between the parties to these proceedings that the foregoing provisions were to lapse upon the101 expiration of MPP's U.S. patent on the instant mashed potato process (which occurred on August 7, 1962) and that supplemental provisions in the 1946 agreement, relating to "know-how" only, were thus to become operative and to remain in force for the duration of the agreement. There was nothing in the supplemental provisions relating to an exclusive license; MPP's undertakings under those provisions were limited to the rendition of advice and assistance, as specified in the above-quoted clause from the main part of the agreement. The royalty rate was thus to be reduced to 1 percent. The 1946 agreement also contained provisions, operative "During the continuance of this Licence," pursuant to which MPP and petitioner were to disclose to the other all "improvements" and "further inventions" related to the process that might in any manner become known to either party.The Commissioner does not seriously contend that the 1946 agreement was not representative of an arm's-length bargain. To be sure, the opportunity may have existed for petitioner's two unrelated British parent companies, which also jointly owned the company holding a majority of MPP's stock, to cause petitioner to agree102 to an arrangement that unfairly favored MPP, but it seems unlikely that petitioner's parent companies would have done so, because they would thus have been diverting funds from a corporation (petitioner) in which they were the sole stockholders to another corporation (MPP) in which a stranger (Chivers) owned 49 percent of the stock. The position of Chivers in the scheme of things in all likelihood assured the arm's-length character of the transaction. 7103 852 Moreover, the only other agreement entered into by MPP authorizing the exploitation of its mashed potato process by another organization was with a wholly unrelated company known as "Produsol," and the terms of that agreement were at least as favorable to MPP as those of its agreement with petitioner. The "Produsol" agreement, executed in 1949, included no exclusive license provisions based on any patent, but rather was one covering "know-how" only. Like the agreement with petitioner, it was to remain in force for 20 years and provided for each party to inform the other of any discovered "improvements" upon the MPP process. The royalties payable by "Produsol" in return for the benefits it was to receive, which were, if anything, less comprehensive than those promised to petitioner, were greater than those to be paid by petitioner.In view of the "Produsol" agreement, it is prima facie apparent that the 1946 agreement was not at all unreasonable, at least from petitioner's standpoint. In later years, to be sure, MPP (through Chivers) derived substantial benefits from petitioner's own considerable research efforts, and, in Templeton Patents, Ltd. v. J. R. Simplot Co., 336 F. 2d 261104 (C.A. 9, 1964), affirming 220 F. Supp. 48">220 F. Supp. 48 (D. Idaho 1963), a process closely resembling the one licensed in 1946 was found to be based on principles already available to the public and therefore not patentable. 8105 The process controlled by MPP, however, was apparently not so well known even in 1949 that "Produsol" was unwilling to pay for it, 9 and the subsequent developments in the relationship between petitioner and MPP suggest only that petitioner might have secured the license on even more advantageous terms if the contracting parties had been able to foresee those developments in 1946. What later transpired in no way detracted from the reasonableness of the agreement when it was made.The royalty provisions of the 1946 agreement were modified by an agreement executed in 1956, by which time petitioner's two British parent companies had merged. The 1956 agreement called for payments at the old rate of 3 percent upon only the first $ 800,000 in annual sales and at 2 percent upon annual sales in excess of that amount. The record is silent as to the reason for that change, but whatever the reason, the parties do not appear to have attributed any consequence to it in respect of the issue before us. However, the 1956 modification, in any event, only made the 1946 agreement comparatively more attractive to petitioner.853 The final revisions in the contractual arrangements between petitioner and MPP, which resulted in the agreement under which the payments here in issue were made, were effected in 1960, after both petitioner and MPP had come fully within the common control of the same British interests. The 1960 agreement superseded the 1946 agreement and was to remain in force for the duration 106 of the period covered by the earlier instrument. It granted to petitioner "a nonexclusive license under M.P.P.'s information, knowledge, technical data, and know-how" for the manufacture and sale of the same instant mashed potato product that had been the subject of the 1946 agreement and provided for royalties to be paid at rates (2 percent on sales made up to December 31, 1961, and 1 percent on sales made thereafter) that were roughly comparable to those called for by the 1946 agreement, at least under the supplemental provisions that were to become effective in August of 1962. The 1960 agreement further contained reciprocal covenants, similar to those in the earlier agreement, relating to disclosure of "improvements or inventions" in connection with the licensed process.The principal effect of the contractual modifications made in 1960 was thus to eliminate references in the 1946 agreement to the patents held by MPP, and the record makes it clear that the sole purpose of the 1960 changes was to bolster petitioner's defense to patent infringement charges that had been brought against it by an unrelated company. The Commissioner does not seriously dispute that such was the purpose107 of the 1960 agreement, nor does he deny that the rights and obligations of the parties under that agreement were little different in substance from those set forth in the 1946 agreement or that the royalties paid by petitioner during the particular taxable years here in issue would have been computed in precisely the same manner under either agreement.Plainly, the mere fact that petitioner and MPP were controlled by the same interests at the time the 1960 agreement was executed is an insufficient ground for disallowance of the claimed royalty deductions so long as the "arm's length" test is met. Cf. L. E. Shunk Latex Products, Inc., 18 T.C. 940">18 T.C. 940, 957; Grenada Industries, Inc., 17 T.C. 231">17 T.C. 231, 254-255, affirmed 202 F. 2d 873 (C.A. 5), certiorari denied 346 U.S. 819">346 U.S. 819. Had petitioner been contractually bound to an unrelated licensor when its patent infringement difficulties arose prior to 1960, there would still be every reason to believe that it might have successfully prevailed upon such a licensor to consent to a modification of the 1946 agreement deleting the troublesome108 references to the patents. But such consent surely could only have been procured if the licensor's rights under the prior contract were left substantially unimpaired. 854 And it was just that sort of arrangement that was in fact settled upon in 1960 by petitioner and MPP, apart from the interim modification of the rate of royalties until the time of expiration of the patent in 1962. 10109 The Commissioner has focused on the particular taxable years in question, 1963 and 1964, and pointed out that petitioner received no significant benefits in those years in return for its royalty payments, that the process licensed under the 1946 agreement was by then widely understood throughout the food industry and therefore of little or no marketable value, and that petitioner had by then developed an impressive potato research capability of its own, the fruits of which it generally made available to its English affiliate without receiving any royalties. The point is, however, that it is inappropriate to view 1963 and 1964 in isolation. The royalties were not necessarily paid for value received during those particular years; rather, they were paid pursuant to valid commitments reasonably undertaken by petitioner as if it had dealt with MPP at arm's length. There is no reason to believe that an unrelated party in MPP's position would have permitted petitioner to avoid its contractual obligations at any time prior to the expiration date of the 1946 and 1960 agreements. The Commissioner's determination therefore cannot stand. Cf. Consolidated Apparel Co. v. Commissioner, 207 F. 2d 580, 583-584110 (C.A. 7), reversing in this connection 17 T.C. 1570">17 T.C. 1570.2. In addition to the allocation under section 482 dealt with above, the Commissioner has also allocated to petitioner additional income ($ 18,671.90 and $ 19,566.18) for the years 1963 and 1964, respectively, representing 1 percent of the net sales of its foreign "brother-sister" affiliates that had free use of petitioner's "trademarks, patents, know-how, etc.," in respect of matters which appear to be unrelated to the mashed potato business. Petitioner is not now contesting that determination. The Commissioner has also determined, however, that the affiliates' free use of these intangibles represented a "constructive dividend" flowing from petitioner to the common British parent and that petitioner 855 was required to withhold income tax thereon under section 1442 (a) of the Code (as modified by article VI of the relevant tax treaty). 11111 It is stipulated that petitioner will never actually receive the income that has been imputed to it under section 482, but the Commissioner's theory is that "petitioner has constructively received that amount [and] passed it constructively to the common parent which has, by permitting its foreign subsidiaries to keep the funds, increased its capital in the petitioner's foreign brother-sister affiliates."It has been held that a distribution by a corporation to a "brother-sister" corporation will be regarded as a dividend to the common shareholder only if the distribution was made for the benefit of the shareholder. See Sammons v. Commissioner, 472 F. 2d 449, 451-452 (C.A. 5), affirming in this respect a Memorandum Opinion of this Court; Sparks Nugget, Inc. v. Commissioner, 458 F.2d 631">458 F. 2d 631, 637-638 (C.A. 9), affirming a Memorandum Opinion of this Court, certiorari denied sub nom. Graves v. Commissioner, 410 U.S. 928">410 U.S. 928; Biltmore Homes, Inc. v. Commissioner, 288 F.2d 336">288 F. 2d 336, 340-341 (C.A. 4), certiorari denied 368 U.S. 825">368 U.S. 825, 112 affirming a Memorandum Opinion of this Court; Clayton E. Greenfield, 60 T.C. 425">60 T.C. 425, 434-435; Glenn E. Edgar, 56 T.C. 717">56 T.C. 717, 758-759; PPG Industries, Inc., 55 T.C. 928">55 T.C. 928, 1002-1003; W. B. Rushing, 52 T.C. 888">52 T.C. 888, 893, affirmed on other issues 441 F. 2d 593 (C.A. 856 5); cf. Worcester v. Commissioner, 370 F. 2d 713, 715 (C.A. 1), affirming in this respect a Memorandum Opinion of this Court; George R. Tollefsen, 52 T.C. 671">52 T.C. 671, 681, affirmed 431 F. 2d 511 (C.A. 2), certiorari denied 401 U.S. 908">401 U.S. 908.The dividends actually declared and paid by petitioner in each of the years in issue ($ 1,750,000 in each year) were so vastly in excess of the additional amounts that the Commissioner would treat as dividends to petitioner's parent corporation ($ 18,671.90 in 1963 and $ 19,566.18 in 1964) that we cannot believe that the free use of petitioner's intangibles represented an attempt by the parent to direct further benefits to itself. 113 It can only be inferred that whatever benefits the parent may have received from these arrangements between its subsidiaries were merely derivative in nature, and it is clear under the foregoing authorities that "constructive dividend" treatment is therefore uncalled for. There being no dividend, petitioner had no duty to withhold any tax. We therefore do not consider the tantalizing question whether it would have been possible for petitioner to "withhold" the required 5 percent in the circumstances of this case.Decisions will be entered under Rule 50. Footnotes1. A possible conflict exists between the finding as to this date and the finding in the preceding paragraph that "until the year 1955" the stated percentages of petitioner's stock were owned by J. & J. Colman Ltd. and Reckitt & Sons Ltd. However, both findings are based upon the stipulation of the parties.↩2. 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. See also Convention with the United Kingdom Respecting Double Taxation and Taxes on Income, Apr. 16, 1945, art. IV, 60 Stat. 1377, 1380, T.I.A.S. No. 1546.↩3. The attitude toward sec. 482 revealed in the cited cases is analogous to that reflected in such decisions as Huber Homes, Inc., 55 T.C. 598">55 T.C. 598, 607-610, and Kahler Corp., 58 T.C. 496">58 T.C. 496, 507-508, nonacq. 2 C.B. 3">1972-2 C.B. 3, which held that sec. 482 may not be used to "create" hypothetical income for a member of a controlled group in a case where the group as a whole derived no income from dealings with third parties that could be related to non-arm's-length transactions within the group. See also Kerry Investment Co., 58 T.C. 479">58 T.C. 479, 490-491, nonacq. 2 C.B. 3">1972-2 C.B. 3. But see B. Forman Co. v. Commissioner, 453 F. 2d 1144, 1155-1156 (C.A. 2), certiorari denied 407 U.S. 934">407 U.S. 934, rehearing denied 409 U.S. 899">409 U.S. 899, reversing in this connection 54 T.C. 912">54 T.C. 912↩.4. See also The Nestle Co., Inc., 22 T.C.M. 46↩, 59.5. In any event it is well established in this connection that a deficiency may be sustained on grounds other than those relied upon by the Commissioner or even where the grounds advanced by him may be incorrect. See Wilkes-Barre Carriage Co., 39 T.C. 839">39 T.C. 839, and cases cited at pp. 845-846, affirmed 332 F. 2d 421 (C.A. 2); Estate of Dorothy E. Beck, 56 T.C. 297">56 T.C. 297, 374; Adirondack League Club, 55 T.C. 796">55 T.C. 796, 813-814 (concurring opinion), affirmed 458 F. 2d 506↩ (C.A. 2).6. The manner in which secs. 162 and 482 intersect, at least for purposes of this case, is thus to be distinguished from situations involving the relationship between sec. 482 and the far more general principles of sec. 61(a). Cf. Rubin v. Commissioner, 429 F. 2d 650, 653-654 (C.A. 2), reversing and remanding 51 T.C. 251">51 T.C. 251; Grenada Industries, Inc., 17 T.C. 231">17 T.C. 231, 252-253, affirmed 202 F. 2d 873 (C.A. 5), certiorari denied 346 U.S. 819">346 U.S. 819↩.7. The matter here considered is entirely different from the superficially similar situation in B. Forman Co. v. Commissioner, 453 F. 2d 1144, 1153-1155 (C.A. 2), reversing in this connection 54 T.C. 912">54 T.C. 912. There two unrelated corporations were the sole stockholders in a third corporation, and thus were together in control of that corporation; and the point on which the Tax Court and the Court of Appeals disagreed was whether the three corporations were to be considered as controlled "by the same interests" for purposes of sec. 482↩. The question before us is whether, as a practical matter, the 1946 agreement was in fact such as might have been entered into at arm's length, and in this respect the 49-percent adverse interest of Chivers in MPP becomes highly relevant.8. The Templeton-Simplot↩ opinions discussed the process extensively, referring to at least three other patents, identified as the Faitelowitz patent, the Volpertas patent, and the Rivoche patent. Nowhere is there any mention of the Rendle patent, involved herein. A reading of those opinions raises a question whether Rendle was really the inventor of the process. However, mystified as we are by these circumstances, the findings that we made herein are based, as they must be, only on the record that is before us.9. Cf. The Nestle Co., Inc., 22 T.C.M. (CCH) 46">22 T.C.M. 46↩, 62-63.10. We find the Commissioner's arguments based on Brulotte v. Thys Co., 379 U.S. 29">379 U.S. 29, rehearing denied 379 U.S. 985">379 U.S. 985, which held the royalty provisions of a patent-licensing agreement unenforceable for the period beyond expiration of the patent, to be without merit. Unlike the licensing agreement involved in Brulotte, the 1946 agreement provided for royalties to be paid after expiration of the patent only in respect of "know -how" and at a substantially reduced rate, and the agreement contained no provisions comparable to those in the Brulotte license that were designed to project the patent monopoly beyond the patent's expiration by withholding its benefits from the public domain. But even if the post-expiration royalty provisions of the 1946 and 1960 agreements were unenforceable under Brulotte, it would not follow, as the Commissioner contends, that they would not have been agreed to by petitioner if it had been dealing at arm's length with an unrelated licensor. The Brulotte↩ decision was not rendered until Nov. 16, 1964, well after the agreements were executed and nearly at the end of the period for which the royalties here in issue were paid.11. SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS.(a) General Rule. -- In the case of foreign corporations subject to taxation under this subtitle, there shall be deducted and withheld at the source in the same manner and on the same items of income as is provided in section 1441 * * * a tax equal to 30 percent thereof * * .Sec. 1441 provides, in relevant part, as follows: SEC. 1441. WITHHOLDING OF TAX ON NONRESIDENT ALIENS.(a) General Rule. -- * * all persons, in whatever capacity acting * * * having the control, receipt, custody, disposal, or payment of any of the items of income specified in subsection (b) (to the extent that any of such items constitutes gross income from sources within the United States), of any nonresident alien * * * shall * * * deduct and withhold from such items a tax equal to 30 percent thereof * * .(b) Income Items. -- The items of income referred to in subsection (a) are * * dividends * * *.Prior to amendment, art. VI(1) of the Convention with the United Kingdom Respecting Double Taxation and Taxes on Income, Apr. 16, 1945, 60 Stat. 1377, 1381, T.I.A.S. No. 1546, provided as follows:(1) The rate of United States tax on dividends derived from a United States corporation by a resident of the United Kingdom who is subject to United Kingdom tax on such dividends and not engaged in trade or business in the United States shall not exceed 15 percent: Provided that such rate of tax shall not exceed five percent if such resident is a corporation controlling, directly or indirectly, at least 95 percent of the entire voting power in the corporation paying the dividend, and not more than 25 percent of the gross income of such paying corporation is derived from interest and dividends, other than interest and dividends received from its own subsidiary corporations. Such reduction of the rate to five percent shall not apply if the relationship of the two corporations has been arranged or is maintained primarily with the intention of securing such reduced rate.See also sec. 507.2(d)(1), Treas. Regs., and sec. 1.1441-6(a), Income Tax Regs.Art. VI of the treaty was superseded by a new provision established by art. 4 of the Supplementary Protocol signed on Mar. 17, 1966, [1966] 17 U.S.T. 1254, 1257, T.I.A.S. No. 6089. However, the amended provision is applicable only to years subsequent to those in issue. See art. 18(2)(b)(i) of the Supplementary Protocol, [1966] 17 U.S.T. at 1267.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621578/	LLOYD BAGNELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBagnell v. CommissionerDocket No. 13707-92United States Tax CourtT.C. Memo 1993-378; 1993 Tax Ct. Memo LEXIS 396; 66 T.C.M. (CCH) 463; August 23, 1993, Filed 396 Decision will be entered for respondent with respect to the income tax deficiency. Decision will be entered for petitioner with respect to the additions to tax. Lloyd Bagnell, pro se. For respondent: Robin Herrell. PATEPATEMEMORANDUM FINDINGS OF FACT AND OPINION PATE, Special Trial Judge: This case was assigned pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. 1Respondent determined the following deficiencies in and additions to petitioner's 1985, 1986, 1987, and 1988 Federal income taxes: Additions to Tax - Sections YearDeficiency6651(a)6653(a)(1) 16653(a)(2)1985$ 898.00$ 224.50$ 44.9021986872.00218.0043.6021987787.00196.7539.3521988844.00211.0042.20N/A397 At trial, respondent conceded all of the additions to tax shown on the notice of deficiency. Consequently, the sole issue for our decision is whether petitioner may exclude from his gross income civil service disability benefits he received during 1985, 1986, 1987, and 1988. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Lloyd Bagnell resided in Glenville, West Virginia, at the time he filed his petition. Petitioner reviewed social security cases for the Department of Health, Education and Welfare (hereinafter HEW) in Baltimore, Maryland, from 1959 until 1960, and then again from 1962 through 1966. While so employed, he made payments to the Civil Service Retirement and Disability Fund (hereinafter the retirement fund) totaling $ 1,403. In 1966, at the age of 39, petitioner became totally disabled, retired, and began receiving Civil Service disability benefits (hereinafter disability benefits). Petitioner has continuously collected disability benefits and has not been employed since he retired. Petitioner collected disability benefits totaling $ 10,044, $ 10,044, $ 10,183, and $ 10,584, during 1985, 1986, 1987, and 1988, respectively. However, he398 did not file Federal income tax returns for any of those years because he believes that his disability benefits are excludable from his gross income, and, therefore, he did not have sufficient gross income in any of those years to require the filing of a return. Respondent determined that petitioner should have filed income tax returns for all those years reporting his disability benefits as gross income thereon. Petitioner contends that his disability benefits are excludable from gross income. He asserts that: (1) He alone contributed to the retirement fund; (2) his disability benefits were tax-exempt when he retired, and any subsequent changes in the law apply only to those who retired after the effective date of the changes; (3) the Internal Revenue Service (hereinafter the IRS) asked him to produce a written diagnosis of his disability, thereby violating his right to privacy and the prohibition against unreasonable searches and seizures; and (4) the IRS told him his disability benefits were excludable from his gross income, and the IRS is bound by that advice. OPINION Respondent maintains that petitioner must include the disability benefits he received in gross income under399 section 61. Section 61 provides that a taxpayer's gross income includes "all income from whatever source derived" unless excluded by another section of the Code. Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426, 430 (1955). Section 61 specifically lists "pensions" as a source of gross income. Sec. 61(a)(11); sec. 1.61-11, Income Tax Regs.Petitioner has not directed our attention to any statute applicable to the years in issue which excludes his disability benefits from gross income. Moreover, we know of no such exclusion. Although sections 104 and 105 exclude from gross income certain payments received on account of injuries or sickness, none of those provisions apply to the facts in this case. Brown v. Commissioner, T.C. Memo 1989-89">T.C. Memo. 1989-89. Accordingly, we find that petitioner's disability benefits are includable in his gross income. Haar v. Commissioner, 78 T.C. 864">78 T.C. 864 (1982), affd. per curiam 709 F.2d 1206">709 F.2d 1206 (8th Cir. 1983). Nevertheless, petitioner argues that only he contributed to the retirement fund, and that all of his disability benefits therefore are 400 excludable from gross income. He relies on an IRS Publication which states: "If the plan says that you must pay a specific part of the cost of your disability pension, any amounts you receive that are due to your payments to the disability pension are not taxed. You do not report them on your return." This statement apparently refers to section 104(a)(3), which provides that amounts received through accident or health insurance for personal injury or sickness are excludable from an employee's gross income to the extent that the employee contributed to the premium payments. It is true that petitioner made contributions to the retirement fund totaling $ 1,403. However, in addition to the contributions deducted from his salary, the government contributed an equal sum. See Hogan v. United States, 513 F.2d 170">513 F.2d 170 (6th Cir. 1975); Act of May 22, 1922, ch. 194, 41 Stat. 614, (superseded by 5 U.S.C. sec. 8334(a) (1966)); see also Executive Departments-Officers-Employees, 5 U.S.C. sec. 2254(a) (1958). Moreover, the fact that petitioner contributed $ 1,403 to the retirement fund does not401 establish that any part of that amount was paid for accident or health insurance. Rather, in the case of a retirement plan to which an employee is required to contribute, it is presumed that the accident and health benefits are funded by employer contributions. Chosiad v. Commissioner, T.C. Memo 1980-408">T.C. Memo. 1980-408. Thus, with a contributing plan which provides both disability and retirement benefits, it is presumed that the disability benefits are attributable to employer contributions unless the plan expressly provides otherwise. Id. Because the retirement fund makes no such express provision, and petitioner has not presented any evidence of the inner workings of the fund to rebut such presumption, no portion of his benefits are excludable. See Hatton v. Commissioner, T.C. Memo. 1983-28, n.5. Next, petitioner argues that, because his disability benefits were excludable from gross income during 1966, he is not subject to any subsequent changes in the tax law. In other words, he maintains that changes in the applicable tax law "can apply only to those who retired after the effective date of the Act," and "To apply these402 later changes is to violate the provision that no law shall be made impairing the obligations of contracts." We do not agree. Prior to 1976, section 105(d) excluded from gross income disability benefits of up to $ 100 per week. In the Tax Reform Act of 1976, Pub. L. 94-455, sec. 505(a), 90 Stat. 1520, 1566, Congress narrowed this exclusion to make it available only if the taxpayer had not yet attained age 65, was totally and permanently disabled, and met certain other requirements. See French v. Commissioner, T.C. Memo 1991-196">T.C. Memo. 1991-196. However, the exclusion contained in section 105(d) was repealed in its entirety in 1983 by section 122(b) of the Social Security Amendments of 1983, Pub. L. 98-21, 97 Stat. 6587. Petitioner argues that he may exclude his disability benefits because section 105(d) was not repealed until 1983 and only taxpayers who retire after 1983 are deprived of the exclusion. However, each taxable year is governed by the tax law applicable to that particular year, and changes in tax laws from year to year are not only typical, but also inevitable, expected, and lawful. Picchione v. Commissioner, 440 F.2d 170">440 F.2d 170, 173 (1st Cir. 1971),403 affg. 54 T.C. 1490">54 T.C. 1490 (1970). In fact, in Pearson v. Commissioner, 76 T.C. 701">76 T.C. 701, 705 (1981), we explicitly found that Congress intended the 1976 amendments to section 105(d) to apply to all taxable years after the effective date of the change "regardless of when the person retired." See also Haye v. Commissioner, T.C. Memo 1983-463">T.C. Memo. 1983-463. Clearly then, after section 105(d) was repealed, the exclusion was no longer available to petitioner. Nevertheless, petitioner argues that he entered into an employment contract with the government which provided that disability payments were nontaxable and such contract cannot be later amended. However, petitioner never produced any "contract" with such a provision. Rather, the record indicates that it was the applicable income tax law at the time he retired which allowed the exclusion. This law was later modified (in 1976) and still later repealed (in 1983). Therefore, no exclusion was in effect in the years 1985 through 1989 and, accordingly, none of petitioner's disability benefits are excludable. As we explained in DeMartino v. Commissioner, 88 T.C. 583">88 T.C. 583, 587 (1987),404 affd. 862 F.2d 400">862 F.2d 400 (2d Cir. 1988), affd. without published opinion sub nom. McDonnell v. Commissioner, 862 F.2d 308">862 F.2d 308 (3d Cir. 1988): taxation is neither a penalty imposed on the taxpayer nor a liability which he assumes by contract, but instead, it is a way of apportioning the cost of Government among those who enjoy its benefits and who must bear the resulting burdens. * See Furlong v. Commissioner, T.C. Memo 1993-191">T.C. Memo. 1993-191. In other words, Congress has the power to change the tax laws regardless of the economic impact of such changes on particular financial transactions. Petitioner also complains that respondent's requirement that "in order to receive the disability credit, a disabled person * * submit a doctor's certificate stating the diagnosis" violates his "right to privacy and the constitutional prohibition against unreasonable search and seizure". We are not exactly sure what doctor's certificate petitioner is alluding to as we have no such certificate in evidence. Moreover, we do not know whether petitioner is complaining "in general" or whether the IRS actually asked 405 him for certain information. In any event, there is no evidence that petitioner's home or person was searched by the IRS. Without evidence of such a search, no issue arises as to its reasonableness under the Fourth Amendment. Midwest Generator Co. v. Commissioner, T.C. Memo 1988-50">T.C. Memo. 1988-50. Rather, it appears that the act complained of by petitioner was a request by the IRS that he voluntarily produce a doctor's certificate to prove that he was disabled. 2 Yet, we have held that the IRS is not prohibited from asking taxpayers to provide documents to substantiate their claims for deductions, exclusions, and credits, and that if the taxpayer fails to produce such documents the IRS may disallow the questioned items. Roberts v. Commissioner, 62 T.C. 834">62 T.C. 834, 836 (1974). Further, requiring taxpayers, who institute civil proceedings to protest deficiencies, to produce records to substantiate their claims also does not constitute an invasion of privacy or unlawful search or seizure. Edwards v. Commissioner, 680 F.2d 1268">680 F.2d 1268, 1270 (9th Cir. 1982); Ebert v. Commissioner, T.C. Memo. 1991-629,406 affd. without published opinion 986 F.2d 1427">986 F.2d 1427 (10th Cir. 1993). Finally, petitioner argues that, because the IRS told him that his disability benefits were excludable from his gross income, the IRS is bound by such advice. However, even if petitioner proved that he received such advice for the years in issue (which he has not proven), in general, incorrect advice by IRS personnel does not preclude the IRS from later maintaining a correct position. Darling v. Commissioner, 49 F.2d 111">49 F.2d 111, 113 (4th Cir. 1931), affg. 19 B.T.A. 337">19 B.T.A. 337 (1930); Fortugno v. Commissioner, 41 T.C. 316">41 T.C. 316, 323-324 (1963), affd. 353 F.2d 429">353 F.2d 429 (3d Cir. 1965).*407 In a case almost identical to this one, Turney v. Commissioner, T.C. Memo. 1987-74, the taxpayer complained that the IRS incorrectly advised him as to the tax treatment accorded his disability benefits. We held that the IRS was not estopped thereby from determining a deficiency in the taxpayer's income based on his unreported disability benefits. For the reasons expressed in that case, we hold that respondent is not estopped from asserting his position here. Based on the foregoing, Decision will be entered for respondent with respect to the income tax deficiency. Decision will be entered for petitioner with respect to the additions to tax. Footnotes1. 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.↩1. The additions to tax for negligence for taxable years 1986 and 1987 are computed under sec. 6653(a)(1)(A).↩2. 50% of the interest due on the deficiency attributable to negligence. The interest for 1986 and 1987 is computed under sec. 6653(a)(1)(B).↩2. We presume that this request was made with regard to years prior to those in issue when sec. 105(d) provided a limited exclusion for disability benefits. We discuss petitioner's argument here only because he raised it with respect to the years in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621579/	Samuel Segel and Margaret D. Segel v. Commissioner.Segel v. CommissionerDocket No. 1239-64.United States Tax CourtT.C. Memo 1965-221; 1965 Tax Ct. Memo LEXIS 109; 24 T.C.M. (CCH) 1131; T.C.M. (RIA) 65221; August 13, 1965Gerard R. Gemmette, for the petitioners. Robert D. Whoriskey, for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: Respondent determined deficiencies in petitioners' income tax for the calendar years 1958, 1959, 1960, and 1961 in the amounts of $678,84, $3,723.73, $19,103.49, and $2,793.01, respectively, and additions to tax for the calendar year 1960 under the provisions of sections 6653(a) and 6654 of the Internal Revenue Code of 1954 in the amounts of $955.17 and $55.35, respectively. The issues for decision are (1) Whether the gain realized by petitioners upon the sale of two tracts of110 land was ordinary income or long-term capital gain, and (2) whether certain documents given to petitioner Samuel Segel by several individuals for commissions on the sale of property constituted notes in payment of the commissions includable in petitioner's income in their face amount or any portion thereof in the year given or whether these documents were merely evidences of the agreement of the makers to pay the amounts stated as commissions to petitioner at a future date. Findings of Fact Some of the facts have been stipulated and are found accordingly. Samuel and Margaret D. Segel, husband and wife residing in Utica, New York, filed joint Federal income tax returns for the calendar years 1958, 1959, 1960, and 1961 with the district director of internal revenue at Syracuse, New York. These returns were filed on the cash receipts and disbursement method of accounting. Samuel Segel (hereinafter referred to as petitioner) is and was during the years here in issue a licensed real estate broker with offices in Utica, New York. Petitioner had worked in the real estate business for a period of approximately 20 years. He is listed in the Utica telephone book as a realtor. For approximately111 10 years prior to the date of the trial of this case in March 1965, petitioner's principal business activity was the listing for sale and procuring of purchasers for property for use as filling stations, office buildings, manufacturing plants, and other business types of property. Prior to that time he had listed residential properties for sale. Generally, petitioner did not own and did not take title to the properties he listed but received a commission for his services in selling them. On July 26, 1957, George H. Burton conveyed by warranty deed certain real property fronting on the easterly side of the intersection of Keyes and Herkimer Roads, Utica, New York, to petitioner. This property was located directly across Keyes Road from property owned at that time by Sarah K. Appleton (hereinafter referred to as the Appleton tract). Petitioner had a reputation in Utica for finding locations to be used by oil companies as gasoline stations. Petitioner visualized a gasoline station on the property which Burton deeded to him on July 26, 1957. Upon inquiring about the lot, he found it was zoned residential. Petitioner had been approached by representatives of several oil companies who112 were interested in acquiring this lot for the purpose of building a filling station thereon. Petitioner considered it difficult to obtain a zoning change from residential to commercial in Utica and the use of property for a filling station required a commercial zoning. Petitioner approached Rufus P. Elefante (hereinafter referred to as Elefante) with respect to obtaining a zoning change for this property. Petitioner entered into an agreement with Elefante that if Elefante would obtain a change in zoning of the property from residential to commercial, petitioner would split the profit to be made by purchasing the property for resale with Elefante. A zoning change from residential to commercial was made on the property. On September 10, 1957, petitioner by warranty deed conveyed the property at the intersection of Keyes and Herkimer Roads to Tremarco Corporation. A profit of $5,133 was realized by petitioner and Elefante from this transaction and shared equally by them. The price at which petitioner sold the property to Tremarco was approximately $25,000. The standard real estate commission for sale of undeveloped acreage in Utica was 10 percent. Under date of December 16, 1955, petitioner113 conveyed by warranty deed property located on Genesee Street in Utica to Louis Kowalsky and Morton Kowalsky. Included in the description of the property contained in the deed was the recitation that it was the same property conveyed to petitioner by Harold Samuel Slater and Florence Lillian Slater by warranty deed dated December 2, 1955. Petitioner received for this property from the Kowalskys the same amount he paid to Slater for the property. The Kowalskys did not want to approach the owners of the property directly and petitioner purchased the property with the intention of reselling it to the Kowalkys at the price he paid for it as a favor to the Kowalskys. By warranty deed under date of July 28, 1958, petitioner conveyed to Wm. F. Hayes Sons Fuel Corporation a tract or parcel of land situated in Utica. The deed recited that this property was the same premises conveyed to petitioner by Herman Caro by a deed which was being executed concurrently with petitioner's deed to Wm. F. Hayes Sons Fuel Corporation. Wm. F. Hayes Sons Fuel Corporation operated a coalyard on this property and desired to purchase the property. Petitioner purchased the property with the intention of selling114 it to Wm. F. Hayes Sons Fuel Corporation at a profit and did sell it to that company at a profit. On or about September 18, 1957, petitioner and Sarah K. Appleton executed a purchase offer relating to the Appleton tract which consisted of 23 1/2 acres of land fronting on Herkimer Road in Utica, New York. The purchase offer fixed a price of $23,500 for the land, $3,000 to be paid upon acceptance of the offer, and the balance to be paid by executing a mortgage in the amount of $20,500, with payment of the $20,500 to "be made within thirty (30) days after September 8th, 1958, or Sarah K. Appleton may elect to have the said mortgage paid to her in annual installments of not less than $7,000 on the 31st day of October 1958, 1959, & $6,500 on Oct. 31, 1960, and which said mortgage shall bear interest at the rate of 5% per annum from and after September 8th, 1958." The offer also provided that Sarah K. Appleton would release any portion of the tract from the lien of the mortgage upon payment of $1,000 per acre, the purchaser to be given credit toward such releases for all payments under the contract. On or about October 24, 1957, Sarah K. Appleton conveyed the Appleton tract to petitioner115 by warranty deed. This deed provided for the reservation from the conveyance of a spring of water and the water course, specifically described therein, and also provided that the premises were conveyed subject to a lease "entered into between Sarah K. Appleton and Joe Castardi under date of September 8th, 1952 and which said lease will terminate on September 8th, 1958." There was also a reservation of the right of Sarah K. Appleton to use certain buildings on the property. On June 17, 1958, petitioner executed a quitclaim deed dedicating certain portions of the Appleton tract to the city of Utica, New York, for street purposes. On September 10, 1958, Sarah K. Appleton executed a release of the rights she reserved in the deed with respect to the spring, rights-of-way and easements across the property, and a part of the rights with respect to the buildings. By warranty deed executed September 12, 1958, petitioner conveyed the Appleton tract to Savage Homes, Inc., a New York corporation with its principal office in Utica, New York. The president of Savage Homes, Inc., was William C. Morris. Petitioner had known Morris for many years and was friendly with him. Petitioner knew that116 Morris made a specialty of the development of subdivisions. Prior to the time petitioner acquired the Appleton tract a plot plan or plat had been made of the property. The price paid to petitioner for the Appleton tract by Savage Homes, Inc., was $77,000. Petitioner and Savage Homes, Inc., entered into an agreement which recited, "THIS AGREEMENT [was] entered into this 12 day of Sept., 1958, by and between SAMUEL SEGEL, * * and SAVAGE HOMES INC., * * ." This agreement contained, among others, the following provisions: 1. The OWNER hereby agrees to sell to the BUILDER and the BUILDER hereby agrees to purchase from the OWNER the afore-described REAL PROPERTY which the OWNER, as part of the consideration herein, hereby agrees to improve and develop into eighty-seven (87) residential building lots in compliance with the rules, regulations and directives of the City of Utica, Veterans Administration, Federal Housing Administration and other governmental authorities and in accordance with the following: (a) Furnish all necessary and required surveying and engineering including all necessary maps in connection therewith; (b) The general plan and layout of the said REAL PROPERTY117 with respect to roads, number and size of lots shall be as shown on the map attached hereto and made a part hereof entitled "Map of KEYES MANOR located in the City of Utica, N. Y." dated June 10, 1958 and made by Leo E. Wheeler, L.S. (Lic. No. 4938)and approved by Victor Brendes, Deputy City Engineer on June 11, 1958; (c) Each building lot shall be not less than one (1) foot nor more than three (3) feet above the grade of the finished road; (d) The four corners of each lot shall be properly marked by stakes duly set by a duly licensed land surveyor or civil engineer; (e) All roads in said REAL PROPERTY shall be duly constructed to meet all requirements of the City of Utica, Veterans Administration, Federal Housing Administration and shall be duly dedicated; (f) It is understood a small creek runs across the northeasterly corner of the said REAL PROPERTY. The OWNER hereby agrees to reroute the said creek along the northerly boundary line of the said REAL PROPERTY to Keyes Road; (g) City of Utica Water Mains (and Storm Sewers, if necessary) shall be duly extended into and throughout the said REAL PROPERTY; (h) All building lots in said REAL PROPERTY shall be approved by the118 City of Utica for erection thereon of pre-fabricated National Homes; and, (i) All City Ordinances shall be duly enacted in order to furnish and supply the said REAL PROPERTY with the aforesaid required roads, water mains, storm sewers and sanitary sewers. (It is, however, agreed and understood that the BUILDER shall, at his own cost and expense, install the sanitary sewers within said REAL PROPERTY and shall assume the cost of the sanitary sewer which shall be constructed along Keyes Road adjacent to the said REAL PROPERTY.) 2. The total and full consideration for the said REAL PROPERTY, completely developed as hereinabove set forth, to be paid by the BUILDER to the OWNER shall be $77,000.00. * 4. It is hereby agreed that the OWNER will perform all of the conditions of this Contract on his part to be performed on or before September 9, 1958, at which time this Contract shall be consummated as herein set forth; * * Petitioner did not pay Sarah K. Appleton the full balance of the purchase price of the property by October 31, 1958, and Savage Homes, Inc., took the property subject to that mortgage, which mortgage contained provisions with respect to the release of lots119 upon partial payments. Certain lots were released in accordance with this agreement prior to September 9, 1959, when petitioner made the final payment on the mortgage to Sarah K. Appleton. Petitioner, at some juncture, entered into an agreement with Elefante whereby he agreed to split the profits on the sale of the Appleton tract with Elefante. Petitioner had been advised to contact Elefante and that Elefante could do the necessary preliminary work to satisfy Savage Homes, Inc., so that the tract could be used for development. Petitioner spent $1,310 for a property survey and staking out streets in the property. Petitioner disbursed one-half of the net profits from the sale of the Appleton tract to Elefante. Petitioner had an agreement with Savage Homes, Inc., for the release of lots upon payment of a certain portion of the selling price. Petitioner received the final payment for the property from Savage Homes, Inc., on September 10, 1959. Under date of February 6, 1959, petitioner executed an agreement to purchase approximately 27 acres of land located in Utica, New York, owned by George H. Burton (hereinafter referred to as the Burton tract) for the sum of $27,000. This agreement120 provided for a mortgage to be given for $24,000 of the purchase price with the principal sum to be payable 2 years from the date of the mortgage and interest at 5 percent payable semiannually. The agreement further provided that the seller would surrender and release a home building lot upon payment of $500. On February 9, 1959, petitioner assigned one-half of his interest in this contract to purchase to Elefante. On May 12, 1959, Burton executed a warranty deed transferring the Burton tract to petitioner, and on the same date petitioner executed a mortgage to George H. Burton covering this tract, which mortgage contained provisions in accordance with the agreement of February 6, 1959, including the right to have a lot released upon payment of $500. On June 3, 1959, petitioner executed a quitclaim deed dedicating certain portions of the Burton tract to the city of Utica for street purposes. On June 25, 1959, petitioner executed a deed granting an easement to the city of Utica to construct and maintain a storm water sewer across the Burton tract. On June 1, 1959, John C. Clarke completed a subdivision map of the Burton tract which was filed with the office of the Clerk of121 the County of Oneida on September 21, 1959. The map contained 93 numbered lots and some unnumbered lots, the unnumbered lots being located across the Utica, New York line in the town of Deerfield, New York. Under date of September 9, 1959, petitioner and Savage Homes, Inc., executed an agreement that Savage Homes, Inc., would purchase the portion of the Burton tract located in Utica from petitioner for a total consideration of $82,305. This agreement recited that petitioner was in the process of having all of the surveying and engineering services performed in order to properly develop the tract into 93 residential building lots which would meet with the approval of, and be acceptable to, the city of Utica, Veterans Administration, Federal Housing Administration, and other governmental authorities. As part of the consideration of this contract of purchase and sale, petitioner also agreed to improve and develop the property into 93 residential building lots in compliance with the rules, regulations and directives of these authorities, to furnish the necessary surveying and engineering services and the general plan and layout with respect to roads and number and size of lots, to reroute122 a small creek on the property, that the lots should be approved by the city of Utica, that the water mains (and storm sewers, if necessary) of the city of Utica should be extended throughout the property, and that city ordinances should be enacted to supply the property with roads, water mains, storm sewers and sanitary sewers with the understanding that the purchaser should install the sanitary sewers at its own expense. On June 14, 1960, petitioner executed a warranty deed transferring the Burton tract, with the exception of the few lots located across the line in the town of Deerfield, New York, to Savage Homes, Inc. On June 14, 1960, Savage Homes, Inc., executed a mortgage to petitioner for the full purchase price of the 93 lots of the Burton tract of $82,305. This mortgage contained a provision for the release of a lot upon the payment by Savage Homes, Inc., to petitioner of $900. The portion of the Burton tract not transferred by petitioner to Savage Homes, Inc., was retained by petitioner until December 27, 1963, when he conveyed it by warranty deed to Pat Cerminaro. Savage Homes, Inc., paid petitioner for the Burton tract property transferred to it $10,800 on September 6, 1960, $11,700123 on September 21, 1960, $22,500 on October 19, 1960, and $38,700 on November 9, 1960, of which petitioner on November 21, 1960, refunded $1,400 as an overpayment. Of the amount received by petitioner from Savage Homes, Inc., petitioner distributed $31,600 to Elefante. Petitioner, at the time of his purchase of the Appleton tract and at the time of his purchase of the Burton tract, would have been able to arrange the financing of the mortgage payments as they came due had he not sold each of the properties prior to any principal payment under the mortgage he had given thereon becoming due. During 1954 petitioner acted as a broker on the sale of real property and became entitled thereby to certain commissions. Between 1954 and 1960 these commissions were paid in part by the purchasers of the property, Samuel J. Grossman and Harry Lasher, who had assumed liability for the commissions on the transactions. In 1960 the balance still due and owing on these commissions was $15,200. At the time Grossman acquired the property it was encumbered by a second mortgage and Grossman was unable to pay both the second mortgage and petitioner's commissions. In order for the sale to be effected, 124 Grossman and petitioner agreed that the full amount of petitioner's commission would not become immediately payable. On July 7, 1960, Grossman issued to petitioner a note in the face value of $7,700 payable in three installments of $2,566.67 each. These installments were to be paid in 3 consecutive years following the issuance of the note. Petitioner and Grossman agreed at the time the note was given to petitioner that the note would not be negotiated, assigned, or discounted. The note was not interest bearing. On September 30, 1960, Grossman and Lasher issued a note agreeing to pay petitioner $7,500 in four payments of $1,875 each. This note was also non-interest-bearing and petitioner agreed with Grossman and Lasher that he would not assign, discount, nor negotiate this note. On June 23, 1961, petitioner received a promissory note in the face amount of $4,500 from Edward J. and Marian F. Kinney. This note represented petitioner's real estate commission on the sale of certain property. The note contained no provision for payment of interest. It showed a due date of June 23, 1962, and had written on it that it was renewable. Petitioner received a $1,000 payment on this note on125 December 6, 1961. On August 1, 1961, petitioner received a promissory note in the amount of $1,000 representing the real estate commission on the sale of certain real property. This note was not interest-bearing. Petitioner agreed with the makers of both the $4,500 note and the $1,000 note that he would not negotiate, assign, nor discount the notes. Petitioner on his income tax returns for the years 1959 and 1960 reported the portion of the gain from the sales of the Burton and Appleton tracts which he did not disburse to Elefante as long-term capital gain and on his 1960 and 1961 income tax returns did not include in commissions received any portion of the Grossman, Grossman and Lasher, or Kinney notes or the August 1, 1961 note for $1,000 he received except the amounts which had been paid thereon. Respondent in his notice of deficiency determined that petitioner received ordinary income from the sales of the Burton and Appleton properties and also determined that petitioner's income should be increased in 1960 by $15,200 representing the face amount of the Grossman and Grossman and Lasher notes and in 1961 by $4,500 representing the $5,500 face amount of the two notes received126 in that year less the $1,000 payment he reported. Respondent also increased petitioner's income in the year 1961 by the amount of payments received on the Grossman note even though he had included the full amount thereof in petitioner's income for the year 1960. Opinion The first issue in this case is whether the gains on the sales by petitioner of the Appleton and Burton tracts are taxable as ordinary income or capital gain. The resolution of this issue requires a determination of whether petitioner held these properties primarily for sale to customers in the ordinary course of his trade or business within the meaning of section 1221(1) of the Internal Revenue Code of 1954. 1127 The facts in this case show that petitioner was in the real estate business and that most of his transactions consisted of making sales for commissions. The record discloses three occasions prior to the sale of the Appleton and Burton tracts in which petitioner had himself purchased property for an undisclosed principal and sold the property to that principal, in two instances, at an increased price which took the place of his commission and which he apparently regarded as ordinary income. In one of such sales petitioner was associated with Elefante, the same individual with whom he was associated in the sales of the Appleton and Burton tracts. Petitioner contends that the fact that he was engaged in the trade or business of selling real estate does not prohibit his holding certain property for investment "in such manner as to benefit from capital gain treatment of gains made upon the sale of such other property." Eline Realty Co., 35 T.C. 1">35 T.C. 1 (1960). Petitioner further contends that even if he is considered as holding the Appleton and Burton tracts for sale, this fact does not remove the properties from the category of capital assets unless the properties were held128 for sale to customers in the ordinary course of his trade or business. Scott v. United States, 305 F. 2d 460 (Ct. Cls., 1962). It is petitioner's position that he was not in the trade or business of selling acreage as a principal and therefore he is entitled to treat the gain from the sales of the Appleton and Burton tracts as capital gains. The cases dealing with the question of whether real property is held by a taxpayer primarily for sale to customers in the ordinary course of his trade or business are numerous. As we have stated in many cases, the determination of this question must ultimately rest upon a consideration of the facts in the particular case. The nature of the acquisition of the property, the frequency and continuity of transactions over a period of time, the substantiality of the transaction, the activities of the seller with respect to the property such as the extent of his improvements thereto or his activity in promoting sales are among the facts to be considered. The ultimate question is not the purpose for which the property was acquired but the purpose for which the property was held at the time of sale. Estate of Peter Finder, 37 T.C. 411">37 T.C. 411, 418 (1961).129 Petitioner argues that any development that occurred on the Appleton and Burton tracts such as surveying and staking, was controlled and supervised solely by Elefante, who received 50 percent of the net profits in return for these services. From this petitioner concludes that under the decision in Smith v. Dunn, 224 F. 2d 353 (C.A. 5, 1955), this circumstance is persuasive that the property here was not held by him primarily for sale to customers in the ordinary course of his trade or business. Although the Court, in Smith v. Dunn, supra, concluded that the taxpayer there involved was entitled to report the gain from the sale of subdivided land which a number of years prior to the date of sale had been inherited from his father, as capital gain, the statements of the tests to be used in making the determination are such that they point to a different conclusion in the instant case. One of the tests stated by the Court in that case is the reason, purpose, and intent in the acquisition and ownership of the property and the duration of such ownership. Another test stated therein is the extent of subdividing, developing, and advertising to increase sales. 130 In the instant case the amount shown as spent on development of the property, unless the 50 percent of the profits that were to go to Elefante could be so classified, is relatively small. However, the large difference in the price petitioner paid for the property and the amount he received for it less than a year later suggests that the property was specifically acquired by petitioner for the purpose of having Elefante develop it to the point that city sewers and water would be available and proper zoning obtained for the builder to build the type houses he desired to build, in order to substantially increase the amount that could be obtained upon a resale of the property. In fact, there are suggestions throughout the record that at the time petitioner purchased the Appleton tract and at the time he purchased the Burton tract, he had the intent and perhaps even some specific general understanding that the property would be so developed as to make it usable by Savage Homes and that Savage Homes would then purchase the property. When petitioner was asked when he first approached Morris, the president of Savage Homes, about selling him the Appleton tract, he never directly answered131 the question and his testimony left some inference that possibly there had been discussion even prior to the time petitioner purchased this tract. 2132 Petitioner assigned one-half of his interest in the contract to purchase the Burton tract to Elefante 3 days after he entered into the contract with George Burton. Petitioner's reason for agreeing to split the profits on the Appleton tract with Elefante was so that Elefante could put the property in condition to be suitable for sale to Savage Homes, Inc., and the inference is that the same reason motivated petitioner in assigning to Elefante a one-half interest in his contract to purchase the Burton tract. These facts, considered in conjunction with other evidence of record, create an inference that petitioner purchased both properties for the purpose of developing them and selling them to Savage Homes, Inc. The record does not show exactly when petitioner entered into his agreement with Elefante as to the Appleton property but does show that Elefante was the person with whom petitioner had made an agreement in 1957 that in return for Elefante's getting certain property zoned commercial petitioner would pay him one-half of the profit he made by purchasing this property and reselling it to a company for erection of a filling station thereon. The record likewise shows that upon purchase133 of the Appleton as well as the Burton tract, petitioner made arrangements to have lots released from the mortgage he gave to the seller as payments on that mortgage were made, indicating that he contemplated a resale of the properties prior to payment in full of the mortgage. Petitioner sold the Appleton tract to Savage Homes, Inc., only a few days after termination of a lease on the property subject to which he had purchased the property. The contract for purchase of this property by Savage Homes, Inc., was obviously drafted sometime prior to the date it was executed on September 12, as shown by the crossing out of the word "August" in the beginning of the contract and substituting the word "September" as well as the reference in the contract to certain action being taken by September 9, one day after the expiration on September 8, 1958, of the lease subject to which petitioner had taken the property. Petitioner testified as follows with respect to his motives in purchasing the Appleton tract: Well, being familiar with the City of Utica, and knowing conditions, I surmised, or I could visualize that this was a valuable tract of land for development. Having that in mind, I made Mrs. 134 Appleton an offer to purchase it for an investment. Petitioner testified that he could have financed the purchase of the property without reselling it and he makes no contention that he resold it within a short time after its purchase because of being unable to finance it. From all the evidence we conclude that petitioner purchased both the Appleton and Burton tracts with the definite intent to sell the property at a profit as soon as feasible after the expiration of the 6-month period necessary to cause the gain on the sale of a capital asset to be taxed as long-term capital gain. We also conclude that at the time of the sale of these properties petitioner held them for sale to such a prospective purchaser as would pay his asking price or to a "customer." There remains the question of whether petitioner was in the trade or business of selling this type of property. Petitioner's trade or business was that of a real estate broker and though generally his sales were made for a commission paid either by the purchaser or seller of the property he had on some occasions bought property for the purpose of making a resale thereof to a known individual, or as petitioner chooses to state, 135 acted in the purchases as "an agent for an undisclosed principal." The selling of property was certainly the major trade or business of petitioner. In the course of this business he sometimes acquired property with the intention of reselling such property. The reasonable conclusion from the record is that property so acquired by petitioner was held by him for sale to customers in the ordinary course of his trade or business. We also conclude from the evidence here that petitioner acquired both the Appleton and Burton tracts for sale to customers in the ordinary course of his trade or business. One of petitioner's major arguments is that since the Appleton and Burton tracts were sold as units and not as individual lots, it follows that he did not hold the properties for sale to customers in the ordinary course of his trade or business. We have, however, held that the fact that a taxpayer disposed of a group of lots does not necessarily mean that the property was not held for sale to customers in the ordinary course of that taxpayer's trade or business. Donald J. Lawrie, 36 T.C. 1117">36 T.C. 1117 (1961). Petitioner has failed to establish that the Appleton and Burton tracts were136 not held by him primarily for sale to customers in the ordinary course of his trade or business. We therefore sustain respondent in his treatment of the gains from these sales as ordinary income. The other issue in this case involves respondent's increase in petitioner's taxable income in the year 1960 by the amount of $15,200 which respondent determined represented notes received by petitioner in that year and the increase in petitioner's income in the year 1961 by the amount of $4,500 which respondent determined represented promissory notes in that face amount received by petitioner in that year less the $1,000 payment on one of the notes reported on petitioner's tax return. Respondent contends that it has long been settled that where a cash basis taxpayer receives for services, promissory notes that such promissory notes constitute payment for the property or income received to the extent of their fair market value, citing Wolfson v. Reinecke, 72 F. 2d 59 (C.A. 7, 1934) and other cases. Respondent also calls attention to his regulation which specifically provides that if a taxpayer is paid for services other than in cash, the fair market value of the property taken137 in payment must be included in that taxpayer's income.3 The question here is not whether as a matter of law notes received in payment for services are includable in a cash basis taxpayer's income at the time received but is whether the documents which petitioner received were notes received in payment of services or merely a written agreement with respect to the manner in which petitioner was to be paid the balance of certain commissions due to him. As we pointed out in Nina J. Ennis, 17 T.C. 465">17 T.C. 465 (1951), a cash basis taxpayer does not receive income until he has received cash or its equivalent. As we stated in that case in determining what obligations are the equivalent of cash, the requirement has always been that the "obligation, like money, be freely and easily negotiable so that it readily passes from hand to hand." 138 The agreements which petitioner in the instant case had were without interest and the very nature of the documents which are involved in the year 1960 indicates that they were not intended to be negotiable. It was petitioner's testimony that there was a definite understanding that these documents merely reduced to writing the agreement of the amount of commissions he was to be paid and the dates when payments were to be made. One other witness testified to the same general effect. This witness was a signer of one of the instruments involved in the determination for the year 1960. Petitioner's testimony is that he agreed in each instance with the maker of the so-called note that it would not be negotiated, that he would not borrow money at a bank using the note as security, and that it was his understanding and the other parties' understanding that these instruments were merely written evidence of the amount of the commissions due to him. Under the evidence here presented we conclude that petitioner did not receive any of the notes here involved in payment of commissions but that these documents merely evidenced the understanding between petitioner and certain of his clients as139 to when commissions would be paid. We therefore hold that petitioner did not receive income by reason of the receipt of the notes but did receive income as payments were made to him by the individuals who executed these agreements and in the amounts of the payments so made. Respondent has increased petitioner's income by payments on the notes when received in the years here involved and has not decreased petitioner's income as reported by eliminating payments reported by petitioner except the $1,000 reduction in 1961. Since we hold that the so-called notes were not payments, we sustain respondent in including in petitioner's income in the year received payments made on these notes. Decision will be entered under Rule 50. Footnotes1. All references are to the Internal Revenue Code of 1954 unless otherwise indicated. SEC. 1221. CAPITAL ASSET DEFINED. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include - (1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; * ↩2. Petitioner in this regard testified as follows: "Q. When did you first approach Mr. Morris about selling the Appleton tract to him to, Savage Homes, Inc.? "A. Well, in the first place, I have known Mr. Morris many years. I knew his family. I knew his father and mother and so forth. I was friendly with Mr. Morris. Knowing that Mr. Morris made a specialty of development, of subdivision, naturally, he would be the first one I would approach. "Q. Approximately when was that? "A. I cannot tell you exactly offhand. * "Q. How do you explain the sharp increase between your cost and the price at which you sold that property? "A. Well, in the first place, I think I bought it right; that is, if it had not been a bargain, I wouldn't have bought it. It bought it strictly originally because I could see a potential in the area. I didn't jockey the price with them. That is what they asked me for. When I contacted Mr. Morris, he voluntarily offered so much for that property. It wasn't a question of bargaining or auctioning it off. It wasn't a question of not agreeing on a price and so forth. We just simply agreed on that basis. "Q. Tell me this: Did Mr. Elefante's activities with the City have anything to do with the sharp increase in price; that is, the installation of sewers and so forth? "A. Oh, no, no, sir. "Q. What work did Mr. Elefante do to justify a division of the profits with him? "A. Well, it was his job, or his part of the deal, to iron out the property so Mr. Morris of Savage Homes could use it on the basis that Mr. Morris wanted it. Not knowing, never having had any experience with a development of any kind like that, I left it entirely up to Mr. Elefante."↩3. Sec. 1.61-2(d)(1), Income Tax Regs. Compensation paid other than in cash - (1) In general. If services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income. If the services were rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary. * *(4) Stock and notes transferred to employee of independent contractor. Except as otherwise provided by section 421 and the regulations thereunder (relating to employee stock options) and § 1.61-15, if a corporation transfers its own stock to an employee or independent contractor as compensation for services, the fair market value of the stock at the time of transfer shall be included in the gross income of the employee or independent contractor. Notes or other evidences of indebtedness received in payment for services constitute income in the amount of their fair market value at the time of the transfer. A taxpayer receiving as compensation a note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as of the time of receipt its fair discounted value computed at the prevailing rate. As payments are received on such note, there shall be included in income that portion of each payment which represents the proportionate part of the discount originally taken on the entire note.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621581/	D. B. Anders, Petitioner v. Commissioner of Internal Revenue, RespondentAnders v. CommissionerDocket No. 5094-64United States Tax Court48 T.C. 815; 1967 U.S. Tax Ct. LEXIS 46; September 6, 1967, Filed 46 Decision will be entered under Rule 50. An industrial laundry which provided a rental service of laundered apparels, coveralls, towels and other items, charged the cost of these items to expense when purchased. Most of the items had a useful life of 12 to 18 months, some longer depending upon how frequently washed and whether of seasonal use in the case of light or heavy materials. Some had the name of the employer-user and in some cases of the individual employee embroidered thereon. The corporation adopted a plan of liquidation under sec. 337, I.R.C. 1954, sold substantially all its property to a new corporation, and distributed its assets within 12 months to its sole stockholder. In arriving at the purchase price $ 233,000 was allotted to the rental items in circulating use, the cost of which had been charged to expense. Held, the gain realized upon the rental items in the liquidating sale is, pursuant to sec. 337, not recognized to the corporation. J. Glenn Hahn and Walter J. Kennedy, for the petitioner.Edward E. Pigg, for the respondent. Bruce, Judge. BRUCE 815 Respondent determined a deficiency in income tax of D. B. Anders, Inc., for the taxable year ended July 31, 1961, in the amount of $ 121,160 and notified petitioner that the deficiency and interest, constituting his liability as transferee of assets of the corporation, would be assessed against him. The sole issue is whether, in49 a liquidation under section 337 of the Internal Revenue Code of 1954, the corporation is entitled to the nonrecognition of gain on items, the cost of which has previously been deducted. Petitioner claims an overpayment.816 FINDINGS OF FACTThe stipulation of facts and the exhibits attached thereto are incorporated by reference.D. B. Anders is an individual residing in Shawnee Mission, Kans.Service Industrial Cleaners, Inc., was a corporation organized in August 1947 under the laws of Kansas with its principal offices in Kansas City, Kans. At all times material its stock was owned by D. B. Anders directly or through his nominees. By amendment filed May 17, 1961, its name was changed to D. B. Anders, Inc. This corporation is referred to herein as Service, or as the corporation.Service filed a corporation income tax return for the fiscal year ended July 31, 1961, on an accrual basis, with the district director of internal revenue at Wichita, Kans., on January 15, 1962, pursuant to an extension granted.Service was engaged in the business of conducting and providing a rental service of cleaned and laundered towels, seat covers, fender covers, wiping materials and dust cloths, 50 coats, coveralls, shirts, pants, and other textiles and apparels, including dusting and wiping equipment, sweeping tools, mops, and accessories, herein referred to collectively as rental items, as well as conducting a cleaning and laundering service of substantially the same type of items owned by others, and in general conducting an industrial laundry business.For Federal income tax purposes Service charged to its expense accounts when purchased the cost of the rental items used in conducting its rental service business. At the end of each taxable year the expense accounts were credited with the costs of the ending inventory of items which had not been placed in service at the end of the taxable year.In its taxable year ended July 31, 1961, prior to May 1961, Service had approximately 500 accounts to which it was furnishing laundry rental service. The average weekly gross income from rental and other laundry business was from $ 19,000 to $ 20,000. Some 13 percent to 20 percent of this was attributable to laundry of property of others, referred to as NOG (not our goods). The remainder was attributable to laundry rental business.The garment rental business was normally handled51 on a yearly contract basis. Service had about 40,000 garments in circulation. Most of the items had a useful life of 12 to 18 months, some longer, depending upon how frequently washed and whether of seasonal use in the case of light or heavy materials. Some had the name of the employer-user and in some cases of the individual employee embroidered thereon. Its garment customers included General Motors, Ford Motor Co., Trans World Airlines, and Bendix, as well as garages, florists, filling stations, motorcar dealers, and small manufacturers. Its shop towel customers 817 included railroads, pipelines, garages, filling stations, printers, and paint factories. Union Pacific Railroad was serviced on a system-wide basis from Service's plants in Kansas City. Office buildings were the principal users of its dust control items. Service's replacement costs of these items averaged about $ 200,000 per year.In May 1961 Anders reached an agreement for the sale of Service's business to a group of persons. The purchasers desired to carry on the business under a different corporation with the same name.On May 12, 1961, the board of directors and the stockholders of Service adopted 52 resolutions approving and authorizing the sale of the corporation's properties and business, changing the corporate name to D. B. Anders, Inc., and adopting a plan of complete liquidation pursuant to the terms of section 337 of the Internal Revenue Code of 1954.As of May 16, 1961, Service entered into an "Agreement of Sale" with Albert Gitlow, Abraham Gitlow, Ben F. Singer, and Joseph L. Fradkin, herein referred to as the purchasers, acting in behalf of Service Industrial Cleaners, Inc., a Kansas corporation, formed on or about May 17, 1961, which corporation is hereinafter referred to as buyer.Under the agreement, Service, as "Seller" and the named individuals, as "Purchasers" agreed to the sale and transfer to the purchasers or their assigns of all seller's inventory of the articles used in conducting the seller's rental service business, furniture and equipment, accounts receivable, interest in real property, name, routes, customers' patronage, and goodwill.The price was computed in the contract as follows:Inventory of rental items$ 228,000Furniture and equipment88,500Sweeping tools, mops, and accessories5,000Goodwill and customer patronage110,000Real property78,000Total509,50053 In addition, there was to be paid a sum equal to the trade accounts receivable at the close of business May 17, 1961, and prepaid items as of that date.The parties also agreed that the foregoing price did not include new, unused, and unwashed garments and rental service items, new and unused sweeping tools and washroom supplies, fuel, and new automobile and truck tires, and that there would be added to the price an amount equal to seller's cost of such items.As of May 17, 1961, Anders entered into a covenant with the purchasers to refrain from competition with them or their corporation in the conduct of rental service or laundry business.818 As of May 22, 1961, Service, then known as D. B. Anders, Inc., entered into an agreement with the purchasers to a similar effect. As of the same date the corporation delivered to the buyer a bill of sale of certain of its assets. On or about May 22 or 23, 1961, the sale by the corporation of subtantially all its assets to the buyer was completed.Pursuant to the plan of liquidation the corporation distributed all its assets in complete liquidation to petitioner, its sole stockholder, within the 12-month period beginning May 12, 1961. 54 The corporation filed with the secretary of state of the State of Kansas its resolution of dissolution in April 1962 and its corporate existence ceased.It is stipulated that the corporation is entitled to a deduction for depreciation on its building and improvements, machinery and equipment, and office equipment for its taxable year ended July 31, 1961, in the amount of $ 7,370.77.The corporation paid its Federal income taxes for its taxable year ended July 31, 1961, as follows:Date PaidAmountOct. 13, 1961$ 20,000.00Jan. 15, 196211,063.38Petitioner paid additional Federal income taxes assessed against the corporation for its taxable year ended July 31, 1961, as follows:Date PaidAmountMay 27, 1963$ 3,832.80Oct. 28, 19635,994.30On its income tax return for the fiscal year ended July 31, 1961, the corporation reported a gain of $ 446,601.89 arising out of the sale of substantially all its assets to the buyer, and claimed exclusion of such gain from taxable income under section 337, I.R.C. of 1954. The gain reported included $ 233,000, which was the amount of the consideration received by Service from Buyer allocated to the items-in-use in55 its laundry rental business.The inventory of rental items which were transferred in the sale had a basis of zero to the corporation.OPINIONPetitioner owned all the stock of Service Industrial Cleaners, Inc., a Kansas corporation organized in 1947, which adopted a plan of liquidation in May, 1961, sold its property, changed its name to D. B. Anders, Inc., and within 12 months after the adoption of the plan distributed all of its assets in complete liquidation to him. The corporation duly filed a notice of dissolution and its existence ceased in April 1962. Petitioner received distributions in excess of the deficiency determined by respondent against the corporation for the taxable year ended 819 July 31, 1961, and is admittedly liable as a transferee for such deficiency if the corporation is liable. Petitioner contends that under the provisions of section 3371 no gain is to be recognized to the corporation from the sale of its property in liquidation in May 1961.56 The parties are in agreement that the corporation adopted a plan of complete liquidation after June 22, 1954 (the date specified in section 337), sold its property, and distributed all its assets within the 12-month period beginning on the date the plan was adopted. They further agree that the rental items involved were not stock in trade, property includable in inventory, or property held by the corporation for sale to customers in the ordinary course of its trade or business. On the basis of these facts, it appears that there was literal compliance with the requirements of section 337(a), and further, not being property specifically excluded by section 337(b)(1), that the rental items involved were property, the gain or loss from the sale of which is not to be recognized to the corporation under section 337(a). See sec. 1.337-3, Income Tax Regs.; Rev. Rul. 59-120, 1 C.B. 74">1959-1 C.B. 74.Respondent contends, however, that $ 233,000 of the total consideration received by the corporation on the sale is includable in the taxable income of the corporation in the year of receipt, on the ground that this amount was for rental items which had previously57 been expensed by the corporation and it had received full tax benefit therefrom. On brief, respondent states that he "relies on the well established 820 rule that if an amount deducted from gross income in one taxable year is recovered in a later year, the recovery is income in the later year." The rule referred to is commonly known as the tax-benefit rule or doctrine.The tax-benefit rule was originally developed through court decisions. Mertens, Law of Federal Income Taxation, sec. 7.34 (1962 rev.); Estate of William H. Block, 39 B.T.A. 338">39 B.T.A. 338 (1939), affirmed sub nom. Union Trust Co. of Indianapolis v. Commissioner, 111 F. 2d 60 (C.A. 7, 1940), certiorari denied 311 U.S. 658">311 U.S. 658; Budd Co. v. United States, 252 F.2d 456">252 F. 2d 456, 458 (C.A. 3, 1957). Though not expressly stated in the Code, it has received indirect statutory recognition, specifically with respect to bad debts, prior taxes, and "delinquency" amounts in section 22(b)(12) of the 1939 Code, substantially reenacted as section 111 of the 1954 Code. 259 T. O. McCamant, 32 T.C. 824.58 The "rule of exclusion" prescribed by the statute has been extended by Treasury regulations 3 to "all other losses, expenditures, and accruals made the basis of deductions from gross income for prior taxable years." For the purposes of the present case, it is not necessary to express any opinion as to whether or not the cited regulation is an unauthorized extension of the otherwise limited congressional approval of the tax-benefit doctrine and we refrain from doing so. See, however, Alice Phelan Sullivan Corp. v. United States, 381 F. 2d 399 (Ct. Cl. 1967).60 Assuming, for the purposes of this case, that the amount in question represents the recovery of expenses previously deducted from gross 821 income by the corporation and that such recovered amount would be taxable to the corporation in the year of recovery under other circumstances, it is nevertheless gain which resulted to the corporation from the sale of all its assets pursuant to a plan of complete liquidation and is nonrecognizable to the corporation under the provisions of section 337.Respondent contends that by the enactment of section 337, Congress never intended the realization of such income to escape taxation at the corporate level.The provisions of section 337 first appeared in the Internal Revenue Code of 1954. Their primary purpose was to eliminate the uncertainties attendant upon the Supreme Court decisions in Commissioner v. Court Holding Co., 331">324 U.S. 331 (1945), and United States v. Cumberland Public Service Co., 338 U.S. 451">338 U.S. 451 (1950), and to permit a liquidating corporation to make a tax-free sale of all its assets with but a single tax being imposed at the stockholder level without 61 regard to the form of the transaction. H. Rept. No. 1337, 83d Cong., 2d Sess., p. A106; Bird Management, Inc., 48 T.C. 586">48 T.C. 586; Frank W. Verito, 43 T.C. 429">43 T.C. 429; Mountain Water Co. of La Crescenta, 35 T.C. 418">35 T.C. 418.Where, as here, application of the tax-benefit rule would contravene the clear and unambiguous provisions of section 337(a), we think it should not be applied. As was stated by the Supreme Court in Lewyt Corp. v. Commissioner, 349 U.S. 237">349 U.S. 237, 240 (1955), "where the benefit claimed by the taxpayer is fairly within the statutory language and the construction sought is in harmony with the statute as an organic whole, the benefits will not be withheld from the taxpayer though they represent an unexpected windfall."In support of his contention that the tax-benefit rule is applicable here, respondent has cited Rev. Rul. 61-214, 2 C.B. 60">1961-2 C.B. 60, wherein it was held that a portion of the proceeds received by an office building corporation, in a sale in complete liquidation, for a stockpile of coal, plumbing supplies, and small62 tools, the cost of which had been deducted in prior years, was to be treated as ordinary income under section 61 and not as nonrecognized gain under section 337(a). 4This ruling is no more than an expression of the opinion or position of the Internal Revenue Service with respect to the law applicable to the facts recited therein and does not have the force of law. See the preface to the Cumulative Bulletin; Rogovin (then Chief Counsel, I.R.S.), "The Four R's: Regulations, Rulings, Reliance and Retroactivity63 -- A View From Within," 43 Taxes 756">43 Taxes 756 (Dec. 1965); Pictorial 822 v. Helvering, 68 F. 2d 766, 768; Radiant Glass Co. v. Burnett, 54 F. 2d 718, affirming 16 B.T.A. 610">16 B.T.A. 610; Bush #1, 48 T.C. 218">48 T.C. 218, 232.Though noted "without comment" in Hollywood Baseball Association, 42 T.C. 234">42 T.C. 234, 262 fn. 6, affd. 352 F. 2d 350 (C.A. 9, 1965), vacated and remanded 383 U.S. 824">383 U.S. 824, Rev. Rul. 61-214 has not to our knowledge been approved by any court. The conclusions reached are not supported by the authorities cited therein, are clearly contrary to the provisions of section 337(a) and, in our opinion, are not a valid interpretation of the statute. See Gutkin & Beck, "Section 337: IRS Wrong in Taxing, at Time of Liquidation, Items Previously Deducted." 17 J. Taxation 146.In Central Building & Loan Association, 34 T.C. 447">34 T.C. 447 (1960), the assets sold in the liquidation sale included notes receivable on which certain 64 interest had been earned to the date of sale. This Court held there was a collection of interest rather than a "sale or exchange" of property and that such amount was not subject to nonrecognition under section 337.In Commissioner v. First State Bank of Stratford, 168 F. 2d 1004 (C.A. 5, 1948), reversing 8 T.C. 831">8 T.C. 831, certiorari denied 335 U.S. 867">335 U.S. 867, a bank voted to declare a dividend in kind and distributed to its shareholders certain notes which had been charged off as worthless. At the time of distribution substantial collections had been effected on the notes and further substantial collections were effected after distribution. The Court of Appeals held the bank taxable under the anticipatory assignment of income rule. Obviously, section 337, enacted some 6 years later, was not involved, nor was there a "sale or exchange" of property in partial or complete liquidation.Neither of these two cases which were cited in Rev. Rul. 61-214, support the ruling or respondent's contention with respect to the application of the tax-benefit rule to a sale in complete65 liquidation under section 337. Nor do any of the other cases cited by respondent on brief.In Commissioner v. Kuckenberg, 309 F. 2d 202 (C.A. 9, 1962), modifying 35 T.C. 473">35 T.C. 473 (1960), certiorari denied 373 U.S. 909">373 U.S. 909, the Court of Appeals rejected the view that section 337 prevented the gain realized by a liquidating corporation from the sale of completed contracts from being taxable to the corporation and treated the transaction as an anticipatory assignment of earned income.In Pridemark, Inc. v. Commissioner, 345 F. 2d 35 (C.A. 4, 1965), affirming in part and reversing in part 42 T.C. 510">42 T.C. 510, certain proceeds received for the assignment of uncompleted sales contracts for prefabricated houses were held not to be exempt under section 337. The Court of Appeals referred to the Tax Court holding that the sale of the contracts constituted an anticipatory assignment of income and stated: "The uncompleted sales contracts not being capital assets, the 823 proceeds received for their assignment are to be taxed as ordinary income."West Seattle National Bank of Seattle, 341">33 T.C. 341 (1959),66 affd. 288 F. 2d 47 (C.A. 9, 1961); and J. E. Hawes Corp., 44 T.C. 705">44 T.C. 705 (1965), both involved sales of accounts receivable with respect to which reserves for bad debts had been deducted. It was held that the amount received equal to the bad debt reserves was ordinary income and section 337 did not apply because the income sought to be taxed did not represent gain from the sale of assets.In the instant case, the rental items were the operating assets -- property used to generate income. They were the trees not the fruit. The sale was of assets, not income. The fact that their income-producing potential had not been exhausted when sold did not alter their character as property used in the business of the corporation. There is no evidence of stockpiling or that the supply of rental items was not reasonable. Replacements were purchased only as needed and the business required. They were as much property used in the trade or business as the machines used to wash them or the trucks used to transport them.Respondent has not questioned the propriety of expensing the rental items when purchased, or the fact that they were67 not inventoried. See sec. 446 (a) and (c), I.R.C. 1954; sec. 1.446-1(c)(iv), Income Tax Regs.; sec. 471, I.R.C. 1954; sec. 1.471-1, Income Tax Regs. See also Smith Leasing Co., 43 T.C. 37">43 T.C. 37, wherein this Court held that respondent could not require the setting up of an inventory as of the end of the year preceding liquidation. 5The fact that the cost of the rental items had previously been expensed does not preclude the nonrecognition of gain to the corporation under section 337. While there is nothing in the legislative history to indicate Congress was aware of the fact pattern of this case, the language of the statute is clear and unambiguous. If the result here is undesirable, the remedy is for Congress, not the courts. Cf. Commissioner v. South Lake Farms, Inc., 324 F. 2d 837, 84068 (C.A. 9, 1963), affirming 36 T.C. 1027">36 T.C. 1027. Whatever may have been the initial intention in enacting section 337, it contains no requirements other than those spelled out. Cf. Estate of Hugh Miller, 48 T.C. 265">48 T.C. 265. In our opinion, the rental items were "property" within the definition of section 337(b)(1) and there was a "sale" of such property on or about May 22 or 23, 1961, when the transfer by Service of all its assets to buyer was completed, pursuant to a plan of complete liquidation and the agreement of sale. Accordingly, we hold that the gain from the sale of the rental items is not to be recognized to the corporation.In view of our holding that such gain is not to be recognized to the corporation, it follows that petitioner is not liable as transferee.Decision will be entered under Rule 50. Footnotes1. 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.↩2. SEC. 111. RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.(a) General Rule. -- Gross income does not include income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount.(b) Definitions. -- For purposes of subsection (a) --* * * * (4) Recovery exclusion. -- The term "recovery exclusion", with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with regulations prescribed by the Secretary or his delegate, of the deductions or credits allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a reduction of the taxpayer's tax under this subtitle * * * reduced by the amount excludable in previous taxable years with respect to such debt, tax, or amount under this section.↩3. Sec. 1.111-1, Income Tax Regs., provides as follows:Sec. 1.111-1 Recovery of certain items previously deducted or credited.(a) General. Section 111 provides that income attributable to the recovery during any taxable year of bad debts, prior taxes, and delinquency amounts shall be excluded from gross income to the extent of the "recovery exclusion" with respect to such items. The rule of exclusion so prescribed by statute applies equally with respect to all other losses, expenditures, and accruals made the basis of deductions from gross income for prior taxable years, including war losses referred to in section 127 of the Internal Revenue Code of 1939, but not including deductions with respect to depreciation, depletion, amortization, or amortizable bond premiums. The term "recovery exclusion" as used in this section means an amount equal to the portion of the bad debts, prior taxes, and delinquency amounts (the items specifically referred to in section 111↩), and of all other items subject to the rule of exclusion which, when deducted or credited for a prior taxable year, did not result in a reduction of any tax of the taxpayer under subtitle A * * *4. In Rev. Rul. 59-308, 2 C.B. 110">1959-2 C.B. 110, respondent held that no taxable gain was to be recognized by a corporation, under sec. 337, from the sale during the period of liquidation of emergency facilities amortized under sec. 168 of the Code. In the stated case the property had been completely amortized. In that ruling respondent conceded that the facilities, not having been specifically excluded from the definition of "property" as used in sec. 337↩, were included in that term.5. In this connection, it is to be noted that had the rental items-in-use been inventoried, sec. 337(b)(2) would have required the nonrecognition of gain to the corporation↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621582/	Marjorie J. Gammill, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentGammill v. CommissionerDocket Nos. 9578-75, 9602-75, 9955-75United States Tax Court73 T.C. 921; 1980 U.S. Tax Ct. LEXIS 177; February 28, 1980, Filed 177 Decision will be entered for the petitioner in docket No. 9578-75.Decisions will be entered for the respondent in docket Nos. 9602-75 and 9955-75. Held: A $ 250,000 money judgment entered against the husband in a decree of divorce was part of a property settlement and not in the nature of support. Therefore, the payments are neither includable in the wife's gross income under sec. 71(a)(1), I.R.C. 1954, nor deductible by the husband under sec. 215(a), I.R.C. 1954. Held, further, sec. 483, I.R.C. 1954, imputed interest provision not applicable to property settlements incident to divorce. Fox v. United States, 510 F.2d 1330">510 F.2d 1330 (3d Cir. 1975), followed. George F. Saunders, for the petitioner in docket No. 9578-75.Gene A. Castleberry, for the petitioners in docket Nos. 9602-75, 9955-75.D. Michael Adcock, for the respondent. Wiles, Judge. WILES922 Respondent determined the following deficiencies in petitioners' Federal income taxes:TaxpayerDocket No.YearDeficiencyMarjorie J. Gammill9578-751971$ 4,351.0019724,458.2019734,348.00John S. Gammill9602-7519715,211.0019724,205.98John S. Gammill andBetty Milliren 9955-7519736,253.00The issues for decision are: (1) Whether payments received by Marjorie J. Gammill from her former husband, John S. Gammill, are includable in her gross income under section 71(a)(1)2 and, therefore, are deductible by John S. Gammill under section 215(a); and (2) whether John S. Gammill is entitled to deductions for imputed interest under section 483 if the payments he made to Marjorie J. Gammill are determined to be in satisfaction180 of a property settlement. As to both issues, respondent is a mere stakeholder in this case.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Marjorie J. Gammill and John S. Gammill resided in Oklahoma City, Okla., when they filed their 1971, 1972, and 1973 Federal income tax returns with the Internal Revenue Service Center, Austin, Tex., and when they filed their petitions in this case. 3Marjorie J. and John S. Gammill were married on February 23, 1946, and two children were born of the marriage. In April 1970, Marjorie commenced an action in the District Court for Oklahoma County, State of Oklahoma, 181 seeking a divorce from 923 John, the custody of their minor son, an equitable division of the property, and an alimony award. On April 21, 1970, the court ordered John to pay $ 1,000 a month for Marjorie's living expenses pending the divorce proceedings. On May 8, 1970, the court reduced the temporary support from $ 1,000 to $ 500 and ordered John to pay the utility bills and the mortgage on the family residence in which Marjorie continued to reside. On November 5, 1970, the court granted Marjorie a divorce from John and filed a "Decree of Divorce and Journal Entry of Judgment" (hereinafter divorce decree).Neither John nor Marjorie had any separate property of substantial value at the time of their marriage, and the record does not indicate that either party had any separate property at the time of their divorce. Therefore, all the assets they had at the time of their divorce were acquired jointly during the course of their marriage. John owned 942,294 of the 2,508,176 outstanding shares of stock of Reserve National Insurance Co. (hereinafter Reserve National), a corporation he formed in 1956. The office building occupied by Reserve National was also titled in John's 182 name. Marjorie, though never having made any payments on the mortgage on the family residence, held a legal interest therein which was quitclaimed to John upon divorce. No other property was legally held in Marjorie's name at the time of the divorce.Marjorie's contribution toward the marriage was essentially that of housewife and mother. She never finished high school and had not been employed outside the home while married to John. Furthermore, her contribution to the success of Reserve National was minimal.During the divorce proceedings, the parties neither agreed to the value of the property acquired during their marriage, nor agreed that either would get a certain percentage of the property. Marjorie believed, however, that she was entitled to one-half the property the couple acquired during the course of their marriage. Her attorney valued the estate to be divided at $ 811,261, broken down as follows:Reserve National stock$ 518,261.70House and furniture100,000.00Republic Brokerage50,000.00Office building105,000.00Stocks, bonds, mutual funds16,000.00Automobile2,000.00Art objects20,000.00811,261.70924 In contemplation of the divorce, 183 Marjorie and John executed an instrument entitled "Property Settlement Agreement" (hereinafter agreement). Marjorie and John entered into the agreement with the advice of their attorneys. With respect to the $ 250,000 money judgment against John, the agreement provided as follows:6. Second Party [John] is to pay to First Party [Marjorie], by way of further division of property and not as alimony, the sum of $ 250,000 which shall be incorporated in the decree as a judgment. [Emphasis added.]The agreement was approved and made a part of the divorce decree by order of the District Court, which found that it fully and fairly divided the marital estate. The portions of the divorce decree which incorporated the paragraph of the agreement pertaining to the $ 250,000 money judgment at issue in this case read as follows:It Is Further Ordered, Adjudged and Decreed that the property settlement agreement entered into by and between the parties on this date is hereby approved and made a part of this Decree, and that as a part of the property and assets set over to the plaintiff as provided by said Contract, that plaintiff is granted judgment against the defendant in the sum 184 of $ 250,000.00 the same to be payable at the defendant's option, without interest, in equal monthly installments of $ 1,041.47 for a period of 240 months with the right of pre-payment of same. That said judgment shall be secured by a judgment lien against 300,000 shares of stock of the defendant in Reserve National Insurance Company, the same representing a portion only of the stock in said insurance company, owned by the defendant. * * It Is Further Ordered, Adjudged and Decreed that in the event that defendant should die or become and remain in default upon the payments due on this judgment for more than 30 days, then this entire judgment shall become due and payable in full, and in addition to the collateral provided for above, that plaintiff shall have all other remedies provided by law against the defendant or his estate, successors or assigns, for collection of said judgment.[Emphasis added.]Both the agreement and the divorce decree provided that the judgment lien on John's Reserve National stock was to be released annually as to 15,000 shares of such stock unless he 925 defaulted in the payment of the installments due during the preceding year or as to a 185 proportionate number of shares of such stock if he prepaid any part of the judgment.In addition to the $ 250,000 money judgment payable, at John's option, by lump sum or in installments over a maximum of 20 years, Marjorie received the following assets valued by her attorney as follows:Office buildings$ 105,000One-half of art objects10,000Automobile2,000Cash50,000167,000The office building transferred to Marjorie was subject to a lease with Reserve National. The lease had 5 years remaining at a monthly rent of $ 1,600. Under the lease, Reserve National had to maintain the building in good repair, pay the utilities, and carry liability insurance on the building. The total value of the money judgment and the assets Marjorie received under the agreement was $ 417,000, or approximately one-half the entire estate as valued by her attorney.Under the agreement, John received the family residence, subject to a mortgage, along with the furnishings therein and "all of those assets accumulated since the date of the marriage save and except those specifically * * set aside to" Marjorie. As such, John retained ownership of the 942,294 shares of Reserve National186 stock.OPINIONThe first issue for decision is whether payments received by Marjorie from her former husband, John, are periodic payments in the nature of support or part of a property settlement. If the payments are determined to be periodic in the nature of support, they are includable in Marjorie's gross income under section 71(a)(1) and deductible by John under section 215(a). On the other hand, if the payments are determined to be part of a property settlement, there will be no tax consequences to either party under sections 71 and 215.Marjorie maintains that the agreement she and John entered, as incorporated in the divorce decree, clearly shows that the $ 250,000 money judgment was part of the property settlement 926 and not periodic payments in the nature of support. She claims the money judgment entered in the divorce decree was in satisfaction of her right to one-half the property acquired during the course of their marriage. John maintains that since Marjorie had no independent means of support, he intended the monthly payments made in satisfaction of the money judgment to be for her support. He claims that under Oklahoma law, Marjorie had no vested rights in187 the property acquired during their marriage in that she made a minimal contribution to the acquisition of such property, and, therefore, was not entitled to one-half the marital estate.For reasons set out below, we find, on the basis of this record, that the $ 250,000 money judgment entered in the divorce decree was part of the property settlement between Marjorie and John. Accordingly, Marjorie is not required to include the payments she received from John in her gross income under section 71(a)(1) and John is not entitled to deduct the amounts he paid under section 215(a).As relevant to this case, section 71(a) provides that if a wife is divorced from her husband under a decree of divorce, the wife's gross income includes periodic payments received in discharge of a legal obligation which, because of the marital or family relationship, is incurred by the husband under the decree incident to such divorce. Section 215(a) permits a deduction to the husband for payments which are includable in the gross income of his wife under section 71. Section 71(a), however, applies only to payments made in recognition of the general obligation to support which is made specific by the decree. 188 Sec. 1.71-1(b)(4), Income Tax Regs. Payments which are part of a property settlement are capital in nature and, therefore, are not subject to the provisions of section 71. Thompson v. Commissioner, 50 T.C. 522">50 T.C. 522, 525 (1968); Price v. Commissioner, 49 T.C. 676">49 T.C. 676 (1968).In determining whether payments are periodic and in the nature of support or part of a property settlement, labels assigned to the payments by the parties in their agreement or by the court in the divorce decree are not conclusive. Thompson v. Commissioner, supra;Bardwell v. Commissioner, 38 T.C. 84">38 T.C. 84, 89-90 (1962), affd. 318 F.2d 786">318 F.2d 786 (10th Cir. 1963). The determination rests upon the surrounding facts and circumstances. Jackson v. 927 , 54 T.C. 125">54 T.C. 125, 130 (1970); Newbury v. Commissioner, 46 T.C. 690">46 T.C. 690, 694 (1966).Marjorie argues that the language in both the agreement and the divorce decree makes it clear that the money judgment was part of the property settlement rather than in the nature of support. 189 We agree. The agreement provided that John was to pay her "by way of further division of property and not as alimony, the sum of $ 250,000 which shall be incorporated in the decree as a judgment." The provision in the divorce decree relating to the money judgment at issue was changed from "in addition to the property and assets set over to the plaintiff" (Marjorie) to "as a part of the property and assets set over to the plaintiff" (Marjorie). The initials of John, Marjorie, and the presiding judge were alongside this change. Although, as noted above, labels assigned by the parties in instruments are not conclusive, we believe that, in light of the surrounding facts and circumstances discussed below, the language used by John and Marjorie is sufficiently clear to find that the judgment was part of the property settlement. Moreover, John's initials alongside the change in the divorce decree, whether by his own hand or that of his attorney, is convincing proof that he knew or should have known that the money judgment was part of the property settlement and not in the nature of support.Our finding is further supported by the Oklahoma statute pertaining to support and to the division190 of property which was applicable at the time of Marjorie and John's divorce. 4 Under this statute, the court could have designated the payments made in satisfaction of the money judgment as support, which it did not do, rather than as part of the property settlement. Moreover, if the payments were periodic or in the nature of support, the 928 statute provides that the court should have made provision for their termination upon Marjorie's remarriage. The payments were not so conditioned in the divorce decree, and, in addition, John testified that he believed the payments would continue even if Marjorie died. Furthermore, not only was the entire judgment due and payable in full if John died or failed to make any payment for more than 30 days, but Marjorie was provided with all other remedies at law against John, his estate, successors, or assigns for collection of said judgment.191 John's argument that since Marjorie had no independent means of support, he intended the money judgment to provide for her support is unpersuasive. John noted that Marjorie had neither worked outside the home for nearly 25 years nor did she have any marketable skills for securing outside employment. John, however, ignores the fact that Marjorie was to receive rent of $ 1,600 per month from the office building transferred to her as part of the property settlement. This rent totaled $ 19,200 per year. After reducing this total by the expenses for maintaining the building which Reserve National was not liable for under the lease, her income was approximately the same as John's annual salary of between $ 15,000 and $ 18,000, exclusive of outside income. By virtue of owning the office building, Marjorie was essentially self-supporting. Moreover, despite Marjorie's initial request for alimony in her petition for divorce, the record does not reflect any consideration by the parties prior to the divorce of the extent of Marjorie's need for support or John's ability to pay such support.John's argument that Marjorie had not acquired any right in the property acquired during their marriage192 is also without merit. Under Oklahoma law, the wife's right to property upon divorce is set forth in Okla. Stat. Ann. tit. 12, sec. 1278 (1967), which, as pertinent, provides:Sec. 1278. Disposition of property -- Restoration of wife's maiden name -- Alimony* * * As to such property, whether real or personal, as shall have been acquired by the parties jointly during their marriage, whether the title thereto be in either or both of said parties, the court shall make such division between the parties respectively as may appear just and reasonable, by a division of the property in kind, or by setting the same apart to one of the parties, and requiring the other thereof to pay such sum as may be just and proper to effect a fair and just division thereof. * * R.L. 1910, § 4969. [Emphasis added.]929 In addressing the wife's property interests, the Supreme Court of Oklahoma has stated that the nature of a wife's interest in jointly acquired property, property acquired by the joint effort of the spouses during marriage, "is similar in conception to community property of community property states, and is regarded as held by a species of common ownership." 193 Collins v. Oklahoma Tax Commission, 446 P.2d 290">446 P.2d 290, 295 (Okla. 1968). Upon divorce, the wife's interest in jointly acquired property is vested, regardless of who holds title. Davis v. Davis, 61 Okla. 1275">61 Okla. 1275, 161 P. 190">161 P. 190, 193 (1916). Since all the property held by John and Marjorie at the time of divorce was jointly acquired property, and Marjorie had a vested interest in all such property, her rights in the property were only subject to a statutory "just and reasonable" division by the trial judge presiding at the divorce action.John's contention that Marjorie is not entitled to one-half the property acquired during their marriage because she expended minimal effort in making Reserve National successful, and therefore such property was not acquired jointly, is not valid. Although Marjorie's efforts in making Reserve National successful appear to be minimal, she testified that John wanted her to stay at home and care for the children. The efforts of the wife need not be outside the home for her contribution to be such as to cause property acquired during marriage to be jointly acquired property. Roberts v. Roberts, 357 P.2d 980 (Okla. 1960);194 Funk v. Funk, 319 P.2d 599 (Okla. 1957), as cited in Collins v. Commissioner, 46 T.C. 461">46 T.C. 461, 471 (1966). By providing for the $ 250,000 money judgment against John in the divorce decree, the court made the statutory just and reasonable division of property consistent with Marjorie's contribution to the marriage as a wife and good mother for over 24 years.The fact that the money judgment was secured by John's stock in Reserve National, which judgment lien would be released annually on 15,000 shares if the payments for the year were timely made, lends further support to the position that the $ 250,000 money judgment was part of the property settlement. The record reveals that John was unable to pay Marjorie $ 250,000 at the time of divorce due to a lack of cash. We believe that John agreed to the money judgment in order to retain ownership of all of his Reserve National stock.The second issue for decision is based on John's claim that if 930 the money judgment is determined to be part of the property settlement, he is entitled to deduct that portion of each payment representing imputed interest under section 483. 195 5 In order for John to be so entitled, not only must there be a "contract for the sale or exchange of property," but section 483 must be found applicable to property settlements incident to divorce. Since we find that section 483 is not applicable to property settlements incident to divorce, we need not determine whether the property settlement agreement John and Marjorie entered into constituted a contract for the sale or exchange of property.Respondent relies on Fox v. United States, 510 F.2d 1330 (3d Cir. 1975),196 6197 for his contention that John is not entitled to such deductions. 7 In Fox, the taxpayer and his former wife entered a written agreement for the division of property incident to their divorce and such agreement provided that the taxpayer pay his former wife $ 1 million over a period of 9 1/2 years. The agreement further provided that the deferred installment payments were to be made without interest. The Third Circuit held that the taxpayer was not entitled to deductions for imputed interest because section 215 limits the deductions a husband may claim on payments made under section 71, and section 483 was never intended to apply to property settlements incident to divorce. Although the court in Fox did not specifically find whether the payments the taxpayer made were periodic payments in the nature of support (alimony), part of a property settlement, or both, we find persuasive its reasoning that section 483 was never intended to apply to property settlements incident to divorce.Section 483 was enacted in 1964 to eliminate undesirable manipulation of the tax laws by sellers and purchasers of capital 931 assets under installment sales agreements which did not specifically provide for interest. The legislative history reveals the general reason for the section as follows:Your committee agrees with the House that there is no reason for not reporting amounts as interest income merely because the seller and purchaser did not specifically provide for interest payments. This treats taxpayers differently in what are essentially the same circumstances merely on the 198 grounds of the names assigned to the payments. In the case of depreciable property this may convert what is in reality ordinary interest income into capital gain to the seller. At the same time the purchaser can still recoup the amount as a deduction against ordinary income through depreciation deductions. Even where the property involved is a nondepreciable capital asset, the difference in tax bracket of the seller and buyer may make a distortion of the treatment of the payments advantageous from a tax standpoint. The House and your committee believe that manipulation of the tax laws in such a manner is undesirable and that corrective action is needed. [S. Rept. 830, to accompany H.R. 8363, 88th Cong., 2d Sess. (1964), 1964 U.S. Code Cong. & Adm. News 1775.]The court in Fox properly noted that:as a practical observation, the application of section 483 to an agreement like the instant one would not seem to further the conceptual framework of the statute. That is, it is highly unlikely that, in negotiating the property settlement agreement, the husband "purchaser" party would tolerate augmentation of the cash "sales price" to reflect "unstated interest." [510 F.2d at 1335.]199 Several cases have held that section 483 is applicable to deferred payments resulting from tax-free reorganizations. Vorbleski v. Commissioner, 589 F.2d 123">589 F.2d 123 (3d Cir. 1978), affg. 68 T.C. 413">68 T.C. 413 (1977); Katkin v. Commissioner, 570 F.2d 139 (6th Cir. 1978), affg. 67 T.C. 379">67 T.C. 379 (1976); Solomon v. Commissioner, 570 F.2d 28">570 F.2d 28 (2d Cir. 1977), affg. 67 T.C. 379">67 T.C. 379 (1976); Jeffers v. United States, 214 Ct. Cl. 9">214 Ct. Cl. 9, 556 F.2d 986">556 F.2d 986 (1977); Catterall v. Commissioner, 68 T.C. 413">68 T.C. 413 (1977). In each of those cases, however, the courts distinguish Fox implicitly recognizing that different considerations are involved in applying section 483 to property settlements incident to divorce. Moreover, this Court, in Catterall v. Commissioner, supra at 420-421, distinguished Fox by stating:The Third Circuit concluded that the tax consequences of divorce-related payments are specifically controlled by sections 71 and 215 and not subject200 to section 483. Fox is clearly distinguishable from the facts of the instant case. Unlike sections 71 and 215 which are broadly couched in terms of the gross income of the wife, section 354 merely provides that no gain is recognized in 932 the case of certain reorganizations described in section 368. Gain, as computed under section 1001(a), is merely one category of gross income described in section 61. Interest, the type of income with which we are concerned, is separately listed in section 61(a)(4). Although gain on the exchange of property is generally the only type of income realized in a reorganization in which no "boot" is received, the language of the reorganization sections does not specifically prohibit the recognition of other types of income. Therefore, no conflict exists between sections 483 and 354 and thus there is no basis for the application of the above-mentioned rule of statutory construction as in Fox.One of the taxpayers in Catterall v. Commissioner, supra, took a separate appeal to the Third Circuit, and, again relying on the Fox rationale, argued that section 483 should not be applied to tax-free201 reorganizations. Vorbleski v. Commissioner, 589 F.2d 123">589 F.2d 123 (3d Cir. 1978), affg. 68 T.C. 413">68 T.C. 413 (1977). In rejecting this argument, the Third Circuit affirmed its position in Fox and distinguished its position in that opinion by indicating again that Fox stood for the narrow rule that "section 483 does not apply to a payment when Congress intended all of the tax consequences of that payment to be governed exclusively by another provision of the Code." (589 F.2d at 132.) The Court then concluded that the provisions applicable to tax-free reorganizations, unlike those applying to divorce, were not intended to determine all the tax consequences of corporate reorganizations.Finally, we note that the agreement John and Marjorie entered, as incorporated by their divorce decree, specifically provided that the $ 250,000 money judgment was to be paid without interest. It is well recognized that parties to a divorce agreement may for tax purposes act as their best interests dictate. Commissioner v. Lester, 366 U.S. 299">366 U.S. 299, 306 (1961). For these reasons, we must deny John's202 claim and hold for respondent on this issue.To reflect the foregoing,Decision will be entered for the petitioner in docket No. 9578-75.Decisions will be entered for the respondent in docket Nos. 9602-75 and 9955-75. Footnotes1. Cases of the following petitioners are consolidated herewith: John S. Gammill, docket No. 9602-75; and John S. Gammill and Betty Milliren, docket No. 9955-75.↩2. Statutory references are to the Internal Revenue Code of 1954, as amended.↩3. Betty Milliren is a party to the petition relating to taxable year 1973 solely because she joined in filing John S. Gammill's 1973 tax return.↩4. The statute, in part, provides:§ 1289. Alimony payments -- Termination -- Payments pertaining to division of property* * * (B) In any divorce decree entered after December 31, 1967, which provides for periodic alimony payments, the Court, at the time of entering the original decree, only, may designate all or a portion of each such payment as support, and all or a portion of such payment as a payment pertaining to a division of property. Upon the death of the recipient, the payments for support, if not already accrued, shall terminate, but the payments pertaining to a division of property shall continue until completed; and the decree shall so specify. The payments pertaining to a division of property shall be irrevocable. * * The Court shall also provide in the divorce decree that any such support payments shall terminate after remarriage of the recipient↩ * * * [1965 Okla. Sess. Laws, ch. 344, sec. 1. Amended by 1967 Okla. Sess. Laws, ch. 328, sec. 1; 1968 Okla. Sess. Laws, ch. 161, sec. 1, emerg. effective Apr. 11, 1968. Emphasis added.]5. Sec. 483, in part provides:SEC. 483. INTEREST ON CERTAIN DEFERRED PAYMENTS.(a) Amount Constituting Interest. -- For purposes of this title, in the case of any contract for the sale or exchange of property↩ there shall be treated as interest that part of a payment to which this section applies which bears the same ratio to the amount of such payment as the total unstated interest under such contract bears to the total of the payments to which this section applies which are due under such contract. [Emphasis added.]6. Rev. Rul. 76-146, 1 C.B. 144">1976-1 C.B. 144, adopted the Fox rationale that sec. 483↩ does not apply to property settlements incident to divorce.7. John cites the case of Gerlach v. United States, 201 Ct. Cl. 884 (1973), as support for his position that he is entitled to deductions for imputed interest. Gerlach did allow the taxpayer a deduction for imputed interest on installment payments to his former wife which payments were found to be part of the property settlement incident to their divorce. In that case, however, the Government conceded the applicability of sec. 483↩ so the court did not consider the issue.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621583/	AUGUST HECKSCHER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Heckscher v. CommissionerDocket No. 82000.United States Board of Tax Appeals36 B.T.A. 1181; 1937 BTA LEXIS 614; December 22, 1937, Promulgated 614 Where a taxpayer exchanged property costing $176,382.05 for other property under a contract which limits his possible recovery on a later sale of said property to $150,000, he suffered a loss of $26,382.05, which is deductible in the year of the exchange. Horace N. Taylor, Esq., and Winthrop G. Brown, Esq., for the petitioner. Philip M. Clark, Esq., and Stanley B. Pierson, Esq., for the respondent. VAN FOSSAN 1181 OPINION. VAN FOSSAN: This proceeding was brought to redetermine a dificiency in the income tax of the petitioner for the year 1932 in the sum of $2,847.93. The sole issue is the deductibility of an alleged loss arising from the sale or exchange of certain stock, costing the petitioner $176,382.05, for real estate in which the petitioner's interest was limited to $150,000. In 1921 the petitioner and his wife organized the Heckscher Foundation for Children, hereinafter called the Foundation. Its purpose 1182 is to help the underprivileged. It owns a building at 104th Street and Fifth Avenue, New York City, equipped with gymnasium, library, swimming pool, theater, etc., and it also owns a summer camp at Peekskill. 615 In 1928 the petitioner gave to the Foundation a tract of land on Long Island containing 16 1/2 acres and three or four dwellings. Due to the market crash of 1929, the income of the Foundation was greatly reduced and the property became a heavy burden. Thereupon the petitioner paid for the Foundation certain carrying charges amounting to over $16,000. He leased the land from August 1, 1930, to May 31, 1931. The petitioner owned 2,500 shares of the capital stock of the Alcoma Corporation which hd had acquired in December 1928 and had cost him $176,382.05. On June 17, 1932, the petitioner transferred to the Foundation the 2,500 shares of Alcoma stock and canceled its $16,000 obligation to him in exchange for the Long Island property. His agreement with the Foundation provided as follows: I further agree that if, as and when, the property is sold, I will pay over to you such net sum as may be realized after deducting therefrom $150,000 representing original cost of the property and after deducting all costs of carrying, maintaining and selling the property, including taxes, repairs, improvements or expenditures of any kind in connection with the property, crediting, however, 616 any income or rent received therefrom from and after the conveyance to me. In his income tax return for 1932 the petitioner deducted as a loss the sum of $26,382.05 representing the difference between the cost of Alcoma stock to him and the maximum amount of his interest in the Long Island property. The respondent disallowed the deduction on the ground that the transaction between him and the Foundation was not entered into for profit. The position of the respondent is precisely expressed in the following explanation of his disallowance of the deduction, contained in his notice of deficiency: Your attention is directed to the contract under which the exchange was made wherein it was stated that if you sold the property received for the stock for more than $150,000.00 the value placed on the property, such excess should be returned to the Foundation. In view of the above it clearly shows that you could not under any consideration expect to make a profit and therefore, the transaction was one not entered into for profit. Counsel for respondent concedes that he can find no authorities in support of his position. 617 The reasoning underlying respondent's action has been rejected in ; affd., . There we said: Respondent's position is based on the theory that the transaction which resulted in the loss in each case was the sale to Lura Hale. That was only one 1183 of several steps, all of which can and must be retraced to find the origin of the transaction. We thus go back to June 6, 1929, when the stock was acquired by petitioners. That acquisition marked the inception of a "transaction entered into for profit" within the meaning of the statute. The principle of relation back to inception is fundamental in the tax statutes. In order to determine gain or loss the amount realized is compared with the basis, and the basis is a figure determined as of the time of acquisition - with a few exceptions, as, for instance, acquisition prior to March 1, 1913. Following a transaction through, it is ordinarily ended and gain or loss computed when property is sold. * * See also 618 . In the case at bar the transaction was a simple one. The Alcoma stock was originally acquired in a transaction entered into for profit at a cost of $176,382.05. The petitioner sold or exchanged the Alcoma shares for Long Island property in which he obtained an interest of a value of not more than $150,000. Thus the value or price of the property received in exchange, i.e., an interest in the Long Island property, was fixed at $150,000 or less. Upon its sale petitioner can derive no profit. In this proceeding he claims a deduction of the loss. He contends that the events of the taxable year fix the amount of such loss. In the Hale case, supra, we expressly refrained from ruling on the situation that arises where the guaranty is satisfied in a later year. Neither are we called on to rule on such issue here. The reasoning of the Hale case is, however, applicable in the present proceeding and is controlling. The taxpayer here can never receive more than the specified amount of $150,000. The present measure of the value of the real estate is exactly $150,000. The cost of the Alcoma stock was $176,382.05. 619 The difference between these sums, or $26,382.05, is the loss suffered by the petitioner by reason of the exchange. It is an allowable deduction from his gross income for the year 1932. Decision will be entered under Rule 50.	01-04-2023	11-21-2020

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