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https://www.courtlistener.com/api/rest/v3/opinions/4622644/	Kamin Chevrolet Company, Petitioner, v. Commissioner of Internal Revenue, RespondentKamin Chevrolet Co. v. CommissionerDocket No. 371United States Tax Court3 T.C. 1076; 1944 U.S. Tax Ct. LEXIS 91; July 10, 1944, Promulgated 91 Decision will be entered under Rule 50. The petitioner filed an excess profits tax return for the calendar year 1940. On June 24, 1940, all of the stockholders of the petitioner entered into an agreement consenting to the dissolution and winding up of its affairs and on the same date the board of directors adopted a like resolution. Pursuant to such resolution the petitioner, on June 29, 1940, distributed all of its assets to its stockholders, subject to its liabilities, but did not surrender its charter. After June 30, 1940, the corporation was an empty shell without capital, income, or expenses. The respondent treated the return filed as one made for the period January 1 to June 30, 1940; determined the excess profits net income for the twelve-month period as provided by section 711 (a) (3) of the Internal Revenue Code; reduced the excess profits credit as provided by section 713 (a) (1) (C); and determined the excess profits tax liability accordingly. Held, that the respondent did not err in treating the excess profits tax return filed as one covering only the period January 1 to June 30, 1940, but that he did err in reducing the excess profits credit by the application92 of section 713 (a) (1) (C). Harry W. Kamin, Esq., for the petitioner.Homer F. Benson, Esq., for the respondent. Smith, Judge. SMITH 1076 This is a proceeding for the redetermination of a deficiency in excess profits tax for 1940 in the amount of $ 633.69. The petitioner alleges as follows:(a) The Commissioner erred in interpreting the return filed as a return for a fractional part of the year 1940 and placing the same on an annual basis.1077 (b) The Commissioner erred in deducting for excess profits tax credit an amount of $ 754.10 representing 6 percent of the net capital reduction.FINDINGS OF FACT.The petitioner is a Pennsylvania corporation, incorporated on October 18, 1935, with its principal office in Pittsburgh. It filed required tax returns for the calendar year 1940 with the collector of internal revenue at Pittsburgh.Its corporate income, declared value excess profits, and defense tax return (Form 1120) showed net income of $ 7,671.12. In the return it is stated: "ASSETS AND LIABILITIES SOLD TO STOCKHOLDERS JUNE 30, 1940, CORPORATION INACTIVE."Its corporation excess profits tax return (Form 1121) for the calendar year 1940 showed excess profits93 net income of $ 6,459.66. No excess profits tax liability was disclosed thereby.In the determination of the deficiency the respondent treated the excess profits tax return as one covering the period January 1 to June 30, 1940, and found the correct excess profits net income for that period to be $ 6,487.41. The petitioner does not question the correctness of the determination of the amount of the excess profits net income for such period. The respondent placed the net income on an annual basis in accordance with the provisions of section 711 (a) (3) of the Internal Revenue Code and found that the excess profits net income for the 12-month period ended June 30, 1940, was in the amount of $ 13,046.11. The petitioner does not question the correctness of this excess profits net income, provided the return filed should be considered as a return for the period January 1 to June 30, 1940. The respondent also found that on June 30, 1940, the petitioner, as a result of the distribution of its assets, effected a net capital reduction of $ 12,568.13, which was arrived at by multiplying its total capital of $ 25,000 by 184, the number of days the petitioner was out of business during the94 year 1940, by dividing by 366, the number of days in the calendar year. By the application of section 713 (a) (1) (C) of the code the respondent effected a reduction in petitioner's excess profits credit of $ 754.10, or 6 percent of the petitioner's net capital reduction.On June 24, 1940, all the stockholders of record of the petitioner entered into an agreement consenting to the dissolution and winding up of the affairs of the petitioner. A special meeting of stockholders of petitioner was held on that date and it was duly resolved as follows: (1) That the petitioner be dissolved and the affairs of the company wound up, and (2) that the petitioner sell, transfer, assign, and deliver to the shareholders all the assets of the petitioner, subject to all of its debts. On June 26, 1940, a special meeting of the board of directors 1078 of petitioner was held, at which the foregoing resolutions were adopted and the proper officers of petitioner were authorized to make a complete liquidation of the assets of petitioner in accordance with the aforesaid resolution.The assets of the petitioner were transferred in accordance with the resolution on June 29, 1940, resulting in a complete95 liquidation of the assets and business of the petitioner. The officers of petitioner did not proceed with the dissolution of the company and the corporate charter of petitioner was not surrendered, but instead its corporate charter continued in existence during and subsequent to the calendar year 1940.OPINION.The first question presented is whether the respondent correctly treated the excess profits tax return filed by the petitioner for 1940 as a return for the 6-month period ended June 30 rather than one for the calendar year. The petitioner submits that since it was in existence for the entire calendar year 1940 it was required to file a return covering the entire calendar year and that the respondent was in error in treating the return filed as one for only a fractional part of the year.Section 48 of the Internal Revenue Code defines a taxable year as meaning:* * * the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed under this Part. "Taxable year" includes, in the case of a return made for a fractional part of a year under the provisions of this chapter or under regulations prescribed by the Commissioner96 with the approval of the Secretary, the period for which such return is made.Section 711 (a) of the code, added by section 201 of the Second Revenue Act of 1940, and paragraph (3) of that subdivision, as amended by section 213 of the Revenue Act of 1942, read in material part as follows:(a) Taxable Years Beginning After December 31, 1939. -- The excess profits net income for any taxable year beginning after December 31, 1939, shall be the normal-tax net income, as defined in section 13 (a) (2), for such year except that the following adjustments shall be made: * * (3) Taxable year less than twelve months. --(A) General Rule. -- If the taxable year is a period of less than twelve months the excess profits net income for such taxable year (referred to in this paragraph as the "short taxable year") shall be placed on an annual basis by multiplying the amount thereof by the number of days in the twelve months ending with the close of the short taxable year and dividing by the number of days in the short taxable year. The tax shall be such part of the tax computed on such annual basis as the number of days in the short taxable year is of the number of days in the twelve months97 ending with the close of the short taxable year.1079 (B) Exception. -- If the taxpayer establishes its adjusted excess profits net income for the period of twelve months beginning with the first day of the short taxable year, computed as if such twelve-month period were a taxable year, under the law applicable to the short taxable year, and using the credits applicable in determining the adjusted excess profits net income for such short taxable year, then the tax for the short taxable year shall be reduced to an amount which is such part of the tax computed on such adjusted excess profits net income so established as the excess profits net income for the short taxable year is of the excess profits net income for such twelve-month period. The taxpayer (other than a taxpayer to which the next sentence applies) shall compute the tax and file its return without the application of this subparagraph. If, prior to one year from the date of the beginning of the short taxable year, the taxpayer has disposed of substantially all its assets, in lieu of the twelve-month period provided in the preceding provisions of this subparagraph, the twelve-month period ending with the close of98 the short taxable year shall be used. For the purposes of this subparagraph, the excess profits net income for the short taxable year shall not be placed on an annual basis as provided in subparagraph (A), and the excess profits net income for the twelve-month period used shall in no case be considered less than the excess profits net income for the short taxable year. The benefits of this subparagraph shall not be allowed unless the taxpayer, at such time as regulations prescribed hereunder require, makes application therefor in accordance with such regulations, and such application, in case the return was filed without regard to this subparagraph, shall be considered a claim for credit or refund. The Commissioner, with the approval of the Secretary, shall prescribe such regulations as he may deem necessary for the application of this subparagraph.Section 213 (b) of the Revenue Act of 1942 provides that the above amendments "shall be applicable to taxable years beginning after December 31, 1939."In support of his determination that the excess profits tax return filed by the petitioner for the calendar year 1940 is a return for the six-month period ended June 30 the respondent99 cites section 35.711 (a)-4 of Regulations 112, in which it is stated: * * A short taxable year is any taxable period of less than 12 months. If the period from the date of incorporation of a corporation to the end of its first accounting period, or the period from the beginning of its last accounting period to the date it ceases operations and is dissolved, retaining no assets, is a period of less than 12 months, such period is a short taxable year. * * In G. C. M. 23064; C. B. 1942-1, p. 140, it is stated:In the instant case the facts show that the corporation was dissolved on June 30, 1940, and retained no assets whatever. Under such circumstances, this office cannot distinguish, in so far as present inquiry is concerned, between the case of a new corporation and one which has completely dissolved.This Office is of the opinion, therefore, that the excess profits tax return filed by the M Company covering the period January 1, 1940, to June 30, 1940, as of which date the taxpayer corporation ceased operations and dissolved, the corporation retaining no assets, is a return for a period of six months; and that under the provisions of section 711 (a)100 3 of the Internal Revenue Code, supra, the excess profits net income should be placed on an annual basis. To hold otherwise would mean that against the six-months' income there would be allowed an excess profits credit based on an average base period net income involving 12 months.1080 The entire contention of the petitioner in this case rests upon the tenuous ground that it did not surrender its charter at the time that it was completely liquidated on June 30, 1940. It claims that since under the laws of the Commonwealth of Pennsylvania it had a legal existence throughout the calendar year 1940, its return correctly covered the entire calendar year. It therefore argues that the respondent was in error in determining its excess profits net income for the year 1940 in accordance with the provisions of section 711 (a) (3) (A) of the Internal Revenue Code.It may be conceded that technically the petitioner had a legal existence for the entire calendar year 1940. Under the laws of the Commonwealth of Pennsylvania a corporation's charter is not canceled by a complete liquidation of the corporation. Some action must be taken either by the corporate officers or by the proper 101 state authorities for the cancellation of the charter before the corporate existence ceases.It does not follow from this that a corporation may not be dissolved for the purpose of the income and excess profits tax prior to the date that its charter is canceled. There may be a de facto dissolution even though there is no de jure dissolution. There can be no doubt that upon the stipulated facts there was a de facto dissolution of the petitioner corporation on June 30, 1940. Thereafter the corporation had no capital, no income, and no expenses. It was a mere empty shell.There appears to us to be no basis for the petitioner's contention. The excess profits tax credit is based on an average base period net income of 12 months. The scheme of the statute does not require a modification of the excess profits credit in the case of a return filed for a period of less than 12 months, but requires that the net income to which the excess profits credit is applicable shall be determined for a period of 12 months in the manner provided by the statute. We think it clear that it was the intention of Congress to apply the excess profits credit for a 12-month period against the net102 income of a 12-month period. See General Aniline & Film Corporation, 3 T. C. 1070. Consequently, we think, the income of a corporation which has completely liquidated during a taxable year must be placed on an annual basis.In Helvering v. Stockholms Enskilda Bank, 293 U.S. 84">293 U.S. 84, it is stated: * * The intention of the lawmaker controls in the construction of taxing acts as it does in the construction of other statutes, and that intention is to be ascertained, not by taking the word or clause in question from its setting and viewing it apart, but by considering it in connection with the context, the general purposes of the statute in which it is found, the occasion and circumstances of its use, and other appropriate tests for the ascertainment of the legislative will. * * See also Helvering v. Weaver Co., 305 U.S. 293">305 U.S. 293.1081 We are of the opinion that the respondent did not err in treating the petitioner's excess profits tax return filed for the year 1940 as a return for the period January 1 to June 30, 1940.The petitioner makes no contention that section 711 (a) (3) (B) of103 the code applies to it.The petitioner further alleges that the respondent erred in deducting from its excess profits tax credit the amount of $ 754.10 representing 6 percent of the net capital reduction effected on June 30, 1940. This deduction was made in accordance with the respondent's interpretation of section 713 of the code, which, so far as material, provides as follows:SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME.(a) Amount of Excess Profits Credit. -- The excess profits credit for any taxable year, computed under this section, shall be --(1) Domestic corporations. -- In the case of a domestic corporation -- * * (C) Minus 6 per centum of the net capital reduction as defined in subsection (g). * * (g) Adjustments in Excess Profits Credit of Account of Capital Changes. -- For the purposes of this section -- * * (2) The net capital reduction for the taxable year shall be the excess, divided by the number of days in the taxable year, of the aggregate of the daily capital reduction for each day of the taxable year over the aggregate of the daily capital addition for each day of the taxable year.We think that this contention of the petitioner must104 be sustained. The 12-month period with which we are dealing is not the calendar year 1940, but a 12-month period ended on June 30, 1940. The last sentence of section 711 (a) (3) (A) of the code provides:* * * The tax shall be such part of the tax computed on such annual basis as the number of days in the short taxable year is of the number of days in the twelve months ending with the close of the short taxable year. [Emphasis supplied.]The petitioner's short taxable year ended on June 30, 1940. There was no reduction in the petitioner's capital investment prior to June 30, 1940. The capital reduction came at the time the petitioner corporation was completely liquidated on that date -- not prior thereto. Therefore, there is no occasion for a reduction in the excess profits tax credit to which the petitioner is entitled.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622645/	Harwood Associates, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentHarwood Associates, Inc. v. CommissionerDocket No. 5940-72United States Tax Court63 T.C. 255; 1974 U.S. Tax Ct. LEXIS 16; 1 Employee Benefits Cas. (BNA) 1135; November 26, 1974, Filed 16 Decision will be entered under Rule 155. 1. Petitioner adopted a profit-sharing retirement plan in which all of its employees were eligible to participate. While a single highly compensated employee chose to participate, all those employees receiving a low level of compensation elected instead to receive a cash bonus currently. Held, respondent properly found this plan discriminatory within the meaning of sec. 401(a)(3)(B), I.R.C. 1954, as amended.2. Due to a misapprehension of a material fact, respondent initially issued a determination letter holding the aforesaid plan qualified within the meaning of sec. 401(a). Held, it was proper for respondent to revoke the determination letter retroactively. Held, further, though a plan be not qualified under sec. 401(a), amounts contributed to a trust established pursuant to such a plan are deductible in accordance with sec. 404(a)(5). J. Ernest Brophy, for the petitioner.Louis J. Zeller, for the respondent. Fay, Judge. FAY255 Respondent has determined the following deficiencies in petitioner's Federal income tax:FYE Aug. 31 --Deficiency1968$ 469.871969242.1219702,094.90The issues presented for decision are: (1) Whether it was proper for respondent retroactively to withdraw a determination letter which held petitioner's profit-sharing retirement19 plan qualified under section 401(a) of the Internal Revenue Code of 256 1954; 1 and if so, (2) to what extent petitioner was entitled to claim deductions in the years before us by reason of the contributions which it made to a trust established pursuant to that plan.FINDINGS OF FACTCertain facts have been stipulated by the parties and are found accordingly. The stipulation of facts and exhibits appended thereto are incorporated herein by this reference.Petitioner Harwood Associates, Inc., was a corporation organized and existing under the laws of the State of New York and engaged in the business of selling products on behalf of several manufacturers. Its principal office was at 661 Pittsford-Victor Road, Pittsford, N.Y., when the petition herein was filed. Petitioner was an accrual basis taxpayer; its corporate income tax returns for its fiscal years ended August 31, 1968, 1969, 20 and 1970, were filed with the district director of internal revenue for Buffalo, N.Y.At all times relevant to the disposition of this case, stock ownership in petitioner was held by the following parties in the percentages set forth below:8/31/678/31/688/31/698/31/70Herbert B. Collins, Jr.53.6853.6853.6850.00Richard G. Collins14.7414.7414.7450.00Annette L. Collins31.5831.5831.580100.00100.00100.00100.00During the same period petitioner's officers were Herbert Collins, Jr. (Herbert), and Richard Collins (Richard), his brother. They, together with Herbert's wife, Annette L. Collins, also served as petitioner's directors. None of these was paid a salary by petitioner; rather, Herbert and Richard were on the payroll of Dynatherm, Inc. (Dynatherm), another corporation under the control of the Collins family and headquartered at 661 Pittsford-Victor Road.During the years listed below, petitioner paid the following amounts to its employees 2 as compensation for services rendered 257 by them:FYEFYEFYEFYE8/31/678/31/688/31/698/31/70Mary Macaluso$ 2,530.00$ 5,580.00$ 4,930.00Wayne Lausin$ 21,986.8830,001.9343,110.5730,446.73Ruth Mallet6,110.003,260.00Joyce Whitbeck80.00192.00Dolores Friel4,761.396,440.007,810.007,780.00Mary Reichenbach1,860.0021 The customary employment of the aforesaid, save Joyce Whitbeck, was for more than 20 hours per week and for more than 5 months per calendar year; and their duties, except those of Wayne Lausin (Lausin), were primarily of a clerical nature.Lausin was first employed by petitioner as a salesman in July 1959 and continued in that position throughout the period now under consideration. Though neither a shareholder nor chosen for a position in the formal structure of petitioner's management, Lausin did participate, together with the Collins brothers, Mike Ferman (Ferman), and John Bacon (Bacon) in making decisions affecting corporate policy. While the Collins brothers, Ferman, and Bacon concerned themselves22 principally with the operations of Dynatherm, Lausin largely bore the responsibility of seeing that petitioner's business was discharged.Wishing to provide for their retirements, the Collins brothers, Ferman, Bacon, and Lausin decided that Dynatherm and petitioner should adopt retirement plans qualified under section 401(a). As a consequence of that decision, petitioner adopted a noncontributory profit-sharing plan, effective as of August 31, 1967, and established a trust pursuant thereto. Pertinent to the disposition of this case are the following provisions of the plan:ARTICLE 3. -- ELIGIBILITY AND MEMBERSHIP3.1 Each Employee of the Employer is eligible for membership in this Plan as of the effective date or any anniversary date [Aug. 31 of each year] if he has satisfied all of the following eligibility requirements on the day preceding the effective date or such anniversary date as the case may be, retroactive to the first day of the current taxable year of the Employer.(a) That he is customarily employed more than twenty hours in one week; 258 and(b) That he is customarily employed more than five months in a period of twelve months.3.2 Notwithstanding the positive23 statements as to eligibility herein made, membership in this Plan shall be entirely voluntary on the part of each Member. * * ARTICLE 4. -- EMPLOYER CONTRIBUTIONS4.1 The amount of the contribution, out of net profit to be made by the Employer under the Plan for each year beginning with the year ended August 31, 1967 shall be any amount in the discretion of the Board of Directors. * However, in no event shall the amount contributed exceed fifteen per cent (15%) of the total compensation paid or accrued to all Members for services rendered during said year. In addition, if for any year there is paid into the trust amounts less than the aforesaid fifteen per cent (15%), the excess, or if no amount is paid, the entire fifteen per cent (15%) shall be carried forward and be paid in the succeeding year in order of time, but the amount so paid under this sentence in any succeeding year shall not exceed fifteen per cent (15%) of the total compensation paid or accrued during such succeeding year to the Members under the Plan.4.2 No Member hereunder shall be obligated or required to contribute to the Trust, it being specifically understood that the Employer shall be the sole contributor24 thereto.4.3 The Employer may make payment of its contribution for any taxable year on any date or dates it elects, provided only that the total amount of its contribution for any taxable year shall be paid in full on or before the due date for filing the Employer's Federal Income Tax Return, including extensions of the filing time for such year. * * ** * ARTICLE 9. -- SEVERANCE AND DISABILITY BENEFITS * 9.2 A Member whose employment is terminated for reason other than retirement, disability or death, shall be entitled to benefits as follows:(a) If severance of employment occurs within two (2) years of the date upon which the Employee became a Member hereunder, such Employee shall not be entitled to any benefits or rights under the Plan.(b) If severance occurs more than two (2) years after the Employee has become a Member under the Plan, such Employee shall receive the percentage of his then beneficial interest in the Plan as shown in the table below for the number of full years of membership then completed.2 Years10%3 Years20%4 Years30%5 Years40%6 Years50%7 Years60%8 Years70%9 Years80%10 Years90%11 Years100% * *259 ARTICLE 25 12. -- DISCONTINUANCE OF CONTRIBUTIONS AND TERMINATION OF PLAN* * 12.5 Regardless of any other provisions of the Plan and Trust, in the event that the Employer fails to make timely payments of the full contribution due under the Plan Contribution Formula, or in the event that no contribution is due under the Plan Contribution Formula for two consecutive years, then, as of the anniversary date for which the full contribution was not timely paid, or as of the first anniversary date for which no contribution was made, the interest of the participants shall become nonforfeitable in all events. If subsequent contributions are made by the Employer, the vesting provisions which otherwise apply under the Plan will be applicable to those contributions.Ruth Mallett (Mallett), Dolores Friel (Friel), and Lausin were all eligible to participate in the plan for the fiscal year ended August 31, 1967; but Mallett and Friel declined coverage, electing to receive a cash bonus instead. Friel, who was to remain in petitioner's employ throughout the period under consideration, repeated this choice in each of the years in issue. When Mary Macaluso and Mary Reichenbach became eligible for coverage, 26 they too chose to receive a cash bonus in lieu of participation in the plan.Petitioner's board of directors authorized and paid into the retirement trust, contributions in the amounts set forth below:Date ofDate ofFor FYE Aug. 31 --Paymentsauthorizationpayment1967$ 1008/18/678/31/671,90011/15/6719682,0008/8/6810/7/6819691,0008/22/698/29/6919709,000(Undisclosed)8/31/70By a letter dated October 25, 1967, petitioner's authorized representative requested that the district director of internal revenue, Buffalo, N.Y., issue a determination letter holding that the plan which petitioner had adopted satisfied the requirements of section 401(a). The letter of October 25, 1967, summarized the basic provisions of the plan and was accompanied by a statement in which the following information was set forth: that petitioner had three employees, all of whom were eligible to participate in the plan, but only one of whom, Lausin, was in fact 260 covered: 3 that in the fiscal year ended August 31, 1967, Lausin received $ 21,986.88 in nondeferred compensation out of the $ 32,938.27 paid by petitioner to all of its employees; that Lausin27 was neither an officer nor a stockholder of petitioner and that his principal duties were not supervisory; and that the length of his service to petitioner was 7 years. The letter of October 25, 1967, also identified Herbert B. Collins, Jr., Richard G. Collins, and Annette L. Collins as petitioner's stockholders and directors and the Collins brothers as its officers. 4On November 22, 1967, petitioner's request for a determination28 letter was assigned to an agent of the respondent. The agent reviewed the materials submitted in support of that request, and on the basis of the information contained therein, erroneously concluded that petitioner's officers, the Collins brothers, were the two employees who had elected not to participate in the plan. In an effort to obtain clarification of this matter, the agent contacted the offices of petitioner's representative by telephone on January 5, 1968. Due to a misunderstanding, this exchange only confirmed the agent in the incorrect inference which he had previously drawn.On January 31, 1968, a determination letter was issued, holding the plan qualified under section 401(a).With respect to each of the years now before us, petitioner claimed as a deduction the amount it contributed to the trust established under the plan. These amounts were:DeductionFYE Aug. 31 --claimed1968$ 2,00019691,00019709,000To each year's return was attached a statement containing information which in all respects relevant to the issues now before us was substantially the same as that contained in the statement attached to the letter of October 25, 1967.Contributions29 to the trust were authorized for the fiscal years ended August 31, 1971, 1972, and 1973, but were not paid.261 Upon audit of petitioner's income tax returns for the fiscal years ended August 31, 1968, 1969, and 1970, respondent became aware that in holding petitioner's retirement plan qualified under section 401(a), he had been acting under a misapprehension as to the facts. The holding of January 31, 1968, was therefore revoked retroactively by a letter to petitioner dated January 20, 1971. The following reason was cited for this action:[In order to qualify under section 401(a), a] plan must benefit employees in general, and towards this end, must cover either a number which is at least equal to that determined under the percentage provisions of Section 401(a)(3)(A) of the Code, or such employees as qualify under a nondiscriminatory classification within the purview of Code Section 401(a)(3)(B).It is held that the participation of one employee does not meet the test of Section 401(a)(3)(A).A Plan which fails to qualify under Section 401(a)(3)(A) of the Code may still qualify under Section 401(a)(3)(B) provided the classification of employees does not discriminate in favor30 of officers, shareholders, supervisors, or highly compensated employees.The figure of three employees as of August 31, 1967 first does not include Herbert B. Collins, Jr., President, and Richard G. Collins, Secretary of Corporation who receive no salary from Harwood Associates, Inc. of the three employees as of August 31, 1967, all three satisfy the eligibility requirements. Two of the three eligible employees who are secretaries of the Corporation refused to participate. The annual compensation of the one participant for the year ending August 31, 1967 was $ 21,986; and for the employees who do not participate $ 6,110 and $ 4,761. The only participant receives compensation which is way in excess of the highest paid of the nonparticipants. Accordingly, the participant is within a class of employees with respect to which discrimination is prohibited.By statutory notice respondent has disallowed the deductions which petitioner claimed for the fiscal years ended August 31, 1968, 1969, and 1970, by reason of its contributions for those years to the trust established pursuant to its profit-sharing retirement plan adopted as of August 31, 1967.OPINIONA retirement plan cannot be 31 qualified within the meaning of section 401(a) if it discriminates in favor of highly compensated employees. 534 A plan which complies with section 401(a)(3)(A) is 262 deemed nondiscriminatory by virtue of that compliance; but compliance with section 401(a)(3)(A) is impossible where, as in the case at bar, only one out of several persons employed and eligible for coverage actually participates in the plan. In enacting section 401(a)(3)(B), however, Congress saw fit to confer upon respondent the authority to determine that a plan not complying with section 401(a)(3)(A) is nevertheless not discriminatory in favor of highly compensated employees. It is appropriate that in exercising this authority respondent set forth in regulations the criteria which he shall employ in making the determinations called for. Such regulations are valid so long as they are reasonably conducive to the realization of the intent of Congress that retirement plans qualified under section 401(a) not discriminate in favor of highly compensated employees. See Estate of Richard R. Wilbur, 43 T.C. 322">43 T.C. 322, 328 (1964). Section 1.401-3(c), Income Tax Regs., which we consider valid32 under the aforesaid standard and to which we will adhere, provides:(c) Since, for the purpose of section 401, a profit-sharing plan is a plan which provides for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as illness, disability, retirement, death, layoff, or severance of employment, employees who receive the amounts allocated to their accounts before the expiration of such a period of time or the occurrence of such a contingency shall not be considered covered by a profit-sharing plan in determining whether the plan meets the coverage requirements of section 401(a)(3)(A) and (B). Thus, in case a plan permits employees to receive immediately the amounts allocated to their accounts, or to have such amounts paid to a profit-sharing plan for them, the employees who receive the shares immediately shall not, for the purpose of section 401, be considered covered by 263 a profit-sharing plan. [Emphasis added.] 6Applying this regulation to petitioner's plan of deferred compensation we find that in its operation the plan did discriminate in favor of highly compensated33 employees; for although all petitioner's employees were eligible for coverage under the plan, only a single highly compensated 735 employee chose to participate while all those employees who received a low level of compensation chose to receive a current cash bonus in lieu of coverage. 8We furthermore hold that respondent properly gave retroactive effect to his withdrawal of the determination letter of January 31, 1968. Under section 7805(b), respondent has authority to do so; and the exercise of that authority is proper where, as here, respondent was not in possession of all the material facts when making the determination which he later deemed it appropriate to withdraw, Woodworth v. Kales, 26 F.2d 178">26 F.2d 178 (C.A. 6, 1928); Austin Co. v. Commissioner, 35 F.2d 910">35 F.2d 910 (C.A. 6, 1929), 9 affirming 8 B.T.A. 628">8 B.T.A. 628 (1927), certiorari denied 281 U.S. 735">281 U.S. 735 (1930).36 Although a plan of deferred compensation may not qualify under section 401(a), an employer may nevertheless be entitled to claim deductions by reason of his having contributed to a trust established pursuant to such a plan.264 Section 404(a)(5)1037 provides that an employer is entitled to deduct the amount of a contribution made pursuant to a nonqualified plan prior to August 2, 1969, if the participating employees' rights derived from such a contribution were not forfeitable at the time when the contribution was made. Section 404(a)(5) provides that an employer is entitled to deductions in respect of a contribution made pursuant to a nonqualified plan after August 1, 1969, when and to the extent that the participating employees' rights derived from the contribution became vested. 11 The deductions which petitioner may claim for 265 the years now before us depend upon the extent to which Lausin's interest in the retirement trust vested in those years.38 Petitioner's plan provides that vesting generally be governed by Article 9 which has been set forth in pertinent part in our Findings of Fact. Respondent contends that Lausin's interest in petitioner's retirement trust vested according to the schedule contained in that article in the years now before us. Petitioner contends on the other hand that under the circumstances obtaining in this instance, Article 12.5, set forth in full in our Findings of Fact, superseded Article 9.The special vesting provisions of Article 12.5 were meant to become operative in either of two instances: when the employer has failed to make timely payment of the full amount due under the "Plan Contribution Formula," or when no amount has become due under that formula for 2 consecutive years.The amount of the contribution to be made each year pursuant to the plan was to be determined in accordance with the provisions of Article 4 which have been set forth in pertinent part in our Findings of Fact. The meaning of that article is at best opaque. It first appears to authorize an annual contribution in an amount to be determined by petitioner's directors in an exercise of their discretion subject only to this39 limitation -- that the contribution not exceed 15 percent of the compensation otherwise paid or accrued to employees covered by the plan during the year in question. The article then goes on apparently 266 to require that contributions be fixed according to an elaborate formula which we need not paraphrase here. 12It would be unreasonable for us to resolve this apparent contradiction by holding that contributions had to be fixed in accordance with the formula to which we have made reference above; for so to hold would be to render meaningless the conferral on petitioner's directors of discretionary authority to determine the amount of each annual contribution. Rather, we think the key to reconciling the40 seemingly contrary provisions of Article 4 is to be found in the fact that the formula set forth therein is patterned after the provisions of section 404(a)(3)(A). 1341 This section sets the upward limit on deductions that may be claimed for contributions made pursuant to profit-sharing plans which qualify under section 401(a). As petitioner's management intended that the plan should qualify under section 401(a), we interpret Article 4 to mean that for each year petitioner's directors could authorize a contribution in any amount not in excess of the amount deductible under section 404(a)(3)(A). This being the case, we fail to perceive how Article 12.5 could have become operative in any of the years now before us; for with respect to each of those years a contribution was authorized by petitioner's directors in an exercise of their discretion and timely paid. We therefore hold, as respondent has contended, that in the 267 years in issue Lausin's interest vested in accordance with the schedule set forth in Article 9. 14Decision will be entered under Rule 155. Footnotes1. All section references are to the provisions of the Internal Revenue Code of 1954 in effect during the taxable years in issue.↩2. We have been asked to determine whether Herbert B. Collins, Jr., and Richard G. Collins were in the employ of petitioner during this period. For reasons that will be stated in our opinion, we consider it unnecessary to the disposition of this case that we make such a determination and therefore decline to do so.↩3. Nowhere in the letter of Oct. 25, 1967, or in the statement appended thereto, were the employees of petitioner other than Lausin, identified by name, their duties described, or their relationship to petitioner set forth. The two other employees to whom reference was made were in fact Friel and Mallett, petitioner's clerical workers.↩4. Though they were petitioner's officers, the Collins brothers were not on petitioner's payroll nor did they consider themselves its employees. However, the letter of Oct. 25, 1967, and the statement appended thereto, did not indicate that this was the case.↩5. SEC. 401. QUALIFIED PENSION, PROFIT-SHARING, AND STOCK BONUS PLANS.(a) Requirements For Qualification. -- A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section -- * (3) if the trust, or two or more trusts, or the trust or trusts and annuity plan or plans are designated by the employer as constituting parts of a plan intended to qualify under this subsection which benefits either -- (A) 70 percent or more of all the employees, or 80 percent or more of all the employees who are eligible to benefit under the plan if 70 percent or more of all the employees are eligible to benefit under the plan, excluding in each case employees who have been employed not more than a minimum period prescribed by the plan, not exceeding 5 years, employees whose customary employment is for not more than 20 hours in any one week, and employees whose customary employment is for not more than 5 months in any calendar year, or(B) such employees as qualify under a classification set up by the employer and found by the Secretary or his delegate not to be discriminatory in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees;↩6. See Rev. Rul. 56-497, 2 C.B. 286">1956-2 C.B. 286, which provides:In the case of a profit-sharing arrangement which grants to each eligible employee an election to receive his allocable share of the profits by current cash payment to him or by payment to a deferred trust for his benefit, qualification of the plan as non-discriminatory must be judged by reference only to those employees who elect to participate in the deferred trust. A determination is made both with respect to the coverage requirements and also as to nondiscrimination in contributions or benefits. See sections 1.401-3(c) and 1.401-4(a)(1)(ii), of the Income Tax Regulations, T.D. 6203↩, page 219, this Bulletin. [Emphasis added.]7. Lausin was unquestionably a highly compensated employee as that term is understood by the United States Court of Appeals for the Second Circuit. See Commissioner v. Pepsi-Cola Niagara Bottling Corp., 390">399 F.2d 390 (C.A. 2, 1968), reversing 48 T.C. 75">48 T.C. 75 (1967); see Jack E. Golsen, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (C.A. 10, 1971), certiorari denied 404 U.S. 940">404 U.S. 940↩ (1971).8. See Rev. Rul. 73-340, 2 C.B. 134">1973-2 C.B. 134. A corporation adopted a pension plan in which its two employees were eligible to participate. The plan was held not to qualify under sec. 401(a)↩ where a highly compensated officer was in fact covered while the other employee, a secretary receiving a low level of compensation, voluntarily waived her right to participate.9. In an attempt to justify his having given retroactive effect to the withdrawal of the determination letter, respondent urged us to find that the Collins brothers were in fact employees of the petitioner, and that its employees therefore numbered five rather than three as stated in the materials submitted in support of petitioner's application for a determination letter. It is not necessary for us to make such a finding in order to sustain respondent's action. It is sufficient under the authorities cited above, that despite a diligent effort on the part of his agent to obtain the relevant information, respondent issued the determination letter while under misapprehension as to material facts.↩10. SEC. 404. DEDUCTION FOR CONTRIBUTIONS OF AN EMPLOYER TO AN EMPLOYEES' TRUST OR ANNUITY PLAN AND COMPENSATION UNDER A DEFERRED-PAYMENT PLAN.(a) General Rule. -- If contributions are paid by an employer to or under a * * profit-sharing * * * plan * * , such contributions * * shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year: * * (5) Other plans. -- In the taxable year when paid, if the * * [profit-sharing plan is not qualified under sec. 401(a)↩,] if the employees' rights to or derived from such employer's contribution or such compensation are nonforfeitable at the time the contribution or compensation is paid.11. With respect to contributions made to profit-sharing plans after Aug. 1, 1969, sec. 404(a) provides:(a) General Rule. -- If contributions are paid by an employer to or under a * * * profit-sharing * * * plan * * , such contributions * * shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year: * * (5) Other plans. -- If the [profit-sharing plan is not qualified under sec. 401(a),] in the taxable year in which an amount attributable to the contribution is includible in the gross income of employees participating in the plan, but, in the case of a plan in which more than one employee participates only if separate accounts are maintained for each employee.Amounts to be included in the gross income of employees by reason of contributions to a trust established pursuant to a plan which does not qualify under sec. 401(a), are determined under sec. 402(b).SEC. 402. TAXABILITY OF BENEFICIARY OF EMPLOYEES' TRUST.(b) Taxability of Beneficiary of Nonexempt Trust. -- Contributions to an employees' trust made by an employer during a taxable year of the employer which ends within or with a taxable year of the trust for which the trust is not exempt from tax under section 501(a) shall be included in the gross income of the employee in accordance with section 83 (relating to property transferred in connection with performance of services), except that the value of the employee's interest in the trust shall be substituted for the fair market value of the property for purposes of applying such section. * SEC. 83. PROPERTY TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES.(a) General Rule. -- If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of -- (1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over(2) the amount (if any) paid for such property,shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. * ** * (c) Special Rules. -- For purposes of this section -- (1) Substantial risk of forfeiture. -- The rights of a person in property are subject to a substantial risk of forfeiture if such person's rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual.(2) Transferability of property. -- The rights of a person in property are transferable only if the rights in such property of any transferee are not subject to a substantial risk of forfeiture.↩12. In our attempt to interpret art. 4, we are not unmindful of the fact that although the plan was drafted on behalf of petitioner who at all events bears the burden of proving respondent's determination erroneous, petitioner has afforded this Court scant evidence as to the intended meaning of the article.↩13. SEC. 404(a). General Rule. -- If contributions are paid by an employer to or under a * * profit-sharing * * * plan, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year: * * (3) Stock bonus and profit-sharing trusts. -- (A) Limits on deductible contributions. -- In the taxable year when paid, if the contributions are paid into a * * profit-sharing trust, and if such taxable year ends within or with a taxable year of the trust with respect to which the trust is exempt under section 501(a)↩, in an amount not in excess of 15 percent of the compensation otherwise paid or accrued during the taxable year to all employees under the * * * profit-sharing plan. If in any taxable year there is paid into the trust, or a similar trust then in effect, amounts less than the amounts deductible under the preceding sentence, the excess, or if no amount is paid, the amounts deductible, shall be carried forward and be deductible when paid in the succeeding taxable years in order of time, but the amount so deductible under this sentence in any such succeeding taxable year shall not exceed 15 percent of the compensation otherwise paid or accrued during such succeeding taxable year to the beneficiaries under the plan. * * *14. The deductions which petitioner is entitled to claim under sec. 404(a)(5) for the years now before us may appropriately be computed under Rule 155, Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622646/	HENRY BRAUN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBraun v. CommissionerDocket No. 8317-75.United States Tax CourtT.C. Memo 1976-185; 1976 Tax Ct. Memo LEXIS 222; 35 T.C.M. (CCH) 810; T.C.M. (RIA) 760185; June 9, 1976, Filed respondent. 222 Henry Braun, pro se. Lowell F. Raeder, for the FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: Respondent has filed a motion for partial summary judgment in this case involving income tax deficiencies for 1971 and 1972 in the respective amounts of $59 and $517, together with additions to tax under section 6653(a), Internal Revenue Code of 1954, as amended, of $35.15 and $25.85, respectively. The motion requests a partial summary judgment on the question of whether the United States' participation in foreign military activities is justification for petitioner's underpayments of tax in 1971 and 1972. Respondent argues that there is no genuine issue of material fact as to this question and that a summary judgment should be granted on this issue as a matter of law. Petitioner, who was a resident of Philadelphia, Pennsylvania, at the time he filed his petition, alleges that his underpayment of taxes "was required of him by international law" and that: "The IRS errs in not giving war tax credit of $406.95 for 1971 and $310 for 1972." Petitioner argues that his payment of the disputed taxes would have violated his moral and religious223 convictions because such taxes would have been used to finance the war in Vietnam. He recognizes that the United States' participation in the Vietnam war has terminated and that his payments of 1971 and 1972 taxes at this time would not be used to support any war effort, but he argues, in effect, that this country's participation in the Vietnam war during those years erased his liability for the amounts he claims as war tax credits. We do not question petitioner's sincerity, but a taxpayer's disagreement (however sincere) with the policies of the Federal Government is no ground for relieving him of his tax obligations, whether that disagreement is articulated in terms of the First Amendment of the Constitution, international law, the Nuremberg Principles, or any other doctrine that has been advanced in a host of decided cases. See, e.g., United States v. Malinowski,472 F.2d 850">472 F.2d 850, 857 (3d Cir. 1973), cert. denied 411 U.S. 970">411 U.S. 970 (1973); Autenrieth v. Cullen,418 F.2d 586">418 F.2d 586 (9th Cir. 1969), cert. denied 397 U.S. 1036">397 U.S. 1036 (1970); Crowe v. Commissioner,396 F.2d 766">396 F.2d 766 (8th Cir. 1968), affg. a Memorandum Opinion of this*224 Court; Lorna H. Scheide,65 T.C. 455">65 T.C. 455 (1975); Susan Jo Russell,60 T.C. 942">60 T.C. 942 (1973); Abraham J. Muste,35 T.C. 913">35 T.C. 913 (1961). Since no issue of material fact has been presented and the legal issues herein involved are controlled by the above authorities, respondent's motion will be granted. To reflect the foregoing, An appropriate order will be issued.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622649/	ARCHER MAYNARD CAMPBELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Campbell v. CommissionerDocket No. 18320.United States Board of Tax Appeals6 B.T.A. 60; 1927 BTA LEXIS 3612; February 4, 1927, Promulgated 3612 H. H. Shelton, Esq., for the petitioner. W. Frank Gibbs, Esq., for the respondent. LITTLETON60 The Commissioner determined a deficiency of $69.17 for the calendar year 1923. Subsequently the parties stipulated that this was in error and that the notice should have stated a deficiency of $32.82. The question is whether a dividend declared by a corporation in December, 1922, payable January 1, 1923, was income to the petitioner, a stockholder of such corporation, for the calendar year 1922 or the calendar year 1923. 61 FINDINGS OF FACT. Petitioner is a resident and citizen of Lynchburg, Va. During the calendar years 1922 and 1923 he was a stockholder and chairman of the board of directors of the Glamorgan Pipe & Foundry Co., a corporation, with principal office and place of business at Lynchburg, Va. In December, 1922, this corporation declared a dividend payable January 1, 1923. The petitioner's proportion of the dividend amounted to $1,020. On January 1, 1923, the corporation mailed a dividend check to the petitioner at Lynchburg, Va., which was received by him in due course. Petitioner has consistently kept his books and rendered3613 his income-tax returns upon an accrual basis. He accrued this dividend as of the date of the declaration in December, 1922, and included the amount thereof in his gross income for the calendar year 1922 and paid the tax thereon. The Commissioner decided that the dividend was income to petitioner for the calendar year 1923, the year in which it was payable. OPINION. LITTLETON: Petitioner consistently kept his books and rendered his returns upon the accrual basis. When the directors of the Glamorgan Pipe & Foundry Co., of which he was chairman, by appropriate resolution in December, 1922, declared the cash dividend, petitioner accrued his proportion thereof upon his books as income and reported the same in his income-tax return for the year 1922. It is not claimed by the Commissioner and there is nothing to indicate that the method of accounting employed by petitioner in keeping his books of account, in accordance with which his return was filed, did not clearly reflect his income. We therefore approve the petitioner's treatment of the dividend as income in 1922. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622651/	JACOB K. NEWMAN AND ELSA SCHWARTZ NEWMAN, EXECUTORS, ESTATE OF EDGAR NEWMAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTNewman v. CommissionerDocket No. 49553.United States Board of Tax Appeals29 B.T.A. 53; 1933 BTA LEXIS 1007; September 26, 1933, Promulgated 1007 Proceeds of life insurance policies, in excess of $40,000 exemption, should be included in gross estate where decedent, who was a resident of Louisiana and died in 1928, retained to the date of his death power to change the beneficiary, notwithstanding the policies (except one) were all taken out prior to the enactment of the Revenue Act of 1918, and the premiums on the policies were paid out of community income. Ralph J. Schwartz, Esq., for the petitioners. John D. Kiley, Esq., for the respondent. ADAMS 53 This proceeding is for the redetermination of a deficiency in Federal estate tax in the amount of $7,027.79. The only issue involved is whether the respondent erred in including proceeds of certain life insurance policies in the amount of $136,851.13 as a part of decedent's gross estate under section 302(g) of the Revenue Act of 1926. FINDINGS OF FACT. Petitioners are the executors of the estate of the late Edgar Newman, who died in the city of New Orleans, Louisiana, on March 9, 1928, and whose estate was administered in Civil District Court for the Parish of Orleans, State of Louisiana, in Cause No. 173796, wherein the petitioners1008 herein were duly appointed and qualified as executors. At the time of his death there were in existence 15 life insurance policies on decedent's life aggregating $176,551.13, and a death benefit from the Pottery, Glass and Brass Salesmen's Association of America in the amount of $300. All of the policies were taken out prior to the enactment of the Revenue Act of 1918, except one in the amount of $5,327.45, which was taken out on December 28, 1923. Each of the policies was made payable to Elsa Schwartz Newman, 54 wife of decedent, and contained the following clause in regard to decedent's right to change the beneficiary: Subject to the rights of any Assignee, the Insured may from time to time, while this Policy is in force, designate a new Beneficiary by filing a written notice thereof at the Home Office of the Company, accompanied by this Policy for endorsement. Such change shall take effect on the endorsement of the same on this Policy by the Company and not before. Should there be no Beneficiary living at the time this Policy becomes a claim by death, the proceeds hereof shall be paid to the Executors, Administrators, or Assigns of the Insured. The decedent at1009 no time ever changed the beneficiary in any of the policies above mentioned. The premiums on all of the policies were paid out of community income from the community that existed between the decedent and his surviving widow, Elsa Schwartz Newman, one of the petitioners herein. The respondent determined that, in accordance with section 302(g) of the Revenue Act of 1926, all of the above mentioned proceeds in excess of $40,000, namely, $136,851.13, should be included as a part of decedent's gross estate. OPINION. ADAMS: Petitioners contend that none of the proceeds mentioned in findings should be included as a part of decedent's gross estate, and, in any event, no more than one half of such proceeds should be so included. In support of the contention that none of the proceeds should be included petitioners rely on three points, as follows: (a) The policies, having been taken out prior to the effective date of the Revenue Act of 1918, are controlled by the decision of the Supreme Court of the United States in the case of 1010 Lewellyn v. Frick,268 U.S. 238">268 U.S. 238. They form no part of the gross estate of the decedent. They cannot be taxed as part of that gross estate, without running counter to the provisions of the Fifth Amendment of the Constitution of the United States and Article 1, Sec. 8 of the Constitution of the United States.(b) The proceeds of these policies cannot be included in the gross estate, because of the decision of the Supreme Court of the United States in the case of Chase National Bank v. United States,278 U.S. 327">278 U.S. 327. That case has no application to the present case and if it were applicable, it is distinguishable. (c) The estate tax is concededly a tax imposed on transfers at death. It is the transfer that is subject to the tax. Under the local law of Louisiana, insurance policies and their proceeds payable to a wife, as in this case, form the separate property of the wife, and no interest was transferred by the death of the decedent. To impose a tax on the wife's property would run counter to the provisions of the Constitution of the United States. The Supreme Court, in 1011 Lewellyn v. Frick, supra, held that the Revenue Act of 1918, imposing a transfer tax on proceeds of insurance 55 policies, applied only to policies issued after the passage of the act. The Frick decision was decided on May 11, 1925, and was followed by this Board in Charles L. Harris, Administrator,5 B.T.A. 41">5 B.T.A. 41 (1926); Martha B. Phelps, Executrix,6 B.T.A. 648">6 B.T.A. 648 (1927); and Mercantile Trust Co., Executor,13 B.T.A. 85">13 B.T.A. 85 (1928); and by the Federal District Court for the Western District of Missouri in Wyeth v. Crooks, 33 Fed.(2d) 1018. On January 2, 1929, the Supreme Court handed down its decisions in Reinecke v. Northern Trust Co.,278 U.S. 339">278 U.S. 339, and Chase Nat. Bank v. United States, supra. Among other things, the former case dealt with two certain trusts which were created prior to the passage of the applicable statute, but "made subject to a power of revocation in the transferor * * ." The Supreme Court held that by reason of the reserved power of revocation the "shifting of the economic interest in the trust property which was the subject1012 of the tax" was not complete until decedent's death, and that the applicable statute was not, therefore, retroactive, since death followed the passage of the statute. In the latter case the decedent on September 13, 1922, took out three insurance policies on his life, named his wife beneficiary in each but reserved the right to change the beneficiary, and died on April 10, 1924. In holding as constitutional the statute which sought to tax as a transfer the proceeds of the policies there in question, the Supreme Court said in part: The statute in terms taxes transfers. * * * The precise question presented is whether the termination at death of that power and the consequent passing to the designated beneficiaries of all rights under the policies freed of the possibility of its exercise may be the legitimate subject of a transfer tax, as is true of the termination by death of any of the other legal incidents of property through which its use or economic enjoyment may be controlled. A power in the decedent to surrender and cancel the policies, to pledge them as security for loans and the power to dispose of them and their proceeds for his own benefit during his life * * * is1013 by no means the least substantial of the legal incidents of ownership, and its termination at his death so as to free the beneficiaries of the policy from the possibility of its exercise would seem to be no less a transfer within the reach of the taxing power than a transfer effected in other ways through death. Cf. Porter v. Commissioner,288 U.S. 436">288 U.S. 436. Subsequent to the decisions in Reinecke v. Northern Trust Co. and Chase Nat. Bank v. United States, supra, it has been held consistently that where a decedent has taken out insurance policies on his own life and reserved, up to the date of his death, the right to change the beneficiary, the proceeds of such policies (subject to an exemption of $40,000 where the proceeds are receivable by beneficiaries other than the executor) are a part of the gross estate of the decedent, regardless 56 of when the policies were taken out. See Louis M. Weiller et al., Executors,18 B.T.A. 1121">18 B.T.A. 1121; Edwin S. Raugh, Executor,19 B.T.A. 993">19 B.T.A. 993; William A . Cushman et al., Executors,19 B.T.A. 1912">19 B.T.A. 1912; 1014 Fannie C. Richardson et al., Trustees,20 B.T.A. 728">20 B.T.A. 728; Helena Liebes, Executrix,20 B.T.A. 731">20 B.T.A. 731; affd. (C.C.A., 9th Cir.), 63 Fed.(2d) 870; Heiner v. Grandin (C.C.A., 3d Cir.), 44 Fed.(2d) 141 (Circuit Judge Buffington dissenting on ground that Frick case was still the law); reaffirmed at 56 Fed.(2d) 1082; Max W. Feuerbacher et al., Executors,22 B.T.A. 734">22 B.T.A. 734; Philip W. Blood et al., Executors,22 B.T.A. 1000">22 B.T.A. 1000; Anthracite Trust Co. v. Phillips (U.S. Dist. Ct., Pa.), 49 Fed.(2d) 910; H. T. Cook et al., Executors,23 B.T.A. 335">23 B.T.A. 335; Lillian T. Latty, Executrix,23 B.T.A. 1250">23 B.T.A. 1250; Bessie M. Ballinger, Executrix,23 B.T.A. 1312">23 B.T.A. 1312; David A. Reed et al., Executors,24 B.T.A. 166">24 B.T.A. 166; Oreon E. Scott et al., Executors and Trustees,25 B.T.A. 131">25 B.T.A. 131; Sally S. Levy et al., Executors,25 B.T.A. 1174">25 B.T.A. 1174; affirmed on this proposition by the second circuit, 1015 65 Fed.(2d) 412; and Harry LeBaron Sampson, Executor,1 Fed.Supp. 95. It would serve no useful purpose to discuss further the three above mentioned points relied upon by petitioners, as each point is decided adversely to petitioners in one or more of the foregoing decisions. We pass, therefore, to petitioners' alternative contention that, in any event, no more than one half of the proceeds in question should be included in decedent's gross estate. Section 302 of the Revenue Act of 1926 provides in part as follows: SEC. 302. 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 - * * * (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life. [Italics supplied.] The total proceeds here involved, $176,851.13, were all receivable by decedent's widow, who was the1016 sole beneficiary under all the policies. No amount was "receivable by the executor * ." Therefore, only the last phrase of section 302(g) is applicable here. And the only matter left for determination under that phrase is whether, in fact and in law, the policies in question were "taken out by the decedent * ." Article 25 of respondent's Regulations 70 provides in part as follows: Insurance is deemed to be taken out by the decedent in all cases where he pays all the premiums, either directly or indirectly, whether or not he makes the application. On the other hand, the insurance is not deemed to be taken out by the decedent, even though the application is made by him, where all 57 the premiums are actually paid by the beneficiary. Where a portion of the premiums were paid by the beneficiary and the remaining portion by the decedent the insurance will be deemed to have been taken out by the latter in the proportion that the premiums paid by him bear to the total of premiums paid. [Italics ours.] The matter contained in section 302(g) , supra, is identically the same as the matter contained in section 402(f) of the Revenue Acts of 1918 and 1921 and section1017 302(g) of the Revenue Act of 1924; and the matter quoted above from article 25 of Regulations 70 is identically the same as is contained in article 25 of Regulations 68 (1924 edition), and substantially the same as is contained in article 27 of Regulations 63 (1922 edition) and article 32 of Regulations 37 (1919 edition). It is petitioners' position that, since it is suipulated that "the premiums on all of the policies were paid out of community income", we are compelled to find that one half of the premiums was paid by decedent and one half by his wife; that under the respondent's regulations only one half the insurance shall be deemed to be "taken out by the decedent"; and that only the proceeds from one half the policies are, therefore, within the statute. We shall divert a moment to make three observations: First, as stated above, the question with which we are concerned is, Were the policies "taken out by the decedent?" On the basis of the pleadings alone, we would be justified in resolving this question in favor of the respondent, for the reason that paragraph 5(b) of the petition alleges, and the answer admits, that "all of the above policies were taken out by decedent1018 * * ." See a similar statement in paragraph 5(a) of the petition, which the answer also admits. But, in view of the stipulation by the parties that "the premiums on all of said policies were paid out of community income," we think it is our province to decide as a matter of law whether, under article 25 of Regulations 70, only one half of the insurance shall be deemed to have been taken out by the decedent. Second, throughout the entire argument of petitioners, considerable stress is laid on statements found in the decisions of the Louisiana courts to the effect that proceeds of insurance policies payable to the wife form no part of the husband's estate. But the "net estate" as used in the Federal statute "does not mean an amount to be ascertained as such under any general rule of law or under statutes governing the administration of estates, but is the gross estate as specifically defined in section 302, less deductions permitted by section 303." Porter v. Commissioner, supra.And as explained above, the "gross estate as specifically defined in section 302" includes proceeds of insurance (in excess of $40,000 when received by the beneficiary) under policies1019 taken out by decedent, regardless of when taken out, in all cases 58 where the insured reserved the right to change the beneficiary. Chase Nat. Bank v. United States, supra, and cases thereafter cited. Third, it should be noted that petitioners concede that the proceeds in question form no part of the community estate, which concession, as far as the proceeds in question are concerned, makes inapplicable the ruling contained in Treasury Decision 3138, 23T.D. 238. Cf. Liebman v. Fontenot,275 Fed. 688. Because of the fact that the premiums were paid out of community income, can it be said that the decedent paid one half and his wife one half, and that under article 25, Regulations 70, supra, only one half of the insurance in question shall be deemed to have been taken out by the decedent? Article 2404 of the Revised Civil Code of the State of Louisiana (third edition) provides in part as follows: The husband is the head and master of the partnership or community of gains; he administers its effects, disposes of the revenues which they produce, and may alienate them by an onerous title, without the consent1020 and permission of his wife. In Moseman's Estate,38 La. Ann. 219">38 La.Ann. 219, the husband, a short while before his marriage, had taken out a policy of insurance on his own life, payable "to his executors, administrators, or assigns." After his marriage the premiums were paid from community funds. After his death, upon settlement of his estate, the question was agitated whether the money paid by the insurance company upon the policy belonged to the community. In holding the money so paid to be property of the husband's separate estate, the court said in part: The contract creates certain reghts and obligations which spring into existence the moment it is formed. Thus, at the date of the policies, Moseman acquired for himself the right to receive, at his death, * * * the sums stipulated to be paid, subject to the conditions of compliance with his own engagements to pay the premiums as they fell due. The court then decided that the "character of the interest and of the ownership thereof takes its impress from the date of the contract" and that "we are bound to hold that the interest of Moseman under these policies, having vested before his second marriage and at a time1021 when he was a single man, belonged to his separate estate, and did not enter into the subsequent community." The court then continued: We are of opinion, however, that the community is entitled to reimbursement of the amount of the several premiums which were paid, after the marriage, out of its funds. We are aware that, in the case of insurance by the husband for the benefit of the wife, it has been held that the latter takes the fund without liability to reimburse the community the preminums paid by it. Succession of Bofenschen, 29 Ann. 714. 59 Cf. E. Michna,24 B.T.A. 715">24 B.T.A. 715. In Succession of Bofenschen,29 La. Ann. 711">29 La.Ann. 711, 714, the court, in referring to Succession of Clark,27 La. Ann. 269">27 La.Ann. 269, said in part: Clark and his wife died on the same day. His death was a few hours before hers. The husband or in other words, the community owed rent for the house in which himself and wife lived. He had but little property, not enough to pay his rent. He had insured his life in his wife's behalf. His lessor, unable to realize the rent from his scanty effects, sought to make this life-policy answerable for it. It was held1022 that the money derived from his policy belonged to his wife's succession, and it was decreed to her legatees. The objections made by the opponents in the present case are the same as those considered in these cases, and pronounced untenable. The policy on the decedent's life issued to his wife for the benefit of herself and children. The premiums were paid by the husband out of community funds, over which he had control as head and master thereof. The most that could be claimed would be the reimbursement of the premiums to the community, but we do not think that claim well founded. [Italics ours.] The law of community property also exists in the adjoining State of Texas. There, as in Louisiana, the husband is head and master of the community. Waterman Lunber & Supply Co. v. Robins,159 S.W. 360">159 S.W. 360; Lasater v. Jamison,203 S.W. 1151">203 S.W. 1151; Stone v. Jackson,109 Tex. 385">109 Tex. 385; 210 S.W. 953">210 S.W. 953; and Moore v. Wooten,265 S.W. 210">265 S.W. 210. Cf. Poe v. Seaborn,282 U.S. 101">282 U.S. 101; and 1023 Bender v. Pfaff,282 U.S. 127">282 U.S. 127. In Martin v. McAllister,94 Tex. 567">94 Tex. 567; 63 S.W. 624">63 S.W. 624, Thomas P. Martin took out an insurance policy on the life of his wife, payable to himself. The premiums were paid out of the community. Upon the wife's death the question arose whether the proceeds belonged to the husband as his separate property or to the community. In holding they belonged to the husband, the court said in part: The money derived from the policy * * * was not acquired during the marriage, but was received by the husband after her death * * * and belonged to Thomas P. Martin in his separate right. [Citing both Louisiana and Texas cases.] * * * It is contended * * * that the husband could not appropriate the community funds to his own use in the purchase of this contract without the of his wife; but our statute specifically provides that the husband shall have the sole right of control of the community property, and it has been uniformly held that such control cannot be interfered with unless it is exercised in fraud of the rights of the wife. In 1024 Whiteselle v. Northwestern Mutual Life Ins. Co.,221 S.W. 575">221 S.W. 575 (Texas), occurs the following statement: The use of community funds in payment of premiums for insurance upon the life of one spouse in favor of the other does not, in the absence of fraud, create in the community the right to reimbursement for the funds so used. In the instant case, petitioners contend that, because it is stipulated that "the premiums on all of the policies were paid out of community income," it follows as a matter of law that the wife paid one 60 half and the husband one half. We do not think this is necessarily so. The husband was head and master of the community, and as such, the law of Louisiana permitted him to use community funds for the payment of insurance premiums on his life, so long as he did not defraud his wife in so doing, and, in the absence of fraud, the wife had no redress. There is no evidence that fraud was present here and, since all the policies were made payable to the wife, such a possibility would scarcely exist. There is, likewise, no evidence of any agreement on the part of the wife that she was to pay any portion of the premiums in question. *1025 The respondent has determined that the policies were taken out by the decedent on his own life, and we find nothing in the record, or in article 25 of Regulations 70, supra, that would warrant us in disturbing this determination. Cf. John Bromley et al., Executors,16 B.T.A. 1322">16 B.T.A. 1322. We, therefore, conclude that the action of the respondent in including in decedent's gross estate under section 302(g), supra, proceeds of insurance in the amount of $136,851.13 was entirely proper and in accordance with the law thereunto pertaining. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622661/	Estate of Sedgwick Minot, Deceased, William E. Dwyer, Executor, Petitioner, v. Commissioner of Internal Revenue, RespondentMinot v. CommissionerDocket No. 666-64United States Tax Court45 T.C. 578; 1966 U.S. Tax Ct. LEXIS 127; March 23, 1966, Filed 127 Decision will be entered under Rule 50. Held, on the facts, appointive assets distributed to takers in default pursuant to an agreement compromising the contest of decedent's will purportedly exercising general powers of appointment over the trust assets are not includable in the gross estate under section 2041, I.R.C. 1954. H. Brian Holland, for the petitioner.J. Frost Walker, Jr., for the respondent. Bruce, Judge. BRUCE 578 Respondent determined a deficiency in estate tax in the amount of $ 337,671.40. Certain issues raised in the pleadings have 579 been conceded by the parties. The sole remaining issue is whether the assets of two trusts are includable in the gross estate.FINDINGS OF FACTSome of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.Sedgwick Minot (hereinafter referred to as decedent) died on April 18, 1959, in Hollywood, Calif. The Federal estate tax return for the Estate of Sedgwick Minot (hereinafter referred to as petitioner) was filed with the district director of internal revenue at Los Angeles, Calif., by William E. Dwyer (hereinafter referred to as Dwyer), duly appointed executor 128 of the estate.William Minot (sometimes hereinafter referred to as William) died testate on November 30, 1900, a resident of Boston, Mass. Decedent was a son of William.In a trust indenture dated February 15, 1900, William created a trust of certain assets and, after providing for the payment of certain minor annuities, directed that the net income from the trust assets be paid to his four children then living in equal shares during their natural lives and further, that upon the death of each child the portion of the principal of the trust corresponding to his share in the net income be transferred to such person or persons as the deceased child by will appointed, or in default of appointment, to the deceased child's then-living issue.In a will dated February 15, 1900, which was admitted to probate by the Probate Court for Suffolk County, Mass., on December 20, 1900, William devised the residue of his estate after minor bequests to certain persons in trust to be set apart in equal shares for his children living at his death, counting for one share the then-living issue of each of his children deceased at the time of his death. The trustees were directed to pay each share set apart 129 for the issue of a deceased child to such issue by the right of representation and to pay the net income from the share set aside for each child then living to such child during his natural life. Upon the death of each child then living, his share of the trust assets was to be distributed to such person or persons as he by will appointed, or in default of appointment, to his then-living issue.On December 27, 1916, decedent married Jane Gould (sometimes hereinafter referred to as Jane). Jane and decedent had three children: Jane Rockwell, Sedgwick, Jr., and Jerome.On February 23, 1926, Jane and decedent entered into a separation agreement providing for the custody of their three children and certain monetary payments by decedent, and also providing in part as follows:11 -- Whereas, under and by virtue of a certain indenture dated February 15, 1900, by and between William Minot, of the one part, and Laurence Minot, and Robert H. Gardner, Trustees, of the second part, and, whereas, also under and by 580 virtue of the last Will and Testament of the same William Minot, father of the party of the first part, the said party of the first part has the right, upon such terms as he shall, by 130 Will, lawfully establish, to appoint certain trust funds to and among such person or persons as he may direct, now, therefore, said party of the first part covenants and agrees that he will, by last Will and Testament, appoint such trust funds in fee in equal shares among his surviving children and issue per stirpes of any deceased child or children, provided, however, that should by any subsequent marriage or marriages the said party of the first part have more than three children, no less than one-half of the trust funds which he may so appoint by virtue of the afore-mentioned indenture and Will shall be appointed to and among the children born of the marriage of the parties of the first and second parts, or the survivor or survivors of such children, -- the surviving issue of any of such child or children that may predecease the party of the first part to receive per stirpes the share its parent would have been entitled to receive if living.Subsequent to the execution of this agreement Jane and decedent were divorced. Decedent married a second time and his second wife, by whom he had no children, predeceased him. Decedent was survived by Jane, Jerome, and Jane Rockwell (now Jane 131 Rockwell Minot Windom). Sedgwick, Jr., predeceased him, leaving no issue.On May 1, 1959, two instruments executed by decedent dated June 28, 1956, and October 17, 1957, respectively, were offered for probate as decedent's last will and codicil in the Probate Court in and for the County of Suffolk, Mass. (hereinafter referred to as the Probate Court), by Dwyer, as executor named in the will. Under the terms of the two instruments, one-third of the decedent's estate, except for tangible personal property and a sum of money to be set aside for the care of a monument to the decedent and his second wife, was devised in trust to pay the income to his surviving children and to the survivor of them for life, and upon the death of the survivor to pay $ 50,000 of the trust principal to a named beneficiary and the balance of the corpus in equal amounts to six charities. The residue of the estate after the payment of certain specific legacies was devised to the same six charities. The second article of the instrument dated June 28, 1956, provided as follows:Second: I hereby exercise all my powers of appointment in regard to all property held in trust for me at the time of my death under any 132 and all trusts over which I have or may have a power in appointment.On June 15, 1959, Jerome and Jane Rockwell, as contestants, each filed a motion by an attorney requesting the Probate Court to submit the following questions to a jury: (1) Whether the instruments purporting to be the last will and codicil of decedent were executed according to law; (2) whether at the time of their execution decedent was of sound mind; and (3) whether their execution had been procured by fraud or undue influence. Thereafter, counsel for Jerome and Jane Rockwell and counsel for the charitable legatees conducted negotiations toward the settlement of the will contest in which counsel for the 581 children, in arguing that the children were entitled to the trust assets as takers in default, relied primarily upon the allegations that the will was invalid for lack of testamentary capacity and that decedent had partially released his powers in favor of his children by his separation agreement with his first wife.On April 15, 1960, an agreement of compromise was executed by the children, the trustees under William's trusts, the executor and trustees under decedent's will, the named beneficiary of $ 50,000 of 133 the principal of the trust created by decedent's will, and the six charities. As herein material, the agreement provided as follows:WITNESSETH THATWhereas said instruments dated respectively June 28, 1956, and October 17, 1957, were, on or about May 4, 1959, filed and offered for probate in the Probate Court of Suffolk County, Massachusetts; andWhereas the heirs have each entered an appearance in said Probate Court for the purpose of objecting to the allowance of said instruments as such last will and testament; andWhereas under the above-mentioned indenture of William Minot the testator had a general testamentary power of appointment over his share of the trust principal thereunder; and in default of appointment, the said share of trust principal goes under the terms of the said indenture share and share alike to the testator's children living at his death; andWhereas under the will of William Minot, the testator had a general testamentary power of appointment over the two funds (known as the No. 3 fund and the accumulated income fund) which together constituted the testator's share of the trust funds under said will; and in default of appointment, the two said funds go under the 134 terms of the said will share and share alike to the testator's living children living at his death; andWhereas under an Agreement made February 23, 1926 by and between the testator and Jane Gould Minot, the testator agreed that he would by his will appoint his share of the trust principal under the above-mentioned indenture of William Minot, and also his share of the said trust funds under the will of William Minot, to the testator's children surviving him, in equal shares; andWhereas the heirs contend that even if said instruments purporting to be the testator's last will and testament were admitted to probate, they could not effectively exercise said powers of appointment for the reason that by said Agreement of February 23, 1926, the testator had released said powers; andWhereas a controversy has arisen between the testator's children, on the one hand, and the charitable organizations named as residuary legatees under said purported will, on the other hand, as to the validity and effect of said purported will and codicil; andWhereas the parties hereto desire to adjust such controversy, and to provide for the allowance of said instruments as the last will and testament of the testator 135 upon the terms and conditions hereinafter set forth;Now, Therefore, in consideration of the premises, said parties do hereby mutually covenant and agree as follows:1. Said instruments dated June 28, 1956 and October 17, 1957 filed and offered for probate as aforesaid, shall be admitted to probate as the will and codicil of Sedgwick Minot, and shall be administered in conformity with the provisions of this Agreement and subject to the following modifications: * * *582 B. The testator's 1926 agreement to appoint to his children was an effective release of his general powers of appointment under the above-mentioned indenture and will of his father, William Minot. The provisions of Article Second of the said instrument dated June 28, 1956, shall be given no effect and all property (other than income in the aggregate amount of $ 8,839.60 collected and accrued from January 1, 1959 to April 18, 1959) held in the above-mentioned trusts for the benefit of the testator under the indenture and will of William Minot shall be distributed, as in default of appointment, in equal shares to the said Jane Rockwell Minot Windom and the said Jerome Minot. * * E. The provisions of Article Fourth of the 136 testator's instrument dated June 28, 1956, shall be given no effect, and that portion of the estate which is in said Article Fourth given to William E. Dwyer, Henry M. Channing and James B. Ames, as trustees, shall instead be added to the residue given by Article Twelfth and shall be distributed in accordance with the terms of that Article as amended by the instrument dated October 17, 1957.On November 17, 1960, the Probate Court, upon petitions filed on that date, entered decrees authorizing Dwyer and the trustees of the two trusts established by William to adjust the controversy in accordance with the terms and conditions set forth in the agreement for compromise. Also, on November 17, 1960, the Probate Court ordered that the instruments in issue be allowed as the last will of decedent and that Dwyer be appointed executor of the will with the direction to administer decedent's estate in accordance with the terms of the will and the agreement of compromise. The estate to be so administered was substantial.In the Federal estate tax return filed on behalf of petitioner, no part of the corpus of the two trusts established by William was included in the gross estate. In his statutory 137 notice of deficiency respondent determined that part of the assets of each trust was includable in the gross estate as assets over which decedent had, and exercised, a general power of appointment, and that the value of the includable assets of the inter vivos trust and the testamentary trust was $ 105,385.78 and $ 863,426.63, respectively.OPINIONThe sole issue is whether the respective values of the trust assets over which decedent was given general powers of appointment by will by his father's trust instruments are includable in his gross estate.The applicable statute includes in the gross estate the value of all property with respect to which a general power of appointment created on or before October 21, 1942, is exercised by the decedent by will. 1139 583 There is no question that the powers conferred upon decedent by his father's instruments were general powers of appointment as defined in the statute. Respondent has determined and here contends that decedent exercised these powers in his will and that the value of the trust assets are thereby included in his gross estate. Petitioner contends: (1) That a legally invalid attempt to exercise a power of appointment is not an exercise 138 within the meaning of the statute; (2) that decedent partially released his powers under his father's trusts by his separation agreement with his first wife so that any exercise thereof was not an exercise of a general power of appointment under section 2041(a)(1)(i); and (3) that under the principles enunciated in Lyeth v. Hoey, 305 U.S. 188">305 U.S. 188, and Helvering v. Safe Deposit Co., 316 U.S. 56">316 U.S. 56, the compromise agreement settling the will contest has the effect of a court decree that decedent did not exercise general powers of appointment in his will. Decedent was the life beneficiary of the income of two trusts, one an inter vivos trust and one a testamentary trust, which had been established by his father for the benefit of his children. Under the terms of the trust indenture and his father's will, a portion of the assets of each trust was to be distributed upon decedent's death to the person or persons appointed in his will, or, in default of appointments, to his then-living issue.Decedent left a will and codicil in which he devised one-third of his estate to trustees to pay the net income therefrom to his children during their lives and at their death to pay the remainder to six named charities. The residue 140 of his estate was also given to these six charities. Article Second of the will purported to exercise all powers of appointment over trust assets held by him at the time of his death.Decedent's will was presented for probate on May 1, 1959. Decedent's children, as contestants of the will's validity, on June 15, 1959, requested the Probate Court to frame questions for a jury trial concerning the will's formal legality, decedent's testamentary capacity, and the presence of fraud or undue influence. On April 15, 1960, a compromise agreement settling the will contest was executed by decedent's 584 children, the charitable legatees, and others. Prior to this agreement, counsel for the children advanced the theory that decedent had partially released his powers of appointment under his father's trusts by the separation agreement with his first wife in which he agreed to appoint to his children. Both the question of testamentary capacity and the question of the release or partial release of the appointive power were considered as serious threats with substantial basis in fact and law by counsel representing the various parties having opposing interests to those of the decedent's two surviving 141 children. The compromise agreement specifically provided that the separation agreement was an effective release of decedent's general powers of appointment over the assets of his father's trusts, that Article Second of the will was to be given no effect, and that the trust assets were to be distributed, as in default of appointment, in equal shares to decedent's two children. Other than the trust assets, decedent's estate was to be distributed as directed in his will. The Probate Court approved the compromise agreement and admitted the will and codicil to probate to be administered in accordance with the terms of the compromise agreement.Lyeth v. Hoey, supra, involved the question whether amounts received by certain heirs in derogation of provisions of a will admitted to probate subject to a compromise agreement were exempt from the income tax because received by inheritance. The Court held that since under State law the recipients' rights under the compromise agreement resulted from their claim as heirs that the will was invalid, the amounts were received "by inheritance" within the meaning of the Federal statute, despite the fact that title under Massachusetts law passed first 142 to the devisees under the will. In so holding the Court said (p. 196):There is no question that petitioner obtained that portion, upon the value of which he is sought to be taxed, because of his standing as an heir and of his claim in that capacity. It does not seem to be questioned that if the contest had been fought to a finish and petitioner had succeeded, the property which he would have received would have been exempt under the federal act. Nor is it questioned that if in any appropriate proceeding, instituted by him as heir, he had recovered judgment for a part of the estate, that part would have been acquired by inheritance within the meaning of the act. We think that the distinction sought to be made between acquisition through such a judgment and acquisition by a compromise agreement in lieu of such a judgment is too formal to be sound, as it disregards the substance of the statutory exemption. It does so, because it disregards the heirship which underlay the compromise, the status which commanded that agreement and was recognized by it. While the will was admitted to probate, the decree also required the distribution of the estate in accordance with the compromise and, 143 so far as the latter provided for distribution to the heirs, it overrode the will. * * The portion of the decedent's property which petitioner obtained under the compromise did not come to him through the testator's will. That portion he obtained because of his heirship and to that extent he took in spite of the will and as in case of intestacy. * * *585 The rationale of Lyeth v. Hoey, supra, was later applied by the Supreme Court in the case of Helvering v. Safe Deposit Co., supra, an estate tax case. In that case the decedent was possessed at his death of a general testamentary power of appointment over the assets of each of three trusts. In default of the exercise of his power the assets were to go to his descendants, or if he had none, to his brother and sisters and their issue per stirpes. Decedent left a will in which he purported to exercise his powers of appointment over the trust assets in favor of his brother and sisters. In proceedings in North Carolina courts, decedent's two children claimed the right to the trust assets as takers in default under the trust instruments on the grounds that the will was invalid. Decedent's brother and sisters asserted their right as appointees 144 under the will which they claimed was valid and, alternatively, as takers in default. The controversy terminated in an agreement under which the brother and sisters received 37 1/2 percent of the trust assets and the compromise was confirmed by court decree. Relying on Lyeth v. Hoey, supra, the Court held that that portion of the 37 1/2 percent of the trust assets which was imputable to the brother's and sisters' claim that the will was valid was includable in decedent's gross estate. The Court said (pp. 64-65):The claim of the decedent's brother and sisters here, so far as based on the validity of the purported appointment, had its roots, like the claimed invalidity of the will in the Lyeth case, in an issue never decided in litigation. If it had been litigated to final judgment by a competent tribunal and the brother and sisters had succeeded in establishing the validity of the exercise of the power, the inclusion in the decedent's gross estate of what they would have received as appointees, pursuant to § 302(f), could not seriously be questioned. In the Lyeth case we said that "the distinction sought to be made between acquisition through such a judgment and acquisition by a compromise 145 agreement in lieu of such a judgment is too formal to be sound." 2 There is no less reason for the same conclusion here. [Footnote omitted.]See also Estate of Gertrude P. Barrett, 22 T.C. 606">22 T.C. 606; Estate of Mary Clare Milner, 6 T.C. 874">6 T.C. 874; In re Sage's Estate, 122 F. 2d 480 (C.A. 3), affirming 42 B.T.A. 1304">42 B.T.A. 1304, certiorari denied 314 U.S. 699">314 U.S. 699, wherein this and other Courts have applied the principle of the Lyeth v. Hoey and Helvering v. Safe Deposit Co. cases.On the basis of Helvering v. Safe Deposit Co., supra, and Lyeth v. Hoey, supra, the action of the Probate Court in the instant case admitting decedent's will to probate to be administered according to the terms of the compromise agreement is to be given the same effect as a judgment by the Probate Court in favor of the claims commanding the compromise agreement. Although the compromise was reached before issues were framed for jury trial, as distinguished from Lyeth v. Hoey, supra, the evidence clearly establishes the existence of a noncollusive controversy and an arm's-length agreement. Accordingly, in applying section 2041, the trust assets are imputed to the children's 586 claims that the will was invalid and that decedent had partially 146 released his powers prior to his death.Respondent does not question the application of State law in determining the will's validity and whether the powers were released, or the inapplicability of section 2041 in the event of partial release. Respondent contends, however, that a testamentary exercise need not be effective to pass title under State law in order to be an exercise within the purview of section 2041.Prior to 1942, section 811(f) of the Internal Revenue Code of 1939, the predecessor of section 2041, provided for inclusion in the gross estate of "any property passing under a general power of appointment exercised by the decedent (1) by will, * ." The requirement that property "pass" resulted in the anomalous exclusion of assets subject to a power exercised by will in favor of the takers in default of appointment, where, under peculiarities of the controlling local law, title to the property passed directly from the donor to the persons occupying the dual status of takers and appointees. See Helvering v. Grinnell, 294 U.S. 153">294 U.S. 153; Lewis v. Rothensies, 138 F. 2d 129 (C.A. 3). In 1942, the statute was amended to eliminate the passing requirement making the possession and 147 exercise of a general power created prior to 1942 the only criteria for inclusion. Powers created after 1942 resulted in inclusion, irrespective of the exercise thereof, if decedent had the right to exercise the power at his death. See section 2041 (a)(2).Cases decided after this statutory change, such as Estate of Sarah V. Moran, 16 T.C. 814">16 T.C. 814; Keating v. Mayer, 136 F. Supp. 286">136 F. Supp. 286 (E.D. Pa.), affd. 236 F. 2d 478 (C.A. 3); and Thompson v. United States, 148 F. Supp. 910">148 F. Supp. 910 (E.D. Pa.), relied upon by respondent, held that property subject to a general power created before 1942 exercised by will in favor of the takers in default was included even though, under local law, title to the property passed directly from the donor. In stating that the exercise of a power of appointment need not be an "effective" exercise, it is clear that the courts were using the word "effective" in the sense of "effective to pass title." This is evident from the language of the Third Circuit in the case of Keating v. Mayer, supra, wherein, after discussion of the Revenue Act of 1942 and the Powers of Appointment Act of 1951, the court concluded (at p. 483):We conclude from the foregoing that when Congress eliminated 148 the requirement of "passing" both in the Revenue Act of 1942 and the Powers of Appointment Act of 1951, but retained in both Acts the requirement of exercise as to powers created prior to October 21, 1942, that it could not possibly have intended that the exercise must be "effective." No other conclusion is possible in view of the elimination of the requirement of "passing" in both statutes. To hold otherwise would be, by judicial legislation, to put back into the statutes referred to that which Congress had eliminated -- "passing" or otherwise stated, "effective" exercise. [Emphasis added.]587 None of the above cases held that an invalid attempt to exercise a power of appointment, or an attempt to exercise a power which, because of a prior release, the decedent did not then possess, was to be considered an "exercise" of such a power within the meaning of such statutes. None of the cases involved contested wills; no issue as to the validity of the exercise of the power was presented therein, and no question was raised that the decedent therein did not possess the power of appointment at the time of the attempted exercise because of a prior release or partial release of the power. 149 The only question was whether the appointive property was subject to tax when the appointment was in favor of the same individuals who would have received it in default of exercise of the power and, under local law, title to the property passed directly from the donor and not by virtue of the exercise of the power. In the present case, the decedent attempted to exercise powers in favor of various individuals and charities which would not have been entitled to take in default of exercise. Both the validity of decedent's act and his possession of the power at the time were questioned in the Probate Court. The cited cases relied upon by respondent, while reaching the correct result on the facts therein, are not relevant to the facts presented herein.Neither the language nor the legislative history of section 2041(a) (1)2 warrants the conclusion that Congress intended an ineffectual attempt to exercise a power to result in the inclusion of the appointive property in the gross estate. See Estate of Edith Wilson Paul, 16 T.C. 743">16 T.C. 743, acq. 2 C.B. 3">1951-2 C.B. 3, wherein this Court held that the term "exercised," as used in section 403(d)(3) of the Revenue Act of 1942, did not include an appointment 150 whereby the decedent sought to create certain remainder interests which were in violation of the Pennsylvania rule against perpetuities. Respondent contended that the appointment was a valid "exercise" within the meaning of the 1942 Act even though it was a legal nullity under the State law. In rejecting respondent's contention this Court said:Perhaps, as explained by the court in Wilson v. Kraemer, supra [190 F. 2d 341 (C.A. 2, 1951), certiorari denied 342 U.S. 859">342 U.S. 859], Congress in drafting the exception in the 1942 amendment did not intend to restrict the meaning of the word "exercise" so as to exclude a valid appointment subsequently rendered ineffective by the refusal of the beneficiary to take under the appointment. Even so, we find no substantial grounds either in the reasoning of the court in Wilson v. Kraemer, supra, or in the legislative history of the Act for concluding that the drafters intended to include a void appointment such as we have here within the meaning of the word "exercise." We do not feel justified in such circumstances in concluding that Congress intended either to make a void act valid for tax purposes or to levy a tax on an estate because of a decedent's 151 mere gesture possessing no legal significance. * *588 It is clear that if the decedent's children had pursued their claims in the Probate Court and obtained a decree that the will was invalid, or that it was invalid insofar as it purported to exercise general powers of appointment, the appointive property would not be subject to Federal estate tax. Under Lyeth v. Hoey, supra, the compromise agreement which was approved by the Probate Court has the same effect, so far as the appointive property was concerned, for Federal estate tax purposes. The compromise agreement specifically provided that the provisions of decedent's will which purported to exercise the powers of appointment should be given no effect and that the property of the William Minot trusts should be distributed to the decedent's children as in default of appointment. To this extent the decrees of the Probate Court approving the settlement "overrode the will" ( Lyeth v. Hoey, supra). The result was that the children took the appointive property in recognition of their claim that, at the time he executed his will, 152 the decedent either did not possess or did not validly exercise any general power of appointment and that they were therefore entitled to the property as takers in default of exercise of the powers. We hold that the assets of the two William Minot trusts are not includable in the decedent's gross estate.Decision will be entered under Rule 50. Footnotes1. Internal Revenue Code of 1954.SEC. 2041. POWERS OF APPOINTMENT.(a) In General. -- The value of the gross estate shall include the value of all property (except real property situated outside of the United States) -- (1) Powers of appointment created on or before October 21, 1942. -- To the extent of any property with respect to which a general power of appointment created on or before October 21, 1942, is exercised by the decedent -- (A) by will, or* * * but the failure to exercise such a power or the complete release of such a power shall not be deemed an exercise thereof. If a general power of appointment created on or before October 21, 1942, has been partially released so that it is no longer a general power of appointment, the exercise of such power shall not be deemed to be the exercise of a general power of appointment if -- (i) such partial release occurred before November 1, 1951, or * * (b) Definitions. -- For purposes of subsection (a) -- (1) General power of appointment. -- The term "general power of appointment" means a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate; * *↩2. H. Rept. No. 2333, 77th Cong., 1st Sess., 2 C.B. 372">1942-2 C.B. 372↩, 417; S. Rept. No. 382, 82d Cong., 1st Sess., p. 3.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622662/	Alexander E. Baker, Jr., and Mary A. Baker, Petitioners v. Commissioner of Internal Revenue, RespondentBaker v. CommissionerDocket No. 7439-76United States Tax Court70 T.C. 460; 1978 U.S. Tax Ct. LEXIS 100; June 15, 1978, Filed 100 Decision will be entered under Rule 155. Petitioner sought to exclude from gross income under sec. 112(b) payments received for accrued leave upon separation from the military. Such amounts were in excess of the $ 500 maximum statutory exclusion. Held, payments received by petitioner for leave accrued during months of active combat service are fully includable in gross income to the extent that such amounts exceed the statutory exclusion provided by sec. 112(b). Alexander E. Baker, Jr., pro se.John Wendell Paul, for the respondent. Forrester, Judge. FORRESTER460 Respondent has determined a deficiency in petitioners' Federal income tax for the taxable year 1973 in the amount of $ 849.65. Concessions having been made, the only issue remaining for our decision is whether petitioner Alexander E. 461 Baker may exclude, in excess of the specific maximum statutory exclusion under section 112(b), 1 the amount received for accrued leave upon separation from the military.FINDINGS OF FACTSome of the facts have been stipulated and are so found.Petitioners Alexander E. Baker, Jr., and Mary A. Baker resided in Overland Park, Kans., at the time they filed the petition herein. Petitioners filed a joint Federal income tax return for 1973 with the Internal Revenue Service Center, Austin, Tex.Petitioner Alexander102 E. Baker (petitioner) was a commissioned officer in the United States Air Force during his tour of active duty. He served in a combat zone from August 6, 1963, to August 6, 1964, and from April 29, 1972, to February 7, 1973. During these periods petitioner excluded the maximum monthly statutory amounts from his base pay.While on active duty petitioner earned annual leave at the rate of 2 1/2 days per month. This resulted in petitioner's accruing 54 1/2 days of unused annual leave comprised of 30 1/2 days from August 6, 1963, to August 6, 1964, and 24 days from April 29, 1972, to February 7, 1973.Petitioner was limited to a maximum carryover of 60 days annual leave from one year to another at the end of a calendar year. Thus, unless petitioner served in a combat zone he lost any unused accrued leave that exceeded 60 days.On May 31, 1973, petitioner retired from the service. Upon retirement he was paid $ 3,251.40 for 60 days of unused accrued leave. On his 1973 return petitioner excluded $ 2,952.57 or 90.80 percent of the unused accrued leave payment based upon 54 1/2 days of accrued annual leave. Respondent denied the exclusion of this amount from petitioner's gross income. 103 OPINIONRespondent argues that petitioner has exhausted the maximum monthly exclusion permitted under section 112(b), thereby precluding any further exclusions from gross income. Section 112 2 provides that certain compensation received by members of 462 the Armed Forces while serving in combat zones or who are hospitalized as a result of injuries received in such zones shall not be included in gross income.104 Enlisted personnel (below the grade of commissioned officer) may exclude all compensation received while in a combat zone. Commissioned officers, on the other hand, need not include compensation up to a maximum of $ 500 per month for active service as a commissioned officer in the Armed Forces provided they actively served in a combat zone or were hospitalized as a result of injuries received in such zone. Therefore, a commissioned officer is limited to a maximum exclusion of $ 500 per month from compensation received.The parties stipulated that petitioner met the requirements of section 112(b) and received the benefits therein during the periods of combat service. However, petitioner contends that he is entitled to exclude, in excess of the maximum monthly amounts for his periods of combat service, all compensation received for unused accrued leave while serving in a combat zone. We disagree.In the instant case, the only relevant statutory authority permitting the exclusion of payments for unused accrued leave is section 112. Petitioner has the burden of proving that he is entitled to exclude such amounts from gross income for 1973. Rule 142(a), Tax Court Rules of Practice105 and Procedure.Since petitioner was a commissioned officer the unlimited gross income exclusion for enlisted personnel under section 112(a) does not apply. As a commissioned officer petitioner has already been granted the maximum benefit of section 112(b). Cf. 463 Land v. Commissioner, 61 T.C. 675">61 T.C. 675, 679-681 (1974). He received the total limited exclusion of $ 500 per month from his regular combat pay for each month during part of which he served in the combat zone. Compensation received by petitioner in excess of this statutory amount is not excludable from gross income under section 112(b). Therefore, the amount received as payment for unused accrued leave incurred while in a combat zone is fully includable in gross income pursuant to section 61. 3106 Petitioner also contends that a commissioned officer should have the same right as an enlisted person to exclude from gross income all accrued leave earned while in a combat zone. Section 112 notwithstanding, petitioner supports this contention by arguing the he was denied the exclusion of accrued leave under Rev. Rul. 73-187, 1 C.B. 51">1973-1 C.B. 51. 4 This ruling holds that accrued leave payments, attributable to active service in a combat zone, paid to members of the Armed Forces at the time of their discharge from the military are excludable from gross income subject to the limitations of section 112.107 In addition, Rev. Rul. 73-187, supra, further prescribes that in the case of a commissioned officer payments for accrued leave while in a combat zone are excludable from his gross income to the extent that the limited exclusion provided by section 112(b) has not been previously exhausted by exclusions from income under that section. The petitioner attacked the validity of this ruling at trial. His attack focused on the tax treatment accorded an enlisted person versus a commissioned officer where each had earned accrued leave while in a combat zone but received payment for such leave after discharge from the service.According to the petitioner, Rev. Rul. 73-187, supra, is based upon fallacious reasoning. He asserts that it permits enlisted personnel the full exclusion of accrued leave pay while it limits commissioned officers to the statutory maximum exclusion of $ 500 per month. At the trial petitioner opined that, statutory limitations notwithstanding, all accrued leave earned within a 464 combat zone by commissioned officers should be fully excludable from gross income.After careful108 consideration of a variety of factors, the most crucial of which being the precise language contained in section 112(b), we have concluded that the result reached by respondent in Rev. Rul. 73-187, supra, is correct. To determine otherwise would threaten the very fabric of section 112.Rev. Rul. 73-187, supra, merely restates and applies the statutory prescription for enlisted personnel and commissioned officers. We think that a close reading of the statutory language of section 112(b) leads to an inescapable conclusion. That is, once having exhausted the maximum monthly amount of $ 500, any additional payments for such month of combat service, whether for accrued leave or some other form of compensation, must be fully includable in the commissioned officer's gross income. See also Rev. Rul. 55-249, 1 C.B. 218">1955-1 C.B. 218.Not only is the statutory language clear but the legislative history underlying section 112 does not support petitioner in his argument that Congress intended to grant commissioned officers a parity with enlisted personnel for compensation109 received as accrued leave payments. See, e.g., H. Rept. 1337, 83d Cong., 2d Sess. 16, A36 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 17, 187 (1954). In the absence of any committee report or debate over section 112 to the contrary, a valid supposition for its enactment is that the unlimited gross income exclusion permitted enlisted personnel was to balance, in some way, the numerous privileges conferred upon commissioned officers. See, e.g., Armed Forces Act, 10 U.S.C. secs. 8011 et seq., p. 9774.In addition, it appears that section 112 reflects the desire of Congress to bestow a greater tax benefit to enlisted personnel whose incomes are smaller and a smaller benefit to commissioned officers whose incomes are greater. Bruinooge v. United States, 550 F.2d 624">550 F.2d 624, 628 (Ct. Cl. 1977). Although the precise question in the instant case has never been before this Court, other courts have determined that section 112 draws a constitutionally valid distinction between enlisted personnel and commissioned officers and we agree. See Bruinooge v. United States, supra.For all of the above reasons, 110 we have no difficulty in holding that amounts received by a commissioned officer upon discharge from the service for leave accrued during months of active 465 combat service are fully includable in gross income to the extent that such amounts exceed the statutory exclusion provided by section 112(b). Our holding is based upon our interpretation of section 112(b) and not upon respondent's ruling; furthermore, we think a fair reading of that section would have alerted petitioner to the fact that the benefits accorded therein are inapplicable to his situation.Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954.↩2. SEC. 112. CERTAIN COMBAT PAY OF MEMBERS OF THE ARMED FORCES.(a) Enlisted Personnel. -- Gross income does not include compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States for any month during any part of which such member -- (1) served in a combat zone, or(2) was hospitalized as a result of wounds, disease, or injury incurred while serving in a combat zone; but this paragraph shall not apply for any month beginning more than 2 years after the date of the termination of combatant activities in such zone.* * * *(b) Commissioned Officers. -- Gross income does not include so much of the compensation as does not exceed $ 500 received for active service as a commissioned officer in the Armed Forces of the United States for any month during any part of which such officer -- (1) served in a combat zone, or(2) was hospitalized as a result of wounds, disease, or injury incurred while serving in a combat zone; but this paragraph shall not apply for any month beginning more than 2 years after the date of the termination of combatant activities in such zone.↩3. We do not reach the question raised in respondent's brief of whether petitioner met his burden of proof in showing that all of the leave claimed for combat service was, in fact, earned in a combat zone because the amount at issue is fully includable in petitioner's gross income.↩4. This revenue ruling merely amplified Rev. Rul. 71-343, 2 C.B. 92">1971-2 C.B. 92↩, on the question of accrued leave payments. In that ruling the Service took the position that certain forms of compensation, including accrued leave payments, received by members of the Armed Forces for active service in a combat zone were excludable from gross income pursuant to sec. 112.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622666/	EARL AND LELA WORTHAM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWortham v. CommissionerDocket No. 8302-91United States Tax CourtT.C. Memo 1994-324; 1994 Tax Ct. Memo LEXIS 332; 68 T.C.M. (CCH) 100; July 18, 1994, Filed 332 Decision will be entered under rule 155. Earl and Lela Wortham, pro se. For respondent: William L. Blodgett. COHENCOHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies of $ 7,711 and $ 6,952 in petitioners' Federal income taxes for 1985 and 1986, respectively. Respondent also determined additions to tax for fraud under section 6653(b) and for substantial understatement under section 6661. In the alternative, respondent determined that petitioners were liable for additions to tax under section 6653(a) for negligence for each year. Prior to trial, respondent conceded that petitioners were not liable for the additions to tax for fraud. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. After concessions, the issues for decision are whether petitioners had unreported income, whether petitioners are entitled to additional deductions for automobile expenses, and whether petitioners are liable for additions to tax for negligence and substantial understatement of tax. FINDINGS OF FACT Some of the333 facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Petitioners were residents of Maryland at the time they filed their petition. Petitioners filed joint Federal income tax returns for the years in issue. During 1985 and 1986, Earl Wortham (petitioner) was a self-employed insurance agent doing business as Citation Insurance Agency and a self-employed real estate agent doing business as Superior Realty Company. Petitioner rented office space in Temple Hills, Maryland, for the purpose of conducting the insurance and real estate businesses. Petitioner received rent from one or more real estate agents for the use of office space and services. During 1985, petitioner maintained a checking account for the insurance agency and deposited not less than $ 141,209 into that account. Petitioner also maintained a separate checking account for the real estate company. A total of $ 3,165 was deposited into the account for the real estate business during 4 months of 1985. Petitioner failed to maintain records of deposits into the business bank accounts during 1985 and 1986 and failed to maintain records of automobile expenses and other334 expenses incurred in his businesses. During audit, respondent accounted for all identifiable nonincome items deposited into the bank accounts and made reasonable allowances for petitioner's automobile expenses. Petitioner stated to the examining agent that he received $ 300 per month from each of two different real estate agents during 1985 and 1986. Petitioners have conceded that in 1985 they had unreported interest income, overstated their interest deductions, overstated their wage expense deduction, and overstated their reduction from gross receipts for unearned commissions. Petitioners also understated their commission expense deduction in that year. OPINION Because respondent conceded the additions to tax for fraud determined in the statutory notice, petitioners have the burden of proof on all remaining issues in this case. Rule 142(a); . Although petitioner admitted that he rented space to real estate agents during the years in issue, he did not report any income from that source on his tax returns. Petitioner contended during trial that the unexplained bank deposits into his account represented cash335 advances charged to his credit cards during the years in issue. Petitioner, however, presented no documentary evidence or other corroboration of his testimony. Although he could not identify any specific incidents of cash advances on his credit cards, he denied vehemently that there was any unreported income. Bank deposits are prima facie evidence of income, and petitioner has the burden of proving that unexplained bank deposits are not income. . See , affg. . Our observation, which respondent does not dispute, is that petitioner appeared to be a credible witness. This general observation does not require that we accept his assertion that none of the unexplained bank deposits represent taxable income. He did not adequately explain his failure to report the rental income that he admitted receiving. He expressed a vague recollection that he had treated it as sales income, but the amounts of reported income were not sufficient to include the rental income as well as336 other income. Petitioner's testimony demonstrated, at a minimum, that his memory was not infallible. Under the circumstances, we believe that some reduction of respondent's adjustment is appropriate for cash advances obtained using petitioner's credit cards. In making our estimation, however, we must weigh heavily against petitioner, because the inexactitude is of his own making. . Using our best judgment on the entire record, we conclude that petitioner deposited $ 5,000 per year of nonincome items into the bank accounts used in respondent's analysis, in addition to those nonincome items already identified by respondent. In reaching this conclusion, we have considered the nature of petitioner's income-producing activities, petitioner's financial situation during the years in issue, and the absence of indicia that petitioner had unreported income at the level determined by respondent. Petitioner has not proven that he is entitled to any deductions beyond those allowed by respondent. (Petitioner apparently was unaware at trial of the amounts that respondent in fact had allowed for automobile expenses.) 337 Petitioner's failure to maintain adequate records and his failure to report taxable interest and rental income justify the additions to tax for negligence. He has not presented any evidence that would satisfy his burden of proving that he is not liable for the additions to tax. See . 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. For this purpose, there is a substantial understatement of income tax if the amount of the understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Provisions for avoidance or reduction of that addition to tax do not apply in this case. If the recomputation of petitioners' liability results in amounts satisfying the statutory criteria of section 6661, petitioners will also be liable for the additions to tax under that section. In order to take account of concessions by the parties, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622667/	RICHARD AND ANNA DOVIAK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDoviak v. CommissionerDocket No. 10908-81.United States Tax CourtT.C. Memo 1984-454; 1984 Tax Ct. Memo LEXIS 213; 48 T.C.M. (CCH) 957; T.C.M. (RIA) 84454; August 28, 1984. Richard Doviak, pro se. David G. Hendricks, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined a $215 deficiency in petitioners' 1978 Federal income taxes. The sole issue for decision is whether petitioners qualify for a home office deduction under section 280A. 1FINDINGS OF FACT Some of the facts have been stipulated and have been found accordingly. Petitioners, Richard Doviak and Anna Doviak, husband and wife, were residents of Norman, Oklahoma, 214 at the time they filed their petition herein. Petitioners filed a joint U.S. individual income tax return (Form 1040) for their 1978 taxable year with the Internal Revenue Service in Boston, Texas. At all relevant times, Richard Doviak (hereinafter petitioner), a scientist, was employed full-time by the National Severe Storms Laboratory, Environmental Research Laboratories, National Oceanographic and Atmospheric Administration, U.S. Department of Commerce, in Norman, Oklahoma (hereinafter NSSL). Petitioner was provided with an office in his place of employment. During 1978, petitioner taught a meteorology course at the University of Oklahoma, in Norman, Oklahoma. The University did not provide petitioner with an office. The meteorology course was taught in the morning, during normal working hours at NSSL, three days per week. Petitioner's employer permitted him to take off time from work for teaching, provided that petitioner put in the time necessary to maintain his current level of performance at the laboratory. Petitioner received no income during 1978 for his services as an instructor at the University of Oklahoma. Petitioner established an office in his home which215 he used to prepare lectures for his classes at the University, to work on a book he is currently writing, to write professional articles, and to do work for his employer. During the year in issue, petitioner received no income on his efforts as a writer, and he did not expect to make a profit from his writing in the future. On their 1978 Federal income tax return, petitioners claimed a miscellaneous deduction in the amount of $746.23 for expenses attributable to maintenance of an office in their home. In the statutory notice of deficiency, respondent allowed $229.35 as miscellaneous employee expenses and disallowed $516.88 of petitioners' claimed home office expenses. OPINION The sole issue for decision is whether petitioners qualify for a home office deduction under section 280A. Generally section 280A disallows deductions to individuals "with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence." However, section 280A(c)(1) sets forth the following exceptions to the general rule: (1) Certain business use.--Subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit216 which is exclusively used on a regular basis-- (A) the principal place of business for any trade or business of the taxpayer, (B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or (C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business. In the case of an employee, the preceding sentence shall apply only if the exclusive use referred to in the preceding sentence is for the convenience of his employer. Petitioner argues that his home office was used both in the normal course of his business for his employer's convenience, and as his principal place of business in his employment as a teacher and writer. Respondent maintains that petitioner is not entitled to the deductions because the home office was not petitioner's principal place of business in his employment with NSSL and was not established for the convenience of NSSL. Respondent also asserts that no deduction is allowable because petitioner was not in the trade or business of being a writer or teacher. Respondent's determination217 is presumptively correct and petitioner bears the burden of proof. Rule 142(a), Tax Court Rules of Practice and Procedure. A taxpayer may have only one principal place of business for each business in which he is engaged. Green v. Commissioner,78 T.C. 428">78 T.C. 428, 433 (1982), revd. on other grounds 707 F. 2d 404 (9th Cir. 1983); Jackson v. Commissioner,76 T.C. 696">76 T.C. 696, 700 (1981). To determine the principal place of business within the meaning of section 280A(c)(1)(A) we must ascertain the "focal point of a taxpayer's business activities." Jackson v. Commissioner,supra.In the instant case, petitioner was a full-time employee of NSSL and his employer provided him with an office there. On the record before us, we must conclude that the focal point of petitioner's business activities as a scientist was at the place of his employment, NSSL. Petitioner's assertion that he did additional research at home because the employer's facilities were closed, or because the air conditioning was shut off in the evenings, is insufficient to convert his home into his principal place of business. 2*218 We similarly reject petitioner's alternative argument that his home office was used as his principal place of business for teaching and writing. In order to be entitled to a deduction, petitioner must establish that he was in the trade or business of being an instructor or an author. See Curphey v. Commissioner,73 T.C. 766">73 T.C. 766, 770 (1980). Petitioner concedes that during the year in issue, he did not receive any income from his teaching or writing. In addition, petitioner admitted at trial that he did not expect to make a profit from his teaching or writing activity. Accordingly, we must conclude that petitioner's teaching and ariting activities did not rise to the level of a separate trade or business. See Gestrich v. Commissioner,74 T.C. 525">74 T.C. 525, 529 (1980), affd. without published opinion 681 F. 2d 805 (3d Cir. 1982). 3To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. Unless indicated otherwise, all section references are to the Internal Revenue Code of 1954, as amended.↩2. Since we find that petitioner's home office was not his principal place of business in connection with his employment at NSSL we need not decide whether the office was used for the convenience of his employer.↩3. In light of our conclusions we need not determine whether the home office was "exclusively used" in petitioner's employment, teaching, or writing activities.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622668/	TEXAS COCA-COLA BOTTLING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Texas Coca-Cola Bottling Co. v. CommissionerDocket No. 54177.United States Board of Tax Appeals30 B.T.A. 736; 1934 BTA LEXIS 1281; May 16, 1934, Promulgated 1281 Where, under the laws of the State of Texas, liability for city, school, state, and county taxes accrued as of January 1, 1928, and is determined by the ownership of the property on that date, and where petitioner acquired the property on March 1, 1928, and paid the taxes for that year, held, that the expenditure for the payment of the taxes became a part of the cost of the property and is not deductible under section 23 of the Revenue Act of 1928. Llewellyn A. Luce, Esq., for the petitioner. P. A. Bayer, Esq., for the respondent. ADAMS 736 OPINION. ADAMS: The respondent determined a deficiency in income tax of $541.13 against the petitioner for the period March 1 to December 31, 1928. The deficiency arises from the disallowance by the respondent of certain deductions for taxes claimed by the petitioner. The taxes were real estate taxes for the year 1928 due the State of Texas and its governmental subdivisions and amounted to $3,859.26. They were paid during the taxable year 1928. The facts were stipulated and the stipulation is adopted as our findings of fact. The material portions of the stipulation are as follows: 1. The1282 Petitioner Corporation was organized under the laws of the State of Texas, on March 1st, 1928, with a paid in Capital Stock of $100,000.00, and is engaged in the business of bottling and distributing Coca Cola, and 737 was so engaged from the time of its organization March 1st, 1928, to and including December 31st, 1928. 2. Petitioner Corporation was the result and product of the incorporation of four partnerships, which were in existence on January 1st, 1928, and had been in existence during the year 1927 and for several years prior thereto. These partnerships were, during their years of existence, in the business of bottling and distributing Coca Cola. The said Partnerships were as follows: Texas Coca-Cola Bottling Co., Abilene, Texas; Coca-Cola Bottling Co., Eastland, Texas; Dublin Coca-Cola Bottling Co., Dublin, Texas; Sweetwater Coca-Cola Bottling Co., Sweetwater, Texas. 3. [The stipulation here sets out the respective holdings of partnership interests by the individual partners.] 4. During the early part of the year 1928 the partners composing the four above mentioned partnerships decided to unite the four partnerships and to incorporate them. This plan1283 was carried out, and the Petitioner Corporation was formed. Stock in the Petitioner Corporation was issued to the members of the aforesaid partnerships, in exchange for the assets thereof, which consisted of both real and personal property. At the time of the incorporation the assets of the Petitioner Corporation were set up on the same basis that they were carried on the partnership books, which created the following Capital and Surplus of the Petitioner Corporation: Capital Stock$100,000.00Surplus108,923.75Total Assets$208,923.755. [This paragraph of the stipulation shows the number of shares issued to each of the stockholders.] 6. During the months of November and December, 1928, the Petitioner Corporation paid the following taxes payable in 1928: [Here is set out a list of taxes paid by petitioner totaling the amount of $3,859.26.] 7. These taxes were based upon real estate owned by the four partnerships on January 1st, 1928. Said real properties were acquired by the Petitioner Corporation on March 1st, 1928, and said Petitioner Corporation held said properties throughout the balance of the year 1928, and used said properties in its business1284 during that period of time. The same real properties were owned, prior to the incorporation, by the four partnerships which united to form the Petitioner Corporation. On January 1st, 1928, the said real properties were held in the name of the four partnerships named hereinafter. 8. The City, School, State and County taxes on the said real properties payable in the year 1927, were paid by the four partnerships. 9. In its income tax return for the period March 1st to and including December 31st, 1928, the Petitioner Corporation claimed as a deduction the sum of $3,859.26, representing the aforesaid City, School, State and County taxes paid by the Petitioner Corporation during the months of November and December, 1928. 10. This deduction was disallowed by the Respondent on the theory that the sum of said taxes represented additional cost of the properties taken over by the Corporation from the partnerships, and was not an ordinary and necessary business expense of Petitioner Corporation. 11. It is agreed between parties hereto that the Board may take judicial notice of the statutes of the State of Texas, regarding liability for the payment 738 of State, County, 1285 School and City taxes, and the assessment and payment thereof. We have for determination the sole question as to whether one acquiring real property in the State of Texas on March 1, 1928, may take as a deduction from its income tax return for that year taxes paid to the state and its subdivisions on such property as an ordinary and necessary business expense. Petitioner's specification of error is as follows: The failure of the Commissioner to find that the payment of City, County, State and School taxes in the amount of $3,859.26 in taxable period covered by this appeal by petitioner was an allowable deduction from gross income. In support of its assignment of error, petitioner asserts that the partnership here involved united to form the petitioner corporation; that the petitioner in all its ordinary business occupied the same position as the partnership; that the assets of petitioner were set up on its books on the same basis as carried on the partnership books; that there was no gain or loss to the members of the partnership upon the transfer of their assets in the organization of the petitioner corporation for the reason the members of the partnership were in control1286 of the partnership immediately after the exchange. In support of these propositions, petitioner cites Western Maryland Ry. Co. v. Commissioner 33 Fed.(2d) 695, in which case it was held by the Circuit Court of Appeals for the Fourth Circuit that a railroad company might deduct in its income tax returns an amortized portion of the bond discount arising upon the sale of bonds by a predecessor corporation which had formerly owned the railroad. In that case, the respondent based his denial of such deductions primarily upon the fact that a distinct and separate entity had been created as a result of the consolidation of the Western Maryland Railway Co. with other corporations. The court held that while there was a technical legal difference between the old and the new corporations, they were the same as a practical matter, both holding the same property and representing the same ownership, and it further declared it is a settled principle that courts will not permit themselves to be blinded or deceived by mere forms of law, but, regardless of fictions, will deal with the substance of the transaction involved as if the corporate agency did not exist and as the justice1287 of the case may require. Petitioner further cites the case of Paradox Land & Transport Co.,23 B.T.A. 1229">23 B.T.A. 1229, which held that where partners sold assets of a partnership to a corporation receiving in payment therefor the common stock of the corporation and were immediately in control of more than 80 percent of all outstanding voting stock of the corporation, and there was no preferred stock outstanding at that time, the basis of cost of such assets to the corporation in determining 739 the profit on a subsequent sale of such assets is their cost to the partnership from which the purchase was made. In our opinion, the cases relied upon by the petitioner are not controlling here. Those cases were dealing primarily with the question of gain or loss and the proper basis for determining such gain or loss. In the instant case, the question is whether the taxes paid are an allowable deduction under the statute. Section 23 of the Revenue Act of 1928 provides: In computing net income, there shall be allowed as deductions: * * (c) Taxes Generally. - Taxes paid or accrued within the taxable year except * * . 1288 This provision of the statute has often been construed to apply only to taxes accrued within the taxable year, such taxes being those due by the taxpayer and for which it is primarily liable. Cf. Charles R. Holden,27 B.T.A. 530">27 B.T.A. 530; First Bond & Mortgage Co.,27 B.T.A. 430">27 B.T.A. 430; Benjamin I. Powell,26 B.T.A. 509">26 B.T.A. 509; National Casket Co.,29 B.T.A. 139">29 B.T.A. 139. It is settled that the owner of property on the date the tax is assessed and becomes due is the taxpayer with respect to such taxes and that such owner is primarily liable for the same. In the event such owner conveys the property after that date and during the taxable year, the taxes so accrued are his taxes and not those of his vendee. The vendee takes the property subject to the lien against it for such taxes and it becomes to him a part of the cost of such property. The question here is controlled by the statutes of the State of Texas, from which it appears that in that state all property must be listed for taxation between January 1 and April 30 of each year when required by the assessor with reference to the property held or owned on the 1st day of January in the year1289 for which it is required to be listed or rendered. Any property purchased or acquired on the 1st day of January shall be listed by or for the person purchasing or acquiring it. Each assessor of taxes is required between the 1st day of January and the 30th day of April of each year to proceed to take a list of the taxable property in his county and assess the value thereof. The assessor is required prior to the first Monday in June or as soon thereafter as practically to submit to the board of equalization for his county for inspection, approval, correction, or equalization all the lists of property rendered to him. After the approved list is returned to the assessor he is required to make a roll or book as required by the comptroller, from the corrected list. On or before August 1 he must submit this roll or assessment book to the county board of equalization. After the board of equalization has returned the roll or assessment book, a copy 740 thereof must be delivered to the tax collector. On or before October 1, or as soon thereafter as the collector is able to obtain the assessment roll or book, he is required to begin the collection of taxes. (Revised Civil Statutes1290 of Texas, 1925, title 122, ch. 6, art. 7151; ch. 7, arts. 7189, 7218, 7219, 7222, and 7224; ch. 8, art. 7255.) In the case of Winters v. Independent School District of Evant,208 S.W. 574">208 S.W. 574, it was held by the Texas Court of Civil Appeals that the "ownership of property on the 1st day of January of any year creates a liability on the part of the owner for taxes levied upon such property for that year." In United States v. Anderson,269 U.S. 422">269 U.S. 422-433, the United States Supreme Court said: In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. The ownership of property in Texas on January 1 is the event which determines the liability for property taxes and fixes the amount, although not ascertainable on that date. (See G.C.M. 6272, VIII-1, p. 170.) We hold that the taxes in question accrued and became a lien on the property conveyed to the petitioner on January 1, 1928, and that petitioner, having1291 acquired the property on March 1 of that year, took it subject to the tax lien, and that the expenditure for the payment of such taxes became a part of the cost of the property to petitioner and is, therefore, not deductible under the Statute. Cf. Grand Hotel Co.,21 B.T.A. 890">21 B.T.A. 890; Leamington Hotel Co.,26 B.T.A. 1004">26 B.T.A. 1004; First Bond & Mortgage Co.,27 B.T.A. 430">27 B.T.A. 430. The determination of the respondent is affirmed. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622671/	WALTER M. McDOWELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMcDowell v. CommissionerDocket No. 18744-81.United States Tax CourtT.C. Memo 1987-186; 1987 Tax Ct. Memo LEXIS 182; 53 T.C.M. (CCH) 536; T.C.M. (RIA) 87186; April 7, 1987. William Carol Baskett and Alan M. Frieden, for the petitioner. William183 L. Ringuette, for the respondent. PARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: By a statutory notice of deficiency dated April 15, 1981, respondent determined deficiencies in and additions to petitioner's Federal income tax as follows: YearDeficiencySec. 6653(b) 1 Addition1972$19,402.70$9,701.35197320,281.0310,140.52197416,250.778,125.38197541,201.5720,600.79By a separate statutory notice of deficiency, also dated April 15, 1981, respondent determined a deficiency in the amount of $1,573 in petitioner's Federal income tax for taxable year 1977. After concessions, 2 the issues remaining for decision are: (1) Whether petitioner had unreported income from the operation of his tour boat business in the amounts of $44,363.10, $42,612.35, $37,152.67, and $72,439.54 for taxable years 1972, 1973, 1974, and 1975, respectively; (2) Whether petitioner had184 unreported interest income from separate transactions with his son and brother in the amounts of $244.20, $244.20, $905, and $1,780.20 for taxable years 1972, 1973, 1974, and 1975, respectively; (3) Whether petitioner had unreported income from "dock rental fees" in the amounts of $195, $975, $1,014, and $4,171.30 3 for taxable years 1972, 1973, 1974, and 1975, respectively; (4) Whether petitioner had unreported dividend income in the amounts of at least $209, $289.28, and $499.58 for taxable years 1972, 1973, and 1975, respectively; (5) Whether petitioner had unreported income in the form of "reimbursed business expenses" in the amounts of $188.33 and $280.01 during taxable years 1973 and 1974, respectively; (6) Whether petitioner had deductible travel expenses and other ordinary and necessary business expenses for taxable year 1972 in excess of the amount allowed by respondent for such year; (7) Whether petitioner is liable for the section 6653(b) fraud addition for taxable years 1972, 1973, 1974, and 1975; (8) Whether the statute of limitations bars assessment and collection of any deficiency found to exist with respect to taxable years 1972, 1973, 1974, and 1975; and185 (9) Whether petitioner is eligible for income averaging pursuant to section 1301 et seq. for taxable year 1977. 186 FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, second supplemental stipulation of facts, and exhibits attached thereto are incorporated herein by this reference. Background FactsPetitioner, Walter M. McDowell, resided in Portsmouth, Virginia, at the time the petition in this case was filed. Petitioner timely filed his Federal income tax returns (Forms 1040) as an unmarried head of household for taxable years 1972, 1973, 1974, 1975, and 1977 with the Internal Revenue Service Center in Memphis, Tennessee. Petitioner timely filed amended U.S. Individual Income Tax Returns (Forms 1040X) for taxable years 1972 and 1974 with the Memphis, Tennessee Service Center in order to claim an investment tax credit in each year. Petitioner personally prepared his original income tax returns that were filed for taxable years 1972, 1973, and 1974. Petitioner's original income tax return for taxable year 1975 and his amended income tax returns for taxable years 1972 and 1974 were prepared by Herbert A. Levin, a certified public accountant practicing in Portsmouth, Virginia. The Tour Boat Business187 During all of the taxable years in issue 4 petitioner owned and operated as a sole proprietorship a business known as "Harbor Tours," offering both public and private sightseeing tours of the harbor of Hampton Roads aboard petitioner's tour boat, the "Carrie B." Petitioner's business season lasted from approximately mid-April until approximately the end of September during each of the years in question. Petitioner from time to time employed various persons in the tour boat business on both a full and part-time basis. These persons included petitioner's son, Walter M. McDowell, Jr., his two then teenage daughters, Gayle and Linda McDowell, Stephen R. Jordan, and Dorothy Furbee. 5 A captain, duly licensed by the U.S. Coast Guard, was required to be aboard the tour boat at all times when she was under way. During the taxable years 1972 and 1973, petitioner was the only captain of the tour boat. Walter M. McDowell, Jr. obtained his captain's license and worked as one of the captains during all of the 1974 tour season and through August of the 1975 tour season. During taxable years 1973, 1974, and 1975, Stephen R. Jordan (Jordan) worked as a "mate" on the tour boat, obtaining his188 captain's license for the 1975 tour season. Gayle and Linda McDowell worked at the snack bar aboard the "Carrie B" and also served as deckhands. Petitioner started in the harbor tour business in 1959, the first such business operating in the Hampton Roads area. The original boat petitioner used could accommodate only a small number of passengers per trip. As the business grew over the years, petitioner changed boats several times in order to accommodate more passengers per trip. The tour boat used by petitioner during the taxable years in issue, the "Carrie B," was qualified and/or licensed for the carriage of 150 persons during taxable years 1972, 1973, and 1974. In January of 1975, the "Carrie B" 189 was outfitted by petitioner and approved by the U.S. Coast Guard for the carriage of 178 persons (including passengers and crew) on protected waters under reasonable conditions. Petitioner offered several different types of tours each season during the years in issue. Not all of these different types of tours were offered throughout the course of an entire tour season, nor was the admission price or policy the same for all types of tours. A brief description of the various types of tours is necessary to a proper resolution of some of the issues raised in this case. Petitioner offered a "school tour" which was essentially a guided tour of the harbor for student groups. School tours embarked from the ports of either Norfolk or Portsmouth. School tours were offered from the beginning of the tour season each year but did not last the entire season, usually ending when school recessed for the summer. A single school tour could and often did consist of groups from several different schools. A school tour generally required that an advance reservation be made, but petitioner did not ordinarily require a monetary deposit to be posted by school groups. 6 Petitioner estimated at trial190 that the general fare was one dollar per child, but indicated that the rate charged could vary from school to school. The teacher(s) accompanying the school group received free passage, as did those school children who could not pay the fare. Members of the general public were occasionally allowed to go on a school tour. A fare was not always charged to the member of the public in such instances, but such fares as were charged ranged from $ .50 to $1.50, there being no set fare for general admission in the case of a school tour. A "public tour" was a daytime tour of the harbor occurring at regularly scheduled times and open to walk-on passengers from the general public. 7 A public tour lasted approximately 1-1/2 hours, and passengers could board from either191 the port of Norfolk or Portsmouth. Public tours were not offered throughout the course of the entire tour season, and usually did not begin until after the weather had gotten warmer. The exact number of public tours offered on a particular day varied over the course of the tour season, ranging from one tour per day during the earlier portion thereof, increasing during the height of the tour season to three or four public tours per day, then once again shifting back to only one scheduled public tour per day. Bold print on advertising brochures used in the tour boat business indicated that the scheduled public tours were taken "rain or shine." At trial petitioner acknowledged this was true if enough passengers were present, but indicated that scheduled public tours were sometimes cancelled due to bad weather if there were insufficient passengers. Petitioner could offer no estimate of the number of such cancellations, and the Court concludes there were very few such cancellations. Fares charged for admission on a public tour during the years in issue ranged from $2.00 to $2.50 for adults; $1.00 for children under age six. Passengers on a public tour paid as they boarded the tour192 boat, generally in cash, but petitioner also accepted traveler's checks and personal checks. A "sunset cruise" was a different type of public tour but also represented a regularly scheduled tour open to walk-on passengers from the general public. Passengers on a sunset cruise could board the tour boat from either the port of Norfolk or Portsmouth. The tour boat advertising brochures indicated during the years in issue that the sunset cruise was offered once per day from June 11 through Labor Day. The admission fee charged for the sunset cruise was $3.00 for both adults and children. As with a daytime public tour, passengers on a sunset cruise paid as they boarded the tour boat, usually in cash. Petitioner also offered various "social cruises" or "charters" (hereinafter referred to as social cruises) which were private group tours of the harbor, not open to members of the general public unless invited by the particular group. More than one group could not go on the same cruise unless the different groups arranged the cruise jointly. Social cruises were offered both193 during the daytime and at night. A "moonlight excursion" was a type of social cruise offered, deriving its name from the fact that it was offered at night, after completion of the sunset cruise. During the 1972 tour season, the following rates were applicable to the various social cruises or charters: 8Sunday through SaturdayDaytime Guided Tours (one and one-half hours) $2.00 per person, $100.00minimum.Sunday through ThursdayDaytime Cruises and MoonlightExcursions (three hours) $2.50 perperson, $190.00 minimum.Friday and SaturdayMoonlight Excursions, $3.00 perperson, $225.00 minimum.Additional Rates$75.00 per hour for any period overthree hours.$40.00 additional from midnight to1:00 a.m.$100.00 additional per hour after1:00 a.m.July and August10 p.m. til 1 a.m. Friday and SaturdayRateAn advance reservation was required to schedule a social cruise. A nonrefundable $50 deposit was normally required unless petitioner had dealt with the particular group before. 194 During some of the years in issue, and particularly during 1972, Dolly Haddock (Haddock) was employed by petitioner to answer the phone and make the reservations for school tours and social cruises. Although Haddock appears to have been primarily responsible for this task, she did not in fact handle all the reservations, and any of the other persons employed by petitioner who happened to answer the phone could make reservations for a school tour or social cruise. When a reservation was booked, Haddock filled out a preprinted form, listing the name of the group, date and time of the tour or cruise, estimated number of passengers, and the port where they wished to board. After the reservation sheet was completed, a copy was given to petitioner or other employees of the tour boat business prior to the scheduled date of the tour. A letter confirming the reservation, detailing the terms and conditions of the cruise, and requesting the $50 deposit (if required) was then sent to the particular customer. After the school tour or social cruise was over, petitioner's copy of the reservation sheet pertaining thereto was thrown away, petitioner indicating at trial that he saw no reason to195 retain it any longer. Some of the groups which had reserved a tour or cruise failed to show up, and petitioner also threw away the reservation sheets pertaining thereto. Petitioner kept no records to indicate either the total number of reservations made or the number of tours or cruises which cancelled or failed to show up for any of the taxable years in issue. 9The tour boat business generated gross receipts from two sources: passenger fares and sales from the snack bar petitioner operated on his boat. Snacks such as soft drinks, sandwiches, potato chips, etc., souvenirs such as pennants and sea shells and film were generally available for purchase by passengers during all tours, unless the particular group chartering a private tour or196 cruise indicated it did not wish to have the snack bar open. In addition, upon request, petitioner provided setups for alcoholic beverages on certain private social cruises. Meals were never furnished by petitioner. No particular employee or employees were in charge of the snack bar operation. Employees on board worked at the snack bar on a rotational basis. Petitioner's daughters and Dorothy Furbee sometimes worked at the snack bar. With regard to walk-on passengers on public tours, fares were collected as the passengers boarded the boat, payment being made primarily in cash. With respect to school tours and social cruises, the particular group also normally paid as it came aboard, either in cash or by check. Only upon request was an invoice (indicating the amount paid) prepared and given to a group which paid upon boarding. Petitioner did not retain copies of these invoices. If the particular group did not pay upon boarding the tour boat, an invoice for the amount due was then prepared, one copy of which was kept by petitioner, the other copy being given to the group. Prompt payment of these invoices was not always made, and petitioner sometimes had to send more than one197 invoice to a party. No particular person on the boat was specifically in charge of collecting the fares from passengers as they boarded, and petitioner, as well as any of his employees, could have collected such fares. However, petitioner or some other person serving as captain usually collected the fares. Regardless of the particular type of cruise, all passengers boarding the tour boat were counted whether they represented a fare-paying customer or a "freebee" -- a person allowed to ride for free -- such as the teacher of a school group or a child who could not afford to pay. This head count was then written down on a piece of paper and kept at the snack bar. This head count was kept to provide information to the Coast Guard concerning the number of passengers aboard the boat in case of an accident. At the end of each day, the total amount received from snack bar sales was counted and placed into a brown paper bag, along with either the cash register tape or a written notation of the amount. The cash register did not always have a tape in it. This bag 10 and the gross receipts from passenger fares, whether in the form of cash, checks, or invoices (in the case of a group198 that did not pay upon boarding), were then placed into another paper bag. No count was generally made of the amount of gross receipts from passenger fares before they were placed into the bag. The sheet on which the head count was noted was sometimes also placed into the gross receipts bag, but generally the head-count information was not retained. Certain expenses were paid in cash from the gross receipts for the day. If this was done, petitioner or the employee paying the expense tried to make a notation thereof and place it into the bag at the end of the day. In addition to expenses, cash refunds were sometimes given from the gross receipts of a particular day. Usually this occurred when checks had been made out in advance, and upon boarding, the groups realized they had overestimated the number of people in their group, thereby overpaying the amount of the actual charge for their tour or cruise.199 In such a case, petitioner or the employee making the refund again attempted to make a notation of such refund and put it into the bag for that day. After the last tour of the day, the money collected from passenger fares and snack bar sales was placed in a bag and the bag was then taken by or given to petitioner. If petitioner was not aboard the boat at that time, the bag was taken by either petitioner's son or Jordan, whoever happened to be the acting captain on the last tour of the day, who would then deliver the bag(s) to petitioner soon thereafter. A number of persons aboard the tour boat had knowledge of the brown paper bags. Once the paper bags came into petitioner's possession, at the end of the day or shortly thereafter, no one except petitioner himself knew what happened to the contents of those bags. At trial, petitioner testified that a bag was made up in the above manner for each day of the tour season. Petitioner testified that he sometimes allowed as many as 12 such individual bags to accumulate at one time, but that he did not, however, continue to maintain the contents of a bag for a particular day in a separate bag for that day, but instead consolidated several200 bags into one, commingling the receipts of several bags into what petitioner loosely referred to as a "monthly" bag. All of these bags were kept by petitioner either in the trunk of his automobile or at his home. Although petitioner maintained a checking account in the name of Harbor Tours with the branch of the Bank of Virginia located at 600 Washington Street, Portsmouth, Virginia, (hereinafter Bank of Virginia), which he used for both business and personal purposes, petitioner did not deposit all of the gross receipts from the tour boat business therein. Instead, petitioner made deposits only when and in such amounts as needed to cover checks written or to be written on the account. 11 Unlike his treatment of cash receipts, the checks petitioner received in the operation of his tour boat business were promptly withdrawn from the paper bag and either deposited to petitioner's checking account or cashed. Petitioner maintained no record of these checks. Petitioner testified that whenever a check was withdrawn from the paper bag, whether for deposit or to be cashed, a notation of the check amount was made on a piece of paper which was then placed in the bag. When a check was removed201 and cashed, the money was not returned to the bag since presumably the slip of paper was already in the bag. Any slips of paper in the bag that had been used to record the head count for a particular tour were discarded, considered by petitioner to be of no further value after the tour was over. Any invoices that might have been in the bag were also withdrawn and kept on a clipboard to await payment. Since such an invoice essentially represented a "credit sale," and did not represent money previously received, it is not clear from the record whether petitioner placed a slip of paper into the bag representing such invoice, or instead waited until payment thereof and placed the cash or check into the bag at that time. In addition to expenditures on board the boat, certain other cash expenditures were also made out of the monies in these paper bags. Petitioner testified that when that occurred, the amount of the202 expenditure was recorded on a slip of paper which was then put into the bag. The remaining amount of money (mostly cash) was either kept in the bags themselves at petitioner's home, kept in a safe at petitioner's home, or kept in one of three safety deposit boxes petitioner maintained at various banks during the years in issue. Money was periodically withdrawn from these sources as needed. At trial, petitioner could give no estimate as to the amount of cash on hand at any one time in either the paper bags, the safe, or the safety deposit boxes. In addition to the cash and checks received on board the tour boat, petitioner also received some tour boat receipts by mail at his home, usually in the form of checks. Petitioner kept no record of these mail receipts. Such checks represented payment for various items, including reservation deposits, group fares, contract prices, and charter fees for future group tours or tours previously taken. At trial, petitioner testified that such amounts received by mail were treated in the same manner as other receipts of the tour boat business, that is, placed in the paper bag with the cash and checks received on the tour boat. Petitioner testified203 that these amounts were then placed into the bag for the day or month in which the tour to which they were attributable occurred if available; if not, petitioner just put these amounts into the bag for the month of collection. 12Method of Recording the Gross Receipts of the Tour Boat BusinessThroughout all of the taxable years in issue, petitioner personally and alone kept the books of account for the tour boat business. For each year, petitioner personally maintained books he designated as a Receipts Book, a Cash Disbursements Journal, a General Journal and a General Ledger. As its name suggests, the Receipts Book was used by petitioner to record the gross receipts from the tour boat business for a particular taxable year. The Cash Disbursements Journal, contrary to what its name suggests, was used to record petitioner's expenses204 paid by check; the General Journal was used to record those expenses paid in cash. Both the expenses paid by check and in cash were then carried to the General Ledger and totaled to arrive at the expense figures petitioner used in computing his income taxes for the years in issue. Petitioner's Receipts Books for the taxable years 1972, 1973, 1974, and 1975 are in evidence. These Receipts Books are informal, consisting of a separate spiral-bound notebook for each year which has been adapted to petitioner's needs. Since many of the issues involved herein focus on these Receipts Books, petitioner testified at length as to how he prepared them. Petitioner did not maintain his Receipts Books over the entire year for any of the taxable years at issue, but only for the portion thereof comprising the tour boat season, beginning with the first day that a tour was offered and ending with the last day a tour was offered for each taxable year. A separate page in the Receipts Book for each year was assigned to each day of the tour season for such year, the day and date being entered on the upper left-hand corner of the appropriate page in the Receipts Book. At trial, petitioner testified205 that he broke the Receipts Book down in this manner prior to the beginning of the tour season for each year, rather than on a daily basis during the tour season. Receipts of the tour boat business were then entered onto the page of the Receipts Book for a particular day in varying ways, depending upon the source of the particular receipts. Privately chartered tours (school tours and social cruises) were generally 13 listed by time of day and names of the chartering organizations, although charters consisting of more than one group were sometimes listed under only a single group name. Under each group name were figures purportedly 14 representing the amount collected from that particular group or groups. A rudimentary "double-entry" system was used to account for receipts from privately chartered tours, a notation under the name on the left side of the page indicating the amount due from the group(s), with a notation on the right side of the page indicating the actual amount collected therefrom. 15 206 Public tours were recorded in an entirely different manner. Notations of different times of day were made in the left-hand margin of the page for a particular day 16 and to the right-hand side numbers representing passenger fares were entered. For the daytime public tours, these passenger fares were generally divided into adult and child; the figure for adult fares appearing first, then followed by a dash and a number representing child fares. The number of adult and child fares on daytime public tours was also often broken down by the port at which the passengers boarded, Norfolk or Portsmouth. 17 The passenger fares for the evening public cruises were not broken down into adult and child figures, apparently in light of the fact that a single fare applied to both adults and children on the evening public cruises. 207 A figure representing the receipts from snack bar sales was entered in the upper right-hand corner of the page. Two separate figures are often listed in this space. However, petitioner offered no explanation at trial as to the significance of the second figure. Following the page assigned to the last day of a particular month was a summary page containing information as to the total amount of receipts for that particular month. This information was broken down into the following six categories of receipts: Snacks, Adult, Child, School, Moonlight and Sunset. The parties do not dispute that the monthly total for each of the above-listed categories comports with the figures noted on the pages for the individual days of the particular month. In other words, all of the daily figures for the month add up to the monthly totals. Petitioner's Receipts Books appear on their face to represent daily records and to have been maintained accordingly. At trial, however, petitioner denied that he kept his Receipts Books on a daily basis or considered them as daily records. 18 Rather, petitioner claimed that substantial periods of time normally passed before he "got around" to entering such208 receipts into the Receipts Book. Petitioner stated that the amounts of snack bar sale receipts were generally placed on the Receipts Book on a monthly basis, since there was state sales tax due on such amounts which had to be reported and paid each month. However, petitioner testified that the remaining gross receipts that were to be entered as passenger fares were not counted and entered into the Receipts Book for the month to which purportedly attributable until after a significant amount of time had passed, sometimes as much as several months later. While the tour season generally ended at some point in September each year, petitioner claimed that preparation of the Receipts Book was not normally completed prior to the close of the taxable year, and that he usually worked on the Receipts Book until his tax returns for the particular year became due, in March or April of the following year. Petitioner indicated that the close of the tour season for a particular year did not mean that the work connected with the tour boat business stopped. However, it did mean there were no further tours and no further brown paper bags containing daily receipts of passenger fares and snack bar209 sales. During the period between the time collected and the time entered on the Receipts Book(s), petitioner testified, the monies representing such receipts, or the slips of paper recording the amount of withdrawals therefrom, were kept at petitioner's home in either the bags themselves or in petitioner's safe or were kept at the banks in one of his three safety deposit boxes. At trial, petitioner indicated that he employed no procedure to keep the receipts other than snack bar sales (which were recorded on a monthly basis) segregated by the actual month in210 which collected. Some, but not all, of the bags were dated. Petitioner stated that without the bag being dated he had no way of knowing to which month a particular bag was actually attributable. Petitioner testified that a bag purportedly containing the gross receipts (other than snack bar sales) for a particular month could contain amounts collected in several different months, since he frequently consolidated several separate bags into a single bag. Petitioner testified he placed little emphasis on keeping the gross receipts separated by the month in which collected, explaining at trial that in his view "It made no difference as long as I counted the money and put it on the book." After the close of the tour season for a particular taxable year, petitioner continued to receive from time to time amounts representing payment for prior tours. Petitioner testified that any such amounts received after the close of the tour season were placed into one of the bags if he had not already completed preparing the Receipts Book for such year when the amount was received. Petitioner claimed that he tried to place the money into a bag for the same month in which the tour had occurred if available211 but, failing that, just put the money into any bag available, whether for an earlier or later month. If the Receipts Book for that particular year had already been completed, petitioner suggested that he then held out the amount and subsequently put it into one of the bags for the next year's tour season. With regard to the actual entry of figures into the Receipts Book, petitioner gave the following explanation. All of the bags purportedly containing the receipts for a particular month were gathered and the money therein or slips of paper representing withdrawals therefrom were counted to arrive at a figure representing the total receipts from all sources for that month. The amount of snack bar sale receipts for the month (of which petitioner claims to have kept a separate monthly record) were then subtracted from this total and recorded in the Receipts Book. With respect to the remaining gross receipts, petitioner testified that he then went back through the month and determined, as best he could from the information available to him, the amounts of receipts derived from school tours and social cruises for that month, entering such amounts as separate categories on the monthly212 total page. It is not clear from the record whether, or to what extent, petitioner utilized the figures listed under a specific group name in making this allocation, or whether petitioner is in fact claiming that he arrived at the monthly totals first and then went back through his Receipts Book filling in such amounts under the names of private tours or school tours. In any event, petitioner testified that he treated the remaining amounts of gross receipts for the month as fares attributable to walk-on passengers on the various public tours offered. According to petitioner, this lump-sum figure of gross receipts treated as passenger fares was then broken down into separate total monthly amounts for adult fares, child fares, and fares for sunset tours based on the prevailing rates with respect to each type. Petitioner claimed he would then go back through the pages reserved in the Receipts Book for each day of the particular month, and randomly enter beside the time slots listed on the left-hand side of each page a sufficient amount of adult and child passengers for each scheduled daytime tour and a single figure for the sunset cruise so that, in the aggregate, the total number213 of adult, child, and sunset cruise passengers listed for all the days of a particular month would equal the number of each category required to generate the previously arrived at monthly total for amounts treated as passenger fares. Petitioner testified that the passenger figures listed for the various daytime public tours and sunset cruises are incorrect as to the actual number of passengers on such tours or cruises, and further indicated that a number for passengers may be listed on his Receipts Book(s) for a particular public tour or cruise which did not in fact occur. 19 While acknowledging that his Receipts Books are inaccurate as to the number of passengers listed for the particular public tour, 20 petitioner steadfastly maintained that they are accurate as to the total amounts of receipts treated as walk-on passenger fares for public tours, as well as the other categories of receipts listed on the monthly summaries. 214 Once petitioner had entered the amount of receipts for a particular month in his Receipts Books, he threw away all documentation which had been in the bag(s) purportedly attributable to that month and which reflected the amount of gross receipts contained therein. Any cash register tapes or other notations of the amount of snack bar sales found in the bags, as well as the bags themselves, were thrown out. Any slips of paper noting the head count for a particular tour which may have found their way into the bag(s) and any slips of paper recording the amount of withdrawals from the gross receipts bag(s) for refunds or payment of expenses were likewise thrown away. Thereafter, petitioner claims to have relied solely on his Receipts Book as the record of the amount of gross receipts from the various sources. At the back of each of the Receipts Books introduced into evidence herein is a page listing the yearly totals by category for the various categories of income petitioner utilized in preparing his monthly summary pages. Petitioner indicated at trial that such a yearly summary was prepared each year subsequent to the preparation of the monthly summaries. These yearly summaries215 in the Receipts Books indicate that petitioner had the following gross receipts from the listed categories during the years in issue as follows: 1972197319741975Snacks:$ 9,555.90$11,464.15$14,054.73$ 18,527.82Adults:23,970.0029,124.0033,277.5048,770.00Child:3,777.001,708.001,661.002,129.00School:8,664.007,664.009,908.6011,352.50Moonlight:3,975.506,250.507,618.5011,117.58Sunset:9,132.0011,556.0012,417.0023,204.00Dock Rental:2,190.00Total$59,074.40$67,766.65$78,937.33$117,290.90The total for taxable year 1972 was then reduced by the sum of $184.50 to reflect a discount apparently given a customer, leaving total gross receipts for taxable year 1972 in the amount of $58,889.90. The total amount of gross receipts listed above and reported on the yearly summary page of petitioner's Receipts Books for taxable years 1972, 1973, 1974, and 1975, respectively, (after adjusting the total figure for taxable year 1975 to reflect "dock rental fees" reported in the Receipts Book for that year and discussed in more detail hereinafter) reconcile with the amount of gross receipts from216 the tour business petitioner reported on the Schedule C's attached to his income tax returns for such years. In other words, the amount of gross receipts reported on petitioner's Schedule C for the tour boat business each year is the same as the yearly summary from the Receipts Book for that year, which is the total of the monthly summaries in that book, which in turn is the total of the daily entries in that book. Other Records MaintainedAs noted earlier, in addition to the Receipts Book, petitioner also maintained, as part of his business records for each taxable year, a book he called a Cash Disbursements Journal which was used to record all the expenses petitioner paid by check during such year, whether personal or business related. Copies of petitioner's Cash Disbursements Journals for taxable years 1972, 1973, and 1974 21 have been introduced into evidence herein. Those Cash Disbursements Journals are very detailed and complete, breaking each taxable year down on a monthly basis and containing a numerical listing of all checks written during a particular month, along with the date, payee, and amount of each check. At a separate point, the checks for each month are217 then assigned to one of several accounts listed in the journal, depending upon the nature of the particular expense or whether for business or personal purposes. In August of 1974, petitioner met with James E. Wharton concerning the possible sale of his tour boat business to Wharton. Also present at this meeting was Wharton's son and Grant Ballard, a certified public accountant representing Wharton in the sales negotiations. During the course of the meeting the parties discussed the manner in which petitioner ran the business, inquiring into the income and expenses of the business over the last three years. In response to Ballard's questions, petitioner provided him with information purportedly representing his income from the tour business for taxable years 1971, 1972, 1973 and the portion of 1974 up to the date of the meeting, as well as his expense figures218 for the tour business' 1971, 1972, and 1973 taxable years, the expense figures for taxable year 1974 having not yet been completed. Petitioner presented four notebooks to Ballard, 22 a separate notebook for each year, each of which contained a separate page in the back thereof entitled "Summary." Listed on the Summary sheet for each year was a figure representing the gross receipts and expenses for that year with some breakdown thereof into its component parts, as well as a more detailed listing of the various expenses incurred in petitioner's tour business for taxable years 1972 and 1973. Ballard did not examine the notebooks closely -- other than flipping through the pages thereof to be sure there was in fact information listed on the pages of the book -- nor in any manner attempt to verify the figures listed on the Summary sheets, but merely copied these figures onto a separate sheet of paper, a copy of which was introduced into evidence herein. 23 These Summary sheets indicate that petitioner's tour business had gross receipts in the amounts of $103,253, $110,379, and $116,090 for taxable years 1972, 1973, and 1974, respectively. 219 At the time he copied the information listed on the Summary pages, Ballard also requested to see petitioner's tax returns for the taxable years 1972 and 1973, the return for taxable year 1974 having not yet been prepared. Petitioner initially responded that it would do no good to compare his returns with the Summary pages, indicating that they would not reconcile with each other. Ballard again requested the returns, which petitioner then furnished for his inspection. Ballard perused only the Schedule C attached to the return for each year, and did not copy any information therefrom. 24220 The Schedule C's attached to petitioner's 1972 and 1973 returns (in conformity with the Receipts Books for those years introduced into evidence herein) reported gross receipts for such years in the amounts of $58,889.90 and $67,766.65, respectively; the Summary pages indicated petitioner's gross receipts for such years to be $103,253 and $110,379, respectively. The expense figures listed on the Summary pages for 1972 and 1973 exactly matched (with the exception of depreciation) all of the expense deductions claimed on the Schedule C's attached to petitioner's 1972 and 1973 returns. Ballard commented, after inspecting such Schedule C's, that they did not reconcile with the Summary pages for those years, but he neither sought nor received a further explanation thereof from petitioner. 25221 An investigation into petitioner's tax liabilities for taxable years 1972, 1973, and 1974 26 was commenced following information received by the Internal Revenue Service from a third party on July 15, 1975. This third party provided respondent's agents with purported gross receipts figures of petitioner's tour business for the taxable years 1972, 1973, and up to August of 1974. These figures were obtained from notations and schedules that had been prepared from the Summary sheets petitioner had furnished to Ballard in connection with the purchase negotiations concerning the tour business in August of 1974. These gross receipts figures were substantially in excess of those reported by petitioner on the Schedule C's attached to his returns for such years. The investigation undertaken was a joint investigation of petitioner's potential criminal and/or civil liabilities for those years; the criminal investigation conducted by Special Agent Robert E. Burgess (Agent Burgess), the civil investigation conducted by Revenue Agent Tom Brown. At trial, Agent Burgess testified at great length about the details and results of his criminal investigation; Revenue Agent Brown did not testify. 222 Agent Burgess' first contact with petitioner occurred on the morning of April 20, 1976. A special agent named Mike Dunlow, who did not testify herein, was also present at this meeting. As his investigation was to be criminal in nature, Burgess identified himself as a special agent and informed petitioner of his constitutional rights, which petitioner indicated he understood. Burgess also informed petitioner of his duties as a special agent. 27Prior to this initial meeting, 223 Agent Burgess had obtained and reviewed copies of petitioner's 1972 return and the original returns filed for 1973 and 1974. Agent Burgess showed petitioner copies of these returns which petitioner identified. Petitioner indicated that he had prepared these returns himself without assistance and that they reported all of his income during those years. With the aid of a form outline commonly used when interviewing taxpayers, Agent Burgess then went over these returns with petitioner line by line. With regard to the Schedule C's attached to these returns, petitioner gave Agent Burgess a brief explanation of the operation of the tour boat business and the method used to report the income therefrom. Specifically, Agent Burgess testified that petitioner told him a notation was made on a piece of paper as to how much money was collected, which was turned over to petitioner at the end of each day and recorded in the gross receipts book, after which the piece of paper was thrown away. Petitioner acknowledged that the money was not all deposited in his bank account, instead being kept at petitioner's home or on his person. Agent Burgess asked petitioner about his bank accounts, to which224 petitioner responded that he had one checking account in the name of Harbor Tours which was used for both business and personal purposes. Petitioner further stated that he had no savings accounts, but did have some savings certificates and gave Agent Burgess the names of those institutions. 28Agent Burgess also asked petitioner about safety deposit boxes, to which petitioner responded that he had a safety deposit box in his name at the Bank of Virginia. Agent Burgess did not question petitioner as to the225 contents of this safety deposit box. Petitioner did not mention any other safety deposit boxes. Specifically, petitioner failed to disclose the existence of the two additional safety deposit boxes he maintained in his own name during the years in issue. Also, at no time during this initial interview did petitioner mention anything about his alleged system of bookkeeping utilizing the various "bags" filled with money as discussed above. Agent Burgess also asked petitioner about the amount of cash on hand, to which petitioner originally replied that "a working man doesn't accumulate cash." In an attempt to get a dollar figure, Agent Burgess asked petitioner if he could have accumulated as much as $1,000, to which petitioner responded affirmatively; Agent Burgess then asked petitioner if it could have been as much as $2,000, to which petitioner once again responded affirmatively. At the conclusion of this initial meeting, Agent Burgess made arrangements to pick up any records petitioner had pertaining to taxable years 1972, 1973, and 1974 and did so at a second meeting later in the afternoon of the same day. This second meeting lasted approximately 20 minutes and took place at226 the dock from which petitioner operated his tour business. Petitioner provided Agent Burgess with three metal boxes which contained petitioner's Receipts Books, Journals, and Ledgers referred to above, and which together comprised all of the records petitioner ever furnished respondent for taxable years 1972, 1973, and 1974. 29 There were no invoices, reservation confirmation sheets, or contracts or any documents of this nature used in the tour business in any of the three boxes petitioner gave to Agent Burgess during this second meeting on April 20, 1976, nor were any documents of this type supplied to Agent Burgess at anytime during his investigation. 30227 Petitioner took one of the Receipts Books from the metal boxes, opened it on the trunk of his car, and gave Agent Burgess a brief explanation of the information listed therein. Petitioner told Agent Burgess that each day's business was recorded separately in the Receipts Book(s), each page representing a particular day's business. Petitioner then explained that each page was further broken down by the nature of the particular receipts in question, showing Agent Burgess examples of how snack bar sales, school cruises, moonlight cruises, and public tours were reported in the Receipts Book. Petitioner told Agent Burgess that public cruises (including sunset cruises) were listed as a head count of the number of people boarding the boat, broken down into adult and children passengers, then further broken down by the port from which boarded, again showing Agent Burgess an example in the Receipts Book. In all, petitioner flipped through several different pages in the Receipts Book explaining how various items were reported therein. Petitioner made no other comments to Agent Burgess at this time concerning how his gross receipts were kept. 31 No mention of any system of record keeping228 involving "bags" filled with receipts from the tour business was mentioned, nor did petitioner indicate that a substantial period of time passed between the collection of gross receipts in his tour business and the recording thereof on the Receipts Books. 229 Petitioner also gave a brief explanation of the other books (Cash Disbursements Journal, General Journal, and General Ledger) contained in the metal boxes, but only to indicate in general what the books were and their purpose. Petitioner did not open these books to show any examples of the items listed therein. However, the issues in this case involve primarily the gross receipts and not the expense items. Following the meeting with petitioner on April 20, 1976, Agent Burgess began an extensive investigation into petitioner's financial affairs and the operation of the tour boat business to determine whether petitioner's Receipts Books for taxable years 1972, 1973, and 1974, 32 which reconciled with the original returns filed for those years, accurately reported petitioner's income for those years. A summons was served upon the Bank of Virginia to obtain the records of the checking account petitioner maintained there during the years in issue. Copies of deposit slips, checks drawn on the account, and customer checks collected through the account were obtained, providing additional information as to customers of petitioner's tour business during those years. A letter was sent230 to area schools. Contact was made with and documents such as cancelled checks, invoices, and reservation confirmations were obtained from schools and organizations listed by name in petitioner's Receipts Books for 1973 and 1974. From these contacts, Agent Burgess also learned of other schools and organizations which had been customers of petitioner's tour boat business during taxable years 1973 and 1974. These other schools and organizations were then subsequently contacted and similar documents obtained from them. In all, at least 100 former customers were contacted in connection with Agent Burgess' investigation for those years. During the course of his investigation, Agent Burgess also contacted several of petitioner's employees and other persons associated with the tour boat business in an attempt to learn more about the operations thereof. These persons included Jordan, Furbee, petitioner's son, and Gayle McDowell, one of petitioner's daughters. From his interviews with these people, Agent Burgess first learned of the brown paper bags used in the collection of the gross231 receipts from the tour boat business. None of these individuals had any personal knowledge or information about the recording of such receipts into petitioner's Receipts Books. In an attempt to corroborate the items listed in the 1973 and 1974 Receipts Books, Agent Burgess prepared a schedule therefrom listing all the private tours 33 reported in the Receipts Book. He then compared this schedule to the third-party documents he had obtained from the schools and tour groups. As a result of this comparison, Agent Burgess uncovered the following items which the parties have now stipulated cannot be found reported "as such" -- that is, as a school tour or as a private tour -- in petitioner's Receipts Books for 1973 and 1974: 341973AmountIdentifiedAmountNameDateAmount PaidAs ReportedUnidentifiedVirginia District N.Y.P.S.None$ 50.000$ 50.00Chamberlayne Elementary School5/11/73$140.000$ 140.00Grand Commandery Committee of5/11/73$200.000$ 200.00the Knights Templar of Va.Dr. Israel Brown AZA/Kruger BBG5/12/73$305.000$ 305.00Norfolk Elks Lodge #385/20/73$600.00$310.00$ 290.00Friends School5/21/73$109.80$ 48.85$ 60.95Madison County High School5/25/73$134.000$ 134.00Employees Welfare and Recreation5/26/73$464.00$358.80$ 105.20Assoc.-Navy Regional Finance(Sales taxCenterNot included)Stanwick Employees Fund-6/2/73$449.00$360.85$ 88.15Stanwick Corporation(Sales taxNot included)Hebrew Academy of Tidewater6/14/73$ 83.000$ 83.00Mrs. Connie Beukema's Group6/23/73$120.00$ 69.00$ 51.00Club Managers Association of6/25/73$228.00$ 28.60$ 199.40America-Tidewater Chapter(Sales taxNot included)Harry's Ship-Stores7/16/73$482.64$309.20$ 173.44Reid School7/23/73$112.000$ 112.00Duplex Club9/73$225.000$ 225.00Awards Board of Norfolk9/15/73$150.000$ 150.00Naval Supply Center9/20/73$190.000$ 190.00Employees ActivitiesAssociationNorfolk Naval Shipyard9/22/73$234.000$ 234.00Officers Wives ClubMutual Federal Savings & Loan9/23/73$537.00$324.80$ 212.20Association of Norfolk(Sales taxNot included)Auxiliary to the Norfolk9/26/73$337.500$ 337.50General Hospital Division ofMedical Center HospitalsAllied Officers Armed Forces9/27/73$199.75$ 24.75$ 175.00Staff CollegeDelta Gamma Chapter of Kappa9/30/73$190.000$ 190.00Alpha OrderTOTAL AMOUNT UNIDENTIFIED$3,705.84232 1974AmountIdentifiedAmountNameDateAmount PaidAs ReportedUnidentifiedDr. Israel Brown AZANone$ 50.000$ 50.00Needlework Guild of Norfolk4/23/74$252.000$ 252.00Churchland Baptist Church4/24/74$106.250$ 106.25KindergartenStuart School5/6/74$112.500$ 112.50Larrymore Elementary School5/7/74$122.50$ 10.00$ 112.50The York Club of Trinity5/16/74$225.000$ 225.00Episcopal ChurchArmed Forces Staff College5/17/74$225.000$ 225.00Seminar 7, Class 55Peat, Marwick, Mitchell & Co.5/18/74$413.000$ 413.00Crossroads Elementary School5/20/74$223.75$120.00$ 103.75First Baptist Church Youth5/22/74$225.000$ 225.00GroupAesop Schools, Inc.5/23/74$ 68.750$ 68.75St. James Episcopal Church5/25/74$335.000$ 335.00Mens ClubArrowhead Elementary School5/29/74$183.75$108.75$ 75.00Point O'View Elementary School5/30/74$ 62.500$ 62.50Armed Forces Staff College5/31/74$225.000$ 225.00SeminarNewtown Road Elementary School6/4/74$ 67.50$ 7.50$ 60.00Trinity Lutheran Church School6/6/74$ 97.500$ 97.50Bugs Club6/6/74$335.00$ 54.85$ 280.15John E. Krome's Party6/7/74$288.85$115.70$ 173.15Frederick Travel Club, Inc.6/9/74$197.00$ 15.80$ 181.20(Sales taxNot included)Welfare & Recreation Assoc.6/9/74$270.000$ 270.00Naval Supply CenterParkview Baptist Church7/1/74$456.000$ 456.00Portsmouth Recreation Dept.7/30/74$223.75$122.50$ 101.25Courts of Calanthe 2879/7/74$245.000$ 245.00(The Gay Mardnetts)Virginia Beach Pests9/20/74$371.000$ 371.00Door Engineering Corporation9/21/74$257.70$ 32.70$ 225.00Auxiliary to the Norfolk General9/25/74$276.000$ 276.00Hospital Division of the MedicalCenter HospitalsFaculty Wives Club of Tidewater9/27/74$225.000$ 225.00Community CollegeLiberty Spring Sunday School9/29/74$442.54$ 15.85$ 426.69Belk Leggett Advertising10/1/74$505.75$448.20$ 57.55Display Assoc.(Sales taxNot included)Chowan 4-H Club10/4/74$273.000$ 273.00Central Christian Academy10/5/74$175.000$ 175.00Delta Gamma Chapter of10/6/74$315.00$225.00$ 90.00Kappa Alpha OrderTOTAL AMOUNT UNIDENTIFIED$6,574.74233 The parties have stipulated that all of the above tours in fact occurred and occurred on the date listed. Based on the above information, Agent Burgess determined that petitioner had underreported his receipts from the tour boat business for taxable years 1973 and 1974 in the amounts of $3,705.84 and $6,574.74, respectively. With regard to the taxable year 1972, Agent Burgess interviewed Haddock and obtained from her the copies of the reservation sheets she prepared during that year and which have been introduced into evidence herein. In discussing the preparation of such reservation sheets, Haddock indicated to Agent Burgess that scheduled tours often rescheduled their trip for another day, sometimes234 cancelling the trip altogether. She had no personal knowledge or information as to which tours had in fact been cancelled. Other than those reservation sheets, Agent Burgess obtained no third-party documentation from former customers pertaining to taxable year 1972. In other words, for 1972 Agent Burgess did not obtain any cancelled checks, invoices, or confirmation sheets from customers. Utilizing only those reservation sheets for which there were no corresponding entries in petitioner's 1972 Receipts Book and which had not been marked as cancelled on the face thereof, Agent Burgess made a determination that petitioner had underreported the gross receipts from the tour boat business in the amount of $6,112.50 for taxable year 1972. 35235 At the time he determined the above stated amounts of unreported gross receipts from the tour boat business with respect to taxable years 1972, 1973, and 1974, Agent Burgess was in possession of the purported gross receipts figures which petitioner had given to Ballard during the August 1974 purchase negotiations. While he indicated that such figures were used in his investigation, Agent Burgess did not utilize those purported gross receipts figures in computing the amounts of unreported gross receipts he determined to exist for those years. He indicated that his failure to do so was based on the fact that he had not actually seen the records which Ballard had been given by petitioner. 36236 As a result of Agent Burgess' investigation and apparently with respect to the specific items of gross receipts set out above which could not be identified as reported in petitioner's Receipts Books for taxable years 1973 and 1974, petitioner was subsequently indicted and tried on two counts of having violated section 7206(1) by reason of having understated the gross receipts of the tour boat business on his 1973 and 1974 income tax returns. In an unreported criminal case 37 decided August 15, 1979, petitioner, who did not testify in his criminal trial, was acquitted of both counts. 38237 Following his acquittal in the criminal case, petitioner's civil income tax file was returned to the Examination Division of the Internal Revenue Service for evaluation. Based on the information obtained during the criminal investigation, a decision 39 was made to proceed civilly against petitioner. However, in the civil tax proceeding, respondent did not limit the deficiencies to the specific items of unreported income determined by Agent Burgess. This resulted in the notice of deficiency herein pertaining to petitioner's 1972, 1973, 1974, and 1975 taxable years. With respect to taxable years 1972, 1973, and 1974, adjustments were made to the gross receipts figures for the tour boat business reported on petitioner's income tax returns for such years to reflect the higher figures that petitioner had given to Ballard in August of 1974. This resulted in increases over the gross receipts figures reported on petitioner's 1972, 1973, and 1974 returns in the amounts of $44,363.10, $42,612.35, and $37,152.67, respectively. 238 With respect to taxable year 1975, respondent simply increased the gross receipts figure reported on petitioner's 1975 return, $117,292, by 61.76 percent, the average percentage by which respondent had determined the gross receipts of the three preceding taxable years had been underreported. 40Dividends, Dock Rental Fees, Reimbursed Business ExpensesIn addition to the gross receipts from the tour boat business, respondent also determined petitioner failed to report as income amounts received as dividends, dock rentals, and reimbursed business expenses. Petitioner has stipulated that during the taxable years in issue he derived income from dividends, dock rental fees, and reimbursed business expenses as follows: DividendsPayor1972197319741975International Harvester$ 63.00$ 67.50$ 72.02$ 76.52Niagara Mohawk Power1.6749.32113.22Corp.Colonial Income Fund80.3281.5579.2973.84U.S. Life Funds164.01190.9119.00192.00Virginia Electric and Power Company236.00$309.00$389.28$170.31$691.58239 Dock Rental FeesPayor1972197319741975E. J. Fleming$ 90$450$ 180$ 360.00Corrine B. Dorsey105225450.00Carlton J. Wilkins300480400.00Peter H. Kamenik7525.00Carol B. Starck50Richard P. Moraski200325.00Lawrence A. McDowell 2940.00John F. Coffey75.00Charles B. Herter, Jr. * 1,701.30John Creecy100.00Joseph Moraski250.00Jacob W. James, Sr.175.00Robert L. Old250.00Total$195$975$1,014$4,151.30Reimbursed Business ExpensesPayor19731974Colorcraft Corporation$170.52$224.30C & P Telephone Company17.817.77Total$188.33$232.07In his notice of deficiency, respondent has also determined that during the taxable year 1974 petitioner received additional income from Furbee in the form of reimbursed business expenses in the amount of $47.94. Other than certain hearsay statements elicited at trial concerning statements Furbee made to Agent Burgess, no evidence with respect to this particular item has been introduced herein. 240 None of petitioner's Receipts Books for any of the taxable years in issue contain any separate listing for any amount of the dividends or reimbursed business expenses which petitioner has stipulated he received during those years. Nor do petitioner's Receipts Books for taxable years 1972, 1973, and 1974, respectively, contain any separate listing for any amount of the dock rental fees which petitioner has stipulated he received during those years. Petitioner's Receipts Book for taxable year 1975 does contain a separate listing in the monthly totals for dock rentals, reporting the following amount of dock rentals during that year: MonthDock RentalsMay$ 750JuneJulyAugustSeptember1,440Total$2,190A notation on both the first page of the Receipts Book and on the page containing the monthly summary for May indicates that the $750 entered for that month represents dock rentals collected in 1974 but omitted from the Receipts Book for that year. 41 Except for dividends in the amount of $192 received from U.S. Life during 1975 reported on his 1975 return and dividends in the amount of $187.31 from an undisclosed source reported on his 1974 return, 241 42 petitioner's returns for those years do not list any other amounts of income from dividends "as such." With regard to rental income, petitioner's 1972, 1973, 1974, and 1975 returns report gross rental income in the amounts of $6,150, $6,000, $6,100, and $6,600, respectively, attributable to the rental of two cinder block buildings located in Portsmouth, Virginia. The returns for those years do not report any amounts of income from dock rental fees "as such." Nor do such returns report any amounts of income from reimbursed business expenses "as such." 242 During the initial interview with Agent Burgess on the morning of April 20, 1976, petitioner either lied to him or told him half-truths. Petitioner, in response to questions concerning ownership of stocks and bonds, stated that he did not own any. Petitioner owned stocks. The subject of rental income was also discussed during this initial meeting. Agent Burgess and petitioner went over the Schedule E's attached to petitioner's 1972, 1973, and 1974 taxable years' returns, petitioner stating that he had no other rental income for such years other than the amounts reported and attributable to the two cinder block buildings. Specifically, petitioner did not mention anything about dock rentals to Agent Burgess. 43243 During the course of the second meeting on April 20, 1976, Agent Burgess noticed several boats docked at petitioner's pier near the waterfront and asked him about these boats. In response, petitioner stated that "you know how people are, they're always bringing derelicts in on top of you." Petitioner did not tell Agent Burgess at that time that he received dock rental fees with regard to such "derelicts." On May 24, 1976, Agent Burgess again met with petitioner 44 at the office of Willard Moody, the attorney who was then representing petitioner. Agent Burgess asked petitioner about stock ownership, to which petitioner replied that he could not remember what stock he owned. Agent Burgess indicated to petitioner that he could not find certain dividend income listed which petitioner had received, to which petitioner replied that such amounts were in his "books," meaning the Receipts Books. Agent Burgess then informed petitioner that he had examined the Receipts Books and could not find any dividends reported therein, and asked petitioner to show him where they were reported. Petitioner replied by stating that he did not know where they were either, but knew they were in the "books. 244 " At trial petitioner reiterated this claim, extending its coverage to include not only the dividends which he has now stipulated he received, but also to include the dock rental fees and reimbursed business expenses he has likewise stipulated he received. Petitioner testified that all of the above-listed amounts of dividends, dock rental fees, and refunds of business expenses were considered by him to represent income attributable to the Harbor Tour business and were treated the same way as any other gross receipts from that business, that is, they were placed in the bags and commingled with the gross receipts from passenger fares. Jordan partially corroborated petitioner's testimony in regard to dock rentals, testifying that from time to time he (Jordan) collected cash or checks for dock rentals which were placed in the bag with the gross receipts from passenger fares. 45Jordan, however, had no personal knowledge or information as to what happened to the cash or checks for245 dock rentals once they came into petitioner's possession. Jordan specifically had no personal knowledge or information about the entries in petitioner's Receipts Books. With respect to the amounts of dock rental fees separately listed as such in petitioner's 1975 Receipts Book (and reflected in the total gross receipts reported on petitioner's 1975 Schedule C), petitioner stated that he first started keeping records of the amount of dock rental fees received in the latter part of 1974, departing from his earlier practice of simply placing them in the bag. Petitioner stated that he kept a small notebook246 in his pocket on which he recorded the amount of dock rental fees paid to him personally, but indicated that such record was still incomplete, since any dock rentals collected by other persons on the boat would still have gone into the bag with the gross receipts, no record thereof being made. With respect to taxable year 1975, petitioner stated that he began keeping a record of the rentals which he considered "permanent" -- lasting more than two to three months in duration -- recording the amount thereof in his notebook by the name of the lessee. Petitioner indicated he had brought such records to the trial pursuant to a Government subpoena, but they were not offered or received in evidence herein. Petitioner again stated that amounts received by other persons on the boat would have been placed into the receipts bag without being entered in his notebook, acknowledging that there were amounts collected as dock rentals which were not listed as such in his 1975 Receipts Book. Petitioner claimed that such amounts were nevertheless recorded therein as passenger fares, thus being reflected in the gross receipts figures reported on his tax returns. Interest Incomea. The Loan247 Transaction During the initial meeting with petitioner on April 20, 1976, Agent Burgess also asked petitioner about any loans he may have received or made to someone else. Petitioner indicated he had no loans payable, expressing his opinion that if you borrowed money from the bank, the bank then owned you. When asked if he had ever loaned anyone any money, petitioner stated that from time to time he loaned small amounts of money to the boys who worked on the boat, deducting it from their pay at the end of the week. Other than such advances, petitioner did not disclose the existence of any other loans he might have made to anyone else. 46Agent Burgess subsequently discovered, and petitioner now acknowledges, that he had in fact loaned $20,000 to his brother, Lawrence H. McDowell (Lawrence), on May 20, 1974. 47248 Lawrence did not appear or testify at trial, the evidence offered concerning the loan consisting almost entirely of petitioner's testimony thereon. 48 Petitioner claimed the loan was a "hand shake" deal, intended to be interest-free. Lawrence understood otherwise. See n. 48, supra. However, petitioner acknowledged that he and his brother orally provided for the payment of eight percent interest on the unpaid balance thereof, petitioner indicating the interest provision was to act only as a "safeguard" in case something happened to Lawrence, not intended to be enforced. 249 Monthly payments in the approximate amount of $206 each were thereafter received on the loan, petitioner indicating that Lawrence had established the amount of the monthly payments. Petitioner denied that any of the monthly payments received during the years in issue contained any interest increment, stating that he regarded all such amounts to be repayment of principal. 49 Petitioner indicated he had maintained a contemporaneous record of such payments which would reflect his claimed treatment thereof. Although he apparently had such a record in his possession while testifying, it was not offered into evidence, and his testimony in that regard was extremely vague. Neither of petitioner's250 tax returns for taxable years 1974 or 1975 reports any amount of interest income from this loan. In his notice of deficiency pertaining to those years, respondent determined that petitioner received interest income from the loan to his brother during taxable years 1974 and 1975 in the amounts of $660.80 and $1,536.00, respectively. b. Sale of the HouseDuring the late 1960's, petitioner sold a house located in Portsmouth, Virginia (the Portsmouth house) to his son, Walter M. McDowell, Jr. The sale was seller financed by petitioner, with a total purchase price of $9,500, payable in monthly increments of $65. The $65 monthly payment included interest on the unpaid balance, but petitioner's son could not recall the exact percentage. Petitioner's son also paid the property taxes on the house. During the early 1970's the house was returned to petitioner in return for a full refund of the amounts paid on the purchase price, including the interest paid. In January of 1972, petitioner's son repurchased the house. This purchase was likewise seller financed by petitioner, the total contract price once again $9,500. A written contract of sale was executed calling for a $600 down251 payment with monthly payments thereafter in the amount of at least $100 each, with five percent interest on the unpaid balance. The agreement also provided that petitioner's son was to pay all property tax. At trial both petitioner and his son testified that, contrary to the express terms of their written contract of sale, the transaction was intended to be interest-free. Petitioner's son speculated that the contract provided for interest to avoid "problems" in case anything happened to himself or petitioner. However, petitioner's son acknowledged that he had nevertheless claimed interest deductions on his own tax returns with respect to the purchase of the house. Petitioner's son sold the house to a third party in 1977, using the sale proceeds to discharge the outstanding balance owing to petitioner. The payment record maintained by petitioner indicates that between the purchase in 1972 and the sale to a third party in 1977, petitioner received payments from his son with respect to the house totaling $10,460, charged on petitioner's payment record as follows: YearAmount PaidPrincipalProperty Tax19721 $ 1,610$1,415.12$194.8819731,050896.55153.4519741,3001,109.02190.9819751,3001,071.48228.521976900671.48228.5219774,3004,300.00Total2 $10,460$9,463.65$996.35252 Petitioner's payment record does not list any amount received from his son with respect to the sale of the house as interest. Petitioner's 1972, 1973, 1974, and 1975 tax returns also report no interest income from the sale of the Portsmouth house. In the notice of deficiency, respondent determined that petitioner had in fact realized interest income from such transaction in the amount of $244.20 with respect to each of his 1972, 1973, 1974, and 1975 taxable years. Additional Business Expenses Claimed by Petitioner for 1972During the taxable years in issue, petitioner purchased film from a company known as Consolidated, such film then being sold to the public from the snack bar on petitioner's tour boat. The parties have introduced into evidence two separate checks drawn on petitioner's bank account during June of 1972 and the matching invoices therefor, both checks payable to Consolidated and in the respective amounts of $291.26253 and $202.96. In petitioner's books of account, these two payments were charged to account number 390, which was petitioner's personal drawing account. These payments were not charged to account number 242, which was reserved for expenses attributable to "stock on boat," nor to any other account used to record expenses of petitioner's tour boat business. These payments were thus not listed as expenses or cost of goods sold on petitioner's books and records nor, consequently, on his 1972 tax return. During the years in issue, petitioner also purchased supplies from Coca-Cola Bottling Works, Inc. of Norfolk, Virginia (Coca-Cola) for resale to passengers from the snack bar. The parties have introduced into evidence a copy of a statement from Coca-Cola which indicates that a payment in the amount of $724.90 was made on petitioner's account during September of 1972. This payment likewise was not charged to account number 242, "stock on boat," nor to any other account used to record expenses attributable to petitioner's tour business. This payment was thus also not listed as any form of expense or cost of goods sold on petitioner's books and records nor, consequently, on his 1972 tax254 return. 50Travel and Entertainment ExpensePetitioner has also introduced copies of checks drawn on petitioner's checking account at the Bank of Virginia during taxable year 1972 as follows: Check No.PayeeAmount2726C.W. Visitor Services$ 15.002954Doug Owens Band90.002971Greek Lines1,277.502983Greek Lines150.00Total$1,532.50In addition, petitioner has introduced copies of miscellaneous receipts and records with various dates in 1972 reflecting amounts totaling $522.70 which were paid or reimbursed through the petty cash account (referred to hereinafter as the petty cash expenditure) of petitioner's books255 maintained for the tour business. The two checks payable to Greek Lines, totaling $1,427.50, represent fares for a cruise from Norfolk, Virginia to the Bahamas during 1972. This cruise was taken by petitioner, Furbee, petitioner's two daughters, Jordan, and another employee named Mark Johnson. At trial, petitioner introduced into evidence a one-page document written on the letterhead of the tour business and allegedly related to this cruise. The document lists the individual passenger fares for petitioner's two daughters, Jordan, and Johnson, stating the total of the passenger fares to be $963.50. 51 At the bottom of the document is a handwritten notation "For a job well done." Jordan, under questioning by petitioner's counsel at trial, could not recall whether there was any specific purpose or reason for the trip, and could not remember whether petitioner had ever told him the purpose of the trip. No other evidence pertaining to this trip was introduced. 256 The $90 check to the Doug Owens Band was for musical entertainment. No other evidence pertaining to this expenditure was introduced. No evidence was introduced as to the $15 check to C. W. Visitor Services. With respect to the petty cash expenditures, the receipts and records introduced with respect thereto indicate that the majority of such expenditures represent motel bills, the remainder consisting of expenditures for mileage or meals. Only a few of the receipts or records contain a notation as to the alleged purpose of the expenditure. Other than the receipts or records themselves, no other evidence was introduced as to the petty cash expenditures. The $15 check to C. W. Visitor Services, the $90 check to Doug Owens Band, $963.50 of the $1,277.50 check to Greek Lines, and the $522.70 petty cash expenditures were all charged to account number 72, "Travel and Entertainment" at certain points in petitioner's books and records, but it is not clear whether such treatment was uniform throughout. The $150 check to Greek Lines and the remaining $314 of the $1,277.50 check thereto were charged to account number 390 in the Cash Disbursements Journal, petitioner's personal drawing257 account. On his 1972 tax return, petitioner claimed travel and entertainment expenses in the amount of $820.40. There is no breakdown of the component parts of this total listed on petitioner's return. In the notice of deficiency pertaining to taxable year 1972, respondent disallowed $730.63 of the claimed deduction, allowing the remaining amount claimed, $89.77. Petitioner now contends that all of the expenditures set out above represent deductible travel and entertainment expenses. Income AveragingOn his 1977 tax return, petitioner elected income averaging, listing as taxable income for his base period years 1973, 1974, and 1975 the amounts of taxable income reported on the tax returns filed for those years. In his notice of deficiency pertaining to taxable year 1977, respondent utilized the higher taxable income figures for such years arising from the various adjustments proposed for those years and contained in the statutory notice of deficiency issued with respect to taxable years 1972, 1973, 1974, and 1975. As a result, respondent determined petitioner was ineligible for income averaging for taxable year 1977 as his taxable income for that year did not exceed258 120 percent of his average base period income within the meaning of section 1302. This adjustment is purely computational and will depend on our decision herein as to petitioner's correct taxable income for taxable years 1973, 1974, and 1975. ULTIMATE FINDINGS OF FACT 1. For the taxable years 1972 and 1975, without regard to any intent to evade tax, respondent failed to prove by clear and convincing evidence any underpayment of tax for either year. Consequently, those years are barred by the statute of limitations. 2. For the taxable years 1973 and 1974, petitioner failed to report gross receipts from his tour boat business in the amounts of at least $3,705.84 and $6,574.74, respectively, thereby understating his income by those amounts, and those understatements of income resulted in an underpayment of tax for each year. 3. For the taxable year 1973, petitioner also failed to report income in the form of dividends of $389.28, dock rental fees of $975, reimbursed business expense of $188.33, and interest of $244.20, which understatements of income resulted in an underpayment of tax for that year. 4. For the taxable year 1974, petitioner also failed to report income259 in the form of dock rental fees of $1,014, reimbursed business expenses of $232.07, and interest of $905, which understatements of income resulted in an underpayment of tax for that year. 5. All or part of the underpayments of tax for 1973 and 1974 were due to fraud on the part of petitioner. OPINION Normally, the taxpayer has the burden of showing that respondent's deficiency determinations are incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Respondent, however, has the burden of establishing by clear and convincing evidence the elements of the fraud for the section 6653(b) addition. Sec. 7454; Rule 142(b); Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 220 (1971). I Statute of LimitationsWhere the normal three-year statute of limitations (sec. 6501(a)) has run, then respondent must prove that the taxpayer's returns were false or fraudulent with the intent to evade tax so that the tax may be assessed "at any time" under section 6501(c)(1). 260 The elements of the fraud under section 6501(c)(1) for limitations purposes are essentially the same as the elements of the fraud under section 6653(b) for the 50 percent civil fraud addition for any "underpayment" of tax "due to fraud." Tomlinson v. Lefkowitz,334 F.2d 262">334 F.2d 262 (5th Cir. 1964), cert. denied 379 U.S. 962">379 U.S. 962 (1965); Estate of Temple v. Commissioner,67 T.C. 143">67 T.C. 143, 159-160 (1976); McGee v. Commissioner,61 T.C. 249">61 T.C. 249, 256-257, 261 (1973), affd. 519 F.2d 1121">519 F.2d 1121 (5th Cir. 1975); Amos v. Commissioner,43 T.C. 50">43 T.C. 50, 55 (1964), affd. 360 F.2d 358">360 F.2d 358 (4th Cir. 1965). In the present case, the normal three-year period for assessment of deficiencies expired before respondent issued his statutory notice of deficiency. Absent a showing of fraud, each of the years 1972 through 1975 is barred by the statute of limitations. Fraud is a question of fact to be determined on the basis of the entire record. 261 Mensik v. Commissioner,328 F.2d 147">328 F.2d 147, 150 (7th Cir. 1964), affg. 37 T.C. 703">37 T.C. 703 (1962), cert. denied 389 U.S. 912">389 U.S. 912 (1967). Respondent must establish each element of the fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b). The elements to be shown are (1) an underpayment of tax, and (2) that some part of this underpayment was due to fraud. Hebrank v. Commissioner,81 T.C. 640">81 T.C. 640, 642 (1983). Respondent need not prove the precise amount of underpayment resulting from fraud, but only that there is some underpayment and that some part of the underpayment is due to fraud. Plunkett v. Commissioner,465 F.2d 299">465 F.2d 299, 303 (7th Cir. 1972), affg. a Memorandum Opinion of this Court. Respondent must prove fraud in each of the years involved. Drieborg v. Commissioner,225 F.2d 216">225 F.2d 216, 220 (6th Cir. 1955). Where, as in this case, the fraud allegations are inextricably intertwined with and dependent upon the alleged omissions of income, we must be extremely careful not to bootstrap a finding of fraud262 upon a taxpayer's failure to carry his burden of proof with respect to the deficiency determination. Drieborg v. Commissioner,supra,225 F.2d at 218; Estate of Beck v. Commissioner,56 T.C. 297">56 T.C. 297, 363 (1971); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105-106 (1969). Accordingly, since respondent must prove fraud to lift the bar of the statute of limitations, we need not, and indeed should not, address the correctness of the deficiency determination unless and until we find respondent has carried his burden of establishing fraud, i.e., has established by clear and convincing evidence that there was an "underpayment" of tax and that some part of that underpayment was "due to fraud." Sec. 6653(b). See Hebrank v. Commissioner,supra,81 T.C. at 642; Stone v. Commissioner,supra,56 T.C. at 220. 52In this case respondent says that each year petitioner understated his income from his tour boat business and omitted certain263 other income items such as interest, dividends, and dock rental fees. To put respondent's arguments and petitioner's counter-arguments into proper context, we must first discuss petitioner's purported handling of gross receipts and his so-called Receipts Books. Petitioner ran a tour boat business that generated large amounts of cash receipts. The cash receipts and other receipts (checks, invoices) were usually collected by petitioner or his employees on board the boat and placed in brown paper bags. Those brown paper bags were taken by (or were given to) petitioner at the end of the day or soon thereafter. After the brown paper bags came into petitioner's possession, only petitioner handled the gross receipts and recorded them in his Receipts Books. While several employees knew about the brown paper bags, only petitioner handled the contents of the bags and only petitioner made entries in the Receipts Books. Those Receipts Books, while an unsophisticated record system, appear regular on their face, reflecting two kinds of receipts - snack bar sales and passenger fares. Those Receipts Books reflect daily receipts throughout the April-to-September tour boat season, with breakdowns264 as to type of tour, numbers of passengers and whether the passengers were adults or children, and sometimes the port where the passengers boarded the boat. Those Receipts Books reflect monthly totals of receipts during the tour boat season, which monthly totals in turn add up to the annual totals. The annual totals reflected on those Receipts Books are the totals reported on petitioner's Schedule C's for the tour boat business. While petitioner insists that the totals of the gross receipts in his Receipts Books and on his tax returns are correct and include all his income for each year, he asks the Court to believe that the daily and monthly entries on these Receipts Books are not what they purport to be. In other words, unlike the usual case, petitioner is really asking the Court to find that his records are totally false in all particulars except for the totals which he insists are totally accurate. Respondent's agents uncovered specific tour receipts from school tours and social tours not shown "as such" on the Receipts Books. At least for 1973 and 1974, these specific school and social tours were well documented by contracts, invoices, and cancelled checks, which documents265 respondent obtained from the schools and the tour groups, not from petitioner. Such clearly documented tour boat receipts, unlike the cash payments from walk-on passengers for the public tours, could and should have been easily entered and identified in the Receipts Books, but they cannot be found "as such." Petitioner insists these tours are all in the Receipts Books somewhere, but neither he nor anyone else can determine where they are. Respondent's agents also uncovered other items of income not related to the tour boat business and not otherwise reported on petitioner's tax returns. Again petitioner insists that these amounts too are included in his Schedule C gross receipts total figures. Respondent uncovered certain dividends, dock rental fees, and reimbursed business expense items not shown on petitioner's tax returns. While petitioner agrees he received these amounts, 53 he insists that these items too are included in the Receipts Books totals. While these items cannot be found "as such" on his books, petitioner again says they are all in the Receipts Books somewhere, but neither he nor anyone else can determine where they are. 266 Had petitioner simply entered a total figure for each day or even for each month, his story might have been plausible, but there was no reason to reconstruct wholly false records as petitioner says he did (to take totals in bags and work backward to figure out the number of tours and number of adults and children that represented). His story about combining the contents of brown paper bags and not making entries in the Receipts Books for up to six months later (long after the tour season ended) is incredible. Petitioner had to report snack bar receipts for state sales tax purposes each month, and he did so. There was no reason to fabricate passenger numbers: those were not the numbers kept daily for the U.S. Coast Guard in case of an accident; those figures were not shown to the Chamber of Commerce or used in any other way except to purport to show the daily activity of his tour boat business for tax purposes. Most of the school tours occurred early in the season before the busy regular season began; if respondent's agent could obtain exact documentation from the schools as he did, then petitioner too had such accurate information available and simply chose not to use it. Also267 since the receipt of dividends and dock rental fees did not always coincide with the tour boat season, we simply do not believe these amounts too somehow ended up in the brown paper bags and ended up as part of petitioner's purported reconstruction of tour boat gross receipts. Once the tour boat season ended, the few receipts coming to petitioner could have been readily and accurately accounted for as received. In support of this unusual twist on record keeping, petitioner testified at length about how he made the entries in his Receipts Books. His putative method, if such intentional falsification could be called a method, could only be intended to make it impossible for petitioner or anyone else to determine what was included in or omitted from the gross receipts totals. Petitioner's story was wholly incredible, and the Court did not believe him. We think the only reasonable conclusion is that these Receipts Books are what they purport to be, a record of tour boat receipts (snack bar sales and passenger fares), albeit an incomplete record. Thus, we are satisfied that petitioner268 in fact understated his gross income in each of the years. However, that alone is not sufficient to establish by clear and convincing evidence that there was an underpayment of tax each year. Because of the method (or indeed lack of method) used by respondent's agents in developing this case, 54 respondent has failed to prove any underpayment of tax for either 1972 or 1975. 269 Unlike the detailed third-party documentation of school and social tours that respondent obtained for 1973 and 1974, the documentation for 1972 consisted solely of reservation sheets prepared by Dolly Haddock. Neither Haddock nor Agent Burgess had any knowledge as to which of these tours in fact took place or were cancelled. While it may be reasonable to assume that many of the scheduled tours took place and should have been identified "as such" in petitioner's 1972 Receipts Book, such an assumption does not rise to the level of clear and convincing evidence. While the Court is troubled by the fact that petitioner did fail to report some small amounts of dividends, interest, and dock rental fees that year that probably resulted in an underpayment of tax, nevertheless the controlling standard of proof is clear and convincing, not a mere preponderance of the evidence. Accordingly, we cannot find an underpayment of tax for 1972. The year 1975 involves an even more egregious lack of proof on respondent's part. Respondent never examined petitioner's 1975 Receipts Book or his other books and records for that year. See nn. 21, 32, 54, supra. Respondent did not obtain any third-party270 documentation of any omitted tour boat receipts, not even reservation sheets such as were obtained for 1972. Instead respondent used a percentage projection. Respondent increased the gross receipts figure reported on petitioner's 1975 return by 61.76 percent, the average percentage by which respondent had determined from the Ballard summaries that petitioner's receipts had been underreported for the preceding three years. Respondent explained on brief with respect to that year that he determined that "because petitioner had understated his gross receipts by an average of 61.76 percent for the years 1972, 1973, and 1974, over the amounts he reported for said years based upon the information and records that he supplied Mr. Grant Ballard * * that he must have done the same for 1975." (Emphasis added.) Respondent must prove fraud for each year. Drieborg v. Commissioner,supra.Also fraud is never imputed or presumed. Olinger v. Commissioner,234 F.2d 823">234 F.2d 823, 824 (5th Cir. 1956); Green v. Commissioner,66 T.C. 538">66 T.C. 538, 550 (1976).271 This type of projection, were it more soundly based, could perhaps satisfy a lesser standard of preponderance of the evidence. However, the projection in this case lacks a sound evidentiary base, has no probative value, and does not constitute clear and convincing evidence of an underpayment of tax for 1975. While the amounts of other omitted income items are substantially larger for 1975 and even more troubling to the Court than those for 1972, the Court cannot conclude, on this record where respondent never examined any of petitioner's books and records for that year, that respondent has established by clear and convincing evidence any underpayment of tax for 1975. For the reasons discussed above and without regard to the intent to evade tax, the Court concludes that since respondent has failed to prove any underpayment of tax for 1972 and 1975, those years are barred by the statute of limitations. We conclude otherwise for 1973 and 1974. Respondent has established by clear and convincing evidence understatements of taxable income that resulted in underpayments of tax for those years. We now turn to the question of whether those underpayments were due to fraud. II 272 FraudThe fraud envisioned by section 6653(b) is actual, intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing. Candela v. United States,635 F.2d 1272">635 F.2d 1272 (7th Cir. 1980); Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968), cert. denied 393 U.S. 1020">393 U.S. 1020 (1969); Mitchell v. Commissioner,118 F.2d 308">118 F.2d 308 (5th Cir. 1941), revg. 40 B.T.A. 424">40 B.T.A. 424 (1939), followed on remand 45 B.T.A. 822">45 B.T.A. 822 (1941); Wilson v. Commissioner,76 T.C. 623">76 T.C. 623, 634 (1981), Supplemental Opinion 77 T.C. 324">77 T.C. 324 (1981). Respondent must show that the taxpayer intended to evade taxes by conduct calculated to conceal, mislead, or otherwise prevent the collection of such taxes. Webb v. Commissioner,394 F.2d 366">394 F.2d 366, 377 (5th Cir. 1968), affg. a Memorandum Opinion of this Court; Acker v. Commissioner,26 T.C. 107">26 T.C. 107, 112-113 (1956). 273 Fraud is a question of fact to be determined on the basis of the entire record. Mensik v. Commissioner,supra;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); Otsuki v. Commissioner,supra,53 T.C. at 105-106. Fraud can seldom be established by direct proof of the taxpayer's intention; therefore, the taxpayer's entire course of conduct must be considered, and fraudulent intent can be established by circumstantial evidence. Spies v. United States,317 U.S. 492">317 U.S. 492 (1943); Gajewski v. Commissioner,supra,67 T.C. at 200; Otsuki v. Commissioner,supra,53 T.C. at 105-106. Specifically, we must consider the taxpayer's conduct and other circumstances surrounding the preparation, signing, and filing of the alleged fraudulent returns. Foster v. Commissioner,391 F.2d 727">391 F.2d 727, 733 (4th Cir. 1968). See also Wilson v. Commissioner,supra,76 T.C. at 634. A consistent274 pattern of underreporting substantial amounts of income over a period of several years is strong evidence of an intent to evade tax. Merritt v. Commissioner,301 F.2d 484">301 F.2d 484, 487 (5th Cir. 1962); Brooks v. Commissioner,82 T.C. 413">82 T.C. 413, 431 (1984). While only the years 1973 and 1974 remain open under the statute of limitations, the record in this case establishes for the four years, 1972 through 1975, a pattern of omitting items of taxable income such as interest, dividends, and dock rental fees. These omitted items increased in amount each year. There is also a pattern of omitting gross receipts, and hence understating taxable income, from the tour boat business. The omissions respondent has proved by clear and convincing evidence for 1973 and 1974 are not particularly large compared to the total gross receipts reported for the tour boat business. Nevertheless, we think these omissions are significant in a business that generated largely cash receipts. These omitted tour boat receipts were well documented by contracts, invoices, and cancelled checks that respondent obtained from petitioner's customers (schools and organized tour groups). Needless275 to say, we did not believe petitioner's story that even these receipts were "in the books" somewhere as part of the cash fares from walk-on passengers. Another factor indicating fraud is petitioner's failure to maintain proper records of his gross receipts. Otsuki v. Commissioner,supra,53 T.C. at 109-110. Petitioner had access to the same documentation of tour boat receipts as his school and tour group customers had, yet he failed to either retain these documents or to use these documents to properly enter the transactions on his Receipts Books. Petitioner's incredible story that everything was somewhere "in the books" even though it could not be found "as such" should be contrasted with the careful, meticulous way in which he maintained records of his expense items. See also n. 55, infra. Moreover, we note the extensive documentation retained by petitioner in support of additional business and travel expenses he claimed at trial for the year 1972. Assuming petitioner had reconstructed his Receipts Books in the manner to which he testified, which we did not276 believe, that would have involved a prodigious expenditure of time and effort and the Receipts Books thus reconstructed would still be wholly meaningless since one could not find therein even a clearly documented transaction. Suffice it to say, the Court did not believe his tale and regards it as an after-the-fact concoction devised to explain away whatever documented receipts respondent could prove. We think petitioner's Receipts Books are only partial records of what he actually received in his tour boat business and that his failure to maintain proper records of gross receipts is evidence of his intent to evade tax. Another factor indicating fraud, in addition to petitioner's total lack of credibility before this Court, was the misstatements, half-truths, and lies petitioner told Agent Burgess the first day he was interviewed. When asked if he had a safety deposit box, he mentioned one but did not mention the other two he had. When asked if he had any stocks or bonds, petitioner indicated he did not, although he knew he was receiving dividend income. When asked about loans he had277 made, he mentioned small loans to crew members that were repaid at the end of the week; he did not mention the $20,000 loan to his brother or the $9,500 loan to his son. When asked about rental income, petitioner mentioned only the cinder block buildings; he did not mention dock rentals. When asked about the boats at his dock, petitioner described them as "derelicts" but did not mention that he was receiving dock rental fees from such "derelicts." This pattern of misstatements, half-truths, and lies is persuasive evidence of petitioner's intent to evade tax. Based upon the record as a whole, we conclude that respondent has established fraud by clear and convincing evidence for the years 1973 and 1974. III DeficienciesBecause of respondent's use of the Ballard summaries for 1972, 1973, and 1974 and use of a percentage projection for 1975, petitioner argues that the statutory notice of deficiency was arbitrary, capricious, and clearly excessive, so that the burden of proof should be shifted to respondent. Helvering v. Taylor,293 U.S. 507">293 U.S. 507 (1935); Weimerskirch v. Commissioner,596 F.2d 358">596 F.2d 358 (9th Cir. 1979),278 revg. 67 T.C. 672">67 T.C. 672 (1977); Llorente v. Commissioner,649 F.2d 152">649 F.2d 152 (2d Cir. 1981), affg. in part and revg. in part 74 T.C. 260">74 T.C. 260 (1980). Respondent, on the other hand, relies upon the presumption of correctness of the notice of deficiency ( Welch v. Helvering,supra) and argues that petitioner is asking the Court to go behind that notice ( Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324 (1974)). While the Court agrees that respondent's investigation and trial preparations were grossly deficient in this case (see n. 54, supra), we do not agree that respondent's notice of deficiency was "arbitrary, capricious, wholly excessive, and the product of institutional bad faith," as petitioner contends. It just means respondent failed to carry his heavy burden of proof as to 1972 and 1975. On the other hand, we do not accept the notice of deficiency at face value, as respondent seems to urge. Invocation of the principle that we should not go behind the notice of deficiency does not mean, however, that279 this Court must shut its eyes to what the record plainly shows, namely, that the notice of deficiency is based upon the Ballard summaries for 1972 through 1974 and upon a mere projection for 1975, and that there is no evidence in the record supporting those figures.55 We think it unnecessary in this case to explore the full ramifications of the procedural device of the presumption of correctness or the nature of the burdens placed on petitioner (burden of ultimate persuasion and burden of going forward). See Foster v. Commissioner,391 F.2d 727">391 F.2d 727, 734-736 (4th Cir. 1968); Stout v. Commissioner,273 F.2d 345">273 F.2d 345, 350 (4th Cir. 1959). For a thorough commentary on these difficult issues, see Judge Tannenwald's concurring opinion in Llorente v. Commissioner,74 T.C. 260">74 T.C. 260, 272-280 (1980), affd. in part and revd. in part 649 F.2d 152">649 F.2d 152 (2d Cir. 1981). Here we think it unnecessary to talk about presumptions after a lengthy trial, and with voluminous documents in the record. Whatever function the notice of deficiency serves, it has long since served its purpose and dropped out of the picture, as has the presumption of correctness. 280 We would reach the same result in this case whether or not the burden of going forward was shifted to respondent. We decide the case on the record as a whole, which establishes only the amounts of omitted income as set out in our Ultimate Findings of Fact. The amount of the resulting deficiencies for 1973 and 1974 must be determined under Rule 155. 281 IV Income AveragingThe only issue for 1977 is whether petitioner's taxable income that year exceeded 120 percent of his "average base period income" for income averaging purposes. Sec. 1301 et seq. This is purely a computational matter to be determined by the parties in their Rule 155 computations. 56282 To reflect the above holdings, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question, and all "Rule" references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner has conceded that he is liable for additional investment tax credit recapture in the amount of $270 for the taxable year 1977. Respondent has conceded that petitioner did not receive taxable income in the form of certain "dock rental fees" from Gaskill Printers in the amounts of $3,025 and $25 in taxable years 1973 and 1974, respectively. Petitioner received rental income of $3,000 in 1973 that was reported on his return for that year. This amount is reflected in adjustment E of Joint Exhibit 8-H as the "Less: Amount Reported ($3,000.00) for 1973." Respondent has also conceded that petitioner did not receive taxable income in the form of certain "reimbursed business expenses" in the amount of $6.54 in taxable year 1974. ↩3. The parties have stipulated herein to the amounts of dock rental fees which petitioner received, such amounts for taxable years 1973, 1974, and 1975 being slightly less than those set out in the notice of deficiency for those years. For the taxable year 1975 the parties stipulated petitioner received dock rental fees of $4,151.30. However, the parties also stipulated that petitioner could have received an additional $20 in cash from Lawrence A. McDowell in dock rental fees during 1975. Thus, we have increased the stipulated amount for 1975 by $20.↩4. At some point during taxable year 1977, petitioner retired and sold the tour business to Stephen R. Jordan, one of petitioner's employees. Since the only issue herein pertaining to taxable year 1977 concerns petitioner's eligibility for income averaging in that year, it is irrelevant that petitioner did not own the tour boat business for all of taxable year 1977. ↩5. Petitioner is now married to Dorothy Furbee, but was not married to her during any of the years in issue.↩6. At trial, petitioner indicated that a lot of school trips did not show up, and his proclaimed general policy of not requiring a deposit from school groups sought to avoid problems associated with refunding such deposits. We note, however, that petitioner's policy as to school groups was not without exception. Certain documentary evidence of record indicates that school groups were sometimes required to post a deposit.↩7. While a school group could also go on a "public tour," petitioner tried to avoid such an occurrence.↩8. The record is unclear whether these were also the rates for social cruises during the 1973, 1974, and 1975 tour seasons. Petitioner testified that the prices increased but was not certain whether the prices increased during those years. These rates represent the minimum rates that would have been applicable to social cruises in 1973, 1974, and 1975.↩9. The parties have introduced as a joint exhibit herein a collection of 227 reservation sheets for school tours and social cruises which were made by and obtained from Haddock for taxable year 1972 and which petitioner estimates to be all of the reservation sheets Haddock prepared that year. However, since persons other than Haddock booked reservations, these sheets do not represent all of the reservations actually made for that year.↩10. The snack bar receipts were not always placed into a separate bag, but were sometimes commingled in a single bag with the gross receipts from passenger fares. Even when the receipts were commingled, the notation of the amount of snack bar sales was still placed in the bag.↩11. Petitioner attributed this practice to a deep distrust of banks imparted to him by living through the Great Depression. However, the Court did not accept this explanation in view of petitioner's various transactions with banks and other financial institutions.↩12. Portions of petitioner's testimony suggested that he attempted to keep the gross receipts from passenger fares segregated into a separate bag on a monthly basis. However, petitioner further testified that what purported to be a bag for one particular month could contain the receipts from a different month or several different months.↩13. With regard to school tours, petitioner's Receipts Books sometimes do not list a school by name specifically, but only designate that the charter is for a school and the general location thereof, i.e., "Norfolk school." Inclusive of the $600 down payment. 14 At trial, petitioner testified that the amount entered under a particular group's name did not necessarily represent the amount which the group had actually paid. In explaining this answer, petitioner stated that "if I had their name on the book and no amount on it, if I remembered on it, I would put down a figure that I thought was right. If I didn't remember anything on it, then I would put the minimum, what it would have -- would have had to been a minimum on it." 15 On certain entries, petitioner has failed to make a corresponding entry on the right-hand side of the page, but has nonetheless stipulated that he in fact received at least all items of gross receipts listed on the left-hand side in his Receipts Books for the years in issue. This omission is most likely due to the fact that petitioner often allowed groups to charge their cruises, making payment therefor at a time subsequent to the date of the cruise, which petitioner inadvertently failed to reflect in the right-hand column at the appropriate point in his Receipts Book.↩16. The number of time slots listed varied over the course of a particular tour season, but formed a pattern which remained fairly constant for each of the taxable years in issue. During approximately the first half of the tour season, the time slots listed generally corresponded with the various public tours offered during that particular portion of the tour season. However, during the latter half of the tour season the pages are not broken down in this manner, generally providing only a single listing for daytime public tours and a separate listing for evening public tours. 17 As was true with the time slots discussed above, the number of fares were usually broken down by the loading port during approximately the first half of the season, but not during the second half.↩18. As detailed above, petitioner's Receipts Books appear regular on their face and appear to be what they purport to be, a daily record of his tour boat business. Petitioner, in explaining how he maintained the Receipts Books, in effect asks the Court to find that everything in these books is false except the annual total figures. Petitioner's testimony was inherently incredible, and the Court did not believe him. However, we set out his testimony in detail to show, among other things, the vast amount of work that would have been involved in creating the inherently meaningless and false records he says he created.↩19. Petitioner stated that he kept no records of the number of trips cancelled due to weather. We note, however, that notations of the weather or of a mechanical breakdown appear at various locations in petitioner's Receipts Book. ↩20. As an apparent explanation of his motives in attempting to break the amounts treated as passenger fares down into adult, child, and sunset cruise fares, petitioner vaguely suggested that he did so to somehow appease the local Chamber of Commerce. However his Receipts Books were never shown to the local Chamber of Commerce or used for advertising or for any other purpose except purportedly to show the daily, monthly, and annual gross receipts of his tour boat business for tax purposes.↩21. Other than his Receipts Book for taxable year 1975, no other business records pertaining to that year have been introduced into evidence herein. Petitioner indicated that he had brought such records with him to trial pursuant to a Government subpoena, but neither party offered any of those records into evidence.↩22. The figures were first given to Ballard orally, and the notebooks were then presented to allow Ballard to make written copies of the summary pages contained therein. ↩23. Respondent's suggestion on brief that the notebooks shown to Ballard represented a secret second set of records maintained by petitioner does not have a sufficient factual basis in the record. While it is true that Ballard could not identify petitioner's Receipts Books as the notebooks he was given during the meeting, as suggested by petitioner, it is clear from the record that his inability is based solely upon the absence of the Summary pages therefrom, which petitioner stated were torn out and thrown away after the sale negotiations ended.↩24. We note that the schedule prepared by Ballard from the Summary pages does contain a notation of the amount of gross receipts per Schedule C for taxable years 1973 and 1974, but Ballard stated he did not copy any information from the Schedule C's, and the ink used in making such notations appears different upon visual inspection. Further, it is clear that Ballard could not have made the notations pertaining to taxable year 1974, as he did not examine any portion of that year's return during the meeting with petitioner. It is not clear when such notations were made or by whom they were made.↩25. Ballard subsequently advised the Whartons not to buy the tour business but, if they chose to do so, advised them to base the purchase price on the fair market value of the boat itself plus some additional payment respecting the net income of the business as reported on the Schedule C's, rather than the larger figures listed on the Summary pages. Ballard indicated his advice was based on a more conservative viewpoint which allowed for losses and did not provide for uncorroborated profits, plus his recognition of the fact that such figures on the Summary pages were possibly "puffed" to some extent. In any event, the extent to which Ballard believed the Summary pages to be correct or "puffed" is irrelevant to any issue in this case.↩26. Taxable year 1975 was apparently beyond the scope of the original investigation which was subsequently expanded to include that year as well.↩27. Petitioner testified at trial that he did not understand at this initial meeting that Agent Burgess was conducting a criminal investigation of his taxes. He further testified that only subsequent to this initial meeting did he discover the criminal nature of the investigation from talking to an unnamed attorney aboard one of his cruises. The Court did not believe his testimony, but it is clear that shortly after the initial meeting, which was friendly and cordial, there was a marked change in petitioner's attitude and behavior toward Agent Burgess.↩28. With regard to savings certificates and cash on hand, the evidence shows that petitioner purchased two savings certificates and two certificates of deposit totaling $16,000 during taxable year 1973, one savings certificate and one certificate of deposit totaling $5,374.67 during taxable year 1974, all of which petitioner still had as of December 31, 1975. Petitioner claims that these amounts were "rollovers" from previous savings certificates or certificates of deposit, but offered no evidence in support thereof. The evidence also shows that petitioner paid $6,040 cash for a boat and $1,429 cash for a trailer, both of which were purchased during taxable year 1974.↩29. Agent Burgess took these records back to his office where they were subsequently photocopied. On May 6, 1976, petitioner telephoned Agent Burgess and requested the return of the records. When Agent Burgess attempted to arrange a return date within a few days at a more convenient time, petitioner demanded that the records be returned that day, and Agent Burgess complied. Petitioner's explanation for this behavior is that he had just learned of the nature of the investigation and Agent Burgess' duties, a claim which we have heretofore rejected. See n. 27, supra.↩30. Indeed, petitioner and his representatives have at no time produced any documents of this type.↩31. Petitioner's testimony about this meeting differs drastically from Agent Burgess', petitioner claiming that the entire meeting lasted only five minutes, and stating that he only showed Agent Burgess one page in the book to illustrate the "double-entry" system he used to report certain amounts and also to indicate that certain figures listed in the book were not "money figures," but only "information figures." Considering the record as a whole and the credibility of the witnesses involved, we are satisfied that Agent Burgess' account more accurately reflects the events of the second meeting on April 20, 1976, and accordingly we accept most of his testimony on this point herein. However, Agent Burgess also testified that petitioner stated that the gross receipts figures for public tours listed on the monthly summaries discussed earlier herein, supra, were arrived at by multiplying the total number of passengers listed by the applicable rate, in contradiction to petitioner's claims that the number of passengers listed over the pages for a particular month was a product of dividing the total gross receipts for the month into the appropriate number of adult, child, and sunset cruise fares necessary to produce the total gross receipts figure. While we do not accept petitioner's explanation, we cannot accept Agent Burgess' testimony on this particular point as accurate either, since it appears that his testimony in this regard reflects Agent Burgess' interpretation of certain statements petitioner made concerning how you could determine the rates↩ charged for passenger fares on the various cruises, Agent Burgess candidly admitting at trial that he did not really know how the gross receipts purportedly attributable to public tours were reported on the Receipts Book(s). However, our failure to accept Agent Burgess' testimony on this particular matter is in no way intended to impugn his other testimony herein, which we found highly credible and worthy of belief.32. Agent Burgess was never in possession of petitioner's Receipts Book for the taxable year 1975.↩33. For obvious practical reasons, no attempt was made to corroborate amounts reported as public tours or snack bar sales (since there was no way to contact such persons), and Agent Burgess acknowledged as much at trial. ↩34. Agent Burgess has, with respect to some of the amounts listed by a specific group as "identified," given petitioner the benefit of the doubt by also including in such amount the snack bar sales figures listed for the particular day the private tour occurred.↩35. Agent Burgess' testimony as set out above was admitted into evidence for the limited purpose of illustrating the steps taken in arriving at the unreported gross receipts figure for taxable year 1972. It is clear from the record that this specific determination is solely an approximation based on the information gleaned from certain of the reservation sheets, as to which there has been no substantive evidence introduced which would indicate that any tours listed on the reservation sheets included in Burgess' computation actually occurred.↩36. The record does not establish which books Ballard was shown. If he was shown the Receipts Books which are in evidence, those books would not add up to the gross receipts figures Ballard copied from the Summary pages (See n. 23, supra↩) and would tend to support petitioner's claim that the Ballard figures were "puffed" projections for negotiation purposes. On the other hand, if Ballard had been shown a different set of Receipts Books, that would tend to support respondent's theory of a secret second set of books maintained by petitioner. The record simply does not provide an answer to this intriguing mystery.37. United States v. Walter M. McDowell,↩ No. CR 79-49-N (E.D. Va. 1979). 38. The parties have entered into extensive stipulations in this case (over respondent's reserved objection as to materiality and relevancy) concerning the conduct of the criminal trial, evidence considered therein, and certain statements made by the presiding judge in announcing the decision of acquittal. While the ultimate fact of petitioner's acquittal of violating section 7206(1) for taxable years 1973 and 1974 is a factor to be considered with respect to those taxable years raised in this proceeding, the remaining facts relating to the earlier criminal trial and set out in the stipulation of facts submitted by the parties do not deserve similar attention. It is clear we must decide the instant civil tax proceeding on its own merits based upon the evidence presented herein, not on the trial of the earlier criminal case. Further, petitioner's strained argument that his earlier acquittal serves to collaterally estop respondent with respect to the civil fraud issue raised herein for the same taxable years involved in the criminal proceeding is devoid of merit. Neaderland v. Commissioner,424 F.2d 639">424 F.2d 639 (2d Cir. 1970), affg. 52 T.C. 532">52 T.C. 532 (1969), cert. denied 400 U.S. 827">400 U.S. 827↩ (1970).39. As with the criminal trial, the parties have submitted extensive stipulations of fact (over respondent's reserved objections as to materiality and relevancy) concerning various events and statements made by persons involved in the decision to proceed civilly against petitioner. Except in rare and unusual circumstances not presented herein, this Court will not look behind the statutory notice of deficiency to examine the evidence used, the propriety of respondent's motives, the administrative policy or procedure followed in making the determination. Riland v. Commissioner,79 T.C. 185">79 T.C. 185 (1982); Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324 (1974). A trial before this Court is a de novo proceeding, and our determination of a taxpayer's tax liability must be based on the merits of the case and not on any previous record developed at the administrative level. Greenberg's Express, Inc. v. Commissioner,supra;O'Dwyer v. Commissioner,28 T.C. 698">28 T.C. 698 (1957), affd. 266 F.2d 575">266 F.2d 575 (4th Cir. 1959), cert. denied 361 U.S. 862">361 U.S. 862↩ (1959).40. On brief, respondent offers the following explanation of this adjustment: "With respect to the year 1975, respondent determined that because petitioner had understated his gross receipts by an average of 61.76 percent for the years 1972, 1973, and 1974, over the amounts he reported for said years based upon the information and records that he supplied Mr. Grant Ballard as set forth above, that he must have done the same for 1975."↩. Petitioner purchased 200 shares of Virginia Electric and Power Company stock on or about October 8, 1974, for a total of $1,778.63, of which $1,700 was in the form of a cashier's check drawn on the Bank of Virginia dated October 10, 1974. The parties have stipulated that the amount listed as "dock rental fees" from petitioner's brother, Lawrence A. McDowell, represented payment for "electricity and water." While the record is unclear, Lawrence A. McDowell apparently did not moor a boat at the docks, but just made use of the utility services available there. Further, the parties have stipulated that the actual "dock rental" figure for taxable year 1975 could have been approximately $20 higher than stated. ** Including reimbursement for electricity.↩41. Respondent suggests that these entries were made after the fact in support of petitioner's claims herein. We note that the total gross receipts reported in petitioner's 1975 Receipts Book, inclusive of the $2,190 stated to represent dock rentals for that year, reconcile with the total amount of gross receipts from the tour business petitioner reported on the Schedule C attached to his 1975 return. However, we also note that while the return indicates it was signed by petitioner on April 12, 1976, prior to the first contact with petitioner on April 20 of that year concerning the investigation of his tax liabilities for certain of the years in issue, the 1975 return was not actually received by the Internal Revenue Service until September 8, 1976 (apparently pursuant to an extension of time in which to file), by which time petitioner was aware of the question concerning the dock rental fees. ↩42. The amount of dividends reported on petitioner's 1974 return is slightly in excess of the amount of dividends which the parties have stipulated to for that year. We note that no increase in income attributable to unreported dividends is proposed for taxable year 1974 in the notice of deficiency.↩43. At trial, both petitioner and his counsel tried to explain away petitioner's answers to the above questions, asserting that petitioner had misunderstood what he was being asked or else he did not properly hear the questions. Petitioner's counsel's comments are not evidence and cannot be considered. With regard to petitioner's testimony on this point, we note that the questions Agent Burgess asked petitioner were of themselves straightforward and not readily subject to misinterpretation. Further, at trial petitioner did not display any difficulty in answering the questions he wanted to answer. We do not believe petitioner's self-serving claims that he misunderstood the questions asked of him during the initial meeting on April 20, 1976.↩44. The meeting grew out of a contact Agent Burgess had with petitioner on May 12, 1976, during which petitioner was given a letter outlining certain areas which Agent Burgess wished to discuss with him.↩45. Jordan indicated, however, that the dock rentals were not put into a bag if collected during a month in which there were no tours, such as before or after the tour season for a particular taxable year, and accordingly for which there would have been no bags maintained aboard the boat. While Jordan did not indicate what happened to such dock rentals, we assume they were ultimately turned over to petitioner, who claims they were then placed in a bag. Petitioner testified that all dock rentals were placed in the brown paper bags, but the Court did not believe his testimony.↩46. Petitioner and his counsel again tried to explain away petitioner's answers, claiming he had misunderstood Burgess' questions. For reasons expressed earlier herein, we do not believe petitioner's explanation. See nn. 27, 43, supra.↩47. The loan was made in the form of four separate cashier's checks, the funds to purchase which petitioner claimed to have come from money previously deposited in the safety deposit boxes or kept in his safe, denying that any such amounts derived from unreported gross receipts of the tour boat business withdrawn from the bags stored at petitioner's home. Two of the cashier's checks were drawn on Citizen's Trust Bank in the face amount of $4,900 each. The entry records for a safety deposit box petitioner maintained there indicate that petitioner visited the safety deposit box on May 20, 1974, the date of the loan to his brother. The third cashier's check was drawn on the Bank of Virginia in the face amount of $5,000. The entry records for the safety deposit box petitioner maintained there do not indicate that petitioner visited the safety deposit box on or near the date of the loan. The fourth cashier's check is drawn on American Fidelity Bank in the face amount of $4,900. The record does not indicate petitioner had any type of account or safety deposit box at this bank.↩48. While he did not testify at trial, Lawrence was interviewed by Agent Burgess as to the details of the loan during his investigation. On cross-examination, petitioner's counsel elicited a body of testimony from Agent Burgess concerning statements Lawrence had made regarding the loan, particularly whether it was interest-free or not. Respondent also introduced into evidence an unsigned document which the parties have stipulated was identified by Lawrence as embodying his understanding of the loan transaction, such document providing for the payment of interest. The record suggests that Agent Burgess in fact prepared this document and that it was not actually part of the loan transaction between petitioner and his brother. Since Lawrence did not testify at trial, it is clear that any statements he may have made to Agent Burgess with regard to whether the loan was interest-free or not constitute hearsay. The Court will rely only upon the parties' stipulation that the document (regardless of who prepared it) embodied Lawrence's understanding of the loan transaction.↩49. The record does indicate, however, and petitioner does not deny, that he did subsequently receive a substantial interest payment with respect to this loan upon the lump-sum repayment thereof in a year subsequent to those before the Court, petitioner claiming to have reported such interest as income for that year. Petitioner asserted that the payment of such interest was of Lawrence's own volition, and not pursuant to the terms of their original loan agreement. See n. 48, supra.↩2. Petitioner's payment record lists a closing balance of $36.35, bringing the total amount of principal to $9,500, the sales price. It is not clear whether petitioner subsequently received this amount.↩50. At trial, petitioner's counsel attempted to question Agent Burgess concerning the respective amounts attributable to Consolidated and Coca-Cola. While Agent Burgess acknowledged that the subject of unclaimed business expenses was mentioned during the May 24, 1976 meeting, it is clear from the record that petitioner's counsel had the wrong witness on the stand. Agent Burgess was involved in the criminal investigation; the revenue agent handled the matters involving the adjustments in the notice of deficiency.↩51. This total figure represents five times the individual passenger fare, and it appears there was another person's fare (possibly petitioner's) included in this total amount other than petitioner's two daughters, Jordan, and Johnson.↩52. See Mosteller v. Commissioner,T.C. Memo. 1986-505↩.53. Respondent also uncovered interest income not reported on petitioner's tax returns. Petitioner denies that he received such interest payments from his son and his brother, but the Court is satisfied that he did.↩54. The only investigation in this case appears to have been that conducted by Agent Burgess for the criminal case, but a charge under section 7206(1) requires neither proof of an underpayment nor proof of intent to evade tax. Wright v. Commissioner,84 T.C. 636">84 T.C. 636 (1985). Even so, the record for the two years involved in the criminal case (1973 and 1974) is more complete than that for the other years. Agent Burgess obtained a few documents (reservation sheets) in regard to 1972, but that year was not part of the criminal case and the facts were never fully developed. The year 1975 apparently was never involved in Agent Burgess' investigation, and he never saw petitioner's Receipts Book or any other books and records for that year. It appears that respondent never examined petitioner's 1975 records even in connection with the trial in this Court. Following petitioner's acquittal of the charges under section 7206(1)↩, this civil tax proceeding was instituted and was expanded to cover all four years. If any further investigation was conducted at any time before the trial, it is not apparent to this Court. The statutory notice of deficiency simply used the figures from the Ballard summaries for the years 1972, 1973, and 1974 and used a percentage projection for 1975. That was essentially the approach taken by respondent's counsel at trial and on brief. Despite the lengthy trial and voluminous documentary evidence, the record before this Court is largely a rehash of Agent Burgess' investigation. There are bits and pieces of data such as petitioner's cash expenditures but without any proof that the source of such funds was the current year's income. This case would have benefited from proper investigation for the civil tax proceeding and use of some recognized method of reconstructing income such as the net worth method or source and application of funds. Some such consistent approach would have either produced a better record or perhaps resulted in a settlement for at least some of the years. We recognize that settlement is difficult in a fraud case where the taxpayer's credibility is in issue. Nevertheless, settlement possibilities would have been enhanced if respondent had not chosen to take such an extreme position and if respondent had evaluated the strength of his evidence more realistically.55. While respondent hinted that petitioner kept a secret second set of books, there was no proof of that except for the summaries CPA Grant Ballard copied from petitioner's books in connection with a proposed sale of the tour boat business in August of 1974. Petitioner destroyed those summaries when the sale fell through, so the Court cannot determine what, if anything, they represented. While petitioner insisted at trial these summaries were just projections he made and simply "puffed" figures for sales negotiation purposes, we found it striking that the expense figures Ballard copied from petitioner's summaries exactly matched the expense figures on petitioner's books in evidence and as reported on his tax returns for 1972 and 1973. However, we decline to engage in speculation beyond that one observation about the expense figures.↩56. At first blush, there may appear to be a problem for 1975. Since respondent failed to prove fraud that year, we did not reach the issue of the correctness of petitioner's taxable income for that year. However, in determining petitioner's average base period income for purposes of the income averaging provisions, it is irrelevant that assessment and collection of any tax in any base period year is barred by the statute of limitations. The income to be used in each base period year is the correct taxable income for such year, not the taxable income as reported ( Unser v. Commissioner,59 T.C. 528">59 T.C. 528 (1973)), and the burden of proving the correctness of the base period income is on petitioner. See also Venditti v. Commissioner,T.C. Memo 1981-390">T.C. Memo. 1981-390; Abernathy v. Commissioner,T.C. Memo. 1978-370↩. However, rather than hold that petitioner has failed to prove his correct taxable income for 1975, the Court would determine the income for that year by increasing his reported income by $499.58 in unreported dividends ($691.58 total dividends received less $192 reported on his 1975 return), by $1,981.30 in unreported dock rentals ($4,171.30 received less $2,190 reported on his 1975 return), and by $1,780.20 in unreported interest income.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622672/	City Investing Company and Subsidiaries, Petitioners, v. Commissioner of Internal Revenue, RespondentCity Investing Co. v. CommissionerDocket No. 83591United States Tax Court38 T.C. 1; 1962 U.S. Tax Ct. LEXIS 162; April 3, 1962, Filed 162 Decision will be entered for the petitioner. Pursuant to a policy of liquidating its property holdings in Lower Manhattan, T corporation in 1950 transferred its fee simple interest in land under certain commercial property to Conn. corporation for $ 4 million. The fair market value of such land on the date of transfer was not in excess of $ 4 million. Simultaneously, Conn. leased back the land to T for an original term of 21 years, subject to specified renewals, at an annual net rental of $ 180,000 which was at least equal to the fair annual net rental for the land at the time. Held that the sale of the land was bona fide and the loss thereon sustained by T was recognizable; the transaction did not constitute an exchange of property for property of like kind plus boot under sections 112(b)(1) and 112(e) of the 1939 Code. D. Nelson Adams, Esq., and Richard R. Dailey, Esq., for the petitioners.Dean P. Kimball, Esq., for the respondent. Raum, Judge. RAUM1 Respondent determined deficiencies in income tax for the taxable years ending April 30, 1950, 1951, and 1952, in the respective amounts of $ 197,306.17, $ 553,786.68, and $ 270,905.32.The only issue is whether a purported sale and leaseback of certain land in Lower Manhattan was in fact a sale for tax purposes resulting in a deductible loss or whether it constituted an exchange of property for property of like kind (plus cash) with the result that no loss is deductible on the transaction because of the nonrecognition provisions contained in sections 112(b)(1) and 112(e) of the 1939 Code. Two other related adjustments have been settled by stipulation of the parties.FINDINGS OF FACT.The facts stipulated by the parties164 are incorporated herein by this reference.City Investing Company, hereinafter referred to as City, is a New York corporation with its principal office at 980 Madison Avenue, New 2 York, New York. During the years ending April 30, 1950 through 1953, City's principal office was at 25 Broad Street, New York, New York.During the years ending April 30, 1950 through 1953, City was the common parent corporation of an affiliated group of corporations for which consolidated Federal income tax returns were filed by City with the collector of internal revenue for the second district of New York. These returns were prepared and the books and records of the affiliated group were kept under an accrual method of accounting for a taxable year ending April 30.During 1943 City acquired by purchase all of the outstanding capital stock of a New York corporation, Thirty Broad Street Corporation, hereinafter referred to as Thirty. Thirty remained a wholly owned subsidiary of City after that date throughout the taxable years here involved. For the taxable years ending April 30, 1950 through 1953, Thirty joined in filing consolidated Federal income tax returns as a member of the affiliated group165 of which City was the common parent corporation.During the years here involved and for some years prior and subsequent thereto, Thirty was engaged in the business of holding title to and renting or leasing and subleasing various office buildings in the downtown or financial district as well as in other parts of New York City.Prior to 1950 in the course of its regular business Thirty acquired by purchase title to two contiguous parcels of land located at 30 and 38-40 Broad Street in New York City. The land at 30 Broad Street was acquired by Thirty in 1930, and the land at 38-40 Broad Street was acquired by Thirty in 1945. On November 9, 1950, Thirty held the land at 30 and 38-40 Broad Street at an adjusted basis of $ 7,825,000.The building on the land at 30 Broad Street, a 47-story office building, was constructed by Thirty in the years 1931 through 1934, and it was held by Thirty on November 9, 1950, at an adjusted basis of $ 2,292,155.20. In November of 1950 this building was one of the newer buildings in its immediate area, and it had an occupancy rate at that time of about 99 percent. The building on the land at 38-40 Broad Street was constructed in 1919 by Western Union166 Telegraph Company as a leasehold improvement under a long-term net lease which was still in effect on June 5, 1952. The building at 38-40 Broad Street is now and has remained since June 5, 1952, occupied and rented.Prior to November 9, 1950, the officers of Thirty determined as a policy matter that Thirty should no longer own property in Lower Manhattan (the portion of Manhattan from Fulton Street to the Battery). This decision was reached on the basis of what the officers 3 of Thirty considered to be disturbing trends in the real estate market in that area.From November 9, 1950, through June 5, 1952, the following sales were made by Thirty on the dates indicated:Property soldDate of sale30 and 38-40 Broad Street (land only)Nov. 9, 195052 BroadwayNov. 30, 195049 BroadwayJuly 16, 195155 BroadwayAug. 6, 195151 BroadwayAug. 23, 195153 BroadwayAug. 23, 195125 Broad StreetJune 1, 195230 and 38-40 Broad Street (building and leasehold interests)June 5, 1952Except for the property at 30 and 38-40 Broad Street, each of the above sales included land and building, involved no leaseback or retention of any other interest by Thirty apart from a security167 interest, and in most cases these sales were made at a profit by Thirty.After 1952 neither City nor any of its subsidiaries (including Thirty) owned or thereafter acquired any property in Lower Manhattan.In the case of the property at 30 and 38-40 Broad Street, the officers of Thirty decided to dispose of the land separately for two reasons. First, they were of the opinion that a higher overall price could be obtained for the property by so doing; second, they wanted to set off the large loss which Thirty would incur from the sale of the land alone against profits realized or to be realized from the sales of other properties.Thirty negotiated with several different insurance companies for the sale of the land at 30 and 38-40 Broad Street. At all times Thirty intended to couple any such sale with a leaseback of the land in order to protect its retained interest in the improvements thereon.On September 7, 1950, Thirty signed a contract for the sale of the land at 30 and 38-40 Broad Street with Connecticut General Life Insurance Company, hereinafter referred to as Connecticut, a corporation unrelated to both City and Thirty. This contract stated that Thirty "agrees to sell and168 convey, and the Purchaser agrees to purchase" the land and that the "purchase price of the land only is Four Million and 00/100 Dollars." The purchase price of $ 4 million was arrived at through negotiation with Connecticut and represented the highest price that Thirty was able to obtain.The contract of September 7, 1950, provided that simultaneously with the delivery of the deed of the land Connecticut would execute and deliver to Thirty a lease of the land for an "original term" of 21 years with "three options of renewals" in favor of Thirty as tenant for 21 years each and a further "option of renewal" for 15 years. The rent for the "original term" was set at $ 180,000 per annum. The 4 rent for the renewal terms was to be determined by arbitration or appraisal at 4 1/2 percent of the arbitrated or appraised value less certain specified amounts, but in no event was the net rent per annum during any renewal term to be less than $ 180,000. In addition, the contract provided as follows:Should said lease not be agreed upon within thirty (30) days from the date hereof, then either party shall have the right to terminate this contract by giving written notice to such effect169 to the other party not later than twenty (20) days from the date of said notice. Upon the giving of such notice this contract shall become null and void from its inception and neither party shall have any claim against the other excepting that the Seller shall be obligated to return to the Purchaser the down payment made hereunder.Prior to entering into the September 7, 1950, contract with Thirty for the purchase of the land at 30 and 38-40 Broad Street, Connecticut requested that Thirty obtain an independent appraisal of the land for Connecticut's use. Such appraisal, dated August 14, 1950, was made by Cruikshank Company and estimated the value of the land subject to a net lease similar to that provided for in the contract of September 7, 1950, to be $ 4 million and estimated the value of the land without any net lease to be $ 2,600,000.On November 9, 1950, pursuant to the contract of September 7, 1950, Thirty conveyed the land at 30 and 38-40 Broad Street to Connecticut subject to the specified leaseback for $ 4 million. On the same day, also pursuant to the contract of September 7, 1950, Connecticut leased the land at 30 and 38-40 Broad Street to Thirty for an original term170 of 21 years at a net annual rental of $ 180,000. The lease contained provision for nine renewal terms extending for an aggregate of 204 years. The renewal provisions covered eight pages of the printed lease and were the result of the extensive negotiation between Thirty and Connecticut. The renewal terms were not automatic extensions of the lease, but rather each such renewal required an affirmative election by the lessee, Thirty. At no time during the first four renewal terms of the lease, extending through the year 2049, could the annual net rental to be paid by Thirty to Connecticut be less than $ 180,000 per year. Depending upon the future market value of the land, the net annual rental during the renewal terms could be more than $ 180,000. Under the terms of the lease Thirty had no right to reacquire the land at any time by purchase or otherwise.The 21-year original term of the lease was determined by Thirty to be the maximum period during which it was willing to obligate itself to pay the net rental demanded by the lease in view of the risks involved in such a real estate investment. Prior to November 9, 1950, no negotiations had been conducted by Thirty for the disposition171 of its interest, exclusive of the land, in the property at 30 and 38-40 Broad Street.5 The deed which conveyed title to the land at 30 and 38-40 Broad Street from Thirty to Connecticut on November 9, 1950, was expressly made "subject to the terms, covenants, conditions, limitations, agreements and provisions" contained in the lease of November 9, 1950, between Connecticut as lessor and Thirty as lessee.Thirty incurred expenses in the amount of $ 122,801.10 in connection with the transfer of the land at 30 and 38-40 Broad Street to Connecticut.On its consolidated Federal income tax return for the taxable year ending April 30, 1951, City claimed that a deductible loss in the amount of $ 3,947,801.10 had been sustained by Thirty as a result of the transfer of the land at 30 and 38-40 Broad Street to Connecticut. Of such claimed loss, $ 1,295,136.81 was applied by City to reduce gains realized by Thirty during the year ending April 30, 1951, under section 117(j) of the 1939 Code and $ 591,044.43 was applied by City to reduce ordinary income realized by Thirty during such year. Of the remainder of the claimed loss, $ 558,129.70 was claimed by City on Form 1139 as a net operating172 loss carryback to be applied against ordinary income realized by Thirty during the year ending April 30, 1950, and $ 528,835.68 was claimed by City as a net operating loss carryover and was applied against ordinary income realized by Thirty during the year ending April 30, 1952.In a statutory notice of deficiency, dated July 13, 1959, respondent disallowed the loss deductions claimed for the taxable years ending April 30, 1950 through 1952. The notice contained the following explanation of the disallowance:The transfer on or about November 9, 1950 by the Thirty Broad Street Corporation of land located at 30 and 38-40 Broad Street, New York, New York, in consideration for $ 4,000,000.00 and a leasehold, is held to constitute an exchange of like property under which no deductible loss is recognizable under Sections 112(b)(1) and 112(e) of the Internal Revenue Code of 1939.The denial of this loss is the only matter presently in controversy between the parties.On June 5, 1952, Thirty sold the building at 30 Broad Street and its leasehold interests as lessee of the land at 30 and 38-40 Broad Street and as sublessor of the land at 38-40 Broad Street to Thirty Associates, a corporation173 unrelated to both City and Thirty, for $ 7,100,000. Thirty reported a gain on the sale of $ 4,358,331.52 for Federal income tax purposes. In connection with this sale, also on June 5, 1952, Thirty and Connecticut signed an agreement of modification of the lease on the land at 30 and 38-40 Broad Street.The gross rentals and net income derived by Thirty from the buildings at 30 and 38-40 Broad Street in each of the years ending April 30, 1944 through 1952, were as follows: 6 YearGross rentalsNet income(or loss)1944$ 571,062.41($ 14,226.50)1945701,635.0297,848.44 1946777,924.78205,584.74 1947866,040.29262,700.20 19481,008,238.57371,057.15 19491,091,527.39399,309.60 19501,141,291.46421,516.75 19511,185,515.48433,606.26 19521,179,286.71281,703.70 The above figures for the years 1951 and 1952 take into account ground rent paid by Thirty of $ 85,000 and $ 180,000, respectively. Repairs and other expenses of operation increased significantly during the year 1952 and account for the decline in net income during that year in excess of the decline attributable to the ground rent.Net rental payments received by Thirty174 from Western Union Telegraph Company for 38-40 Broad Street amounted to $ 33,750 during the years 1944 through 1948 and to $ 38,750 during the years 1949 through 1952.The properties at 30 and 38-40 Broad Street were assessed for purposes of real property taxes at the following values for the periods indicated:30 BROAD STREETTax YearLandTotal1942-43$ 2,200,000$ 5,075,0001943-442,200,0005,075,0001944-452,100,0004,950,0001945-462,100,0004,950,0001946-472,000,0004,850,0001947-482,000,0005,000,0001948-492,000,0005,100,0001949-502,000,0005,200,0001950-511,800,0005,150,0001951-521,900,0005,150,00038-40 BROAD STREET1942-43800,000925,0001943-44740,000860,0001944-45740,000835,0001945-46695,000815,0001946-47680,000800,0001947-48680,000800,0001948-49680,000820,0001949-50680,000820,0001950-51680,000820,0001951-52700,000840,000Real property in New York City is required by law to be assessed at its full value for purposes of real property taxes.The fair market value of the land at 30 and 38-40 Broad Street on November 9, 1950, was not in excess of $ 4 million. On 175 the same day the fair market value of such land subject to the leaseback signed on that day was not in excess of $ 4 million.A fair annual net rental payment for the land at 30 and 38-40 Broad Street on November 9, 1950, was not in excess of $ 180,000.7 OPINION.On November 9, 1950, Thirty purportedly conveyed a fee simple interest in the land at 30 and 38-40 Broad Street in New York City to Connecticut General Life Insurance Company for a cash consideration of $ 4 million. On the same day Connecticut leased back the same land to Thirty for an original term of 21 years for an annual net rental of $ 180,000. The true nature of these two transactions, which the parties agree were closely linked in form as well as in substance, is the issue to be decided.Respondent has determined that Thirty's formal sale and immediate leaseback of the land did not constitute a bona fide sale and separate leasing for tax purposes, but rather that it was an exchange of "property * * * for property of a like kind" plus boot (cash in the amount of $ 4 million) pursuant to sections 112(b)(1) and 112(e) of the 1939 Code 1177 with the result that the loss which Thirty claimed 2 as a consequence of176 the purported sale was not deductible under the statute. Petitioner's primary position is that there was a genuine sale of the land, not an exchange of property interests. As proof that the transaction constituted a true sale, petitioner has presented evidence that the fair market value of the subject land at the time of the transfer was not in excess of the $ 4 million which Connecticut paid to Thirty. However, if we should hold that there was an exchange and not a sale for tax purposes, petitioner makes the secondary argument that such exchange was not of property of "like kind" as required for nonrecognition of the loss under the statute.After careful consideration of all the evidence, we agree with petitioner that there was a bona fide sale of the land by Thirty. Cf. Standard Envelope Mfg. Co., 15 T.C. 41">15 T.C. 41; May Department Stores Co., 16 T.C. 547">16 T.C. 547. Therefore, we do not pass upon the question whether the exchange of the particular leasehold interest here involved for an interest in fee in the same land could be considered 8 an exchange of "like" properties. Cf. sec. 29.112(b)(1)-1, Regs. 111; Century Electric Co., 15 T.C. 581">15 T.C. 581, affirmed 192 F. 2d 155 (C.A. 8), certiorari denied 342 U.S. 954">342 U.S. 954.178 The record shows that the transfer in question was made pursuant to Thirty's adopted policy of liquidating its property holdings in Lower Manhattan. It is this factor which in the main sets the instant case apart from prior sale and leaseback transactions considered by this Court. In particular it makes the present case distinguishable from both Century Electric Co., supra, upon which respondent chiefly relies, and Jordan Marsh Company v. Commissioner, 269 F. 2d 453 (C.A. 2), reversing a Memorandum Opinion of this Court, which petitioner argues is controlling. We conclude, therefore, that it is not necessary for purposes of decision in the present case to decide whether the decision of the Court of Appeals for the Second Circuit in Jordan Marsh is inconsistent with the result in the earlier Century Electric Co. case. Cf. Rev. Rul. 60-43, 1 C.B. 687">1960-1 C.B. 687.There is no dispute that Thirty had adopted a policy of liquidating its property interests in Lower Manhattan prior to the transaction here involved. It was stipulated that Thirty sold its interest in six Lower 179 Manhattan properties, in addition to the subject property, between November 9, 1950, and June 5, 1952. After the latter date, Thirty no longer owned nor thereafter acquired any property in Lower Manhattan. In disposing of its interest in the property at 30 and 38-40 Broad Street, Thirty decided to sell its interest in the land and its interest in the improvements thereon separately. An officer of Thirty testified that this was done not only because the officers of Thirty believed that they could thereby obtain a higher overall price for the whole property, but also because they wanted to register a tax loss on the land to offset profits on other sales by the corporation. As a result only the land was transferred to Connecticut on November 9, 1950. Although it appears that Thirty had not yet negotiated the sale of the improvements on the land together with the leasehold interest that it obtained back from Connecticut, it is apparent that at the time of the sale to Connecticut Thirty intended also to liquidate these remaining interests in the property. The record reveals that it did in fact sell these interests in the 30 and 38-40 Broad Street property to an unrelated corporation, 180 Thirty Associates, within 2 years, on June 5, 1952.In these circumstances we think that the transfer of the land alone on November 9, 1950, was a bona fide sale. Thirty conveyed its fee interest in the property without reserving any right of repurchase. We have made a finding that the fair market value of the land on the date of transfer was not in excess of the $ 4 million which Connecticut paid to Thirty. In addition, we have made a 9 finding that a fair annual net rental for this land on November 9, 1950, was not in excess of the $ 180,000 which Thirty agreed to pay Connecticut. Thus, it does not appear that the leaseback arrangement which Thirty and Connecticut signed as a part of the total transaction had any separate value which can properly be viewed as a portion of the consideration paid or exchanged.The fact that Thirty was willing to sell the land in question only with some kind of leaseback arrangement included does not of itself detract from the reality of the sale. Nor does the fact that tax considerations in part motivated the particular transaction. Both of these factors were also present in Standard Envelope Mfg. Co., supra,181 and May Department Stores Co., supra, where it was held that bona fide sales had taken place. In those cases, as here, the sale was the result of extended arm's-length negotiation, the price paid was at least equal to the property's then fair market value, and the only interest retained by the seller was that of lessee for a definite term. While those cases did not involve a segregated sale of only land apart from the improvements thereon, we think that the presence of this factor in the instant case should not change the result. Since, as already noted, the conveyance here involved was made pursuant to a policy of liquidating Thirty's property holdings in the immediate area, in many respects the instant case presents an even stronger set of facts in support of the reality of the sale.After November 9, 1950, we think that Thirty's rights as lessee of the land at 30 and 38-40 Broad Street were in no sense a "continuation of the old investment [in the land] still unliquidated." Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260, 268; sec. 29.112 (a)-1, Regs. 111. We are satisfied that Thirty yielded substantial economic182 and property rights by transferring its ownership in fee to Connecticut and that it succeeded for purposes of this transaction in liquidating its invested capital in the land. As such there was a true sale, and petitioner is entitled under the statute to recognize the loss that was thereby sustained.Decision will be entered for the petitioner. Footnotes1. SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) Exchanges Solely in Kind. -- (1) Property held for productive use or investment. -- No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment. * * (e) Loss From Exchanges not Solely in Kind. -- If an exchange would be within the provisions of subsection (b) (1) * * of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.↩2. Neither the amount of the loss which Thirty sustained if the sale was bona fide nor the manner in which such loss was carried back as a net operating loss and deducted in the taxable year ending April 30, 1950, deducted as a net operating loss for the taxable year ending April 30, 1951, and carried forward as a net operating loss and deducted in the taxable year ending April 30, 1952, is presently in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622675/	MONARCH LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Monarch Life Ins. Co. v. CommissionerDocket No. 88811.United States Board of Tax Appeals38 B.T.A. 801; 1938 BTA LEXIS 822; October 11, 1938, Promulgated 822 Dividends declared by petitioner, an insurance company, other than life or mutual, on participating life insurance policies, and paid or credited for the benefit of policyholders under the various options granted in the policies, held not deductible as "return premiums" within the provisions of section 204, Revenue Act of 1932; held, further, that they are not deductible as "ordinary and necessary expenses", in view of the specific provisions mentioned. Frederick A. Ballard, Esq., and Abbott P. Mills, Esq., for the petitioner. L. W. Creason, Esq., for the respondent. OPPER801 This proceeding involves a deficiency of $3,560.42 in income tax for the year 1932. Petitioner appealed from the disallowance of deductions for dividends declared on participating life insurance policies, and from a depreciation adjustment made by respondent. Petitioner now concedes the correctness of the depreciation adjustment, leaving as the only question at issue the deductibility of the policy dividends. FINDINGS OF FACT. The following excerpts and abstracts summarize a stipulation of facts filed by the parties, which is adopted as our findings823 of fact: 1. The petitioner is a stock insurance company, incorporated in Massachusetts and licensed to write life and accident and health insurance contracts. It was so engaged in 1932, doing business in Massachusetts and 32 other states and the District of Columbia. It was organized in 1931 to take over the business of the Monarch Accident 802 Insurance Co. and the Monarch Life Insurance Co., both Massachusetts corporations. 2. "Less than 50% of petitioner's total reserve funds held during the taxable year were held for the fulfillment of life insurance contracts and petitioner was accordingly taxable as an insurance company other than life or mutual, under Sections 201(a) and 204 of the Revenue Act of 1932." (Stipulation, par. II.) 3. Petitioner filed separate statements for its life insurance business and for its accident and health insurance business with the Commissioner of Insurance for the State of Massachusetts, as required by law. The statements were in the form adopted by the National Convention of Insurance Commissioners. 4. "Petitioner's life policies in force during the taxable year were participating policies. * * * During the taxable year petitioner824 paid or credited to the holders of such policies, pursuant to the exercise by such holders of the options set forth in such policies, the following amounts as set out in petitioner's annual statement (Life, 1932): "Life StatementPage 3, line 9: 'Dividends to policyholders':(a) Applied to pay renewal premiums$9,239.45(b) Applied to shorten the endowment or premium paying period0.00(c) Applied to purchase paid up additions and annuities1,327.57(d) Paid in cash or applied in liquidation of loans or notes3,205.62(e) Increase during year in dividends left with the Company to accumulate at interest ($10,972.46 left during the year 1932, less $2,378.90, dividends held on deposit surrendered during the year, see line 12(a))8,593.561 Page 5, lines 32, 33: Increase during year in dividends due or apportioned to policyholders.December 31, 1932$13,798.00December 31, 193113,260.00538.00Total$22,904.20825 803 "These amounts were apportioned to the various policyholders in question, upon the contribution to surplus plan, as soon after December 31, 1931 as was practicable. The amounts so apportioned represented petitioner's remaining funds after proper provision had been made for the reserves required or permitted by the insurance laws of Massachusetts, and for all other liabilities, including dividends declared upon capital stock." (Stipulation, par. V.) 5. "During the taxable year petitioner's premium rates on such participating policies were approximately 11 1/2% in excess of the average premium rates in that year of stock life insurance companies doing business in Massachusetts, on non-participating policies. The aggregate amount of such excess with respect to premiums earned during the taxable year was $47,359.79. The total amount of dividends paid or apportioned to policyholders during the taxable year was $25,283.10. The predominating purpose of such excess premiums was to provide for a surplus sufficient to pay the dividends here in question. The reason for providing for such dividend payments was to attract business in competition with mutual companies, this826 method of competition having been found necessary by most stock life insurance companies, including petitioner. During and prior to the taxable year the petitioner and its predecessor, Monarch Life Insurance Company, represented in advertising that such dividend payments had been made annually in the past and would continue to be made annually at approximately the same rate assuming that the earnings of the company continued to make such rate lawful. Many of the holders of petitioner's participating policies during the taxable year had held such policies in the predecessor Monarch Life Insurance Company and had received similar dividends." (Stipulation, par. VI.) Such dividends have been paid or credited annually to the holders of participating life policies by petitioner and by its predecessor, Monarch Life Insurance Co., in amounts increased from $1,182.27 in 1928 to $20,523.98 in 1931, and $28,270.83 in 1937. 6. Petitioner claimed the items set out in finding 4, supra, as deductions from gross income on its income tax return for the taxable year, but the deductions were disallowed by the respondent. OPINION. OPPER: Not a little of the difficulty inhering in the disposition827 of this proceeding is due to the anomalous factual circumstances giving rise to petitioner's claim. It is stipulated that "less than 50% of petitioner's total reserve funds held during the taxable year were held for the fulfillment of life insurance contracts." Petitioner is, 804 therefore, not a "life insurance company" as that term is used in the Revenue Act of 1928 2 and, being a privately owned stock company, must be treated as an insurance company "other than life or mutual." Nevertheless all of the items of dividends for which petitioner claims credit either as an exclusion from gross income or as a deduction arise out of its life insurance contracts. It should be noted at the outset and borne in mind throughout the consideration of the question raised in this proceeding that, since Congress has seen fit to place petitioner in the category of insurance companies other than life, its position must be treated without regard to the nature of the insurance contracts involved and specifically without giving effect to any special attributes that may inhere in life insurance contracts. 828 Petitioner bases its contention that it is entitled to deduct dividends credited or paid on its participating life policies on the alternative grounds that such payments or credits constitute "return premiums" within the meaning of section 204(b)(5), or "ordinary and necessary expenses" within section 204(c)(1), Revenue Act of 1932. 3 If 805 the petitioner is entitled to exclude these dividends from gross income as "return premiums", then, obviously it is not necessary to discuss whether they could constitute ordinary and necessary expenses. On the other hand, since they are items having a unique existence in the insurance business, allowance thereof would be expected among the technical provisions covering the peculiar types of income and deductions of an insurance company, section 204(b), especially subdivisions (3) - (7), rather than in the provisions referring to the deductions allowed to corporations generally, section 204(c); and, in fact, in referring to mutual companies, that is the method adopted by Congress. 4 Therefore if Congress in the provisions dealing specifically with insurance companies did not intend to permit the exclusion of policy dividends in computing829 net income it can not, in the absence of specific language, be assumed that it was intended to allow them under the general provision for deduction of such ordinary and necessary expenses as are common to all corporations. "It is an old and familiar rule that, 'where there is, in the same statute, a particular 806 enactment, and also a general one, which, in its most comprehensive sense, would include what is embraced in the former, the particular enactment must be operative, and the general enactment must be taken to affect only such cases within its general language as are not within the provisions of the particular enactment.'" ; also . In our view, then, the petitioner's case must stand or fall on whether the term "return premiums" was intended to embrace "dividends" to policyholders. For this reason, and because of the different character of the petitioner's commitments from those in , we do not regard that case as of any controlling effect. 830 Moreover, the respondent did not question there that the refunds were deductible expenses, and perhaps for that reason there was no consideration of the bearing which , might have had upon the issue if raised. 831 Respondent contends that the term "return premiums" means unearned premiums, arising from cancellations, terminations, or rescissions, which are returned because the risk did not attach to the extent originally contemplated. In such cases there is a "return" of premiums as such. Provisions for return or refund of premiums are common in fire insurance policies. However, in life policies, including those here in question, there are comparable provisions, e.g., in the case of military or naval service in violation of the terms of the policy. But it is not vital to the sense of the statute that the term "return premiums" has any application at all to life policies since as pointed out above the section in question in terms applies to all stock insurance companies other than life, as defined in the statute. The petitioner claims that the term "return premiums" is applicable to its policy dividends, no matter how they are paid or applied, although it admits that they are not returned as an earmarked "excess premium" but rather out of the general surplus of the company in which the policyholders are permitted to participate. There has not been cited nor have we been able to find832 any authoritative or accepted definition of the term as used generally or in the insurance business. Apparently, the most that can be said is that its meaning depends upon the context in which it is used. It is evidently sometimes used with the meaning attributed to it by the respondent, as in , where corporate bylaws provided separately for payment of "return premiums" and policy dividends. And the term is sometimes used where it might be susceptible of the interpretation given it by petitioner, as in the Massachusetts General Laws (ch. 175, sec. 1), which refer to "return 807 premiums, other than premiums returned to policyholders as dividends." It seems to us that the context of the provisions of the Revenue Act of 1932 covering insurance companies indicates an intention to use the term "return premiums" restrictively. In the first place, where Congress intended to allow the deduction of any repayments to policyholders (in addition to policy losses) as for example in the case of mutual insurance companies other than life, it used much fuller language which made its meaning clear. 5 Its failure to use any such language833 here is significant. In the second place, the term "return premiums" appears in the section defining and designed to arrive at "premiums earned." The item is permitted as a deduction from gross premiums received. It may therefore be assumed to be limited to premiums considered "unearned." This is borne out by the allowance as a deduction of premiums paid for reinsurance, in which case the risk is merely transferred and the original insurer earns nothing. But we are dealing here with dividends paid out of an obviously earned surplus, 6 resulting in part from investment profits and in part from prior premium payments, both of which are treated as earnings at the time of receipt. 7834 808 Had Congress intended to exclude from "earned premiums" the amount of dividends on participating policies it could have used language similar to that of the Massachusetts statute cited supra, which provides that a participating company "shall not be required to include * * in its earned premiums" a loading charged "solely for dividends." Finally, there is the rule that the provision in question, even though it appears in a section for computing gross income, is an exemption from tax which is to be construed strictly against the taxpayer. . Two factors in the legislative history of the measure bear out this construction of "return premiums." In addition to the provisions regarding mutual companies quoted supra, footnote 5, the early acts in the case of life insurance companies (which were not restricted by definition as in the later acts) contained specific provision for the noninclusion in income of "such portion of any actual premium received from any individual policyholder as is paid back or credited to, or treated as an abatement of premium of such individual policyholder, within the year. 835 " 8 This provision made it clear that dividends applied in abatement of premiums were to be excluded in computing net income. (1920). But this language was stricken from the 1921 Revenue Bill by the Senate.9 And significantly no such language was embodied in section 246 (counterpart of section 204, Revenue Act of 1932) when that section was added by the Senate. 10In the second place, the Senate proposed to limit the new provisions inserted by the House in the 1921 Bill to life companies, 11 as defined, and it was originally proposed in the Senate to treat both mutual and stock companies, "other than life", in the same section (246). 12 As836 so written, the subdivision of section 246 dealing with the computation of "earned premiums" allowed the deduction of return premiums in the following language: * * * deduct return premiums (or, in the case of mutual companies, dividends or unabsorbed premiums returned or credited to the assured) and premiums paid for reinsurance. 13It seems to us inescapable that as there used and applied only to nonmutual companies, "return premiums" did not include dividends or other payments the effect of which would be to reduce premiums 809 already paid - otherwise the parenthetical clause would have been pure surplusage. Since effect must, if possible, be given to "every clause and part" of a statute (), if the quoted language were before us there could be no question that "return premiums" was intended to exclude dividends. While still in the Senate the section was altered837 so that the application was restricted to nonmutual companies, its language relating to "return premiums" assumed its present form, and the sections covering mutual companies in the existing law were left substantially unchanged. The few changes from the section as originally proposed (including the striking of the parenthetical clause quoted above) were characterized by Senator Smoot of the Finance Committee in charge of presenting the section on the floor, 14 as intended only to make the section inapplicable to mutual companies.15 Thus no change of intent in the use of the term "return premiums" is apparent. The section as thus amended was adopted by the Senate and thereafter by the Conference Committee and by the House. The statement by Senator Smoot is entitled to respect as being in the nature of a supplemental committee report (see , since section 246 was proposed by the Committee after its original report had been made. 16 And the intent of the Senate must be attributed to the House, which acted later with presumable knowledge of the Senate proceedings. 838 This assumption is implicit in decisions giving effect to the intent manifested by the initiating House. See . Petitioner contends that it is inconceivable that Congress could have preferred mutual companies over stock companies. This assumption we think unwarranted. Not only has the desire of Congress to favor mutual enterprises been recognized (see 839 ) but express statements during consideration of this measure indicate that to be precisely what was intended.17 What 810 thus seems inconceivable is that Congress intended to prefer stock companies over mutual companies. Yet that is the position which petitioner's contention will reach. It claims, either as an exclusion from income or as a deduction for expense, all of the policy dividends paid or credited without regard to the actual disposition of such dividends. This is a preferential treatment to which not even a mutual company would be entitled. The Supreme Court in , summarized provisions of the 1913 Act as follows: * * Congress treated the so-called repayments or dividends in this way (p. 173): (a) Mutual fire companies "shall not return as income any portion of the premium deposits returned to their policyholders." (b) Mutual marine companies "shall be entitled to include in deductions from gross income amounts repaid to policyholders on account of premiums previously paid by them and interest paid upon such amounts between the ascertainment thereof840 and the payment thereof." (c) Life insurance companies (that is both stock and strictly mutual) "shall not include as income in any year such portion of any actual premium received from any individual policyholder as shall have been paid back or credited to such individual policyholder, or treated as an abatement of premium of such individual policyholder, within such year." (d) For all insurance companies, whatever their field of operation, and whether stock or mutual, the act provides that there be deducted from gross income "the net addition, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts." 841 Of these provisions, which are in pari materia18 with the provisions of the 1932 Act governing mutual companies, the Court said: If the terms of the non-inclusion clause, (c) above, standing alone, permitted of a doubt as to its proper construction, the doubt would disappear when it is read in connection with the deduction clause, (d) above. The deduction there prescribed is of "the sums other than dividends paid within the year on policy and annuity contracts." This is tantamount to a direction that dividends shall not be deducted. It was argued that the dividends there referred to are "commercial" dividends like those upon capital stock; and that those here involved are dividends of a different character. But the dividends which the deduction clause says, in effect, shall not be deducted, are the very dividends here in question, that is dividends "on policy and annuity contracts." None such may be deducted by any insurance company except as expressly provided for in the act, in clauses quoted above, (a)(b) and (c). That is, clauses (a)(b) and (c) are, in effect, exceptions to the general exclusion of dividends from the permissible deductions as prescribed in clause842 (d) above. As so interpreted by the Supreme Court, the revenue acts were not intended to provide that dividends as such should be deductible in 811 the case of mutual companies - except in the cases specifically mentioned. We can not believe that Congress intended that they could nevertheless be deducted by stock companies. It is doubtful whether the only exception permitted to mutual companies generally would be broad enough to grant a deduction even to a mutual company operating as did the petitioner. 19 But, in any event Congress has failed to include the exceptions granted in favor of mutual companies in the provisions relating to companies other than life and mutual, and we think that failure must be regarded as intentional. We accordingly conclude that petitioner is not entitled to allowance for any of the dividends in question. 843 Reviewed by the Board. Decision will be entered for the respondent.ARUNDELL, VAN FOSSAN, LEECH, MELLOTT, and ARNOLD dissent. Footnotes1. "The item 'Dividends or other profits due policyholders, including those contingent on payment of outstanding and deferred premiums' (Life Statement, page 5, line 32), represents amounts payable as dividends under policies providing for deduction of he dividend from premiums due, where the premium is due but is still within the grace period so that the Company has had no opportunity to apply the dividend in payment. The item 'Dividends declared on or apportioned to annual dividend policies payable to policyholders to and including June 30 of following year, whether contingent upon the payment of renewal premiums or otherwise,' (page 5, line 33) represents the estimated amount of dividends which have been declared and which will become payable upon the anniversary date of policies dated between January 1 and June 30. The total of these two sums on December 31, 1931 was $13,260.00. On December 31, 1932 the total of such amounts was $13,798.00; the increase during the taxable year thus amounting to $538.00." (Stipulation, par. VII.) ↩2. SEC. 201. TAX ON LIFE INSURANCE COMPANIES. (a) Definition.↩ - When used in this title the term "life insurance company" means an insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds. 3. SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL. (a) IMPOSITION OF TAX. - In lieu of the tax imposed by section 13 of this title, there shall be levied, collected, and paid for each taxable year upon the net income of every insurance company (other than a life or mutual insurance company) a tax as follows: (1) In the case of such a domestic insurance company, 13 3/4 per centum of its net income; (2) In the case of such a foreign insurance company, 13 3/4 per centum of its net income from sources within the United States. (b) DEFINITION OF INCOME, ETC. - In the case of an insurance company subject to the tax imposed by this section - (1) GROSS INCOME. - "Gross income" means the sum of (A) the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners, and (B) gain during the taxable year from the sale or other disposition of property; and (C) all other items constituting gross income under section 22; (2) NET INCOME. - "Net income" means the gross income as defined in paragraph (1) of this subsection less the deductions allowed by subsection (c) of this section; (3) INVESTMENT INCOME. - "Investment income" means the gross amount of income earned during the taxable year from interest, dividends, and rents, computed as follows: To all interest, dividends and rents received during the taxable year, add interest, dividends and rents due and accrued at the end of the taxable year, and deduct all interest, dividends and rents due and accrued at the end of the preceding taxable year. (4) UNDERWRITING INCOME. - "Underwriting income" means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred; (5) PREMIUMS EARNED. - "Premiums earned on insurance contracts during the taxable year" means an amount computed as follows: From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year; (6) LOSSES INCURRED. - "Losses incurred" means losses incurred during the taxable year on insurance contracts, computed as follows: To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year, and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year. To the result so obtained add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year; (7) EXPENSES INCURRED. - "Expenses incurred" means all expenses shown on the annual statement approved by the National Convention of Insurance Commissioners, and shall be computed as follows: To all expenses paid during the taxable year add expenses unpaid at the end of the taxable year and deduct expenses unpaid at the end of the preceding taxable year. For the purpose of computing the net income subject to the tax imposed by this section there shall be deducted from expenses incurred as defined in this paragraph all expenses incurred which are not allowed as deductions by subsection (c) of this section. (c) DEDUCTIONS ALLOWED. - In computing the net income of an insurance company subject to the tax imposed by this section there shall be allowed as deductions: (1) All ordinary and necessary expenses incurred, as provided in section 23(a); (2) All interest as provided in section 23(b); (3) Taxes as provided in section 23(c); (4) Losses incurred as defined in subsection (b)(6) of this section; (5) Losses sustained during the taxable year from the sale or other disposition of property; (6) Bad debts in the nature of agency balances and bills receivable ascertained to be worthless and charged off within the taxable year; (7) The amount received as dividends from corporations as provided in section 23(p); (8) The amount of interest earned during the taxable year which under section 22(b)(4) is exempt from the taxes imposed by this title, and the amount of interest allowed as a credit under section 26; (9) A reasonable allowance for the exhaustion, wear and tear of property, as provided in section 23(k); (d) DEDUCTIONS OF FOREIGN CORPORATIONS. - In the case of a foreign corporation the deductions allowed in this section shall be allowed to the extent provided in Supplement I. (e) DOUBLE DEDUCTIONS. - Nothing in this section shall be construed to permit the same item to be twice deducted. ↩4. See footnote 5, infra.↩5. SEC. 208. MUTUAL INSURANCE COMPANIES OTHER THAN LIFE. (a) APPLICATION OF TITLE. - Mutual insurance companies, other than life insurance companies, shall be taxable in the same manner as other corporations, except as hereinafter provided in this section. (b) GROSS INCOME. - Mutual marine-insurance companies shall include in gross income the gross premiums collected and received by them less amounts paid for reinsurance. (c) DEDUCTIONS. - In addition to the deductions allowed to corporations by section 23 the following deductions to insurance companies shall also be allowed, unless otherwise allowed - (1) MUTUAL INSURANCE COMPANIES OTHER THAN LIFE INSURANCE. - In the case of mutual insurance companies other than life insurance companies - (A) the net addition required by law to be made within the taxable year to reserve funds (including in the case of assessment insurance companies the actual deposit of sums with State or Territorial officers pursuant to law as additions to guarantee or reserve funds); and (B) the sums other than dividends paid within the taxable year on policy and annuity contracts. (2) MUTUAL MARINE INSURANCE COMPANIES. - In the case of mutual marine insurance companies, in addition to the deductions allowed in paragraph (1) of this subsection, unless otherwise allowed, amounts repaid to policyholders on account of premiums previously paid by them, and interest paid upon such amounts between the ascertainment and the payment thereof; (3) MUTUAL INSURANCE COMPANIES OTHER THAN LIFE AND MARINE. - In the case of mutual insurance companies (including interinsurers and reciprocal underwriters, but not including mutual life or mutual marine insurance companies) requiring their members to make premium deposits to provide for losses and expenses, the amount of premium deposits returned to their policyholders, and the amount of premium deposits retained for the payment of losses, expenses, and reinsurance reserves. ↩6. Petitioner's policies provide: "SURPLUS. - After premiums for two full years have been paid hereon, upon each succeeding anniversary of the date hereof, this policy shall be entitled to participate in any distribution of surplus made by the company * ." ↩7. Income Statements for 1931 and 1932 list investment profits from interest, dividends and rents; they also list total gross premiums less amounts paid for re-insurance, but with no deduction for "return premiums." ↩8. Tariff Act of 1913. II. G(b); Revenue Act of 1916, sec. (12)(a)(2d); Semble,↩ Revenue Act of 1918, sec. 233(a)(1). 9. H.R. 8245, Calendar No. 286, 67th Cong., 1st sess., Senate Report No. 272, pp. 40, 156, and Senate Report No. 275, p. 83, line 5. Also, H.R. 8245, "As Agreed to in Conference", p. 89, line 20. ↩10. H.R. 8245, "As Agreed to in Conference", p. 118, line 17; see also, Conference Report, H.R. 8245, House Report No. 486, 67th Cong., 1st sess., pp. 40-41. ↩11. H.R. 8245, Senate Report No. 272 (footnote 9, supra↩ ) p. 171; Senate Report 275, p. 102; "As Agreed to in Conference", p. 113. 12. Congressional Record, vol. 61, part 7, p. 6981, 67th Cong., 1st sess. ↩13. Footnote 12, supra.↩14. Congressional Record, vol. 61, part 7, p. 7159, 67th Cong., 1st sess. ↩15. Congressional Record, vol. 61, part 7, p. 7159, 67th Cong., 1st sess.: "Mr. Smoot: * * These amendments are simply to perfect the original amendment so as to exclude mutual companies from the tax imposed under this amendment and allow the mutual companies to pay under existing law. * * *." See also footnote 17, infra.↩16. Footnote 12, supra; see also Senate Report No. 275, 67th Cong., 1st sess., p. 20; H.R. 8245, Senate Report No. 272, p. 175, and Senate Report No. 275, p. 107; and see footnote 14, supra.↩17. Congressional Record, vol. 61, part 7, p. 7159, 67th Cong., 1st sess.: "Mr. Smoot. I will tell the Senator what the changes are. The only changes are that we have amended the amendment by making a separate provision for mutual companies. In the past the mutual companies have paid scarcely any tax whatever. In some cases it is so small that it would hardly be denominated a tax. If they are included in this amendment, the tax in some cases would represent an increase of over 400 per cent. The purpose of it is to allow the mutual companies to pay taxes under existing law. "Mr. Simmons. You exempt them from this new scheme? "Mr. Smoot. We exempt them from this new scheme. "Mr. Simmons. So as not to overtax them. I agree with the Senator about it. "Mr. Smoot. That is all there is to it." ↩18. The comparable parts of the 1932 Act are section 208(c)(1)-(3), footnote 5, supra. The provision designated (c) in the quoted excerpt was omitted in the 1921 Act. See footnote 9, supra.↩19. The exception is for the amount of "premium deposits" returned to policy holders or retained for specified purposes. It seems that a premium deposit is a deposit against the payment of a premium the amount of which is to be determined at a later time, and not the payment of a fixed premium with a possible subsequent right to share in profits by means of a dividend. See Solicitor's Opinion 156, III-1, C.B. 284. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622676/	James M. McDonald, Petitioner, v. Commissioner of Internal Revenue, RespondentMcDonald v. CommissionerDocket No. 23887United States Tax Court23 T.C. 1052; 1955 U.S. Tax Ct. LEXIS 220; March 23, 1955, Filed 220 Decision will be entered under Rule 50. Petitioner, owner of a dairy and breeding herd, sustained a loss on its operation during each of the years 1942 to 1946, inclusive. Petitioner sold certain cattle from the herd in 1946 on which he realized capital gains. Respondent determined that only one-half of such capital gains is includible in petitioner's gross income from his dairy and breeding herd, and that petitioner's net income must be recomputed for the year 1946 pursuant to section 130 of the Internal Revenue Code of 1939 to limit the deductible losses from such business to $ 50,000 for that year. The respondent concedes that if the entire amount of such capital gains is includible in the gross income of this business, petitioner's deductions (other than the taxes and interest) do not exceed such gross income by $ 50,000, and section 130 is inapplicable. Held, 100 per cent of capital gains is includible in gross income for the purpose of a section 130 recomputation; and, consequently, petitioner's net income is not subject to recomputation under such section for the year 1946. Philip M. Aitken, Esq., for the petitioner.Clay C. Holmes, Esq., for the respondent. Rice, Judge. RICE1053 This proceeding is before us on remand from the United States Court of Appeals for the Second Circuit for further proceedings in accordance with the opinion of that court, appearing at 214 F. 2d 341 (1954). In its opinion the court reversed our holding, at 17 T. C. 210 (1951), that the gains derived by petitioner from the sale of certain cattle were to be taxed as ordinary income rather than capital gains. We must now decide, pursuant to the mandate, an issue which we did not reach in our prior opinion; namely, whether the entire amount or one-half223 of such capital gains is includible in petitioner's gross income from his dairy and breeding herd for the purpose of determining the applicability of section 130 of the Internal Revenue Code of 1939. Respondent determined a deficiency in income tax for the year 1946 in the amount of $ 96,863.87 on the basis of a section 130 recomputation.SUPPLEMENTAL FINDINGS OF FACT.The following facts are summarized from our Findings of Fact at 17 T. C. 210 (1951), insofar as pertinent to the decision of the issue now before us:Petitioner was, during the year 1946, the owner of a dairy and breeding herd of pure bred Guernsey cattle which he started developing in the year 1933. In 1946 petitioner had a herd of 523 Guernsey cattle on his 1,500-acre farm which was located near the town of Cortland, New York. It was one of the best herds of Guernsey cattle in the United States.Petitioner has, through the years, attempted to improve the quality of his herd. Thus, he frequently purchased animals from other herds to get new blood. He eliminated from his herd, as rapidly as possible, all animals whose breeding qualities he considered inferior. Some calves were sold within224 2 to 5 days after birth; however, it took up to 8 or 9 years to determine whether the majority of the animals were able to transmit the desired characteristics and should, therefore, be retained in the herd. The quality of petitioner's herd improved over the years, as shown by a 50 per cent increase in average milk production per cow, without an increase in the amount of feed consumed.Petitioner sustained a loss from the operation of his dairy and breeding herd during each of the years 1942 through 1946, inclusive.SUPPLEMENTAL OPINION.The deficiency determined by respondent was based originally on the theory that the proceeds from the sale of cattle by petitioner were taxable as ordinary income rather than capital gains. But, by amended answer, respondent affirmatively raised an alternative 1054 issue which must now be decided. Respondent contends, in this alternative issue, that if the proceeds of such sales are taxable as capital gains (as they must be according to the holding of the Court of Appeals) then petitioner's net income for 1946 must be recomputed pursuant to section 130 of the Internal Revenue Code of 1939, 1 in order to limit the deductions (other than taxes225 and interest) allowable for his dairy and breeding herd to $ 50,000 for that year.Respondent concedes that if 100 per cent of the capital gains realized by petitioner on the sale of226 cattle is includible in the gross income of his dairy and breeding herd, the deductions allowable for that business will not exceed its gross income by $ 50,000 for 1946 and, consequently, section 130 will not apply. However, respondent contends that only one-half of capital gains is properly includible in gross income. Computing gross income in this manner, he has determined that petitioner's deductions (other than taxes and interest) attributable to this business exceeded his gross income therefrom by more than $ 50,000 for 5 consecutive years. Respondent, therefore, contends that petitioner's net income for the year here in issue, 1946, must be recomputed pursuant to section 130 (a) in order to limit his deductible losses from his dairy and breeding herd for that year to $ 50,000.Whether all or one-half of the capital gains realized by a taxpayer are includible in his gross income for the purpose of a section 130 recomputation appears to be a question not heretofore decided. Respondent relies on United States v. Benedict, 338 U.S. 692">338 U.S. 692 (1950). In that case, the trustees under a testamentary trust had, as directed in the will, set aside 45 227 per cent of the trust's net income to a charitable corporation. Included in the trust's net income were long-term capital gains. The trustees claimed the right to deduct the full amount of the contribution, pursuant to section 162 (a), which provides for the deduction from trust income of "any part of the gross income" paid over to a charitable corporation. This was opposed on the theory that part of this contribution was made from capital gains, only half of which are taken into account in computing net income. The Supreme Court was thus faced with the problem of whether all or one-half of the capital gains realized by the trust were includible in gross income for the purpose of determining the amount of charitable contributions 1055 deductible pursuant to section 162 (a). The Court stated the issue as follows, p. 696:The narrow statutory question thus presented is whether the entire recognized capital gains or only that half taken into account under § 117 (b) shall constitute gross income for tax purposes. Stated conversely, the question is whether that half of a taxpayer's recognized capital gains that is not taken into account for tax purposes shall be left out of 228 account by way of its initial exclusion from gross income, or by way of its subsequent deduction from gross income. On this precise question the Code is silent. No provision of the Code and nothing in the legislative history or administrative practice expressly settles the course to be followed. We, therefore, seek the purposes of the applicable sections of the Code and adopt that construction which best gives effect to those purposes.The two sections there involved were sections 162 (a) and 117 (b). The Court found that the purpose of section 162 (a) would be served by either of the constructions urged by the parties, but that the inclusion of 100 per cent of the capital gains in gross incomewould result in taxing the capital gains at substantially less than 50% of the amount at which they would be taxed if they were ordinary income. To the extent that the amount subject to tax goes below that percentage, it fails to give effect to the purpose of § 117 (b). * * The Court therefore held, at pages 698 and 699:We treat the words in § 117 (b), which state that only 50% of certain recognized capital gains "shall be taken into account in computing * * net income," as applying229 to the entire computation of the tax, beginning with the statement of the gross income of the trust and concluding with its taxable net income. * * We treat that percentage of capital gains which expressly is not to be taken into account in computing taxable net income as also excluded from statutory gross income. * * The Supreme Court could find nothing in the Code or legislative history to settle the problem of whether gross income included all or one-half of capital gains. Nor could it find any help in the alternative formula for computing gains provided by section 117 (c). 2 In Commissioner v. Central Hanover B. & T. Co., 163 F. 2d 208 (C. A. 2, 1947), certiorari denied 332 U.S. 830">332 U.S. 830 (1947), it was held that section 22 (a) required the inclusion in gross income of "gains" only as defined in section 117 (a) (4) and (5); that long-term gains, as defined in that section, consist only of the amount actually taken into account in computing net income; and that "Accordingly the amount of long-term capital gain not taken into account under § 117 does not 1056 constitute gross income * * * under § 22 (a)." This230 theory was rejected by the Court of Claims in Helen W. Benedict, et al., 112 Ct. Cl. 550">112 Ct. Cl. 550, 558, 81 F. Supp. 717 (1949), revd. 338 U.S. 692">338 U.S. 692 (1950), holding that:Section 117 (a) (4) recognizes as gross income the entire gain defined by Sections 22 and 111, and then classifies such gain as a "long-term capital gain" for special treatment in computing net income only if the asset from which such total or gross gain was derived, had been held for more than 6 months.In reversing the Court of Claims in the Benedict case, the Supreme Court restricted its holding to that interpretation of the sections involved as would best effectuate the congressional intent. We think that approach should be used here.231 Section 130 became a part of the Code in 1943 to limit the so-called "hobby losses" of individuals. If an individual's deductions 3 from a trade or business exceed his gross income therefrom by more than $ 50,000 for each of 5 consecutive years, this section requires that his net income be recomputed to limit his deductible losses from that business to $ 50,000 for each of such years. We have carefully examined the legislative history of this section and are convinced that it was designed to limit the deductibility of losses only with respect to those businesses which were actually conducted at a loss in excess of $ 50,000 for each of 5 consecutive years. It was recognized in the debate in the Senate that this section might affect many taxpayers who did not conceive of the operation of their unprofitable business as hobbies and that they might suffer large losses during the developmental stage. But, such history shows that the legislators intended to limit the deductibility of losses from such business also.232 However, if respondent's argument is correct that only one-half of an individual's capital gains is includible in gross income for the purpose of this recomputation, even profitable businesses would sometimes be affected. There is nothing in the legislative history of the section that even remotely compels this result. The following illustration will serve to show the unsoundness of respondent's position. Assuming that a taxpayer's income is $ 400,000 which he has received from the sale of raised cattle and milk from his breeding and dairy herd, and that his expenses for the year were $ 305,000, the results of his operations for the year would be:Sale of milk$ 100,000Sale of cattle300,00Total income$ 400,000Less: Expenses305,000Taxpayer's profit $ 95,0001057 Under respondent's theory of section 130, this individual's tax would be recomputed and his net taxable income increased $ 5,000, because his deduction for expenses would be limited to $ 300,000, as the following figures illustrate:Ordinary income:Sale of milk$ 100,000Capital gains:Sale of cattle$ 300,000Less one-half because long-term capital gain150,000150,000Gross income$ 250,000Total expenses305,000Taxpayer's "loss" $ 55,000233 Since the loss exceeds $ 50,000, the taxpayer's liability for taxes must be recomputed under section 130, as follows: 4Total Deductions Under Section 130"Gross income"$ 250,000Statutory maximum50,000$ 300,000Expenses deducted on return305,000Amount of deduction which is in excess of allowable deduction undersection 130 would be added to the taxpayer's net taxable income $ 5,000Thus, in spite of the fact that this individual was operating a profitable business, showing a profit of $ 95,000, the Commissioner, under his theory, could add $ 5,000 more to his net taxable income which he did not make or receive, and all on the theory that he was running an unsuccessful business with losses exceeding $ 50,000 which required a recomputation of his taxes under section 130.We, therefore, hold that, for the purpose of a section 130 recomputation, gross income includes 100 per cent of the capital gains realized 234 by an individual. 5 As in the Benedict case (which construed a different section of the Code), we follow the rationale there used by the Supreme Court and reach a conclusion that will best effectuate the congressional intent underlying the enactment of section 130; and, 1058 while the result herein is different from the result in that case, we feel it is justified here, as it was there, in order to give proper effect to the purpose of the section. 6235 Decision will be entered under Rule 50. Footnotes1. SEC. 130. LIMITATION ON DEDUCTIONS ALLOWABLE TO INDIVIDUALS IN CERTAIN CASES.(a) Recomputation of Net Income. -- If the deductions (other than taxes and interest) allowable to an individual (except for the provisions of this section) and attributable to a trade or business carried on by him for five consecutive taxable years have, in each of such years, exceeded by more than $ 50,000 the gross income derived from such trade or business, the net income of such individual for each of such years shall be recomputed. For the purpose of such recomputation in the case of any such taxable year, such deductions shall be allowed only to the extent of $ 50,000 plus the gross income attributable to such trade or business, except that the net operating loss deduction, to the extent attributable to such trade or business, shall not be allowed.↩2. SEC. 117. CAPITAL GAINS AND LOSSES.(c) Alternative Taxes. -- * * * (2) Other taxpayers. -- If for any taxable year the net long-term capital gain of any taxpayer (other than a corporation) exceeds the net short-term capital loss, there shall be levied, collected, and paid, in lieu of the tax imposed by sections 11 and 12, a tax determined as follows, if and only if such tax is less than the tax imposed by such sections:A partial tax shall first be computed upon the net income reduced by the amount of such excess, at the rates and in the manner as if this subsection had not been enacted, and the total tax shall be the partial tax plus 50 per centum of such excess.↩3. With certain specified exceptions, see footnote 1, supra↩.4. Assuming losses in excess of $ 50,000 for each of the 4 preceding years.↩5. Regs. 111.Sec. 29.22(a)-7. Gross Income of Farmers. -- A farmer reporting on the basis of receipts and disbursements (in which no inventory to determine profits is used) shall include in his gross income for the taxable year (1) the amount of cash * * received during the taxable year from the sale of live stock * * * which were raised during the taxable year or prior years, * * *↩6. For interpretations of a different section of the Code dealing with the amount of capital gains includible in gross income for the purpose of the application of the 5-year statute of limitations pursuant to section 275 (c), see Emma B. Maloy, 45 B. T. A. 1104 (1941); but cf. American Foundation Co., 2 T. C. 502↩ (1943).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622677/	John E. Palmer and Hilda I. Palmer, Petitioners, v. Commissioner of Internal Revenue, RespondentPalmer v. CommissionerDocket No. 5173-63United States Tax Court44 T.C. 92; 1965 U.S. Tax Ct. LEXIS 98; April 22, 1965, Filed 98 Decision will be entered under Rule 50. Petitioners contracted to sell real property owned by Hilda and received part payment of the purchase price. Two days later they transferred the property to a corporation wholly owned by them. Subsequently the corporation carried out the sales contract by transferring the property to the named purchasers and received the balance of the purchase price. Held, the sale was actually made by petitioners, not the corporation, and the gain realized upon the sale of the property is taxable to petitioners as long-term capital gain. John A. Mitchell, for the petitioners.John C. Galluzzo, Jr., for the respondent. Mulroney, Judge. MULRONEY 92 OPINIONRespondent determined a deficiency in petitioners' 1960 income tax in the amount of $ 6,214.33. The issue is whether the gain realized upon the sale of a parcel of realty is taxable to petitioners or their wholly owned corporation.All of the facts have been stipulated and they are found accordingly.John E. Palmer and Hilda I. Palmer, with residence at Cumberland Center, Maine, filed a joint income tax return for the taxable year 1960 with the district director of internal revenue, 99 Augusta, Maine.J. E. Palmer Co. is a Maine corporation which is wholly owned by petitioners. Of the 579 shares of no-par stock outstanding, John E. Palmer owns 576 shares and Hilda I. Palmer owns the remaining 3 shares. J. E. Palmer Co. filed its Federal income tax returns on the basis of a fiscal year ending January 31.For the fiscal years ended January 31, 1958, January 31, 1959, and January 31, 1960, J. E. Palmer Co. reported on its Federal income tax returns net losses as follows:Fiscal yearNet lossended Jan. 31 --reported1958$ 12,503.78195911,122.68196031,135.92During the year 1960 Hilda I. Palmer, petitioner herein, was the sole owner of a parcel of real estate located in Raymond, Maine. This parcel had a basis to her of $ 5,000 and a fair market value of $ 35,000 during the taxable year 1960.In December 1959 J. E. Palmer Co. was indebted to the Canal National Bank of Portland, Maine, in the amount of $ 177,000, and the bank became concerned about the security which it held and demanded that John E. Palmer furnish additional security.93 The petitioners agreed to mortgage the parcel of real estate located in Raymond, Maine, as additional100 security. By a mortgage deed dated January 5, 1960, and recorded with Cumberland County Registry of Deeds on January 15, 1960, the parcel of real estate located in Raymond, Maine, was made subject to a mortgage in favor of the Canal National Bank up to the principal sum of $ 35,000. The petitioners did not sign a promissory note nor was any money advanced to them at the time the mortgage deed was given to the Canal National Bank of Portland, Maine.In the spring of 1960, because J. E. Palmer Co. was showing signs of continuing to operate at a loss, the Canal National Bank suggested to the petitioner, John E. Palmer, that consideration should be given to obtaining substantial additional capital for the J. E. Palmer Co., or selling the corporation, or obtaining financing elsewhere. On June 8, 1960, after several conferences with the Canal National Bank, the petitioners advised the Canal National Bank that Hilda I. Palmer, petitioner herein, would sell the real estate located in Raymond, Maine, the net proceeds to be used to reduce the indebtedness of J. E. Palmer Co. to the Canal National Bank.During the months of June and July 1960, petitioners negotiated the sale of the parcel101 of real estate located in Raymond, Maine, with Edward H. Shively. On August 6, 1960, petitioners entered into a written contract for sale of the parcel of real estate located in Raymond, Maine, wherein it was provided that petitioners agreed to sell and Edward H. Shively and Elizabeth M. Shively agreed to purchase the said real estate for a total purchase price of $ 35,000. On that same date the sum of $ 1,000 was given to petitioners as part earnest money and in part payment on account of the purchase price. Edward H. Shively and Elizabeth M. Shively agreed to pay the balance of the purchase price and execute all papers necessary for completion of the purchase on or before October 10, 1960.On August 8, 1960, Hilda I. Palmer executed a warranty deed transferring the parcel of real estate located in Raymond, Maine, to J. E. Palmer Co. This transfer of the real estate located in Raymond, Maine, was reflected on the books of J. E. Palmer Co. as follows:DebitCreditReal estate$ 5,000Local A/P$ 5,000To record purchase of real estate at Raymond, Maine, from Mrs.J. E. Palmer.On September 19, 1960, the warranty deed transferring the property located in Raymond, 102 Maine, from Hilda I. Palmer to J. E. Palmer Co. was recorded with the Cumberland County Registry of Deeds.94 On October 10, 1960, Edward H. Shively and Elizabeth M. Shively tendered $ 34,000 as payment in full for the property located in Raymond, Maine, in conformity with the agreement dated August 6, 1960.On October 10, 1960, J. E. Palmer Co. executed a warranty deed conveying the parcel of real estate located in Raymond, Maine, to Edward H. Shively and Elizabeth M. Shively.On October 11, 1960, a warranty deed dated October 10, 1960, conveying the parcel of real estate from J. E. Palmer Co. to Edward H. Shively and Elizabeth M. Shively, was recorded with the Cumberland County Registry of Deeds.The cost incurred in selling the property located in Raymond, Maine, amounted to $ 2,306, computed as follows:Broker's commission$ 2,260.00Recording of deed7.50Transfer stamps38.50Total2,306.00J. E. Palmer Co. reported the conveyance of the real estate located in Raymond, Maine, on its corporate income tax return for the fiscal year ended January 31, 1961, as follows:Gross sales price$ 35,000Cost of property$ 5,000Expense of sale2,3067,306Short-term capital gain27,694103 Of the $ 35,000 received from the sale of the parcel of real estate located in Raymond, Maine, petitioners retained $ 5,000 for their own use and $ 27,500 was turned over to the Canal National Bank of Portland, Maine, to reduce the indebtedness of J. E. Palmer Co.Respondent determined, as set forth in his notice of deficiency, that petitioners "realized a long term capital gain in the amount of $ 35,000 resulting from the sale of the mortgaged property in Raymond, Maine." His computation of deficiency is based on a sale price of the realty at $ 40,000 but he now concedes the sale price was $ 35,000 and he also stipulates the total costs incurred in the sale was the sum of $ 2,306.It is respondent's position that J. E. Palmer Co. was a mere conduit through which title passed in effecting the sale of the Raymond real estate by petitioner Hilda I. Palmer to the Shivelys. He argues the transaction must be regarded as Hilda's sale to the Shivelys and he relies upon .Petitioners admit on brief "that the transfer to J. E. Palmer Co. was made for the purpose of saving taxes by utilizing the company loss 104 carry over" but they argue that does not mean the transaction 95 was a sham; that there was a bona fide sale of the Raymond property to the corporation; and the transfer of the Raymond property to the corporation served a business purpose.We agree with respondent. The subsequent transfer of the Raymond property to the corporation after petitioners' execution of the contract to sell to the Shivelys would be ineffective to avoid the taxing of the profit on the sale to the petitioner. ;, and . This case is parallel to Court , but it is stronger for respondent than that case. There the corporation had entered into sale negotiations but no binding contract for the sale of its realty before the liquidation transfer of the realty to its stockholders. When the latter subsequently conveyed to the purchaser who had originally negotiated for the purchase from the corporation, the Supreme Court held the evidence warranted a finding that it was a 105 sale by the corporation and not the stockholders. In the instant case the presence of the written contract to sell and also the payment of $ 1,000 to petitioners as part payment of the purchase price before title was passed to the corporation, practically demands that this be regarded as a sale by petitioners and their corporation be regarded as acting on their behalf in taking title and disposing of it in accordance with their contract of sale.The argument that some business purpose was served by the transfer of title to the corporation is without force. That transfer was necessarily subject to the outstanding contract of sale which both petitioners had executed just 2 days before. There was nothing for the corporation to do but pass along the title in conformity with petitioners' contract.Petitioners minimize Hilda's connection with the corporation and argue on brief that "Hilda I. Palmer is a stranger to the corporation and individually received no gain." The corporation income tax return shows she was president of the corporation working full time for a yearly salary of $ 2,290. It is true that she owned but a small stock interest (3 shares out of 579 issued) but this was106 a family corporation where she and her husband owned all the stock and it can hardly be said she was a stranger to the corporation.In our opinion the intermediate transfer of the title to the Raymond property after the contract of sale, so it could pass title on to the purchasers named in the contract, was merely one step taken by petitioners in their transfer of title to the named purchasers. Such a step is not entitled to separate tax treatment. The transaction must be viewed as a whole. The substance of the transaction, or the sum of all steps to reach an intended result, was petitioners' sale of the Raymond property to the Shivelys for $ 35,000. That is what is to be taxed. 96 Petitioners had signed a written agreement to furnish the Shivelys with title to the Raymond property. The fact that title, on its way from petitioners to the Shivelys, passed through their family-owned corporation does not alter the tax consequences arising from a sale by petitioners to the Shivelys.Respondent's determination that the long-term gain realized on the sale of the Raymond property to the Shivelys is taxable to petitioners is sustained. However, the gain is to be based upon a *107 sale price of $ 35,000 with deduction for the stipulated costs of sale.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622678/	JOSEPH L. SIKES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSikes v. CommissionerDocket No. 10637-79.United States Tax CourtT.C. Memo 1982-490; 1982 Tax Ct. Memo LEXIS 253; 44 T.C.M. (CCH) 955; T.C.M. (RIA) 82490; August 25, 1982. 253 P filed Forms 1040 for 1976 and 1977 on which he failed to provide specific information as to income and deductions. On such forms, he asserted a variety of constitutional objections and attached a number of printed materials supporting his contentions. Held, P is liable for the deficiencies determined by the Commissioner. Held, further, as the Forms 1040 do not constitute returns, P is liable for the additions to tax under sec. 6651(a)(1), I.R.C. 1954, for failure to file returns. Joseph L. Sikes, pro se. Willie Fortenberry, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined the following deficiencies in and additions to the petitioner's Federal254 income taxes: Additions to TaxSec. 6651(a)(1)YearDeficiencyI.R.C. 1954 11976$1,250.00$75.0019771,108.0077.00The issues for decision are: (1) Whether the petitioner properly reported his income during 1976 and 1977; and (2) whether the petitioner is liable for the additions to tax under section 6651(a)(1) for failure to file returns. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioner, Joseph L. Sikes, resided in Bushnell, Fla., at the time he filed his petition in this case. For 1976, Mr. Sikes filed an individual Form 1040 containing his name, address, and social security number. He listed his occupation as clergy and claimed a total of four exemptions. Such Form 1040 was signed and dated April 12, 1977. Beneath his signature was the statement "Information and signature involuntarily submitted under threat of statutory punishment." On such form, he entered no amounts for income, adjustments, or computations; he stated that: "objection is take[n] to the specific255 question on grounds of the 4th and 5th Amendments of the U.S. Constitution." Mr. Sikes attached a computation of social security self-employment tax (Schedule SE) to his Form 1040 where he listed $8,500.00 as self-employment income. On the Schedule SE, he computed a tax of $671.50 and entered such figure on the Form 1040 (lines 50 and 21). To this figure he added $278.50, resulting in total taxes of $950.00 (line 22). He claimed estimated tax payments of $950.00 (line 22) and showed no balance due or no amount overpaid (lines 25 and 26). Mr. Sikes attached five additional pages to his Form 1040, including a printed form letter to the Internal Revenue Service setting forth constitutional objections, affidavits by W. Vaughn Ellsworth and by witnesses of his trial, quotations from Federal cases, and a copy of a news clipping. For 1977, Mr. Sikes filed a Form 1040 similar to the one he had submitted for 1976. As in the form for 1976, he included no information concerning the amount of his income or deductions. However, on the Form 1040 for 1977, his objections were based on the Fourth, Fifth, Seventh, Eighth, Ninth, Tenth, Thirteenth, Fourteenth, and Sixteenth Amendments. 256 He attached a Schedule SE on which he reported $8,150.00 of self-employment income. On such schedule, he computed a tax of $643.00 and entered the $643.00 figure on the Form 1040. To this figure he added $139.00 (line 35), resulting in total taxes of $782.00. He claimed estimated tax payments of $800.00 and an overpayment of $18.00. In his notice of deficiency, the Commissioner determined that the petitioner received gross income of $8,500.00 in 1976 and $8,150.00 in 1977 and that such income was not properly reported. The Commissioner also determined that the petitioner failed to file timely returns and that such failure was not due to reasonable cause. Accordingly, he asserted an addition to tax under section 6651(a)(1) for both years. OPINION The first issue for decision is whether the petitioner properly reported his income during 1976 and 1977. The petitioner has the burden of disproving the deficiencies determined by the Commissioner. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). At trial, the petitioner offered no evidence to rebut such determination; instead, he relied on the Constitution as257 a basis for his withholding of financial information. It is well settled that taxpayers are required to file income tax returns in accordance with the provisions of the Internal Revenue Code. Mr. Sikes' constitutional objections all have been considered on repeated occasions by the courts and have been held to be totally without merit. See, e.g., United States v. Sullivan,274 U.S. 259">274 U.S. 259 (1927); United States v. Daly,481 F.2d 28">481 F. 2d 28, 30 (8th Cir. 1973); Rechtzigel v. Commissioner, 79 T.C. (July 26, 1982); Jarvis v. Commissioner,78 T.C. 646">78 T.C. 646 (1982); Thompson v. Commissioner,78 T.C. 558">78 T.C. 558 (1982); Reiff v.Commissioner,77 T.C. 1169">77 T.C. 1169 (1981); McCoy v. Commissioner,76 T.C. 1027">76 T.C. 1027 (1981), on appeal (9th Cir., Sept. 15, 1981); Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895 (1977); Cupp v.Commissioner,65 T.C. 68">65 T.C. 68 (1975), affd. 559 F. 2d 1207 (3d Cir. 1977). As the petitioner has failed to present any evidence to rebut the Commissioner's determinations, we sustain such determinations as to the deficiencies for 1976 and 1977. The second258 issue for decision is whether the Commissioner properly asserted the addition to tax under section 6651(a)(1). Such section provides that for failure to file a return, there shall be due an addition to tax of up to 25 percent of the tax required to be shown on the return, reduced by certain timely payments, unless it is shown that such failure to file is due to reasonable cause and not willful neglect. The petitioner has the burden of proving that there was reasonable cause for the failure to file. Rule 142(a), Tax Court Rules of Practice and Procedure; BJR Corp. v. Commissioner,67 T.C. 111">67 T.C. 111, 131 (1976). In order for a document to constitute a valid return, it must contain sufficient information for the Commissioner to compute and assess the liability with respect to a particular tax of a taxpayer. Automobile Club of Mich. v. Commissioner,353 U.S. 180">353 U.S. 180, 188 (1957); Florsheim Bros. Drygoods Co.v. United States,280 U.S. 453">280 U.S. 453 (1930); United States v. Edelson,604 F. 2d 232 (3d Cir. 1979); United States v. Johnson,577 F. 2d 1304, 1311 (5th Cir. 1978); United States v. Daly,supra;259 Reiff v. Commissioner,supra. The disclosure of such data must be provided in a uniform, complete, and orderly fashion. Commissioner v. Lane-Wells Co.,321 U.S. 219">321 U.S. 219, 223 (1944). Furthermore, a Form 1040 does not qualify as a return where it does not specifically state the items of gross income and the deductions and credits claimed by the taxpayer. See United States v. Moore,627 F. 2d 830 (7th Cir. 1980); Thompson v. Commissioner,supra;Conforte v. Commissioner,74 T.C. 1160">74 T.C. 1160, 1195 (1980); Sanders v. Commissioner,21 T.C. 1012">21 T.C. 1012 (1954), affd. 225 F. 2d 629 (10th Cir. 1955); see also United States v. Johnson,supra.It is clear from the record that the Forms 1040 filed by the petitioner fall woefully short of constituting returns. Furthermore, Mr. Sikes has shown no "bona fide misunderstanding as to his liability for the tax, [or] as to his duty to make a return." United States v. Murdock,290 U.S. 389">290 U.S. 389, 396 (1933). His vague assertion of constitutional violations and his erroneous interpretation of existing case law260 simply does not convince us that his failure to file was due to reasonable cause. See Muste v. Commissioner,35 T.C. 913">35 T.C. 913 (1961); see also Richardson v. Commissioner,72 T.C. 818">72 T.C. 818 (1979); Hatfieldv. Commissioner,supra.Accordingly, we sustain the Commissioner's determination on this issue. Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during 1976 and 1977.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622679/	HAROLD KLAPPER, Petitioner COMMISSIONER OF INTERNAL REVENUE, RespondentKlapper v. CommissionerDocket No. 36115-87United States Tax CourtT.C. Memo 1990-372; 1990 Tax Ct. Memo LEXIS 392; 60 T.C.M. (CCH) 182; T.C.M. (RIA) 90372; July 23, 1990, Filed 392 Decision will be entered under Rule 155. Harold Klapper, pro se. Hannah Klapper, for the respondent. WELLSMEMORANDUM OPINION Respondent determined deficiencies in and additions to petitioner's Federal income taxes as follows: Addition to Tax UnderTaxable YearDeficiencySection 6651(a) 11979$ 6,307.00 $ - 0 -198111,987.00784.40198212,013.00268.90198314,264.00- 0 -19858,547.00 - 0 -393 After concessions, we must decide the following issues: (1) whether petitioner's writing/photography and law activities during the taxable years in issue were engaged in for profit; (2) whether petitioner has substantiated deductions attributable to those activities and charitable contributions; and (3) whether the instant proceedings have been maintained by petitioner primarily for delay, or whether petitioner's position has been frivolous or groundless within the meaning of section 6673(a) of the Internal Revenue Code. For convenience, we will combine our findings of fact and opinion. The parties each refused to sign the other's proposed stipulation of facts. Consequently, none of the facts were stipulated for trial. In his opening brief, petitioner did not propose findings394 of fact, and in his reply brief, petitioner made no objections to respondent's proposed findings of fact, as required by Rule 151(e)(3). Petitioner made only the following statement with regard to proposed findings of fact: Because of the nature of the law and constitutional violations by the respondent and Judge Wells, the facts upon which judgment should be found for petitioner, is the record, absorbed from the total record to this matter including, but not exclusively, the transcript of the record at trial, (including those portions of the record the trial judge kept out of evidence and/or from being identified). [Emphasis in original.]We find petitioner's statement to be frivolous. Accordingly, we assume that petitioner has no objections to respondent's proposed findings of fact. Petitioner's legal arguments on brief are similarly vague and incoherent. Petitioner's sole argument on brief is that "under binding authority, petitioner in law, fact and equity, and constitutional mandate, is right." We find petitioner's statement to be frivolous and not in compliance with Rule 151(e)(5), which requires parties to set forth and discuss the points of law395 involved and any disputed questions of fact. Petitioner is an attorney and should therefore know that his brief is insufficient. Although we may treat arguments not briefed as conceded (Rule 151(e); Remuzzi v. Commissioner, T.C. Memo. 1988-8), we nevertheless will addressthe issues set out above. Petitioner bears the burden of proof with respect to all issues in the instant case. Rule 142(a). Petitioner resided in New York, New York, at the time he filed his petition. Petitioner is an attorney and a member of the New York bar. At trial, petitioner offered as evidence, for the purpose of substantiating his Schedule C expenses, plastic grocery shopping bags filled with disheveled, disorganized, and incomplete statements and receipts. The Court stated that it would not admit the documents in such condition and that it would admit the documents only if copies were made and the documents offered into evidence in an organized manner. The Court offered petitioner time to copy and organize the documents, but petitioner declined the Court's offer. Thereupon, the Court ruled that the documents would not be admitted. To prove Schedule C expenses, petitioner also396 offered the same bank statement that he had offered to prove interest expenses that had been the subject of a stipulated settlement by the parties. The record contains no records, receipts, or written statements to substantiate the amounts of alleged travel expenditures, the time of alleged travel, or the business purpose of alleged travel, during the years in issue. Sec. 274(d). In sum, petitioner has not substantiated by credible evidence any of the deductions in issue beyond those allowed by respondent. Moreover, petitioner has not proved that any of his alleged writing/photography or law activities were engaged in for profit as required by section 183. Petitioner has the burden of proving that he engaged in his alleged activities with the requisite profit objective. Rule 142(a); Dunn v. Commissioner, 70 T.C. 715">70 T.C. 715, 720 (1978), affd. 615 F.2d 578">615 F.2d 578 (2d Cir. 1980).Based upon the record as a whole, we find that petitioner has failed to prove that those alleged activities were conducted with an actual and honest profit objective. Levy v. Commissioner, 91 T.C. 838">91 T.C. 838, 871 (1988); Elliott v. Commissioner, 90 T.C. 960">90 T.C. 960 (1988),397 affd. 899 F.2d 18">899 F.2d 18 (9th Cir. 1990); Dreicer v. Commissioner, 78 T.C. 642">78 T.C. 642 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983).Petitioner did not prove that he carried on his activities in a businesslike manner, that he maintained adequate books and records, that he made significant changes in his operating methods, that he sought expert advice, that he spent substantial time and effort on his activities, that he had a history of profit from his activities, and that he did not derive significant personal pleasure from his activities. Sec. 1.183-2(b), Income Tax Regs. After observing petitioner's demeanor on the witness stand, we find that petitioner is not a credible witness. Throughout the trial, and before and after the trial, petitioner attempted to mischaracterize statements of the Court and of respondent's counsel. Petitioner appeared hostile and belligerent. During the trial, the Court admonished petitioner for his attempts to impugn the Court and warned him that the Court would hold him in contempt if he continued such conduct. The only argument made by petitioner in these proceedings is that he is the victim of unconstitutional398 discrimination. Petitioner made that argument in a motion for summary judgment denied by the Court prior to trial. As a general rule, we do not look behind a deficiency notice to examine the evidence used or the propriety of respondent's motives or of the administrative policy or procedure involved in making the determinations. Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324, 327 (1974).An exception to the foregoing rule is made when a taxpayer produces "substantial evidence of unconstitutional conduct by respondent in determining the deficiency * ." (Citations omitted.) Berkery v. Commissioner, 91 T.C. 179">91 T.C. 179, 186 (1988), affd. 872 F.2d 411">872 F.2d 411 (3d Cir. 1989); Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792, 814 (1972), overruled in part Guzzetta v. Commissioner, 78 T.C. 173">78 T.C. 173, 184 (1982).2 Nonetheless, in the instant case, petitioner failed to produce "substantial evidence of unconstitutional conduct" by respondent. Moreover, how a taxpayer is treated by the Commissioner in relation to other taxpayers is generally irrelevant to deciding a case before us. Penn-Field Industries, Inc. v. Commissioner, 74 T.C. 720">74 T.C. 720, 723 (1980);399 Davis v. Commissioner, 65 T.C. 1014">65 T.C. 1014, 1022 (1976).Therefore, petitioner's vague claims of unconstitutional conduct do not affect the resolution of the instant case. Respondent has moved, pursuant to section 6673, for an award of damages (penalty) in the instant case. We believe that such an award is appropriate. As noted above, *400 petitioner's statements and actions throughout the instant proceedings have been frivolous and groundless and have amounted to a waste of the Court's time and that of respondent. Rather than pursuing the issues before us in the instant proceedings, petitioner pursued issues concerning the conduct of respondent, as noted above, which allegedly occurred during the audit of petitioner for the years in issue. Accordingly, we will grant respondent's motion for damages and award the United States damages (penalty) in the amount of $ 5,000. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. In Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792, 814 (1972), overruled in part Guzzetta v. Commissioner, 78 T.C. 173">78 T.C. 173, 184 (1982), we held that violation of the Fourth Amendment right to be free from unreasonable searches and seizures required that the burden of going forward with the evidence be shifted to respondent. The portion of Suarez excluding the evidence obtained in violation of the Fourth Amendment↩ has been overruled because of United States Supreme Court precedent limiting the scope of the exclusionary rule. The portion of the opinion shifting the burden of going forward with evidence, however, appears to remain good law.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622680/	JUDITH S. COFFEY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCoffey v. Comm'rDocket No. 4720-10.United States Tax Court2011 U.S. Tax Ct. LEXIS 46; January 12, 2011, Decided46 Julian I. Jacobs, Judge.Julian I. JacobsORDERAsserting an interest in the outcome of this case, on December 15, 2010, the Government of the U.S.Virgin Islands (Virgin Islands) filed a motion to intervene. The Virgin Islands asserts that under Rule 1(b), Tax Court Rules of Practice and Procedure, it should be permitted to intervene as of right pursuant to Rule 24(a), Federal Rules of Civil Procedure, or, alternatively, pursuant to the permissive intervention rules of Rule 24(b)(2), Federal Rules of Civil Procedure.This case presents issues similar to those presented in Appleton v. Commissioner, 135 T.C. 461">135 T.C. 461 (2010), wherein we declined to permit the Virgin Islands to intervene. We believe that because intervention by the Virgin Islands could result in trial complications, and for other reasons set forth in Appleton, intervention is not the method which the Virgin Islands should use to express its position.The premises considered, it isORDERED that the Virgin Islands motion to intervene, filed December 15, 2010, is denied. It is furtherORDERED that in addition to regular service on the parties, service of this Order shall be made onVincent F. Frazer, Esq.Attorney GeneralVirgin Islands47 Department of JusticeGERS Complex48B-50C Kronprindsens GadeSt. Thomas, U.S.Virgin Islands 00802andBarry J. Hart, Esq.Winston & Strawn LLP1700 K Street, NWWashington, DC 20006(Signed) Julian I. JacobsJudgeDated: Washington, D.C.January 12, 2011	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622681/	ISMAT M. ABEID, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAbeid v. Comm'rNo. 10441-02 United States Tax Court122 T.C. 404; 2004 U.S. Tax Ct. LEXIS 24; 122 T.C. No. 24; June 29, 2004, Filed 24 Respondent's cross-motion for summary judgment was granted and petitioner's motion for summary judgment was denied. P, a nonresident alien residing in Israel during 1997, 1998, and 1999 (years in issue), became entitled to 20 annual payments of $ 722,000 each by virtue of a 1992 purchase of a $ 1 ticket that won a lottery sponsored by the State of California. P received a payment of $ 722,000 from the California State Lottery in each of the years in issue. P filed U.S. Federal income tax returns for those years in which he took the position that the payments were not subject to U.S. tax. R determined that the payments were subject to U.S. tax under sec. 871(a)(1)(A), I.R.C., resulting in a deficiency for each year in issue. P contends that the payments constitute "annuities" within the meaning of par. (5) of art. 20 of the Income Tax Convention, Nov. 20, 1975, U.S.-Isr., Hein's No. KAV 971, at xxii (treaty) and are therefore exempt from U.S. tax pursuant to paragraph (2) of Article 20 of the treaty, which provides that "annuities" shall be taxable only in the jurisdiction in which25 the recipient resides. Held: The payments at issue are not "annuities" as that term is defined in the treaty, because they were not paid "under an obligation to make the payments in return for adequate and full consideration" as provided in the treaty. Accordingly, the payments are subject to U.S. tax as determined by R. Donald L. Feurzeig, for petitioner.Paul R. Zamolo and Rebecca Duewer, for respondent. Gale, Joseph H.GALE405 OPINIONGALE, Judge: This case is before us on the parties' cross-motions for summary judgment under Rule 121. 1 The issue for decision is whether certain payments received by petitioner from a lottery operated by the State of California (California State Lottery) are exempt from U.S. taxation pursuant to the Income Tax Convention, Nov. 20, 1975, U.S.-Isr., Hein's No. KAV 971 (U.S. - Israel Income Tax Treaty or treaty).26 Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678">90 T.C. 678, 681 (1988). Summary judgment may be granted with respect to all or any part of the legal issues in controversy "if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Rule 121(a) and (b); Sundstrand Corp. v. Commissioner, 98 T.C. 518">98 T.C. 518, 520 (1992), affd. 17 F.3d 965">17 F.3d 965 (7th Cir. 1994). In the instant case, the parties agree that there are no genuine issues of material fact and that judgment may be rendered as a matter of law.In support of their respective motions, each party has submitted a memorandum of points and authorities. A hearing on the motions was also held.406 The parties do not dispute that, at the time of filing of the petition, petitioner was a resident of Israel. 227 During 1992, while residing in California, petitioner, an Israeli citizen, purchased a California State Lottery ticket for $ 1. That ticket won the "Super Lotto" lottery, entitling petitioner to receive annual payments of $ 722,000 from the California State Lottery for 20 years. Petitioner did not have a choice as to the timing or manner of payment of his lottery winnings.During 1997, 1998, and 1999 (years in issue), petitioner resided in Israel. For each of the years in issue, petitioner received payments of $ 722,000 in California State Lottery winnings but did not report these amounts as income on his Federal income tax returns (filed as a nonresident alien). For purposes of computing his Israeli income tax liability for the years in issue, petitioner took the position that the payments were lottery winnings, exempt from Israeli income tax. Petitioner did not pay any Israeli income tax on account of the payments.In a notice of deficiency, respondent determined that the lottery payments were includible in petitioner's taxable income pursuant to section 871(a)(1)(A), resulting in a deficiency of $ 216,600 for each year in issue. In his petition, petitioner alleges that the payments28 are exempt from U.S. taxation pursuant to the U.S.- Israel Income Tax Treaty because they constitute "annuities" within the meaning of paragraphs (2) and (5) of Article 20 of the treaty.In general, "interest * , dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income" received by a nonresident alien from sources within the United States and that are not effectively connected with a U.S. trade or business, are subject to a 30-percent tax. Sec. 871(a)(1)(A). Gambling winnings paid to a nonresident alien fall within this provision, Barba v. United States, 2 Cl. Ct. 674">2 Cl. Ct. 674 (1983), with limited exceptions, see sec. 871(j). Annual payments of State lottery winnings are treated as gambling winnings. Rusnak v. Commissioner, T.C. Memo. 1987-249; see also sec. 3402(q)(3)(B)407 (treating certain proceeds from wagers in State-conducted lotteries as gambling winnings).329 The provisions of the Internal Revenue Code are applied to a taxpayer, however, "with due regard to any treaty obligation of the United States which applies to such taxpayer." Sec. 894(a)(1). The U.S.-Israel Income Tax Treaty, Hein's No. KAV 971, at xxii, provides:Article 20 -- Private Pensions and Annuities * * * * * * (2) Alimony and annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that Contracting State. * * * * * * * (5) The term "annuities", as used in this Article, means a stated sum paid periodically at stated times during life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).Petitioner's position is that the payments he received during the years at issue from the California State Lottery were an "annuity" within the meaning of the treaty and therefore exempt from taxation by the United States under Article30 20(2) thereof. While respondent does not dispute that petitioner was a resident of Israel, entitled as such to the benefits of the treaty, respondent nonetheless contends that the treaty provides no exemption for the payments at issue because they are not an "annuity" as defined in the treaty. Consequently, the payments are taxable under section 871(a)(1)(A) as U.S.-sourced income of a nonresident alien. 4To support his position that the payments constitute an annuity, petitioner relies on our decision in Estate of Gribauskas v. Commissioner, 116 T.C. 142">116 T.C. 142 (2001), revd. and remanded 342 F.3d 85">342 F.3d 85 (2d Cir. 2003), 5 in which we held that 408 annual payments of a State lottery prize were an annuity for purposes of section 7520.6 See also Estate of Cook v. Commissioner, T.C. Memo. 2001-170,31 affd. 349 F.3d 850">349 F.3d 850 (5th Cir. 2003). However, we do not believe our holding in Estate of Gribauskas helps petitioner here. Article 2(2) of the U.S. - Israel Income Tax Treaty, Hein's No. KAV 971, at viii, provides that "Any * * term used in this Convention and not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined." (Emphasis added.) As noted, "annuities" as used in the treaty is defined in the treaty. The treaty definition, as pertinent here, provides that "annuities" means a stated sum paid periodically at stated times "under an obligation to make the payments in return for adequate and full consideration (other than services rendered)."32 In Estate of Gribauskas, in holding that annual payments of a lottery prize were an "annuity" for purposes of section 7520, we decided that it was the characteristics of the payment stream as fixed and periodic that generally determined whether the arrangement was an annuity. One of the arguments advanced by the taxpayer was that the annual payments of the lottery prize could not constitute an annuity because the consideration provided was only the $ 1 paid for the lottery ticket, rather than a substantial premium. Estate of Gribauskas v. Commissioner, 116 T.C. at 152. In rejecting that argument, we reasoned that while a substantial premium might be characteristic of a commercial annuity, it need not be present in a private annuity, an arrangement that we concluded also fell within the scope of the term "annuity" as used in section 7520. Id. at 154-155. Thus, the nature of the consideration provided was not determinative of whether an arrangement constituted an annuity for purposes of section 7520.409 By contrast, the definition of "annuities" provided in the U.S.-Israel Income Tax Treaty requires that the obligation to make the payments have arisen "in return33 for adequate and full consideration". Consequently, the fact that the payments at issue in this case may qualify as an annuity for purposes of section 7520 under the holding in Estate of Gribauskas does not determine whether they constitute an annuity under the U.S. - Israel Income Tax Treaty. The latter depends upon whether the payments were made "in return for adequate and full consideration" within the meaning of Article 20(5) of the treaty.The term "adequate and full consideration" is not defined in the treaty. Thus, pursuant to Article 2(2) of the treaty, the term "shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined"; here, the United States.The term "adequate and full consideration" appears extensively in the Internal Revenue Code, generally followed by the phrase "in money or money's worth", 7 in a multitude of contexts. 8 The term is generally used to connote a purchase or exchange of property that is bona fide and at an arm's- length price, as distinguished from a gift or other transfer of property between persons who do not transact at arm's length. A definition of "adequate34 and full consideration" appearing in the regulations under section 6323, concerning the validity and priority of tax liens, provides that "adequate and full consideration" means consideration that has a "reasonable relationship to the true value of the interest in property acquired." Sec. 301.6323(h)-1(f)(3), Proced. & Admin. Regs.; see also Estate of Frothingham v. Commissioner, 60 T.C. 211">60 T.C. 211, 215 (1973) (for estate tax purposes, "adequate and full consideration in money or money's worth" generally410 means consideration of "equivalent amount" to the property transferred for it).35 Petitioner contends that the consideration element of the treaty definition has been met here by virtue of the fact that the California State Lottery received "adequate and full consideration" for the payments made to petitioner from all purchasers of tickets for the lottery he won. According to petitioner, the terms of the treaty do not require that the recipient of the lottery payments be the source of the consideration; rather, it is sufficient if the payor (California State Lottery) received adequate and full consideration from any source -- in this case, the other purchasers of lottery tickets.We do not believe petitioner's theory comports with the language of the treaty. The California State Lottery's "obligation" to make the payments at issue was not "in return for" any consideration provided by the nonwinning purchasers of lottery tickets. The consideration provided by these purchasers was in return for, and fully expended for, a chance to win the lottery; i.e., a wager. Cf. Goldman v. Commissioner, 46 T.C. 136">46 T.C. 136, 139 (1966)(purchase price of a lottery ticket is consideration expended for chance to win, not a contribution to the sponsoring charity), affd. 388 F.2d 476">388 F.2d 476 (6th Cir. 1967).36 The other purchasers of tickets in the lottery won by petitioner did not provide consideration "in return for" the California State Lottery's obligation to make the subject payments to petitioner.Petitioner argues in the alternative that, if the treaty is construed to require that "adequate and full consideration" come from the recipient of the lottery payments, then he provided such consideration because he paid the full, undiscounted price for the winning lottery ticket; namely, $ 1. We disagree. Petitioner's contention mischaracterizes the transaction which gave rise to his right to the lottery payments. The $ 1 paid by petitioner was not "adequate and full consideration" for the right to 20 annual payments of $ 722,000. One dollar bears no "reasonable relationship" to the value of such a right, nor was the right transferred to him "in return for" the $ 1 of consideration he provided. The $ 1 paid by petitioner was the consideration for the ticket itself; i.e., for the wager. This $ 1 consideration was fully expended for, and secured only, a chance to win the right to 411 the payments at issue herein. 9 Cf. Goldman v. Commissioner, supra.Petitioner became entitled to37 the stream of payments not by reason of any exchange of consideration, but by virtue of winning a wager, a separate taxable event under U.S. tax law constituting an accession to wealth. See, e.g., McClanahan v. United States, 292 F.2d 630">292 F.2d 630, 631-632 (5th Cir. 1961); Solomon v. Commissioner, 25 T.C. 936">25 T.C. 936, 938-939 (1956); Lutz v. Commissioner, T.C. Memo 2002-89">T.C. Memo 2002-89; Lyszkowski v. Commissioner, T.C. Memo. 1995-235, affd. without published opinion 79 F.3d 1138">79 F.3d 1138 (3d Cir. 1996). Thus, the payments petitioner received from the California State Lottery were neither "in return for" the $ 1 consideration he cites, nor was this consideration "adequate and full" with respect to those payments. The payments were the proceeds of a winning wager; i.e., gambling winnings.38 Petitioner also relies upon Estate of Shackleford v. United States, 1998 U.S. Dist. LEXIS 12442">1998 U.S. Dist. LEXIS 12442, 82 AFTR 2d 98-5538, 98-2 USTC par. 60,320 (E. D. Cal. 1998), affd. 262 F.3d 1028">262 F.3d 1028 (9th Cir. 2001), to support his claim that the $ 1 purchase price of the lottery ticket was adequate and full consideration for the lottery payments. In that case, a decedent lottery winner's estate argued that the decedent's right to California lottery payments, if deemed an annuity, should not be included in the gross estate by virtue of section 2039(b). Section 2039(b)limits the inclusion in the gross estate of the value of certain annuities to "only such part of the value of the annuity * * * as is proportionate to that part of the purchase price therefor contributed by the decedent." Accordingly, the estate argued, since the decedent had provided only $ 1 towards the purchase price of the annuity represented by the lottery payments, which was an infinitesimal percentage of the purchase price contributed by the other purchasers of tickets in the same lottery, the portion of the annuity includible in the gross estate should be zero. The District Court rejected this argument, concluding that no portion of39 the annuity qualified for exclusion under section 2039(b) because the interest in the lottery payments "represents the accumulated wealth of the decedent." Estate of 412 Shackleford v. United States, 1998 U.S. Dist. LEXIS 12442, 82 AFTR 2d at 98-5542, 98-2 USTC par. 60320 at 86,530. Consequently, the entire annuity was includible in the gross estate.Petitioner here reasons that, since the District Court in Estate of Shackleford rejected the argument that a $ 1 lottery ticket constituted only "part of the purchase price" (within the meaning of section 2039(b)) of the annuity resulting from the lottery win, and instead required that the entire annuity be included in the gross estate, it follows that the decedent's $ 1 payment for the lottery ticket constituted the entire purchase price for the annuity. Thus, petitioner reasons, if the $ 1 price of the lottery ticket was the entire purchase price of the resulting annuity for purposes of section 2039(b), it must by extension also constitute "adequate and full consideration" for the annuity.Petitioner's reliance on Estate of Shackleford is misplaced. The District Court therein did not conclude that the entire annuity was includible in the gross estate40 because the annuity was acquired solely through decedent's purchase of a $ 1 lottery ticket. Instead, the court reasoned that full inclusion was required because the taxpayer had not shown that any part of the lottery payments was "'attributable to contributions by the surviving beneficiary or contributions from another as a gift.'" Estate of Shackleford v. United States, 1998 U.S. Dist. LEXIS 12442, 82 AFTR 2d at 98-5542, 98-2 USTC at 86,530 (quoting Neely v. United States, 222 Ct. Cl. 250">222 Ct. Cl. 250, 613 F.2d 802">613 F.2d 802 (1980)). The District Court's conclusion that the annuity "represents the accumulated wealth of the decedent", id., comports with our view that the obligation to pay out lottery winnings arises from the lottery participant's winning a wager, not from his providing adequate and full consideration.We therefore hold that the payments petitioner received from the California State Lottery were not an annuity within the meaning of the U.S.-Israel Income Tax Treaty because the payments did not arise from the exchange of adequate and full consideration; rather, they were the result of winning a wager. Thus, the sums were not paid "under an obligation to make the payments in return for adequate41 and full consideration" (emphasis added) within the meaning of Article 20(5) of the treaty.As the treaty is silent with respect to gambling winnings, and petitioner has failed to establish that the payments at *413 issue were an "annuity" within the treaty's meaning, the treaty does not prevent the United States from imposing a tax under section 871(a)(1)(A) upon such payments. Accordingly, respondent is entitled to judgment as a matter of law. We shall therefore grant respondent's cross-motion for summary judgment and deny petitioner's motion. To reflect the foregoing,An appropriate order and decision will be entered. Footnotes1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code for the taxable years in issue.↩2. The parties have stipulated that review of this case shall be by the U.S. Court of Appeals for the D.C. Circuit.↩3. We note that whether annual payments of State lottery winnings are categorized under sec. 871(a)(1) as "annuities" (as the term is used in that section) or as "fixed or determinable annual or periodical gains, profits, and income" is immaterial in the instant case, as the tax imposed by sec. 871(a)(1)↩ applies to either category. As discussed hereinafter, the result in this case turns upon the meaning of "annuities" as used in the U.S. - Israel Income Tax Treaty.4. Petitioner has not claimed he was in the business of gambling or that the lottery winnings were effectively connected with a U.S. trade or business within the meaning of sec. 871(a)(1)(A)↩.5. Although the Court of Appeals for the Second Circuit reversed our decision in Estate of Gribauskas insofar as it held that the lottery prize must be valued pursuant to the valuation tables prescribed in sec. 7520, the Court of Appeals left undisturbed our holding that the annual payments of the lottery prize constituted an annuity for purposes of sec. 7520. Estate of Gribauskas v. Commissioner, 342 F.3d 85">342 F.3d 85 (2d Cir. 2003), revg. and remanding 116 T.C. 142">116 T.C. 142 (2001); see also Estate of Shackleford v. United States, 262 F.3d 1028">262 F.3d 1028 (9th Cir. 2001)(annual payments of a lottery prize constitute an annuity, valuation of which is made outside tables prescribed by sec. 7520↩).6. Petitioner notes that in Estate of Gribauskas, we described our holding as a conclusion that annual payments of lottery winnings "constitute an annuity for tax purposes and within the meaning of section 7520". Estate of Gribauskas v. Commissioner, 116 T.C. 142">116 T.C. 142, 159↩ (2001)(emphasis added). As discussed hereinafter, our conclusion in this case is based upon a construction of the term "annuities" as defined in the U.S. - Israel Income Tax Treaty. Accordingly, we express no opinion regarding the extent to which our holding in Estate of Gribauskas may impact the meaning of "annuity" as used elsewhere in the Internal Revenue Code.7. The meaning of the phrase "in money or money's worth", when it follows "adequate and full consideration", has been interpreted to confine the scope of "consideration" to money or its equivalent; i.e., to exclude a mere promise or agreement as consideration. See, e.g., Commissioner v. Wemyss, 324 U.S. 303">324 U.S. 303, 89 L. Ed. 958">89 L. Ed. 958, 65 S. Ct. 652">65 S. Ct. 652, 1945 C.B. 416">1945 C.B. 416↩ (1945). Since the only consideration that petitioner claims is "adequate and full consideration" in this case is money, we do not believe the absence of the "in money or money's worth" qualifier in the treaty language has any material effect on the analysis herein.8. See, e.g., secs. 274(e)(8), 675(1), 2035(d), 2036(a), 2037(a), 2038(a), 2040(a), 2043(a), 2043(b), 2053(c)(1)(A), 2055(e)(2), 2056(b)(1)(A), 2106(a)(1), 2512(b), 2522(c)(2), 2523(b)(1), 6019(3)(A)(ii), 6323(h)(6)↩.9. The conclusion that the $ 1 consideration was expended for the wager itself is consistent with the definition of "wager" for purposes of sec. 3402(q), governing withholding from certain gambling winnings, including those from State-conducted lotteries, that are "proceeds from a wager". The regulations under that section provide that, in order for a transaction, in which a chance to win a prize is acquired, to be treated as a wager, consideration must have been provided to obtain such chance. See sec. 31.3402(q)-1(d), Example (10)↩, Employment Tax Regs.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622682/	ENRIQUE F. RODDA AND GLADYS RODDA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRodda v. CommissionerDocket No. 152-78.United States Tax CourtT.C. Memo 1983-267; 1983 Tax Ct. Memo LEXIS 518; 46 T.C.M. (CCH) 156; T.C.M. (RIA) 83267; May 16, 1983. 518 Alan R. Harter, for the petitioners. Ronald D. Dalrymple and Francis J. Elward, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to Special Trial Judge Francis J. Cantrel for the purpose of conducting the hearing and ruling on respondent's Motion for Summary Judgment filed herein.After a review of the record, we agree with and adopt his opinion which is set forth below. 1519 OPINION OF THE SPECIAL TRIAL JUDGE CANTREL, Special Trial Judge: This case is before the Court on respondent's Motion for Summary Judgment, filed on March 15, 1983, pursuant to Rule 121, Tax Court Rules of Practice and Procedure.2Respondent, in his notice of deficiency issued to petitioners on October 5, 1977, determined a deficiency in petitioners' Federal income tax for the taxable calendar year 1972 in the amount of $2,340.39. The sole adjustment determined by respondent in his deficiency notice is for unreported tip ("toke") income received by Enrique F. Rodda (hereinafter called petitioner) in 1972 in the amount of $10,530.00. Petitioners timely filed their petition on January 3, 1978 and respondent filed his answer on February 13, 1978. Thus, the pleadings are closed. Respondent's motion was filed more than 30 days after the pleadings were closed. See Rules 34, 36, 38, and 121. When respondent's good faith attempts to make arrangements with petitioners' counsel for informal consultations or communications proved unsuccessful, 3 he, not desiring to rest on the pleadings520 alone, on July 16, 1982, served a 43 paragraph Request for Admissions on petitioners' counsel. 4 Petitioners' counsel at no time served written answers upon respondent nor did he file an original of such answers with the Court. Rule 90(c). Hence, each matter contained in respondent's request for admissions is deemed admitted and conclusively established. 5521 The following findings of fact are based upon the record as a whole, the allegations of respondent's answer admitting allegations in the petition, the matters deemed admitted with respect to respondent's request for admissions, three affidavits and exhibits attached to respondent's motion. FINDINGS OF FACT Petitioners' resided at 3755 Silbert Lane, Las Vegas, Nevada on the date their petition was filed. They filed a joint 1972 Federal income tax return with the Internal Revenue Service. During 1972 petitioner was employed as a blackjack dealer at the Sands Hotel and Casino (hereinafter sometimes referred to as the "Casino") in Las Vegas, Nevada. His normal work shift constituted 8 hours per day and he was only required to work, by his employer, 5 days out of any consecutive 7 day period. His normal days off during 1972 were Wednesday and Thursday. In the course of his employment, petitioner received tokes from patrons of the Casino. In accordance with house rules these tokes were routinely pooled by petitioner and other blackjack dealers by placing said tokes in a common toke box before leaving the area of the gaming tables on a break or at the end of a shift. The total522 amount so pooled was divided at he end of each 24-hour period among the dealers on duty during that 24-hour period. These pooled tokes were divided on the basis of a full share to a dealer for each 8 hour shift. Dealers generally received their share of the pooled tokes in an envelope when they returned to work at the beginning of their next shift.Under house rules some provision was made for allowing a share of the tokes for dealers who were unable to work because of sickness. During 1972 petitioner participated in and received his equal share of such pooled tokes. Petitioner, in 1972, did not maintain a written diary, log, worksheet, or other record, made at or near the time he received tokes, which set forth the date, amount of tokes received and amounts he may have expended as gratuities to co-workers. Players (patrons) at the Casino did from time to time place bets on petitioner's behalf. Such bets remained under the control of the patron until the winnings, if any, were actually given to petitioner. The patron was free to take back the winning bet if he so desired. The Nevada State Gaming Authority regards a bet made by a patron for petitioner as a wager made by and523 on behalf of the patron. Petitioner was forbidden from gambling or placing bets at the table he was working.Under house rules any winning bets received by petitioner were pooled and distributed. Neither petitioner nor the toke pool was required to reimburse a patron who had placed a losing bet on petitioner's behalf. In 1972 petitioner gambled in his individual and private capacity during his off duty time. He maintained no records which accurately reflected the date, amount of bets and amounts won and lost. Petitioner was paid a salary by his employer in 1972. The salary was in addition to the tokes he received. He was paid a salary for 244 8-hour shifts. He was paid for 8-hour shifts when he did not actually work; such shifts did not exceed 24 for 1972. 6Petitioner is required by law to report the toke income he received to his employer. For 1972 he reported to his employer that he received toke income in the amount of $1,273. That amount together with his salary were reported on the 1972 joint return. No additional toke income was reported524 on that return. The amount reported to his employer and reported on the return was based on an estimate and not on any written records maintained by petitioner or any third party on his behalf. The amount of toke income received by petitioner in 1972 averaged not less than $53.65 for each 8-hour shift he actually worked. Petitioner received additional toke income in 1972 in the amount of $10,530, which said amount was not reported on the 1972 joint return. Petitioners do not have in their possession or under their control any documentary evidence to support the allegations in their petition that respondent's determination was arbitrary. They have no knowledge of any material facts which would distinguish their case from those of the petitioners, similarly situated, in Williams v. Commissioner,T.C. Memo 1980-494">T.C. Memo. 1980-494. OPINION It is well settled that tokes are not gifts but taxable income which must be included in a taxpayer's gross income. Olk v. United States,536 F.2d 876">536 F.2d 876 (9th Cir. 1976); 7Clover v. Commissioner,T.C. Memo. 1983-181; Foreman v. Commissioner,T.C. Memo 1983-130">T.C. Memo. 1983-130; Parker v. Commissioner,T.C. Memo. 1983-87;525 Kurimai v. Commissioner,T.C. Memo. 1983-86; Parker v. Commissioner,T.C. Memo 1983-85">T.C. Memo. 1983-85; Randolph v. Commissioner,T.C. Memo. 1983-84; Owens v. Commissioner,T.C. Memo. 1983-30 (on appeal 9th Cir., Feb. 14, 1983); Williams v. Commissioner,supra. It is conclusively established in this record that petitioners received unreported toke income in 1972 in the amount of $10,530. Petitioners' contention that respondent's determination is arbitrary is baseless. Here, petitioner kept no records which would accurately reflect the toke income which he received in 1972. In such circumstances, the Commissioner may, in his notice of deficiency, make a determination based upon any reasnable method where a taxpayer refuses to produce his records or where those records are inadequately maintained. Holland v. United States,348 U.S. 121">348 U.S. 121 (1954); Merritt v. Commissioner,301 F.2d 484">301 F.2d 484, 486 (5th Cir. 1962); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 82 (1975),526 affd. in an unpublished opinion 559 F.2d 1207">559 F.2d 1207 (3rd Cir. 1977); Giddio v. Commissioner,54 T.C. 1530">54 T.C. 1530 (1970); Meneguzzo v. Commissioner,43 T.C. 824">43 T.C. 824 (1965). 8Respondent's determination herein is presumptively correct and the burden is on petitioners to establish that it is incorrect or arbitrary. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Avery v. Commissioner,574 F.2d 467">574 F.2d 467, 468 (9th Cir. 1978); Rule 142(a). Petitioners here totally failed to show that determination to be incorrect or arbitrary. Rule 121(b) provides that a motion for summary judgment shall be granted if the "pleadings * * admissions and any other acceptable materials, together with the affidavits * * * show that there is no genuine issue as to any material527 fact and that a decision may be rendered as a matter of law. * *". [Emphasis supplied.] Here, petitioners have refused to submit any information which contradicts respondent's factual determinations. On the basis of the pleadings, those matters deemed admitted in respondent's request for admissions, the exhibits attached to respondent's motion (which include a copy of the 1972 return and a full copy of the notice of deficiency) and respondent's affidavits, respondent has amply demonstrated to our satisfaction that there is no genuine issue as to any material fact present in this record and, thus, that respondent is entitled to a decision as a matter of law. Hence, summary judgment is a proper procedure for disposition of this case. An appropriate order and decision will be entered.Footnotes1. Since this is a pre-trial motion and there is no genuine issue of material fact, the Court has concluded that the post-trial procedures of Rule 182, Tax Court Rules of Practice and Procedure, are not applicable in these particular circumstances. This conclusion is based on the authority of the "otherwise provided" language of that rule. The parties were afforded a full opportunity to present their views on the law at the hearing at Washington, D.C. on April 27, 1983. No appearance was made by or on behalf of petitioners nor was a response to respondent's motion filed, albeit a copy thereof and a copy of respondent's affidavits together with a copy of the Court's Notice of Hearing were served on petitioners' counsel by the Court on March 18, 1983. See Rule 50(c), Tax Court Rules of Practice and Procedure.↩2. All rule references are to the Tax Court Rules of Practice and Procedure.↩3. See Odend'hal v. Commissioner,75 T.C. 400">75 T.C. 400↩ (1980); Rule 90(a). 4. The original of that request was filed with the Court on July 19, 1982. Rule 90(b). ↩5. See Freedson v. Commissioner,65 T.C. 333">65 T.C. 333, 335 (1975), affd. 565 F.2d 954">565 F.2d 954 (5th Cir. 1978); Rules 90(c) and (e). See also McKinnon v. Commissioner,T.C. Memo. 1982-229; Knudson v. Commissioner,T.C. Memo 1982-179">T.C. Memo. 1982-179; Oaks v. Commissioner,T.C. Memo. 1981-605; Wallace v. Commissioner,T.C. Memo. 1981-274; Myers v. Commissioner,T.C. Memo. 1980-549; Edelson v. Commissioner,T.C. Memo. 1979-431; Saba v. Commissioner,T.C. Memo. 1979-397; Bassett v. Commissioner,T.C. Memo. 1979-14↩.6. The 24 shifts were not included in respondent's determination of additional toke income received by petitioner in 1972.↩7. We observe that venue on appeal of this case would lie in the United States Court of Appeals for the Ninth Circuit.↩8. The method used here by respondent was clearly reasonable. See Williams v. Commissioner,T.C. Memo. 1980-494↩, where on facts virtually indistinguishable from those we consider herein, this Court stated--"We conclude that 'all tokes' received by petitioners, whether directly from the player or through a winning bet, are taxable gratuities".	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622687/	Ernest E. Rollman and Hilda S. Rollman, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentRollman v. Comm'rDocket Nos. 51963, 51974, 51975, 51976United States Tax Court25 T.C. 481; 1955 U.S. Tax Ct. LEXIS 21; 106 U.S.P.Q. (BNA) 233; December 15, 1955, Filed 21 Decisions will be entered under Rule 50. 1. A partnership of which petitioners were members transferred certain patent rights by agreement conveying "an exclusive license * * for the manufacture and sale of shoes." Held, amounts received pursuant to the agreement are royalties derived from a licensing agreement and not long-term capital gain from the sale of a capital asset, since the contract did not effect a transfer of all of the rights of the patentee, i. e., the right to make, the right to use, and the right to vend.2. The respondent disallowed deductions for depreciation on two patents used by petitioners in their trade or business. Held, upon the evidence presented, that the right to an allowance for depreciation was established in the amount determined in respect to one patent, but that in respect to the other an amount in excess of the basis for depreciation here established having already been recovered, petitioners are not entitled to any additional allowance. Held, further, that depreciation is allowable in the amount determined in respect to the patent subject to the above-mentioned licensing agreement. David Alter, Esq., for the petitioners. 22 Hubert E. Kelly, Esq., for the respondent. Fisher, Judge. FISHER233 482 The respondent determined deficiencies in the Federal income taxes of petitioners as follows:Petitioners194719481949Ernest and Hilda Rollman, husband and wife$ 785.06$ 1,653.21Curt and Louise Kaufman, husband and wife$ 51455.78782.76Heinz and Tania Rollman, husband and wife412.02678.92Walter and Ellen Kaufman, husband and wife51507.50821.63The issues presented for our consideration are:(a) Whether amounts received by The Rollmans, a partnership, from Rikol, Inc., in 1947, 1948, and 1949, pursuant to a written agreement in respect to patent rights owned by The Rollmans, represent long-term capital gain from the sale of a capital asset or ordinary income, either from royalties pursuant to a licensing agreement, or from the sale of a patent held primarily for sale to customers in the ordinary course of business. If the payments are to be treated as ordinary royalty income, a subsidiary question is presented as to what extent, if any, depreciation on the patent may be allowed.(b) To what extent, if any, the partnership is entitled to a deduction for depreciation23 on two other United States patents.Other adjustments made by respondent in the notices of deficiency have been conceded by petitioners.FINDINGS OF FACT.All of the petitioners filed timely joint Federal income tax returns for the years 234 involved. Ernest and Hilda Rollman so filed with the then collector of internal revenue for the sixth district of California. The other petitioners filed with the then collector of internal revenue for the district of North Carolina.Petitioners Heinz W. Rollman, Ernest E. Rollman, Curt Kaufman, and Walter Kaufman (hereinafter sometimes referred to as petitioners) are members of a partnership known as The Rollmans, presently with its principal place of business at Waynesville, North Carolina.The Rollmans was first formed as a partnership in Brussels, Belgium, on April 13, 1936, then including as partners Hans Rollman, 483 now deceased, father of petitioners Heinz and Ernest Rollman, Heinz and Ernest, and their cousins Walter and Curt Kaufman. Prior to formation of the partnership, petitioners had lived in Germany and had been employed there in several shoe factories owned by Hans Rollman. While so employed, petitioners were trained in the24 various production methods of leather and rubber shoe manufacture. In 1935, all of petitioners' and their families' properties, including the shoe factories, other equipment, and patents owned by them, were confiscated by the German Government. Petitioners and their families were forced to flee from Germany to Brussels, Belgium. There they formed The Rollmans to utilize their knowledge and skill in shoe manufacture on behalf of other organizations, being unable for lack of funds to reenter the shoe manufacturing business.Petitioners and Hans Rollman, through The Rollmans, became technical advisers to the shoe industry and also embarked on a program of research to develop new processes of shoe manufacture and sale. The business of the partnership consisted largely of rendering technical assistance and "know-how" services to shoe manufacturers and of granting limited licenses to such manufacturers for the production of shoes under patents developed by The Rollmans. The business activity of The Rollmans has continued in this fashion to date.Rajeh Patent.On September 6, 1938, the partnership was issued a United States patent, No. 2,129,106 (hereinafter called the Rajeh patent), 25 on a previously perfected process relative to the manufacture of rubber footwear. The patent had been assigned to the partnership by Hans Rollman and Andreas Szerenyi.In 1939, Heinz Rollman, anticipating war in Europe, secured from each of the partners of The Rollmans an assignment to himself of certain patent applications and patents, including the Rajeh patent, owned by The Rollmans, authorizing him to dispose of them and execute other appropriate agreements in respect thereto on behalf of the partnership. Heinz came to the United States to establish a business here on behalf of The Rollmans.Heinz first attempted to arrange with Leo Weill for The Rollmans to engage in the manufacture of shoes on the basis of an exchange of the Rajeh patent for one-half of the common stock of a corporation to be organized to engage in such manufacture. For various reasons this arrangement was not consummated.Heinz then negotiated with Rikol, Inc. (hereinafter called Rikol), a corporation controlled by Leo Weill, for the partnership's customary know-how and technical assistance service and a license under the Rajeh patent. This plan also was not completed, largely because the 484 manufacture26 of shoes under the Rajeh patent required, in addition to special shoe machinery, a supply of uncured rubber compound which would involve the use of certain rubber machinery costing about $ 250,000. Rikol could not finance the building of a rubber plant, which would have been necessary to meet this supply, in addition to the required shoe manufacturing factory. Consequently, negotiations were undertaken between Rikol, Heinz (on behalf of The Rollmans), and the Dayton Rubber Company (hereinafter called Dayton) for Dayton to build the rubber plant, lease space to Rikol, and furnish Rikol's requirements for uncured rubber compound for manufacture under the Rajeh patent. Dayton, while interested in the venture, would not agree to make the required investment until it had investigated the limits of the claim of the Rajeh patent. Dayton also wanted to review the agreement proposed by Heinz to grant a limited license under the Rajeh patent to Rikol, since Dayton was then, at least, contemplating a possible complete transfer of all rights under the patents to Rikol in order to safeguard the proposed investment in a rubber plant. The investigation disclosed the existence of possible conflicting27 patents owned by Ludwig H. Grunebaum and a group of persons whom he represented (hereinafter called the Grunebaum group) acquired by them after the German Government confiscated petitioners' and Hans Rollmans' outstanding United States patents in 1935. Heinz thereafter contacted the Grunebaum group to arrange for a transfer of its patent rights along with the transfer of the Rajeh patent.On December 19, 1940, Heinz, acting on his own behalf and that of the partnership, entered into an agreement with 235 Rikol, which insofar as is here pertinent is set out below.ROLLMANN, individually and as a member of the co-partnership, and GRUNEBAUM do hereby respectively grant to RIKOL, subject to the conditions hereinafter set forth, an exclusive license (except for two non-exclusive licenses now outstanding in United States Rubber Products, Inc., and Pirelli, Ltd.) for the manufacture and sale of shoes pursuant to all of the above mentioned patents and any renewals, continuations, divisions, reissues or extensions thereof. Said license shall extend to the entire territory of the United States of America, and so long as Mr. LEO WEILL, the representative of RIKOL, shall remain alive and shall 28 remain the holder of a majority of the stock of Rikol, shall likewise extend to the possessions and dependencies of the United States of America. * * It is understood that a contract shall be entered into between RIKOL, or a subsidiary or affiliated company of RIKOL, with a rubber company to supply rubber mixture and semi-vulcanized sole shells. It is understood that said contract will be negotiated by Mr. LEO WEILL, as the representative of RIKOL, in conjunction with ROLLMANN and that said contract shall be approved by ROLLMANN before its execution. Upon the execution of a contract as aforesaid, ROLLMANN agrees to place at the disposal of the management of said rubber 485 factory all of the formulas necessary for the manufacture of the rubber materials needed by RIKOL in order to fully exercise the license granted to it under the patents mentioned herein.* * * The license herein granted to RIKOL shall be exclusive for the duration of this agreement with respect to the RAJEH PATENT, and shall be exclusive with respect to the ROLLMANN PATENTS, except for the non-exclusive license possessed by the United States Rubber Products, Inc. and Pirelli, Ltd., ROLLMANN and GRUNEBAUM29 herein agreeing that except for the two non-exclusive licenses above mentioned, no other licenses will be granted with regard to said patents during the term of this agreement. ROLLMANN and GRUNEBAUM do hereby agree that the license heretofore granted to Pirelli, Ltd., and the United States Rubber Products, Inc. will not be renewed and that no other party will be substituted in place of Pirelli, Ltd. or the United States Rubber Products, Inc. in the event of a cancellation or other termination of said license or licenses. The patents hereinbefore named are licensed solely and exclusively to RIKOL (excepting United States Rubber Products, Inc. and Pirelli, Ltd.), subjct to the conditions as set forth in this agreement. * * RIKOL agrees that it will not grant sub-licenses with respect to the patents for which licenses are herein granted, or any improvements or developments with regard thereto; unless it shall first receive the written consent of ROLLMANN thereto; except, however, that RIKOL shall have the right to grant licenses to any corporations or other enterprises in which LEO WEILL shall directly or indirectly control a majority of the stock. In any event it is understood30 and agreed that RIKOL shall have the right to assign the within agreement to a corporation to be formed, provided that LEO WEILL shall directly or indirectly control at least a majority of the stock of such new corporation, and upon such new corporation assuming in writing all of the terms and provisions of the within agreement on RIKOL'S part to be performed, RIKOL shall be released from any and all further liability hereunder.Subsequently, on March 19, 1941, Leo Weill organized Wellco Shoe Corporation (hereinafter called Wellco) as contemplated by the agreement of December 19, 1940. Rikol and Wellco were both controlled by Leo Weill.On that same date, Rikol entered into an agreement with Wellco granting Wellco an exclusive sublicense to manufacture and sell shoes pursuant to United States Patent Nos. 1,955,720 and 2,168,243, in accordance with the rights which Rikol had acquired under the agreement of December 19, 1940. The agreement, in pertinent part, is as follows:Whereas RIKOL has heretofore entered into a certain agreement dated the 19th day of December, 1940 with Heinz Rollman and Ludwig H. Grunebaum, whereby it obtained a license with respect to the use of United States31 Patent No. 1,955,720 dated April 17, 1934 and Patent No. 2,168,243 dated August 1, 1939 relating to shoes and the manufacture thereof; andWhereas RIKOL, under said agreement has the right to grant a sublicense to WELLCO by reason of the fact that Leo Weill controls a majority of the stock in WELLCO; andWhereas RIKOL is desirous of granting a sublicense and WELLCO desires to obtain a sublicense with respect to 236 the aforesaid patents subject to the terms and provisions hereinafter set forth,486 Now Therefore, it is mutually agreed between the parties hereto as follows:1. RIKOL does hereby grant to WELLCO, subject to the conditions hereafter set forth, an exclusive license for the manufacture and sale of shoes pursuant to the two United States patents above mentioned, bearing Nos. 1,955,720 and 2,168,243.No further agreements were made in the United States with respect to the Rajeh patent, or any improvements thereon, by either Rikol or The Rollmans.During 1947, 1948, and 1949, The Rollmans received payments from Wellco, pursuant to the agreement of December 19, 1940, in the amounts of $ 9,417.77, $ 20,178.03, and $ 17,900.69, respectively. The partnership reported these 32 amounts on its Federal income tax returns as long-term capital gain. The respondent determined that the payments constituted ordinary income to The Rollmans and in accordance therewith adjusted petitioners' respective distributable shares of ordinary income from the partnership for the years in issue.Depreciation.From about mid-1936 to May 1940, The Rollmans, then located in Brussels, Belgium, worked on the development of three processes, hereinafter referred to as Paraflex, Snow Boot, and Rajeh, resulting in United States patents, No. 2,178,086, dated October 31, 1939, No. 2,357,360, dated September 5, 1944, and No. 2,129,106, dated September 6, 1938, respectively. The books and records of the Belgian partnership reflecting the development and other costs of these assets were left behind in Belgium at the time the partners came to the United States in 1940 after Germany invaded Belgium. After World War II (and prior to the trial of this proceeding) petitioners contacted the firm occupying the offices where The Rollmans had previously been located in Belgium and requested that firm to forward to the United States any records of The Rollmans in their possession. The books 33 and records of the partnership were no longer located at the premises formerly occupied by The Rollmans, and the attempt to locate them by this means was not successful. No other effort was made by the partners to trace their books and records. Petitioners assumed that the books and records had been destroyed by the Germans.Experimentation in conjunction with the development of Paraflex, Snow Boot, and Rajeh required the use of certain machinery and equipment, including hydraulic presses and steel molds. The first hydraulic press constructed for The Rollmans for this research cost 500,000 Belgian francs, or approximately 16,667 American dollars converted at the then appropriate rate of exchange of 30 Belgian francs to 1 American dollar. Three other presses also used in this work cost The Rollmans 60,000 francs each or $ 2,000, a total of $ 6,000. 487 Use of these machines was continuous during the period 1936 through May 10, 1940, in the development and perfection of the three processes. Such use was approximately in equal proportion for each process.Each of the presses had a useful life of approximately 20 years. They were left behind in Belgium in 1940 when the Rollmans34 came to the United States and petitioners have never been able to recover the presses or any part of their value. No depreciation was ever claimed on the presses.In addition to the costs of this machine equipment attributable to the development of the Paraflex, Snow Boot, and Rajeh processes, certain payments were made by The Rollmans to acquire full interest in the United States patents on Paraflex and Rajeh. The Rollmans paid Szerenyi the amounts set forth below, for Paraflex, which he owned completely, for the one-half interest in Rajeh owned by him, as inventor and co-inventor, respectively, and for his general advisory services to The Rollmans. The amounts attributable to Szerenyi's interest in Paraflex and Rajeh represent a portion of the amounts received by him under an agreement with The Rollmans, dated January 15, 1937, which covered the matter of his compensation for general advisory service as well as his interest in Paraflex and Rajeh.The agreement in pertinent part is as follows:ARTICLE 1 -- SZERENYI undertakes to assist ROKA [The Rollmans] in the capacity of a consulting engineer, in executing all its contractual obligations, and to guard and promote the interests35 of ROKA to the best of his knowledge and belief.* * * ARTICLE 3 -- SZERENYI transfers one invention pertaining to shoe manufacture, which was perfected by him in accordance with a suggestion by Mr. Hans Rollmann and is owned jointly by him and the partners of ROKA and is detailed in Austrian Patent Application A 100/36, with all pertinent rights to the ownership of ROKA upon conclusion of this agreement and in consideration of no other compensations then stipulated in the provisions of this agreement.ARTICLE 4 -- Furthermore, SZERENYI transfers * * the patents designated hereinafter and pertaining to a process for the manufacture of footwear with full rubber sole as invented by him, wherein the unvulcanised [sic] rubber in one operation is molded, vulcanized and attached to the shaft, and he furthermore undertakes to furnish his signature for the purpose of such property transfer, underneath the following: Italian Patent No. 318 470; French Patent No. 777 754; English Patent No. 429 143; Spanish Patent No. 135 583; Belgian Patent No. 406 803 and Argentine Patent Application No. 51 710. Also SZERENYI transfers to ownership by ROKA, US Patent Application No. 740 734 pertaining36 to the same process, which was transferred to him by ROLLMAN & MAYER and is registered to the name of Mr. Hans ROLLMANN. (The patents and patent applications detailed in this Article are referred to hereinafter as PARAFLEX Patents.)ARTICLE 5 -- ROKA shall be entitled to file patent applications on future improvements of the inventions underlying the PARAFLEX Patents. Such patents and/or patent applications shall be owned by ROKA. * *488 ARTICLE 6 -- All inventions within the scope of ROKA which may be made by SZERENYI during the lifetime of this Agreement, shall become the exclusive property of ROKA without any other compensation due Mr. Szerenyi than that stipulated in this agreement. * ** * * ARTICLE 8 -- ROKA shall not be obligated to preserve the PARAFLEX Patents mentioned in Article 4 herein, if the Company states that such patents are of no interest to same. In that case ROKA shall retransfer the pertinent patents or patent applications to the ownership of Mr. SZERENYI * ** * * ARTICLE 11 -- In consideration of all obligations undertaken by Mr. SZERENYI as per this agreement, ROKA undertakes to pay him as follows: * * (b) 5 (five) % of the net yield37 from existing or future agreements between ROKA and PIRELLI (ROPI Agreements);(c) (5) (five) % of the net yield from agreements, possibly to be acquired by ROKA, between the ROMIKA Shoe Works, Inc., in Gusterath and the latter's licensees;(d) 22 1/2 (twenty-two and one-half) % of the net yield from exploitation of the PARAFLEX Patents mentioned in Article 4 herein, with the exception of the PIRELLI countries, from exploitation of any future improvements of the PARAFLEX Process in accordance with Article 5, regardless whether such exploitation is based on a patent or not, with the exception of the PIRELLI territories. In the PIRELLI Territories too, Mr. SZERENYI shall be entitled to the same 22 1/2% from the net yield of the exploitation of the PARAFLEX Patents mentioned in Articles 4 and 5, in case this process is not used by PIRELLI itself;(e) 12 1/2 (twelve and one-half) % from the net yield of the operations of ROKA, unless a different ratio of participation has been defined in (b) through (d).Net yield in the meaning of this agreement shall be the amount of the total revenue by ROKA from operations such as defined in (b) through (e) or from additional activities undertaken38 with partners' approval, after deduction of expenditures disbursed by ROKA for costs, expenses and taxes of all kinds in connection with business operations.The amount of Belgian francs 21,750 to be paid Mr. SZERENYI as expenses in accordance with Paragraph (a) of ARTICLE 11 is to be considered as such, and not as a participating share as is due Mr. SZERENYI for his activities in accordance with Paragraphs (b) through (e) in Article 11. * * ARTICLE 12 -- Net yields in accordance with Article 11 are calculated jointly by a ROKA partner and by Mr. SZERENYI, in accordance with the books. Settlements occur half-yearly, for the first time on the 31st day of December 1936.ARTICLE 13 -- All profit shares due Mr. SZERENYI shall be made available to him in the pertinent currencies and in the countries where they were earned by and are available to ROKA. * * ARTICLE 16 -- The lifetime of this agreement shall coincide with that of the most extensive ROPI agreement. Upon giving notice of cancellation for the aforementioned ROPI agreement, ROKA shall be obliged to notify immediately Mr. SZERENYI of such development.This agreement shall become effective as of Jan. 1, 1936.489 39 ARTICLE 17 -- Upon expiration of this agreement or its termination by forces beyond control, including withdrawl [sic] of residence permission in Belgium, the ROKA Co. shall continue to pay to Mr. SERENYI [sic] or his legal successor, the participating share of 12 1/2% stipulated in Paragraph (e) of Article 11, which results from agreements entered into for the first time during the lifetime of this agreement. In such case, the provisions of Paragraphs (2) and (3) of Article 11 as well as of Articles 12 and 13 shall remain in force. Revenues resulting from agreements entered into after expiration of this agreement, shall be subject to the same conditions as stipulated in the first part of this Article, if a considerable and decisive portion of the preliminary work fell into the period of the lifetime of this agreement.ARTICLE 18 -- If after termination of the ROPI Agreement the ROKA Co. concludes a new agreement with PIRELLI, but does not renew the agreement with Mr. SZERENYI or in case the present agreement should be earlier terminated by forces beyond control, then the ROKA Co. shall pay to Mr. SZERENYI from all footgear manufactured in the PIRELLI territories in accordance40 with the PARAFLEX Process, 22 1/2% from the revenues obtained thereof, with consideration of the provisions of Article 11, Paragraphs 2 and 3 and Articles 12 and 13.* * * ARTICLE 20 -- Upon expiration of this agreement or upon its termination through forces beyond control, an understanding shall be arrived at between ROKA and Mr. SZERENYI, whereby in accordance with Article 4, 50% of any existing PARAFLEX patents and 50% of any improvements as per Article 5, will be transferred to ownership of Mr. SZERENYI and registered in his name. Such patents throughout the PIRELLI territories shall remain in any case, property of the ROKA and shall not be subject to the aforementioned 50% partition. In the partition, however, shall be included aside from the patents, all agreements connected with exploitation of the PARAFLEX Process in accordance with Articles 4 and 5, that is, including such agreements which were concluded in countries where such patents either exist or existed.These 50% shall be fixed according to value, not according to quantity. Costs of title transfer shall be born [sic] in equal parts by Mr. SZERENYI and ROKA.ARTICLE 21 -- The provisions of Article 20 shall 41 be accordingly applied to the countries of the ROPI Agreements, if and when the ROPI Agreement is not renewed or if cooperation between PIRELLI and ROKA in accordance with the ROPI Agreements is terminated, in so far as there do not exist today contrary agreements with PIRELLI.ARTICLE 22 -- If upon expiration of this Agreement a renewal of same is rejected by ROKA, all existing but not exploited patents of the inventions mentioned in Articles 3 and 6 or improvements thereon, shall be registered to SZERENYI at the expense of ROKA and shall become his property. Excepted from such transfer shall be the pertinent patents in the PIRELLI Territories or the Patents pertaining to Article 3, in such countries where ROKA in accordance with existing agreements either has ceded the ROMIKA Sponge-rubber Sole Patent or for some reason has undertaken not to exploit the Patent pertaining to article 3 or if upon this provision taking effect, this Patent is not exploited.The same regulation as stipulated in this Article, shall apply if this Agreement should be early terminated either due to forces beyond control or due to withdrawl [sic] of Mr. SZERENYI's residence permission in Belgium, with42 the reservation however that in such a case not all, but only half of all existing but not exploited patents on the inventions referred to in Articles 3 and 6 or improvements thereon, are transferred to Mr. SZERENYI, whereby such a division shall 490 be based on anticipated values and not on numbers. Any Patents in countries reserved in Paragraph 1 of this Article shall not be considered in such a partition and shall remain exclusive property of ROKA. If existence of one or several ROKA-owned patents should for any reason depend upon preservation of a patent which by the provisions of this Agreement is to be transferred to ownership by Mr. SZERENYI, then property transfer shall be replaced by an agreement guaranteeing to Mr. Szerenyi the right of exploitation of such a patent in the same manner as if such patent had been transferred to Mr. SZERENYI. Any patent royalties which may be due Mr. SZERENYI by virtue of license agreements concluded by him for such patents, are to be ceded by him to ROKA.ARTICLE 23 -- Upon premature termination of this agreement through forces beyond control, Mr. SZERENYI shall be entitled for the period of one year but not longer than the termination43 of the most extensive ROPI Agreement, counted from the date of such premature termination, to his share of participation in the net profits of ROKA during this period in accordance with Article 11, and he shall be entitled on the basis of this claim, to a monthly advance payment of 1,750 Belgian francs. Likewise, upon premature termination of this Agreement, Mr. SZERENYI shall receive -- provided such termination was caused by forces beyond control -- from the net profits of ROKA resulting from earnings of the PIRELLI Co. in connection with merchandise produced by the process mentioned in Article 3 (RAJEH Process), a compensation of 12 1/2% for the duration of the most extensive ROPI agreement.ARTICLE 24 -- No participation shall be enjoyed by Mr. SZERENYI in the revenues obtained from exploitation of the PARAFLEX patents and improvement thereon which have remained properties of ROKA, notwithstanding the regulations governing the PIRELLI territories as stipulated in Articles 18 and 19, after termination of this Agreement, nor shall ROKA be entitled to sharing in the PARAFLEX and RAJEH Patents transferred to ownership by Mr. SZERENYI.Szerenyi received $ 20,000 (converted from Belgian44 exchange) under this agreement from 1936 through May 1940 for his interest in Paraflex and half that much, or $ 10,000, during the same period, for his interest in Rajeh, representing approximately 20 per cent and 10 per cent, respectively, of the total amount received by Szerenyi under the agreement for this period.OPINION.The first issue presented is whether amounts received by The Rollmans in 1947, 1948, and 1949, pursuant to the agreement of December 19, 1940 (set out in our Findings of Fact), are ordinary income or long-term capital gain. Petitioners contend that the payments in question are based on a sale of the Rajeh patent, a capital asset, whereas respondent determined that the payments represent royalties derived from a licensing agreement. The agreement in question grants to Rikol on behalf of 237 The Rollmans "an exclusive license (except for two non-exclusive licenses now outstanding * ) for the manufacture and sale of shoes" under the Rajeh patent throughout the United States.491 Whether the transfer of the patent rights (held for more than 18 months prior to transfer) resulted in capital gain or ordinary income depends on whether the patent was a capital 45 asset in the hands of the transferor, and if so, whether the transfer amounted to a sale or assignment of patent rights as distinguished from a mere license agreement. See Edward C. Myers, 6 T. C. 258 (1946); Parke, Davis & Co., 31 B. T. A. 427 (1934). We will assume arguendo that the Rajeh patent was a capital asset held by The Rollmans for the length of time required for long-term capital gain treatment, so that the practical problem reduces itself to the question of whether there was a sale or a license.It is well established that while the name or form of an agreement does not control its nature and legal effect, A. B. Watson, 24 B. T. A. 466 (1939), affd. (C. A. 9, 1932) 62 F. 2d 35; Parke, Davis & Co., supra;Kimble Glass Co., 9 T. C. 183 (1947), the agreement must effect a transfer of all of the substantial rights of the patentee under the patent in order to constitute a sale for Federal income tax purposes. The view expressed by the United States Supreme Court in Waterman v. MacKenzie, 138 U.S. 252">138 U.S. 252 (1891),46 in respect to the type of transfer which constitutes an assignment or sale as distinguished from a mere license is here controlling. In the Waterman case, the Court said:Whether a transfer of a particular right or interest under a patent is an assignment or a license does not depend upon the name by which it calls itself, but upon the legal effect of its provisions. For instance, a grant of an exclusive right to make, use and vend two patented machines within a certain district, is an assignment, and gives the grantee the right to sue in his own name for an infringement within the district, because the right, although limited to making, using and vending two machines, excludes all other persons, even the patentee, from making, using or vending like machines within the district. Wilson v. Rousseau, 4 How. 646">4 How. 646, 686. On the other hand, the grant of an exclusive right under the patent within a certain district, which does not include the right to make and the right to use, and the right to sell, is not a grant of a title in the whole patent right within the district, and is therefore only a license. Such, for instance, is a grant of "the full47 and exclusive right to make and vend" within a certain district, reserving to the grantor the right to make within the district, to be sold outside of it. Gayler v. Wilder, above cited. So is a grant of "the exclusive right to make and use," but not to sell, patented machines within a certain district. Mitchell v. Hawley, 16 Wall. 544">16 Wall. 544. So is an instrument granting "the sole right and privilege of manufacturing and selling" patented articles, and not expressly authorizing their use because, though this might carry by implication the right to use articles made under the patent by the licensee, it certainly would not authorize him to use such articles made by others. Hayward v. Andrews, 106 U.S. 672">106 U.S. 672. See also Oliver v. Rumford Chemical Works, 109 U.S. 75">109 U.S. 75.See Edward C. Myers, supra;Federal Laboratories, Inc., 8 T. C. 1150 (1947); Kimble Glass Co., supra;Cleveland Graphite Bronze Co., 10 T. C. 974 (1948), affirmed per curiam (C. A. 6, 1949) 177 F. 2d 200;48 Lynne Gregg, 18 T. C. 291 (1952), affirmed per curiam on the basis of 492 the Opinion of this Court ( C. A. 3, 1953) 203 F.2d 954">203 F. 2d 954. See also Broderick v. Neale, (C. A. 10, 1953) 201 F. 2d 621. It is necessary, therefore, that the conveyance include the exclusive right to make, use, and vend the patented item throughout the United States (or some part thereof) if the transaction is to be deemed to constitute an assignment or sale. See United States v. General Electric Co., 272 U.S. 476 (1928). A conveyance of anything less would not be a sale or assignment but merely a license.The agreement here in question conveys exclusively to Rikol only the right to manufacture and sell shoes made by Rikol under the patented process. It prevents Rikol from granting sublicenses except that Rikol shall have the right to grant licenses to other corporations or enterprises directly or indirectly controlled by Leo Weill. It permits Rikol to assign the contract only to a corporation to be formed provided the corporation is directly or indirectly controlled by Leo Weill. 49 It does not allow Rikol to license or permit the use of the patented process by other than enterprises controlled by Weill for the manufacture of shoes to be sold by Rikol or its assignee controlled by Weill. The transfer, therefore, was not a grant of all of the substantial rights of The Rollmans under the Rajeh patent. Waterman v. MacKenzie, supra;Cleveland 238 Graphite Bronze Co., supra;Lynne Gregg, supra.Petitioners urge us to find that the parties intended to consummate a sale rather than a license on the basis of testimony of Ernest Rollman to the effect that, during the negotiations, Dayton insisted on a complete transfer of the rights of The Rollmans under the Rajeh patent in order to safeguard its proposed investment in a rubber plant. We can readily visualize such an approach by Dayton, but the contract as ultimately written is inconsistent with this objective in the material respects which we have already set forth, and we can only assume that Dayton was finally satisfied that its own interests were sufficiently protected by the agreement which was accepted and executed by the parties. 50 Upon the record, we see no reason to vary its clear and unambiguous terms.The case before us is distinguishable from Allen v. Werner, (C. A. 5, 1951) 190 F.2d 840">190 F. 2d 840, relied on by petitioners. There the precise question presented to the Court of Appeals was whether the trial court erred in admitting and considering parol evidence in the construction of an agreement relative to the manufacture and sale of hydraulic lifting jacks under a patent. The tax question before the lower court was whether amounts received by the grantor were ordinary income or long-term capital gain from the sale of a capital asset. The dispute of the parties centered on whether the agreement conveyed the right of use in addition to the exclusive right to manufacture and sale. There the initial grant in the contract had not included 493 the right to use, but in another portion of the document it was expressly stated that the licensee contemplated manufacture, use, and sale. In such circumstances it was evident, and the lower court so held, that the terms and provisions of the written agreement were ambiguous, and that parol evidence might therefore properly be51 admitted to resolve the ambiguity.Petitioner argues further on the basis of the lower court's Conclusions of Law in the Werner case that as a consequence of the nature of the patented subject matter, the retention of the right of use would be inconsequential, and that for tax purposes it would be proper to disregard that factor in determining whether the patentee had effected a sale rather than a license. In essence, petitioner contends that in the case of a patent of a process for the manufacture of an article for sale, failure to grant the transferee the right to permit a third party to use the process in manufacturing the article for sale by the transferee does not result in a transfer of less than all of the substantial rights under the patent. We note that the Court of Appeals did not consider this issue in the Werner case. In the case before us we are satisfied that the right to permit use of the patented process by a third party for its own or the transferee's benefit was a substantial right and that Rikol and its assignee controlled by Weill was not granted that right by the terms of the contract. We add that a careful examination of the facts of the Waterman52 case and of the cases decided by this Court on the authority of Waterman discloses that, in the main, patents of the type here under consideration were involved, and the factor of "use" was deemed substantial. We find no reason to hold otherwise in the instant case.Other cases relied upon by petitioners are distinguishable on their facts.In Commissioner v. Celanese Corp., (C. A., D. C., 1944) 140 F.2d 339">140 F. 2d 339, and Commissioner v. Hopkinson, (C. A. 2, 1942) 126 F. 2d 406, the owners of the patent rights executed agreements which contained language showing a clear and unmistakable intent to part with the whole of the patents, and in addition executed assignments of each of the patents which were recorded in the United States Patent Office. In Celanese the agreement stated that the vendors "assign and make over * * the said processes and the full benefit thereof." The court concluded that the parties intended to effect a purchase and sale of the patents and not merely a royalty use when they used such words of outright conveyance and sale. Similarly, in Hopkinson the contract stated that the seller 53 "has granted, bargained, sold, conveyed, transferred, assigned, set over and delivered" its right in certain patents. The court there concluded that the parties' intention as shown by the language in the contract was to have the "seller" sell 494 and the "purchaser" buy the property. See also General Aniline & Film Corp. v. Commissioner, (C. A. 2, 1944) 139 F.2d 759">139 F. 2d 759.In Kronner v. United States, (Ct. Cl., 1953) 110 F. Supp. 730">110 F. Supp. 730, the agreement, there designated as a "license," contained clear language of sale, conveying "the sole and exclusive right to manufacture, vend, sell, license, or relicense, or in anywise use * * * the invention * * * for the life of the patent." The court, despite defendant's contention, believed that the intention of the parties was best evidenced by the words used in the contract and concluded 239 that the patentee had parted with the whole of his patent rights.With respect to Parke, Davis & Co., supra, there was a grant of an undivided share of the exclusive right to make and use the invention covered by the patent. We deem it unnecessary to discuss54 the case further than to point out that the contract granted to the transferee, in substance, the right which the agreement in the instant case fails to cover, namely, "the exclusive right, license and privilege to manufacture and have manufactured for its exclusive use * * ."Since we have held that the transfer in the instant case was not a grant of all of the substantial rights of The Rollmans, it is unnecessary for us to consider respondent's other contention that the patent here in question was not a capital asset in the hands of The Rollmans, having been held primarily for sale to customers in the ordinary course of business.The remaining question concerns the amount, if any, to be allowed as a deduction for depreciation on two patents known as Paraflex and Snow Boot used by petitioners in their business, and, in view of our holding on the first issue, a like question with respect to the Rajeh patent held by petitioners for the production of income. See sec. 23(l), I. R. C. 1939, and Regs. 111, sec. 29.23(l)-3.During each of the years involved The Rollmans deducted on its partnership returns, $ 1,765 in respect to Paraflex and $ 882.50 in respect to Snow Boot. These amounts55 claimed for depreciation were based on a useful life of 17 years of each patent and a cost of $ 30,000 for Paraflex and $ 15,000 for Snow Boot. No deduction has heretofore been taken on the Rajeh patent. Petitioners here claim depreciation allowances in the amounts above stated in respect to Paraflex and Snow Boot and an additional allowance for the years involved in respect to Rajeh on the basis of a cost of $ 25,000 to $ 50,000. Respondent's main contention is that petitioners have failed to prove their cost basis for depreciation on the three patents, and therefore, that the disallowance of the amounts claimed for depreciation should be sustained for lack of substantiation by petitioners.Petitioners were unable to produce their books and records reflecting the various elements of cost properly attributable to the development 495 of the patents here in question. Petitioners left their books and records in Belgium when they were forced to flee that country at the time of the German invasion in 1940. Admittedly they have made little effort to locate these books and records. Nevertheless, under the circumstances of this case, we think that petitioners have fairly assumed56 on the basis of the response to their limited inquiries that the books and records of the Belgian partnership were in all probability destroyed by the German occupation authorities. We are therefore faced with a situation where it is obvious that petitioners are entitled to an allowance for depreciation, but are unable to substantiate their cost basis in the depreciable assets by the books and records they kept reflecting the development costs of the patents in question. Such a situation is not an unusual consequence of war and we think it does not pose an unsurmountable obstacle to a reasonable allowance. We have before us the testimony of petitioners who were familiar with the circumstances of and the cost of development at the time. Obviously, precise contemporaneous records of the basis of the assets would, if available, represent the sound foundation to be desired, but, despite the passage of substantial time, we think the evidence is sufficient to warrant exercise of our discretion under the rule of Cohan v. Commissioner, (C. A. 2, 1930) 39 F.2d 540">39 F. 2d 540.There are involved here two elements of cost. First, there is the cost of certain hydraulic57 presses used by The Rollmans solely in connection with the development of the three patents here in question. These hydraulic presses, four in number, were purchased at various times during 1936 and were used from the time of purchase through May 10, 1940, when the Germans invaded Belgium. As a consequence of the German occupation, The Rollmans have never been able to recover the machines or any part of their value. Each of the presses purchased in 1936 had a useful life of approximately 20 years. The cost of the first press constructed for The Rollmans was 500,000 Belgian francs, which converted at the then existing rate of exchange was $ 16,667. Each of the other presses cost The Rollmans 60,000 Belgium francs or $ 2,000, as conceded by petitioners. The presses were used for approximately 4 years in the development of the patented processes here in issue and subject to depreciation. Therefore, one-fifth of the useful life of these presses entered into the development of these processes and one-fifth of the cost of the presses should be attributable to the development of these processes as a basis for depreciation. Petitioner Ernest Rollman estimates that approximately one-third58 of the cost of the presses attributable to the cost of patents is attributable to each of the processes developed and we have so found in accordance with his testimony. See Claude Neon Lights, Inc., 35 B. T. A. 424, 442240 (1937); John F. Canning, 29 B. T. A. 99 (1933); Buffalo Forge Co., 5 B. T. A. 947 (1926).496 In addition to these amounts, petitioners contend that The Rollmans incurred a further expense in connection with the acquisition of Paraflex and Rajeh, the first of which was owned completely by Szerenyi as inventor, and the second of which was owned equally by Szerenyi and Hans Rollman as co-inventors. Respondent, on the other hand, contends that any amounts paid to Szerenyi by The Rollmans were in reality his share of partnership earnings or of the earnings from a joint venture, entered into between Szerenyi and The Rollmans to exploit the Paraflex and Rajeh patents, and that such amounts were not payments by The Rollmans partnership to Szerenyi on account of his interest in these two processes which The Rollmans wished to acquire. (The controlling agreement in pertinent59 part is set forth in the Findings of Fact.) The respondent points out in support of his contention that Szerenyi's association with the partnership was necessary for the success of the partnership business, mainly because the partnership did not otherwise have access to any great inventive ability, that Szerenyi's participation in the profits of The Rollmans was at least as much and probably greater than that of a junior partner, and that under Articles 20-23 of the agreement, provision was made for partition of the assets in case of termination of the agreement. We think, however, that the substance of these various provisions of the agreement and other circumstances pointed to by respondent are equally consistent with the petitioners' view, and that the agreement, in accordance with its terms, was one for the transfer of patent rights and for the rendering of consulting services, essentially as an employee. It must be kept in mind that individuals may arrange their business relations freely and in any manner which best suits their needs, and that no other quality than that intended should be attributed to such arrangement in the absence of some compelling consideration to prevent60 tax avoidance and to preserve the substance of a transaction over its form.Whether or not parties to an agreement have undertaken thereby to engage in a joint venture is a question of their intention in entering into the agreement, to be gleaned from the terms of the agreement and the conduct of the parties in carrying out its provisions. Wm. J. Lemp Brewing Co., 18 T. C. 586 (1952). (This is the only real issue raised by respondent, we think, since it is quite clear from the terms of the agreement that there was no formal taking in of Szerenyi as another partner in The Rollmans, which business consisted of very much more than the exploitation of the Paraflex and Rajeh patents.) While the agreement between Szerenyi and The Rollmans is intricate and complex, we believe that it was not intended to and did not establish between them a working arrangement in the nature of a joint venture. The terms of the agreement are drawn in language 497 of sale and professional service with respect to the transfer of Szerenyi's patent rights and for his rendering of consulting services. The basing of Szerenyi's compensation on the net yields from certain exploitation61 of the Paraflex and Rajeh patents and from the other operations of The Rollmans, which doubtless included possible use of these patents in connection with the technical consulting function, appears to be an appropriate means of realizing upon the value of the patent rights. An accounting likewise appears to be a proper means to insure full payment, rather than an indication of control over the venture by Szerenyi, as suggested by the respondent. Further, the coincidence of the amount of the payments (which must have accorded with the parties' estimate of the value of the patent rights transferred) with the share of the profits of The Rollmans to which a junior partner would be entitled to receive does not appear to us to be significant in the light of the other circumstances involved in this case. It should be noted that future improvements and other inventions of Szerenyi became by the terms of the agreement the property of The Rollmans alone without further compensation to Szerenyi. With respect to the provisions for retransfer of certain of the patents or patent rights upon termination of the agreement under specified circumstances, we need only point out that at least with62 respect to the patents here in issue The Rollmans have permanently acquired them as their own under the agreement, and we think that such acquisition is consistent with the view that it is a result of the purchase of those patents and not the result of a subsequent apportioning of Szerenyi's capital contribution to a joint venture between himself and The Rollmans, as contended for by respondent. We might add that the provisions for reconveying to Szerenyi certain patents or patent rights upon termination of the particular agreement here in question might well have been intended as a means of insuring the further extension of the basic agreement for compensating Szerenyi for the transfer. The various circumstances pointed to by respondent, whether considered separately or as a whole, seem to us largely equivocal and not sufficient to counterbalance the other language of the agreement, or the actions of the parties under the agreement.In the light of the foregoing, we hold that the payments made to Szerenyi for his interest in these two patents were made under a contract between The Rollmans and Szerenyi concerning the purchase of these interests and compensation for his activity63 as an advisory consultant to The Rollmans.Respondent argues further that whatever payments may have been made to Szerenyi under the agreement were made for the several Paraflex and Rajeh patents (the two processes having been patented in several countries) so transferred, and therefore, that any amount 498 to be capitalized should be apportioned among the various countries in which patents for these processes were issued. Respondent urges that if such allocation is not possible upon the record, no allowance should be made. Respondent does not make a like argument in respect to the actual development costs for creation of the process in the first instance and we need not take up the latter point.The record is not as clear as it might be with respect to the basis of the patents for depreciation purposes. Because of this, we have, in our ultimate Findings of Fact (and see further discussion, infra), resolved any doubts in this connection against petitioners. Since The Rollmans reported income from all sources, including foreign income, we think the issue suggested by respondent has little practical significance in the instant case, and does not warrant any further reduction64 of what we regard as a minimum basis on the whole record. It may be added that respondent has limited his argument to the issue of basis, and does not question the rate.Petitioner Ernest Rollman testified variously that payments to Szerenyi under the contract were from $ 20,000 to $ 35,000 (converted from Belgian exchange) for his interest in Paraflex for the 4-year period, 1936 through May 1940, and half as much for his interest in Rajeh. Although the testimony is not precise, we are satisfied that substantial amounts were paid to Szerenyi for his interests in Paraflex and Rajeh. Having in mind the principles of Cohan v. Commissioner, supra, we hold that $ 20,000 was paid to Szerenyi for his interest in Paraflex and $ 10,000 for his interest in Rajeh. This determination is reflected in our Findings of Fact.No evidence was introduced by petitioners to support other costs for steel molds and sundry tools used in the development of any of the three processes. We therefore sustain the respondent in disallowing any depreciation in relation to such items.In the light of the foregoing, we hold that petitioners' bases for depreciation (over a useful*65 life of 17 years) during the years in question are as set out below:SzerenyiMachinesPaymentsTotalRajeh$ 1,512$ 10,000$ 11,512Paraflex1,51220,00021,512In respect to Snow Boot, no basis remains for depreciation. Petitioners have previously deducted $ 2,647 in depreciation on Snow Boot. We could here find a basis not in excess of $ 1,512. Petitioners have, therefore, been allowed to recover an amount in excess of the basis which they have here established and are entitled to recover no more. See sec. 113 (b) (1) (B).Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Curt E. Kaufman and Louise Kaufman, Husband and Wife, Docket No. 51974; Heinz W. Rollman and Tania Rollman, Husband and Wife, Docket No. 51975; Walter Kaufman and Ellen Kaufman, Husband and Wife, Docket No. 51976.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622688/	ILLINOIS CENTRAL RAILROAD COMPANY AND YAZOO & MISSISSIPPI VALLEY RAILROAD COMPANY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Illinois C. R. Co. v. CommissionerDocket Nos. 62023, 62991.United States Board of Tax Appeals30 B.T.A. 1107; 1934 BTA LEXIS 1220; June 29, 1934, Promulgated 1220 1. In 1926 one of the affiliated petitioners, as lessee, leased certain railroad properties for a period of approximately 350 years, with options to renew for an additional period of 999 years. The lease contracts required the lessee, at its own cost and expense, to repair, replace, and renew the leased properties so as to maintain them in as good condition as at the date of the agreements, but the lessors were to reimburse the lessee for all additions, betterments, and improvements. Held (a) that the lessee is not entitled to deductions representing the cost to the lessors, less salvage recovered, of the leased properties replaced during the taxable years; and (b) that the lessee is entitled to deduct as ordinary and necessary business expense the cost of replacements to the extent that such cost was borne by it. Certain claimed deductions are disallowed for lack of proof to show that they constitute ordinary and necessary expense. 2. The lease contracts provided that the lessee should immediately replace all units of equipment when and as retired. During the taxable years and in 1930 the lessee from time to time retired numerous units of leased equipment, which were1221 replaced with other equipment furnished by petitioner in 1929 and 1930, but title thereto was not conveyed to the lessors until 1932. Petitioners' books were kept on an accrual basis. Held since the liability of the petitioner-lessee to replace was fixed and determined at the time each unit of equipment was retired and definitely ascertainable in amount, the deduction allowable from the lessee's income for each taxable year was the aggregate value, as of June 2, 1926, of the equipment units retired during such year. Petitioners having failed to establish the amount of the lessee's liability on account of equipment units retired in each taxable year, the deductions claimed are disallowed. 3. Petitioners are entitled to deduct from gross income for each of the taxable years depreciation sustained on the replacement units which were not conveyed to the lessors prior to 1932. R. C. Beckett, Esq., for the petitioners. J. L. Backstrom, Esq., for the respondent. TRAMMELL 1108 OPINION. TRAMMELL: Respondent determined deficiencies in income tax of $27,088.88 for 1926, $84,611.39 for 1927, $46,663.09 for 1928, and $29,463.82 for 1929. Petitioners1222 allege that respondent's determinations are erroneous in that as to each taxable year he did not deduct from the income of the Yazoo & Mississippi Valley Railroad Co. the cost of replacements of leased property. The respondent claims increased deficiencies for all of the taxable years, alleging that he erred in allowing deductions from the income of the Yazoo & Mississippi Valley Railroad Co. (1) of $142,248.26 for 1926, $148,603.57 for 1927, $158,959.70 for 1928, and $68,441.88 for 1929, representing the excess of cost of items of roadway and structures leased from the Alabama & Vicksburg Railway Co., which were replaced, over the value of the salvage recovered; (2) of $86,871.44 for 1926, $144,415.44 for 1927, $126,569.21 for 1928, and $163,660.52 for 1929, representing the excess of cost of items of roadway and structures leased from the Vicksburg, Shreveport & Pacific Railway Co., which were replaced, over the value of the salvage recovered; (3) of $17,938.74 for 1926, $19,999.74 for 1927, $16,513.90 for 1928, and $9,523.34 for 1929, representing the labor cost of removing replaced rail and other track material from, and the labor cost of laying new rail and other track material1223 replacements on, the roadway leased from the Alabama & Vicksburg Railway Co.; (4) of $14,500.60 for 1926, $21,492.94 for 1927, $11,101.98 for 1928, and $13,461.22 for 1929, representing the labor cost of removing replaced rail and other track material from, and the labor cost of laying new rail and other track material replacements on, the roadway leased from the Vicksburg, Shreveport & Pacific Railway Co.; and (5) of $74,774.05 for 1929, for depreciation of railway equipment now alleged by the petitioner to have been transferred by the Yazoo & Mississippi Valley Railroad Co. to 1109 the Alabama & Vicksburg Railway Co. and the Vicksburg, Shreveport & Pacific Railway Co. in that year to replace equipment retired. The parties submitted a stipulation embodying substantially all of the material facts, which is incorporated herein by reference. The proceedings were consolidated for hearing and decision. Petitioner Illinois Central Railroad Co. is an Illinois corporation, with is principal office at Chicago. It filed consolidated returns for the taxable years, for itself and its subsidiaries, which included the net income of petitioner Yazoo & Mississippi Valley Railroad Co. 1224 It is liable for any and all deficiencies, and is entitled to recover any overpayment for 1929 based upon the consolidated returns. On March 31, 1925, the Yazoo & Mississippi Valley Railroad Co., hereinafter called the lessee, entered into separate agreements with the Alabama & Vicksburg Railway Co. and the Vicksburg, Shreveport & Pacific Railway Co., hereinafter called the lessors, by the terms of which it leased the properties of the two last mentioned companies until July 1, 2282, with options to renew the leases for an additional period of 999 years. The lessee agreed that it would keep up, maintain, repair, replace, and renew the leased properties during the terms of the leases so that such properties would at all times be in substantially as good repair, working order, and condition as of the effective date of the lease agreements; and it further agreed, that whenever during the terms of the leases any part of the leased properties, including rolling stock and equipment, should be damaged, destroyed, or otherwise become unfit for its appropriate use and purpose, to cause the same to be repaired, renewed, rebuilt, or replaced by property of equal value. These covenants were1225 to be performed at the lessee's sole cost and expense. The lease agreements also provided that the lessee should have the right to make such additions and extensions to, and betterments and improvements of, the leased properties as it deemed necessary, for which it was to be reimbursed by the lessors. The leases became effective on June 2, 1926, and the lessee took over the leased properties on the same day. During the taxable years the lessee made substantial replacements of rail and other track materials on the leased roadways. In most, if not all, instances the rail and other track material replacements were heavier than the rail and material removed from the roadways, and to that extent were betterments or improvements of the leased properties. Substantial portions of the lessee's expenditures for such replacements were charged to and borne by the lessors, as the costs of the betterments or improvements. The following statement shows for each taxable year the actual cost, exclusive of labor, of rail and other track material replacements made by the lessee, the part of such cost charged to and borne by the lessors, and the cost to replace 1110 the removed rail and1226 other track material in kind, which was borne by the lessee: 1926192719281929Cost of replacements$394,875.75$427,166.24$399,714.22$320,032.73Charged to lessors61,974.2368,453.7358,942.5150,672.52Cost to replace in kind borne by lessee332,901.52358,712.51340,771.71269,360.21The labor costs incurred and borne by the lessee in making the replacements were $32,439.33 for 1926, $41,492.71 for 1927, $27,615.87 for 1928, and $22,984.56 for 1929. One half of these labor costs were incurred in taking up the removed rail and other track materials and one half in laying the replacements. Also, during the taxable years the lessee replaced 57, more or less, bridges and trestles on the leased roadways. In most, if not all, instances the replacements were improvements over the removed structures. Substantial portions of the lessee's expenditures for such replacements were charged to and borne by the lessors, as the costs of the betterments or improvements. The following statement shows for each taxable year the actual cost of such replacements made by the lessee, the part of such cost charged to and borne by the lessors, the1227 part of such cost borne by the lessee, and what it would have cost to replace the structures in kind: 1926192719281929Cost of replacements$65,560.82$50,321.05$181,115.43$268,126.92Charges to lessors27,904.7640,916.79128,773.23190,689.90Cost borne by lessee37,656.069,404.2652,342.2077,437.02Cost to replace in kind42,095.9221,755.78134,480.66145,855.31In each instance, the part of the cost borne by the lessee is equal to the cost to the lessors, of the removed structures. Further, during the taxable years the lessee replaced other parts of roadways and roadway structures, extended and rearranged existing trackage, constructed new facilities, installed tie plates, and otherwise made changes on the leased properties. Most, if not all, of these changes were betterments or improvements of those properties. Substantial portions of the lessee's expenditures for such changes were charged to and borne by the lessors as the costs of the betterments and improvements. The following statement shows for each taxable year the actual cost of the changes made by the lessee, the part of such cost charged to and borne by1228 the lessors, the part of such cost borne by the lessee, and what it would have cost to replace all removed properties in kind: 1926192719281929Cost of changes$23,665.41$355,855.39$127,393.98$152,971.38Charged to lessors20,974.38282,126.57106,155.71121,238.20Cost borne by lessee2,691.0373,729.6221,238.2731,733.18Cost to replace in kind2,300.7087,796.8925,213.5037,951.161111 The costs borne by the lessee, except for $283.80 in 1926, $36,174.22 in 1927, and $6,470.90 in 1928, are equal to the costs to the lessors, of items of roadway and roadway structures that were removed in making the changes. As to the excepted costs, they represent actual costs to replace the properties in kind. In computing the lessee's net income for the taxable years, the respondent allowed deductions of $229,119.70 for 1926, $293,019.01 for 1927, $286,528.91 for 1928, and $232,102.40 for 1929, representing in each instance the cost to the lessors, less salvage recovered, of the leased properties that were replaced during the taxable years; and, also, he allowed deductions of the amounts enumerated above as the labor costs1229 incurred and borne by the lessee in making the rail and other track material replacements. He now asserts that he erred in allowing any and all of these deductions. Petitioners concede that the lessee is not entitled to the deductions allowed by the respondent in respect of the leased properties that were replaced, since the lessee was not the owner thereof and had no capital investment in those properties. We agree with that concession, because it is in line with the authorities on the question, ; ; ; ; affd., ; certiorari denied, ; and ; and the respondent's claim for increased deficiencies is allowed to that extent. Petitioners contend, however, that the lessee is entitled to deduct from the income of each taxable year an amount equivalent to what it would have cost to replace the properties in kind. As to the expenditures for rail and other1230 track material replacements on the leased properties, including the labor costs of making them, there can be no doubt that, to the extent they were actually borne by the lessee, they constitute ordinary and necessary expenses of its business and are deductible in computing taxable net income The maintenance engineer of the petitioners testified that the replaced rail was from 12 to 18 years old and in poor condition; that the replacements were made in pursuance of the maintenance program adopted and followed by the Illinois Central, of which the lessee is a subsidiary line; and that such replacements were necessary to the proper upkeep and maintenance of the leased properties. 1112 There is nothing in the record to the contrary. The expenditures are ordinary in the business in which the lessee is engaged and they are necessary, because the lessee was required to make them in the performance of its covenants to keep up and maintain the properties. To the extent indicated, the expenditures did not contain anything of a capital nature; the cost of the additions, betterments, and improvements were charged to and borne by the lessors. Obviously, the deductions must be limited1231 to the lessee's burden of the expenditures; for the statute will not permit the deduction of amounts for which it was reimbursed, or to be reimbursed, by the lessors. , and cases therein cited. As to the second group of expenditures, for replacement of bridges and trestles, and the third group, for so-called "miscellaneous roadway replacements", the evidence is insufficient, in respect of all but three items, to enable us to determine whether or not they may be deducted from income, even to the extent that they were borne by the lessee. While expenditures for ordinary upkeep and maintenance, such as those for rail and other track material replacements referred to above, are proper deductions from income, the lessee may not deduct expenditures made primarily for adding to and improving the leased properties. The witness, heretofore referred to, without stating his reasons therefor and apparently basing his opinion on the meager facts in the stipulation, expressed the opinion that all of the expenditures were necessary to the proper maintenance of1232 the leased properties. If by that he meant that they were necessary in order to keep the properties in good repair and good running condition, and no more than that, the inaccuracy of his opinion is clearly disclosed by the stipulated facts. The depression and rearrangement of existing tracks, the construction of concrete subways where none existed before, the extension of yard leads, and the application of more than a hundred thousand additional tie plates to the roadways are clearly betterments or improvements and cannot categorically be ascribed to that kind of upkeep and maintenance that may be deducted from income. Further, it is to be noted that some of the bridges and trestles replaced in the taxable years were constructed or erected as late as 1917 and 1918, and, as to them, while we have been given no evidence as to the usual normal life of this type of structures, there obviously must be some doubt that their replacement was due to normal upkeep and maintenance rather than to bettering or improving the leased properties. As to all of the expenditures included in these two groups, the stipulated facts, except as to three items, contain only a very meager description of1233 what was done, the cost, the respective parts of the cost that were borne 1113 by the lessors and lessee, cost of the replaced items of roadways and roadway structures, and the value of the salvaged materials; and none of the facts as to the reasons and necessities for what was done have been given to us. In this state of the record, we are unable to determine the extent to which these expenditures, other than the three excepted items, fall within the categories of deductible expenses and nondeductible capital expenditures. The three excepted items are $283.80 expended in 1926 for replacing a wornout cypress shingle roof on a section house; $36,174.22 expended in 1927 for replacing 17 miles of main track that had been washed out by flood conditions; and the cost of replacing 36,292 tie plates in 1928. The cost of the latter item is not separately shown, but is included in the lessee's cost of $6,470.90 for installing $156,193 tie plates, of which 119,901 were new installations and 36,292 were used for replacements. The cost of the replacements is determined to be 36292/156193 of the total cost, or $1,503.54. These three items are proper deductions in computing the lessee's1234 taxable net income. Deduction of the remaining expenditures in the second and third groups must be denied for lack of proof that they are ordinary and necessary expenses. During the taxable years and 1930, the lessee retired units of leased equipment, such as locomotives and freight train cars, as follows: 81 in 1926, 757 in 1927, 389 in 1928, 164 in 1929, and 73 in 1930, a total of 1,464 units, having a depreciated book value as of June 2, 1926, as agreed upon by the lessee and lessors, of $1,157,752.92. As each equipment unit was retired, the lessee recorded its liability for replacement thereof on its books in an amount equal to its depreciated book value at June 2, 1926, by a credit to the account of the lessor owning the unit. These retired units were replaced by the lessee with equipment furnished by the petitioner, as guarantor under the lease agreements, as follows: 577 units in 1929, and 29 units in 1930, a total of 606 units; but title thereto was not conveyed to the lessors at the times of replacement. The value of these replacement units, on the petitioner's books, which was cost less depreciation previously allowed, was $1,020,121.99; but for the purposes of the1235 replacements, the lessee and lessors agreed upon values of $1,103,579.22 for the 1929 replacements, and $60,408.60 for the 1930 replacements, a total of $1,163,987.82. In August 1929 it was agreed that the lessee should convey to the lessors title to all such equipment replacements and to such other equipment as was necessary to replace all units of leased equipment that had been and would be retired up to December 31 of that year, in order that all such equipment replacements might be brought immediately within the liens of the lessor's mortgages. By reason of the delay in agreeing upon the values and classes of replacement units that were to be conveyed by the lessee to the lessors, 1114 the conveyances of title were not formally made to the lessors until 1932. The accounting for the transfer of the replacement units was made on the books of the lessee and lessors in 1932. Petitioners contend that the lessee is entitled to deduct from 1929 income the amount of its entire liability to the close of that year in respect of equipment replacements required to be made under the provisions of the lease agreements and lessors' mortgages. The respondent says that if the deduction1236 is to be made at all, it must be from the income of 1932, the year in which the lessee formally conveyed the replacement units to the lessors. We disagree with both positions. Under the lease agreements, the lessee was required immediately to replace all units of equipment retired from service. Therefore, as and when the lessee retired a unit of equipment, a liability in praesenti, to make replacement, was created. The amount of the lessee's liability was measurable, under the terms of the lease agreements, by the value as of June 2, 1926, of the equipment units retired. Consequently, the lessee's liability to replace was fixed and determined at the time each unit of equipment was retired and was definitely ascertainable in amount. The lessee's books were kept on an accrual basis, and the accounting for its liability to the lessors was made at the time the equipment units were retired. Under the circumstances, the amount to be deducted from the lessee's income of any taxable year on account of its replacements of equipment is the aggregate value, as of June 2, 1926, of the equipment units retired during that particular taxable year. Cf. 1237 . While the number of equipment units retired in each taxable year is shown, there is no evidence upon which we can determine the amount of the lessee's liability as to each such taxable year. Accordingly, the issue must be resolved against the petitioners. The fifth ground assigned by the respondent as the basis for his claim to increased deficiencies, particularly, in this instance, as to 1929, is an alternative matter and is pressed only in the event that the Board should decide that the lessee is entitled to deduct from the income of that year the amount of its entire liability to the close of the year in respect of equipment replacements. While our decision on the latter question obviates the necessity for passing upon the respondent's alternative claim, we would feel constrained to hold adversely to him if a decision were necessary, since the lessee was the actual owner of the replacement units until it formally conveyed them to the lessors in 1932, and, accordingly, it is entitled to the depreciation deduction, in respect of such units, which the respondent allowed for 1929. Reviewed by the Board. Judgment1238 will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622689/	WOODRUFF LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Woodruff Lumber Co. v. CommissionerDocket No. 7262.United States Board of Tax Appeals6 B.T.A. 515; 1927 BTA LEXIS 3489; March 15, 1927, Promulgated 3489 Increased salaries paid to each of the two principal officers and stockholders, whose experience and efforts were responsible for the unusual profits earned, held reasonable and deductible, where the ratio of net profits, after the deduction, to average investment was greater than such ratio in other years when lesser salaries were paid. H. A. Mihills, C.P.A., for the petitioner. F. O. Graves, Esq., for the respondent. MILLIKEN 515 This proceeding results from the determination by the respondent of a deficiency in income and profits taxes for the year 1920, in the 516 amount of $10,880.26. The petitioner contests only that portion of the deficiency due to respondent's disallowance of $20,000, deduction claimed for salaries paid to officers, and the disallowance of $4,818.99 of the amount claimed as a depreciation deduction. At the hearing, petitioner waived the error with respect to depreciation, leaving in issue only the reasonableness of the salaries paid to officers for services rendered. FINDINGS OF FACT. Petitioner is a Minnesota corporation, engaged in the wholesale and retail lumber business, with principal offices3490 in Duluth. It was incorporated in 1907 to take over and continue the business conducted by C. B. Woodruff, as a sole proprietorship, from 1886 to 1905, and as a partnership, from 1905 to 1907, composed of C. B. Woodruff and A. W. King, under the name of The Woodruff Lumber Co. The business was taken over, upon incorporation, at its book value, and A. W. King paid in $39,200 in cash. The stock holdings, on January 1, 1920, and December 31, 1920, after a stock dividend of about 50 per cent had been declared in October, were as follows: StockholderJan. 1, 1920.Dec. 31, 1920.C. B. Woodruff, president343515A. W. King, secretary-treasurer543772Freemont Woodruff (brother of C. B. Woodruff)104156Eva Woodruff (sister of Mrs. C. B. Woodruff)3757Total1,0271,500Petitioner operated a sash and door factory, manufacturing sash, doors, interior finish and store work; acted as the wholesale representative of other companies located elsewhere, and was engaged in the retail lumber business. The lumber business was highly competitive and petitioner had developed a number of special lines of business which a segregation of accounts of the various3491 branches of its business had indicated were less competitive and more profitable. It had early specialized in handling heavy timber for shipbuilding, vessel and bridge repairs, mines, grain elevator construction, and the street railway business. By 1920 it had also developed a specialty in furnishing pattern lumber and lumber suitable for manual training work in schools. The president and secretary-treasurer were experienced lumbermen and were in complete control of the policies of the petitioner corporation. They devoted all their time to petitioner's affairs, their 517 office hours being from 8 a.m. to about 6 p.m. The principal sales made during 1920 were to customers they had secured and retained as an established clientele through many years of fair dealing and service with the trade. Woodruff, the president, had charge of a branch yard operating in the east end of Duluth. He also did practically all of the lumber buying. His knowledge of lumber, and his long acquaintance with those associated with the lumber mills of that vicinity, enabled him to make very advantageous purchases, especially on piling which those mills were anxious to close out. King, the secretary-treasurer, 3492 was in charge of the sash and door factory and handled the financial affairs of the petitioner. He also purchased the glass needed in petitioner's business and arranged for its insurance. His knowledge of the glass market enabled him to buy advantageously. He put the petitioner's properties in such shape as to enable petitioner to obtain unusually low insurance rates, considering the nature of the business. Both Woodruff and King personally indorsed all of the paper of the petitioner, and were able to secure for it very liberal credit. King also borrowed money on his personal credit for the use of the petitioner, when he considered it good policy to reduce the petitioner's paper. A composite balance sheet for the years 1917 to 1921, inclusive, is as follows: December 31,December 31,December 31,191719181919Assets:Cash$221.88$2,811.07$418.06Accounts receivable65,092.9768,062.7095,058.48Bills receivable1,332.111,598.001,692.24Inventories112,734.33105,221.78118,298.28Liberty bonds1,240.004,700.007,700.00Other bondsChattels11,634.9114,810.8618,386.73Machinery and tools22,026.6422,026.6426,714.49Boiler3,818.223,818.223,818.22Building, lumber sheds6,465.08Building, factory16,528.7416,860.4410,395,36Building, office7,155.067,518.907,518.90Office furniture1,533.591,819.291,836.31Prepaid expense2,058.072,883.272,511.83245,376.52252,131.17300,813.98Liabilities:Notes payable20,875.0022,700.00Accounts payable13,209.2028,359.06Accrued taxes994.191,148.16Accrued labor43,407.441,992.162,823.18Depreciation reserve55,127.1060,685.2268,334.57Capital stock86,100.0086,100.00100,000.00Surplus60,741.9868,275.4077,449.01245,376.52252,131.17300,813.983493 December 31,December 31,19201921Assets:Cash$420.38$121.92Accounts receivable75,788.1089,019.40Bills receivable8,339.3012,732.47Inventories58,169.2765,828.75Liberty bonds37,550.0023,000.00Other bonds54,000.0077,000.00Chattels20,876.7320,754.04Machinery and tools26,496.9926,539.36Boiler3,818.223,818.22Building, lumber sheds6,465.086,465.08Building, factory10,395.3610,395.36Building, office7,518.907,518.90Office furniture2,017.752,017.75Prepaid expense237.51312,093.79345,211.25Liabilities:Notes payable4,000.009,000.00Accounts payable30,554.0830,064.88Accrued taxes3,648.751,668.03Accrued labor1,787.452,412.21Depreciation reserve75,983.8577,508.71Capital stock150,000.00166,500.00Surplus77,449.0158,057.42312,093.79345,211.25518 The net sales of petitioner, for the years 1907 to 1922, inclusive, are as follows: Period ended - AmountNov. 30, 1907$329,976.37Nov. 30, 1908302,559.99Nov. 30, 1909285,881.96Nov. 30, 1910337,476.91Dec. 31, 1911, 13 months245,035.84Dec. 31, 1912222,370.22Dec. 31, 1913243,272.82Dec. 31, 1914226,295.30Dec. 31, 1915$194,277.42Dec. 31, 1916260,170.51Dec. 31, 1917396,234.45Dec. 31, 1918480,560.23Dec. 31, 1919539,428.48Dec. 31, 1920547,998.66Dec. 31, 1921340,852.70Dec. 31, 1922431,702.023494 A condensed statement of petitioner's operations during the years 1917 to 1921, inclusive, is as follows: 1921AmountPercentto salesNet sales$ 340,852.70100.00Cost of goods194,532.9657.05soldGross profit146,319.7442.93Other income11,127.263.26157,447.0046.19Operating 110,680.7632.47expense 1Depreciation1,524.86.45112,205.2632.92215,241.3813.27Officers20,000.005.87salariesNet profit25,241.387.40The large profits during 1920 were in part due to advantageous purchases of lumber and glass when prices were low in 1919. The large supply of materials on hand necessitated the buying, in 1920, of only enough to fill in. A minimum of buying at high 1920 prices, 519 and the unusual sales made during that year, left petitioner with a small amount of goods on hand at the close of 1920 when prices were lower. The president and secretary-treasurer were the only stockholders who were regularly engaged in the petitioner's affairs and were the only officers to whom salaries were paid. Fremont Woodruff, a brother3495 of the president, was vice president, but aside from acting in an advisory capacity, he rendered no services. During years prior to 1920, the petitioner needed capital and the officers sought to develop the business on a conservative basis. Their salaries were fixed on the basis of their actual needs. Prior to 1917, they each drew $175 per month. During 1918, they each drew $225 per month for the first six months, and $400 per month for the remainder of the year, and a bonus of $3,000 each. During 1920, they each drew $400 per month and a bonus sufficient to make the salary paid to each, in that year, total $20,000. The bonus payments were informally authorized by the two officers, who controlled the petitioner's policies, and were paid within the year. During 1920, the employees of the petitioner numbered between 60 and 70, which was a substantially larger number than had been formerly employed. Beginning with the year 1918, the petitioner adopted the custom, then prevalent in that locality, of paying bonuses to employees rather than increasing fixed salaries. The bonuses paid to employees and officers during the years 1918 to 1921, inclusive, are shown by the following3496 table: Position heldAmount1918Aug. WickmanYard foreman$200.00N. A. ZetterlundMillwright450.00N. JensonBookkeeper300.001919W. GerkenClerk250.00N. JensonBookkeeper500.00Chas. DiceSuperintendent350.00N. A. ZetterlundMillwright700.00Aug. WickmanYard foreman350.00A. W. King3,000.00C. B. Woodruff3,000.001920N. JensonBookkeeper1,600.00Chas. DiceSuperintendent1,000.00Russell DiceEstimator800.00N. A. ZetterlundMillwright200.00Hazel GrayCost accountant600.00E. E. WilliamsEstimator200.00C. W. StarkEstimator700.00W. GerkenClerk200.00Aug. WickmanYard foreman300.00Leonard OhmanCabinet foreman100.00A. W. King15,200.00C. B. Woodruff15,200.001921A. W. King5,200.00C. B. Woodruff5,200.00520 The petitioner corporation has been successful in its operations from the beginning. It has paid dividends in every year except one. The average investment and the percentage of net profits earned thereon for the years 1917 to 1921, inclusive, are shown by the following table: 1917.1918.1919.1920.1921.As at January 1:Capital stock$76,100.00$86,100.00$86,100.00$100,000.00$150,000.00outstandingSurplus and 51,869.9760,741.9868,275.4077,449.0147,119.66undivided profitsTotal127,969.97146,841.98154,375.40177,449.01197,119.66As at December 31:Capital stock86,100.0086,100.00100,000.00150,000.00166,500.00outstandingSurplus and60,741.9868,275.40177,449.0147,119.6658,057.42undivided profitsTotal146,841.98154,375.40177,449.01197,119.66224,557.42Grand total:274,811.95301,217.38331,824.41374,568.67421,677.08Average investment137,405.97150,608.69165,912.21187,284.34210,838.54Net profit24,960.0117,059.6231,011.3531,722.0125,241.38Per cent net18.17%11.33%18.69%16.94%11.97%profit to averageinvestment3497 The petitioner claimed the $40,000 paid to its president and secretary-treasurer as a deduction in its return for 1920. An examining revenue agent took no exception to the salary deduction as claimed. The respondent determined that the salaries paid to the two officers were in excess of reasonable compensation for services rendered, and disallowed $10,000 of the salary paid to each officer, or $20,000 of the deduction claimed, as unreasonable. OPINION. MILLIKEN: The only question presented is whether the salary of $20,000 paid to each of the two officers during 1920 was reasonable compensation for personal services actually rendered in that year. The evidence is all to the effect that the compensation paid was reasonable compensation for the services rendered. The two officers were men of long experience in the lumber business. They were responsible for the successful growth of the business in former years, as well as its successful operations in 1920. They kept in close touch with the markets and were skillful buyers. The unusual sales of 1920 were due almost entirely to their efforts. The net profits of the petitioner corporation for 1920, after the salaries and all3498 other expenses had been paid, represented a return of 16.94 per cent on the average investment for the year. The ratio of net profits to average investment for 1920 is greater than the average over the five-year period from 1917 to 1921. We are of the opinion that, measured by the results accomplished, both from the standpoint of volume of business transacted and *521 profits to the corporation arising therefrom, the salaries paid to its officers were not unreasonable or excessive for the services rendered. The deficiency will be recomputed, allowing the $40,000 salary deduction claimed. Judgment will be entered on 15 days' notice, under Rule 50.Footnotes1. Exclusive of depreciation and officers' salaries. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622691/	DUANE STRANAHAN, JR. and CECILY S. STRANAHAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentStranahan v. CommissionerDocket No. 1147-80.United States Tax CourtT.C. Memo 1982-151; 1982 Tax Ct. Memo LEXIS 592; 43 T.C.M. (CCH) 883; T.C.M. (RIA) 82151; March 25, 1982. Louise A. Jackson, for the petitioners. Kristine A. Roth, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: Tax Year EndedDeficiency1975$ 2,58419763,345Petitioners claim an overpayment of "minimum tax" under section 56(a) 1 in the amount of $ 61,031. The sole issue for decision attributable to the asserted deficiencies is the deductibility under section 212 of certain aircraft rental expenditures incurred by petitioner Duane Stranahan, Jr. in order to attend board meetings and shareholder meetings of a corporation in which he held a substantial minority block of stock. After the filing of the petition in this case, petitioners filed an amended return for the year 1976 in which they sought a refund of the $ 61,031 they paid for the tax imposed by section594 56(a). Respondent rejected this claim for refund. By proper amendments to the pleadings, the parties now bring before the Court the following additional issues for decision: 1) whether the tax imposed by section 56(a), the "minimum tax," is unconstitutional because it is not an income tax but rather is a direct tax not apportioned among the several states or in proportion to the census in violation of the Sixteenth Amendment, Article I, section 2, clause 3 and Article I, section 9, clause 4, of the Constitution; 2) whether the minimum tax as applied to petitioners violates the Due Process and Just Compensation Clauses of the Fifth Amendment; and 3) whether, if the minimum tax is held constitutional, petitioners are entitled to deduct such tax as an excise tax under section 162 or section 212. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation together with the exhibits attached thereto is incorporated herein by reference. Petitioners Duane Stranahan, Jr. ("Stranahan") and Cecily S. Stranahan, husband and wife, resided at Perrysburg, Ohio, at the time they filed the petition in this case. They timely filed joint income tax returns595 for the taxable years 1975 and 1976. Petitioners' principal sources of income in 1975 and 1976 were investment income from domestic and foreign securities, income from partnership oil and gas exploration and development activities and income from Stranahan's law practice. Between 1964 and 1973, Stranahan, in gradual amounts, invested over $ 2 million in the American Aviation Corporation, a struggling company in the light or very small airplane business (primarily single-engine airplanes) located in Cleveland, Ohio. This investment represented between 10 and 20 percent of petitioner's assets during the years in question. In 1973, the Grumman Corporation ("Grumman"), a New York corporation engaged primarily in the military aircraft business, transferred a corporate business jet, an agricultural airplane and substantial manufacturing facilities to the American Aviation Corporation in exchange for 80 percent of the latter corporation's stock. At the same time, the name of American Aviation Corporation was changed to GrummanAmerican Aviation Corporation ("GAAC"). As a result of these transactions, Stranahan was left with a roughly four percent stock interest in GAAC, plus warrants596 to acquire a proportionate amount of additional shares five years later at $ 1 per share. Prior to this combination, Stranahan had been a member of the Executive Committee of American Aviation Corporation. In the first year after the merger, he was invited to attend directors meetings of GAAC as a guest. In 1974, Stranahan was elected a director of GAAC. He remained an uncompensated director in 1975 and 1976, the years before the Court, and served in that capacity on the Audit Committee of the Board. During 1975 and 1976, Stranahan at various times rented a small plane at the rate of $ 100 per hour to fly to meetings where GAAC business was discussed. These meetings were either meetings of the Board of Directors of GAAC, meetings with other minority directors and shareholders immediately prior to Board of Directors meetings or meetings with corporate officers of GAAC. The subject matter of each of these meetings included reviewing operating reports, budgets, financial statements and the routine administerial matters with which directors customarily deal. But the principal problem of these meetings was the ongoing disagreement between the minority shareholders and directors597 of GAAC and the Grumman-sponsored directors of GAAC over how the company should be run. It was the minority's position that Grumman was operating GAAC like a division and that, as a result, the minority's stock was in danger of losing its considerable value. In particular, the minority shareholders, including Stranahan, complained that Grumman 1) was charging excessive management fees to GAAC, 2) was causing GAAC to pay unnecessary distributor's fees to Page Airways in connection with the sale of GAAC planes and 3) was neglecting business opportunities of GAAC. Through his attendance at these various meetings in 1975 and 1976, Stranahan attempted to alter this state of affairs. Ultimately, in 1978, the minority shareholders as well as Grumman itself disposed of all the stock of GAAC to a third party. On this sale of GAAC stock in 1978, Stranahan realized gain in the amount of roughly $ 1 million. Stranahan never asked for, nor did he receive, reimbursement from GAAC for the cost of the above-mentioned airplane rentals. GAAC paid no dividends to its shareholders in 1975 or 1976. The respondent disallowed deductions for aircraft rental expenditures to fly to the meetings598 described above in the amounts of $ 3,883 and $ 5,166 in 1975 and 1976, respectively. The respondent allowed deductions for aircraft rental expenditures of $ 4,367 and $ 2,526 for the years 1975 and 1976, respectively, relating to 16 other trips taken by Stranahan in those years. These meetings were as follows: DatePurposeJanuary 10, 1975Attend Michigan Council TroutUnlimited (C)February 14, 1975Meeting H. G. Davis, D. Linder,D. Stranahan re: Stock InvestmentAdvisorsApril 18, 1975 -Meeting O. B. Mobley, Jr.,April 20, 1975D. Linder, S. Stranahan,M. Stranahan, re: Hydro CarbonLimited PartnershipsJune 19, 1975 -Hearing at Court of Appeals forJune 20, 1975Sixth Circuit, J. Mattimoe,R. KelseyJuly 22, 1975Meeting H. G. Davis, D. Stranahan,re: Stock AdvisorSeptember 3, 1975 -Meeting O. B. Mobley, S. S. Stranahan,September 5, 1975R. Krechman, R. Kronbach, re: Hydro Carbon Financial RecordsOctober 8, 1975Meeting with Elasta-Turf Rep.,re: Tennis Court Surface withDean Bailey, K. BaileyOctober 17, 1975Meeting with Wadsworth, S. Stranahan,C. Stranahan, re: RestructuringFamily Charitable Activities (C)November 10, 1975Meeting Cincinnati Floor Rep.,re: Paddle Tennis Courts ShadowValley Development Corporationwith Dean BaileyNovember 20, 1975 -Cleveland Bar Association TaxNovember 21, 1975Institute, P. McKenzie, Sam Young,R. KrechmanFebruary 4, 1976Meeting O. B. Mobley, Jr., andR. Kronbach, re: Improved productionsand financial reportsFebruary 13, 1976Family money management meeting.April 20, 1976 -Interviews with potential securityApril 22, 1976investment advisors, MorganGuaranty, Neuberger & Berman,F. Eberstadt & Co. and Templeton& DebrowMay 4, 1976Preparation for Appellate reviewof charitable deduction, S. R. YoungP. R. McKenzie, N. Miles, A. WiedemanSeptember 30, 1976Ohio Council of Foundation panelmember, re: Private FoundationsNovember 11, 1976 -Cleveland Tax Institute with MMBBNovember 14, 1976representatives599 At sometime during 1975 or 1976, Stranahan made trips to New York City to confer with an investment banker regarding the possibility of finding an "industrial minority" to replace the existing minority stockholders. 2OPINION Issue 1. Aircraft Rental ExpensesThe first issue for decision is the deductibility under section 212(2)3 of aircraft rental expenses incurred by Stranahan in 1975 and 1976 for the purpose of flying to meetings of the Board of Directors of GAAC, meetings with other minority directors and shareholders and meetings with officers of GAAC. Petitioners assert that the above expenses were ordinary and necessary expenditures600 made to protect the value of Stranahan's substantial investment in GAAC -- that without these expenditures the majority shareholder, Grumman, would have seriously jeopardized the value of the holdings of the minority shareholders. Respondent, on the other hand, argues that the expenses are not deductible under section 212(2) because 1) the expenses did not advance an income-producing motive, 2) as a fiduciary of the company, Stranahan was conducting corporate rather than personal business, 3) the reasonableness of each expenditure was not shown and 4) the variety and number of meetings were not shown to be ordinary and necessary to protect the interests of a minority shareholder. 4Notwithstanding respondent's reliance upon the above four arguments, he places most of his emphasis on the contention that Stranahan was conducting corporate rather than personal business, thereby converting601 his expenditures from personally deductible expenses to contributions to the corporation. Inherent in respondent's position on this point, however, is the thought that involvement in corporate affairs through board membership fatally taints, insofar as section 212(2) deductions are concerned, activities otherwise acceptable in connection with the management, conservation or maintenance of property held for the production of income. As stated in our findings of fact, Stranahan's roughly $ 2 million investment in GAAC represented only 10 to 20 percent of his assets. This, plus the nature of many of the trips for which respondent did in fact allow deductions, reflect the substantiality of Stranahan's investments and his activities related thereto. Stranahan's GAAC role, in other words, was only one of a multi-faceted business and investment activity conducted by Stranahan during the years in question. As we have said in a different factual context, "[t]he line of demarcation between currently deductible and capital expenditures is often a shadowy one * * ." Boagni v. Commissioner,59 T.C. 708">59 T.C. 708, 712 (1973).602 The facts before us amply demonstrate, when laid side-by-side with those of other cases in a similar context, that we are in he realm of nuance when we search for the line of demarcation. For example, in Nichols v. Commissioner,T.C. Memo. 1963-148, we held against a taxpayer who incurred and sought to deduct substantial travel and other expenses in connection with a corporation which he, his wife and his daughter substantially owned. The facts relied upon by the Court in reaching its conclusion made it abundantly clear that the taxpayer had inextricably interwoven the corporation's overall affairs with his own. We did not find any ground for allowance of the deductions by reason of taxpayer's activities as a director, nor did we accept his fall-back position that he should be allowed some deduction under section 212(2). The expenditures incurred essentially benefited the corporation, not the taxpayer. By way of contrast, the facts of this case convince us that what Stranahan was in fact engaged in was damage control -- a fight for the life of his investment. ( Treas. Reg. Section 1.212-1(b)603 allows a deduction "even though the property is held merely to minimize a loss with respect thereto.") Stranahan testified that at one point Grumman offered the GAAC minority shareholders $ 4 per share for their stock. Later Grumman attempted a "freeze-out" merger at $ 5 per share. That Stranahan was ultimately able to realize $ 8.50 per share for his stock, amounting to a net profit of about $ 1 million, is eloquent testimony to the success of his efforts. 5 Unless we were willing to conclude (which we are not), that the words of section 212(2) have been totally sapped of their vitality, the facts before us present a convincing case that Stranahan's expenditures were incurred for the management, conservation, or maintenance of his property held by him for the production of income. Thus, we find that petitioners have amply rebutted respondent's disallowance based upon the propositions that the expenses did not advance an income-producing motive and were corporate rather than personal. 604 With regard to point 3 of respondent's basis for disallowance, he asserts on brief merely that "[t]he reasonableness of the expenses with respect to the choice of mode of transportation was also not shown," without further elaboration. Since respondent makes no further mention of this point, and in fact allowed expenses for exactly the same mode of transportation related to Stranahan's other business, investment and charitable activities, we conclude that the expenditures in question were reasonable. We turn now to the question of whether the claimed expenses were "ordinary and necessary" within the intendment of section 1.212-1(d) of the Regulations. 6 As the Second Circuit Court of Appeals pointed out in Low v. Nunan (Commissioner),154 F.2d 261">154 F.2d 261 (2d Cir. 1946), affg. a Memorandum Opinion of this Court, section 212(2) must be read in light of Deputy v. du Pont,308 U.S. 488">308 U.S. 488 (1940). There, the Supreme Court held that there may be deducted as "ordinary" only what can be placed in the category of those items of expenses which a substantial stockholder in a corporation engaged in conserving and enhancing his estate would ordinarily incur.605 In Low, the taxpayer involved himself extensively in the affairs of a corporation formed for the purpose of facilitating the settlement of the substantial estate of his parents. The taxpayer and his wife lived on real estate owned by the corporation and incurred a number of miscellaneous unreimbursed costs in connection with the corporation. The Circuit Court held that "[s]tockholders -- and especially those who, like the Lows, own considerably less than all of the stock of a corporation -- when engaged in management, conservation or maintenance of their property in that stock, do not ordinarily incur or pay expenses such as those claimed to be deductible here." Id.606 at 264. It seems clear that the analogy which the Court in Low had in mind was the situation of a minority stockholder of a major listed corporation such as, for example, AT&T. Clearly, such a stockholder would not ordinarily incur unreimbursed expenses for telephone calls, travel, entertainment, etc. on behalf of AT&T in connection with maintaining his stock position. More appropriate for deduction in such a case, as the court pointed out, would be such items as rental of safe deposit boxes, cost of investment counsel, investment and secretarial services, etc. But that is not our case. Unlike the taxpayer in Low v. Nunan, Stranahan did not confuse his corporation's affairs with his own, but to the contrary, simply acted consistently and effectively to forestall Grumman's concerted efforts to denigrate his investment. Stranahan testified that he understood that Grumman "was charging a million dollars a year for their management services and we thought that was too high, and we didn't want to charge anything [as directors' fees, reimbursement for expenses, etc.] to make the point." While it may be perfectly true that Stranahan acted not alone but in concert with607 other substantial minority stockholders, their joint efforts were essentially directed toward the protection of their respective investments. Thus it cannot be convincingly argued that Stranahan's expenditures benefited others and only peripherally himself. As indicated above, the concerted efforts of Stranahan and his fellow minority stockholders to preserve their investment in GAAC was ultimately successful. We think these efforts, including Stranahan's, were obviously necessary, and since they were what any investor similar situated might reasonably have done, they were "ordinary." "The situation [may be] unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part." Welch v. Helvering,290 U.S. 111">290 U.S. 111, 114 (1933). Accordingly, we hold for petitioners on this issue. Issue 2. Minimum TaxThe second issue involves both the constitutionality and the deductibility of the minimum tax. On their 1976 returns, petitioners paid $ 61,031 attributable to the tax imposed by section 56(a), the minimum tax. Petitioners' items of tax preference for purposes of the minimum tax amounted to $ 528,605, composed608 of $ 63,971 of depletion, $ 195,386 of capital gain and $ 269,248 of intangible drilling costs. Petitioners now seek a refund of the minimum tax they paid on the following grounds: 1) the minimum tax is a direct tax not apportioned among the states or in proportion to the census in violation of the Sixteenth Amendment, Artice I, section 2, clause 3, and Article I, section 9, clause 4 of the Constitution; 2) the minimum tax as applied to petitioners violates the Due Process and Just Compensation Clauses of the Fifth Amendment; and 3) the minimum tax, if constitutional, is a deductible excise tax under either section 162 or section 212. In Graff v. Commissioner,74 T.C. 743">74 T.C. 743, 765-767 (1980), we held that the minimum tax was an income tax, not subject to the requirement of apportionment among the states or by the census by virtue of the Sixteenth Amendment. See also Wyly v. United States,662 F.2d 397">662 F.2d 397 (5th Cir. 1981), affg. an unreported district court opinion ( N.D. Tex. 1980, 46 AFTR2d 80-5892, 80-2 USTC par. 9645). This holding accords with609 the implicit assumption to the same effect of such cases as United States v. Darusmont,449 U.S. 292">449 U.S. 292 (1981), a per curiam reversal of an unreported district court opinion ( E.D. Cal. 1980, 46 AFTR2d 80-5805, 80-2 USTC par. 9671); Estate of Kearns v. Commissioner,73 T.C. 1223">73 T.C. 1223 (1980); and Buttke v. Commissioner,72 T.C. 677">72 T.C. 677 (1979), affd. per curiam 625 F.2d 202">625 F.2d 202 (8th Cir. 1980), to name only a few. Petitioners attempt to distinguish these prior cases on the grounds that they focused primarily on the capital gain item of tax preference when concluding that the minimum tax merely adjusted the rate of income tax on net gain measured elsewhere in the Code. Petitioners argue that items of tax preference such as excess intangible drilling costs under section 263(c) (i.e., those exceeding straight line capitalized intangible drilling costs) and excess percentage depletion deductions (i.e., those exceeding the taxpayer's adjusted basis in the assets) are really items of capital recovery and to impose a tax on these items would be to impose an impermissible direct tax on cost basis recovery deductions, not merely610 to adjust tax rates on net gain already constitutionally measured. See Burke, "Graff,Revenue Ruling 78-61 And Inland Steel Company: What Is The Add-On Minimum Tax?," 59 TAXES 161 (1981). We see no merit whatsoever in this argument as regards the preference item for percentage depletion deductions taken exceeding the taxpayer's basis in the property. As to this item, other provisions of the Internal Revenue Code still allow a taxpayer a complete nontaxable recovery of his cost basis in the property. Only depletion deductions in excess of cost basis are subjected to the minimum tax. However, we do, at least initially, see some merit in petitioners' argument as regards the intangible drilling cost tax preference item. The intangible drilling cost deduction of section 263(c) provides an elective method of accelerating the recovery of actual cost (normally recoverable by capitalization and amortization). A taxpayer electing to take the section 263(c) deduction may be subject611 to an additional minimum tax on part of this actual cost basis recovery deduction -- i.e., the part of his actual cost deduction which exceeds the deduction he would have been able to take in the taxable year in which taken had he capitalized and amortized the expenditures. At first blush, then, the section 56(a) tax appears to impose an impermissible direct tax on part of the recovery of the taxpayer's capital. See Burnet v. Logan,283 U.S. 404">283 U.S. 404 (1931); Southern Pacific Co. v. Lowe,247 U.S. 330">247 U.S. 330 (1918). However, the section 56(a) tax on intangible drilling costs is, in effect, an elective tax, incurred only if the taxpayer chooses under section 263(c) to forgo the normal method of cost recovery (i.e., capitalization and amortization). This normal method allows for a complete, non-taxable recovery of the taxpayer's capital investment. Such a tax as section 56(a), which is imposed only on taxpayers who in essence elect to have it imposed by their own actions in taking certain preferential deductions, is simply not a direct tax prohibited by the Constitution. Not being a direct tax, it need not be apportioned among the states or in accordance with612 the census to be constitutional. Having reaffirmed our position that the minimum tax is constitutional because it is not a direct tax (whether or not it is truly an income tax for purposes of constitutional analysis) we next proceed to petitioners' Due Process and Just Compensation Clause arguments. Petitioners apparently have abandoned their Just Compensation Clause argument for we can find no reference to it in their briefs. Consequently, we do not deal with it here. As to the Due Process Clause argument, petitioners contend that the retroactive application of the 1976 amendment which made intangible drilling costs a new item of tax preference 4 for purposes of the minimum tax violated due process as applied to petitioners. In Darusmont,supra, the Supreme Court held that retroactive application of an increased rate of minimum tax to capital gains preference items did not violate due process when the amendment increasing the rate of tax was passed after the transactions producing the gain were completed. We have no evidence in this record as to what transactions613 gave rise to petitioners' $ 269,248 of intangible drilling cost preference items in 1976. For all we know, the transactions giving rise to these preference items may have been completed after the October 4, 1976, date of the passage of the amendment. In such a case the amendment would not apply retroactively as to petitioners. On this record we can certainly find no violation of the Due Process Clause. Petitioners' final argument is that the minimum tax is an excise tax, and is therefore deductible by them under section 162 or section 212. We have recently held that the minimum tax is not a deductible tax. Standard Oil Co. (Indiana) v. Commissioner,77 T.C. 349">77 T.C. 349, 411-412 (1981) on appeal (7th Cir., March 1, 1982). Accord Wyly v. United States,supra at 406. We see no reason614 to reexamine that holding here. Accordingly, petitioners have not made an overpayment of minimum tax. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954 in effect during the years before the Court, unless otherwise indicated.↩2. The record is not clear as to whether these trips were included among those for which respondent allowed deductions.↩3. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year-- (2) for the management, conservation, or maintenance of property held for the production of income; * * .↩4. We would observe that respondent has not attempted to invoke the so-called "defense of title" regulations; i.e., sec. 1.212-1(k), Income Tax Regs. Cf. Cruttenden v. Commissioner,70 T.C. 191">70 T.C. 191 (1978), affd. 644 F.2d 1368">644 F.2d 1368↩ (9th Cir. 1981).5. The term "income" in section 212includes not merely income of the taxable year but also income which the taxpayer * * may realize in subsequent taxable years; and is not confined to recurring income but applies as well to gains from the disposition of property. [Section 1.212-1(b), Income Tax Regs.↩]6. Section 1.212-1(d), Income Tax Regs., provides: (d) Expenses, to be deductible under section 212↩, must be "ordinary and necessary". Thus, such expenses must be reasonable in amount and must bear a reasonable and proximate relation to the production or collection of taxable income or to the management, conservation, or maintenance of property held for the production of income.4. Tax Reform act of 1976, Pub. L. No. 94-455, sec. 301(c)(1)(B), 90 Stat. 1550. The amendment, passed October 4, 1976, was made applicable to all items of tax preference for taxable years beginning after December 31, 1975. Id.,↩ sec. 301(g)(1), 90 Stat. 1553.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622692/	HERSHEY MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hershey Mfg. Co. v. CommissionerDocket Nos. 28862, 32108.United States Board of Tax Appeals14 B.T.A. 867; 1928 BTA LEXIS 2898; December 20, 1928, Promulgated 2898 1. A patent application is an assignable property right capable of being valued as evidence of the value of stock of a corporation for which it was exchanged. 2. Costs of development incurred subsequent to the filing of the application for a patent must be shown to add to the capital value of that patent before they can be added to the depreciable base of such patent. 3. A patent application is not a depreciable asset. When a patent issues, however, depreciation may be taken over the life of the patent. 4. Experimental expenses should be charged to capital or expense depending upon the nature of the expenditure. In the absence of evidence as to the nature of the experiment the deduction of such expenses can not be allowed. 5. Cost of organizing a corporation may not be recovered by exhaustion deductions. Geo. E. H. Goodner, Esq., for the petitioner. Harry LeRoy Jones, Esq., for the respondent. SIEFKIN867 These proceedings result from deficiencies asserted in income taxes for the years 1922 and 1923, in the respective amounts of $1,727.26 and $524.55. The two cases were consolidated for hearing and decision. The errors2899 alleged and pressed were: (1) Inadequate depreciation allowance on patents (involving a question of basic cost of patent application acquired for stock); (2) Disallowance of deduction amortizing corporate organization expenses over the period of corporate life; and (3) Disallowance of cost of experimental work as deduction. FINDINGS OF FACT. Petitioner is, and during the years in controversy was, a Colorado corporation with principal offices at Denver. It was incorporated on October 18, 1919, to take over a patent application on an automobile lock and to engage in marketing that device as set forth in greater detail below. About March of 1919, O. S. Hershey, a machinist and tool maker who had been employed in the experimental departments of a number of concerns, became impressed with the need of a theft-proof automobile lock. After conceiving the idea incorporated in the lock patented, he consulted with his brother, J. C. Hershey, resigned his position and went to work upon the patterns preparing to make the first model. Within the course of several weeks after the formulation of the design in his mind, he had the matter in the hands of 868 a patent attorney. 2900 The design was worked out without reference to any existing locks. The invention was a lock designed to be secured to the steering column of an automobile within convenient reach of the driver. The basic principle of the lock was a bolt which moved inwardly into a hole in the steering post to prevent that post from rotating when the car was locked. The bolt was actuated by a key working in an ordinary cylinder lock. If the hole in the post was not turned directly toward the bolt, it could not advance, but the key was actuated regardless of the position of the steering post so that, upon subsequent attempt to steer the car, the bolt would engage the steering post when the hole was first turned directly toward the bolt, making the post rigid and making it impossible to steer the car. This latter feature was thoroughly covered by the patent application. The only way a car equipped with such device could be stolen was by use of some apparatus raising the front wheels off the ground. The lock could not be removed from the steering wheel while in the locked position for, when in that position, all of the screws by which it was attached, were concealed. There were several automobile2901 locks on the market at the time. Aside from a steering wheel lock, which is no longer on the market and worked on a different principle than the invention in question, the most effective prior locks operated on the transmission. They locked the gears in the neutral position. In two respects the Hershey lock represented an improvement over those. In the first place the gear locks were so located as to require the driver to change position to lock his car, which caused many to neglect to do so. More important still, a car with a transmission lock could be stolen by means of towing. Under an agreement between the inventor and his brother, the latter was to have a half interest in whatever developed in return for his supplying needed funds. The brother interested three others George L. Nye, George L. Felt, and Rens E. Schirmer. Nye was a prominent attorney of Denver who afterward was active in the petitioner's organization and gave counsel on general legal matters. Felt and Schirmer were prominent mining engineers of that locality. Felt later dropped out and his place was taken by Joe Terry, a wealthy mine owner, who became general manager. He also asked for the exclusive2902 sales right in part of the United States. Schirmer became interested at his own request. The half interest of J. C. Hershey was divided equally among these four giving each a one-eighth interest, which interest continued until petitioner was organized. The preliminary expense connected with the invention amounted to $2,000. Credit for an additional $5,000 was given to these four individuals in investigating the marketability of the device to determine whether 869 additional investment was justified. No further effort was made to raise additional capital prior to incorporation. The reaction to the lock device was encouraging from the start. Several models were made experimenting with its appearance. It was then decided to build 300 locks as an initial step. Of this number about 200 were manufactured by the interested parties at a cost of about $6 each. All but twelve, which were given away, were sold, put on cars and used. They proved satisfactory and no complaints were made concerning them. The Denver representative of the Cadillac Motor Car Co. purchased 25 to put on cars he sold to customers. Locks had not become standard equipment on any cars at that time2903 and the only approach to automobile manufacturers was by building up a demand through the accessory market. No other locks were manufactured prior to incorporation. Salesmen using the models, however, took orders for some 600 locks. The list price was fixed at $12 per lock with 50 per cent off to jobbers. From the cost of manufacturing those already made and from bids obtained from manufacturers, it was estimated that the locks could be made at a cost of $3.50 each. Cost of selling, commissions, advertising, and traveling expenses were estimated at $1.50 per lock, leaving an estimated profit of $1 per lock. Consultation with advertising firms and jobbers who desired selling rights convinced the parties interested that they had a product of merit which would be in great demand. The Underwriters Laboratories (which tested locks for the National Automobile Underwriters) conference approved the lock as entitling owners whose cars were equipped with the device to the 15 per cent reduction in insurance rates allowed for adequate locking equipment. Automobile production was on the increase at this time. Some 2,000,000 new cars were being produced annually. The advertiser consulted2904 advised that no difficulty ought to be encountered in selling 1,000,000 locks in 10 years. On the basis of the foregoing facts the several associates interested in the invention estimated they could sell 5 per cent of the anticipated motor car production which resulted in an estimate of 1,000,000 sales in 10 years at a profit of $1 each. They expected that such a number of sales would be attained only be continuously increasing sales from year to year. They concluded their rights in the patent application were worth $250,000 when petitioner corporation was organized in October of 1919. Petitioner's authorized capital stock of $500,000, divided into 8,000 shares of common and 2,000 shares of preferred, each share having a par value of $50, was issued to the incorporators for their interests in the patent application and any refinements pertaining thereto developed or to be developed by the inventor. Half of such stock, including all the preferred, was returned to the petitioner as treasury 870 stock to be sold to raise needed working capital. Sales were made only to the incorporators, close friends and office associates. The preferred stock was sold at par and the common2905 stock issued therewith as bonus stock. The rate of bonus stock issued decreased in the later sales. Subsequently changes were made in capitalization giving petitioner authorized preferred stock having a $200,000 par value. The sale of preferred stock to date amounts to $110,000 par value. The object of providing working capital having been attained, no attempt was made to sell additional stock. In recent years all preferred stock was made convertible into common stock at the option of the holder and all but 58 shares have been so converted. The first quantity order for 25,000 locks came in July, 1920, from the Simplex Corporation of Chicago, an accessory firm, after that firm, during the course of that month, had investigated the lock, found it satisfactory, and took over the distribution. The net profit realized upon this order amounted to $1.75 per lock. This firm continued to handle distribution for three or four years until petitioner decided to abandon the accessory field. During that time it purchased approximately $550,000 worth of locks from petitioner. It considered the lock far superior to any other lock of any type and attributed its success to its merits. 2906 By 1920 petitioner began approaching automobile manufacturers to adopt the lock as built-in standard equipment. The Elgin Motor Car Co. was the first to adopt the lock, in 1921. The Rickenbacker Motor Car Co. followed in 1923, and the Studebaker Co. in 1924. The first two companies have since gone out of business. The automobiles on which the lock was standard equipment at the time of hearing were the Studebaker, Graham-Paige, Buick, Lincoln, Chevrolet and Jordan. The Ford Motor Car Co. negotiated for a license to manufacture under the patent for use on the Ford car but failed, as the granting of such license was contrary to petitioner's policy. During the 8 1/2 years following incorporation petitioner sold approximately 2,500,000 locks. The estimated present annual output is 1,000,000. At first petitioner had the lock manufactured by others. Later it built a factory and now makes them in its own plant. The profits and losses of the petitioner for the years 1919 to 1924, inclusive, were as follows: ProfitLoss1919$1,426.8819206,290.731921$14,575.30192229,548.6219236,196.37192431,236.71871 The dividends paid2907 by petitioner to July 1, 1925, were as follows: 1920$281.3919212,522.1319221,492.001923$1,492.0019241,499.961925, to July 12,519.63The principle patented has been used throughout petitioner's life. Refinements have to do largely with the outside appearance. The lock remained essentially the same, though adjustments have been made to adapt the lock to uses on the various makes of automobiles. The patent, No. 1,417,603, was issued to the petitioner corporation on May 30, 1922, pursuant to the application filed by the inventor and assignment made by him to petitioner when petitioner was organized. The two years delay in issuing the patent was a reasonable time to complete the proceedings. Some of the claims made in the application had been allowed by the patent office before petitioner acquired the rights thereto. Those rejected were denied on merely formal grounds. The application was investigated prior to the time petitioner received it in exchange for stock. The Simplex Corporation also caused an investigation to be made before entering into the contract of distribution in July, 1920. None of these searches disclosed any infringement2908 of other patents. Nor has petitioner or others ever had other than minor threats concerning alleged infringements, none of which resulted in litigation. Petitioner holds some 17 other patents acquired by purchase, none of which are in use. They were purchased as a matter of good business to forestall possible litigation and to prevent use by competitors. None of these involve the same principle covered by the Hershey patent. No effort has ever been made to build up a trade name or trademark around the patented device. While in the accessory market, orders were received for the "Hershey Lock" and the "Theft Proof Lock." Those sold to manufacturers were not separately identified but were sold as the car maker's own product. The value of the rights to the patent application paid in for stock was $75,000 on the date the exchange was effected, and, as this was the sole corporate asset at that time, the stock issued therefore had a value equal to the worth of such asset. Between the time petitioner acquired the rights to the patent application and the date the patent was issued, petitioner expended $4,666.77 in experiments relating to such patent. This experimental cost2909 was capitalized. Petitioner first claimed depreciation on account of the Hershey patent in 1922 in the amount of $8,578.43, of which only $61.62 was allowed. In 1923, the depreciation deduction claimed was $14,705.88, all of which was disallowed. Experimental costs pertaining to the patent during the year 1923, amounting to $329.50, were claimed and disallowed as an expense deduction for that year. 872 The cost of organizing petitioner corporation was $1,271.71. Its charter was for a period of 20 years. Petitioner's claimed deduction in each year in question, in the amount of $127, by way of amortization of such organization cost was disallowed. In now claims one-twentieth of such cost as an allowable deduction for each of the years in question. OPINION. SIEFKIN: The principal question herein presented for our consideration is the basis for computing the depreciation or exhaustion allowance on the Hershey patent for the years in question. The first step in the acquisition of this patent by petitioner consisted of an exchange of 4,000 shares of its common stock issued at the time of incorporation to the inventor, his brother and three associates, for their2910 rights in an application for patent then pending. It is the value of the stock at the time exchanged that is the primary object of our search. Kennedy Construction Co.,4 B.T.A. 276">4 B.T.A. 276. We are concerned with the value, if any, of the patent application only as it may be reflected in, and constitute evidence of the value of the stock. No stock was offered to others than those interested in the patent application or their close friends. Under such circumstances stock sales, though the evidence concerning them were more complete, would not, standing alone, be a dependable index to the value of the stock. The record consists principally of evidence pertaining to facts relating to the patent application and its value. We have repeatedly held that the value of corporate assets evidences the value of the stock. Respondent, however, earnestly urges that an application for a patent is not an assignable right which may be definitely valued and asks reconsideration of prior decisions by this Board holding the contrary. See 2911 Individual Towel & Cabinet Service Co.,5 B.T.A. 158">5 B.T.A. 158; Commercial Truck Co. of America,5 B.T.A. 602">5 B.T.A. 602; Union Paper Co.,9 B.T.A. 1010">9 B.T.A. 1010; Hartford-Fairmont Co.,12 B.T.A. 98">12 B.T.A. 98; and International Banding Machine Co.,12 B.T.A. 1062">12 B.T.A. 1062. As this contention attacks the means principally relied upon by petitioner to show the value of the stock, it must be disposed of as a preliminary to any discussion of the value established by such evidence. Respondent cites Marsh v. Nichols, Shepard & Co.,128 U.S. 605">128 U.S. 605, as authority for his proposition that there is no property right in a patent application. That case merely holds that there is no such right in a patent application as will ground a suit for infringement. While it is true the court in that case did say there was no property right until the patent issued, the import of such statement was limited 873 to the matter in question by the addition of the clause "that is, no such right as the inventor can enforce." Furthermore, that decision quotes with approval from Gayler v. Wilder ,10 Howard 476">10 Howard 476, at page 491, in which the court2912 said: The inventor of a new and useful improvement certainly has no exclusive right to it, until he obtains a patent. This right is created by the patent, and no suit can be maintained by the inventor against any one for using it before the patent is issued. But the discoverer of a new and useful improvement is vested by law with an inchoate right to its exclusive use, which he may perfect and make absolute by proceeding in the manner which the law requires. Fitzgerald possessed this inchoate right at the time of the assignment. The discovery had been made, and the specification prepared to obtain a patent. And it appears by the language of the assignment, that it was intended to operate upon the perfect legal title which Fitzgerald then had a lawful right to obtain, as well as upon the imperfect and inchoate interest which he actually possessed. The assignment requests that the patent may issue to the assignee. And there would seem to be no sound reason for defeating the intention of the parties by restraining the assignment to the latter interest, and compelling them to execute another transfer, unless the act of Congress makes it necessary. The court thinks it does not. 2913 The act of 1836 declares that every patent shall be assignable, in law, and that the assignment must be in writing, and recorded within the time specified. But the thing to be assigned is not the mere parchment on which the grant is written. It is the monopoly which the grant confers; the right of property which it creates. And when the party has acquired an inchoate right to it, and the power to make that right perfect and absolute at his pleasure, the assignment of his whole interest, whether executed before or after the patent issued, is equally within the provisions of the act of Congress. Cf. Keystone Type Foundry v. Fasteners Co.,263 Fed. 99, at page 100. There is nothing in the Marsh case, supra, indicating any intention to overrule the principle established by the excerpt quoted. On the other hand the principles there enunciated have been followed in subsequent cases; see Montgomery, Income Tax Procedure, 1925. We must, therefore, reject the contention that there is no property right in a patent application. It is likewise apparent from the above quoted excerpt that such property right is assignable. 2914 May such assignable property right be definitely valued? The case of Durham v. Seymour,161 U.S. 235">161 U.S. 235, is cited by respondent as authority for his negative assertion. In that case, which was an appeal from a decision of a lower court refusing a decree authorizing the Commissioner of Patents to issue a patent, the only question, so far as pertinent to this discussion, was whether the matter in dispute, i.e., whether or not a patent should issue, amounted to at least $5,000 so as to give the United States Supreme Court jurisdiction to consider the appeal under acts of Congress pertaining thereto. In 874 answering the question considered in the negative, the court said in part: The matter in dispute was not money, and the only remaining inquiry is whether it was a right capable of being ascertained in money and appearing to be of the requisite pecuniary value? The answer to this inquiry requires the application of the settled and necessary principle that the matter in dispute is, * * "the subject of the litigation - the matter for which the suit is brought," and that matter here was the issue of a patent, that is, an application to the courts below2915 to hold the alleged invention patentable and authorize a patent to be issued. After referring to the decision cited above to the effect that a patent application was an assignable property right, the court continues: The right to apply for a patent was being availed of in this proceeding and the invention cannot be regarded for jurisdictional purposes as in itself property or a right of property having an actual value susceptible of estimation in money. Whether the alleged invention were patentable or not was the question, and that question had no relation to its value in money. If the invention were not patentable, Durham had suffered no loss; if the invention were patentable, it was not material whether it had or had not a money value. The bill, properly enough, does not allege that any sum of money was in dispute, although there are averments that the value of the invention is generally recognized, and that sundry persons are deriving large profits in making the device sought to be patented. Evidence of that kind, though not controlling, is sometimes introduced in suits on patents as indicative of invention in the production of new and beneficial results, but it is2916 not relevant here, nor are the affidavits presented on the question of value if the patent were granted. The matter in dispute must have actual value, and that cannot be supplied by speculation on the possibility that, in a given case, an invention might be held patentable. * * * We are of opinion that the matter in dispute in this case was not capable of being valued in money, and that the appeal must be dismissed. In our opinion, the language of the Supreme Court quoted above, when the question before the court is noted, does not go to the extent of holding that there is no property capable of valuation. No question of the value of the alleged right to obtain a patent had been raised in the courts below. Nor was any question of such value involved in the appeal. The sole reason for considering the point was to determine whether the record showed a minimum sum in controversy to give the court jurisdiction. The record did not only show no such amount but that the question presented had no relation to value. It was pointed out that a patent when issued may or may not have a value. That being true, the court could only speculate as to the value of alleged right. That2917 the court refused to do. In other words the court saw no justification for assuming that the 875 patent application in question had a value. That is very different from saying that such value is not susceptible of proof as evidence of value of stock exchanged therefor. Considering the traditional policy of the Supreme Court of deciding only the issue before it, we do not consider the language authority for the respondent's broad assertion that an application for a patent can not be definitely valued. Nor is the contention persuasive upon its merits. While such value may be difficult of proof, the same may be said of other intangible property values which the courts are constantly determining from evidence. In Robb's Patent Essentials, 1922, page 258, it is said: While it is very common to-day for assignments of inventions to be made prior to issue of the patent therefor, strictly speaking, an invention is not an assignable monopoly until its ownership is fixed. The only method of establishing a prima facie ownership is by obtaining a patent. Therefore, it is to be understood that the risk is upon the purchaser who buys an invention while it is resting under2918 an applicat on for patent. Proper investigations will enable the determination of the allowability of a patent, and the probable scope thereof, with a fair degree of safety. When such investigations are made there is a suitable basis for both inventor and purchaser to come to terms for the purpose of transfer of the monopoly. Undoubtedly, petitioner purchased the application rights at its risk. But such risk is not peculiar to patent rights. Questionable titles and supposed causes of action are often the subject matter of valuation, purchase and sale. Doubts as to title or the extent of ultimate rights are matters to be considered in any attempt at appraising propery rights to which they pertain. They influence but do not preclude valuation. We must, accordingly, reject petitioner's preliminary contention that the patent application was not an assignable property right which could be definitely valued. Respondent claims that the evidence of record is subject to the same infirmity as was found by the Board in Commercial Truck Co., supra, in regard to which we stated: The evidence submitted consisted of the testimony of engineers familiar with the petitioner's2919 invention. Their opinions of value were upon the hypothesis that petitioner owned a patent on March 1, 1913, and were based upon the estimated royalties from the patented articles. This evidence is not sufficient to enable the Board to determine what value, if any, should be ascribed to the application for letters patent, which application was all that the petitioner owned on March 1, 1913. (Italics supplied.) It is true, as respondent points out, that some of the questions framed by petitioner's counsel purport to refer to a patent rather than a patent application. But it is also apparent that the witnesses, including those who gave opinion testimony, were familiar with the 876 history of petitioner and knew that what petitioner received was a patent application. The two terms were used interchangeably throughout the record. If the confusion in terminology led to confusion in thought, the respondent's point would be well taken. A careful search of the record, however, leaves no doubt in our mind that there was no such confusion as to the subject matter of testimony. It is clear that the evidence relates to that which petitioner actually received - a patent application. 2920 None of the parties, including counsel for respondent, were misled. The record clearly distinguishes the case from such circumstances as are set forth in the excerpt quoted. We come then to the question of determining the value of the stock issued for the patent application by reference to the value of the only corporate asset - the application. We are of the opinion that a substantial value in such asset has been proven. A substantial improvement over the prior art, and then existing prospects of a large market for the device at a good profit, are well established. The wide market has been substantiated by subsequent events, and the failure to realize the anticipated large profits may be due to many elements having no relation to the value of the patent application or the patent later issued. The evidence tending to show the claimed value of $250,000 is not inconsiderable. We have, however, discounted the claimed value to the $75,000 as found, in view of all the evidence. Petitioner asserts that to this initial cost of the patent application there should be added the subsequent costs of experiment and development incurred to the date the patent was issued to determine2921 the basis for depreciating such patent. Our belief is that before the expenditures can be either capitalized or charged as expense, their nature must be shown. If they can be compared to the cost of prosecuting the claim for a patent or cost incurred in defending title thereto once the patent issues, they can be said to relate directly to the patent property right. So far as appears here, however, the experimental cost subsequent to the acquisition of the application did not add to the capital value of the patent in question and should be excluded from its depreciation base. This brings us to a consideration of the proper depreciation period over which the patent capital account may be exhausted. It is elementary that an asset which has no definite period of useful life is not the proper subject of exhaustion, as one of the essentials to measuring the deduction is unknown. The period covered by application pending is a variable factor. Furthermore, the date the patent issues marks the beginning of the asset in use in an enforceable 877 right, as well as fixes its life. It follows that the inchoate right represented by a patent application matures into a depreciable2922 asset beginning with the date the patent is issued and extending over the 17-year period covered thereby. What has been said respecting experimental costs resolves the claim for a deduction for 1923 on account of such expenditures made in that year against the petitioner. It is claimed that such expenditures were development expenditures under the patent. We are without evidence from which the nature of the expenditures may be determined, and the denial of the deduction taken must be approved. There remains the question whether costs of organization may be recovered by pro rata exhaustion deductions over the twenty-year period of corporate life. We have heretofore held that such cost can not be deducted as an expense item; Logan-Gregg Hardware Co.,2 B.T.A. 647">2 B.T.A. 647; First National Bank of St. Louis,3 B.T.A. 807">3 B.T.A. 807; Emerson Electric Manufacturing Co.,3 B.T.A. 932">3 B.T.A. 932; American Colortype Co.,10 B.T.A. 1276">10 B.T.A. 1276. It represents the expenditure for a corporate asset used or useful in its business. In 2923 Corning Glass Works,9 B.T.A. 771">9 B.T.A. 771, we held that the amount paid to financial agents for services in selling stock could neither be amortized over the maximum life of the stock and thus (based upon the remaining life of the corporation) taken as a deduction, nor be taken as a deduction in a later year when the stock was retired. Reasoning from that case, we see similar reasons here for denying any pro rata deduction even though it be admitted that the organization costs are capital items. It is a matter of common knowledge that corporate charters for a definite period are often renewed or materially changed during that period or are permitted to lapse before the term expires. Further, although we have found that the cost of organizing the petitioner corporation was $1,271.71, we are unable to find from the evidence that such amount was paid by the petitioner. There is a possibility, at least, that such amount was paid by the promoters, before the corporation came into existence. We are unable to say that the revenue acts contemplate a deduction for exhaustion in such a case. Reviewed by the Board. Judgment will be entered under Rule 50.TRAMMELL and*2924 PHILLIPS dissent on the last point.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622694/	CARLYLE STURM AND CHARLOTTE STURM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSturm v. CommissionerDocket No. 26723-83.United States Tax CourtT.C. Memo 1987-625; 1987 Tax Ct. Memo LEXIS 670; 54 T.C.M. (CCH) 1394; T.C.M. (RIA) 87625; December 30, 1987. Thomas F. Topel, J. Marquis Eastwood, Kenneth L. Cutler, and Maureen H. Parkinson, for the petitioners. Randall G. Durfee and Joel A. Lopata, for the respondent. HAMBLENMEMORANDUM FINDINGS OF FACT AND OPINION HAMBLEN, Judge: Respondent determined deficiencies in petitioners, 1 Federal income tax liability as follows: 671 YearDeficiency1979$ 67,658.001980$ 39,067.00The primary issues for our determination are whether petitioner's transactions with respect to certain computer equipment were structured as a tax-avoidance scheme devoid of economic substance which should be disregarded for Federal income tax purposes and whether petitioner acquired the benefits and burdens of ownership. Subsidiary issues for our determination are: (1) whether the ownership interest acquired by petitioner, if any, was a future interest; (2) whether petitioner was entitled to deduct certain interest paid with respect to certain promissory notes and an agreement of assumption; (3) whether petitioner was at risk within the meaning of section 465 2 with respect to certain promissory notes and an agreement of assumption; (4) whether petitioner was entitled to elect the modified half-year convention672 method of depreciation for the taxable year 1979 and whether petitioner was entitled to use the double declining balance method of depreciation; and (5) whether petitioner is liable for an additional interest amount determined pursuant to section 6621(c). 3FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners resided within the state of Montana at the time their petition herein was filed. Petitioner received a Ph.D. degree in business and economics from the University of Wisconsin in the year 1940. Petitioner is a semi-retired business insurance consultant, licensed in673 Montana. During the year 1979, in a transaction that is the subject of this action, petitioner purchased 4 from Finalco, Incorporated ("Finalco"), certain computer equipment manufactured by Honeywell Information Systems, Inc. ("Honeywell"). Petitioner and Finalco entered into a Lease Agreement which provided that petitioner would lease the acquired computer equipment back to Finalco for a period of 84 months commencing April 30, 1979. FinalcoFinalco is the principal subsidiary of Finalco Group, Inc., formerly Financial Analytics Corporation, a publicly-held corporation, the stock of which is traded over-the-counter674 and reported in NASDAQ quotations. The principal offices of Finalco and Finalco Group, Inc., are located in McLean, Virginia. During the years in issue, Finalco was a closely-held company. During the years in issue, Finalco typically engaged in leasing transactions involving electronic data processing equipment in which Finalco negotiated and entered into a lease with an end-user, purchased the equipment, financed the purchase with a lending institution, and resold the equipment in a sale and leaseback transaction with an independent third party. The resale of the equipment provided Finalco with much of the capital necessary to generate additional lease transactions. In addition to generating transactions through its own marketing programs, Finalco also acquired equipment subject to existing end-user leases from other leasing companies. During its fiscal year ending June 30, 1979, Finalco entered into lease transactions of approximately $ 129,000,000 based on the original cost of equipment. John F. Olmstead ("Olmstead") was president of Finalco at the time petitioner entered into the transaction. Lease Pro, Inc.Lease Pro, Inc. ("Lease Pro") is a Montana corporation675 engaged in the purchase, sale and leasing of computer equipment. Lease Pro has served as a general partner in a partnership that leases personal property, other than computer equipment, and owns an interest in a leased building. During the years in issue, Lease Pro was owned by J. L. DuBois ("DuBois") and Dean Schennum ("Schennum"). DuBois acted as the sales agent at Lease Pro. Schennum acted as business manager and administrator. DuBois and Schennum are also the principals in DuBois-Schennum Assoc., Ltd., a Montana corporation organized in August of 1980, and registered with the National Association of Securities Dealers ("NASD") for the purposes of acting as a broker-dealer. Lease Pro acted as sales agent for Finalco in the pursuit to locate investors. Lease Pro received a commission in the amount of ten percent of the equity investment, including cash and any recourse note. During 1979 and 1980, Lease Pro's revenue attributable to Finalco arranged computer lease transactions approximated 90 percent of all revenue it earned. Lease Pro had no shareholders, officers, directors, or employees in common with Finalco Group, Inc., its affiliates, or subsidiaries. Equipment Acquisition676 by FinalcoHoneywell agreed to sell certain computer equipment to Finalco for the purpose of leasing such equipment to Ford Motor Company ("the end user") for use at various facilities. A Sale Agreement ("the Honeywell Sale Agreement") executed by Finalco and Honeywell, which was dated April 30, 1979, by Finalco and dated July 12, 1979, by Honeywell, separately described in schedules thereto 18 computer systems to be installed at 18 different Ford facilities. Finalco and Honeywell acknowledged by separate agreement ("Amendments to Honeywell Sale Agreement") executed by each party contemporaneously with the Honeywell Sale Agreement that the effective date of the Honeywell Sale Agreement was April 30, 1979. The Honeywell Sale Agreement provided that title to units of equipment would pass on the date the unit of equipment was shipped by Honeywell or if installed equipment being converted to purchase, on the last day of the month that any existing Honeywell lease agreement terminates. The Honeywell Sale Agreement provided that Honeywell maintain insurance for risk of loss or damage to the equipment for a period of 60 days after shipment or until the equipment was installed and ready677 for use, whichever occurs first. Finalco acquired the computer equipment included in the Honeywell Sale Agreement for the sum of $ 7,083,424 as evidenced by a Bill of Sale ("the Honeywell Bill of Sale") dated April 30, 1979. The computer equipment was installed at 18 different Ford facilities. The Honeywell Sale Agreement included certain computer equipment ("the Equipment") installed at a Ford facility located in Claycomo, Missouri. The Honeywell list price of the Equipment was $ 840,797 as evidenced in the Honeywell customer invoice dated July 30, 1979. The net price Finalco paid for the Equipment was the amount of $ 522,704. The Equipment included both new and used computer equipment. Finalco paid the Honeywell list price of $ 297,030 for new Equipment. Finalco paid $ 225,674 for the used items of the Equipment, an amount of approximately 41 percent of the Honeywell list price. The used Equipment had been installed at the End User location on December 19, 1974. The Honeywell Sale Agreement misidentified an item of the Equipment acquired by Finalco as follows: ListNetQuantityModel #DescriptionPricePurchase1CPS 620364K Memory$ 105,360$ 38,467Increment678 The above model number should have indicated model number CNK 6002, however the other data is accurate. Model number CPS 6203 is a Central Processor which at the time of the transaction commanded a list price in the approximate amount of $ 848,000. The Honeywell Bill of Sale adopted the misidentified model number and altered the description to indicate that a Central Processor was included as part of the Equipment purchased by Finalco. The Honeywell customer invoice also reflects the erroneous CPS 6203 model number and Central Processor description; however, the Honeywell customer invoice correctly billed Finalco the amount of $ 105,360 which is the list price amount of model number CNK 6002 described as a 64K Memory Increment. The 64K Memory Increment was in fact an item of computer equipment acquired by Finalco as part of the Equipment. 5679 Finalco leased the equipment to the End User pursuant to a lease agreement between Finalco and the End User dated April 30, 1979 ("End User Lease"). The End User Lease had an initial term of 48 rental installments. The End User Lease was a typical commercial triple net lease. With respect to the Equipment leased as a component of the End User Lease, Ford agreed to pay Finalco one rental installment of $ 22,554 (three times $ 7,518) for the months of February, March, and April on April 30, 1979, followed by 48 rental installments commencing May 1, 1979. The first 18 rental installments are each in the amount of $ 7,742, and the remaining 30 rental installments are each in the amount of $ 16,133. Upon the expiration or termination of the End User Lease, the End User was obligated to deliver the equipment to a location specified by the lessor, at the expense of the End User. The End User Lease gives the End User an upgrade option; a termination option after 36 months allowing the End User to terminate the End User Lease by paying a termination value equal to the original acquisition financing multiplied by a percentage that decreases with time; and an option to purchase the equipment680 at a price equal to the greater of the then-current fair market value or the termination value increased by 15 percent. The computer equipment subject to the End User Lease was placed in service as of April 30, 1979. To provide the purchase money financing, the Philadelphia Savings Funds Society (the "Bank") loaned EDP Investments, Inc. ("EDP"), a wholly owned subsidiary of Finalco Group, Inc., and a sister corporation to Finalco, a total of $ 9,789,477.21 evidenced by 19 secured promissory notes dated August 3, 1979, issued by EDP to the Bank. One secured note was issued in the principal amount of $ 7,283,457.21 and 18 other secured notes, referred to as "Seller's Notes," were issued in the total principal amount of $ 2,506,020. One such Seller's Note was issued in the principal amount of $ 160,750 (the "Sturm Seller's Note"). All such secured notes were nonrecourse and provided that interest be paid at the rate of 10.2 percent per year. yEDP loaned Finalco $ 9,789,477.21, and Finalco issued a promissory note to EDP, dated August 3, 1979, in the amount of $ 9,789.477.21 which EDP assigned to the Bank. As security, Finalco agreed to assign to EDP certain installment notes, 681 security agreements and leases executed by individuals purchasing the computer equipment covered by the Honeywell Sale Agreement including the Sturm Equipment from Finalco. As security for the purchase money financing, EDP, Finalco and the Bank executed a Security Agreement, dated August 3, 1978, in which EDP and Finalco granted to the Bank their security interest in the Sturm Equipment, title to which had been transferred to petitioner, and interest in all proceeds, notes and leases related to the sale of the Sturm Equipment to petitioner and lease to the End User. Entry Into TransactionPetitioner sold his insurance business to Rollins, Burdick, Hunter ("RBH"), a Chicago based company on June 27, 1979, in exchange for stock and a five-year employment contract with RBH. Petitioner's accountant, Robert Murray ("Murray"), advised petitioner and prepared financial statements in connection with the sale of petitioner's insurance company. Petitioner and Murray discussed financial planning strategies that would supplement retirement income in five years after the expiration of his employment contract. Murray suggested an investment in a leveraged computer lease transaction682 involving Finalco. According to Murray, the reason he suggested an investment in a leveraged computer lease transaction was because of the tax deferral during the initial five years of the lease agreement with some expectation of residual value at the termination of the lease agreement. Murray did not discuss the personal liability aspects of the recourse note and the assumption agreement aspect of the transaction. The description of the Equipment was not provided to Murray prior to petitioner's entry into the transaction such that neither Murray nor petitioner were aware of the Equipment acquired. Neither petitioner nor Murray investigated the End User or the term of the End User Lease. Murray did not appraise the fair market value of the Equipment nor seek an independent appraisal of the residual value. Murray had represented other clients who had invested in leveraged lease programs arranged by Finalco and he had personally purchased such a program. Based on his prior experience with Finalco, Murray relied solely on the representation of Finalco and DuBois that both the purchase price and the projected residual value were reasonable. Murray introduced petitioner to DuBois, 683 of Lease Pro, for the purpose of discussing Finalco's arranged leveraged lease programs. DuBois had acted as a sales agent for Finalco and had directed the placement of many types of investments. DuBois discussed with Murray and petitioner the computer leasing transactions, the projection, and the anticipated income from lease renewals of the computer equipment and the income anticipated from residual value. DuBois represented that petitioner could anticipate receipt of approximately 125 percent of the equity investment of $ 68,000, or $ 85,000, solely from the residual value of the equipment. DuBois also represented that petitioner could anticipate the receipt of 20 percent of the total purchase including renewal proceeds and resale proceeds, of approximately $ 104,000. DuBois did not obtain outside appraisals of the Equipment, but relied solely on the values determined by Finalco. 6DuBois gave petitioner a projected profit and loss statement for the proposed investment for the years 1979-1986, inclusive684 (the "Projection"). The Projection, prepared by Finalco, assumed that the owner of the Equipment would depreciate the Equipment under the Class Life Asset Depreciation Range system, electing the modified half-year convention and the 200 percent declining balance method of depreciation with a seven-year useful life for the new component of the Equipment and the 150 percent declining balance method and a five-year useful life for the used component of the Equipment. The depreciation expense calculated by Finalco for 1979 was $ 152,568. The after-tax savings from the time of investment in 1979 through 1983 was projected to be $ 164,382. The tax that would be due on profits from 1984 through 1986 was projected to be $ 111,489, yielding an overall tax savings of $ 52,893. The Projection assumed an equity investment of $ 68,000, which is greater than the overall tax savings of $ 52,893. The Projection indicated that DuBois orally communicated to petitioner to expect Finalco to generate $ 100,000 of annual renewal income for the period 1984 through 1986 and that petitioner could expect 50 percent of such amount commencing May 1, 1984. 7685 Petitioner did not seek an independent appraisal of the fair market value or residual value of the Equipment. Petitioner did not consult his attorney to review the transaction documents. With respect to equity investments, petitioner principally relied on the investment advice of Richard Spaulding ("Spaulding") a stock analyst with the firm of Merrill Lynch. Spaulding advised petitioner that Merrill Lynch did not recommend leveraged computer leases due to the risk of obsolescence inherent in the computer industry and the resultant uncertainty of residual value. In this regard, Spaulding supplied petitioner with a brochure which detailed the view of Merrill Lynch concerning leveraged computer leasing. Petitioner was not familiar with either computer technology or computer products. Petitioner was unaware as to whether the Equipment included a central processor unit as was incorrectly specified in the equipment schedule provided at the time of purchase. At trial petitioner was not aware of the purpose or approximate value of a central processor unit in comparison to the peripheral items of the Equipment. Petitioner relied solely on DuBois as to both the fair market value and686 residual value of the Equipment, including any renewal proceeds to be expected during the term of the lease and the determination of the amount thereof. As evidenced by an internal memorandum, on June 4, 1979, Finalco began to prepare the documentation necessary to complete petitioner's purchase of the Sturm Equipment. According to petitioner, the transaction was contingent on the sale of his insurance business to RBH. The TransactionThe Purchase Agreement between petitioner and Finalco, dated April 15, 1979 (the "Purchase Agreement"), provided that petitioner would purchase the Equipment from Finalco, subject to the End User Lease, for a total purchase price of $ 522,704 payable as follows: Full Recourse Promissory Note$ 68,000 Nonrecourse Installment Note293,954Assumption of Sturm Seller's Note160,750TOTAL$ 522,704The Purchase Agreement permitted Finalco to encumber the equipment for the purpose of financing its initial acquisition. Finalco represented that the rent payable under the End User Lease during the non-cancellable term thereof would equal or exceed the principal and interest accuring under such encumbrance. Petitioner687 signed a recourse Promissory Note and Security Agreement in favor of Finalco, dated April 15, 1979, in the amount of $ 68,000, with interest on the unpaid balance of 11 percent per annum (the "Recourse Note"). The Recourse Note provided for a down payment of $ 12,000 on June 1, 1979, and four annual payments of $ 14,000 plus accrued interest on each June 1 thereafter. 8 All documentation related to the transaction was signed by petitioner by June 28, 1979, except an Agreement of Assumption, relative to the assumption of the Sturm Seller's Note, which was signed July 31, 1979, and Remarketing Agreement which was signed in October of 1979. Petitioner also signed the nonrecourse Installment Note in favor of Finalco, dated April 15, 1979, in the amount of $ 293,954 (the "Installment Note"). The Installment Note provided that interest would be paid at688 the rate of 10.2 percent per annum. The Installment Note provided for 84 monthly payments -- $ 3,254.20 for the first 45 months and $ 7,531.68 for the remaining 39 months and further provided that in the event of default by petitioner the holder of the Note could declare the entire amount immediately due and payable. To secure the amounts due under the Installment Note, petitioner granted Finalco a security interest in the equipment. Pursuant to an Agreement of Assumption dated July 31, 1979, petitioner assumed the Sturm Seller's Note in the amount of $ 160,750 issued by EDP in favor of the Bank. The assumption by petitioner was sent to, accepted and acknowledged by the Bank. The Sturm Seller's Note required 44 monthly payments of $ 4,393.18, and its assumption was required by the Purchase Agreement as part of the purchase price. Leaseback to FinalcoSimultaneously, upon petitioner's purchase of the equipment, petitioner and Finalco entered into a Lease Agreement, dated April 15, 1979, providing that petitioner would lease the equipment back to Finalco beginning on April 30, 1979 (the "Owner Lease"). The term of the Owner Lease was 84 months, commencing April 30, 1979 (the689 "Original Term"). The monthly rental was $ 7,625.02 per month; however, during the first 45 months of the Owner Lease the monthly rental payable by Finalco would be reduced to $ 3,347.54 provided the End User made its regular monthly rental payment of $ 4,277.48 which was assigned to petitioner as collateral for the Owner Lease. The monthly rent due from Finalco to petitioner was sufficient to amortize the Installment Note obligation and to generate $ 93.33 of cash flow to petitioner during the Owner Lease. Finalco credited petitioner with rental payments beginning April 30, 1979, and petitioner recognized such payments as income. At the expiration of the Owner Lease, Finalco was required, at its expense, to deliver the Equipment to petitioner or his designee, in its original condition. Finalco was granted an option to renew the Owner Lease at the then fair market rental value. The Owner Lease gave Finalco certain other options. Finalco was entitled to terminate the Owner Lease after 12 months by paying a termination value (which was a multiple of the purchase price, depending upon the time of termination) only if the End User terminated its lease. Finalco could purchase the690 Equipment from petitioner after the expiration of the Original Term at fair market value; and purchase the Equipment from petitioner during the Original Term only if the End User had and exercised an option to purchase the equipment from Finalco. In such case, the price would be the greater of the termination value or fair market value plus any and all sales, use or other taxes due as a result of the exercise of the option. Finalco could exchange the Equipment if Finalco gave petitioner title to equipment of equal fair market value. Finalco could renew the Owner Lease at fair market rental value. In addition to remedies available at law or equity, the Owner Lease provided remedies upon default. Upon default by petitioner, Finalco could terminate the lease by paying the scheduled termination value and redelivering the equipment to petitioner. Upon default by Finalco, petitioner could declare the exercise of the termination option by Finalco; sums accrued and unpaid would become due and petitioner would have the option to terminate the Owner Lease, take possession of the equipment, re-lease the equipment, or sell the equipment, and apply the proceeds to Finalco's obligation under691 the Owner Lease. Remarketing AgreementIn connection with the purchase and leaseback transaction with Finalco, petitioner also executed a Remarketing Agreement dated April 15, 1979. In the Remarketing Agreement petitioner agreed not to sell the Equipment during the Original Term of the Owner Lease without the consent of Finalco. Petitioner granted to Finalco the "express right" to sell equipment for petitioner at any time during the Owner Lease and to execute any renewals. Petitioner granted Finalco a right of first refusal to match the terms of any sale or any offer for the equipment not referred by Finalco. The Remarketing Agreement is cast in the form of a brokerage agreement subject to commission; however, the substance of the Remarketing Agreement is that petitioner must rely on Finalco to remarket the equipment such that a fair inference is that Finalco had an exclusive interest in remarketing efforts. Remarketing services are defined to include: (i) renewals under the lease; (ii) purchase of equipment by lessee, (iii) referral of a willing lessee or buyer at fair market value or fair rental value. Residual Revenue is defined as "any and all sums received: 692 (i) from use of the Equipment in excess of or in addition to the rentals due during the Original Term of the Lease; (ii) from sale of the Equipment during the Original Term of the Lease; or (iii) in excess of or in addition to any termination or substitution value if such is paid pursuant to the Lease." (Emphasis added.) The Owner Lease provided for Finalco to pay petitioner $ 7,070.25 per month during the Original Term. The 48-month End User Lease provided that the End User pay Finalco $ 16,133 per month during the last 30 months of the End User Lease Term. Residual Revenue shall be allocated as follows: (a) Renewals: after the sixtieth month of the Original Term of the Owner Lease, 50 percent of Residual Revenue from renewals to petitioner and the remainder to Finalco; (b) Sales: petitioner receives all proceeds until he has received 120 percent of his net equity, then 30 percent of the sale proceeds go to Finalco and 70 percent to petitioner. 9 Net equity is defined as the sum of (a) the cash down payment and (b) the original balance of the recourse note, less (c) all cash flow distribution up to the time of sale. According to Olmstead, Finalco calculated "all693 cash flow distributions up to the time of sale" to be the amount of any cash distributed to petitioner in excess of the corresponding installment note payments due by petitioner. Even though Finalco is entitled to receive payment pursuant to the Remarketing Agreement only if Finalco is responsible for the sale or renewal of the Equipment, the reality of the transaction is such that petitioner must rely on Finalco for remarketing efforts. 694 By letter dated August 5, 1983, Finalco advised petitioner that the End User renewed its lease beyond the initial 48-month term at $ 7,070.35 per month for 20 months. 10 The letter also advised petitioner that Finalco construed the terms of the Remarketing Agreement to entitle petitioner to receive 50 percent of said renewal proceeds for an eight-month period commencing May 1, 1984. Petitioner received from Finalco a total of $ 28,281.40 for the last eight months of 1984. 11 By letter dated January 15, 1985, petitioner was advised that the End User again renewed its lease through April 1, 1985. Petitioner received $ 10,605.54 from Finalco in 1985. The Equipment was not re-leased after termination by the End User on April 1, 1985, and was stored at a Finalco warehouse. The End User had extended the lease due to difficulty encountered in the conversion to the IBM 4331 computer system. 695 Finalco Document Dating PracticesAlthough petitioner signed the Purchase Agreement and other related documents including the leaseback documents on June 28, 1979, the documents bore the date of April 15, 1979. The documents were prepared and packaged by Finalco. According to Olmstead, Finalco dated documents transferring title to the investors on or before the end user lease so that banks which financed the acquisition of the computer equipment would have a first perfected security interest in the equipment. According to Olmstead, Finalco did not date documents in a year prior to the tax year in which the investor purchased the equipment or, if the investor purchased the equipment in the last half of the tax year, Finalco did not date such documents in the first half of the tax year in order to comply with the modified half convention method of depreciation. Despite the fact that Finalco was aware that petitioner signed the Purchase Agreement on June 28, 1979, Finalco warranted that petitioner would be entitled to treat the cost of certain items of the Equipment as new equipment for purposes of the double declining balance method of accelerated depreciation. Petitioner696 agreed to file an election to pass the Investment Tax Credit ("ITC") through to Finalco and signed the election, dated April 15, 1979. The election stated that possession of the Equipment was transferred on April 30, 1979. Finalco signed a similar election, passing ITC through to the End User, dated February 12, 1980. By Bill of Sale date April 30, 1979, Finalco transferred all its rights, title, and interest in the equipment to petitioner. The Equipment and Industry ConditionsThe Equipment contains peripheral equipment for the Honeywell Series 60 Level 66/20 Computer Systems ("Honeywell 66/20") which was introduced in April of 1974. 12 Honeywell acquired the General Electric computer line in 1970. Honeywell encountered difficulty producing a unified product combining the desired features of each computerline. The Honeywell 6000 Series was announced in 1971 but used peripheral equipment developed by General Electric for the GE600 Series. The Honeywell Series 60 was developed to compete with the IBM 370 Series which was introduced in 1971. The Honeywell Series 60 presented new Honeywell peripheral equipment; nonetheless, the state-of-the-art specifications were comparable697 to the IBM 370 which had been on the market for three prior years. The Honeywell Series 60 was intended to serve as an upgrade product to the Honeywell 6000. The IBM 370/138 was introduced as an enhanced IBM 370 Series product in June of 1976. Honeywell responded with the enhanced Honeywell Series 60 Level 66/DPS ("the Honeywell 66/DPS") in September of 1978. In January of 1979, IBM announced the IBM 4300 ("the IBM 4300") which presented a dramatic increase in price/performance capability far in excess of the industry expectations. The IBM 4300 depressed the expected residual values of existing computer equipment. 698 The market for third party leasing of computer equipment developed rapidly in the 1970's. Projections of residual value are critical to evaluate an investment in computer equipment. Such projections vary among experts and fluctuate with market conditions. Computers do not depreciate with age, but rather are subject to technological obsolescence. Because IBM dominates the computer industry, the technological advancements of IBM products have significant impact upon the residual value of progenitors. Industry experts have had varied success in the ability to predict technology advancements of IBM. The volume of used computer equipment transactions can be discerned from the advertisement of the weekly trade journal Computer World. IBM has the largest market share and IBM computer prices are evidenced in the Computer Price Guide ("The Blue Book"). 13 In 1979, Computer World referenced few Honeywell used computer advertisements.699 Honeywell was a competitor during such period. In 1975, Honeywell adopted an unprecedented policy intended to control the secondary sale of Honeywell equipment. Honeywell restricted the relicense of computer software to secondary purchasers of Honeywell central processors and charged substantial fees for engineering and standard maintenance as well as software relicensing. Honeywell desired to control the secondary sale of Honeywell equipment by limiting the use of support services and computer software. These costs imposed by Honeywell upon dealers or users of Honeywell equipment in the secondary market exceeded the standard established by IBM to acquire and maintain comparable IBM equipment. In 1975, Honeywell agreed to exempt Finalco and subsequent owners of Honeywell computer equipment acquired from Finalco from the restriction on the transfer of licensed Honeywell software. ("The Honeywell-Finalco Software Agreement"). Honeywell and Finalco had an extensive business relationship since the founding of Finalco in the year 1968. Some Finalco programs included Honeywell residual participation and Honeywell provided financing for some Finalco acquisitions. The Amendment to700 the Honeywell Sale Agreement provides that: All references to software products and computer programs in Exhibit A to the [Honeywell] Sale Agreement are hereby deleted, since Honeywell will directly license software products to Ford AAD. Honeywell agrees, that upon request of Finalco at any time in the future, it will license any of its then current software products and provide any other items or materials required to make the Equipment operational to Finalco or its assignee or subsequent purchasers or lessees from Finalco, pursuant to Honeywell's then current terms, prices and conditions. Finalco and certain Honeywell users developed a network to provide maintenance specialists to service Honeywell equipment acquired from Finalco. The maintenance function network was incorporated in 1978 and coordinated the maintenance functions among various Honeywell users and published a Honeywell user newsletter. Expert Testimony of Fair Market ValueS. Paul Blumenthal ("Blumenthal") was qualified to testify as an expert on behalf of petitioner. Blumenthal is a senior vice president of American Computer Group and is the senior corporate officer of American Technology Appraisal701 Service ("ATAS"), a special valuation consulting division of American Computer Group. 14Blumenthal opined that the fair market value of the Equipment during the period April through July of 1979 was $ 597,278. According to Blumenthal, such amount represents 73 percent of the Honeywell list price of $ 820,889. 15Blumenthal presented three different valuation methods and adopts the mathematical average of such methods as his opinion of the fair market value of the Equipment. The three methods and values are as follows: MethodFair Market ValueHoneywell 4200 Historical Life$ 504,5151979 ATAS Report B605,981 1979 Dealer "Ask" Price681,338 The Honeywell 4200 was introduced in the year 1964. The technological life of the Honeywell 4200 was 13 years, such that the residual value was zero in the year 1977. Because the technological702 life of the Honeywell 4200 had ended by the year 1977, the historical price data of the Honeywell 4200 did not accurately account for the price affect of the Honeywell policy adopted in 1975 which restricted software transfers and maintenance services to purchasers of Honeywell equipment in the secondary market. Blumenthal reviewed the transactional records of American Used Computers and determined that the costs incurred by users of Honeywell equipment acquired in the secondary market necessary to enhance and maintain such equipment were approximately 24 percent of the Honeywell list price. Blumenthal determined that the Honeywell-Finalco Software Agreement added 24 percent of the Honeywell list price to the fair market value of equipment subject to Finalco arranged leases. Blumenthal concluded that the extrapolated fair market value of the Equipment based on the Honeywell 4200 historical data available in 1979 was $ 504,515, or approximately 61 percent of the Honeywell list price. In 1979, ATAS prepared an analysis entitled "Report B: Current Status and Financial Future IBM System/370 (models 155 through 168) and IBM 3032" ("1979 ATAS Report B"). Based on the 1979 ATAS Report703 B, Blumenthal concluded that the fair market value of the Equipment during April of 1979 was $ 605,981, or approximately 74 percent of the Honeywell list price. Lastly, Blumenthal based an opinion of fair market value upon a dealer "ask" quote in ATAS records in 1979 for a similar system with similar peripherals. The dealer "ask" quote was $ 681,338, or approximately 83 percent of the Honeywell list price. Dee Morgan ("Morgan") was qualified to testify as an expert on behalf of respondent. Morgan has worked for IBM as a systems service representative and for Burroughs Corporation as a technical service representative. From 1965 through 1983, Morgan was employed by the General Services Administration ("GSA") as a computer equipment analyst and data processing systems coordinator. While employed with GSA, part of Morgan's responsibilities involved providing estimates of residual value and economic life of computer equipment to the Defense Contract Audit Agency. Morgan determined the fair market value of the Equipment as of April 15, 1979, to be $ 420,399, or approximately 50 percent of the Honeywell list price. According to Morgan, her files contain a record that on August 4, 1977, a704 Honeywell dealer in the secondary market quoted to her that 50 percent of the Honeywell list price was the fair market value of the Honeywell 66/20. Morgan stated that the negotiated price of Honeywell equipment in the secondary market was susceptible to a wide range of price negotiation due in part to the Honeywell restriction of software and maintenance. Morgan made no reference to the 1975 Finalco-Honeywell Software Agreement or the Finalco network of Honeywell users. Morgan stated that peripheral equipment was comparable to the IBM 370 Series introduced in 1971. Morgan stated that the used items of the Equipment were installed at the End User on December 19, 1974, and that the technological age of the entire Equipment dated to 1971 such that the peripherals were no longer state-of-the-art technology. Morgan concluded that the January of 1979 introduction of the IBM 4300 rendered the Honeywell 66/20 obsolete. Furthermore, Morgan maintained that the Honeywell 66/DPS was introduced in September of 1978 and that the Honeywell 66/20 was no longer available on new orders. Expert Testimony of Residual ValueBlumenthal used the three following methods to project the anticipated705 residual value of the Equipment in April of 1986: ProjectedPercentResidualofMethodValueList PriceHoneywell 4201-3 Life Curve$ 210,61726Stanford Research Institute Report82,089 101979 ATAS "Report B"365,264 44The Honeywell 4201-3 was introduced in the 1965. The Honeywell 4201-3 had an economic life of 12 years. Blumenthal extrapolated the life curve for the Honeywell 4201-3 and determined the residual value of the Honeywell 66/20 in the year 1986 would be two percent of the Honeywell list price. Blumenthal also determined that the residual value of a Finalco arranged lease of a Honeywell 66/20 should reflect additional residual value due to the Honeywell-Finalco Software Agreement and to account for the Finalco arranged network of maintenance services. Blumenthal increased the extrapolated value of the Equipment based on the Honeywell 4203-1 life curve by 24 percent of the Honeywell list price and concluded that the Equipment should expect a residual value of $ 210,617, or approximately 26 percent of the Honeywell list price. Blumenthal used as a second method of residual valuation the report prepared by the Stanford706 Research Institute in the year 1975 (the "SRI Report"). The SRI Report included a graph titled "Used Computer and Peripheral Valuation Curves," which Blumenthal includes within his report. 16 Such graph indicates that as of 1975 the expected technological life of a central processor was expected to be 15 years. The SRI Report was prepared to value IBM equipment but was based upon a generic composite of computer transactions, surveys of brokers and dealers, and other industry publications. According to Blumenthal, it would have been reasonable in April of 1979 to rely upon the SRI Report to predict the residual value of the Equipment. The SRI Report indicates that in the year 1986, 12 years after the Honeywell 66/20 was introduced, the Equipment should expect a residual value of $ 82,089, or approximately 10 percent of the Honeywell list price. The SRI Report indicates that 15 years after the introduction of the IBM 370 in the year 1971, the Equipment should expect a residual value of $ 24,628, or approximately three percent of the Honeywell list price. Blumenthal did not increase the SRI Report based determination by the 24 percent factor of the Honeywell-Finalco Software Agreement. 707 Lastly, Blumenthal relied upon the 1979 ATAS Report B residual analysis. The 1979 ATAS Report B residual analysis concluded that large scale IBM mainframes have an average market life of 15 years and that the residual values of such equipment decline to 10 percent of list price as of the fifteenth year. As of 1979, Blumenthal stated that the Honeywell 66/20 and the IBM 370/158 were comparable computer equipment. Blumenthal factored 24 percent of the Honeywell list price value to reflect the Honeywell-Finalco Software Agreement and the Finalco maintenance network for services. Based upon the 1979 ATAS Report B, Blumenthal concluded that in April of 1979, it was reasonable to predict a 1986 residual value of $ 365,264, or 44 percent of list price. 17Blumenthal prepared a contingent rent analysis to project in April of 1979 the amount of contingent708 Residual Revenue from equipment renewals pursuant to the Remarketing Agreement which petitioner may have reasonably expected to receive commencing on May 1, 1984. Blumenthal's contingent rent analysis is premised on the identical methods and the findings previously discussed to predict residual value as of April 30, 1986. The record is not clear as to the method employed to determine contingent rent based on the residual value. Blumenthal concluded that petitioner could reasonably expect to receive the following amounts of contingent rent for the period May 1, 1984, to April 30, 1986: ContingentMethodRentHoneywell 4200 Life$ 270,893SRI Report135,086 1979 ATAS Report B402,237 Morgan concluded that as of December of 1979 the expected residual value of the Equipment would be zero at the termination date of the Owner Lease on April 30, 1986. Morgan determined that the residual value of the Equipment would have likewise been zero on April 30, 1984, the date the Residual Revenue provision regarding contingent renewal rents became effective. Morgan stated that a sporadic sale of the Honeywell 66/20 equipment may have been expected to occur but709 that level of expected sales would not constitute a price platform. Morgan based her determination on the expected technological life of Honeywell Series 60 which was introduced in 1974 but which related back in technological capacity to the IBM 370 introduction date of 1971. Morgan reviewed the technological advancements of IBM during the period of 1971 through 1979. Morgan viewed the introduction of the IBM 4300 in January of 1979 to be critical to determination of any expected residual value of the Equipment in December of 1979. Morgan noted the increased price competition in memory capacity due to technological advancements and the 1975 Honeywell policy to restrict the transfer of software and maintenance. Morgan made no reference to the Honeywell-Finalco Software Agreement or the existence of a Finalco sponsored network of Honeywell maintenance services. Tax ReportingPetitioner is a cash basis taxpayer reporting on a calendar year basis. Petitioner reported the following items with respect to the purchase and leaseback of the Equipment on his joint 1979 and 1980 Federal income tax returns: EquityNetRentalNoteInstallmentIncomeIncomeDepreciationInterestNote Interest(Loss)1979$ 61,000$ 152,568-0-$ 25,931($ 117,499)198091,500 108,010 $ 6,16040,594 (63,264) 710 For each of the calendar years 1981 through 1983, inclusive, petitioner reported on his Federal income tax returns a net loss from his equipment purchase and leaseback transactions with respect to the Equipment, as follows: Taxable Year EndedNet LossDecember 31, 198135,766.85December 31, 198218,232.35December 31, 198368.02For calendar year 1984 petitioner reported on his Federal income tax return taxable income from his equipment purchase and leaseback transaction with respect to the equipment of $ 83,935. As of the date of trial, Finalco projected that for calendar year 1985 petitioner should recognize taxable income from his equipment purchase and leaseback transaction in the amount of $ 84,352.54, plus any additional interim revenue sharing amounts pursuant to the Remarketing Agreement. OPINION The present case is a companion case selected as one of five representative test cases for a large number of dockets involving the investment in Finalco arranged sale and leaseback transactions of leveraged computer equipment. 18 The issues presented here are similar to those presented in the companion cases except that the transactional structuring711 differed in certain pertinent respects. At the outset, we address respondent's primary assertion that petitioner's transactions with respect to the Equipment was a tax-avoidance scheme devoid of economic substance which is to be disregarded for Federal income tax purpose. Petitioner asserts that ownership of the Equipment for Federal income tax purposes has been established where petitioner entered the transaction with the requisite business purpose and the transaction was supported by economic substance. Taxpayers are generally free to structure their business transactions as they please, though motivated by tax reduction considerations. Gregory v. Helvering,293 U.S. 465">293 U.S. 465 (1935); Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 196 (1983), affd. on this issue 752 F.2d 89">752 F.2d 89 (4th Cir. 1985).712 However, it is well settled that a transaction entered into solely for the purpose of tax reduction and which is without economic, commercial or legal purpose other than the expected tax benefits is an economic sham without effect for Federal income tax purposes. Frank Lyon Co. v. United States,435 U.S. 561">435 U.S. 561 (1978); Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 196; Grodt & McKay Realty, Inc. v. Commissioner,77 T.C. 1221">77 T.C. 1221, 1243 (1981). Nevertheless, the existence of tax benefits accruing to an investor does not necessarily deprive a transaction of economic substance. Frank Lyon Co. v. United States, supra;Estate of Thomas v. Commissioner,84 T.C. 412">84 T.C. 412, 432 (1985). In the sale and leaseback context, we set forth a standard that the nonuser-owner recipient of tax benefits must specifically establish that the entry into the transaction was motivated by business purpose to justify the form of the transaction and that the transaction was supported by economic substance. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 201-203. 19 In Rice's Toyota World, Inc., we stated713 that the tests developed under the sham transaction doctrine are applied to determine whether a threshold level of business purposes or economic substance is present. Rice's Toyota World, Inc.,81 T.C. at 196. 20Our inquiry of business purpose and economic substance is inherently factual as indicated in several recent cases concerning sale and leaseback transactions of computer equipment. Torres v. Commissioner,88 T.C. 702">88 T.C. 702 (1987); Bussing v. Commissioner,88 T.C. 449">88 T.C. 449 (1987), supplemental opinion 89 T.C. (Nov. 24, 1987); Gefan v. Commissioner,87 T.C. 1471">87 T.C. 1471 (1986); Mukerji v. Commissioner,87 T.C. 926">87 T.C. 926, 968 (1986); James v. Commissioner,87 T.C. 905">87 T.C. 905 (1986); Coleman v. Commissioner,87 T.C. 178">87 T.C. 178 (1986),714 affd. per curiam 833 F.2d 303">833 F.2d 303 (3d Cir. 1987); Estate of Thomas v. Commissioner, supra; Rice's Toyota World, Inc. v. Commissioner, supra.21We noted in Rice's Toyota World that the drawing of a precise line of demarcation between valid and invalid transactions is invariably difficult. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 197. In this context, petitioner bears the burden of proof as respondent's determination that the transaction was a tax-avoidance scheme devoid of economic substance is presumptively correct. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Based on our review of the record herein, we conclude that the transaction was not motivated by a business purpose and was devoid of economic substance. Consequently, the transaction is disregarded for Federal income tax purposes. The record clearly indicates that petitioner's entry into the transaction715 at issue was contingent on the sale of his insurance business to RBH. RBH provided petitioner with a five-year executive employment contract with RBH to terminate in 1984. Murray prepared financial statements and advised petitioner in connection with the sale of his company. Murray's suggestion of an investment in a leveraged lease computer transaction was motivated by a desire to offset income generated by the sale of the insurance business to RGH and the related five-year employment contract. Petitioner consulted his broker with the investment firm of Merrill Lynch who advised petitioner that such firm did not recommend leveraged computer lease transactions due to the obsolescence factor inherent in the computer industry and the resultant uncertainty of residual value. Despite such advice, petitioner relied solely on the representations of Finalco and DuBois as to the fair market value of the Equipment as well as the residual value of the Equipment. We find petitioner's failure to seek an independent appraisal or other independent and reliable opinion of the fair market value and the716 residual value of the Equipment to be an important factor indicative of the absence of the requisite business purpose. Petitioner had no knowledge of computer technology and was even, at trial, incapable of determining whether or not the Equipment included a central processing unit as incorrectly indicated in the Honeywell Bill of Sale. Petitioner made no effort to contact the End User or to examine the End User Lease. Petitioner's level of inquiry and the degree to which Murray was requested to assist in the Finalco transaction pales in comparison to the level demonstrated in the sale of his insurance business. We find that petitioner was motivated solely by the promised tax benefits of the transaction. The focus of our inquiry is to perform an objective analysis of the investment to determine whether any realistic opportunity for economic profit existed exclusive of the anticipated tax benefits. We analyze the transaction as a prudent investor, Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 209, but we recognize that our determination cannot depend on unrealistic717 demands for certainty. Gefen v. Commissioner,87 T.C. at 1492. The parties rely on the expert testimony to establish the fair market value and residual value of the Equipment as of June 1, 1979. We are not bound by the opinion of any expert witness when that opinion is contrary to our own judgment. Chiu v. Commissioner,84 T.C. 722">84 T.C. 722, 734 (1985). 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. Based on our analysis of this investment, we determine that the transaction was not supported with economic substance. We are satisfied that the Equipment purchase price amount of $ 522,704 was its fair market value, although top of the line value in the market. Petitioner paid the Honeywell list price for the new items of the Equipment and 41 percent of the Honeywell list price for the used items of the Equipment. Morgan718 determined that the fair market value of the Equipment was at most 50 percent of the Honeywell list price. Her finding comports with the purchase price of the used Equipment. While the prudent investor may not have paid the Honeywell list price for the new items of the Equipment in 1979, we do attach some significance to the fact that petitioner purchased an arranged leveraged lease investment subject to an end user commitment. See Mukerji v. Commissioner,87 T.C. at 965. Petitioner's assertion that the transaction was supported by economic substance depends on our determination of the Residual Revenue, as defined, to be expected at the termination of the Owner Lease and at the commencement of the Interim Revenue provisions. We found Blumenthal to be unpersuasive in each respect. Blumenthal determined that the Honeywell-Finalco Software Agreement and maintenance network warranted a uniform increase of 24 percent value. The record does not support such contention. Blumenthal failed to demonstrate that a uniform increase of 24 percent due to software and service is warranted where the inherent technology is obsolete at the commencement of the Interim Revenue719 Period and at the termination of the Owner Lease. Pursuant to such view, the Equipment or any Finalco arranged Honeywell lease would not devalue to an amount less than 24 percent. 22 Blumenthal offered the Honeywell 4200 historical life method which indicated a residual value of two percent without the additional value and 26 percent with the additional value. We simply are not convinced as to the value of the Honeywell-Finalco Software Agreement which is pivotal in the assertion of Blumenthal. Blumenthal offered an opinion of residual value of 44 percent based on the IBM 370/158 as indicated in the 1979 ATAS Report B. Blumenthal stated that the IBM 370/158 and the Honeywell 66/20 were comparable equipment. Blumenthal included a720 factor of 24 percent due to the Honeywell-Finalco Software Agreement and maintenance network which we have found to be not supported by the record. The record also indicates that the IBM 370/158 is a class 6 computer and that Honeywell 66/20 is a Class 5 computer. The average rental values and residual values are not comparable. The 1979 ATAS Report B indicates that the introduction of IBM 303X family of computers "terminated the economic market life" of the IBM 370. The 1979 ATAS Report B made no reference to the IBM 4300 announcement in January of 1979. For such reasons, we find that an assertion of 44 percent residual value of the Equipment is totally without merit and casts the testimonny of Blumenthal as incredulous. Blumenthal also offered the 1975 SRI Report. Based on an introduction date of 1974, the SRI Report indicates a residual value for the Equipment of ten percent. However, based on an introduction date of 1971, the SRI Report indicates a residual value of three percent. For reasons not clear in the record, Blumenthal did not factor an addition for the software agreement and maintenance network. For reasons discussed herein, we find the SRI Report to be the most721 reliable source of opinion evidence as to residual value. Morgan determined a residual value of zero based on the technological life of the Equipment and technology achievement of IBM and Honeywell viewed as of June of 1979. Morgan concluded that the technological life of the Equipment commenced with introduction of the IBM 370 in 1971, not the Honeywell introduction date of 1974, due to the comparable technology of the IBM 370. We agree with her opinion to such extent. The record demonstrates the Honeywell was consistently out-distanced by the technology advancements of IBM. In 1979, few used equipment transactions for Honeywell equipment were evident in the trade journal Computerland. The Honeywell-Finalco software agreement and maintenance network cannot overcome the technology defect which rendered the Equipment obsolete at the commencement of the Interim Revenue period and at the termination of the Owner Lease. We find it inappropriate to extend the economic life, in other words the technology life, of the Honeywell 66/20 due to a delayed introduction date. We also found Morgan more credible with respect to the amount of Residual Revenue to be expected from renewals.722 Morgan stated that the expectation of renewal rents depended primarily on the lease extension of the End User and that such occurrence was not guaranteed. Morgan indicated that extension of an end user lease did occur at times when an end user encountered difficulty in the installation of new equipment. In this instance, the End User converted to the new IBM 4331, a product of the IBM 4300 system introduced in January of 1979. The End User encountered difficulty in the conversion and was required to extend the lease. Based on the testimony of Morgan and known market conditions concerning Honeywell equipment, we find that in 1979 petitioner could expect insignificant Residual Revenue commencing in 1984. 23 We find that any significant Residual Revenue to commence in 1984 depended on the renewal of an end user who decided to defer the installation of new equipment as occurred here. We find no significant secondary market for the Honeywell Series 60 to exist in 1984 so as to expect the location of a different end use. 723 We determine that in 1979 it was reasonable to expect the Equipment to have a residual value of an amount not in excess of three percent based on the SRI Report after 15 years of economic life and that, in general, insignificant Residual Revenue from renewals could be expected to commence in 1984. Based on our determination, the transaction does not comport with economic substance even where we accept as reasonable the receipt of Residual Revenue actually received by petitioner.24 Petitioner is entitled to deduct the interest paid on the Recourse Note during the years at issue. In Rice's Toyota World, the Court of Appeals of the Fourth Circuit held that a sham determination did not preclude the deduction of interest paid on a recourse installment note. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d at 96. In Rose v. Commissioner,88 T.C. 386">88 T.C. 386, 423 (1987), we accepted the view of the Court of Appeals for the Fourth Circuit.24724 By Amendment to Answer, respondent asserts the increased rate of interest provisions of section 6621(c) attributable to tax-motivated transactions. Respondent bears the burden of proof. Rule 142(a); Rose v. Commissioner, supra;Zirker v. Commissioner,87 T.C. 970">87 T.C. 970 (1986). Section 6621(c) provides for an interest rate of 120 percent of the adjusted rate determined under section 6621(b) where there is a substantial underpayment in any taxable year attributable to one or more tax-motivated transactions. A substantial underpayment exists where such underpayment attributable to a tax-motivated transaction exceeds $ 1,000. Sec. 6621(c)(2). Section 6621(c) is applicable solely with respect to interest accruing after December 31, 1984, even though the transaction was entered into prior to the date of enactment of section 6621(c). Solowiejczyk v. Commissioner,85 T.C. 552">85 T.C. 552 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). Respondent asserts the provisions of section 6621(c) are applicable because the725 transactions at issue are defined as tax-motivated transactions where losses were disallowed by reason of section 465(a). Sec. 6621(c)(3)(A)(ii). We have determined that the Equipment transactions were tax-motivated schemes devoid of economic substance. Section 6621(c)(3)(A)(v) was added by Congress to specifically include within the definition of tax-motivated transactions "any sham or fraudulent transaction." 26 We have previously determined that "any sham or fraudulent transaction" within the meaning of section 6621(c)(3)(A)(v) includes a transaction which lacked subject profit motive and which was without economic substance. Patin v. Commissioner,88 T.C. 1086">88 T.C. 1086, 1128-1129 (1987). We have recently determined that the presence of profit motive does not preclude the determination that a transaction lacks economic substance and is, therefore, a sham. Cherin v. Commissioner, 89 T.C. (Nov. 23, 1987). In this case, we determined that petitioner did not manifest a subjective profit motive and that the Equipment transactions were not supported with economic substance.726 Consequently, petitioner is liable for additional interest on the substantial underpayment of tax attributable to a tax-motivated transaction within the meaning of section 6621(c)(3)(A)(v) where the Equipment transactions are transactions determined to be shams of fraudulent transactions. Decision will be entered under Rule 155.Footnotes1. Petitioner Charlotte Sturm was not involved in any of the transactions at issue and is a party to this action solely by reason of filing a joint Federal income tax return for each of the taxable years involved. Unless otherwise specified, petitioner shall refer only to petitioner Carlyle Sturm.↩2. Unless otherwise indicated, all sections referred to are sections of the Internal Revenue Code of 1954, as amended and in effect during the years in question, and all rules referred to are rules of the Tax Court Rules of Practice and Procedure. ↩3. Subsec. (d) of sec. 6621↩ was redesignated subsec. (c) and amended by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744. We use the reference to the Internal Revenue Code as redesignated and amended. 4. The use of such terms as "purchase," "lease," and other like words does not imply that we consider the underlying transaction to be in fact construed as a "purchase" or "lease" for Federal income tax purposes. We probe beyond the labels given by the parties to determine whether an actual economic investment existed. Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 210 (1983), affd. on this ground 752 F.2d 89">752 F.2d 89↩ (4th Cir. 1985). 5. The transactional documentation between Honeywell and Finalco indicates the following additional inaccuracies. The Honeywell Bill of Sale and the Honeywell customer invoice incorrectly indicated that the Sturm Equipment included model number DCF 6001 "System Console without CRT." The Honeywell invoice billed Finalco the amount of $ 240 for such item. The Honeywell Sale Agreement indicated that the Sturm Equipment included model number DCF 6001 "Speed Adapter" and indicated that Finalco pay the list price of $ 240. The Sturm Equipment in fact included the "Speed Adapter" as represented in the Honeywell Sale Agreement. The record does not indicate the list price of the "System Console without CRT;" however, the record indicates that the Sturm Equipment included a "Speed Adapter" and that Finalco paid list price. Additionally, the Honeywell customer invoice transposed the model number and the description of nine of 28 items referenced. Such transposition did not affect the amount billed to or the character of equipment purchased by Finalco. ↩6. According to the representations of DuBois, petitioner should expect the following: ↩Renewal proceeds$ 19,000Residual Value proceeds85,000$ 104,0007. The Projection indicated that petitioner could expect renewal income of $ 25,000 in 1984 and $ 50,000 in 1985 and $ 50,000 in 1986. Such representation of DuBois is in contradiction to the representation communicated to petitioner that petitioner may expect 20 percent of the purchase price as a return including renewals which indicated that renewal income would be $ 19,000. See n. 6, supra.↩ Our conclusion is that DuBois was not informed as to realistic rental renewals to be expected and was primarily concerned with the sale of the tax benefits inherent in the leveraged computer lease programs. 8. Petitioner paid the annual installments pursuant to the Recourse note in full as follows: ↩PaymentInterestPrincipalDateAmountAmountAmountMay 29, 1980$ 20,160$ 6,160$ 14,000May 28, 198118,6204,62014,000May 22, 198217,0803,08014,000May 18, 198315,5401,54014,0009. By letter dated July 21, 1981, DuBois-Schennum Assoc., Ltd., informed petitioner that Finalco "has eliminated your 10% expense for remarketing of your computer which they will absorb." Petitioner assumed Finalco had reduced the remarketing fee from 30 percent to 20 percent and returned, as directed, the Remarketing Agreement to DuBois-Schennum. The Remarketing Agreement was returned to petitioner without alteration. We are certain that the 10 percent expense to be eliminated referred to the remarketing expense evident in the Remarketing Agreement of certain companion cases. Lease Pro clearly did not examine petitioner's transaction prior to the mailing of the letter. Such is further incidence of the transactional carelessness evident in this record and the companion cases. ↩10. The End User Lease provided monthly rental payments of $ 18,930 for 48 months to terminate April 30, 1983. The End User renewed the lease for a total of 23 months at $ 7,070.25. The renewal terms are not in accord with the End User Lease which provided three optional renewal schedules with reduced monthly rental based on length of renewal. The schedule that most resembles the terms of the End User renewal provided a renewal term of not less than seven months and not more than fourteen months at 50 percent of the basic monthly rent amount of $ 18,930. The record does not indicate the reason that Finalco renewed the lease for terms less favorable than those of the End User Lease. ↩11. (Eight times $ 7,070.35) times 50/100. ↩12. Generally, computer equipment can be divided into two broad classifications, peripheral equipment and mainframe or central processing equipment. Peripheral equipment refers to the equipment in a computer system which feeds information into and out of the central processor. The central processor is the "core" or "brain" of the computer which performs data processing functions. The Sturm Equipment includes such peripheral equipment as magnetic tape memory, disk memory, card and unit record devices, system main memory, and front end communications processing. ↩13. The Computer Price Guide is a quarterly journal published by Computer Merchants, Inc. The Computer Price Guide was the computer industry's first regularly published source of price and market information for both new and used computer equipment and is widely relied upon in the industry. See Mukerji v. Commissioner,87 T.C. 926">87 T.C. 926, 946-947↩ (1986). 14. American Computer Group includes two additional operating divisions. American Terminal Lease Corporation leases computer terminals and American Used Computers trades used computers in the secondary market. ↩15. The Honeywell Sale Agreement indicates that the Honeywell lis price was $ 840,797 on April 30, 1979. ↩16. The Stanford Research Institute graph is reproduced in our opinion of Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 193 (1983), affd. in part, revd. in part 752 F.2d 89">752 F.2d 89↩ (4th Cir. 1985). 17. The 1979 ATAS Report B indicates that the future residual value of 44 percent is $ 361,191. ↩18. The companion cases are: Larsen v. Commissioner, 89 T.C. (1987); Moore v. Commissioner,T.C. Memo 1987-626">T.C. Memo. 1987-626; Shriver v. Commissioner,T.C. Memo. 1987-627; Casebeer v. Commissioner,T.C. Memo. 1987-628↩. 19. Carlson v. Commissioner,T.C. Memo. 1987-306↩. 20. The presence of business purpose does not entitle a transaction to be recognized for Federal tax purposes where objective indicia of economic substance indicating a realistic potential for economic profit are not manifest. Cherin v. Commissioner,↩ 89 T.C. (Nov. 23, 1987). 21. Dobbs v. Commissioner,T.C. Memo. 1987-361; Kaufman v. Commissioner,T.C. Memo. 1987-350↩. 22. Blumenthal realized the fallacy of his determination at trial. In contradiction to his report, Blumenthal stated on direct examination that the value of the Honeywell-Finalco Software Agreement and maintenance service method would decline to ten percent over time. We find the attempt of Blumenthal to reduce the added value of the Honeywell-Finalco Software Agreement and maintenance network to ten percent to be arbitrary and not persuasive. ↩23. The parties disagree as to the Lease referred to in the Remarketing Agreement. Respondent asserts that the Remarketing Agreement refers to the Original Term of the Owner Lease. Respondent asserts that the Remarketing Agreement entitled petitioner to 50 percent of the amount by which End User income exceeded Owner Lease rentals. Aggregate Owner Lease rentals were the amount of $ 91,500. Consequently, respondent asserts that petitioner was entitled to 50 percent of any rental income in excess of $ 91,500. Petitioner asserts that the Lease referred to in the Remarketing Agreement refers to the End User Lease such that petitioner is entitled to 50 percent of any rental income generated by Finalco after the 60th month of the Owner Lease. Finalco construed the Remarketing Agreement to refer to the End User Lease. Pursuant to Finalco's construction of the Remarketing Agreement, petitioner received $ 38,887 due to the End User renewal for 11 months during 1984 and 1985. The terms "Lease" as referred to in the Remarketing Agreement does not clearly indicate whether the Owner Lease or the End User Lease was intended. Respondent failed to question any witness with respect to whether the Owner Lease or End User Lease was intended. As stated, we believe that Residual Revenue from rentals depended primarily on the need of the End User to renew due to internal decisional factors. We do not believe that the computer secondary market for the Honeywell Series 60 provided a favorable opportunity to sell or re-lease the Equipment. While we suspect that in August of 1983, Finalco construed the terms of the Remarketing Agreement to refer to the End User Lease to provide window dressing to the transaction to avert an expected examination by the Internal Revenue Service, we perform an objective analysis based on the actual Residual Revenue received by petitioner. We note the issuance of our opinion in Rice's Toyota World, Inc.↩ followed shortly after the Finalco construction of the Remarketing Agreement terms. 24. Residual Revenue from sale (.03 x 840,747)$ 25,222Net Equity:Equity Investment $ 68,000Cash Flow 7,840Residual Revenue for Renewal 38,88721,273x1.20Net Equity $ 25,52825,528Initial Share 25,222Balance Share (70 percent) - 0 -Finalco Share (30 percent) - 0 -Economic Profit:Cash Flow $ 7,840Residual Revenue Rentals 38,887Initial Share 25,222Balance Share - 0 -Economic Profit 71,949Equity Investment$ 68,000Recourse Note Interest15,400Total Investment $ 83,400n25 Dobbs v. Commissioner,T.C. Memo. 1987-361↩. 26. Pub. L. 99-514, sec. 1535(a), 100 Stat. 2085, 2750. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622697/	HAROLD T. AND ALEXANDER WHITE, EXECUTORS, ESTATE OF WILLIAM AUGUSTUS WHITE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.White v. CommissionerDocket No. 16053.United States Board of Tax Appeals15 B.T.A. 1417; 1929 BTA LEXIS 2674; April 12, 1929, Promulgated 2674 Gifts inter vivos made by the decedent prior to the passage of the Revenue Act of 1924, to wit, June 2, 1924, are not taxable under sections 319-324 of that Act as amended by the Revenue Act of 1926. Charles C. Parlin, Esq., for the petitioners. Eugene Meacham, Esq., for the respondent. MORRIS 1417 This proceeding is for the redetermination of a deficiency in tax of $30,152.67 upon gifts made during the calendar year 1924, and the sole question for determination is the amount of said gifts properly taxable under sections 319-324 of the Revenue Act of 1924, as amended by the Revenue Act of 1926. FINDINGS OF FACT. The decedent, prior to his death on May 6, 1927, filed a Federal gift-tax return of gifts made by him during the calendar year 1924, in which he reported the following: Cash giftsDateValueMrs. William EmersonJan. 4$20,000.00 Do100.00Alexander M. WhiteJan. 420,000.00 Do100.00Harold T. WhiteJan. 420,000.00Francis M. WeldJan. 410,000.00 Do225.00Alexander F. Moffat100.00Donald Moffat100.00George B. Moffat100.00Frances M. Frazier100.00Elinor White$100.00Margaret L. Weld1,157.00Alfred White Weld112.50David Weld225.00Mrs. Margaret White Weld5,000.00Rev. Charles H. Lyttle1,000.00Mrs. Genevieve L. Frothingham1,000.00Miss Hilda Loines600.00Miss Elma Loines600.00Miss Sylvia Loines600.002675 1418 In addition to the foregoing cash gifts he also reported gifts to 14 grandchildren on March 5, 1924, of 200 shares of Washington Water Power Co., 100 shares American Telephone & Telegraph Co., and 75 shares General Electric Co., valued for tax purposes at $696,325. The gifts recorded as having been made on January 4 and March 5, 1924, were actually consummated on those dates. The following gifts, hereinabove listed without dates, were made subsequently to June 2, 1924: Donald Moffat $100George B. Moffat100Frances M. Frazier100Alexander M. White, jr100Elinor White100Margaret White Weld5,000Mrs. Genevieve L. Frothingham1,000Rev. Charles H. Lyttle1,000Margaret L. Weld (portion of $1,157 gift hereinbefore listed)357Hilda Loines (portion of $600 gift hereinbefore listed)100Elma Loines (portion of $600 gift hereinbefore listed)100Sylvia Loines (portion of $600 gift hereinbefore listed)100The remaining $800 of the $1,157 gift made to Margaret L. Weld was recorded in the decedent's check book as having been made on April 8, 1924, and the remaining $500 of each of the $600 gifts to Hilda, Elma and Sylvia Loines2676 were made on May 26, 1924. The gifts of $112.50, $225, and $225 to Alfred White Weld, Francis M. Weld, and David Weld, respectively, were recorded as having been made on or about April 15, 1924. Margaret L. Weld was the only one of the recipients to receive in excess of $50,000 during the entire calendar year 1924, she receiving $50,894.50, $49,737.50 of which amount was received prior to June 2, 1924. OPINION. MORRIS: The taxability of gifts fully consummated by a decedent prior to June 2, 1924, is controlled by Blodgett v. Holden,275 U.S. 142">275 U.S. 142, and Untermyer v. Anderson,276 U.S. 440">276 U.S. 440, in which it was held that insofar as the gift-tax provisions of the Revenue Act of 1924 1419 were applicable to bona fide gifts not made in anticipation of death and fully consummated prior to June 2, 1924, said provisions were arbitrary and invalid under the due process clause of the Fifth Amendment to the Constitution. The record does not show when the two gifts of $100 each were made to Mrs William Emerson and Alexander F. Moffat. However, since the specific exemption of $50,000 clearly exceeded the amount of all gifts made subsequently*2677 to June 2, 1924, no tax was due under the return as filed, and, therefore, the proposed deficiency based upon said return must be disapproved. Judgment will be entered for the petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622698/	ALFRED J. DIESCHER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Diescher v. CommissionerDocket No. 13121.United States Board of Tax Appeals18 B.T.A. 353; 1929 BTA LEXIS 2070; November 27, 1929, Promulgated 2070 1. The collection of taxes for 1917, assessed before the effective date of the Revenue Act of 1924, is barred unless proceedings therefor are instituted within five years from the filing of the return. Russell v. United States,278 U.S. 181">278 U.S. 181. 2. In the circumstances herein the waiver upon which the respondent relies was invalid because it was signed under duress and at the date of the deficiency notice said respondent was without authority to determine additional taxes for 1917. Joseph G. Carey, Esq., and Mark H. Adams, Esq., for the petitioner. Arthur H. Murray, Esq., for the respondent. LANSDON 354 The respondent has asserted a deficiency in income tax for the year 1917 in the amount of $86,670.72. For his causes of action in seeking a redetermination of such deficiency the petitioner avers: (1) That at the date of the deficiency notice the statute of limitations had run against any additional tax liability for the year 1917; (2) That the Commissioner erroneously valued certain shares of stock received by the petitioner at $160 per share and that such valuation was grossly excessive; (3) That the taxable2071 event resulting in the asserted deficiency occurred in the year 1916 and not in 1917, as alleged by the Commissioner; and (4) That the alleged taxable income upon which the deficiency is based was not profit resulting from a business transaction but was in fact a gift received by the petitioner in the year 1916. FINDINGS OF FACT. The petitioner is an individual, a resident of Winfield, Kans. In November of the year 1916, he entered into a written contract with one Hale, in which he agreed to deliver to Hale 333 shares of the capital stock of the Eureka Oil Co., a Kansas corporation, for which he was to receive 1,665 shares of the Eureka Oil Co., a Delaware corporation, to be thereafter organized by said Hale. Pursuant to such agreement he delivered the shares of the Kansas corporation to Hale in November, 1916, and in February, 1917, after organization of said Delaware corporation, received from him the 1,665 shares of stock in that corporation. At the date of the contract the stock of the Kansas corporation had a fair market value of $100 per share and at the date of their issue in February, 1917, the parties have stipulated and we find that the stock of the Delaware corporation2072 had a fair market value of $100 per share. There were no material changes in the value of stock of the Kansas corporation between November, 1916, and February, 1917, nor was there any change in the value of the assets paid in to the Delaware corporation between such dates. The petitioner timely made and filed his individual income-tax return for the year 1917 and the same was received by the collector of internal revenue at Oklahoma City, Okla., on March 29, 1918. 355 Such return disclosed taxable income in the amount of $204,751.69, and tax liability in the amount of $51,078.40, and did not include in gross income any profit realized from the sale or exchange of his stock in the Kansas corporation for the stock of the Delaware corporation. Upon audit of such return the Commissioner determined additional tax liability thereon and assessed the same against the petitioner on March 13, 1923, in the amount of $4,698.96. Thereafter, in February, 1924, the Commissioner, through a revenue agent at Pittsburgh, Pa., asked the petitioner to sign a waiver of the statute of limitations as to his additional tax liability for the year 1917, and stated that if such waiver was not2073 signed a fraud penalty for the year in question would be imposed. Upon advice of an attorney petitioner refused to sign a waiver, and following such refusal, in April, 1924, the respondent made an additional assessment against the petitioner of $41,709.04 in taxes for said year, to which he added a 100 per cent penalty for fraud, amounting to $97,486.40. Thereafter, and on October 15, 1925, petitioner by telegraph requested a conference with the Deputy Commissioner of Internal Revenue, with a view to closing the case entirely. In reply to such telegram and on October 16, 1925, the Solicitor of Internal Revenue advised the petitioner by telegraph that the requested conference would be granted on October 21, 1925, "first provided taxpayer files in this office prior to that date, waivers under which assessment may be made of any additional tax which may be found due for 1916 and 1917." Pursuant to the telegram from the Solicitor, the petitioner and his attorney appeared for conference at the time and place designated. Sometime after such conference began the representatives of the Commissioner refused to proceed further unless petitioner would sign a waiver as requested in the telegram2074 from the Solicitor. Petitioner's attorney advised him not to sign such waiver, but, fearing that the Commissioner would proceed at once to collect the deficiency and penalty theretofore assessed in the respective amounts of $41,709.04 and $97,486.40, petitioner signed the following: INCOME AND PROFITS TAX WAIVER For Taxable Years Ended Prior to January 1, 1922. OCTOBER 21, 1925. In pursuance of the provisions of existing Internal Revenue Laws Alfred J. Diescher, a taxpayer of Winfield, Kansas, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the years 1916 and 1917 under existing revenue acts, or under prior revenue acts. This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice 356 of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty2075 days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. (Signed) ALFRED J. DIESCHER, Taxpayer.D. H. BLAIR, CAD Commissioner.On or about February 6, 1926, the Commissioner mailed to petitioner the deficiency notice which is the basis for this proceeding. In the statement attached thereto additional tax in the amount of $40,262.72 was asserted, which together with the amounts of $4,698.96 and $41,709.04, assessed as additional taxes in March, 1923, and April, 1924, make up the total tax of $86,670.72, which is here in controversy. The statement further shows that in his audit respondent determined profit accruing to the petitioner out of his aforesaid stock transaction upon a basis which fixed a value of the Kansas corporation stock at $100 per share and the Delaware corporation stock received at $160 per share; also, further profit to petitioner through the sale of 952 1/4 shares of the Delaware corporation stock during the year, which cost to petitioner was fixed at $160 per share. In the same letter the penalty2076 in the amount of $97,486.40, which had been assessed April 2, 1925, was treated as an overassessment with the following explanation thereof attached: The Solicitor of Internal Revenue has given further consideration to your case and holds that the penalty indicated in Bureau letter of April 2, 1924, should not be asserted. On March 3, 1926, a certificate of overassessment abating the penalty assessment in the amount of $97,486.40 was issued to the petitioner. OPINION. LANSDON: Petitioner's first assignment of error raises the statute of limitations against the proposed assessment, also against the collection of the two prior assessments made March 20, 1923, and April 14, 1924, respectively, included in the deficiency asserted by respondent's audit letter dated February 6, 1926. The basic return in this case was filed March 29, 1918, and since each of the two assessments whose collection is thus challenged, was made prior to the effective date of the Revenue Act of 1924, they are governed by the five-year period of limitation then in effect. 2077 ; ; ; . 357 No proceedings having been instituted for the collection of either of these assessments before five years from the filing of said return, and the period of collection not having been waived, it follows that their collection is now barred. ; ; . Petitioner's first assignment of error, in so far as it pertains to these prior assessments, must be sustained. In respect to the additional assessment of $40,262.72, proposed in the audit letter, authority is claimed by respondent for its assertion by virtue of the waiver executed October 21, 1925. The petitioner contends that this waiver having been executed long after the running of the statute of limitations, is void for the want of consideration; also that its execution was procured2078 under duress and is, therefore, without binding force. Petitioner's first objection to this waiver must be overruled in view of our prior holdings sustaining waivers executed after the expiration of the statute. ; ; ; ; : ; ; . Briefly summarized, the facts which the Board finds in connection with petitioner's contention that the waiver relating to his tax liability for 1917 was signed under duress are as follows: The tax return in question was timely filed on or about April 1, 1918. In the absence of waivers the statute of limitations tolled all liability thereon five years later or on or about April 1, 1923. In April, 1924, an agent of the Commissioner asked the petitioner to execute a waiver of the statutory time for assessing and collecting any additional tax liability for the years 1916 and2079 1917. This he refused to do, and following such refusal the agent then told the petitioner that unless he signed such a waiver a fraud penalty would be asserted and additional assessments based thereon would be made. Acting on advice of counsel the petitioner again refused to sign. A short time thereafter, the Commissioner held that the return for 1917 was false and fraudulent and made additional assessments of taxes and penalties in the respective amounts of $41,704.04 and $97,846.40. Later, and as a condition precedent to an office review of his tax liability for 1917, the charges of fraud in connection therewith, and the penalty imposed for such alleged fraud, the petitioner under protest and contrary to the advice of his attorney signed the waiver which he now contends was executed under duress and for that reason is void and invalid. After the waiver was signed the office review was had and on February 5, 1926, the Commissioner 358 mailed the petitioner the letter which is the basis of this proceeding. In such letter it was stated that the fraud penalty assessed on April 2, 1924, should not be asserted and the amount thereof was abated and treated as an overassessment, 2080 but the deficiencies theretofore determined for 1917 were reasserted in the total amount of $86,670.72. The respondent contends that the facts above set out do not show that the waiver in question was executed under duress. He argues that, inasmuch as the law afforded other means for a review of the legality of his acts in asserting and assessing a fraud penalty, he was not obliged to grant an office conference and that his refusal so to do would have deprived the petitioner of no advantage that he then enjoyed. It is true that the petitioner was not limited to an office review to secure relief. After the denial of his claim for abatement he could bring the matter before this Board or he could pay the assessments under protest and sue in the Federal district court for a refund. It is obvious that, if the controversies could be settled by an office conference or review, the petitioner would be saved the trouble and expense of adjudication before the Board or in the district court. The waiver was signed, the conference was held, and the Commissioner contends that as a result thereof the fraud charge was withdrawn and the penalty was abated and that the petitioner can not therefore2081 maintain his averment that the waiver was not a voluntary act or that it was without consideration. In modern jurisprudence the definition of duress has been enlarged much beyond the narrow limits recognized in the common law. It is now well settled that if an act of one party deprives another of his freedom of will to do or not to do a specific act the party so coerced becomes subject to the will of the other, there is duress, and in such a situation no act of the coerced person is voluntary and contracts made in such circumstances are void because there has been no voluntary meeting of the minds of the parties thereto. See, ; ; ; ; Nelson v. Suddarth (; ; ; . In the instant proceeding it is obvious that in signing the waiver the petitioner was not acting with a free will, 2082 but was coerced by the will of the respondent. If there was fraud the respondent needed no waiver, since the statute never runs against additional tax due on a false and fraudulent return wilfully made. In these circumstances it is clear that if the petitioner had paid the additional tax and penalty he could have recovered the amount so paid in an action at law. ; ; 359 ; ; . It would seem very strange, therefore, that a document signed under similar pressure of circumstances could be a voluntary act and more binding than the payment of money. The parties to the waiver were not dealing with each other at arm's length and the only election enjoyed by the petitioner was the opportunity to choose what he believed to be the lesser of two evils. The waiver was signed under duress and is invalid. At the date of the deficiency notice2083 herein the five-year period of limitation had run against the petitioner's liability for any additional 1917 taxes and the Commissioner on that date, there being no valid waiver in existence, was without authority to determine the deficiency here in controversy. In view of our findings and the conclusions reached above, it is unnecessary to consider the remaining questions raised in the pleadings. Reviewed by the Board. Decision will be entered for the petitioner.MURDOCK dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622700/	FRANK HOLTON & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Frank Holton & Co. v. CommissionerDocket No. 10261.United States Board of Tax Appeals10 B.T.A. 1317; 1928 BTA LEXIS 3909; March 12, 1928, Promulgated 3909 1. The cost to the donor of property deeded to petitioner in 1920 held not to constitute income. 2. Invested capital may not be increased because of donations by nonstockholders. 3. Deductions for depreciation may not be taken for 1918, 1919 and the first half of 1920 on property to which petitioner did not have title. 4. Rate of depreciation to be applied determined. H. A. Mihills, C.P.A., for the petitioner. D. D. Shephard, Esq., for the respondent. ARUNDELL1317 Proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years and in the amounts as follows: 1919$2,970.32192019,905.091921402.771922243.29The issues are: (1) Whether the respondent erred in adding to income for 1920 the amount of $45,475.82, on account of the conveyance to petitioner of factory property costing that amount; (2) whether invested capital should be increased for 1919 and 1920, by 1318 the amount of $45,475.82; (3) whether deductions for depreciation should be allowed for 1918, 1919 and a part of 1920, on the factory building acquired; (4) the rate of depreciation applicable; 3910 As an alternative to the first issue petitioner asks special assessment. Other errors alleged in the petition were abandoned at the hearing. FINDINGS OF FACT. Petitioner is an Illinois corporation with its principal office at Elkhorn, Wis. It was incorporated in 1904 and has at all times been engaged in the manufacture of musical instruments. Prior to April 15, 1918, its plant and office were located at Chicago, Ill., and in each of the years that it operated there it earned a profit. In the spring of 1916 there was a strike which lasted several months and petitioner's officers became dissatisfied with labor conditions in Chicago. In that year Frank Holton, president of the petitioner, visited his farm about five and a half miles north of Elkhorn, Wis., and while there a neighbor suggested that the petitioner move its plant to Elkhorn. No action was taken on the suggestion and later, about September of 1916, Holton was approached to determine whether he would consider moving the company to Elkhorn. He inquired what the town would offer as an inducement, and shortly thereafter a committee called upon Holton at Chicago and, after some negotiation, Holton advised them that3911 the company would move to Elkhorn if a suitable plant with 40,000 square feet of floor space was erected. Residents of Elkhorn thereupon organized a corporation known as the Elkhorn Factory Co. for the purpose of acquiring a site and erecting a plant. That company started a compaign to raise funds for the project, and engaged an architect who prepared plans which were accepted by the petitioner. The company issued stock as receipts for contributions. In the latter part of 1916 it began to appear doubtful that the amount to be realized from subscriptions would be sufficient to construct the buiding planned, due in part to the advancing price of materials, whereupon representatives of the Elkhorn Factory Co. sought and obtained the consent of petitioner to a plan providing for less expensive construction than called for by the original drawings. The directors of petitioner went to Elkhorn to inspect the sites offered for petitioner's use and found only one tract with which they were satisfied and that was held at a price higher than the Elkhorn Factory Co. felt that it could pay. In order to secure that particular parcel petitioner agreed to purchase stock of the Elkhorn Factory3912 Co. in the amount of $2,000, as set forth in the agreement referred to hereinafter. The land was conveyed to the 1319 Elkhorn Factory Co. by deed dated February 15, 1917, for a consideration of $5,000. In March, 1917, petitioner and the Elkhorn Factory Co. entered into a written agreement, setting forth the terms of the arrangement theretofore made, and which provided, with material parts quoted, as follows: The Elkhorn Factory Co. agreed: 1. To erect on said site [above referred to] a factory building with Thirty Thousand (30,000) square feet of floor space in accordance with the plans and specifications * . 2. To Transfer and convey the said site and factory building to said Frank Holton & Co., its successor or assigns, free and clear of all incumbrances (except such as are created by, charged to or suffered to be created by said Frank Holton & Co., its successors, lessees and assigns or any of them) upon the terms and conditions hereinafter provided. 3. To lease said site and factory building to said Frank Holton & Co., for the term of seven (7) years, commencing the first day of May, 1918, upon the terms and conditions hereinafter provided * * 3913 The petitioner agreed: 1. To subscribe for two hundred shares of the capital stock of the Elkhorn Factory Company and to pay therefor the sum of ten ($10.00) dollars per share in cash on or before the first day of July, 1917. The amount so paid to be used by the Elkhorn Factory Company toward the cost of erecting said factory building. 2. To lease said factory building from the said Elkhorn Factory Company, for the term or seven (7) years commencing the first day of May, 1918, as aforesaid to be used by said Frank Holton & Co., its successors, lessees and assigns for the manufacture and carrying on of a band instrument manufacturing business and to pay therefore an annual rental equal to six (6) per cent of the amount expended by said Elkhorn Factory Company for said site and building, which rental shall be payable annually, and to remove its main offices and band instrument manufacturing business to Elkhorn, Wisconsin, on or before the first day of May, 1918. 3. During the aforesaid term of seven (7) years, to pay all taxes upon said site and building, to keep said building insured * * all such policies of insurance to be made payable to the Elkhorn Factory Company, 3914 * * to pay all premiums on such policy or policies of insurance; also to make all necessary repairs * * . * * 5. To purchase said site and factory buildings from the said Elkhorn Factory Company at the expiration of said period of seven (7) years and to pay the Elkhorn Factory Company for the same the amount expended by it for said site and building: Provided, however, that if said Frank Holton & Co., shall on or before May 1st, 1918, remove its main offices and bank instrument manufacturing business from the City of Chicago, State of Illinois, to the City of Elkhorn, State of Wisconsin, and shall make said city of Elkhorn its principal place of business and shall continue so to do for the said period of seven (7) years, and shall place the words, "Elkhorn, Wisconsin" upon all of the band instruments 1320 manufactured by it, and shall employ sufficient empolyees in its business and plant at said City of Elkhorn so that its payroll for employees (not including officers' salaries) shall amount to the sum of fifty thousand ($50,000.00) dollars or more for the first (1st) year and the sum of seventy-five thousand ($75,000.00) dollars or more for each succeeding year3915 during the said period of seven (7) years, then no rent for said site and buildings other than the aforesaid taxes and insurance shall be paid by said Frank Holton & Co. in any year during which it pays its employees as aforesaid the said respective amounts; And provided further, that if the said Frank Holton & Co. shall have paid at any time during the said period of seven (7) years an aggregate amount of five hundred thousand ($500,000.00) dollars in wages (not including officers' salaries) to its employes employed in its business and plant at the said City of Elkhorn as aforesaid, then the said purchase price shall be considered fully paid and said site and building shall be conveyed and transferred without further consideration to the said Frank Holton & Co., its successors, or assigns, free and clear of all incumbrances except such as are created by, charged to or suffered to be created by said Frank Holton & Co., and from and after the date of said conveyance, no rent shall be chargeable to said Frank Holton & Co., its successors, lessees or assigns. And in case said Frank Holton & Co. shall not, during the said period of seven (7) years as aforesaid, have paid to its said3916 employes employed in its business and plant at the said City of Elkhorn the sum of Five Hundred Thousand ($500,000.00) dollars as aforesaid, it shall however, upon the purchase of said site and building at the end of the said period of seven years, be credited with such portion of the purchase price thereof as the amount it shall have so paid to its employes as aforesaid bears to the sum of Five Hundred Thousand ($500,000.00) dollars. Prior to 1917 petitioner normally had from 200 to 225 employees and a weekly pay roll of about $4,000. When it became known that petitioner was preparing to move to Elkhorn many of its employees secured other positions and petitioner was unable to fill all the places of those who left. Petitioner moved its equipment to Elkhorn on April 15, 1918 Only 57 of its old employees accompanied it and some of them later returned to Chicago. Housing facilities were inadequate and in 1919 Holton built 27 houses. The only rail transportation at Elkhorn consisted of two branch lines, and a greater length of time was required for shipments to reach customers than was the case with shipments from Chicago. The building erected for petitioner's use was two3917 stories high, of so-called mill construction type, that is, cement foundations and walls of brick. In laying the ground floor a filling of cinders was put in and tamped, on that pine boards were laid, and on the pine boards 3/8" maple flooring. The second floor consisted of 2" pine boards and on that maple flooring. A large part of the ground floor warped and was replaced by the petitioner. The roof was of tar paper and gravel construction. The paper was of inferior quality 1321 and within two years petitioner was required to reroof the entire building. The brick used in the walls began to deteriorate in a short time, and petitioner was required to paint the entire exterior of the building. Petitioner required gas for brazing and soldering and, as the town of Elkhorn was not supplied with gas, petitioner was obliged to install its own gas plant. This it did in 1918, but the plant installed proved unsatisfactory and was replaced with a different kind of plant. Petitioner also installed all of the electric wiring, put in a sprinkler system, finished the plumbing, and built benches for workmen. It was found in the fall of 1918 that the heating plant was inadequate3918 and an additional boiler was installed. Petitioner was reimbursed by the contractor for a part of the cost of the additional boiler, and the cost of the other installations mentioned herein was charged to the Elkhorn Factory Co. During the remaining portion of 1918, after removal to Elkhorn, petitioner expended as wages the sum of $94,052.76, in 1919, the sum of $192,215.68, and in 1920, the sum of $275,029.51, exclusive. in each case, of officers' salaries. In the latter part of 1920 petitioner, by letter, advised the Elkhorn Factory Co. that it had complied with the requirements of the contract of March, 1917, and requested a deed to the property. By resolution of December 29, 1920, the board of directors of the Elkhorn Factory Co. authorized and directed the president and secretary of the company to execute and deliver to petitioner a deed, to bear date of November 1, 1920. This resolution was complied with and the deed filed for record on December 30, 1920. The plant thus acquired by petitioner was constructed at a cost of $40,475.82, and on April 15, 1918, it had a useful life of not more than 33 1/3 years. For the year 1918 petitioner reported a loss of $53,635.05, 3919 of which $2,751.06 represented a loss on the sale of its Chicago real estate and building. Net income was reported for subsequent years as follows: 1919$65,192.68192046,406.25192123,707.28192259,740.30Petitioner claimed no depreciation on the Elkhorn building for 1918. In its return for 1919 it claimed depreciation on an amount of $19,904.74, which it designated as addition to buildings not yet owned. In 1920 the property acquired from the Elkhorn Factory Co. was appraised at $66,607.47, and that amount was listed in the return filed as an increase in invested capital in that year. Depreciation 1322 was claimed in that return at 3 per cent on the amount of $66,650.64, which was designated as buildings acquired in 1920. The respondent added to income reported for 1920 the amount of $45,475.82 as the cost to the Elkhorn Factory Co. of the property transferred to the petitioner. OPINION. ARUNDELL: Among the claims advanced in this case are claims for additional depreciation for 1918 and for inclusion in invested capital for that year of the cost of the Elkhorn land and building. Inasmuch as no deficiency has been determined for 1918, 3920 we can consider the facts for that year only in so far as they may affect taxes for subsequent years and not for the purpose of determining that year's tax. Section 274(g) of the Revenue Act of 1926. The several issues presented all arise out of the item of $45,475.82, representing the cost to the Elkhorn Factory Co. of property deeded to the petitioner in 1920. The petitioner says that that amount was not income in any year, or, in the alternative, that if it was income at all it was income in 1918 when it obtained "equitable title by possession." The petitioner must be sustained on its first contention, namely, that no income was realized in any year by the receipt of the property from the Elkhorn Factory Co. ; ; ; ; S. E. Overton Co. v. Holden, Collector, decided by the District Court of the United States for the Western District of Michigan, Southern Division, September 19, 1927. 3921 Petitioner claims that the cost of the property to the donor should be included in invested capital of petitioner from the time petitioner took possession in 1918. We had a similar situation in , where a contract was acquired by the taxpayer from nonstockholders. We there held: It seems clear that the petitioner secured a very favorable contract from the three organizations owning the lease, none of which were stockholders in the petitioner corporation. Such a transaction does not give rise to paid-in surplus. The contract was not paid in by the stockholders; it was not a gift from the stockholders. It was acquired from nonstockholders, and the petitioner is no more entitled to have its value included in invested capital than the value of any other advantageous contract. That decision is accord with the principle underlying the computation of invested capital, that is, that the amount shall be restricted to sums risked in the business with the hope of realizing a gain from the investment. It is said in 3922 , that: 1323 When speaking of the capital of a business corporation or partnership, such as the act deals with, "to invest" imports a laying out of money, or money's worth, either by an individual in acquiring an interest in the concern with a view to obtaining income or profit from the conduct of its business, or by the concern itself in acquiring something of permanent use in the business. In the present case, while undoubtedly the contributors to the fund raised for purchasing the donated property hoped to benefit therefrom through the stimulation of business in the community, such hope is far removed from an expectation of gain through an investment in the business enterprise. As far as the record shows neither the contributors nor the donor of the property were stockholders in the petitioner; they acquired no interest of any kind in it. In these circumstances, the cost of the property to the donor does not constitute paid-in surplus and no part of it can properly go into invested capital. The next assignment of error is the failure of respondent to allow a deduction for depreciation upon the3923 depreciable portion of the property here involved for the full years 1918, 1919, and the first half of the year 1920. The respondent denies that he so erred. On this state of the pleadings we assume that the respondent allowed depreciation on the building for the latter half of the year 1920, and, as no issue is raised as to that allowance, except as to the amount, we do not pass on it. The evidence is that some time during 1920 the petitioner completed performance of the obligations placed upon it by the contract of March, 1917, as conditions precedent to the right to acquire title to the property. Under the contract petitioner's relation to the property was nothing more than that of a lessee with an option to oventually acquire title by fulfilling the terms laid down. It did not have title to the property, nor did it have a capital investment therein, in 1918, 1919, or the first half of 1920, and it is not entitled to deductions for depreciation for that period. . On the question as to the depreciation rate, the petitioner has established that the useful life of the building acquired was not in excess of 33 1/3 years, and3924 it is accordingly entitled to deductions of 3 per cent per year for the latter half of 1920 and for the subsequent years involved. Petitioner asks that this rate be applied to the cost of the building to the donor, in the amount of $40,475.82. We are satisfied from the evidence that the building had a value of at least that amount when acquired by the petitioner in 1920, and the 3 per cent rate should be applied to that figure. Special assessment is asked by the petitioner, as an alternative in the event we find that the cost of the property involved was income *1324 to it. Having found for the petitioner on that question, we do not pass on the alternative issue. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1842368/	367 B.R. 428 (2007) In re 360NETWORKS (USA) INC., et al., Debtors. The Official Committee of Unsecured Creditors of 360Networks (USA) Inc., et al., and 360Networks (USA) Inc., by and through The Official Committee of Unsecured Creditors of 360Networks (USA) Inc., et al., v. Pirelli Communications Cables and Systems USA LLC, Defendant. Bankruptcy No. 01-13721 (ALG). Adversary No. 03-04267 (MG). United States Bankruptcy Court, S.D. New York. April 24, 2007. 429 430 Norman N. Kinel, Esq., Terence D. Watson, Esq., Dreier LLP, New York, NY, Attorneys for the Official Committee of Unsecured Creditors of 360networks (USA) inc., et al., and the Estate of 360networks (USA) inc. Richard P. Krasnow, Esq., Richard L. Levine, Esq., Christopher Marcus, Esq., Weil, Gotshal & Manges LLP, New York, NY, Attorneys for Pirelli Communications Cables and Systems LLC. OPINION AND ORDER DENYING PLAINTIFF'S MOTION FOR LEAVE TO AMEND THE COMPLAINT MARTIN GLENN, United States Bankruptcy Judge. The Official Committee of Unsecured Creditors of 360networks (USA) inc., et al. (the "Plaintiff') brought an action against Pirelli Communications Cables and Systems USA LLC ("Pirelli" or the "Defendant") seeking the avoidance, recovery, and turnover of certain preferential transfers pursuant to §§ 547 and 550 of the Bankruptcy Code. See Complaint (ECF Doc. No. 1). In its original complaint (the "Complaint"), filed on June 17, 2003, Plaintiff sought to avoid and recover preferential transfers in the aggregate sum of "at least $17,330,644.54." Attached to the Complaint as Exhibit A is a schedule showing a detailed breakdown of each transfer, with check number, payment date, invoice number, invoice date and payment amount. The statute of limitations for Plaintiffs avoidance actions expired on June 27, 2003. On February 17, 2007, Plaintiff filed a motion (the "Motion") seeking (i) a determination that an amendment to the Complaint is not required for the Plaintiffs to avoid and recover additional transfers in the amount of $12,350,815.69, or, in the alternative, (ii) permission to amend the Complaint and for a finding that the proposed amended complaint will relate back to the filing of the Complaint and will not be barred by the applicable statute of limitations. For the reasons explained below, the Court holds that an amendment to the Complaint would be required, but would be futile because the statute of limitations has expired with respect to the additional transfers. An amendment to add the additional transfers would not relate back to the original Complaint under Fed.R.Civ.P. 15(c)(2). Therefore, the request for, leave to amend is denied. I. DISCUSSION A. The Parties Contentions In its Motion, Plaintiff contends that it is entitled to seek the recovery of additional transfers in the amount of $12,350,815.69, 431 bringing the total amount sought to $29,681,460.23, from Pirelli without amending the Complaint because the Complaint satisfies the liberal pleading requirements of Rule 8(a)(2) of the Federal Rules of Civil Procedure. Specifically, Plaintiff points to the language of the Complaint seeking the avoidance and recovery of preferential transfers made by the Debtor to Pirelli in the amount of "at least $17,330,644.54." See Complaint ¶ 1, at 2 (ECF Doc. No. 1). Plaintiff contends that this language provided Pirelli with fair notice that more than $17,330,644.54 was at issue by explicitly demanding the avoidance and recovery of "at least" $17,330,644.54. In the event the Court deems an amendment necessary, Plaintiff seeks leave of Court to amend the Complaint under Fed. R.Civ.P. 15(a) and further contends that, pursuant to Fed.R.Civ.P. 15(c), the amendment should be deemed to relate back to the filing of the Complaint so as not to be barred by the statute of limitations. Plaintiff states that an amendment will relate back to the filing of an original complaint where, like here, (i) the original complaint evidences an intent to seek recovery of more than the specifically identified transfers and (ii) the amendment merely quantifies the amount sought in the original complaint. Plaintiff contends that any amendment to the Complaint here should similarly be deemed to relate back to the date of the filing of the Complaint since the Complaint clearly provided Pirelli with sufficient notice of the Plaintiffs intent to seek recovery of more than or "at least" $17,330,644.54, and the amendment merely amplifies the transfers referred to in the Complaint. In its reply brief, Plaintiff further argues that the amendment should relate back to the timely filed Complaint because the transfers all arise out of the same common core of operative facts. Specifcally, Plaintiff contends that between 1999 and mid-2001 the Debtor and its predecessors purchased a large amount of fiber-optic cable from Pirelli pursuant to a Supply Agreement executed in January 1999 (the "Supply Agreement") and that all of the transfers were payments for such fiber-optic cable. See Reply to Motion at 6 (ECF Doc. No. 17). The Defendant contends that the Plaintiff should be required to seek leave to amend the Complaint because the actual language of the Complaint did not put it on notice that additional transactions might be challenged and, therefore, the requirements of Fed.R.Civ.P. 8 have not been satisfied. Defendant states that the Complaint, not any other source, must provide the defendant with fair notice and here the Complaint does not contain any information or even a hint that Plaintiff may later pursue additional transfers. Defendant further argues that leave to amend should be denied because amending the Complaint would be futile since these additional transfers do not "relate back" to the original Complaint under Fed.R.Civ.P. 15(c). The Defendant argues that for Plaintiffs proposed amendment to "relate back" the Court must find, among other things, that the Complaint provided fair and reasonable notice to Pirelli that transfers in addition to those specifically identified in the Complaint would or could be challenged. The Defendant argues that the only language to which Plaintiff points to support its assertion that Pirelli had notice that additional transfers may be challenged is that the Complaint seeks avoidance and recovery of "at least $17,330,644.54." Defendant states that the phrase "at least" serves only to preserve the Plaintiffs right to seek an increase in its recovery as a result of interest and that the Complaint makes no reference to other transfers," course of conduct, or any other 432 fact that might link any other transfers that occurred during the preference period. B. Application of Rule 8 of Fed. R.Civ.P. Rule 8(a) requires a complaint to contain "a short and plain statement of the claim showing that the pleader is entitled to relief," and governs the specificity necessary to state a claim under Fed.R.Civ.P. 12(b)(6). The purpose of the statement is to provide "fair notice" of the claim and "the grounds upon which it rests." Enron Corp. v. J.P. Morgan Sec., Inc. (In re Enron Corp.), 325 B.R. 671 (Bankr. S.D.N.Y.2005) (citing Conley v. Gibson, 355 U.S. 41, 47, 78 S. Ct. 99, 2 L. Ed. 2d 80 (1957)). In other words, "[Rule 8] is designed to permit the defendant to have a fair understanding of what the plaintiff is complaining about and to know whether there is a legal basis for recovery." Ricciuti v. New York City Transit Auth., 941 F.2d 119, 123 (2d Cir.1991). Rule 8 does not control the issue before the Court. Plaintiffs argument that it is not required to amend the Complaint because the Complaint meets the liberal pleading standard of Rule 8(a)(2) appears to be an attempt to make an endrun around the requirements of Rule 15(c)(2). Plaintiff cites Family Golf Centers, Inc. v. Acushnet Co. (In re Randall's Island Family Golf Centers, Inc.), 290 B.R. 55 (Bankr.S.D.N.Y.2003) and Official Comm. of Unsecured Creditors of the IT Group, Inc. v. Brandywine Apartments (In re The IT Group, Inc.), 313 B.R. 370, 371 (Bankr.D.Del.2004) in support of its argument. Plaintiffs reliance on these cases is misplaced. Neither case involved a proposed amendment seeking recovery of new payments after the expiration of the statute of limitations. See In re Randall's Island, 290 B.R. at 64-65 (denying a motion to dismiss subsequent complaint that, sought to recover the same transfers made by the same payor to the same transferees as the initial complaint, because the complaint met the liberal pleading standard under Rule 8); In re The IT Group, 313 B.R. 370 (considering the liberal pleading standard of Rule 8(c) in the context of a motion to dismiss where defendant alleged that plaintiff failed to plead the required elements for a preferential transfer). All of the cases cited by Plaintiff that address the issue of amending a complaint to recover additional payments analyze the issue under Rule 15(c)(2). Even assuming arguendo that Rule 8 is relevant to this analysis, the Court finds that the Complaint does not satisfy the notice pleading requirements of Rule 8 with respect to the additional preference claims. The only language to which Plaintiff points to support its contention that the Defendant had notice that additional transfers may be challenged is that the Complaint seeks avoidance and recovery of "at least $17,330,644.54." However, the terms "at least" appear to apply to the sum of the transfers, specifically identified in Exhibit A to the Complaint, rather than the number of transfers being pursued. See Complaint ¶ 11, at 4. Further, the term "at least $17,330,644.54" was explained in the relief requested section to mean the stipulated amount plus interest as of the date of the Demand Letter. See Complaint at 5 ("[D]eclaring that Pirelli pay the amount of at least $17,330,644.54, representing the amount owed by Pirelli, plus interest from the date of the Demand Letter as permitted by law"). The Complaint does not include any additional language that would put the Defendant on notice of these additional transfers. C. Application of Fed.R.Civ.P. 15 Rule 15(a) provides that leave to amend is to be freely granted. Fed. 433 R.Civ.P. 15(a). But an amendment should be denied where the additional claims sought to be asserted would be barred by the statute of limitations unless the amendment relates back under Rule 15(c). Metzeler v. Bouchard Transp. Co., Inc. (In re Metzeler), 66 B.R. 977, 981 (Bankr. S.D.N.Y.1986). The dispositive issue in this matter, therefore, is whether the additional transfers set forth in the proposed amendment to the Complaint would "relate back" under Rule 15(c). If the additional transfers set forth in the proposed amendment to the Complaint do not relate back then allowing the Plaintiff to amend the Complaint would be futile. Rule 15(c), made applicable by Bankruptcy Rule 7015, provides in relevant part: An amendment of a pleading relates back to the date of the original pleading when ... (2) the claim or defense asserted in the amended pleading arose out of the conduct, transaction, or occurrence set forth or attempted to be set forth in the original pleading.... Fed.R.Civ.P. 15(c). "[T]he purpose of Rule 15 is to provide maximum opportunity for each claim to be decided on its merits rather than on procedural technicalities," however, a court must not "undermine the purpose of repose for which statutes of limitations were designed." Enron Corp. v. J.P. Morgan Sec. Inc. (In re Enron Corp.), 357 B.R. 257, 263 (Bankr. S.D.N.Y.2006) (citations and quotations omitted). The moving party who asserts the relation back bears the burden of proof. In re Enron Corp., 298 B.R. 513, 522 (Bankr.S.D.N.Y.2003). The primary consideration in determining whether the proposed amendment to the Complaint should relate back is whether the Complaint put the defendant on notice that additional transfers may be pursued at a later date. Courts will not consider the subjective state of mind of what one party was thinking when it filed its original complaint, but will instead objectively consider whether the original complaint put the other party on notice as to the cause of action being asserted against it. Enron Corp. and Nat'l Energy Prod. Corp. v. Granite Constr. Co. (In re Enron Corp.), No. 03-93172, 2006 WL 2400369, 10 (Bankr.S.D.N.Y. May 11, 2006) (citing In re Kam Kuo Seafood Corp., 67 B.R. 304, 306 (Bankr.S.D.N.Y. 1986)). Under Rule 15(c)(2), an amended pleading relates back to an earlier pleading if the amended pleading sets forth claims arising out of the same conduct, transaction or occurrence set forth or attempted to be set forth in the original pleading. "The principal inquiry is whether adequate notice of the matters raised in the amended pleading has been given to the opposing party by the general fact situation alleged in the original pleading." Id. (citing Weiss v. Alicea (In re Alicea), 230 B.R. 492, 498-99 (Bankr.S.D.N.Y. 1999)); Stevelman v. Alias Research Inc., 174 F.3d 79, 86-87 (2d Cir.1999) ("Under Fed.R.Civ.P. 15(c), the central inquiry is whether adequate notice of the matters raised in the amended pleading has been given to the opposing party within the statute of limitations `by the general fact situation alleged in the original pleading.'") (quotations and citations omitted); Rosenberg v. Martin, 478 F.2d 520 (2d Cir.1973) ("[T]he inquiry in a determination of whether a claim should relate back will focus on the notice given by the general fact situation set forth in the original pleading.") (citing Snoqualmie Tribe v. United States, 178 Ct. Cl. 570, 372 F.2d 951, 960 (1967)) (quotations omitted). "If the facts in the original pleading do not provide defendant with notice of facts out of which the time-barred claim arises then 434 relation back is inappropriate." 106 Mile Transp. Associates v. Koch, 656 F. Supp. 1474, 1487 (S.D.N.Y.1987). The general factual allegations made in the original pleading must be enough to put the opposing party on notice as to the potential action that awaits it. Enron Corp., 2006 WL 2400369 at 11. "One test that many courts have employed in order to determine whether an amendment to pleadings will relate back is to determine whether the initial complaint put the defendants ... on notice of what must be defended against in the amended pleadings. This test does not require that the prior complaint put the defendants on notice of new or additional legal theories that the plaintiffs seek to assert against the defendants, but it must inform the defendants of the facts that support those new claims." Barr v. Charterhouse Group Ina, Inc. (In re Everfresh, Beverages, Inc.), 238 B.R. 558, 573-74 (Bankr. S.D.N.Y.1999) (citations omitted). Plaintiff goes to great lengths to set forth numerous facts outside of the Complaint that, it claims, gave Pirelli notice, well in advance of the expiration of the applicable statute of limitations, that Plaintiff would be seeking the recovery of all preferential transfers received by each of the defendants in the preference actions. See Motion at 9. However, as discussed above, the Court must objectively consider whether the general fact allegations set forth in the Complaint gave Defendant notice of additional claims; matters outside of the Complaint are irrelevant for purposes of a Rule 15(c)(2) analysis. Here, the Complaint fails to set forth any facts putting the Defendant on notice that additional transactions may be challenged. Specifically, no facts are alleged regarding the nature of the Debtor's relationship with Pirelli or the nature of the transfers made between the Debtor or Pirelli during the alleged preference period. The Complaint merely alleges that "[o]n or within ninety (90) days before the Petition Date, 360 made preferential transfers to or for the benefit of Pirelli in the aggregate sum of at least $17,330,644.54, in cash...." Exhibit A to the Complaint identifies specific transfers; it does not provide any information from which the Defendant can glean that the Debtor intended to challenge additional transfers. The Complaint does not mention the Supply Agreement between the Debtor and Pirelli, raised by the Debtor for the first time in its reply memorandum. The Court finds that the Defendant was not put on notice that additional transfers may be pursued at a later date. Indeed, the plain language of the Complaint reflects that, no other claims were being asserted or contemplated. Under these circumstances, relation back of the proposed amendment is inappropriate. See, e.g., Kam Kuo, 67 B.R. at 308 (denying motion for leave to amend because among other things "the original complaint assert[ed] no such continuing close relationship or conduct from which both the originally pleaded and subsequently pleaded transactions sprung"). Further, the mere fact that all of these transactions are potentially preferential transfers is of no consequence when performing a Rule 15(c)(2) analysis. In the context of preference actions, each potential preferential transfer is a separate and distinct transaction: a preference action based on one transfer does not put defendant on notice of claims with respect to any other unidentified transfers. Kam Kuo, 67 B.R. at 308; see Metzeler v. Bouchard Transp. Co. (In re Metzeler), 66 B.R. 977, 984 (Bankr.S.D.N.Y.1986) ("Courts have consistently treated preferential transactions as separate and distinct under Rule 15(c)"). For these reasons, the Court concludes that the proposed amendment *435 would not relate back to the timely filed Complaint. II. CONCLUSION For the reasons provided above, the Plaintiffs Motion to Amend the Complaint is DENIED. IT IS SO ORDERED.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4537709/	NOT DESIGNATED FOR PUBLICATION No. 121,364 IN THE COURT OF APPEALS OF THE STATE OF KANSAS In the Interests of K.H., Z.H., AND L.H., Minor Children. MEMORANDUM OPINION Appeal from Sedgwick District Court, GREGORY D. KEITH, judge. Opinion filed May 29, 2020. Affirmed. Michael P. Whalen, of Law Office of Michael P. Whalen, of Wichita, for appellant. Julie A. Koon, assistant district attorney, and Marc Bennett, district attorney, for appellee. Before STANDRIDGE, P.J., LEBEN AND BRUNS, JJ. PER CURIAM: Mother, A.H., appeals from the district court's order terminating her parental rights to three children. Such rights may be terminated only in circumstances set out by statute and only when clear and convincing evidence supports the termination. See K.S.A. 2019 Supp. 38-2269. Mother contends on appeal that the evidence wasn't enough for the district court to terminate her parental rights and that no reasonable person could conclude that terminating her rights was in the children's best interests. But termination is authorized when a parent has shown a lack of effort to adjust his or her circumstances, conduct, and condition to meet the children's needs, K.S.A. 2019 Supp. 38-2269(b)(8); when reasonable efforts by public and private agencies to get the family back together have failed, K.S.A. 2019 Supp. 38-2269(b)(7); and when a parent fails to carry out a reasonable court-approved plan aimed at reintegrating the family, K.S.A. 2019 Supp. 38- 2269(c)(3). Here, when the district court terminated Mother's parental rights, the children had been in State custody (placed in foster homes) for 32 months—30 of those after the children had been legally declared "children in need of care" under K.S.A. 2019 Supp. 38-2202(d), a finding Mother did not contest. Despite that, Mother denied that her conduct needed to change to get the family back together, she was habitually late to weekly visitations, and she did not work to foster a good relationship with her children. And although the family had received extensive services from social-services agencies, Mother failed to follow through with family therapy, individual therapy, or substance- abuse treatment, as the family's case plan required. We recognize that termination of parental rights is a serious matter. We have reviewed the entire record, and we find clear and convincing evidence to support the district court's findings that Mother was unfit as a parent and that the conditions leading to that finding were unlikely to change in the foreseeable future. We also find that a reasonable person could agree with the district court that terminating Mother's parental rights was in the children's best interests. We therefore affirm the district court's judgment. FACTUAL AND PROCEDURAL BACKGROUND Cases like these are necessarily fact-driven, so the factual background must be described in some detail. Mother has three sons: K.H. (born 2008), Z.H. (born 2009), and L.H. (born 2011). K.H. and Z.H. have autism. The three boys have the same father, C.H., who died during these proceedings. The Kansas Department for Children and Families first received reports about the family in 2012. Those reports concerned the parents' mental health and the children's education. Between November 2014 and November 2015, the department received 10 2 reports of abuse or neglect of the boys, including a report that Father had attempted suicide in the family home in October 2015 while the children were in the home. The department also learned that the family had been investigated in Florida before moving to Kansas. By early December 2015, all three children had been placed in temporary State custody. The parents did not contest the State's allegation that the three boys were children in need of care under Kansas law, and the district court adjudicated them as such under K.S.A. 2019 Supp. 38-2202(d)(1) (lacking adequate parental care), (d)(2) (lacking care or control necessary for child's physical, mental, or emotional needs), and, for K.H., (d)(8) (child committed an act which if done by an adult would be a felony or misdemeanor). The finding that the boys were children in need of care—which happened in February 2016—is not at issue on appeal. There is not much in the record before us about the first six months of 2016, but it appears that the children were close to being reintegrated—by July, they were spending five days of the week at home. But a turning point happened in July 2016, when Mother and Father were in a severe car accident. Father died instantly; Mother was hospitalized for several months. After Mother was released from the hospital, the district court began holding periodic hearings about how to proceed toward reintegration. Each time, the court ordered the boys remain in State custody. Before each hearing, caseworkers at a social- service agency, Saint Francis Community Services, prepared progress reports. Those reports describe the events that prompted the State's motion. In November 2016, Pheasant Weber, a Saint Francis caseworker, reported that Mother was argumentative and uncooperative during her initial parenting assessment; Mother also failed to appreciate that different parenting techniques were appropriate for 3 children with autism. Weber noted that Saint Francis had struggled to work with Mother: Mother refused to get a required mental-health evaluation, she struggled to set a consistent structure or routine in the home, she refused to allow two of her children to receive educational testing, and she was not appropriately addressing her children's behavioral issues. Weber also said that school staff and therapists had raised concerns about the children's unsupervised visits with Mother, saying the children had returned dressed inappropriately, dirty, hungry, or overly tired. After this report, the district court ordered Mother to engage in both individual therapy and family therapy with the boys. In January 2017, Weber reported that little progress had been made and that her working relationship with Mother was strained (the case was later transferred to another caseworker). Weber said that Mother had refused to sign a plan outlining steps that she needed to take to regain custody of her boys. Mother remained confrontational and uncooperative, according to the report, and had told her children not to talk to Saint Francis about visits at Mother's house. The report also said that Mother struggled to parent her children during visits, spending most of the time on her cell phone and failing to address her children's aggressive behavior. A different Saint Francis caseworker, Alyssa McCarroll, took over Mother's case the next month. Her initial assessment was that Mother's lack of transparency and her inability to accept guidance was a barrier to reintegration. She worked with Mother to develop a new plan to help make sure the children would have a safe and appropriate home to return to. Tasks on that plan included beginning individual therapy and family therapy with her children; allowing periodic walk-throughs of her home; providing financial information; and not encouraging her children to behave poorly. Mother signed the plan, acknowledging that failing to complete the tasks could lead to continued out-of- home placement or the termination of parental rights. 4 McCarroll did not note significant progress when she updated the district court in June 2017. She said that Mother continued to resist guidance in parenting her children and addressing mental health issues—for example, Mother hadn't followed through with family therapy. McCarroll also said Mother continued to be inconsistent with keeping appointments and following through with the various professionals involved. This report also noted that Mother had recently become engaged to J.P., a man who had been living in her house. Mother had posted on Facebook that he'd recently been using methamphetamine while they were temporarily estranged. The district court entered additional orders after this report. The court ordered J.P. to comply with the tasks in the case plan, and it reiterated that Mother needed to go to family therapy with her children. It also had Mother and J.P. submit to a urinalysis and hair-follicle test to screen for narcotics; both tested positive. For a time, things appeared to turn in the right direction for Mother after those court orders. McCarroll's August 2017 report said that Mother was fixing up her house for the boys' return and that Mother had been more cooperative and was making progress on changes in her life. McCarroll concluded that Mother was adequately completing her assigned court orders, thanks in part to substantial effort by Saint Francis staff. After that report, the court ordered Mother to begin individual therapy again; apparently, she had stopped that at some point. Mother's progress did not continue. After Mother and J.P. both tested positive for drugs more than once, the district court entered new orders in November 2017. The court ordered both to comply with drug-testing requests, obtain a substance-abuse evaluation, and follow any recommendations in it. The court also reiterated that Mother needed to start individual therapy and that Mother and J.P. needed to start couples' therapy. Mother did get a substance-abuse evaluation in early December 2017—testing positive for methamphetamine in the process—but she didn't follow the evaluation's recommendation of outpatient therapy. 5 McCarroll reported in January 2018 that Mother continued to regress. She said that Mother's behavior toward caseworkers had returned to being secretive and explosive. McCarroll also addressed two other concerns. First, Mother and J.P. had been involved in a domestic-violence situation, with each party alleging that the other was the aggressor. And second, McCarroll said that Saint Francis had learned that Mother had been using drugs throughout the case. Our record shows that Mother had tested positive for various narcotics 10 times between April 2017 and February 2018, which is when the State moved to terminate her parental rights. In January 2018, workers involved in Mother's case met to determine whether to stick with the goal of reintegration, which had been their recommendation until that time. They concluded that it was time to change course and recommend adoption instead of reintegration. Concerns noted during that meeting included the poor condition of the home; Mother's continued drug use and failure to submit to drug tests; and the domestic- violence situation between Mother and J.P. McCarroll's final report in February 2018 said that little progress had been made in the case; McCarroll said that Mother was not being transparent and that she had refused to follow a court order that she sign a release of information relating to the July 2016 car accident that killed the boys' father. In February 2018, the State moved to terminate Mother's parental rights. The district court held a trial during which Mother, McCarroll, J.P., and other individuals involved with the case testified. The trial was apparently originally expected to take one day but ended up taking two—one in June and one in August 2018. We've organized the relevant testimony by topic. 6 Inconsistency during visitations McCarroll testified about Mother's inconsistency during visits with her children. She said at the first day of the trial that Mother has missed two of her scheduled visitations with her children, rescheduled or sought to reschedule a couple visits, and been late to almost all her visitations. At the second day of trial, McCarroll said that Mother had been consistently 15, 20, or 30 minutes late to her weekly, hour-long visitations. McCaroll said that Mother's inconsistency was a huge concern. If Mother couldn't make it to appointments herself, McCarroll asked, how would Mother make sure that her special-needs children got to therapy, treatment, and doctor's appointments? Lack of secondary changes McCarroll said that Mother had not made "secondary changes," which McCarroll said meant taking responsibility and acknowledging that something is wrong, then changing those aspects of your life. She said that there had been little secondary change over the 30 months that the case had been open. She said that Mother did not accept responsibility, still believed that her actions had not been wrong, and said that it was Saint Francis' fault that she did not have her children back. When Mother took the stand, she said that she had heard the concerns raised by Saint Francis workers, but that their concerns were just their opinions. Mother said that there was no reason that the kids should not be at home with her. She also said that Saint Francis had not provided enough support and that Saint Francis and its staff, not Mother, needed to change. She also accused the Saint Francis caseworkers of lying. 7 Failure to complete family therapy McCarroll testified about Mother's failure to complete family therapy. She said that Saint Francis had originally recommended family therapy because staff members were concerned about Mother inappropriately discussing the case during visitation and the lack of bonding between the children and Mother. A Saint Francis clinician did a six- session evaluation with Mother and the children and recommended the family participate in a type of family therapy involving in-the-home parenting training. McCarroll said she thought that would benefit Mother because Mother had struggled to parent her children appropriately, especially her special-needs children. She said Mother continually gave in to anything the kids requested. McCarroll said she told Mother that Mother would need to contact the clinician to set up the in-home training visits. McCarroll said Mother did not want to do the therapy. McCarroll said that Mother needed to meet with the clinician to fill out forms, but that Mother failed to show up for three or four meetings. After Mother said she that did not trust the clinician, McCarroll said she offered three other clinicians, but Mother was not willing to use them. McCarroll said that she discussed family therapy again in an email conversation with Mother's attorney in May 2018 (one month before the first day of trial). McCarroll reiterated that Mother needed to complete family therapy. McCarroll said that she contacted the Saint Francis clinical director, but they said there was a six-week waiting period and they didn't want to fill the waiting list with somebody who had failed to comply. Mother testified that she did not refuse to do family therapy. She said that she had signed the paperwork but that the family therapy never started because the Saint Francis clinician would not return her texts to schedule a meeting. 8 Failure to complete individual therapy According to McCarroll and Connie Mayes, Mother's therapist, Mother also failed to complete individual therapy. McCarroll testified that Mother had done a psychological evaluation and a parenting assessment, both of which had recommended individual therapy. McCarroll said that when she took over the case in January 2017—more than a year after the State assumed custody of the children—Mother had not done the individual therapy. McCarroll said she made another referral in November 2017 to Connie Mayes and that Mother did an intake and started attending individual therapy. McCarroll said that Mother consistently attended from at least December 2017 to February 2018, but then she missed the entire month of May 2018. Mayes testified that Mother started doing individual therapy in November 2017. She said they tried to schedule twice a week, which sometimes worked, but that there were gaps when Mother wouldn't come. Of the times that Mother missed, about half of them were cancellations and half were no-shows. Mayes also said that in between the two trial dates, Mother had attended four appointments and no-showed to five. Failure to get substance-abuse treatment Mother testified about getting a substance-abuse assessment and treatment. She said that her first substance-abuse evaluation recommended outpatient treatment. She said that she was admitted into an outpatient program called Seventh Direction but that she stopped going after a week. Mother also said that she tried intensive outpatient therapy but only for a couple of weeks. After that, Mother said, she had done no substance-abuse counseling although her therapist had recommended it. Mother said she knew that getting a substance-abuse evaluation was a top priority after the first day of trial in June 2018, 9 but she hadn't done it by the second day of trial (held in August). Mother said that she still planned on doing it. Lorna Stoecklein, a substance-abuse counselor, also testified about Mother's substance-abuse treatment. Stoecklein said that she met with Mother in April 2018 after Connie Mayes referred Mother. Stoecklein said she recommended inpatient treatment, but that Mother thought that would be too intense. Stoecklein said she also suggested intensive outpatient therapy but that Mother thought that would cause her to miss visitations. She said that they agreed to do sessions twice a week. At time of the second day of trial in August, Stoecklein said that she had not had another session with Mother after the one in early June. She said Mother had not followed up on recommendations for outpatient treatment, inpatient treatment, or a 12-step program. Saint Francis' efforts McCarroll discussed the amount of effort she had expended on Mother's case. McCarroll said she was there around the clock for Mother. She said that if Mother called at 10 p.m., McCarroll would answer, and that if Mother contacted her at 2 a.m., McCarroll would return the call at 5:30 a.m. when she woke up. McCarroll said she had made many referrals for Mother and would remind Mom to call people and follow up. McCarroll said she had communicated with Mother four or five times per week. She also said she had put in a lot of time on this case and tried to use all available resources. McCarroll said that this one case had overwhelmed all her other cases. Lack of progress between hearings Finally, McCarroll testified about the lack of progress that Mother had made between the two days of trial. McCarroll said that before the first day in June, she had emailed Mother's attorney about ongoing concerns with the case. She said that she had 10 raised these issues with the attorney: (1) Mother had not provided reliable income information; (2) Mother had provided six addresses; (3) Mother was not following through with drug testing; (4) Mother needed to do family therapy; (5) Mother needed to be involved in her children's education; (6) Mother needed to get treatment; (7) Mother needed to better manage her schedule; (8) Mother's communications were not always accurate and consistent; and (9) Mother needed to encourage a relationship with her children. McCarroll said she told Mother that it was fundamentally necessary to address these problems. But McCarroll said she didn't feel like there was any progress on these by the time the trial concluded in August. McCarroll said she didn't believe that Mom was a fit parent. After hearing all the evidence, the district court agreed and found that Mother was an unfit parent. The court found that Mother was unfit because mental illness had rendered her unable to care for the ongoing needs of her children, K.S.A. 2019 Supp. 38- 2269(b)(1); because her use of narcotics rendered her unable to meet the ongoing needs of her children, K.S.A. 2019 Supp. 38-2269(b)(3); because reasonable efforts by appropriate agencies had been unable to rehabilitate the family, K.S.A. 2019 Supp. 38- 2269(b)(7); because Mother had not made sufficient effort to adjust her circumstances to meet the needs of the children, K.S.A. 2019 Supp. 38-2269(b)(8); and because Mother had failed to carry out a reasonable plan approved by the court directed toward the reintegration of children into Mother's home, K.S.A. 2019 Supp. 38-2269(c)(3). The district court also concluded that these conditions were unlikely to change in the foreseeable future. It noted Mother's regression since the previous fall and emphasized that Mother had used methamphetamine just weeks before the trial began. The court also noted that Mother had had 60 days between the two trial dates to get a substance-abuse evaluation and submit to drug tests; despite knowing how important it was to the case, the court said, Mother had failed to complete those tasks. All of this led the court to conclude that Mother's behavior was unlikely to change going forward. 11 Finally, the court determined that it was in the children's best interests to terminate Mother's parental rights. The court didn't make any further explanation; instead, after orally reciting the reasons that Mother was unfit and why that was unlikely to change for the foreseeable future, the court said that it had considered the physical, mental, and emotion health of the children and had concluded that termination of Mother's rights was in their best interests. Mother has appealed to this court the district court's order terminating her parental rights to K.H., Z.H., and L.H. ANALYSIS We begin with the legal standards that guide our review. To terminate parental rights, the district court must make three findings: (1) that the parent is unfit; (2) that the conduct or condition making the parent unfit is unlikely to change in the foreseeable future; and (3) that termination of parental rights is in the best interests of the child. K.S.A. 2019 Supp. 38-2269(a), (g)(1). The first two are factual determinations that must be supported by clear and convincing evidence. On appeal, we must determine whether the evidence, taken in the light most favorable to the State (since the fact-finder, the district court, found in its favor), provided clear and convincing support for the district court's factual findings. The test is whether a rational fact-finder could have found the facts highly probable based on the evidence. In re Adoption of C.L., 308 Kan. 1268, 1278-79, 427 P.3d 951 (2018). The third determination—that the termination of parental rights is in the child's best interests—is a discretionary judgment call. On appeal, we review that determination for abuse of discretion. A district court abuses its discretion when no reasonable person 12 would agree with its decision or when the decision is based on a legal or factual error. State ex rel. Secretary of DCF v. Smith, 306 Kan. 40, 60, 392 P.3d 68 (2017). The district court's finding that Mother was presently unfit is supported by clear and convincing evidence, as is its finding that Mother's unfitness is unlikely to change in the foreseeable future. Mother's first argument on appeal is that there was not clear and convincing evidence to support the district court's finding that she was unfit and that her unfitness was unlikely to change in the foreseeable future. The district court must base its finding that a parent is unfit on one of several statutory bases outlined by the Legislature. See K.S.A. 2019 Supp. 38-2269. And—if supported by clear and convincing evidence—a single such basis can be enough to terminate a parent's rights. K.S.A. 2019 Supp. 38- 2269(f). Here, the district court relied on five of these statutory factors: (1) that Mother had shown a lack of effort to adjust her circumstances, conduct, and condition to meet the children's needs, K.S.A. 2019 Supp. 38-2269(b)(8); (2) that reasonable efforts by public and private agencies to get the family back together had failed, K.S.A.2019 Supp. 38- 2269(b)(7); (3) that Mother had failed to carry out a reasonable, court-approved plan directed toward reintegrating the children into her home, K.S.A.2019 Supp. 38- 2269(c)(3); (4) that Mother's use of narcotics rendered her unable to care for her children. K.S.A. 2019 Supp. 38-2269(b)(3); and (5) that Mother's mental illness rendered her unable to care for her children, K.S.A. 2019 Supp. 38-2269(b)(1). Mother contends that it was improper for the district court to rely on the fifth factor because the State had not alleged that Mother's mental illness made her unfit in its motion to terminate parental rights. Because of that, Mother says, she was not on notice that her mental health might form a basis for finding her unfit, so she could not 13 meaningfully respond to that allegation. Mother argues that lack of notice amounted to a due-process violation. The State contends that Mother's due-process argument is not properly before this court because Mother has raised it for the first time on appeal. See State v. Godfrey, 301 Kan. 1041, 1043, 350 P.3d 1068 (2015). The State cites our Supreme Court's decision in Godfrey, which held that a party must invoke an exception to the general rule about raising issues for the first time on appeal and explain why the issue is properly before the appellate court. 301 Kan. at 1043. Since Mother has failed to explain why her due- process claim is before this court, the State says that she has abandoned the issue. But we may review claims of constitutional error for the first time on appeal when that's required to serve the ends of justice or to prevent the denial of a party's fundamental rights. State v. Bowen, 299 Kan. 339, 354, 323 P.3d 853 (2014). Mother's fundamental rights are implicated here—a parent's right to the control, custody, and care of children is a fundamental right protected by the United States Constitution. Frazier v. Goudschaal, 296 Kan. 730, 752-53, 295 P.3d 542 (2013). So we will consider the merits of her argument. Because parental control is a fundamental right, due-process protections apply to a termination proceeding. Matter of Ellison, 305 Kan. 519, 526, 385 P.3d 15, (2016); In re X.D., 51 Kan. App. 2d 71, 73-74, 340 P.3d 1230, (2014). The essence of due process is notice and the right to be heard at a meaningful time and in a meaningful manner. Alliance Mortg. Co. v. Pastine, 281 Kan. 1266, 1275, 136 P.3d 457 (2006); Matter of Estate of Herrman, No. 118,731, 2018 WL 4262634, at *2 (Kan. App. 2018) (unpublished opinion). Here, the State had not raised the issue, and the court did not raise it until after both parties had presented their evidence. Under those circumstances, Mother could not have meaningfully addressed the court's finding because she did not have notice that mental illness might support terminating her parental rights. We 14 therefore agree with Mother that the district court should not have raised this statutory factor on its own accord; we will not consider the fifth factor (whether Mother's mental illness rendered her unfit) when determining whether to uphold the district court's decision. The State suggests that we could summarily affirm the district court based on Mother's failure to adequately brief any complaint about the district court's reliance on the first factor (Mother's lack of effort to adjust to the children's needs). The State may be right about that; Mother has at least failed to address that factor explicitly. But that factor is closely related to the third factor we listed (Mother's failure to carry out a reasonable, court-approved reintegration plan). Given the importance of the issues at stake here, we will address Mother's appeal on its merits, not find in the State's favor because Mother's appellate brief was imperfect. We turn, then, to the evidence supporting the remaining four factors—(1) that Mother had shown a lack of effort to adjust to the children's needs; (2) that reasonable efforts by public and private agencies to get the family back together had failed; (3) that Mother had failed to carry out a court-approved reintegration plan; and (4) that Mother's use of narcotics rendered her unable to care for her children. We agree with Mother that there is not clear and convincing evidence that her drug use rendered her unable to care for her children. It is clear from the record before us that Mother used drugs—she admits as much in her brief, though she calls her drug use "sporadic." But the statute requires that drug use "render the parent unable to care for the ongoing physical, mental or emotional needs of the child" before the drug use may be a basis for terminating parental rights—so there must be some connection between the drug use and the child's wellbeing. K.S.A. 2019 Supp. 38-2269(b)(3); see In re L.C.W., 42 Kan. App. 2d 293, 301, 211 P.3d 829 (2009) ("'Just because parents use drugs, or have been convicted of using drugs, or drink too much alcohol, does not automatically mean 15 the child is likely to sustain harm, or the home is contrary to the child's welfare. If that were the test, then thousands of children would be removed from the home weekly.'"). Here, the State has detailed Mother's drug use, but it has not connected the drug use to Mother's inability to meet her children's needs. As a result, this statutory factor is not supported by the evidence. Even so, we find that clear and convincing evidence supports the other three statutory factors. Testimony at trial showed that Mother had repeatedly failed to carry out significant parts of the court-approved reintegration plan for nearly three years. Despite Mother's struggles to parent her special-needs children, testimony showed that Mother had refused to sign up for in-home family therapy, as a clinician had recommended. As the reintegration plan required, Mother got a substance-abuse and mental-health evaluation, but Mother did not follow through with those recommendations, only sporadically seeking treatment as the termination proceedings drew near. Mother was also consistently late for her weekly, hour-long visitations with her children, often missing up to half of the visit, and was not fostering her relationship with her children; McCarroll testified that this inconsistency was especially concerning because it suggested that Mother would struggle to get her special-needs children to therapy, treatment, and doctor's appointments. McCarroll also described her own efforts on the case as having been above and beyond what a typical case required. Finally, Mother herself testified that she did not think she needed to change her conduct. We understand that Mother may have a very different view of the facts of the case, but this court must take the evidence in the light most favorable to the State. We also may not reweigh the evidence, judge the credibility of witnesses, or redetermine questions of fact. See In re Adoption of C.L., 308 Kan. at 1279. Under those standards, clear and convincing evidence supports the district court's unfitness finding based on the remaining three factors (Mother's lack of effort to adjust her circumstances to the children's needs, 16 Mother's failure to carry out the reintegration plan, and the failure of reasonable agency efforts aimed at reintegration). Clear and convincing evidence also supports the district court's finding that Mother's unfitness was unlikely to change in the foreseeable future. We measure the foreseeable future from the children's perspective, as a child's time perspective differs from an adult's. In re R.S., 50 Kan. App. 2d 1105, 1117, 336 P.3d 903 (2014). Here, by the time the district court terminated Mother's parental rights, the boys had been in State custody for nearly three years. Although it's true that Mother and the boys' father initially made progress, the evidence shows that during the two years after Father's death, Mother made little progress towards reintegration. Even in the two months between the two days of trial, Mother did not make progress on tasks that caseworkers viewed as critical. The district court properly determined that Mother's unfitness was unlikely to change in the foreseeable future. The district court did not abuse its discretion when it determined that the children's best interests supported termination of Mother's parental rights. Mother's final argument on appeal is that in determining whether the termination of parental rights was in the children's best interests, the district court erred by not allowing additional time for Mother to comply with court orders. Because the children were in a stable foster placement for at least four more months, Mother says that the court should have waited to terminate her rights. Of course, the district court knew this information. It had to decide whether terminating Mother's parental rights was in the boys' best interest. K.S.A. 2019 Supp. 38- 2269(g)(1). In doing so, the court must give primary consideration to the physical, mental, and emotional health of the child. K.S.A. 2019 Supp. 38-2269(g)(1). 17 On appeal, our role is a limited one. The court that hears the evidence directly— the district court—is in the best position to decide whether terminating parental rights is in a child's best interests. Accordingly, we may overturn its decision only for an abuse of discretion. See Smith, 306 Kan. at 60. We find no abuse of discretion here. The children had waited three years to be reintegrated with Mother, yet Mother had not made significant progress toward that goal even as the termination trial was held. Mother failed to recognize that she needed to change her conduct, did not foster the relationship with her children, refused to do family therapy until right before the trial (when it was not available), and, despite many opportunities to do so, did not follow through with substance-abuse and mental-health treatment as the family case plan required. So a reasonable person could agree with the district court's decision that terminating Mother's parental rights was in the boys' best interests. In closing, comments this court has made in another case are equally true here: "Cases like this are difficult ones. A parent may be labeled 'unfit' under the law even though he or she loves the child and wants to do the right thing, which may be the case here. But we must judge these cases based mostly upon actions, not intentions, and we must keep in mind that a child deserves to have some final resolution within a time frame that is appropriate from that child's sense of time. . . . The district court's decision was squarely supported by the evidence. It is time to allow [the child] to move on with her life." In re A.A., 38 Kan. App. 2d 1100, 1105, 176 P.3d 237 (2008). We affirm the district court's judgment. 18	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622701/	JOHN E. SHADDUCK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentShadduck v. CommissionerDocket No. 10384-82.United States Tax CourtT.C. Memo 1985-265; 1985 Tax Ct. Memo LEXIS 369; 50 T.C.M. (CCH) 23; T.C.M. (RIA) 85265; June 3, 1985. John E. Shadduck, pro se. Keith Johnson, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION 370 WILBUR, Judge: Respondent determined the following deficiency and additions to tax for petitioner's 1980 taxable year: Additions to tax under SectionsDeficiency6651(a)(1)6653(a)6654 1$16,041.51$4,010.38$802.08$1,024In an amendment to his answer respondent requested that we redetermine an additional deficiency of $503.65 and corresponding additions to tax under sections 6651(a)(1), 6653(a) and 6654 of $125.91, $25.18 and $31.26, respectively. After concessions, the issues for our determination are: (1) whether petitioner is relieved from income tax liability because of his "vow of poverty" and his association with the Life Science Church; and (2) whether petitioner is liable for additions to tax under sections 6651(a)(1), 6653(a) and 6654. FINDINGS OF FACT Some of the facts were orally stipulated at trial and are found accordingly. Those stipulations and accompanying exhibits are incorporated herein by this reference. Petitioner, John E. Shadduck, resided at 5716 Sam C Road, Brooksville, Florida371 at the time of the filing of the instant petition. He failed to file a Federal income tax return for his 1980 taxable year. Petitioner received commissions of $37,201.13 from Investment Management and Research, Inc. for his services as an investment broker, life insurance agent and financial planner during 1980. He also received fees of $600 for trustee services as well as other commissions of $1732.68. Checks in payment for Mr. Shadduck's services were made payable to him personally. Petitioner received two form documents from the Life Science Church both dated January 22, 1980. One document states that the CHURCH OF GOOD SHEPHERD No. 12036 is a "duly organized chapter" of the Life Science Church and the other states that petitioner is ordained a minister of the Life Science Church. On May 16, 1980, petitioner signed a form document entitled "VOW OF POVERTY" in which Mr. Shadduck purports to irrevocably give all his possessions and income to the CHURCH OF GOOD SHEPHERD, Charter #12036 subject, however, to being voided if "civil government officialdom * * * block[s] the rightful tax-exempt status and maintenance of the Church * * . 2" 372 Also on May 16, 1980, petitioner executed three quitclaim deeds which purport to transfer his residence, 4 automobiles, and three horses to the CHURCH OF GOOD SHEPHERD. These documents have never been recorded. As of the date of trial, recorded title to petitioner's residence remained in the name of John Shadduck. During the taxable year at issue, petitioner and his wife maintained only one bank account which was in the name of the Church of Good Shepherd. The "church" paid for all personal living expenses of petitioner and his family including food, mortgage payments, real estate taxes, clothing, and all business related expenses. Petitioner filed income tax returns for his taxable years 1976, 1977, 1978 and 1979. He claimed total deductions for charitable contributions during those years of $139, $187, $174 and $390, respectively. In the notice of deficiency dated February 26, 1982, respondent determined that petitioner received unreported taxable income during 1980 and that he was liable for additions to tax under sections 6651(a)(1) for failure to file a return, 6653(a) for negligence or intentional disregard of rules and regulations, and 6654 for failure to pay estimated373 tax. OPINION The parties have stipulated that petitioner received a total of $39,533.81 in payment for his services from various sources during 1980. The primary issue presented is whether such amounts are includable in Mr. Shadduck's gross income. The determinations made by respondent in the notice of deficiency are presumed to be correct and petitioner bears the burden of proving error in such determinations. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.3Section 61(a) states the general rule that except as otherwise provided, "gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation374 for services, including fees, commissions, and similar items * * ." It is petitioner's contention that the income he received during the taxable year in issue was not earned by him in his individual capacity but rather as an agent for the Church of Good Shepherd. He contends that because he was ordained a minister by the Life Science Church and executed a vow of poverty all income received by him properly belonged to the Church.4 We have considered and rejected this argument in prior cases. Eg. Schuster v. Commissioner, 84 T.C. (April 29, 1985); McGahen v. Commissioner,76 T.C. 468">76 T.C. 468 (1981), affd. without published opinion 720 F.2d 664">720 F.2d 664 (3d Cir. 1983). In McGahen v. Commissioner,supra at 478, we stated: A member of a religious order under a vow of poverty is not immune from Federal income tax by reason of his clerical status or his vow of poverty, but is subject to tax to the same extent as any other person on income earned or received in his individual capacity. Kelley v. Commissioner,62 T.C. 131">62 T.C. 131 (1974); Rev. Rul. 77-290, 2 C.B. 26">1977-2 C.B. 26. 375 It is clear from the facts before us that no agent-principal relationship could exist here because the Church of Good Shepherd was not a separate and distinct principal in that petitioner had unfettered ability to use for his own benefit all property and funds purportedly transferred to the "church". Stephenson v. Commissioner,79 T.C. 995">79 T.C. 995, 1000 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984). As we further stated in McGahen v. Commissioner,supra at 478-479: [W]hen a member of a religious order receives income on behalf of that order and, pursuant to a vow of poverty, turns it over to the order, it is the income of the order and not the member. Where, however, there is no agent-principal relationship, it is a basic rule of tax law that an assignment by a taxpayer of compensation for services to another person is ineffectual to relieve the taxpayer of Federal income tax liability on such compensation regardless of the motivation behind the assignment. Lucas v. Earl,281 U.S. 111">281 U.S. 111 (1930). See also Helvering v. Horst,311 U.S. 112">311 U.S. 112 (1940); Helvering v. Eubank,311 U.S. 122">311 U.S. 122 (1940).376 This is where [taxpayer's] argument collapses. The income received by him was not received on behalf of a separate and distinct principal, but was received by him in his individual capacity. Although he made a vow of poverty, the manner in which he handled his economic and financial affairs was the same as it was before he was ordained and chartered as a "church personally." He had no limitations on the use of his earnings.There was no accounting to assure the frugal and ascetic life of one who takes a vow of poverty of what was earned and how it was spent. * * The facts before us are indistinguishable in all material respects from those in McGahen. Although no records of the checking account set up in the name of the Church of Good Shepherd were produced either during the audit or at trial, petitioner admitted that such account was used to pay all personal living expenses for himself and his family. 5 The trustees of the Church of Good Shepherd were petitioner, his wife and his son and church headquarters were located in petitioner's home. It is abundantly clear that the funds purportedly transferred to the alleged "church" never left petitioner's dominion and control. 377 Petitioner offered only vague testimony about the effect of the "vow of poverty" on his standard of living. We are unconvinced that Mr. Shadduck's standard of living declined in any way after his "vow of poverty" was executed. In fact, it is more likely that his standard of living rose since the amounts he failed to pay in Federal income tax were available for his consumption. As demonstrated by his having filed income tax returns for prior years and his occupation as a financial planner378 and investment broker, Mr. Shadduck was well aware that he had a duty to file Federal income tax returns and to pay tax on his income. It is more than a little surprising that a person who earns his livelihood as a financial planner could expect to escape liability for income taxation and still enjoy unrestricted access to all his income by so simple a step as the creation of a "church." See Stephenson v. Commissioner,supra,79 T.C. at 1006. Respondent's determination is sustained. During the hearing in his case petitioner argued that if we find the income earned by him to be taxable to him despite his "vow of poverty", we should allow as deductions certain unspecified business expenses. Respondent computed petitioner's tax liability allowing only standard deductions because of Mr. Shadduck's refusal to produce records or cooperate in any way during the audit process. Such refusal continued up to the day of the trial until the Court indicated its intention to dismiss the case and enter a decision in respondent's favor. Mr. Shadduck had more than ample opportunity to substantiate any business deductions he may have incurred during 1980, but he chose not to379 do so. The purpose of this proceeding is not, as petitioner claims to believe, to merely determine whether he is required to file a return. Rather, the purpose is to redetermine the amount of the deficiency determined by respondent. Petitioner has introduced no evidence concerning specific amounts of business expenses incurred during taxable year 1980. Expenses claimed on prior unaudited returns are not credible evidence of expenses incurred in the year before the Court. Therefore, petitioner has failed to meet his burden of proof. Rule 142(a), supra. His current predicament is of his own making. Respondent also determined additions to tax for the taxable year 1980 under sections 6651(a)(1), 6653(a) and 6654. Petitioner introduced no evidence on these items. Section 6651(a)(1) provides for an addition to tax for failure to file a timely return unless it is shown that such failure is due to reasonable cause and not due to willful neglect. Section 6653(a) provides for an addition to tax if any part of the underpayment of tax is due to negligence or intentional disregard of rules and regulations. We are unable to conceive of how petitioner could establish reasonable cause380 or lack of negligence on the facts before us. As a matter of fact, we recently upheld respondent's determination of the addition to tax for fraud on similar facts. Stephenson v. Commissioner,supra,79 T.C. at 1005-1008. 6Finally, respondent determined that petitioner is liable for the addition to tax under section 6654 for failure to make timely estimated tax payments in 1980. The section 6654 addition is mandatory unless petitioner falls within one of the computational exceptions. Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1, 20-21 (1980). None of the computational exceptions is applicable here. Therefore, respondent's determinations of the additions to tax as well as the additional amounts requested in the Amendment to Answer are sustained. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year in issue.↩2. This "VOW OF POVERTY" provides in part as follows: I, John Earl Shadduck of the City of Brooksville, County of Hernando, State of Florida, hereby make an irrevocable gift of all my possessions, real, personal and otherwise and all my income whatsoever, regardless of the form of the income, to the Church or Order herein named, thus divesting myself of all my possessions and income whatsoever to be used for Religious purposes to support the basic Biblical Law of the Church or Order hereinafter named. All such possessions and income, if any, hereinafter will be the property of the said Church or Order regardless of whether or not they continue to appear in my personal name. Outside employment remuneration (when directed by the Church or Order) is not personal income, but rather income/gift to the Church or Order and not of the individual or the undersigned. The Church or Order designated to receive said income and possessions is the CHURCH OF GOOD SHEPHERD, Chapter #12036. Therefore, I, John Earl Shadduck hereby take the Vow of Poverty. NOTE: While this initial gift and succeeding gifts herein provided for are irrevocable, thus complying with the irrevocable gift-tax exempt statutes, they will revert to the giver instead of continuing in perpetuity if civil government officialdom were to "void" this act against my express will and intent as by invalidating my right to continue as a member, minister or official of the Church or Order, or by impeding the power of the Church or Order designated to designate after death succession to religious hierarchy, or by blocking the rightful tax-exempt status and maintenance of the Church or Order, possessions in whatever way determined as in setting other religious Orders/Churches, anywhere else in this created world, or by interfering anyway with Universal Law rights and benefits as accorded Churches and religious orders and are the true right and privilege of any religious body under the Constitution of the United States and the 1st, 2nd, 4th, 5th, 6th, 7th, 9th, 10th, 13th and 14th Amendments↩ thereof as rightfully, along with the Declaration of Independence, accorded this Church or Order at the below date.3. Although respondent has the burden of proof as to increases in the deficiency and additions to tax, Rule 142(a)↩, here the parties orally stipulated that the amounts upon which the additional deficiency and additions to tax were based were received by petitioner during the taxable year. Therefore, only the legal questions of whether all such amounts are includable in petitioner's gross income and the applicability of the additions to tax remain.4. We note that the "vow of poverty" herein was not executed until May 16, 1980 and that, therefore, even if such document was sufficient to shift the incidence of taxation away from petitioner that it would not affect income earned before that date. Our resolution of this issue, however, makes such distinction unnecessary.↩5. See also Jenny v. Commissioner,T.C. Memo, 1983-1. On this point we noted in McGahen v. Commissioner.76 T.C. 468">76 T.C. 468 (1981), affd. without published opinion 720 F.2d 664">720 F.2d 664 (3d Cir. 1983), that the taxpayer therein incorporated himself into a church in order to avoid the prohibition of section 262 against decreasing the income subject to tax by amounts paid for "personal, living, or family expenses" and stated that [Taxpayer] attempts to transmute the commercial into the ecclesiastical and thus avoid the congressional separation of taxable individual income and tax-exempt religious order income. This is not permitted. supra↩ at 480.6. See also Merritt v. Commissioner,T.C. Memo. 1983-218↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622702/	Duncan Industries, Inc. (Successor in Interest to Marblcast, Inc.), Petitioner v. Commissioner of Internal Revenue, RespondentDuncan Industries, Inc., etc. v. CommissionerDocket No. 6412-77United States Tax Court73 T.C. 266; 1979 U.S. Tax Ct. LEXIS 23; November 15, 1979, Filed 23 Decision will be entered under Rule 155. Petitioner borrowed $ 100,000 from Dycap, Inc., a small business investment corporation. Under the loan agreement, petitioner was to pay a variable rate of interest pegged to the prime interest rate being charged by a New York bank, $ 3,000 in points, and agreed to sell Dycap a 20-percent equity interest in petitioner for $ 500. The 20-percent equity interest involved 24,050 shares of petitioner's $ 1 par value stock for which Dycap paid about $ 0.02 per share. At about the time the agreement was executed, the book value of petitioner's stock was in excess of its $ 1 par value, and petitioner sold 17,500 shares of its stock to four knowledgeable individuals for $ 1 per share. Held: The sale of 24,050 shares of stock to Dycap for $ 500 was an integral part of the loan agreement without which petitioner could not have obtained the loan. The fair market value of the 24,050 shares of stock was $ 24,050 at the time of the sale. Petitioner is entitled to amortize the $ 23,550 difference between the fair market value of the stock and the amount paid therefor over the life of the loan as a cost of obtaining the loan. Andrew J. Duncan, Jr. (an 24 officer), for the petitioner.John W. Harris, for the respondent. Drennen, Judge. DRENNEN267 Respondent has determined the following deficiencies in petitioner's corporate income tax:FYE Mar. 31 --Deficiency1973$ 1,85819747,287The following issues 1 are presented for our resolution:(1) Whether petitioner sold discounted stock in connection with a certain loan agreement;(2) If the stock was in fact discounted, does section 1032, I.R.C. 1954, 2 bar a deduction under section 162;(3) Whether petitioner must show its compliance with the terms of section 83(h) in order to claim a deduction in connection with this transaction. FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts together with the exhibits attached thereto are incorporated herein by reference.Petitioner, an Ohio corporation, 25 maintained its principal place of business in Montecito, Calif. Petitioner filed a timely U.S. Corporation Income Tax return for the fiscal year ending March 31, 1973, with the District Director of the Internal Revenue Service at Cincinnati, Ohio. Petitioner filed its U.S. Corporation Income Tax return for the fiscal year ending March 31, 1974, on September 17, 1974. It also filed an amended return for this year on December 16, 1974. Both these returns were filed with the District Director of the Internal Revenue Service at Cincinnati, Ohio.The petitioner's predecessor in interest, Marblcast, Inc. (Marblcast), was formed on February 18, 1969, under the laws of the State of Georgia, and began the manufacture of marble products. The authorized capital stock of the corporation was 1 268 million shares of $ 1 par value stock. At that time, Andrew J. Duncan, Jr. (Duncan), was its sole shareholder and president. 3 In its first year of operation, Marblcast incurred an operating loss of approximately $ 40,000.Dycap, Inc. (Dycap), is a small 26 business investment company (SBIC). Dycap, as are all SBICs, is licensed under the Small Business Investment Act of 1958. It is a privately owned and capitalized company and engages in the business of making high-risk loans to new or financially unsettled corporations. Dycap is regulated by the Small Business Administration (SBA) and is subject to annual examination by the SBA to determine if its regulations are being properly followed.When Dycap determines to make a loan, it typically borrows funds from the SBA. The SBA will loan Dycap $ 3 for every dollar of privately invested capital it raises and will charge a 7 3/8-percent rate of interest on the money loaned. Dycap then loans the funds to other companies at a mutually agreeable rate of interest. However, pursuant to SBA regulations, it may not lend money with an interest rate in excess of 15 percent.Because of this interest limitation and the usually small spread between the interest paid to the SBA and the interest received from its debtor companies, Dycap usually purchased an equity interest in the companies to which it was lending money. Dycap obtained these interests in one of two ways, either by purchasing the stock 27 outright, or by purchasing call options with the striking price set at the time of the making of the loan. Outside of the 15-percent-a-year limit on the amount charged on the outstanding principal, the SBA placed no restrictions on Dycap on the amount of consideration paid for these equity positions, nor did it limit fees charged for obtaining a loan.During 1969, Ballinger, Inc. (Ballinger), an Ohio corporation and a competitor of Marblcast, obtained a loan from Dycap. Incident thereto, Dycap purchased 100 shares of Ballinger preferred stock. This loan was repaid with the life insurance proceeds obtained as a result of the death of Mr. Ballinger, president of Ballinger.In December 1969, it came to Duncan's attention that Ballinger might be for sale. Ballinger was a relatively new 269 company and had a negative net worth since its inception. Marblcast was in need of additional sales accounts. Duncan believed that a purchase of Ballinger, with its existing sales accounts, would be financially expedient and at that time contacted A. Gordon Imhoff (Imhoff), who had been running Ballinger during the period following Mr. Ballinger's death. Imhoff was also a director and general manager 28 of Dycap. Additionally, Imhoff handled all of Dycap's portfolio investments.Duncan was unable to secure financing from conventional lenders with which to complete the purchase of Ballinger. Since without financing there could be no purchase, he then contacted Imhoff about the possibility of obtaining a loan from Dycap. Marblcast supplied Imhoff with information regarding its financial status, history, and makeup of management; additionally, Imhoff requested and was supplied information regarding Duncan's background. Among the documents Imhoff reviewed incident to this loan request was Marblcast's unaudited balance sheet for the period ending December 31, 1969 (Exhibit 14-N), which was as follows: 4270 DECEMBER 31, 1969AssetsCurrent assets:Cash $ 25Accounts receivable -- trade 43,533Employee advances 50Inventories 19,600Prepaid expenses 4,240Total current assets 67,448Fixed assets:Machinery and equipment $ 50,804 Automobiles 3,697 Leasehold improvements 6,704 Office equipment 7,984 Sales equipment 692 Molds 11,405 81,286 Less: accumulated depreciation 8,372 72,914Other assets:Unamorized [sic] organization expense 650 Unamortized pre-production costs 6,620 Deposits 1,300 8,570148,932Liabilities and Stockholders' EquityCurrent liabilities:Notes payable -- banks 45,000Installment notes payable -- current 5,290Accounts payable 32,939Payroll taxes -- withheld and accrued 6,829Overdraft -- checking accounts 168Accrued interest 708Total current liabilities 90,934Long-term liabilities:Installment notes $ 11,915 Less: current portion above 5,290 $ 6,625Other liabilities:Loan payable -- stockholder 4,265Stockholders' equity:Common stock 73,500 Net (loss) -- year to date -- (Exhibit B) (26,392)47,108148,932Prepared without audit.29 271 Although Imhoff found problems with the treatment of certain items on the balance sheet and, therefore, believed Marblcast had a net worth substantially below the $ 47,108 listed therein, he nevertheless agreed to make the loan. The primary reason 30 for granting the loan was Imhoff's confidence in Duncan's management ability and his belief that with additional working capital, Marblcast had a good chance of success. Imhoff's judgment proved correct, for, subsequent to the loan, Marblcast became a profitable company.On March 17, 1970, Dycap entered into a financing agreement with Marblcast and Ballinger which provided, inter alia, for Dycap to agree to loan Marblcast $ 100,000 for the purposes of acquiring 100 percent of Ballinger's common stock and increasing its working capital. A 3-percent loan fee ($ 3,000) was added to the face amount of the loan. The loan bore a 10-percent variable interest rate, whereby it was adjusted semiannually to 1 1/2 percent over the prime rate of the First National City Bank of New York City. The loan had an 8-year term, but it provided for prepayment at the option of Marblcast.In 31 addition to the interest and points, and as a condition to the making of the loan, Marblcast was required to sell to Dycap 20 percent of its outstanding stock for the sum of $ 500. This requirement was spelled out in article 1, section 5 of the financing agreement between Marblcast, Ballinger, and Dycap which provided:Section 5. Subject to the terms and conditions of this Agreement, MARBLCAST agrees to sell to DYCAP and DYCAP agrees to buy from MARBLCAST:20% of the amount of outstanding and subscribed for common stock of MARBLCAST thirty (30) days from the date of this Financing Agreement at a total price of $ 500.00.272 Both parties were represented by counsel throughout the negotiations leading up to the execution of the loan agreement. These negotiations were at arm's length, without collusion between the parties. The consideration paid for the Marblcast stock was set by a committee of Dycap and was not subject to negotiation by Marblcast. The loan and the stock purchase were part of a single integrated transaction and were mutually dependent and interrelated in that one event would not have occurred without the other.Due to additional stock sales by Marblcast, as will be hereinafter 32 discussed, the 20-percent interest in Marblcast equaled 24,050 shares. These shares were issued 5 to Dycap as fully paid and nonassessable for its $ 500 investment no later than April 16, 1970. The consideration per share was approximately $ 0.02.Previous to the consummation of the financing agreement, Duncan had been informed by his attorney that under the Georgia Blue Sky Laws, stock could not be issued for less than par value. Duncan considered the transaction to be a purchase by Dycap of 24,050 shares for $ 24,050, consisting of a cash payment of $ 500 and a constructive loan fee of $ 23,550.When Marblcast borrowed money from two Atlanta banks sometime prior to the negotiations with Dycap, Duncan was required to convert his $ 60,000 loan to Marblcast into 60,000 shares of stock.The net proceeds from the Dycap loan were dispersed as follows: (1) $ 36,000 was used to purchase a 100-percent interest in Ballinger; (2) $ 40,000 was used to retire a short-term note 33 payable in favor of the First National Bank of Atlanta, Ga.; and (3) the remaining $ 24,000 was used to provide Marblcast with working capital.Immediately after this transaction, Ballinger became a wholly owned subsidiary of Marblcast.During the loan negotiations, it was suggested by Imhoff that outside capital should be raised by Marblcast. Imhoff approached three associates who agreed that Marblcast might be a good investment. Duncan was also successful in interesting an associate of his to invest in Marblcast. Within 3 weeks of the 273 March 17, 1970, financing agreement, Marblcast entered into subscription agreements with the following individuals in the following amounts:William Randall4,000 sharesJ. L. Fitzgerald6 10,000 sharesHenry Egner1,000 sharesAndrew Baur2,500 shares The consideration to be paid by these individuals for the Marblcast stock was $ 1 per share, or approximately 50 times the amount that Dycap paid for its interest in Marblcast.All of these individuals knew all relevant facts about the financial condition of Marblcast and 34 could be termed sophisticated investors. Randall is an attorney and was president of Dycap. Egner was Dycap's largest shareholder, and Fitzgerald, a director of Dycap, was acting for himself and as trustee for the attorney of the Ballinger family. Baur was formerly a loan officer at the First National Bank of Atlanta, Ga. (the bank at which Marblcast had previously obtained financing).The subscription agreements, with the exception of Baur's, 7 were subject to the following conditions:(1) Consummation of the $ 103,000 loan by Dycap to Marblcast; (2) acquisition of all the Ballinger stock by Marblcast; and (3) qualification of the subscription and/or the shares to be issued pursuant to the applicable Blue Sky Laws. All four individuals actually purchased the stock in Marblcast after the Dycap loan had been consummated. Randall, Fitzgerald, and Egner invested in Marblcast solely due to Dycap's loan to Marblcast.Pursuant to the Dycap loan agreement, Marblcast was obligated to hire an independent accountant suitable to Dycap. Marblcast retained the certified public accountant firm 35 of Arthur Young & Co., which prepared Marblcast's financial statements for the taxable periods immediately following Dycap's loan. No deferred loan costs were reflected on Marblcast's balance sheet submitted to Dycap for the period ending September 30, 1970, or on the consolidated balance sheet for Marblcast 274 and Ballinger for the period ending March 31, 1971. Additionally, there was no indication in the minutes of the special meeting of Marblcast's board of directors, dated March 16, 1970, that Marblcast would sell 20 percent of its outstanding stock at a discount.In 1973, Marblcast obtained a loan from the SBA in the amount of $ 180,000 for the purpose of new construction. Also in 1973, Marblcast repaid the Dycap loan.In 1974, both Marblcast and Ballinger were dissolved and the assets of both these corporations were transferred to a newly formed Ohio corporation, Duncan Industries, the petitioner herein. Dycap received 500 shares of Duncan Industries for its interest in Marblcast. These shares were repurchased by Duncan Industries for $ 48,100 in 1974, which is approximately 96 times greater than Dycap's original investment.On its tax returns for the taxable periods subsequent 36 to the acquisition of the loan, petitioner took the position that the shares purchased by Dycap were issued at a discount, the fair market value of the stock being $ 1 per share. It amortized the amount of the discount ($ 24,050 minus $ 500 = $ 23,550) over the 8-year term of the loan. For the taxable year ending March 31, 1974, the year in which petitioner paid the Dycap loan, it claimed a "loss on early extinguishment of debt" in the amount of $ 13,002. This figure represented the unamortized portion of the claimed loan costs.Respondent has disallowed the deduction, inter alia, on the basis that this loan cost was not actually incurred, stating the fair market value of the stock at the time of Dycap's purchase was not in excess of the $ 500 received.ULTIMATE FINDING OF FACTThe fair market value of the Marblcast stock at the time of the sale to Dycap was $ 1 per share or $ 24,050.OPINIONWe must determine the fair market value of the 24,050 shares of Marblcast sold to Dycap pursuant to the financing agreement entered into by the respective parties. Petitioner contends the value on that date was $ 24,050 ($ 1 per share). Respondent asserts the value was $ 500 ($ 0.02 per share).The 37 issue is before us due to respondent's disallowance of 275 petitioner's amortization of the "loan fee" which petitioner contends Marblcast paid to Dycap in the form of a discount sale of Marblcast's stock. Respondent contends that petitioner has failed to establish that these costs were actually incurred, it being his position that the consideration paid by Dycap for the Marblcast stock equaled its fair market value at the time of sale.Commissions and fees paid to obtain a loan are capital expenditures and may be ratably deducted 839 over the life of the loan. Detroit Consolidated Theatres, Inc. v. Commissioner, 133 F.2d 200">133 F.2d 200 (6th Cir. 1942). 9 In order to prevail, petitioner has the burden of showing that these costs were actually incurred in the form of a discount sale of stock to Dycap in connection with the acquisition of the loan. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. If the transaction was simply a sale of stock for less than par, this would affect only the capital structure of petitioner and would not affect its operating income, so no deduction would be available either as a current business expense, or as a loss, or 38 as an amortization deduction. On the other hand, if the stock was sold to Dycap at a discount in lieu of a fee for making the loan, any discount from fair market value would be a business expenditure. Emerson Electric Manufacturing Co. v. Commissioner, 3 B.T.A. 932">3 B.T.A. 932 (1926).Initially, there is no question that the stock sale was not a separate and distinct transaction from the loan. Respondent's witness, Imhoff, Dycap's general manager at the time, expressly stated on numerous occasions during the trial that Dycap would not have advanced Marblcast any funds without being afforded the opportunity to acquire an equity position in Marblcast. Dycap did not charge the maximum interest rate it could charge under SBA regulations; instead, it acquired a 20-percent stock 276 interest in petitioner for a very small investment which, if petitioner was successful, would pay it a handsome rate of return on the loan, which it did, presumably as capital gain. We believe this arrangement was designed by Dycap and was insisted on in lieu of a cash fee for making the loan. Certainly, petitioner would not have sold 20 percent of its stock for $ 500 if its sole purpose was to raise capital. It simultaneously acquired $ 17,500 additional capital by selling 17,500 shares of its stock to four individual investors for $ 1 per share.We therefore find that the stock sale and obtention 40 of the loan were mutually dependent on each other and that if any discount was involved, such discount was an additional cost of the loan.Next, we turn to the question of whether there was in fact a discount involved on this sale. To resolve this issue, we must determine the value of the stock on the date of sale. 1041 The question of "valuation of stock for tax purposes is a matter of 'pure fact.'" Hamm v. Commissioner, 325 F.2d 934">325 F.2d 934, 938 (8th Cir. 1963), affg. a Memorandum Opinion of this Court. In general, this question requires a determination of "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." Sec. 20.2031-1(b), Estate Tax Regs.; United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 551 (1973); see also Estate of McNary v. Commissioner, 467">47 T.C. 467 (1967).In determining the value of unlisted stocks, actual sales made in reasonable amounts at arm's length, in the normal course of business within a reasonable time before or after the valuation date are the best criteria of market value. Fitts' Estate v. Commissioner, 237 F.2d 729">237 F.2d 729 (8th Cir. 1956).In efforts to comport with this standard, both petitioner and respondent offer as evidence sales of Marblcast's stock. Respondent offers the sale to Dycap at $ 0.02 a share in support of his determination. Petitioner offers the sales to the individual investors at $ 1 a share to prove the same. We feel the sales to the individual investors more clearly reflect the true value of the 277 stock sold to Dycap and we, therefore, hold the petitioner has carried his burden of proof.The respondent's reliance on the sale between Marblcast and Dycap as setting the market value of the stock is not justified, for, while it is true that both parties were represented by counsel and the negotiations were at arm's length, respondent overlooks the fact that Marblcast was compelled to enter the transaction.Although in a normal situation the purchase price of the 42 property changing hands between two unrelated parties would be highly reflective of fair market value ( Grill v. United States, 157 Ct. Cl. 804">157 Ct. Cl. 804, 303 F.2d 922">303 F.2d 922, 927 (1962)), this is not the case before us.On the facts before us, we observe that Marblcast, a financially troubled corporation, desired to purchase Ballinger to obtain badly needed sales accounts. Marblcast believed that the purchase of Ballinger would greatly improve its financial outlook and that is what in fact happened. Marblcast approached conventional lending institutions about the possibility of financing this purchase but met with no success. It was under these circumstances that Marblcast approached Dycap to finance the purchase of Ballinger. Dycap agreed to make the loan, but on the condition that it be allowed to purchase 20 percent of Marblcast's stock for $ 500. This price was determined by a committee of Dycap, and we do not believe it was open to negotiation. In essence, it was a "take it or leave it" proposition. Faced with the proposition of forgoing the Ballinger purchase, we feel that Marblcast had no choice but to assent to the sale. This hardly presents the situation of a willing seller under no 43 compulsion. It is more akin to a forced sale which the regulations admonish us not to consider. See sec. 20.2031-1(b), Estate Tax Regs. "The fair market value of * * * property * * * is not to be determined by a forced sales price." See also Heiner v. Crosby, 24 F.2d 191">24 F.2d 191 (3d Cir. 1928). This element of compulsion precludes a determination of value by reference to that sale. Palmer v. Commissioner, 62 T.C. 684">62 T.C. 684 (1974), affd. 523 F.2d 1308">523 F.2d 1308 (8th Cir. 1975).Far more persuasive of the value of the stock sold to Dycap is the sales price of the shares sold to Randall, Fitzgerald, Egner, and Baur. These sales occurred relatively close in time to the 278 Dycap sale so as to accurately reflect the market conditions existing on the date of the Dycap sale. 11 Cf. Fitts' Estate v. Commissioner, supra. Moreover, these sales lacked the element of compulsion on the part of the parties that is fatal to the consideration of the Dycap sale. When looking to the position 44 of the parties relative to these sales, we find a totally different picture. The motive behind these sales was the desire on the part of Marblcast to raise additional capital. Although it was advantageous for Marblcast to procure additional capital, in no sense was this necessary, nor was it compelled to do so. Additionally, the evidence lends itself to the conclusion that these parties entered into the transaction with complete knowledge of all the facts relative to the financial condition of Marblcast and Ballinger. Randall, Fitzgerald, and Egner were all directors of Dycap. They possessed at that time all the financial information supplied by Marblcast to Dycap. Additionally, since Dycap was also a shareholder of Ballinger, we assume that they were familiar with the financial picture of that company. Moreover, respondent's witness affirmatively stated that Randall and Egner could be termed sophisticated investors. We are also prepared to assume that Baur was relatively informed about the condition of Marblcast since he had previously been involved in a lending transaction with it.Although we recognize that isolated sales are not determinative of fair market value in face 45 of evidence to the contrary, no such evidence has been introduced, and we are persuaded that these sales are indicative of the fair market value of the stock on the relevant date. The fact that Duncan agreed to accept 60,000 shares of stock in payment of his loan of $ 60,000 to Marblcast also lends support to this conclusion.Respondent contends that the price paid by the individual investors is not a true indicator of the value of the shares on the relevant date for the following reasons: (1) The subscription agreements were conditioned on the consummation of the loan agreement and the purchase of Ballinger; (2) the infusion of capital substantially improved the net worth of Marblcast and, therefore, the value of the shares sold to the individual investors; and (3) the net worth of Marblcast was substantially 279 below the $ 47,000 figure listed on the balance sheet submitted to Dycap. 12 In disposing of respondent's first two contentions, we note that respondent has failed to consider that the sale to Dycap was also contingent 46 on the completion of the loan agreement and the purchase of Ballinger. Since we have found as a fact that the loan and the sale were part of a single integrated transaction, we find that whatever increment in value resulted from the obtention of the loan existed on the date of the sale to Dycap as well as on the dates of the sales to the individuals. We find this not because the loan and sales were made in any temporal order but because all sales were made in contemplation of the loan. We also note in passing that to accept respondent's position would require us to hold that the infusion of $ 100,000 capital, although accompanied by an offsetting liability, increased the value of Marblcast 50 times in a period of less than 30 days. This we simply cannot do.To support his third contention, respondent offered the testimony of one witness, A. Gordon Imhoff. Imhoff is currently Dycap's president and was the individual most responsible for negotiating the loan. In addition to his duties at Dycap, Imhoff is also a registered representative with the New York Stock Exchange and has worked in the financial and security fields since 1946.In analyzing the Marblcast balance sheet for the 47 period ending December 31, 1969, Imhoff found problems with the treatment of the following items: (1) Inventories, (2) molds, and (3) unamortized preproduction and organizational expenditures. Without going into Imhoff's testimony on this matter, it will suffice to say that he testified that the inclusion of these items as assets resulted in an inaccurate picture of the true net worth of Marblcast, but he did not indicate by how much.While the value of the assets is not ordinarily relied on to determine fair market value of stock of a small closely held operating corporation ( Palmer v. Commissioner, supra at 699; Weber v. Rasquin, 101 F.2d 62">101 F.2d 62, 64 (2d Cir. 1939)), reference may 280 be made to asset value or book value to justify a conclusion as to fair market value based on other factors. 13 Even if the inventories, molds, and unamortized expenses referred to by Imhoff were eliminated entirely from the assets listed on the December 31, 1969, balance sheet, the stockholders' equity would still be about $ 10,000 or $ 1 per share on the 10,000 shares outstanding. And an examination of the March 31, 1970, balance sheet, which we have set out in a footnote and which appears to be revised 48 somewhat along the lines of Imhoff's objections, reveals that the 10,000 shares of stock outstanding had a book value of $ 2.41 per share.Another factor which we found to be compelling in our determination that the fair market value of Marblcast may have been even in excess of the value shown on the balance sheets is the excellent management capability of Duncan which Imhoff indicated was one of the primary reasons for his approval of the loan. See Estate of Vandenhoeck v. Commissioner, 4 T.C. 125">4 T.C. 125, 127 (1944). It appears that Imhoff's reliance on Duncan's competence was well justified because within 4 years Dycap was able to liquidate its investment in the stock for approximately $ 48,100, a profit exceeding 96 times its original investment.Imhoff's testimony suggests that the stock acquisition by Dycap came first and that Dycap felt it was paying fair value for the stock. 14 Imhoff readily admits, however, that Dycap would not have bought the stock unless the loan was also consummated, and a closer analysis 49 of his testimony convinces us that Dycap gave little consideration to the actual value of the stock -- it simply insisted on receiving a 20-percent equity interest in Marblcast for as little investment as possible. This was a condition and consideration for making the loan without an additional front-end fee. What an SBIC is willing to pay for an equity interest in a borrower is not a very reliable measure of the value of that interest. The increment in value of the equity investment is often the only way the SBIC will make a reasonable profit on the loan. 15281 Respondent also argues that there was an absence of intent on the part of Marblcast to sell stock at a discount. While intent of the parties is a factor in determining the ultimate 50 deductibility of certain expenditures (see Aspegren v. Commissioner, 51 T.C. 945 (1969); Gardner-Denver Co. v. Commissioner, 75 F.2d 38">75 F.2d 38 (7th Cir. 1935), cert. denied 295 U.S. 763">295 U.S. 763 (1935)), it is not a factor that is helpful or determinative of fair market value. However, possibly because of the Blue Sky Law which prohibited a sale of stock for less than par value, petitioner does not claim that it sold the stock to Dycap at a discount. Rather, it claims that it sold the stock for $ 24,050 and that the difference between the amount actually paid by Dycap and $ 24,050 was payment by petitioner of a loan fee. Moreover, the fact that petitioner was simultaneously selling its stock to four individuals at par 16 indicates that petitioner was intentionally transferring the stock to Dycap for less than what it considered to be fair market value.We have considered respondent's other arguments and find them equally unpersuasive that the sales to the individual investors are not the best evidence of the fair market value of the Marblcast stock on the facts before us. Accordingly, 51 we find that the fair market value of the Marblcast stock sold to Dycap was $ 24,050 ($ 1 per share).Respondent next contends that the nonrecognition provisions of section 1032 apply to disallow petitioner's amortization deduction. Section 1032 provides that a corporation shall not recognize gain nor loss "on the receipt of money or other property in exchange for stock (including treasury stock) of such corporation." It appears to be respondent's position that the sale for $ 500 between Marblcast and Dycap involved no more than a readjustment of Marblcast's capital structure. Implicit in respondent's argument is the conclusion that there has been no expenditure of the $ 23,550 that Marblcast seeks to amortize.We do not agree with respondent and for reasons set forth below, hold that section 1032 has no application to the transaction in issue.Section 1032 was originally enacted by the 1954 Code. It has no counterpart in the 1939 Code. The purpose of its enactment 282 was to remove the uncertainties that existed under current law. H. Rept. 1337, 83d Cong., 2d Sess. 268; S. Rept. 1622, 83d Cong., 2d Sess. 426.Before 1954, the regulations generally provided that a corporation realized 52 no gain or loss on the original issuance of its stock. When, however, a corporation dealt in its treasury stock as it might in the shares of another corporation, gain or loss would be recognized.Whether a corporation was dealing in its own shares as it might in the shares of another corporation depended upon the real nature of the transaction, as ascertained from all its facts and circumstances. Sec. 29.22(a)-15, Regs. 111. See also Commissioner v. S. A. Woods Mach. Co., 57 F.2d 635">57 F.2d 635 (1st Cir. 1932).Divergent views as to the circumstances in which a corporation would recognize gain or loss on the sale of its treasury stock developed. Some courts read the regulation mechanically and held that whenever a corporation acquired its own shares for the purpose of reselling them, and did resell them, then the gain was taxable regardless of motive. Commissioner v. H. W. Porter & Co., 187 F.2d 939 (3d Cir. 1951), revg. 14 T.C. 307">14 T.C. 307 (1950). See also Commissioner v. Batten, Barton, D. & O., 171 F.2d 474">171 F.2d 474 (2d Cir. 1948), revg. 9 T.C. 448">9 T.C. 448 (1947); Commissioner v. Rollins Burdick Hunter Co., 174 F.2d 698 (7th Cir. 1949), revg. 9 T.C. 169">9 T.C. 169 (1947); Commissioner v. Landers Corp., 210 F.2d 188">210 F.2d 188 (6th Cir. 1954), 53 revg. a Memorandum Opinion of this Court.Originally, this Court and the Court of Claims did not follow this reasoning and held that for the gain to be taxable, the purchase and sale must have been made with a profit or investment motive. H. W. Porter & Co. v. Commissioner, 14 T.C. 307 (1950), revd. 187 F.2d 939">187 F.2d 939 (3d Cir. 1951); Dr. Pepper Bottling Co. of Miss. v. Commissioner, 1 T.C. 80 (1943); Anderson Clayton & Co. v. United States, 129 Ct. Cl. 295">129 Ct. Cl. 295, 122 F. Supp. 837">122 F. Supp. 837 (1954), affd. 350 U.S. 55">350 U.S. 55 (1955). But see Burrus Mills, Inc. v. Commissioner, 22 T.C. 881 (1954).Although it is not completely clear from the legislative history, we believe that it was this conflict in the above-cited cases that created the uncertainty in the law that section 1032 was enacted to remedy. It was intended to give uniform treatment to the taxability of consideration received as the subscription price for corporate stock. This is not the issue before 283 us, for in none of the above-cited cases does it appear that the sales in question were for anything other than fair value.As to the situation before us, we do not feel that section 1032 altered the existing law as to the tax consequences accruing to a corporation 54 when it pays an otherwise deductible expense by issuance of its own stock. Before 1954, the law was well settled that the fair market value of stock was deductible as a business expense if the payment of cash would have otherwise given rise to such deduction. Haskell & Barker Car Co. v. Commissioner, 9 B.T.A. 1087">9 B.T.A. 1087 (1928); W. M. Ritter Lumber Co. v. Commissioner, 30 B.T.A. 231 (1934); Alger-Sullivan Lumber Co. v. Commissioner, 57 F.2d 3">57 F.2d 3 (5th Cir. 1932); National Bellas Hess, Inc. v. Commissioner, 20 T.C. 636">20 T.C. 636 (1953), affd. on other issues 220 F.2d 415">220 F.2d 415 (8th Cir. 1955); Hercules Powder Co. v. United States, 149 Ct. Cl. 77">149 Ct. Cl. 77, 180 F. Supp. 363">180 F. Supp. 363 (1960). And this was so even though no gain (or loss) was recognized on the resale of the treasury stock. Hercules Powder Co. v. United States, supra.Additionally, the Commissioner has appeared to adopt this position in Rev. Rul. 62-217, 2 C.B. 59">1962-2 C.B. 59; Rev. Rul. 69-75, 1 C.B. 52">1969-1 C.B. 52. In these rulings the Commissioner held the fair market value of stock (either treasury or unissued) is deductible as a business expense when paid as compensation. These rulings further held that the nonrecognition provisions of section 1032(a) have no effect on a business 55 expense deduction otherwise allowable under section 162. Implicit in these determinations is the view, which we hold is correct, that section 1032 did not alter existing law on the issue. See also Hollywood Baseball Association v. Commissioner, 42 T.C. 234">42 T.C. 234 (1964), affd. on other issues 352 F.2d 350">352 F.2d 350 (9th Cir. 1965), allowing amortization of organizational expenditures paid with the corporation's stock. See also B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 3.13, pp. 3-53, 54 (4th ed. 1979).We find this situation to be no different than if petitioner had sold 24,050 shares of stock to third parties and had used the proceeds of the sale to pay Dycap its loan fee. We therefore find that petitioner has actually incurred a deductible expenditure. To hold otherwise would exhalt form over substance. See also Hudson Motor Car Co. v. United States, 78 Ct. Cl. 117">78 Ct. Cl. 117, 3 F. Supp. 834">3 F. Supp. 834, 846 (1933), where the court noted: "if the additional compensation had been paid in cash and the cash had been used 284 to acquire the stock, no question * * could have been raised as to its deductibility."Respondent's reliance on McCoy-Garten Realty Co. v. Commissioner, 14 B.T.A. 853">14 B.T.A. 853 (1928), 56 and Carter Hotel Co. v. Commissioner, 642">67 F.2d 642 (4th Cir. 1933), is misplaced.In McCoy-Garten Realty Co., the principal issue was whether the preferred stock actually represented stock or debt, and the reason for the conclusion that the discount on the sale of the preferred stock could not be amortized was apparently that it was sold to raise capital rather than pay an expense. Also, there was no evidence as to whether the taxpayer's stock had been sold below market value, as we find here. The facts in Carter Hotel present a pure original issuance of stock, below par, to raise capital. No contention in that case was made that the taxpayer was actually paying an otherwise deductible expense.Accordingly, we hold that section 1032 has no application to the transaction in issue.Finally, respondent argues the petitioner has not established its entitlement to a deduction under the provisions of section 83. 1757 58 While we agree with respondent, we fail to see how this helps his position.Section 83(a) applies generally to establish the tax consequences attaching to a situation where restricted property 285 (including stock) is transferred in connection with the performance of services. Section 83(h) expressly allows the person for whom the services were performed to deduct an amount equal to the amount includable in the service performer's income under section 83(a). It further provides for the year in which the deduction must be claimed. Respondent takes the position that since no services were performed by Dycap in connection with the transfer of the Marblcast stock, the expense is, therefore, not deductible.It appears that respondent reads section 83(h) as a substantive deduction-granting section with which taxpayers 59 transferring stock must show compliance before being entitled to a claimed deduction. Respondent's interpretation of that section is clearly incorrect. Section 83(h) is a modification of section 162 which only affects the time and amount of deductions otherwise allowable, when property is transferred in connection with services. Compliance with the requirements of section 83(h) is not necessary to entitlement of a deduction unless the transaction in issue falls within its intended scope.It is conceded that no services were provided by Dycap in consideration for the transfer of the Marblcast stock. Section 83 is expressly applicable only when services are performed in consideration for transfers of property. Since section 83 is not applicable to the facts in issue, section 83(h) poses no additional independent requirement to the deductibility of the expenditure in question.We conclude that respondent was in error in disallowing the amortization deductions claimed by petitioner.Because of petitioner's concession on another issue,Decision will be entered under Rule 155. Footnotes1. Due to a concession by petitioner on an issue involving depreciation on a certain building, decision under Rule 155, Tax Court Rules of Practice and Procedure↩, will be necessary if petitioner ultimately prevails.2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years at issue, unless otherwise specified.↩3. Duncan originally paid $ 10,000 for 10,000 shares of the stock. Subsequently, he converted a $ 60,000 loan to Marblcast into 60,000 shares of stock.↩4. While it is not clear whether Imhoff received it, there is attached to Exhibit 14-N a proforma balance sheet for Marblcast, Inc., as of Mar. 31, 1970, which is as follows:↩MARCH 31, 1970AssetsCurrent assets:Cash $ 5,713Accounts receivable 65,433Inventories: Finished goods $ 8,382Materials 13,75022,132Prepaid expenses 69Total current assets 93,347Fixed assets:Machinery and equipment 61,864Furniture and fixtures 2,317Automobile and trailer 4,887Leasehold improvements 2,93772,005Less: accumulated depreciation 8,19363,812Other assets:Unamortized pre-production charges 2,772Unamortized organization expense 857Deposits 5754,204161,363LiabilitiesCurrent liabilities:Notes payable -- bank $ 60,000Installment note payable 681Accounts payable 15,221Payroll taxes withheld and accrued 1,296Total current liabilities 77,198Long-term debt:Note payable -- stockholder 60,000Stockholders' equity:Common stock $ 10,000Retained earnings 14,16524,165161,3635. The record does not indicate if these shares were held by Marblcast as treasury stock. Since Duncan testified that there had never been a redemption, we will assume that the shares transferred had been previously unissued.↩6. Five thousand shares purchased in Fitzgerald's name were held by him as trustee for a Mr. Grigsby, the attorney for the Ballinger family.↩7. No evidence was offered by either party as to the nature of the agreement between Marblcast and Baur.↩8. No issue has been raised that the transaction was a mere bargain purchase with no tax consequences accruing to it. See Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63 (1937); Aspegren v. Commissioner, 51 T.C. 945 (1969); Gardner-Denver Co. v. Commissioner, 75 F.2d 38">75 F.2d 38 (7th Cir. 1935), cert. denied 295 U.S. 763">295 U.S. 763 (1935).Additionally, though respondent makes the assertion on brief that the expense in question was not ordinary and necessary, he appears to abandon that contention as he makes no argument to support it. We note, however, that even if respondent is correct in his contention, the expenditures in question would properly be amortizable as being in the nature of interest, unless otherwise disallowed by another provision of the Code. See Wilkerson v. Commissioner, 70 T.C. 240">70 T.C. 240 (1978); Lay v. Commissioner, 69 T.C. 421 (1977).Also, neither party discussed the possible applicability of secs. 1.163-4(a) and 1.1232-3(b)(2)(ii), Income Tax Regs., to this transaction, so we have not considered it.9. See also Rev. Rul. 75-172, 1 C.B. 145">1975-1 C.B. 145↩.10. No evidence was presented to establish the exact date of sale. Art. 1, sec. 5 of the Mar. 17, 1970, financing agreement provided for the sale to occur within 30 days of the above date. Since the parties have stipulated that the stock was actually paid for and received, we find that the sale occurred no later than Apr. 16, 1970.11. We have found that the sale to Dycap occurred before Apr. 16, 1970; the evidence established that Randall, Fitzgerald, and Egner purchased their shares before that date, and that Baur purchased his interest no later than Apr. 21, 1970.↩12. Of course, if there were only 10,000 shares outstanding at the time, which we believe to be the fact, the book value of those shares would be $ 4.70 per share.↩13. Here, Marblcast had been in existence for such a short time that capitalization of earnings and other factors that are usually considered in valuing stock would not be reliable.↩14. We note that it was probably in the best interests of Dycap, taxwise, as well, to keep the fair market value of petitioner's stock low. Imhoff was president of Dycap at the time he testified.↩15. In fact, the testimony at trial indicated that, due to a drop in the prime rate, Marblcast at one point was paying less interest to Dycap than the 7 3/8 percent which Dycap was paying the SBA on the money that it had to borrow in order to make the loan.↩16. By emphasizing this fact, we do not imply that the par value of the shares influenced our determination of value.↩17. SEC. 83. PROPERTY TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES.(a) General Rule. -- If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of -- (1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over(2) the amount (if any) paid for such property,shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. The preceding sentence shall not apply if such person sells or otherwise disposes of such property in an arm's length transaction before his rights in such property become transferable or not subject to a substantial risk of forfeiture. * * *(h) Deduction by Employer. -- In the case of a transfer of property to which this section applies or a cancellation of a restriction described in subsection (d), there shall be allowed as a deduction under section 162, to the person for whom were performed the services in connection with which such property was transferred, an amount equal to the amount included under subsection (a), (b), or (d)(2) in the gross income of the person who performed such services. Such deduction shall be allowed for the taxable year of such person in which or with which ends the taxable year in which such amount is included in the gross income of the person who performed such services.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622704/	Robert M. Brittingham, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentBrittingham v. CommissionerDocket Nos. 6626-71, 6627-71, 6631-71, 7774-71, 7810-71United States Tax Court66 T.C. 373; 1976 U.S. Tax Ct. LEXIS 98; June 3, 1976, Filed 98 Decisions will be entered under Rule 155. Two brothers, Robert and Juan (together with their immediate families), each owned a 37-percent interest in D, a Texas corporation. D purchased tile from C, a Mexican corporation, for resale in the United States. Juan and his family owned and controlled C. The price D paid for such tile was substantially higher than the customs value as determined by the U.S. Bureau of Customs. Held: (1) D and C were not owned or controlled by the same interests within the meaning of sec. 482, I.R.C. 1954; (2) D paid an arm's-length price for the tile purchased from C; (3) no part of the payments by D for such tile was dividend income to Juan or Robert; (4) no fraud penalty applicable; (5) Juan received a constructive dividend as a result of a bargain sale by D to his son-in-law; (6) Juan failed to file true and accurate returns within the meaning of sec. 874(a), I.R.C. 1954, resulting in the disallowance of his claimed deductions and certain credits; (7) residence of Roberta determined; and (8) failure to file penalty approved with respect to Roberta. Ethan B. Stroud, Robert W. Ryan, Jr., L. Vance Stanton, Cameron Dee Sewell, and Michael D. Cropper, 99 for the petitioners.John B. Turner and John W. Dierker, for the respondent. Simpson, Judge. SIMPSON374 In his notices of deficiency, the Commissioner determined the following deficiencies in, and additions to, the petitioners' income tax:Sec. 6653(b) 2100 Sec. 6651(a)PetitionerYearDeficiencyadditionadditionRobert M. Brittingham andJeanne G. Brittingham 31963$ 854,814.71$ 427,407.361964760,754.31380,377.161965739,626.48369,813.241966685,911.03342,955.52Dal las Ceramic Co.1963392,080.75196,040.381964346,842.59173,421.301965369,259.17184,629.59Juan R. Brittingham19632,180,403.871,090,279.5219641,433,215.49716,607.7519651,138,884.01569,442.011966864,952.67432,476.34Roberta M. Brittingham19604,174.00$ 1,043.50196119,589.344,897.34196270,603.5317,650.881963337,691.7484,422.941964100,279.9225,069.98196590,505.2022,626.301966102,065.1325,516.28 In an amendment to his answer in the case of Roberta M. Brittingham, the Commissioner redetermined the deficiencies in, and additions to, tax as follows:AmendedAmended sec. 6651(a)Yeardeficiencyaddition1960$ 82,096.39$ 20,524.10196196,972.6024,243.151962213,737.2753,434.321963563,734.34140,933.591964259,189.1064,797.281965187,168.3246,792.081966217,372.6054,343.15375 Some of the issues have been settled and the issues remaining for decision are: (1) Whether the petitioner, Dallas Ceramic Co., and Ceramica Regiomontana, S.A., were "owned or controlled directly or indirectly by the same interests" within the meaning of section 482 and whether Dallas Ceramic Co. paid an arm's-length price for the ceramic tile it purchased from Ceramica Regiomontana, S.A.; (2) whether the fraud penalty is applicable with respect to Dallas Ceramic Co. during the years in issue; (3) whether Robert M. and Jeanne G. Brittingham received unreported taxable income as a result of certain checks issued by Dallas Ceramic Co. to Ceramica Regiomontana, S.A., and whether the fraud penalty is applicable to them for the years in issue; (4) whether Juan R. Brittingham received unreported taxable income as a result of certain checks issued by Dallas Ceramic Co. to 101 Ceramica Regiomontana, S.A.; (5) whether Juan R. Brittingham filed true and accurate returns for the years in issue within the meaning of section 874(a); (6) whether Juan R. Brittingham received a constructive dividend as a result of the sale of property by Dallas Ceramic Co. to his son-in-law in 1963; (7) whether the fraud penalty is applicable to Juan R. Brittingham for the years in issue; and (8) whether Roberta M. Brittingham was a resident alien during the years 1960 through 1966, and whether her failure to file returns for such years was due to reasonable cause.FINDINGS OF FACTSome of the facts have been stipulated, and those facts are so found.The petitioners Robert M. Brittingham and Jeanne G. Brittingham lived in Dallas, Tex., at the time of filing their petitions in this case. During the years 1963 through 1966, they were husband and wife and timely filed their joint Federal income tax returns with the District Director of Internal Revenue, Dallas, Tex. Robert M. Brittingham will sometimes be referred to as Robert.The petitioner Juan R. Brittingham was a citizen and resident of the Republic of Mexico, whose address at the time of filing his petition herein was Monterrey, 102 Mexico. He timely filed his Federal nonresident alien income tax returns for the years 1963 through 1966 with the Director of International Operations, 376 Washington, D.C. Juan R. Brittingham is the brother of Robert and will sometimes be referred to as Juan.The petitioner Roberta M. Brittingham is a citizen of the Republic of Mexico, whose address at the time of filing her petition herein was Monterrey, Mexico. She filed no U.S. Federal income tax returns for the years 1960 through 1966. Roberta M. Brittingham is the mother of Robert and Juan and will sometimes be referred to as Roberta.The petitioner Dallas Ceramic Co. (Dallas Ceramic) was incorporated in 1947 under the laws of Texas and had its principal place of business in Dallas, Tex., at the time of filing its petition herein. It filed its Federal corporate income tax returns for the years 1963 through 1965 with the District Director of Internal Revenue, Dallas, Tex.Description of Dallas Ceramic and the Tile IndustryUpon its incorporation, the principal organizers of Dallas Ceramic were Robert, Juan, Richard Evans, and Jack E. Jenkins. Robert, together with his immediate family, and Juan, together with his immediate family, 103 have each owned an equal amount of Dallas Ceramic's stock since its incorporation.When it was first organized, Dallas Ceramic was engaged only in manufacturing ceramic wall and floor tile, which was sold through its own stores and through its distributors. However, it soon began buying tile and related products from other suppliers and selling the purchased products in addition to its own products. During the years 1963 through 1966, it had about 300 employees and had average annual sales of approximately $ 8 million. In volume of sales, it ranked approximately fifth among all companies manufacturing and selling ceramic tile in the United States during this period. Its products were sold nationwide except in the far eastern part of the United States and the Central Atlantic States.The ceramic tile manufactured by Dallas Ceramic is used in residential and apartment bathrooms and kitchens, commercial buildings, hospitals, airports, schools, and hotels. The tile's brand name is Dal-Tile, and it is manufactured in many shapes and sizes and with various finishes. Such tile is produced in 31 bright colors, 29 crystalline colors, and 10 satin matte colors. The most widely used size of 104 tile is a flat piece, 4 1/4 inches square (4 1/4-inch tile), and there are eight of such pieces in a square foot of tile.377 Ceramic tile is made by mixing a "body," consisting of talc and ball clays, and pressing it into different shapes. In a separate procedure, a glaze is made by mixing seven or eight raw materials, melting the mixture, and adding water and a stain. This glaze is sprayed on the pressed tile, which is then put into a kiln and fired at a peak temperature of about 2,000 degrees Fahrenheit. Finally, the completed tile product is allowed to cool and is ready to be sorted and packed.Dallas Ceramic has employees known as sorters, who grade the finished tile, select the standard-grade tile, and generally pack 100 pieces of tile into each box. In 1961, the U.S. Department of Commerce issued voluntary recommended standards for grading tile (American standards). Standard-grade tile has no visible imperfections such as bumps, slivered edges, unglazed edges, cracks, or other imperfections. Second- and third-grade tile have varying degrees of such imperfections. Under the American standards, each box of tile labeled "standard grade" may contain no more than 5-percent second-grade 105 tile and no third grade.In addition to grading the tile based upon visible imperfections, the sorters are also required to make certain that the color of all tile in a box is uniform and that each box is marked with the correct shade number. If the color grading of the tile is not performed properly, its installation will be more expensive since the purchaser will be required to use additional labor to sort the tile.Uniform sizing is also a factor in making and grading tile. The chemical content of the tile is important in insuring uniform sizes. During the "firing" process, the tile body undergoes some shrinkage. By having a uniformly blended "body," the shrinkage will be uniform and can thus be controlled. Uniform sizing is important to the tile purchaser for, if the sizing is not uniform, much more labor will be required to install the tile.Purchases from ProductosIn 1951 and 1954, Dallas Ceramic purchased tile from Productos Ceramicos, S.A. (Productos), a Mexican corporation with its principal place of business in Monterrey, Mexico. The brand name of such tile was Procesa. The quality of the Procesa tile was similar to the quality of the tile which Dallas Ceramic was making 106 at that time, except that different standards were applied to the grading of the Procesa tile. At times, a box of 378 Procesa tile labeled standard included as much as 25-percent second-grade tile and sometimes even some third-grade tile. Productos sold, as standard grade, colored plain-glaze 4 1/4-inch wall tile for 24.96 cents per square foot and colored dura-glaze 4 1/4-inch tile for 28.80 cents per square foot, f.o.b. Monterrey, Mexico, during 1954 and 1955. Since 1954, the costs of manufacturing tile in Mexico have increased. Juan was a founder of Productos in 1944. He owned 19 percent of its stock and was the production manager of its tile plant until 1954, when he sold his stock and left Productos. As production manager, Juan was in charge of production, grading of tile, computing the cost of manufacturing tile, and purchasing raw materials used in manufacturing tile.Formation of Ceramica Regiomontana, S.A.On November 17, 1955, Juan organized Ceramica Regiomontana, S.A. (Ceramica), a Mexican corporation, which began producing tile in December 1955. The shareholders of Ceramica in 1955 through 1966 were Juan, his wife, Maria Christina Brittingham, his mother, Roberta, and three 107 qualifying shareholders, who each owned 1 share. Juan controlled and operated the assets of his mother under a power of attorney.Robert did not assist Juan in the organization of Ceramica's plant in Monterrey, but two Dallas Ceramic employees did go to Monterrey to assist in the plant layout. One employee stayed for 2 weeks; the other employee stayed permanently and was hired as production manager at Ceramica.Ceramica manufactured ceramic glazed wall and floor tile which was exported to the United States and also sold to purchasers in Mexico. It manufactured 4 1/4-inch flat tile, 6- by 6-inch flat tile, 4 1/4-by 8 1/2-inch flat tile, 4 1/4-by 6-inch flat tile, and 4 1/4-inch scored tile. Each of these types of tile was made in 19 bright colors, 19 crystalline colors, 11 jewel colors, 6 faience colors, and 9 marble colors. The flat tile was made in plain glaze, dura glaze, mottle glaze, and in an extensive line of decorative designs. It also manufactured all the trim shapes (approximately 96 different shapes) necessary for the commercial tile market in the United States. The trim shapes complemented each of the various lines and types of tile. Dal-Monte was the trade name of the 108 tile made by Ceramica.379 Purchase of Dal-Monte TileWhen Juan first formed Ceramica, he entered into negotiations with Robert, acting on behalf of Dallas Ceramic, for the sale of Dal-Monte tile to Dallas Ceramic. Dallas Ceramic agreed to purchase Ceramica's tile if it satisfied a number of conditions. Dallas Ceramic required that the tile be uniform in size and shading, that it must be a complete line with all necessary trim pieces, that the Dal-Monte colors match the Dal-Tile colors, and that the tile be graded in accordance with American standards and packed in boxes similar to those used by American manufacturers. In addition, Ceramica was required to use raw materials specified by Dallas Ceramic and maintain, at all times, an inventory of tile equal to 1 1/2 months' production in order to give Dallas Ceramic prompt service on its orders. Dallas Ceramic's orders were to be given preference over all other purchasers. It was also to be granted 180 days' extended credit on its purchases.These conditions were valuable to Dallas Ceramic since they insured that the Dal-Monte tile would be nearly identical to its own Dal-Tile. By requiring that Ceramica use its tile "body" and glaze formulas, 109 Dallas Ceramic insured that the Dal-Monte tile would be uniform in size and shade, making it interchangeable with Dal-Tile to some degree. The requirement that Ceramica produce a complete line of trim pieces enabled Dallas Ceramic to satisfy the most demanding specifications established by architects for construction projects in the United States, thereby enabling it to compete for every type of construction project. The boxes required by Dallas Ceramic were of a higher quality than the boxes used by other Mexican manufacturers and helped insure the safe shipping of the tile. The large inventory requirement allowed Dallas Ceramic to provide excellent service to its customers. Finally, by requiring Ceramica to grade its tile in accordance with American standards, the Dal-Monte tile was able to compete with the best American-made tile.Ceramica agreed to the conditions specified by Dallas Ceramic and entered into an agreement whereby Dallas Ceramic was appointed Ceramica's sole and exclusive distributor in the United States. A price list for the tile was agreed to based upon what each company considered a fair price. The 4 1/4-inch plain-glaze tile was priced at 31.6 cents per square 110 foot, while the 4 1/4-inch 380 dura-glaze tile was priced at 34.6 cents per square foot. 4 These two types of tile were the ones most commonly used. Prices were also set for the other types of tile, including trim pieces. As a result of the excellent quality of the Dal-Monte tile and the conditions required by Dallas Ceramic, Dal-Monte tile had acquired an excellent reputation by 1963. This reputation enabled Dallas Ceramic to sell the tile for much higher prices than other Mexican tile sold in the United States.The conditions required by Dallas Ceramic increased Ceramica's costs of production in comparison with other Mexican manufacturers. The boxes used by Ceramica for packing the tile were more expensive than those used by other Mexican manufacturers. Mexican tile contractors used primarily four basic trim pieces, while American commercial contractors required a much more extensive line of tile; thus, Ceramica was required to purchase over 60 dyes used in making trim pieces, which cost from $ 3,000 to over $ 12,000 each, and which would not have been necessary in manufacturing 111 tile for sale in Mexico. Furthermore, since the Mexican tile contractors did not normally use the numerous trim pieces made by Ceramica, it did not have a ready market for its excess production; consequently, making such a large variety of trim pieces also increased Ceramica's costs of production in relation to other Mexican manufacturers. Another condition which increased Ceramica's relative costs of production was the requirement that it match its colors to those used by Dallas Ceramic; as a result, it manufactured some colors which were not compatible with the colors commonly used in Mexico.Dallas Ceramic purchased the Dal-Monte tile f.o.b. Monterrey, Mexico, with title to the tile passing to Dallas Ceramic in Monterrey. It paid all costs of freight and insurance from Monterrey to the various points of destination and paid all customs duties and brokerage fees incurred by importing the tile into the United States. The tile was normally packed in boxes containing 100 pieces. Each box was stamped with the Dal-Monte trademark, and the trademark also appeared on the reverse side of each piece of tile.During the early 1960's, Japanese manufacturers began selling ceramic tile to 112 American purchasers at very low prices. Such 381 competition caused American manufacturers to lower their prices. As a result, Dallas Ceramic had several talks with Ceramica concerning a reduction in the price of its Dal-Monte tile. In 1962, Ceramica agreed to lower the price of its 4 1/4-inch plain-glaze and dura-glaze tile to 28.8 cents and 31.6 cents per square foot, respectively. Dallas Ceramic paid such prices during the period 1963 through 1966. During such years, the 4 1/4-inch plain-glaze and dura-glaze tile represented between 67 and 70 percent of the tile purchased from Ceramica in terms of volume of pieces and approximately 53 percent of the dollar volume of sales.Dallas Ceramic sold the Dal-Monte tile both through its warehouses and directly to its customers. During the years at issue, approximately 30 percent of the Dal-Monte tile was shipped directly from Monterrey to its customers and was never placed in Dallas Ceramic's warehouses. The tile was sold according to a published price list. The list price of the 4 1/4-inch plain-glaze Dal-Monte tile was 50 cents per square foot, and the list price of the 4 1/4-inch dura-glaze tile was 55.5 cents per square foot. Discounts 113 from the list price were given to certain large volume purchasers, and although these discounts varied, the average discount was 10 percent of list price. The invoice prices of the tile purchased from Ceramica, the net costs of the tile sold, the net receipts from the tile sold, and Dallas Ceramic's gross profits from the sale of the Dal-Monte tile were as follows:YearInvoice pricesNet costsNet receipts 1Gross profits1963$ 2,392,585$ 2,790,107$ 3,527,606$ 737,49919642,253,8142,661,1083,421,085759,97719652,401,9833,027,4173,734,888707,471The evidence in the record does not disclose the portion of Dallas Ceramic's overhead and selling expenses properly allocable to the sale of the Dal-Monte tile so that its net profits from such sales cannot be determined.Method of Payment for Dal-Monte TileDallas Ceramic paid Ceramica for the Dal-Monte tile by issuing two checks each time a group of invoices was paid. Beginning in 1955 and ending in 1962, the practice was to compute the total amount of all the invoices being paid at that 382 time, and two checks were issued -- one in the amount of 65 percent of the total and the other in the amount 114 of 35 percent of the total. Both checks were then mailed to Ceramica in Monterrey, Mexico, in payment for the tile. In September 1962, the percentages of the two checks changed to 60 and 40 percent. The two-check method of payment continued through the years at issue. Dallas Ceramic paid for the Dal-Monte tile in this manner because Ceramica requested that it do so. Both checks were issued to pay Ceramica for the tile it sold to Dallas Ceramic.Dallas Ceramic never attempted to conceal on its books and records the fact that two checks were issued for the payment of the Dal-Monte tile. On March 12, 1958, Robert described the two-check procedure to a customs agent from the U.S. Department of the Treasury, both orally and by letter. The two-check method of payment was readily apparent to the Commissioner's agents when they audited Dallas Ceramic's books.Until July 1963, Ceramica deposited all the checks it received from Dallas Ceramic in its Mexican bank accounts, but beginning in that month, the 40-percent checks were mailed to Ceramica in Monterrey, where they were endorsed and deposited by mail in its account at the Republic National Bank (Republic) in Dallas, Tex. Later, the 115 40-percent checks were mailed directly to Republic for deposit in Ceramica's account.Pursuant to instructions given to Republic by Juan, as director general of Ceramica, whenever the balance of Ceramica's account at Republic exceeded $ 1,000, any excess was to be transferred to account No. 66-351-4 in the name of Juan Brittingham and Angel Marroquin at Republic. Beginning on April 20, 1965, the excess from Ceramica's account was transferred to account No. 80-104-6 in Juan's name at Republic. In addition to Juan, Angel Marroquin and Harold Turk, officers of Ceramica, were authorized to withdraw funds from each of the three accounts at Republic. Personal funds belonging to Juan, his wife, and Roberta were also deposited in account Nos. 66-351-4 and 80-104-6. The money in such accounts was used both by Juan personally and by Ceramica. Ceramica's accountants kept records concerning the interest of each person in the accounts, but no evidence of any formal accounting of the funds was presented to the Court. On two occasions during the years 1963 through 1966, checks issued to Ceramica were deposited directly into Juan's account at Republic, but these deposits were made by mistake 116 and did not 383 reflect a change in the procedure for handling the 40-percent checks.Ownership and Control of Dallas Ceramic and CeramicaDuring the years 1963 through 1966, the shareholders of Dallas Ceramic were as follows:Stock ownedStock ownedPercent of1/1/64-Percent ofShareholder1/1/63ownership12/31/66ownershipRobert5,760165,76016Robert G. Brittingham,son of Robert1,2603.53,78010.5John G. Brittingham,son of Robert1,2603.53,78010.5Juan36013601Maria Christina Brittingham,wife of Juan5,400155,40015Barbara B. de Marroquin,daughter of Juan8402.332,5207Christina B. de Lobeira,daughter of Juan8402.332,5207Roberta Brittingham,daughter of Juan8402.332,5207Albert A. Brittingham,uncle of Robert and Juan3,600103,60010Harry A. Brittingham,uncle of Robert and Juan3,600103,60010Alice Jean Brittingham,daughter of Harry36013601Denise Brittingham,daughter of Harry36013601Elizabeth Brittingham,daughter of Harry36013601Mary Joan Brittingham,daughter of Harry36013601Jack E. Jenkins6,1201700Esperanza B. Mabee,aunt of Robert and Juan1117 720200Nem & Co.007202Edward G. Brittingham,cousin of Robert and Juan1,9805.500Joy B. Snell,cousin of Robert and Juan300.8300Joanne Gail B. Halbert,cousin of Robert and Juan300.8300Jeanne B. McCormick,cousin of Robert and Juan1,3803.8300Total36,00036,000384 Roberta owned no stock in Dallas Ceramic during such period.The annual shareholder meetings of Dallas Ceramic were not attended by most shareholders during the period 1963 through 1966. Only in 1963 did any shareholder other than Robert and Juan attend the annual meeting in person, but many shareholders gave their proxies to Robert and Juan each year. Robert and Juan were each directors during the years in issue and attended all meetings of the board of directors. Robert served as president of Dallas Ceramic for such years. Juan was not an officer during this period. Robert, as president, controlled the daily policies and actions of Dallas Ceramic. Juan neither had, nor exercised, the power to dictate corporate actions, to give orders, or to formulate policy at Dallas Ceramic.The exact stock ownership of Ceramica during the years in issue is unclear. The stock was principally owned by Juan, his wife, and Roberta, whose stock was controlled by Juan. During the years in issue, Roberta took no part in the management of Ceramica. Robert has never been a shareholder 118 nor member of any governing board of Ceramica, and Dallas Ceramic owned no stock in Ceramica. During the years in issue, Juan completely controlled the operations and policies of Ceramica, and Robert had no control, directly or indirectly, over the management or operation of Ceramica.Neither Robert, his children, nor Dallas Ceramic received from Ceramica any kickbacks, rebates, loans, dividends, or payments of any kind because of Dallas Ceramic's purchase of tile from Ceramica. Robert never received any of the money paid to Ceramica by Dallas Ceramic and deposited in its account at Republic. Juan and Robert frequently went on hunting trips together, and on two occasions, Juan paid Robert's expenses.Sale of Dal-Monte Tile in MexicoIn 1963, Ceramica sold approximately 26 percent of its tile in Mexico, and by 1966, such sales had increased to 41 percent. During these years, it had from 96 to 127 independent distributors located throughout the Republic of Mexico (Mexican distributors). Neither Juan nor Ceramica owned or controlled, directly or indirectly, any of these distributors.385 The Dal-Monte tile sold by Ceramica in Mexico was identical to the tile sold to Dallas Ceramic. The 119 Mexican distributors in Monterrey paid about 38.6 cents per square foot for the 4 1/4-inch plain-glaze and dura-glaze tile, f.o.b. Monterrey, while the Mexican distributors in Mexico City paid about 35.8 cents per square foot for the same tile, f.o.b. Mexico City, during the years in issue. A 5-percent prompt payment discount was given to a distributor if he paid for the tile within 30 days. The prices Ceramica charged the Mexican distributors for the many other types of tile and trim were not proven at trial. The evidence suggests that each of the Mexican distributors was a retailer selling directly to the public, and the amount of tile purchased from Ceramica by each of such distributors was very small in comparison to the amount of tile purchased by Dallas Ceramic.Comparison of Dal-Monte and Procesa TileProductos and its successors continued to manufacture Procesa tile in Monterrey, Mexico, through the years in issue. During some of such years, the company was known as Ideal Standard, S.A. It sold its tile primarily for use in Mexico, but it did sell approximately $ 500,000 worth of tile a year to distributors in the United States during some of such years.The Procesa tile 120 was similar to the Dal-Monte tile in that it was made with substantially the same raw materials by a process similar to that used by Ceramica. To a layman, a 4 1/4-inch piece of Dal-Monte tile looks very similar to a 4 1/4-inch piece of Procesa tile. However, despite the superficial similarities, the quality and value of the two brands of tile were substantially different.Ceramica manufactured a complete line of tile and trim pieces including over 300 types, and such tile was manufactured in more than 60 colors. On the other hand, Ideal Standard produced a much more limited line of tile. Procesa tile was available in less than 50 types and in only 25 colors. In addition, because of the large inventory maintained by Ceramica and the preference given to the orders of Dallas Ceramic, it could provide good service for its customers; whereas, Ideal Standard offered only a limited amount of tile for sale to customers in the United States, and that tile was available only on a quota basis.The ability to provide good service aids substantially in the sale of tile. The plentiful and dependable supply of tile, together with a wide variety of trim pieces, can save tile contractors much 386 time 121 and money when the tile is being installed. Dallas Ceramic was able to attract business due to the excellent service it provided on the Dal-Monte tile. On the contrary, the American distributors of Procesa tile were not able to provide such good service to their customers due to the limited quantity and variety of Procesa tile available, and such situation reduced the demand for such tile. Tile contractors were willing to pay more for the Dal-Monte tile because of the better service.In addition, the Procesa tile sold in the United States was "kiln-run" and was not graded to American standards. Each box contained a mixture of standard, second, and third grade tile, and the quality of the tile varied widely from box to box. Ideal Standard's price list to its American distributors did not specify that the Procesa tile was standard grade. At least some of the boxes had the blue standard grade label on them, but the Procesa tile was not standard grade and did not meet the voluntary American standards. This difference in quality of tile also caused the Procesa tile to be worth less in the United States than the Dal-Monte tile.In order to be used on any commercial construction project, 122 ceramic tile must be accepted by the architect. The architect must decide whether the tile selected by the contractor meets the requirements for which it will be used. Since the commercial construction business uses a large amount of ceramic tile, it is important that a brand of tile is accepted by architects.During the years 1963 through 1966, Dal-Monte tile was architecturally accepted and used on many large construction projects. However, Procesa tile was rarely, if ever, used on such projects. Procesa tile was used primarily in small houses, apartments, or motels, where costs were the overriding consideration.During the years in issue, the trade name Dal-Monte enjoyed a good reputation and was considered a first-quality tile. Procesa, on the other hand, had a poor reputation. It was regarded as an inferior product comparable to other companies' second-quality tile. Procesa distributors usually sold a first-quality line of tile for architecturally controlled jobs and used the Procesa tile as a second line.Ideal Standard sold the 4 1/4-inch plain-glaze and dura-glaze Procesa tile to the American distributors for 22 cents and 27.5 cents per square foot, respectively, f.o.b. Monterrey. 123 The Procesa 387 tile was generally sold in the United States at prices below all domestic and imported standard-grade tile. First-quality tile, such as Dal-Monte, available in a plentiful supply, was worth from 15 to 30 cents more per square foot to the tile contractors than the inferior grade tile.Customs DeterminationsDallas Ceramic was required to pay customs duties on the Dal-Monte tile it imported into the United States. The amount of such duties was based upon its value as determined by the U.S. Bureau of Customs (customs value). The customs laws were amended effective in 1958 to provide that the customs value shall normally be the export value, defined as the price at which such or similar merchandise is "freely sold or, in the absence of sales, offered for sale" in the principal markets of the exporting country, in the usual wholesale quantities and "in the ordinary course of trade" for exportation to the United States. 19 U.S.C. sec. 1401a(b) (1970 ed.). The term "freely sold or, in the absence of sales, offered for sale" is defined in 19 U.S.C. sec. 1401a(f)(1) to mean sold or offered:(A) to all purchasers at wholesale, or(B) in the ordinary course of trade to one or more 124 selected purchasers at wholesale at a price which fairly reflects the market value of the merchandise,In 1958, Dallas Ceramic employed an attorney, specializing in customs law, to seek a determination by the Bureau of Customs of the correct customs value under the amended law. The customs attorney prepared a letter to the Bureau of Customs dated March 10, 1958, which was signed by Robert and Juan on behalf of Dallas Ceramic and Ceramica, respectively. Such letter disclosed the stock ownership of both corporations and made several arguments why the customs value of the Dal-Monte tile was not the price which Ceramica charged Dallas Ceramic for it (invoice price):Actually Ceramica * * does not offer the tile for sale to Dallas Ceramic, and the price at which it is invoiced to Dallas Ceramic is arrived at in the following manner: Mr. Jack [Juan] Brittingham of Ceramica * * * and Officials of Dallas Ceramic * * * get together, and the Officials of Dallas Ceramic * * * decide on what price they can pay for the tile manufactured by Ceramica * * , taking into consideration that the sales price in the United States of such tile will be ten or fifteen percent less than the sales price of 125 similar tile manufactured and sold by Dallas Ceramic * * *388 Due to the control of the Brittingham families and relatives of the two companies, the law of supply and demand has no bearing on the price paid for the tile nor is there any opportunity of bargaining between seller and receiver, and the invoice price arrived at cannot be said to fairly reflect the market value of the merchandise.It seems very evident that the procedure used in arriving at the invoice value of the goods cannot be used in the ordinary course of trade, which means the conditions and practices, which for a reasonable time prior to the exportation of the merchandise was normal in the trade under consideration with respect to merchandise of the same class or kind.The letter stated that, instead of using the invoice price, the price of "similar" tile should be used to determine the customs value:It is our opinion that tile shipped by Ceramica * * to Dallas Ceramic is similar to tile manufactured and shipped to the States by Productos * * * at Monterrey. This opinion is based on the following reasons: The tile manufactured by both plants in Monterrey meets Federal specifications of U. S. Bureau of Standards for 126 Grade No. 1 and Grade 2 glazed, wall, and floor tile. Labels are attached to the boxes shipped showing such grades. Mr. Jack [Juan] Brittingham was part owner of the tile factory, Productos * , until about three years ago when he sold his interest and organized and started operating the tile plant Ceramica * . He is thoroughly familiar with the procedure and material used in making tile. According to information furnished by Mr. Jack Brittingham, the materials used in the manufacturing of tile are Clay, Talc, Feldspar, Lead, Borax, Flourspar [sic], Color Stain, and Silica. Both plants, Productos * * and Ceramica * * * use these materials and in many instances the materials are obtained from the same suppliers, however, Productos * * * uses a small amount of Kaolin Clay which is not used by Ceramica * * . This clearly indicates that the tile of both plants is composed of approximately the same materials. The tile is made of the same size and to U. S.Grade Specifications with identical lugs, and if of same color and shade, it would be commercially interchangeable and adaptable to the same use. The cost of labor in both plants is approximately the same, which means that 127 the cost of manufacturing per square ft. of tile is approximately the same.It is our opinion that the above information clearly indicates that the tile shipped by Ceramica * * * is similar in all respects to the tile exported to the United States by Productos * * , and in the absence of export value on tile shipped to the States by Ceramica * * the export price of similar tile exported to the States by Productos * * * is proper for appraisement purposes.On April 18, 1958, the customs attorney sent another memorandum to the Bureau of Customs containing additional arguments why she felt that the invoice price was not the proper customs value. She argued that the invoice price did not "fairly reflect the market value" of the Dal-Monte tile for several reasons. She stated that Ceramica was selling the Dal-Monte tile 389 in Mexico for home consumption at the same prices as similar tile, such as Procesa, was sold. These prices were lower than the invoice prices to Dallas Ceramic. She also stated that while Dallas Ceramic paid more for the Dal-Monte tile than other American importers paid for similar Procesa tile, the two tiles were retailed in the United States at about the same price. 128 Thus, she concluded that the invoice price of the Dal-Monte tile did not "fairly reflect the market value." The customs attorney further argued that because Dallas Ceramic and Ceramica were "related persons" under customs law within the meaning of 19 U.S.C. sec. 1401a(g)(2) (1970 ed.) and that because the Dal-Monte tile was not sold "in the ordinary course of trade" at prices which "fairly reflect the market value," the sales were not "arm's-length transactions."The Bureau of Customs later determined that the sales of Dal-Monte to Dallas Ceramic were not "in the ordinary course of trade" at a "price which fairly reflects the market value of the merchandise" so that the invoice price could not be used to determine customs value. It further determined that the price of Procesa tile imported into the United States was an acceptable basis upon which to determine customs value. Any type of tile made by Ceramica and not made by Productos was to be valued by other means. Thus, the customs value was significantly less than the invoice price of the Dal-Monte tile. Through an error by some customs agents, Dallas Ceramic was charged duties based upon the invoice price, resulting in substantial 129 overpayments. Dallas Ceramic was able to recover these overpayments in the period 1963 to 1965.In 1962, a customs agent made inquiries of Ceramica to determine the "constructed value" of the types of tile made by Ceramica but not made by other Mexican manufacturers. Constructed value in customs law is defined as the sum of:(1) the cost of materials * * and of fabrication or other processing of any kind employed in producing such or similar merchandise, * * * in the ordinary course of business;(2) an amount for general expenses and profit equal to that usually reflected in sales of merchandise of the same general class or kind as the merchandise undergoing appraisement which are made by producers in the country of exportation, in the usual wholesale quantities and in the ordinary course of trade, for shipment to the United States; and390 (3) the cost of all containers * * and all other expenses incidental to placing the merchandise undergoing appraisement in condition, packed ready for shipment to the United States. [19 U.S.C. sec. 1401a(d) (1970 ed.).]The Bureau of Customs determined that the constructed value of the Dal-Monte tile was obtained by reducing the invoice price by 53.31 130 percent and by adding to the amount so obtained 35.72 percent of the invoice price. The net result of this formula was that the constructed value of the tile valued in this manner was 82.41 percent of the invoice price. No evidence was presented at trial explaining how this formula was devised.In 1970, the Bureau of Customs began valuing the Dal-Monte tile at the invoice price, rather than by the methods previously used. Dallas Ceramic has filed protests of this action. In May 1973, Robert wrote a letter on behalf of Dallas Ceramic to the Commissioner of Customs in which he stated the reasons why the invoice price was not the proper customs value. The letter provided in part:There have been no changes, over the intervening years, in the material facts asserted in 1958 in our application to the Bureau of Customs for a ruling on the dutiable value of tile manufactured in Mexico by Ceramica * * and imported into the United States by Dallas Ceramic * * . Controlling interest in Ceramica * * is still held by Mr. Juan (Jack) Brittingham and members of his immediate family, who also own and control over 20% of the stock in the importing firm, Dallas Ceramic * * . I, Robert M. Brittingham, 131 the brother of Juan Brittingham, still own 16% of the stock of Dallas Ceramic * * , the balance of which is still owned by other relatives of both. This has been true throughout the period of the importations covered by the above case and continues to the present.This letter also contained his arguments why Dallas Ceramic's position with the Internal Revenue Service concerning the application of section 482 to its transactions with Ceramica was not inconsistent with its representations to the Bureau of Customs.District Court CaseThe Commissioner determined a deficiency in, and an addition to, the Federal income tax of Dallas Ceramic for the taxable year 1966. Dallas Ceramic paid the deficiency and penalty for that year, plus interest, and brought suit for refund in the U. S. District Court for the Northern District of Texas (District Court). On November 6, 1974, after a nonjury trial, the District Court issued its Findings of Fact and Conclusions of Law. Dallas 391 Ceramic Co. v. United States, an unreported case ( N.D. Tex. 1974, 35 AFTR 2d 75-394, 74-2 USTC par. 9830). The District Court concluded that Dallas Ceramic and Ceramica were owned or controlled, directly or indirectly, 132 by the same interests; that Dallas Ceramic failed to prove that the Commissioner's allocation pursuant to section 482 was unreasonable, arbitrary, or capricious; and that the fraud penalty was properly imposed. On November 26, 1975, the District Court ordered that the trial of that case be reopened for an evidentiary hearing, but at the time of the filing of this opinion, the matter is still under consideration by the District Court.Returns of Juan BrittinghamJuan was a nonresident alien living in Mexico during the years in issue. His U. S. income tax returns for such years (Form 1040B) were prepared by a certified public accountant in the United States.The 40-percent checks which were sent to Ceramica in Monterrey, Mexico, during 1963 for the Dal-Monte tile totaled $ 441,983.68. The following table sets forth the amounts deposited in account Nos. 66-351-4 and 80-104-6 at Republic during the years indicated, the amounts which the Commissioner now concedes are not income from U. S. sources, and the amounts which he claims to be income from such sources:Amount concededAmount claimed byYearAmountby CommissionerCommissioner1963$ 1,928,014.49$ 1,507,799.62$ 420,214.8719643,043,523.472,115,453.30928,070.1719651,771,195.83830,407.44940,788.3919662,001,272.731,122,431.99878,840.74All 133 of the deposits which the Commissioner claims to have been unreported taxable income consist of the 40-percent checks issued by Dallas Ceramic to Ceramica pursuant to invoices for tile purchases and payments for technical services supplied to Dallas Ceramic by Ceramica.During the years in issue, Juan was a partner in Texas Talc Co., which did business in the United States. As a result of settlement negotiations with the Commissioner, his income from the partnership was redetermined as follows: 392 Amount reportedAmount claimed inYearon returnnotice of deficiencyAgreed amount1963$ 5,060.10$ 12,909.48$ 9,118.89196418,848.3240,386.3129,993.501965790.4221,265.3611,380.9119668,542.2224,112.7313,117.31 Juan failed to report dividend income from U. S. sources of $ 1,617.04 in 1963. However, since he was a nonresident alien, 30 percent of the dividends were withheld at the source so that he had an unclaimed tax credit of $ 635.11 in that year.During the years in issue, Juan claimed the following deductions, dividends received credits, and investment credits on his U. S. income tax returns:YearDeductionsCredits1963$ 33,314.32$ 1,226.78196435,732.5884.11196534,090.110 106616,736.4975.41Sale 134 of Birmingham PropertyIn 1960, Dallas Ceramic purchased a lot in Birmingham, Ala. (Birmingham lot), for about $ 17,300, intending to build a warehouse on it. In February 1963, a real estate salesman in Birmingham wrote to Dallas Ceramic informing it that the market value of the Birmingham lot had increased and that the market price to someone who could use the lot would be from $ 22,500 to $ 25,000. Robert later decided that the lot did not satisfy the requirements of Dallas Ceramic since it was too small. Robert talked Juan and Mr. Marroquin into purchasing adjoining property upon which they constructed a warehouse and leased it to Dallas Ceramic. The Birmingham lot was then sold in December 1963 to Mr. Marroquin for $ 17,600. He was married to Juan's daughter, Barbara, who owned 7 percent of the stock of Dallas Ceramic. Juan loaned Mr. Marroquin the money to purchase the Birmingham lot.Residency of Roberta M. BrittinghamRoberta was born on March 22, 1891, in Janesville, Wis., and moved to Mexico when she was 5 years old. She was a U. S. citizen at birth, and in 1943, she also became a naturalized citizen of the Republic of Mexico and remained so during the 393 years in issue. 135 At the time of the trial in this case, she was living in Monterrey, Mexico, was bedridden, and was unable to testify.During the years in issue, Roberta received the following income:Interest andLong-termYeardividend incomecapital gain1960$ 117,197.370 1961106,066.440 1962169,875.090 1963120,897.15$ 7,521.211964108,587.2098,090.201965153.901.000 1966178,245.27976.77All of such income was derived from sources outside the United States, except for the long-term capital gain earned in 1966.In 1941, 1942, and 1946, Roberta filed an Alien Registration Foreign Service Form with the U. S. Immigration and Naturalization Service. Each such form indicated that she was entering the United States for a period of 6 months for recreational purposes.From 1945 to 1968, Roberta maintained an apartment in Beverly Hills, Calif. She regularly lived in such apartment and was seen there often by the mail carrier who delivered her mail for over 20 years. A phone was listed in her name in the local telephone directory for Los Angeles, Calif., from 1945 to 1968, and during the period 1963 through 1966, an average of almost three phone calls per month were made from Dallas Ceramic's offices in 136 Dallas to Roberta's telephone number in Beverly Hills. She maintained a checking account in the Bank of America in Beverly Hills, Calif., and wrote approximately 35 checks on that account each month from 1961 through 1966.At least during some of the years 1960 through 1966, Roberta held a passport issued by the Republic of Mexico. On June 27, 1965, and January 6, 1966, she filed an "Application to Extend Time of Temporary Stay" with the U. S. Immigration and Naturalization Service. The record does not disclose whether such applications were also made in prior years.In 1965, after an investigation by the California Franchise Tax Board, Roberta filed late California resident income tax returns for 1960 and 1963. These returns include the statement that she had not filed returns for prior years because she thought she was not a resident of California. She filed timely California resident 394 tax returns for 1964, 1965, and 1966. One question asked on each return was whether the total income reported on the California tax return was the same as the total income reported on the Federal income tax return, and if not, an explanation was required. Roberta stated that she was a nonresident 137 alien and did not file a Federal return.Notices of DeficiencyIn his notice of deficiency to Dallas Ceramic, the Commissioner determined that Dallas Ceramic and Ceramica were commonly controlled and that the purchases of Dal-Monte tile from Ceramica were not arm's-length transactions. Using the values determined by the Bureau of Customs as the fair market price for the Dal-Monte tile, he reduced Dallas Ceramic's cost of goods sold by the following amounts:YearAmount1963$ 526,899.051964453,430.801965506,523.10He also determined that all or part of the underpayment of tax was due to fraud and that section 6653(b) was applicable for all the years in issue.In his notice of deficiency to Robert and Jeanne Brittingham, the Commissioner determined that the "40-percent checks" issued by Dallas Ceramic to Ceramica were "appropriated" to their use and benefit and represented unreported income in the following amounts:YearAmount1963$ 882,605.571964896,773.671965978,113.341966882,630.06It was also determined that the section 6653(b) fraud penalty was applicable for each of such years.In his notice of deficiency to Juan Brittingham, the Commissioner determined that the bank deposits in Republic 138 and certain checks issued to Ceramica by Dallas Ceramic were unreported income received by Juan from U. S. sources. The Commissioner has since stipulated that only the "40-percent checks" and some payments for technical services were unreported income of Juan. He also determined that at the instigation and direction of Juan, Dallas Ceramic sold the Birmingham lot to Mr. 395 Marroquin for $ 17,600 when its fair market value was $ 25,935. In addition, he determined that Juan did not file a true and accurate return for the years in issue so that the deductions and certain credits claimed by him were not allowable. Alternatively, he determined that Juan had not adequately substantiated some of his deductions. Finally, he determined that the section 6653(b) fraud penalty was applicable for all the years in issue.In his notice of deficiency to Roberta M. Brittingham, the Commissioner determined that she had unreported income in each of the years in issue and that Roberta failed to file a return for each year without reasonable cause and was liable for the section 6651(a) penalty. In an amendment to answer, he determined additional amounts of unreported income.OPINION1. Adjustments in 139 Prices Paid by Dallas CeramicOf the many issues to be decided in this case, the primary one is whether, pursuant to section 482, the Commissioner may allocate substantial amounts of income to Dallas Ceramic from Ceramica by adjusting Dallas Ceramic's cost of goods sold.Section 482 provides: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.The purposes of section 482 and the Commissioner's authority to effectuate such purposes were described in Pauline W. Ach, 42 T.C. 114">42 T.C. 114, 125-126 (1964), affd. 358 F.2d 342">358 F.2d 342 (6th Cir. 1966), cert. denied 385 U.S. 899">385 U.S. 899 (1966), where it was said:Respondent may allocate income under section 482140 in order to prevent "evasion of taxes or clearly to reflect the income." The legislative history of section 482 indicates that it was designed to prevent evasion of taxes by the arbitrary shifting of profits, the making of fictitious sales, and other such methods used to "milk" a taxable entity. * * 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. * * *396 See Marc's Big Boy-Prospect, Inc., 52 T.C. 1073">52 T.C. 1073, 1092-1093 (1969), affd. sub nom. Wisconsin Big Boy Corp. v. Commissioner, 452 F.2d 137">452 F.2d 137 (7th Cir. 1971); T.V.D. Co., 27 T.C. 879">27 T.C. 879, 884 (1957); H. Rept. No. 2, 70th Cong., 1st Sess. (1927), 1939-1 C.B. (Part 2) 384, 395; S. Rept. No. 960, 70th Cong., 1st Sess. (1928), 1939-1 C.B. (Part 2) 409, 426.By using the standard of an uncontrolled taxpayer to determine the controlled taxpayer's "true taxable income," section 482 equalizes the treatment of controlled and uncontrolled taxpayers and prevents the artificial shifting of income between related businesses. Huber Homes, Inc., 55 T.C. 598">55 T.C. 598, 605 (1971); 141 see Baldwin-Lima-Hamilton Corp. v. United States, 435 F.2d 182">435 F.2d 182, 185 (7th Cir. 1970); Kerry Investment Co., 58 T.C. 479">58 T.C. 479, 484 (1972), affd. on this issue 500 F.2d 108">500 F.2d 108 (9th Cir. 1974); Asiatic Petroleum Co. (Delaware) Ltd., 31 B.T.A. 1152">31 B.T.A. 1152 (1935), affd. 79 F.2d 234">79 F.2d 234 (2d Cir. 1935), cert. denied 296 U.S. 645">296 U.S. 645 (1935); sec. 1.482-1(b) (1), Income Tax Regs.The Commissioner contends that Dallas Ceramic and Ceramica were owned or controlled by the same interests and that the price Dallas Ceramic paid for the Dal-Monte tile purchased from Ceramica was not an arm's-length price. Thus, he argues that he properly reduced Dallas Ceramic's "cost of goods sold" to reflect what he alleges was the uncontrolled price of the tile to prevent the evasion of taxes. Petitioner Dallas Ceramic argues that the Commissioner acted without authority in making the section 482 allocation, since it was not owned or controlled by the same interests as Ceramica and since it paid an arm's-length price for the Dal-Monte tile. We agree with both positions urged by the petitioner Dallas Ceramic.A. Common ownership or control. -- For section 482 to be applied, there must be two or more organizations, trades, or businesses 142 "owned or controlled directly or indirectly by the same interests." Section 1.482-1(a)(3) of the Income Tax Regulations defines "controlled" to include:any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of the control which is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.Actual control and not record ownership determines whether the statute applies. See Pauline W. Ach, 42 T.C. at 125; Grenada 397 ., 17 T.C. 231">17 T.C. 231, 254 (1951), affd. 202 F.2d 873">202 F.2d 873 (5th Cir. 1953), cert. denied 346 U.S. 819">346 U.S. 819 (1953). The record in this case clearly demonstrates that Dallas Ceramic and Ceramica were not owned or controlled by the same interests within the meaning of section 482.During the years in issue, Juan, his wife, and Roberta owned all the stock of Ceramica, except for a few qualifying shares. Juan controlled Roberta's shares pursuant to a power of attorney, and she took no part in the business affairs of the company. Juan was Ceramica's director general and exercised complete control over its operations and policies. 143 Robert and his immediate family neither owned any stock in, nor exercised any control over, the operations of Ceramica.During most of the years in issue, Robert and his children owned 37 percent of the stock of Dallas Ceramic, while Juan, his wife, and children owned an equal amount. The balance of the stock was owned by uncles, an aunt, and cousins of Robert and Juan. Robert and Juan each controlled the interests of his immediate family in Dallas Ceramic. However, neither Juan alone, nor together with his immediate family, did or could exercise control over the business policies of Dallas Ceramic.The Commissioner apparently does not argue that either Robert or Juan alone owned or controlled the two companies. Rather, he maintains that the "family unit" of Roberta, Juan, and Robert constitutes the "same interests" necessary for the application of section 482, and that this "family unit" owns or controls both corporations. The petitioners agree that the members of such "family unit" collectively owned or controlled both corporations but vigorously deny that the family unit constitutes the "same interests."The term "same interests" is not defined in the statute or regulations. Its 144 meaning must be determined in light of the congressional purpose in enacting section 482. Such section is remedial in nature and must not be narrowly construed to frustrate the legislative intent. Pauline W. Ach, supra.Section 482 was enacted to prevent the artificial shifting of income between controlled taxpayers to avoid Federal taxes. See H. Rept. No. 2, supra; S. Rept. No. 960, supra. In using the term "same interests," Congress apparently intended to include more than "the same persons" or "the same individuals." Different persons with a common goal or purpose for artificially shifting 398 income can constitute the "same interests" for the purposes of the statute. Cf. Rishell Phonograph Co., 2 B.T.A. 229">2 B.T.A. 229, 232-233 (1925). Thus, it is not necessary that the same person or persons own or control each controlled business before section 482 can be applied, but there must be a common design for the shifting of income in order for different individuals to constitute the "same interests." Here, the two businesses were owned and controlled by different individuals, and it is clear there was no design to shift income among them.Without doubt, Roberta did not constitute the "same 145 interests" controlling Dallas Ceramic and Ceramica since she owned no interest in Dallas Ceramic and exercised no control over the affairs of either corporation. Moreover, Robert and Juan, although brothers, each had his own family, and each was financially independent of the other. Any overpayment made by Dallas Ceramic to Ceramica would have been completely contrary to Robert and his family's financial interest since they had no interest in Ceramica and would have received no benefits from such overpayments. While it is true that Juan paid Robert's expenses on two joint hunting trips, the payment of such expenses would not be sufficient inducement to cause Robert to arrange for Dallas Ceramic to overpay for the Dal-Monte tile. To believe that Robert would be a part of a plan to divert $ 1.5 million from a corporation in which he and his children owned a 37-percent interest to a corporation in which his immediate family had no interest strains all credulity.The many cases cited by the Commissioner do not establish the rule for which he argues. In South Texas Rice Warehouse Co., 43 T.C. 540">43 T.C. 540 (1965), affd. 366 F.2d 890">366 F.2d 890 (5th Cir. 1966), cert. denied 386 U.S. 1016">386 U.S. 1016 (1967), four families 146 owned equal interests in Warehouse and Enterprise. The ownership within each family group varied in that the children owned a larger share of each family's interest in Enterprise. We held that both businesses were controlled by the "same interests" and found that the variation in intrafamily ownership was not significant, since the purpose of forming Enterprise was to effectuate a short-term reallocation of income among the family members of certain units. However, the facts of that case are significantly different than those of this case. In that case, each family group owned an equal interest in each business, and the variation of ownership within each family group was a result of a plan by the fathers in 399 three of the families to shift income to their children. In this case, the families of Juan and Robert did not own proportionate interests in both corporations, and there was never a plan to shift income from Robert to Juan. Their fraternal relationship alone is not sufficient to infer that there existed any plan to shift income between them.The Commissioner also relies upon Charles Town, Inc. v. Commissioner, 372 F.2d 415">372 F.2d 415 (4th Cir. 1967), affg. a Memorandum Opinion of this 147 Court, cert. denied 389 U.S. 841">389 U.S. 841 (1967), to support his contention that Juan and Robert constitute the "same interests." In Charles Town, two brothers equally owned and controlled Fairmont and equally controlled Charles Town, although they owned very little of it. Income was shifted from Charles Town to Fairmont. We found that the two businesses were controlled by the "same interests." The Commissioner argues that the facts of the present case are analogous. However, in Charles Town, the brothers shared control of Charles Town and shared ownership and control of Fairmont to which the income was shifted; whereas, in this case, Robert and his family had no interest in Ceramica to which the Commissioner claims income was shifted. In view of Robert's lack of interest in Ceramica, we can find no reason for him to participate in a plan to shift income to that corporation, and accordingly, the Charles Town case is also not apposite.The other cases relied upon by the Commissioner also involve significantly different facts. See Advance Machinery Exch. v. Commissioner, 196 F.2d 1006">196 F.2d 1006 (2d Cir. 1952), affg. a Memorandum Opinion of this Court, cert. denied 344 U.S. 835">344 U.S. 835 (1952); Jesse E. Hall, Sr., 32 T.C. 390">32 T.C. 390 (1959), 148 affd. 294 F.2d 82">294 F.2d 82 (5th Cir. 1961); Friedlander Corp., 25 T.C. 70">25 T.C. 70 (1955); Grenada Industries, Inc., supra. In each case, the fact that different persons were related was not the sole basis for determining that the interests involved were the same; there also was evidence indicating that income was arbitrarily shifted. Each case involved either paternal or marital relationships, not fraternal relationships. Finally, in each case, the same people either owned or controlled an interest in each controlled business.In his brief, the Commissioner cited a number of examples of transactions that occurred between Dallas Ceramic and Ceramica, in which he claimed that one of the businesses conferred special benefits on the other and which therefore 400 reflect a plan to divert income from one business to the other. However, none of such examples provide any evidence that income was shifted to Ceramica as part of a common purpose or scheme. The business relationships between the two corporations were extensive, and it was in the best interest of each of them to cooperate in the production and sale of high quality tile. The alleged preferences given to Dallas Ceramic were miniscule compared to 149 the amount of income which the Commissioner claimed was improperly diverted to Ceramica. Robert appears to have been a successful businessman, and the transactions to which the Commissioner refers would clearly not be sufficient to have caused him to divert more than $ 1.5 million from a corporation in which he and his family owned a 37-percent interest.B. Arm's-length price -- We are also convinced that the Commissioner acted unreasonably in determining that the customs value constituted an arm's-length price for the sale of the Dal-Monte tile to Dallas Ceramic.Section 1.482-2(e)(1)(i) of the Income Tax Regulations provides in part:Where one member of a group of controlled entities * * * sells * * * tangible property to another member of such group * * * at other than an arm's length price * * , the district director may make appropriate allocations between the seller and the buyer to reflect an arm's length price for such sale * . An arm's length price is the price that an unrelated party would have paid under the same circumstances for the property involved in the controlled sale. * The regulations provide three basic methods for determining the arm's-length price: 150 the comparable uncontrolled price method, the resale price method, and the cost-plus method. If there are comparable uncontrolled sales, the comparable uncontrolled price method must be used, since it is the most accurate method of establishing an arm's-length price. If there are no comparable uncontrolled sales, the resale method must be used if the requirements for its standards are met, since it is the method next most accurate in determining an arm's-length price. If neither the comparable uncontrolled price method nor the resale method can be used, the cost-plus method is applicable. See sec. 1.482-2(e)(1)(ii), Income Tax Regs.Uncontrolled sales are sales in which the seller and the buyer are not owned or controlled by the same interests. Uncontrolled sales will be considered comparable to controlled sales if the 401 physical property and circumstances involved in the two sales are identical or so nearly identical that the differences can be reflected in a reasonable number of adjustments to the uncontrolled price. In judging whether sales are comparable and what adjustments need to be made in prices, some of the facts to be considered are differences in the quality of the 151 product, sale terms, intangibles associated with the sale, and the level of the market and the geographic market in which the sale takes place. Sec. 1.482-2(e)(1)(ii), Income Tax Regs.; see American Terrazzo Strip Co., 56 T.C. 961">56 T.C. 961, 972-973 (1971); Woodward Governor Co., 55 T.C. 56">55 T.C. 56, 64-68 (1970).Obviously, the customs value is not one of the methods provided in the regulations for determining an arm's-length price. Yet, in Ross Glove Co., 60 T.C. 569">60 T.C. 569, 605 (1973), we held that:Considering the similarity between the constructed value computation of Customs and the cost-plus method of section 482, we find that the markups used by Customs in computing the value of gloves imported by Ross Glove may serve as a basis for determining an arm's-length price under section 482. Such markups may be used because they are the best available evidence as to the amounts that a seller would receive to cover overhead and profit in an arm's-length sale.The Commissioner argues that the customs value should likewise be used in this case. However, in Ross Glove, we relied upon the customs determinations because they were the best available evidence; here, the evidence convinces us that the customs determinations 152 were not indicative of an arm's-length price.The Bureau of Customs based its valuation on the assumption that Dal-Monte tile was similar to Procesa tile in 1958. However, the evidence produced at the trial of this case clearly established that during the years 1963 through 1966, the Dal-Monte tile was far superior to Procesa tile in quality, availability, and reputation. Dal-Monte tile was available in many more shapes, colors, and styles than was Procesa. It was available in large and dependable quantities, thus allowing its distributors to provide better service to their customers. Dal-Monte tile met American grading standards, but Procesa did not. As a result, Dal-Monte tile was regarded as equal to all types of American-made tile, while Procesa was known as an inferior quality tile. These, together with other significant differences between the two tiles set forth in our Findings of Fact, make it entirely clear that the 402 Dal-Monte tile was significantly more valuable than Procesa. This conclusion is corroborated by the fact that in 1970 Customs increased its valuation to equal the invoice price paid for the Dal-Monte tile.The Commissioner argues that Dallas Ceramic and Ceramica 153 made representations to the Bureau of Customs in 1958 that Dal-Monte and Procesa were similar and should be estopped from repudiating such statements. The petitioner Dallas Ceramic argues that the representations to the Bureau of Customs are not inconsistent with its position in this tax case; it asserts that the apparent inconsistencies are due to differences between the customs and tax laws. However, it is not necessary for us to resolve this dispute.In the first place, the Commissioner has failed to lay a basis for invoking the doctrine of estoppel; he has not established that he relied upon the customs statement to his detriment, and in the absence of the establishment of such fact, there can be no estoppel. See Ross Glove Co., 60 T.C. at 593; Northport Shores, Inc., 31 B.T.A. 1013">31 B.T.A. 1013 (1935). Yet, in judging the credibility of the testimony given by Robert and Juan in this case, their representations to the Bureau of Customs must be taken into consideration. However, Dallas Ceramic did not rely simply upon the testimony of Robert and Juan; it produced a number of other disinterested witnesses who testified as to the differences in the relative values of Procesa and Dal-Monte tile 154 during the years in issue. We found the testimony of those disinterested witnesses to be altogether credible, and our conclusion was based on such testimony. Thus, our findings and holdings are based on the evidence of record in this tax case, and are made without having to decide whether some of the factual assertions made by Robert and Juan to the Bureau of Customs are reconcilable with their testimony in this case.The Commissioner also relied upon the judgment of the District Court with respect to Dallas Ceramic's alleged overpayments in 1966. He does not argue for the application of the doctrine of collateral estoppel, but he does seek to apply the doctrine of stare decisis. However, since the District Court has ordered that case reopened for further evidentiary hearing, its judgment is not final and cannot be relied upon at this time. 1B Moore, Federal Practice, pars. 0.409[1], 0.416[1], and 0.416[3] (2d ed. 1948).403 Since the Customs determination of value in 1958 was based upon an erroneous assumption as to the relative values of the Procesa and Dal-Monte tile, we hold that the Commissioner's determination of an arm's-length price for the sale of the Dal-Monte tile to Dallas 155 Ceramic based on such value was unreasonable. The Customs determination established a formula for determining the value of the types of Dal-Monte tile not manufactured by Procesa. Since we have no explanation of the basis for such formula, and since the Customs determination of value was otherwise based on an erroneous assumption as to the relative values of Dal-Monte and Procesa tile, we also hold the Commissioner's determination to be unreasonable insofar as it relied upon such formula for determining the arm's-length price of Dal-Monte tile.In support of its position, the petitioner Dallas Ceramic produced the evidence of the prices at which the Dal-Monte tile was sold in Mexico. However, we found that evidence not to be convincing because those sales appear not to be comparable to the sales to Dallas Ceramic. The sales in Mexico were made in much smaller quantities and were apparently made to retailers. Even though we found that evidence not to be helpful, we are satisfied by the other evidence as to the relative values of the Procesa and Dal-Monte tile in the years in issue that the price paid by Dallas Ceramic for the Dal-Monte tile was reasonable and may be considered an 156 arm's-length price for purposes of section 482. Accordingly, we hold that no price adjustment was authorized by section 482.2. Fraud on the Part of Dallas CeramicThe second issue to be decided is whether the fraud penalty is applicable to Dallas Ceramic for the years 1963 through 1965.Fraud is an intentional wrongdoing and the intent required is the specific purpose to avoid the payment of taxes believed to be owed. Mitchell v. Commissioner, 118 F.2d 308">118 F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A. 424">40 B.T.A. 424 (1939), and Supplemental Opinion 45 B.T.A. 822">45 B.T.A. 822 (1941); see Ross Glove Co., 60 T.C. 569">60 T.C. 569, 608 (1973); William G. Stratton, 54 T.C. 255">54 T.C. 255, 284 (1970). The Commissioner must establish fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Mensik v. Commissioner, 328 F.2d 147">328 F.2d 147, 150 (7th 404 Cir. 1964), affg. 37 T.C. 703">37 T.C. 703 (1962), cert. denied 379 U.S. 827">379 U.S. 827 (1964); Blaine S. Fox, 61 T.C. 704">61 T.C. 704 (1974).We find that the Commissioner has failed to present any evidence tending to establish fraud on the part of Dallas Ceramic. His argument of fraud is based on the assertion that Robert and Juan engaged in a scheme to overpay for the tile Dallas Ceramic 157 purchased from Ceramic. However, we have previously found that there was no overpayment. Consequently, the first link in the Commissioner's tenuous chain of "evidence" is destroyed. While this finding effectively disposes of the fraud issue, we feel compelled to comment upon the rest of the Commissioner's "evidence."The Commissioner contends that there are many indicia of fraud in this case. He argues that there was evidence of a double set of books, false entries, and the destruction of books or records. All of these allegations were made concerning Ceramica and not Dallas Ceramic. There was conflicting evidence that Ceramica kept two sets of books and made false entries in 1958, but such evidence, even if true, is not evidence of fraud by Dallas Ceramic. At most, it could raise questions as to whether Ceramica may have committed fraud in connection with the Mexican income tax. The Commissioner also complains that all the books and records of Ceramica for the years in issue were not produced. However, this failure was adequately explained. Most of the missing records were destroyed in a fire in 1966, and others were routinely destroyed after 5 years, since Mexican authorities 158 did not require that records be maintained beyond that period. Furthermore, the Commissioner has not alleged how the missing books could possibly help in proving fraud on the part of Dallas Ceramic.Another indicium of fraud alleged by the Commissioner is based upon Robert and Juan's statements to the Bureau of Customs. As we have previously indicated, we need not determine whether such statements are contrary to the facts established in this case. Even if a significant difference exists, it would only mean that possibly a fraud was committed on the Bureau of Customs. It does not mean that there was any fraud concerning Dallas Ceramic's payment of Federal income tax.The Commissioner's final "badge" of fraud concerns the two-check method of payment used by Dallas Ceramic to pay the invoices from Ceramica. He refers to this method of payment as 405 "surreptitious" and "mysterious." However, the record clearly indicates that these statements are gross distortions of the truth. In 1958, Robert, as president of Dallas Ceramic, both orally and in writing, fully disclosed the two-check method of payment to a customs agent from the U.S. Treasury Department. Furthermore, the Commissioner's 159 own special agent who initially investigated Dallas Ceramic was asked about the two-check method during his testimony at trial:Q. Now, did you find that this was a big secret? Was this something hidden?A. No, sir.Q. As a matter of fact, it had been spelled out on the record at the United States Treasury Department since 1958, hadn't it * * ?A. To the Treasury Department to Customs, yes, sir.In light of this testimony by the Commissioner's own special agent, his references to the "mysteriousness" surrounding the payments are highly improper.3. Unreported Income of Robert and Jeanne BrittinghamThe next issue to be decided is whether the 40-percent checks issued by Dallas Ceramic to Ceramica from 1963 through 1966 for the tile it purchased were unreported income of Robert and Jeanne.The Commissioner argues that Robert and Jeanne received additional unreported income on the theory that Dallas Ceramic overpaid for the Dal-Monte tile as a result of a common conspiracy between Robert and Juan. Since we have previously held that there was no such overpayment, no basis for the imputation of income to Robert remains. Moreover, since the Commissioner stipulated that the 40-percent checks 160 were issued by Dallas Ceramic to Ceramica in payment for the Dal-Monte tile, they could not represent income to Robert. The Commissioner argues that Robert ultimately received the benefit of some of these funds, but the only specific benefits to which he alludes were those two occasions when Juan paid certain expenses of two joint hunting trips with Robert. Such benefits are hardly sufficient to establish that the 40-percent checks were income to Robert. Robert testified that he received no kickbacks, rebates, loans, dividends, or payments of any kind in connection with Dallas Ceramic's purchase of tile from Ceramica, and there was no evidence tending to contradict such testimony. Accordingly, 406 we find that the 40-percent checks were not unreported income of Robert and Jeanne.The Commissioner also argues in the alternative that if an allocation under section 482 is authorized, the amount of the allocation is dividend income to Robert. See Engineering Sales, Inc. v. United States, 510 F.2d 565">510 F.2d 565 (5th Cir. 1975); Sammons v. Commissioner, 472 F.2d 449">472 F.2d 449, 453 n. 1 (5th Cir. 1972), revg. on another issue a Memorandum Opinion of this Court. Since we have found that no section 482 allocation 161 is authorized, there can be no dividend income attributed to Robert and Jeanne for such reason.The Commissioner also asserts that the fraud penalty is applicable to Robert and Jeanne during each of the years in issue. The Commissioner must establish fraud by clear and convincing evidence in order to prevail. Blaine S. Fox, 61 T.C. 704">61 T.C. 704, 717 (1974).The only evidence of fraud which the Commissioner relies upon is the failure to report the 40-percent checks as income. Since we have previously found that such checks were not income to Robert, there is absolutely no evidence of fraud on the part of Robert during the years in issue.4. Unreported Income of JuanThe first issue we must decide involving Juan is whether he had unreported U.S.-source income during the years in issue. The Commissioner originally determined that almost all the deposits in Juan's accounts in Republic were unreported income; but the parties have since stipulated to the source of all such deposits, and the Commissioner has conceded that the majority of such deposits were not income. The only deposits not conceded by him are the proceeds of the 40-percent checks and certain check payments by Dallas Ceramic to Ceramica 162 for technical services. The Commissioner also determined that the 40-percent checks sent to Ceramica in Mexico were unreported U.S.-source income. Thus, the only question to be decided is whether the deposits not covered by the concession and the checks sent to Mexico were unreported U.S.-source income.The Commissioner argues that such deposits and checks were not issued to Ceramica in payment for tile, were not accounted for by Ceramica for Mexican tax purposes, and were subject to Juan's dominion and control. Juan vigorously denies each of these 407 arguments. We have already found that all the 40-percent checks were issued to Ceramica in payment for the Dal-Monte tile purchased in Mexico and that the other payments to Ceramica were for services actually rendered. Such findings adequately dispose of the Commissioner's first argument for treating such amounts as unreported income of Juan.Juan submitted some evidence tending to show that Ceramica did in fact include all the payments which it received for the Dal-Monte tile in the income reported to the Mexican Government. However, we need not pass on the validity of such evidence, since the fact is immaterial in determining whether 163 Juan received any unreported U.S.-source income. Whether Ceramica properly reported all its income to the Mexican Government is a matter for that country to decide, and has nothing to do with the questions properly before this Court.Nor is there any merit in the Commissioner's argument that such deposits and checks constituted unreported income of Juan because he exercised dominion and control over them. Since we have found that such amounts were paid to Ceramica for tile, they could constitute income of Juan only if we found that they were diverted from such corporation. However, Ceramica was a foreign corporation, and Juan was a nonresident alien; accordingly, any dividends from such a corporation are includable in his U.S.-source income only if the corporation received income from U.S. sources. See secs. 872(a), 862(a)(2), and 861(a)(2). 5 The Commissioner has not contended that any dividends from Ceramica should be reported by Juan for U.S. tax purposes, and has never raised the question as to whether Ceramica had income from U.S. sources, and there is no evidence indicating that it had any such income. Under these circumstances, we need not decide whether Juan did in fact 164 divert any of the deposits or checks to his personal use, since they would not, in any event, constitute income from U.S. sources.The Commissioner also argues in the alternative that if his section 482 allocation is upheld, Juan received dividend income from Dallas Ceramic. Since we have found that no section 482 allocation is authorized, there can be no constructive dividend from Dallas Ceramic attributable to any section 482 adjustment.408 5. Disallowed Deductions and Credits of JuanSection 873(a) provides that in the case of nonresident alien individuals, deductions shall be allowed only if and to the extent that they are connected with income from U.S. sources. The rules for allocating deductions to income from within and without the United States are set forth in the regulations. Sec. 1.873-1, Income Tax Regs. However, section 874(a) provides in part:(a) Return Prerequisite to Allowance. -- A nonresident alien individual shall receive the benefit of the deductions and credits allowed to him in this subtitle only by filing or causing to be filed a true and accurate return of his total income received 165 from all sources in the United States, in the manner prescribed in subtitle F * * , including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at the source * The Commissioner takes the position that Juan did not file "true and accurate" returns for the years in issue and that therefore all of his claimed deductions and certain credits must be disallowed.Juan argues that section 874(a) merely requires the complete disallowance of all deductions and certain credits when no return is timely filed, and that such provision is not applicable to him because he did timely file a return each year. See Frank W. Ross, 44 B.T.A. 1 (1941); Nicholas Roerich, 38 B.T.A. 567">38 B.T.A. 567 (1938), affd. 115 F.2d 39">115 F.2d 39 (D.C. Cir. 1940), cert. denied 312 U.S. 700">312 U.S. 700 (1941). However, such argument is contrary to the words of the statute and has been rejected in other cases. The meaning of the statute is emphasized in the regulations, sec. 1.874-1, which provides in pertinent part:(a) Return required. A nonresident alien individual 166 shall receive the benefit of the deductions and credits allowed to him with respect to the income tax, only if he files or causes to be filed with the district director (or, if applicable, with the Director of International Operations), in accordance with section 6012 and the regulations thereunder, a true and accurate return of his total income received from all sources within the United States. This paragraph shall not be construed, however, to deny the credits provided by sections 31 and 32.(b) Tax on gross income. If a return is not so filed, the tax shall be collected on the basis of gross income, * * * without regard to any deductions otherwise allowable, and the only credits allowable against the tax so computed shall be those allowed by sections 31 and 32. This paragraph shall apply even though the tax determined in accordance with § 1.871-7 has been fully satisfied at the source. * * When paragraph (a) of such regulations is read in conjunction with paragraph (b), it is clear that not only must a return be filed, 409 but that such return must be "true and accurate." To satisfy the statutory requirement, a "true and accurate" return of income from U. S. sources containing 167 sufficient information upon which the claimed deductions and credits can be evaluated must be filed. Thus, the mere filing of a return is insufficient. Cf. Fides, A. G., 47 B.T.A. 280">47 B.T.A. 280, 285 (1942), affd. 137 F.2d 731">137 F.2d 731 (4th Cir. 1943), cert. denied 320 U.S. 797">320 U.S. 797 (1943); Blenheim Co., Ltd., 42 B.T.A. 1248">42 B.T.A. 1248, 1253 (1940), affd. 125 F.2d 906">125 F.2d 906 (4th Cir. 1942).Juan also argues that the returns he filed each year contained only minor errors and were "true and accurate" within the meaning of section 874(a). That term is not defined in either the statute or the regulations. Furthermore, the legislative history of section 874 and its predecessors provides no insight into the proper construction of the term. The Commissioner concedes that minor errors in a return or simple disallowed deductions do not disqualify a return. However, he argues that where a nonresident alien has substantial amounts of unreported income, his returns are not "true and accurate."Juan concedes that he had unreported income annually of $ 4,000 to $ 11,000 from the Texas Talc Co. To disallow all deductions and certain credits because of the omission of such amounts of income from a return may appear, in some circumstances, 168 to constitute an unduly harsh penalty. However, such omissions are certainly material, and a return which omits them cannot be said to be "true and accurate." This provision of the statute is long standing, and the similar provision with respect to foreign corporations has been applied whenever returns fail to include material information. Sec. 882(c)(2); see Fides, A. G., supra;Blenheim Co., Ltd., supra.Under the circumstances, we must apply section 874(a) and sustain the Commissioner's disallowance of all the deductions and certain credits claimed by Juan. In view of that conclusion, we need not consider the Commissioner's alternative contention that Juan had failed to substantiate adequately some of his claimed deductions.6. Constructive Dividend to JuanIt is well established that a sale of property by a corporation to a shareholder for an amount less than its fair market value will constitute a dividend if the sale "is in purpose or effect used as an implement for the distribution of corporate earnings to stockholders." Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63, 70 (1937); see 410 Richard R. Riss, Sr., 56 T.C. 388">56 T.C. 388, 429 (1971), affd. on this issue 478 F.2d 1160">478 F.2d 1160 (8th Cir. 1973); Harry L. Epstein, 53 T.C. 459">53 T.C. 459, 474 (1969); 169 Lester E. Dellinger, 32 T.C. 1178">32 T.C. 1178, 1181-1182 (1959); see also sec. 1.301-1(j), Income Tax Regs. Furthermore, dividend treatment is not avoided merely because the property is transferred for insufficient consideration to someone other than the shareholder. "It has been long recognized that where a corporation has made such a transfer to a member of the stockholder's family * * , the stockholder has enjoyed the use of such property no less than if it had been distributed to him directly." Harry L. Epstein, supra at 474 (emphasis supplied); see Byers v. Commissioner, 199 F.2d 273">199 F.2d 273 (8th Cir. 1952), affg. a Memorandum Opinion of this Court, cert. denied 345 U.S. 907">345 U.S. 907 (1953); Nicholls, North, Buse Co., 56 T.C. 1225">56 T.C. 1225, 1239 (1971); Percy H. Clark, 31 B.T.A. 1082">31 B.T.A. 1082, 1084-1085 (1935), affd. 84 F.2d 725">84 F.2d 725 (3d Cir. 1936); cf. Helvering v. Horst, 311 U.S. 112 (1940).The Commissioner determined that Dallas Ceramic sold the Birmingham lot to Juan's son-in-law for $ 17,600 when its fair market value was $ 25,935 at Juan's instigation and direction. The Commissioner argues that such transfer resulted in a constructive dividend to Juan of the difference between the sale price and the fair market value. 170 Juan argues that the lot was not worth as much as the Commissioner alleges and that he received no benefit from the sale to Mr. Marroquin. Juan bears the burden of proof on this issue. Rule 142(a), Tax Court Rules of Practice and Procedure; Lester E. Dellinger, supra.The only evidence in the record concerning the value of the Birmingham lot was a letter to Dallas Ceramic, written by a real estate salesman, 9 months prior to the sale. In such letter, the salesman expressed his opinion that the lot would be worth $ 22,500 to $ 25,000 to someone who could use the property. We find this letter, standing alone, to be of little probative value, and even Juan argues that such evidence is unreliable. Without some foundation evidence for the opinion expressed in the letter, the letter proves nothing concerning the actual fair market value of the lot. Consequently, since Juan has presented us with absolutely no evidence of the value of the lot, we must accept the Commissioner's determination of the value of the lot at the time of the sale as correct. Thus, the price paid for the lot was only two-thirds of its actual value.411 The other question to be resolved is whether Juan exercised substantial 171 influence in causing Dallas Ceramic to make the bargain sale. Green v. United States, 460 F.2d 412">460 F.2d 412, 420 (5th Cir. 1972). Juan was a director of Dallas Ceramic and effectively controlled his family's 37-percent interest in the company. Obviously, he was well aware of the sale to Mr. Marroquin since he loaned his son-in-law the money to purchase the lot and was involved in building a warehouse on adjoining property. There is no evidence in the record to establish that he did not exercise substantial influence in causing Dallas Ceramic to make the bargain sale. Indeed, the circumstantial evidence tends to establish that he was influential in the sale. Since Juan has totally failed to present evidence satisfying his burden of proof, we must uphold the Commissioner's determination that the bargain sale was made at Juan's request. While it is true that Juan did not control Dallas Ceramic and had no right to compel the bargain sale, he did exercise substantial influence in causing the sale. Green v. United States, supra.Juan's argument that he received no benefit from the bargain sale is without merit. He personally enjoyed the constructive dividend since he was able to confer a benefit 172 on a member of his family. Green v. United States, supra;Lester E. Dellinger, supra.The fact that his daughter also owned stock in Dallas Ceramic is irrelevant since she did not influence the bargain sale. See Nicholls, North, Buse Co., 56 T.C. at 1240. A constructive dividend can be found even though it is not a pro rata distribution to all shareholders and even though neither the shareholder nor the corporation intended a dividend. See Crosby v. United States, 496 F.2d 1384">496 F.2d 1384, 1388 (5th Cir. 1974); Paramount-Richards Th. v. Commissioner, 153 F.2d 602">153 F.2d 602, 604 (5th Cir. 1946), affg. a Memorandum Opinion of this Court. Thus, the fact that Juan owned only 1 percent of the stock in Dallas Ceramic does not establish that he did not receive a constructive dividend. Upon the meager record before us, we hold that Juan received a constructive dividend of $ 8,335 in 1963 from Dallas Ceramic as a result of the sale of the Birmingham lot to Mr. Marroquin.7. Fraud on the Part of JuanThe final issue which we must decide involving Juan is whether the penalty for fraud is applicable for each of the years 1963 through 1966. Sec. 6653(b). The Commissioner must 412 establish fraud by clear and convincing 173 evidence. Sec. 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Blaine S. Fox, 61 T.C. 704 (1974).All of the Commissioner's allegations of fraud in his answer and his arguments in his brief relate to the alleged fraudulent sales price charged for the Dal-Monte tile and resulting constructive dividend to Juan from Ceramica. Since we have previously found the Commissioner's arguments on this issue to be meritless, his determination of fraud on the part of Juan must likewise be rejected.8. Residence of RobertaThe parties have stipulated the amount of Roberta's income for the years in issue. The issue to be decided is whether she was an alien resident of the United States during the years 1960 through 1966. 6174 If she was a resident alien, she is taxable on income from all sources. See sec. 1.1-1(a), Income Tax Regs. However, if she was a nonresident alien, she is taxable only on her income from sources within the United States. Sec. 872.Residence is an elusive concept which is undefined by both the Code and the legislative history of section 872. See Weible v. United States, 244 F.2d 158">244 F.2d 158, 163 (9th Cir. 1957). It has been frequently said that residence does not necessarily mean domicile for Federal income tax purposes. See, e.g., Cristina de Bourbon Patino, 13 T.C. 816">13 T.C. 816, 821 (1949), affd. 186 F.2d 962">186 F.2d 962 (4th Cir. 1950); Florica Constantinescu, 11 T.C. 37">11 T.C. 37, 41 (1948); J. P. Schumacher, 32 B.T.A. 1242">32 B.T.A. 1242, 1247 (1935). Thus, a person may acquire a residence even though he does not intend to reside permanently and has a domicile elsewhere. See Marsman v. Commissioner, 205 F.2d 335">205 F.2d 335, 338 (4th Cir. 1953), affg. on this issue 18 T.C. 1">18 T.C. 1 (1952), cert denied 348 U.S. 943">348 U.S. 943 (1955); Ceska Cooper, 15 T.C. 757">15 T.C. 757, 763 (1950); John Henry Chapman, 9 T.C. 619">9 T.C. 619, 622 (1947).Both physical presence plus the definite intent to make one's home at that place is necessary to establish a residence. William E. Adams, 46 T.C. 352">46 T.C. 352, 361 (1966). "[A] nonresident alien cannot establish a residence in the United States by intent alone 413 since there must be 175 an act or fact of being present, of dwelling, of making one's home in the United States for some time in order to become a resident of the United States." Joyce de la Begassiere, 31 T.C. 1031">31 T.C. 1031, 1036 (1959), affd. per curiam 272 F.2d 709">272 F.2d 709 (5th Cir. 1959); see William E. Adams, supra at 361. Likewise, mere physical presence in a country does not by itself establish residence. Florica Constantinescu, supra at 43-44. However, the unexplained continued presence in a country for a prolonged period is strong evidence of an intent to make that place one's residence. Cristina de Bourbon Patino, supra at 821-822; see Rudolf Jellinek, 36 T.C. 826">36 T.C. 826 (1961); cf. Carpenter v. United States, 495 F.2d 175">495 F.2d 175 (5th Cir. 1974). The determination of residence is factual and must be made in light of all the facts and circumstances. See, e.g., William E. Adams, supra at 358; Ceska Cooper, supra at 762; Herman Frederick Baehre, 15 T.C. 236">15 T.C. 236, 241 (1950).Roberta relies upon section 1.871-4(b) of the regulations, which provides:(b) Nonresidence presumed. An alien, by reason of his alienage, is presumed to be a nonresident alien.However, the evidence presented by the Commissioner clearly rebuts the presumption of 176 nonresidency. Roberta maintained and regularly lived in an apartment in Beverly Hills, Calif., for a period in excess of 20 years extending through the years in issue. Section 1.871-4(c)(2)(iii) of the regulations provides that the presumption may be rebutted by showing that the alien's stay in the United States "has been of such an extended nature as to constitute him a resident." A stay of over 20 years is obviously extended in nature. Furthermore, to argue that a person who regularly lives in an apartment for over 20 years is a mere transient or sojourner is clearly untenable. Roberta presented no evidence which tended to show that she was anything other than a resident of the United States.although "residence" does not require a permanent home * * or even a definite and settled abode, * * * it does require that the taxpayer have some degree of permanent attachment for the country of which he is an alien, * * * and it has been said that it is this degree of permanence of an individual's attachment for a country in which he is at some time physically present which determines whether he is a domiciliary, a resident, or a transient of that country * * * [Rudolf Jellinek, 36 T.C. at 834; 177 citations omitted.]414 It is clear to us that 20 years of almost continuous presence is sufficiently permanent to classify Roberta as a resident of the United States.Roberta also argues that she was a nonresident during the years in issue since her stay was limited to a definite period by the immigration laws. She relies upon section 1.871-2(b) of the regulations, which provides in part: "An alien whose stay in the United States is limited to a definite period by the immigration laws is not a resident of the United States within the meaning of this section, in the absence of exceptional circumstances." However, the evidence supporting this contention is very sparse. A copy of her Mexican passport effective for some of the years in issue was offered into evidence, but the visa stamp marks on the passport were completely illegible. The only other evidence offered by Roberta consisted of two forms filed with the U.S. Immigration and Naturalization Service requesting an extension of the time of her stay in the United States. Such forms were required only for certain nonimmigrant aliens. See 8 C.F.R. sec. 214.1(a) (1967). While such evidence does tend to establish that she was not an 178 immigrant at the time of those requests in 1965 and 1966, we do not know whether she acted properly in filing such requests, and we have no evidence as to her status in the other years in issue. Thus, she has failed to establish that she was in the United States under a temporary visa during all the years in issue.Moreover, even if Roberta had established that her presence each year was limited by the immigration laws, we are nonetheless convinced that she was a resident of the United States during each of the years in issue. We have held on several occasions that aliens whose stay in the United States was limited by immigration laws were nevertheless residents of the United States. See, e.g., Marsman v. Commissioner, supra;Ceska Cooper, supra;Joe May, 39 B.T.A. 946">39 B.T.A. 946 (1939); J. P. Schumacher, supra.While the facts of each of these cases may be distinguishable, such cases clearly establish that the immigration status of an alien does not conclusively determine whether she is a resident of the United States. J. P. Schumacher, 32 B.T.A. at 1247. Roberta lived in an apartment in the United States for over 20 years on an apparently permanent basis. No evidence was presented to show 179 why she chose to reside in the United States for such an extended period. Although she was unable to testify at trial, her sons, who 415 did testify extensively, provided no evidence on this issue. Based on these facts, it is apparent that "exceptional circumstances" exist in this case. While Roberta's stay may have been nominally limited by the immigration laws, the fact remains that she was able to continuously reside in the United States for over 20 years.The final issue for decision is whether the failure to file penalty should be imposed on Roberta. Section 6651(a) provides for an addition to tax for failure to file a return timely. However, the addition is not applicable if "it is shown that such failure is due to reasonable cause and not due to willful neglect." The taxpayer has the burden of proving that such failure was due to reasonable cause. Electric & Neon, Inc., 56 T.C. 1324">56 T.C. 1324, 1342 (1971), affd. without published opinion 496 F.2d 876">496 F.2d 876 (5th Cir. 1974); Rudolf A. Zivnuska, 33 T.C. 226">33 T.C. 226, 239 (1959).Although she offered no evidence on this issue, Roberta argues in her brief that her failure to file was reasonable since "common sense told her * * she owed no United States*180 income tax." She may have been sincere in her belief, but "Mere uninformed and unsupported belief by a taxpayer, no matter how sincere that belief may be, that he is not required to file a tax return, is insufficient to constitute reasonable cause for his failure so to file." Robert A. Henningsen, 26 T.C. 528">26 T.C. 528, 536 (1956), affd. 243 F.2d 954">243 F.2d 954 (4th Cir. 1957); see Estate of Martha K. Campbell, 59 T.C. 133">59 T.C. 133, 139 (1972); N.Y. State Assn. Real Est. Bd. Group Ins. Fund, 54 T.C. 1325">54 T.C. 1325, 1336 (1970). There is no evidence that Roberta ever sought the advice of counsel in deciding not to file returns. Compare Cristina de Bourbon Patino, 13 T.C. 816">13 T.C. 816, 826-827 (1949). Roberta has simply given us no evidence upon which a finding of reasonable cause could be based. See William E. Adams, 46 T.C. 352">46 T.C. 352, 363 (1966). We hold that the penalty is applicable.Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: Dallas Ceramic Company, docket No. 6627-71; Jeanne G. Brittingham, docket No. 6631-71; Juan R. Brittingham, docket No. 7774-71; Roberta M. Brittingham, docket No. 7810-71.↩2. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years at issue, unless otherwise indicated.3. Petitioners Robert M. and Jeanne G. Brittingham filed joint Federal income tax returns for the years at issue and received a joint notice of deficiency, but filed separate petitions herein.↩4. All references to prices hereinafter will be for tile graded standard in accordance with American standards.↩1. Gross receipts less the average discount of 10 percent.↩1. Dallas Ceramic's capital stock ledger indicates that Esperanza B. Mabee's stock was transferred to Nem & Co. on Nov. 1, 1964.5. These sections were amended by the Foreign Investors Tax Act of 1966, 80 Stat. 1539.↩6. The parties have assumed that Roberta was not a citizen of the United States during the years in issue, and we will accept that assumption as true for purposes of deciding this case. However, there is no evidence that she ever relinquished or otherwise lost her U. S. citizenship. See United States v. Matheson, 532 F.2d 809">532 F.2d 809↩ (2d Cir. 1976).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622705/	WILSON FURS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. SELBERT, LTD., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wilson Furs, Inc. v. CommissionerDocket Nos. 57058, 57059.United States Board of Tax Appeals29 B.T.A. 319; 1933 BTA LEXIS 956; November 14, 1933, Promulgated 956 1. Where taxpayer, engaged in the retail business, sells garments on an installment payment plan, retaining the garments until paid for in full, and, upon failure of customers to make payment in full, cancels such sales and declares payments theretofore made forfeited, an amount set up on taxpayer's books of account in the taxable year in question as a reserve to meet possible claims for such forfeited deposits held, upon the evidence, not to be an allowable deduction in computing net income for the taxable year. 2. Where the consolidated net loss of an affiliated group in 1926 represents the unabsorbed net loss of only one of the members, such unabsorbed net loss is the statutory net loss of such member, which may be carried forward and applied against its 1928 net income, but only to the extent of its own net income for 1928, before computation of the 1928 consolidated net income. William Gellin, Esq., for the petitioners. J. M. Leinenkugel, Esq., for the respondent. MCMAHON 319 These proceedings, duly consolidated for hearing, are for the redetermination of asserted deficiencies in income tax as follows: Docket No.YearAmount570581927$316.62Do19281,821.44570591928142.58957 320 In Docket No. 57058 it is alleged that the respondent erred in adding to reported income for the year 1927 the amount of $3,000 by transferring the amount of "Reserve for Forfeited Deposits" from a liability to an income account. In Docket Nos. 57058 and 57059 it is alleged that the respondent erred in deducting the net loss for the year 1926 of $31,954.53, attributable to Selbert, Ltd., only in the sum of $7,616.94, whereas the respondent should have deducted the sum of $9,508.72, which would have offset the income reported by Selbert, Ltd., for the year 1928. FINDINGS OF FACT. The petitioner, Wilson Furs, Inc., is a corporation organized under the laws of the State of New York, and has its office at No. 29 West 35th Street, New York City. The petitioner, Selbert, Ltd., is a corporation oeganized under the laws of the State of New York, with offices at No. 7 West 36th Street, New York City. Wilson Furs, Inc., is engaged in the retail fur garment business. The majority of sales are made on the installment payment plan, the petitioner retaining possession of the garments sold until paid for in full. When a garment is sold it is taken from inventory and set958 aside for the purchaser or customer. The method of treating a sale upon the books of account of Wilson Furs, Inc., is to debit cash account with the deposit made by the purchaser, debit the accounts receivable account with the balance due from the purchaser, and credit sales account with the total sale price. A detailed customers' ledger is kept, wherein all the customers' accounts are carried separately. A sales book is also kept in which each sale is entered separately. The customer generally indicates the time within which the garment purchased is to be paid for in full and taken out. In the event that a purchaser or customer fails to complete payments as agreed or fails to call for the garment, it is the custom of Wilson Furs, Inc., to cancel the sale, return the garment to inventory, and credit the amount theretofore paid by the customer to forfeited deposits account. If a customer, whose purchase of a garment has been thus canceled, appears and demands a refund of the deposit made, it is the custom of Wilson Furs, Inc., either to give the customer a credit slip covering the deposit, which credit may be applied against a future sale, or to sell such customer another959 fur garment and apply the deposit against such sale. If a customer does not call for the deposit it is credited to income. The back of the sales slips used by the petitioner bears the following statement: "Deposits are refunded in 5 days if the customer changes her mind." As of December 31, 1927, an entry was made in the journal of Wilson Furs, Inc., debiting forfeited deposits with $3,000 and crediting 321 reserve for forfeited deposits with $3,000, with the explanation, "to set up estimate of possible claim from forfeited deposits." Petitioners filed a consolidated income tax return for the year 1926. For the years 1927 and 1928 the petitioners filed consolidated income tax returns together with Ford Furs, Inc., which was organized in 1927. The net losses and net incomes reported by the petitioners and Ford Furs, Inc., are as follows: 192619271928Wilson Furs, Inc$1,598.95$2,032.98$24,175.85Selbert, Ltd(Loss) - 33,553.48(Loss) - 1,417.699,508.72Ford Furs, Inc(Loss) - 269.95(Loss) - 6,701.62The net income and net losses of the three companies determined by the respondent for the years 1926, 1927, and 1928, as960 shown by the deficiency notice, are the same as set forth above, except the net income of Wilson Furs, Inc., for the year 1927 in the amount of $2,032.98, which the respondent increased by the amount of $4,000 by adding thereto two items as: Unallowable deductions and additional income:Reserve for bad debts$1,000Reserve for forfeited deposits3,000Total4,000The addition to income of the item of $1,000 is not questioned by Wilson Furs, Inc. The respondent computed taxable consolidated net income for the year 1928, as shown by the deficiency notice, as follows: Wilson Furs, Inc$24,175.85Selbert, Limited9,508.72Total$33,684.57Ford Furs, Inc., Net Loss6,701.62$26,982.95Loss, attributable to Selbert, Ltd., 1926 Allowed - 1928 - $9,508.72/33,684.57 X $26,982.95 or7,616.94Cons. net income, 1928 taxable$19,366.01In respect to the allowance of a portion of the unabsorbed statutory net loss of Selbert, Inc., in 1926 as a deduction in 1928, the deficiency notice addressed to Wilson Furs, Inc., contains the following statement: In accordance with961 General Counsel Memorandum 8132, published in Internal Revenue Bulletin, Volume IX-1, January-June 1930, page 287, the loss 322 for the year 1926, attributable to Selbert, Ltd., $31,954.53, may not be allowed as a deduction in 1927, inasmuch as this company sustained a loss in that year. This loss for 1926 may, however, be deducted in 1928 to the extent of the net income of Selbert, Ltd., for 1928, $9,508.72 reduced proportionately by the loss of Ford Furs, Inc., $6,701.62. OPINION. MCMAHON: The petitioner, Wilson Furs, Inc., contends that the account designated "Reserve for Forfeited Deposits" is truly a liability account, that the cancellation of sales and forfeiture of deposits were made without the consent of the customer, and that should the customer thereafter demand the refund of the deposit, the petitioner would be obliged to (1) refund the deposit, (2) give credit for same on sale of another garment, or (3) issue a credit slip to be applied against a future sale; and that therefore the sum of $3,000 should be treated as a liability and not as income. The auditor of petitioner testified that for the year ended December 31, 1926, the books of account962 showed that there was credited to "Income Forfeited Deposits" the amount of $846.85; that this was treated as income and was included in gross income reported by the petitioner in its income tax return for the year 1927; that there appears on the petitioner's books of account an account called "Credit Checks" in the sum of $2,546.10 as of January 1, 1927 [which does not appear as a liability on its income tax balance sheet as of December 31, 1926, notwithstanding his testimony to the contrary]; that the credit item of $3,343 shown on the income tax balance sheet as of December 31, 1927, as "Credit Checks & Reserve Forfeited Deposits" is reflected in its books of account, the $343 appearing as credit checks and the $3,000 appearing as reserve for forfeited deposits; and that the sum of $3,000 was treated as reserve for forfeited deposits to set up the estimate of possible claims for forfeited deposits. The auditor also testified that "this business does about $200,000 worth of advertising a year, and it could not afford lawsuits so that it does return, as a matter of practice, the deposits when demanded by customers rather than go to court"; and, again, that "In the year 1927, they963 paid $200,204.75 for advertising; they did a business of $1,429,947.46, so that this business can not afford to have lawsuits for return of deposits"; and that the difference between the balance of January 1 and the balance of December 31 in credit checks represents "payments actually made to customers by checks or credits given on new sales." The latter statement as to payments is ambiguous, particularly in view of the testimony of the auditor that "credit checks" is petitioner's designation for "credit slips." 323 It is argued by the petitioner that, although the account may have been designated as a reserve, it is a true liability account; that the charge of this reserve was properly deducted by the petitioner; and that the $3,000 should be treated as a liability and not as income. In view of the notation "Deposits are refunded in 5 days if the customer changes her mind" appearing on the sales slips; the testimony of the auditor that, rather than go to court, deposits were refunded; and the unsatisfactory and indefinite testimony as to actual cash refunds of forfeited deposits, it seems to us reasonable to conclude that the petitioner considered a sale closed and final964 after the lapse of five days; that thereafter it did not recognize or admit liability for the return of such deposits; and that it did not return or refund such deposits unless court proceedings impended. Furthermore, the journal entry discloses that the reserve was set up to meet possible claims for forfeited deposits. The Board has considered the question of the deduction of reserves in a number of cases. In William J. Ostheimer,1 B.T.A. 18">1 B.T.A. 18, the Board stated: While it might have been sound business practice on the part of the taxpayer to set up a reserve out of his income to meet a future liability, such a reserve is not deductible in determining net income. The revenue laws prior to the 1921 Act have never recognized reserves as being deductible from gross income in determining net income except in the case of insurance companies. In the Revenue Act of 1921 specific provision was made for the deduction of reserves for bad debts. If reserves had been deductible under the general provisions of the Act it would not have been necessary to make specific provision for the deduction of particular reserves in the case of insurance companies or for bad debts. 965 The statute specifies what deductions are allowable and, except in the case of insurance companies, no provision is made in the 1918 Act for the deduction of a reserve as such. Items of expense must actually have been paid or liability therefor incurred in order to be deductible under that Act. See also Hanff-Metzger, Inc.,4 B.T.A. 1214">4 B.T.A. 1214; Amigo Coal Co.,8 B.T.A. 598">8 B.T.A. 598; Commercial Liquidation Co.,16 B.T.A. 559">16 B.T.A. 559, and cases cited; and Atlas Mixed Mortar Co.,23 B.T.A. 245">23 B.T.A. 245, and cases cited. Cf. Union Security Co.,16 B.T.A. 1412">16 B.T.A. 1412. The action of the respondent in disallowing the deduction of the amount of the reserve and in adding it to net income is therefore approved. In 1928 Wilson Furs, Inc., and Selbert, Ltd., had net incomes of $24,175.85 and $9,508.72, respectively, and Ford Furs, Inc., had a loss of $6,701.62. In computing consolidated net income the respondent disregarded the 1926 unabsorbed statutory net loss of Selbert, Ltd., of $31,954.53, and computed consolidated net income by deducting the loss of Ford Furs, Inc., of $6,701.62 from the combined income of the petitioners of $33,684.57. 966 From such net consolidated income of $26,982.95, he deducted a portion of the unabsorbed statutory 324 net loss of Selbert, Ltd., of 1926 in the amount of $7,616.94, computed in the manner heretofore shown by our findings. The consolidated net income as thus computed by the respondent is $19,336.01. The petitioner contends that the 1926 unabsorbed statutory net loss of the petitioner, Selbert, Ltd., should be allowed as a deduction in 1928 against the income of Selbert, Ltd., to the extent of $9,508.72, which would offset its income of $9,508.72 for 1928; and that such unabsorbed statutory net loss of 1926 should be deducted from the net income of Selbert, Ltd., in 1928 before computation of consolidated net income for 1928. The applicable provisions of the Revenue Act of 1928 are set forth in the margin. 1967 In 1926 there were only two members in the affiliated group, one, Selbert, Ltd., sustaining a net loss of $33,553.48, and the other, Wilson Furs, Inc., having a net income of $1,598.95, the result being a consolidated statutory net loss of $31,954.53. This amount represents the unabsorbed statutory net loss of Selbert, Ltd.While a statutory net loss of a member of an affiliated group may not be carried forward to a succeeding year if such member does not have a net income in the succeeding year, we find no authority which holds that a consolidated net loss, representing the unabsorbed net loss of only one member of the affiliated group, may not be carried forward to a subsequent year to the extent of the net income in such subsequent year of the member which sustained such net loss. On the contrary, in Beneficial Loan Society,26 B.T.A. 858">26 B.T.A. 858 (affirmed in Beneficial Loan Society v. Commissioner, 65 Fed.(2d) 759, on authority of Woolford Realty Co. v. Rose,286 U.S. 319">286 U.S. 319; certiorari denied, October 23, 1933), the Board stated: The statutory net loss provisions are to be applied separately to each member of an affiliated968 group. Where some members of the group, as here, have losses 325 and others have income in 1923, but the total loss exceeds the total income of the group, the losses are first used to absorb the income and the excess loss is distributed proportionately among the members having losses. The amount thus apportioned to each company having a loss is used to compute the statutory net loss of that company. Swift & Co. v. United States, 38 Fed.(2d) 365; Kaiwiki Sugar Co.,21 B.T.A. 997">21 B.T.A. 997. In the following year this statutory net loss may be used to offset any income which that particular company has for the year before being reduced by any losses of its affiliates. If there is an excess of loss it is carried over to the third year. See Delaware & Hudson Co.,26 B.T.A. 520">26 B.T.A. 520. Cf. Woolford Realty Co. v. Rose,286 U.S. 319">286 U.S. 319; Planters Cotton Oil Co. v. Hopkins,285 U.S. 533">285 U.S. 533. To the same effect, see Kaiwiki Sugar Co. v. Burnet, 63 Fed.(2d) 822, affirming 969 Kaiwiki Sugar Co., Ltd.,21 B.T.A. 997">21 B.T.A. 997; Delaware & Hudson Co. v. Commissioner, 65 Fed.(2d) 292; affirming Delaware & Hudson Co.,26 B.T.A. 520">26 B.T.A. 520; Sweets Co. of America v. Commissioner, 40 Fed.(2d) 436; California Wharf & Warehouse Co.,28 B.T.A. 509">28 B.T.A. 509; Albert Leon & Son, Inc.,29 B.T.A. 251">29 B.T.A. 251. Cf. Crocker First Nat. Bank of San Francisco,26 B.T.A. 1078">26 B.T.A. 1078. Since the unabsorbed net loss in 1926 of Selbert, Ltd., is the amount of $31,954.53, such amount may be carried forward by such petitioner to 1928 to the extent of its own net income for that year, or $9,508.72. The net income of Selbert, Ltd., in 1928 being entirely offset by its statutory net loss of 1926, the consolidated net income for 1928 is $17,474.23, which is arrived at by deducting the loss of Ford Furs, Inc., of $6,701.62 from the net income of Wilson Furs, Inc., of $24,175.85. Upon the authority of the foregoing cases the excess of such statutory net loss over such 1928 income may not be used in computing consolidated net income for 1928. 970 The respondent on brief states that his contention upon this issue is set forth in G.C.M. 8132, IX-1 C.B. 287, 292. We have examined this memorandum, but we cannot agree with the view therein presented that the portion of a consolidated net loss for a prior year properly attributable to a member of an affiliated group may be applied in a subsequent year against the "consolidated net income allocable" to such member, or in other words, that the net income of a member in a subsequent year must first be reduced proportionately by the loss of other members before deducting the prior year's net loss attributable to such member. Decision will be entered under Rule 50Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * (i) Net losses. - The special deduction for net losses of prior years, to the extent provided in section 117. SEC. 117. NET LOSSES. (b) Net loss as a deduction. - If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called "second year"), and if such net loss is in excess of such net income (computed without such deduction), the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding year (hereinafter in this section called "third year"); the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary. * * * (e) Net loss for 1926 or 1927.↩ - If for the taxable year 1926 or 1927 a taxpayer sustained a net loss within the provisions of the Revenue Act of 1926, the amount of such net loss shall be allowed as a deduction in computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622707/	LEN O. HANNAMAN AND WILDEANA HANNAMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHannaman v. CommissionerDocket No. 7678-88United States Tax CourtT.C. Memo 1991-96; 1991 Tax Ct. Memo LEXIS 115; 61 T.C.M. (CCH) 2067; T.C.M. (RIA) 91096; March 5, 1991, Filed 115 Decision will be entered under Rule 155. Janet L. Bolvin, for the petitioners. Robert P. Crowther, for the respondent. PARR, Judge. PARRMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in and additions to petitioners' joint Federal income taxes as follows: Additions to TaxYearDeficiency1 Section 6653(a) Section 6653(a)(1)Section 6653(a)(2)1979$ 5,720.00 $ 286.00----1981$ 3,726.00 --$ 186.00 1982$ 10,534.00--$ 529.95* After concessions by respondent, 2 the issues remaining for decision are: (1) Whether a component structure described more particularly herein is "section 38 property" as defined in section 48(a)(1); (2) whether the component structure avoids the section 46(a)(3)116 disqualification of lodging facilities as section 38 property; and (3) whether petitioners avoid the section 46(e)(3) noncorporate lessor limitation by having "manufactured or produced" the property for which they claim investment tax credit. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated herein by this reference. Petitioners 3 resided in Anchorage, Alaska, at the time they filed their petition in this case. 117 Petitioner began working in construction as an apprentice electrician at the age of 14. Since then he has been a marketing representative and group manager of marketing representatives for manufacturers of modular structures. In 1975 petitioner organized his own construction company named L & H Enterprises, Inc. (LHEI). LHEI specializes in construction of pre-engineered buildings, but also performs general construction work. During the relevant period, LHEI employed carpenters, engineering consultants, a draftsman/designer, a mechanical contractor, and an electrical contractor. Petitioner is president and chief executive officer of LHEI. His duties include selling construction projects, managing the office paperwork and office staff, and managing the design and construction of projects. He averages building one build-leaseback property every two to three years. One of petitioner's build-leaseback projects was an office building leased to Geophysical Service, Inc. (GSI). By late 1981, GSI was planning a support camp facility to be used in connection with its seismic exploration of the Prudhoe Bay off Alaska's northern coast. On March 30, 1982, the State of Alaska, as lessor, 118 and GSI, as lessee, entered into a lease for a parcel of land at the airport in Deadhorse, Alaska, to be used for their support camp facility (Alaska Lease). The Alaska Lease had a 35-year term beginning May 7, 1982, and authorized the following uses: Construction, maintenance, and operation of office and shop buildings for use in conjunction with [GSI's] seismic exploration services; storage of seismic camp units and equipment; maintenance of seismic camp units and equipment; storage of heating and vehicle fuel; and food and lodging for [GSI's] employees and sublessee's employees only.The Alaska Lease also contained the following special covenant: 9. Use of the Premises for any of the following purposes is hereby specifically prohibited: Commercial hotel providing lodging services to the general public, restaurant or other facility providing meal services to the general public, liquor store, bar, and cocktail lounge.GSI's facilities manager, Rob Mood, consulted petitioner during the period the performance specifications for the proposed camp were prepared. The performance specifications developed at GSI's request for the facility were compiled in a 50-plus-page119 document entitled "Technical Specifications for Pad Installation and Camp and Service Building Design and Construction" (Specifications Document). GSI solicited competitive bids for construction of the support camp based upon the Specifications Document which described the scope of work to be performed as follows: This contract shall include the design, fabrication, and installation of the camp, service building, and a gravel pad at the Prudhoe Bay site. This contract shall include all labor, transportation, and materials required to provide an operating camp, service building as described herein, and gravel pad as shown on the drawings.The Specifications Document contains drawings of the site plan, front and rear elevation views of the shop building, and floor plans for the shop building. The site plan, dated March 1982, shows the area of the leased parcel that is to be covered by a gravel pad, and locations on the gravel pad for the service building and camp. The Specifications Document does not contain a floor plan for the camp unit, but places a rectangular camp unit approximately 50 feet from the service building. The Specifications Document also provides as follows: 120 1.3.1 Calculations(a) Subcontractor shall collect and develop the following data and shall use these data as the basis for sizing the system components, checking system performance, and setting system protective relays and devices: (1) load list (2) Short Circuit data2.3.13 GeneratorsThe Contractor shall furnish two identical diesel generator sets of equal KW capacity output, each sized to handle the complex load, plus a minimum of 25% extra capacity above this load. Additionally, the generator radiator shall be ducted to the service building warehouse, and a small blower attached to capture waste heat. * 2.3.15 Support for EquipmentContractor shall provide all necessary supports for equipment installed under this specification section. * Petitioner submitted a bid in the name of Len O. Hannaman & Associates (LOHA). He used the "& Associates" designation to provide for the eventuality of bringing in partners if he could not obtain sufficient capital to finance the project himself. LOHA has always been petitioner's sole proprietorship and has never had partners or associates. GSI assigned the Alaska Lease to LOHA on July 8, 121 1982. The lease assignment agreement required LOHA to assume all rights and obligations of GSI under the Alaska Lease, and to comply with all terms and conditions contained therein. LOHA, as lessor, simultaneously subleased the parcel back to GSI, as lessee, on July 8, 1982. The sublease contained the following recitals: B. Alaska Industrial Development Corporation ("AIDA") has adopted a resolution whereby it will issue 10-year industrial development bonds (the "Bonds") for the purpose of having certain improvements constructed by the Lessor, [LOHA] to the specifications of the Lessee, [GSI] on the land covered by the Ground Lease. The Bonds shall be paid from the rental of such improvements. C. Lessor [LOHA] and Lessee [GSI] now desire to arrange for the construction of the improvements and the terms of the agreement for subleasing of the real property covered by the Ground Lease, [Alaska Lease] together with the improvements.The sublease was for an initial 10-year period with two successive 5-year renewal options, and contained the following covenants: Construction and Use of PremisesIt is understood and agreed that Lessor [LOHA] will construct on the122 land the Improvements for the use of the Lessee, [GSI] described as follows: 10 acre gravel fill pad 5 feet deep, 6250 gross square foot shop/warehouse building, and a camp building of approximately 4600 square feet to accommodate 33-person living quarters.The improvements shall be constructed in accordance with the Plans and Specifications. The Plans and Specifications have been examined and approved by Lessee. If Lessor finds it is necessary or appropriate to make any changes in the Plans and Specifications at any time prior to or during construction, Lessor must first obtain Lessee's written consent, which consent shall not be unreasonably withheld. Lessor shall complete construction of the Improvements by , 1983. The Lessor shall be responsible for methods of construction, installation of materials and equipment, and warrants that the Improvements will be constructed in compliance with the applicable laws, ordinances, rules, and regulations of the governing body(ies) having jurisdiction over such construction: and any damages resulting from a breach of this warranty will be the sole responsibility of the Lessor, subject to the limitation on claims by the Lessee 123 * 29. Acceptance of ImprovementsUpon written notice from Lessor that the Improvements are completed, Lessee agrees to make an immediate inspection of the Improvements and to acknowledge acceptance thereof as completed in accordance with the Plans and Specifications, or to give the Lessor written notice of such items the Lessee deems to be incomplete, such items hereinafter referred to as "Punch List Items." If the Punch List Items do not prevent the Lessee from using the Premises for the intended use, then rent payments shall commence from the date of Lessor's notice of completion and the Lessor shall proceed forthwith to complete the Punch List Items. If the Punch List Items are such that the Lessee may not use the Premises for the intended purpose until completion of such items, the rent payments for the Improvements shall not commence until the Punch List Items are completed, or the Bonds are issued, whichever occurs first. The expiration date shall not be extended for the time used in completing the Punch list Items.On July 12, 1982, LOHA formally entered into a contract with LHEI for the construction of the GSI facility. That contract provides as follows: 124 The Contractor shall perform all the Work required by the Contract documents, including materials, labor, equipment, supervision, and related management services as described herein: Design and construct a 10 acre gravel pad, 6,250 square foot shop building, and a 33 man modular camp, in accordance with contract drawings and specifications. Contract price includes all design costs, permitting, freight, travel expense, room and board cost, equipment, material, labor and management services, as required for a complete turnkey construction of the above facility.The service building LHEI constructed for the facility is a pre-engineered steel building. Adjacent to the service building is an electrical power generation module. The power generation module provides the electrical power supply to the whole 20-acre site and consists of two 250 kilowatt generator sets (gensets) placed on a metal skid covered by a protective shed. The shed is an integral part of the generator module that protects the gensets and associated controls from the harsh environment of Alaska's north slope. The shed protecting the gensets is constructed of a wood frame with a sheet metal exterior matching125 the service building. The shed is connected to the service building solely by 26-gauge flashing to prevent snow from falling in between the generator module and the service building. The shed has two doors that provide access to allow maintenance personnel to service the gensets and room for nothing other than the gensets and service space. There is also an air duct running from the generator module to the shop that allows the waste heat from the generators to flow into the service building. LHEI procured the gensets and metal skid from Waukesha Alaska Corporation. The gensets are assembled from a Kato generator and a Deutz diesel engine and are anchored to the skid. 4 The metal skid is placed on timbers to level the gensets and prevent them from sinking into the gravel. The power generation module is a mobile unit and may be transported by merely placing the skid on a trailer or long flat-bed truck. 126 On June 4, 1982, Evergreen Mobile Co. (Evergreen), as a subcontractor, submitted a bid to LHEI, as general contractor, for construction of the 33-man camp facility which, after modifications, was ultimately accepted. The camp facility is a two-story structure constructed from eight subunits each resembling a mobile home from the exterior. The subunits were manufactured in Washington State and hauled on dollies to the Seattle, Washington, docks. From Seattle, they were shipped by barge to Anchorage, Alaska, then transported by truck over the Haul Road to the Deadhorse Airport site for final assembly. Upon arrival at the construction site, the four ground-floor units were anchored to steel pilings, leveled, and squared. Two of the ground floor subunits were laid end-to-end, and the other two ground floor subunits, also laid end-to-end, were placed in juxtaposition to the other two leaving a gap between them. A corridor consisting of 4- by 8- foot sections was placed in the gap on steel angled shelves forming the hallway for the completed floor. In an identical fashion, the four top floor subunits were stacked on the first floor units and additional 4- by 8-foot sections were127 placed in the gap for the top floor hallway. Final on-site assembly of the camp building included connecting the electrical supply, connecting the plumbing supply and disposal, hanging doors, assembling permanent furniture, and building the exterior stair wells. The following table represents petitioner's cost in constructing the support camp. Site preparation (10 acre gravel pad)and shop and warehouse building $ 1,963,607Modular structure:Purchase price of modular units $ 261,360Freight 50,324Subcontract 33,205Labor and materials 27,311Overhead allocation 44,664416,864Generator and surrounding structure:Purchase of generator and base plate $ 106,469Freight 11,101Labor 10,000Overhead allocation 16,152Miscellaneous materials 7,030150,752Petitioner assisted in selecting the work crews used to perform the construction labor. Because of financing concerns, he also supervised construction costs and was involved in the negotiations and purchasing decisions for the modular units and generator equipment. The on-site day-to-day construction was supervised by Aaron Jones, the project supervisor employed by LHEI. 128 Petitioner visited the construction site approximately five or six times during the construction period. One of those visits was the final inspection for completing the "punch list." However, petitioner was in daily contact with Mr. Jones. By November 1982 GSI had moved in and was using the facility. More than 50 percent of the 33-man camp structure was used as living accommodations for GSI employees, none of whom stayed more than 30 days at any one time. In addition to GSI employees, two caretakers provided under contract by Arctic Hosts, Inc., stayed at the camp. Petitioner claimed investment tax credit in 1982 based on the cost of the modular structure and the generator with its surrounding structure. He did not claim investment credit for the shop and warehouse building or the gravel pad. Respondent disallowed the investment credit because the 33-man camp structure is a building and not section 38 property; because the 33-man camp structure does not fall within the section 48(a)(3) lodging exception; and because petitioner is a noncorporate lessor within the meaning of section 46(a)(3). OPINION During the relevant period, 5sections 38 and 46 allowed, inter alia, a 129 tax credit for the investment in qualifying property (i.e., "section 38 property") as defined in section 48. Petitioner bears the burden of proving he is entitled to the credit. Rule 142(a). He contends that the 33-man modular structure is section 38 property as described in section 48(a)(1) and not a "building" under decided case law; and, he falls within the section 48(a)(3) exception for property used for lodging. Section 48(a) provides, in relevant part to our discussion, 6 as follows: SEC. 48 DEFINITIONS; SPECIAL RULES (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)* * * (3) Property used for lodging. -- Property which is used130 predominantly to furnish lodging or in connection with the furnishing of lodging shall not be treated as section 38 property. The preceding sentence shall not apply to -- (B) property used by a hotel or motel in connection with the trade or business of furnishing lodging where the predominant portion of the accommodations is used by transients.A cursory reading demonstrates that section 48(a)(1)(A) generally describes section 38 property and section 48(a)(3) provides a specific exclusion of property predominantly used for lodging from the section 38 property description. However, section 48(a)(3) also excepts certain property from that exclusion. A time-honored principle in statutory construction is that specific provisions of a statute prevail over its general131 provisions. See Bulova Watch Co. v. United States, 365 U.S. 753">365 U.S. 753, 758, 6 L. Ed. 2d 72">6 L. Ed. 2d 72, 81 S. Ct. 864">81 S. Ct. 864 (1961); Ginsberg & Sons v. Popkin, 285 U.S. 204">285 U.S. 204, 208, 76 L. Ed. 704">76 L. Ed. 704, 52 S. Ct. 322">52 S. Ct. 322 (1932). There can be no serious dispute that the 33-man camp structure was used predominantly to furnish lodging for GSI employees. Therefore, unless the exception applies, we need not decide whether the modular structure is section 38 property as generally described in section 48(a)(1)(A). Section 48(a)(3)(B) excepts property used by a hotel or motel in connection with the trade or business of furnishing lodging where the predominant portion of the accommodations is used by transients. Petitioner was not in the trade or business of providing lodging and was expressly prohibited by the lease from operating a hotel. Thus, petitioner does not fall within the lodging exception. The 33-man camp structure is not section 38 property and does not qualify for investment tax credit. Respondent concedes the generator module is section 38 property; however, he disallowed petitioner's claimed investment tax credit because petitioner is a noncorporate lessor. Petitioner contends that he "manufactured or produced" the generator132 module and, therefore, falls within the section 46(e)(3)(A) exception. 7Section 46(e)(3)(A) provides, in relevant part, as follows: (3) Noncorporate Lessors. -- A credit shall be allowed by section 38 to a person which is not a corporation with respect to property of which the person is the lessor only if -- (A) the property subject to the lease has been manufactured or produced by the lessor * The focus of the "property subject to the lease" language is the leased property for which the investment tax credit is sought. Egizii v. Commissioner, 86 T.C. 450">86 T.C. 450, 455 (1986). The lessor would have to be the one who actually manufactured the property or the one who at least controlled the details of manufacture of the property to satisfy section 46(e)(3)(A). Carlson v. Commissioner, 79 T.C. 215">79 T.C. 215, 222 (1982),133 affd. 712 F.2d 1314">712 F.2d 1314 (9th Cir. 1983) The terms "manufactured or produced" include "constructed". S. Rept. No. 92-437 (1971), 1 C.B. 559">1972-1 C.B. 559, 583. The accompanying regulation adds the requirement that the subject property must be manufactured or produced in the ordinary course of the lessor's business. Sec. 1.46-4(d)(1)(i), Income Tax Regs. With the foregoing principles in mind, the question we must answer is whether petitioner exercised sufficient control over the generator module construction details 8 in the ordinary course of his business to satisfy section 46(e)(3)(A). We first construed section 46(e)(3)(A) in Carlson v. Commissioner, supra. The lessor-taxpayer in Carlson leased apple bins physically assembled by the lessee's employees. He failed to convince the Court that he controlled the details of assembly or that his involvement in the assembly was anything134 more than reimbursing the lessee for the expenses of completing assembly of the apple bins. We stated that "property is not transformed into property manufactured by the lessor simply because the lessor pays the costs and expenses associated with manufacturing it." 79 T.C. at 223. We next interpreted section 46(e)(3)(A) in Egizii v. Commissioner, supra, a case factually closer to the instant case, but also distinguishable. Therein, the taxpayers contracted with an unrelated construction corporation to build a warehouse the taxpayers leased to their wholly owned corporation. Even though the taxpayers held weekly consultations with their architect and made weekly inspection visits to the construction site, their involvement in the construction overall was limited to discerning the propriety of progress payments. The contractor therein was responsible for the construction details under the terms of the construction contract. Egizii v. Commissioner, 86 T.C. at 457. We dismissed the taxpayers' role in the overall construction and held that entitlement to the investment tax credit depended upon the lessor's manufacture of the135 section 38 property subject to the lease, not the entire property subject to the lease. In both Carlson and Egizii, we considered factors such as the provision of the specifications for the property and the selection, supervision, and instruction of the workers to be the significant factors in deciding whether the taxpayer exercised sufficient control over construction details. Neither of these factors is necessarily controlling, and they collectively amount to the exercise of control over the construction details. The clear import of our decisions in both cases is that taxpayers must do more than merely finance the project; they must be actively involved in the construction to be considered the "manufacturer or producer" of the section 38 property. Those cases do not, however, specify the minimum level of involvement sufficient to satisfy the statute and we do not intend to do so here. The most obvious distinguishing features of this case and Egizii are (1) petitioner's wholly owned construction corporation actually constructed the property for which the investment tax credit is sought, i.e., the generator module; and, (2) petitioner individually was responsible 136 for the construction methods and installation of materials and equipment. Petitioner may not rely on his status as president and chief executive officer of LHEI to fulfill the construction requirement of the statute. Such status is not equivalent to involvement. 9 We must examine petitioner's actual involvement, as proprietor of LOHA, in building the generator module with the caveat that some of the functions petitioner performed in his corporate capacity in the overall project necessarily affect the generator module. 137 Petitioner was consulted during the period GSI was compiling the Specifications Document. The extent to which petitioner's suggestions, if any, were eventually incorporated into the Specifications Document is not clear from the record. 10 However, the Specification Document does not contain blue-prints for the facility or specify the size or manufacturer of the generators to be used. Further, the Specifications Document clearly states that the design for the entire facility, other than the site plan and warehouse building, is the contractor's responsibility. The generator module actually built differs from the configuration of the "generator building" shown on the warehouse floor plan in the Specifications Document. Those specifications138 require that the contractor provide support for the equipment, but do not specifically require the gensets to be placed on metal skids. The concrete flooring of the warehouse building could easily have been extended to provide support for the gensets. 11 The least that may accurately be stated is that provision of the detailed project specifications was a cooperative effort between GSI and petitioner. 139 The portions of the Specifications Document regarding the generator requirements served as the basis for soliciting bids from suppliers of electrical generators. The Specifications Document requires installation of two equal kilowatt electrical generators sized to handle the complex load, plus an extra 25-percent capacity. Petitioner's subcontractor was required by the Specifications Document to calculate the complex load and determine the required generator size. Petitioner did not have the resources or equipment to manufacture gensets which, in any event, were purchased. The gensets, however, are only two of the components comprising the generator module. The sublease agreement petitioner entered into after having been awarded the project required him to construct the agreed-upon improvements and placed the responsibility for "methods of construction, installation of materials and equipment" upon him. Petitioner assisted in selecting the construction workers, chose the supplier of the gensets, and was responsible for the generator module installation and testing. The construction workers were supervised by a project supervisor employed by LHEI who was in daily contact with140 petitioner. Petitioner's role in the construction process may summarily be described as that of the prime contractor. The significant factors critically absent in Carlson and Egizii (i.e., provision of specifications, and selection, supervision, and instruction of workers) are at least tangentially present in this case. Based on the entire record we conclude that petitioner constructed the generator module in the ordinary course of his business and is entitled to the investment tax credit for the generator module. Respondent argues that petitioner must respect LHEI as a corporate entity and may not disregard its existence in determining whether he individually was the manufacturer. See Bollinger v. Commissioner, 485 U.S. 340">485 U.S. 340, 99 L. Ed. 2d 357">99 L. Ed. 2d 357, 108 S. Ct. 1173">108 S. Ct. 1173 (1988); National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, 93 L. Ed. 779">93 L. Ed. 779, 69 S. Ct. 726">69 S. Ct. 726 (1949); Moline Properties v. Commissioner, 319 U.S. 436">319 U.S. 436, 87 L. Ed. 1499">87 L. Ed. 1499, 63 S. Ct. 1132">63 S. Ct. 1132 (1943). Petitioner cites the same authority and argues essentially that LHEI was petitioner's agent for construction. A corporation is a separate taxable entity; however, it is also an artificial creature created under statute that may only act through its officers, agents, 141 and employees. A fair inference is that petitioner submitted his bid contemplating that his corporate employees would perform the physical construction labor under his direction as proprietor of LOHA. Thus, whether or not the corporation was petitioner's agent, petitioner individually controlled the generator module construction details sufficiently to satisfy section 46(e)(3)(A). We have considered the parties' alternative arguments on all issues presented, and conclude they are unpersuasive. To reflect respondent's concessions and 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 for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩*. 50 percent of the interest payable on the deficiency.↩2. Respondent concedes the additions to tax under section 6653(a), and that petitioners incurred a net operating loss in 1985 that may be carried back to 1982.↩3. Inasmuch as Wildeana Hannaman is a party to this proceeding solely because she filed joint returns with her husband, for convenience we will hereinafter refer to Len O. Hannaman as petitioner.↩4. Petitioner purchased the skid upon which the gensets rested from the manufacturer of the gensets because they quoted the lowest price. The gensets were attached to the skid by Waukesha prior to shipment.↩5. The investment tax credit was repealed by sec. 211(a) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2166, effective, subject to transition rules, for property placed in service after December 31, 1985.↩6. We assume petitioner is arguing the modular structure meets the general section 48(a)(1)(A) requirements. Section 48(a)(1)(B) includes "other tangible property" only if it is used by the taxpayer in enumerated activities which do not apply here.↩7. Petitioner has stipulated that the lease term with extensions exceeds one-half of the useful life of the leased property and does not assert that the tests set forth in sec. 46(e)(3)(B)↩ are satisfied.8. Petitioner does not contend that he labored in physically building the generator module.↩9. Miyamoto v. Commissioner, T.C. Memo 1986-313">T.C. Memo 1986-313, involved a case strikingly similar to Egizii v. Commissioner, 86 T.C. 450↩ (1986). Therein, partnerships were formed to lease restaurants and restaurant equipment associated with a national fast-food chain. One of the partners owned, and was president of, a construction corporation that contracted for construction involving two of the restaurants. The extent of any construction work performed by that partner was not attributed to the partnerships. To the extent manufacture of the restaurant components may have been accomplished by construction, the partnerships failed to prove they exercised control over the construction details in the ordinary course of their business.10. Petitioner argues that the specifications initially called for a T-shaped drilling complex for the camp portion of the facility and he changed the shape of the camp to a rectangular structure. The Specifications Document site plan dated March 1982 indicates to the contrary.↩11. The Specifications Document provides for placement of a concrete pad for the service building "in accordance with the attached specification 'Concrete Placement'." The "Concrete Placement" specification is not included with the Specifications Document which was the parties' joint exhibit. It is not significant that "Concrete Placement" specifications are not included in the Specifications Document because if the specifications document required the generators to be anchored to the concrete slab, they were not. If the gensets were not required to be anchored to the concrete slab, they could have been. Either scenario demonstrates petitioner's flexibility in building the module.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622708/	CAROL PATTON HAGERTY (Formerly Mrs. Carol Patton), 1 Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Hagerty v. CommissionerDocket Nos. 4034-70, 4792-70, 5497-70United States Tax CourtT.C. Memo 1973-162; 1973 Tax Ct. Memo LEXIS 125; 32 T.C.M. (CCH) 788; T.C.M. (RIA) 73162; July 24, 1973, Filed 125 During 1963 and the major portion of 1964 petitioners traveled throughout Europe selling the products of the American corporation. In October of 1964 they returned to Europe, settling in France, to assist their customers in merchandising the products sold in the earlier years, to create and test new marketing and advertising ideas for the American corporation and to form a European sales office which would take over the selling activities of the American corporation. Petitioners returned to the United States in June of 1966. Held: Petitioners were bona fide residents of a foreign country for one entire taxable year and the income received while residents of France was attributable to services performed in a foreign country and therefore such income is excludable under sec. 911. Stephen A. Seall and James F. Thornburg, for the petitioners. Robert P. Ruwe, for the respondent. 2 STERRETTMEMORANDUM FINDINGS OF FACT AND OPINION STERRETT, Judge: The Commissioner determined deficiencies in petitioners' Federal income taxes as follows: PetitionerDocket No.YearAmount Carol Patton Hagerty4034-701966$3,894.03Carol Patton Hagerty4792-7019655,620.00William J. Hagerty5497-7019664,167.16126 The sole issue presented for adjudication relates to whether the income received by petitioners during the years in issue qualifies under section 9112 as earned income from sources without the United States and is thereby exempt from taxation. This decision rests on: (1) Whether petitioners were bona fide residents of a foreign country for an uninterrupted period which includes an entire taxable year, and (2) Whether the payments by W. J. Hagerty & Sons, Ltd., Inc., an American corporation, to petitioners constitute earned income attributable to personal services performed in a foreign country. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation, together with the exhibits attached thereto, are incorporated herein by this reference. 3 Carol Patton Hagerty (formerly Mrs. Carol Patton) (hereinafter referred to as Carol or petitioner) filed her 1965 and 1966 Federal individual income tax returns with the district director of internal revenue at Indianapolis, Indiana. William J. Hagerty (hereinafter referred to as Hagerty or petitioner) filed his 1966 127 Federal individual income tax return with the district director of internal revenue at Indianapolis, Indiana. At the time of the filing of the petitions herein the petitioners resided in South Bend, Indiana. W. J. Hagerty & Sons, Ltd., Inc. (hereinafter referred to as the American corporation) was incorporated under the laws of the State of Indiana on February 1, 1961. During the years in issue the American corporation engaged in the business of selling silver polish and related items (hereinafter sometimes referred to as the Hagerty Products), which had been originated by Hagerty's mother and father. From the time of its incorporation until August 11, 1964, Hagerty was the president and treasurer of the American corporation. Thereafter he became chairman of the board with his brother, M. Patrick Hagerty (hereinafter referred to as Patrick) assuming the position of president and his mother, Mary Helena Hagerty (hereinafter referred to as Mary) accepting the post of secretary. In addition to himself, his 4 brother and mother, various other relatives were also employed by the American corporation. The outstanding stock of the American corporation consisted of 10 shares which were 128 owned by petitioner from February 1961 through December of the same year, at which time said shares were transferred pro rata to the grandchildren of petitioner's father. Whenever a new grandchild was born, the original 10 shares were redivided and reissued. During 1963 and 1964, Hagerty and Carol traveled extensively throughout Europe to merchandise the silver polish, tarnish preventive, and related products of the American corporation to European silversmiths. Carol was Hagerty's secretary and administrative assistant. The American corporation's European sales during this 2 year period totaled approximately $915,000. Sales for 1963 and 1964 may be summarized as follows: CustomerGross Sales for 1963Sales CreditsNet Sales Van Kempen & Begeer - Holland$305,447.22$57,809.00$247,638.22Van Kempen & Begeer - Belgium11,840.0011,840.00Van Kempen & Begeer - Germany50,924.8050,924.00Van Kempen & Begeer - Swiss7,488.007,488.00McArthur - Ireland1,728.00136.401,591.60Christofle - France1,321.631,081.63240.00Kronen-Denmark8,064.00186.107,877.90Guldsmeds - Sweden48,928.5648,928.56Olafsson - Iceland678.00678.00$436,420.21$59,213.13$377,207.08 5 CustomerGross Sales for 1964Sales CreditsNet Sales Van Kempen & Begeer - Holland$191,169.80$103,415.52$87,754.28Van Kempen & Begeer - Belgium45,300.0045,300.00Van Kempen & Begeer - Germany40,960.0040,960.00Van Kempen & Begeer - Swiss15,691.3015,691.30Van Kempen & Begeer - Austria2,928.282,928.28David Anderson - Norway40,838.2040,838.20Christofle - Italy2,464.801,040.921,423.88McArthur - Ireland2,289.60545.761,743.84Hopeakeskus - Findland12,451.8084.7312,367.07Christofle - France24,105.0024,105.00Kronen - Denmark17,828.28339.1017,489.18Guldsmeds - Sweden98,259.4498,259.44Olafsson - Iceland1,012.051,012.05$495,298.55$105,426.03$389,872.52The 129 credits issued were due in part to the return of the merchandise to the American corporation. The American corporation did not receive payments for the goods sold until its customers conveyed the products to their retail dealers. The accounts receivable reflected on the American corporation's books as a result of the 1963 and 1964 sales are noted as follows: CustomerAccounts Receivable as of Dec. 31, 1964 Van Kempen & Begeer$68,182.52David Anderson32,870.20Christofle - Italy1,140.00McArthur1,743.84Hopeakeskus6,624.17Christofle - France24,105.00Kronen2,681.00Guldsmeds98,259.44Olafsson334.05$235,940.22 6 The accounts receivable representing 1963 and 1964 sales were substantially paid by November 9, 1965. On October 8, 1964 and October 27, 1964, respectively, Hagerty and Carol traveled to Europe to assist their customers in merchandising the products sold in 1963 and 1964 through the creation of various advertising programs, so as to stimulate payment of the yet unpaid accounts, to create and test new marketing and advertising ideas for the American corporation, to form a European sales office which would take over the selling activities of the American corporation, and generally 130 to give the European customers better service. On first arriving in Europe, Hagerty, for approximately 6 to 8 weeks, traveled throughout the continent as a salesman. Thereafter in December of 1964, he, along with Carol and their two children (one from Carol's previous marriage) settled on the French Riviera. They first acquired an apartment in Cannes but shortly thereafter moved to a home a short distance away in La Napoule, France. They intended to remain for at least 1 year. From December 1964 until their permanent return to the United States on June 25, 1966, petitioners lived in a rented home or apartment. The children attended school and the petitioners generally became involved in community life. They formed friendships with the people of the village 7 and participated in various social and cultural events. Hagerty maintained French bank accounts. Petitioners made no statements to French public officials that they were not residents of France. On January 1, 1965, Hagerty established a proprietorship which sold Hagerty products in Europe until May 14, 1965. At that time he formed W. J. Hagerty & Sons, Ltd., Inc., Treuunternehmen Reg. (hereinafter the Trust) a Liechtenstein131 Trust which assumed the European selling activities. Of approximately $344,000 of Hagerty products sold in Europe during 1965 no more than $12,000 was attributable to the American corporation. During the period that petitioners resided in Europe they rendered administrative, promotional, merchandising, marketing and advertising services to their European customers on behalf of the American corporation as well as the newly formed Trust. Specifically, with regard to the American corporation, they administered the making of adjustments and credits due to faulty products, originated and tested advertising campagins and sales contests, initiated letter-writing campaigns from European to American customers and created companion products. In addition, petitioners rendered substantial services to the American corporation during that same 8 period by advising and counseling the American corporation with respect to the promotional, merchandising, marketing and advertising programs which they were developing and utilizing in Europe so that the American corporation could in turn utilize such programs in the United States' market. From October 1964 to June of 1966 Hagerty returned to the United 132 States on three occasions; in May of 1965 for approximately 2 weeks, from October 7, 1965 to November 26, 1965 and in May of 1966, remaining for an additional 2 weeks. Carol traveled to the United States from November 5 to November 27, 1965, returning to Europe with Hagerty. Hagerty's trips to the United States were prompted by a desire to see his family, render services to the American corporation and to meet with representatives of the Internal Revenue Service who were in the process of investigating the activities of the American corporation. Carol, during her stay in South Bend, also worked for the American corporation. In November of 1965, while in the United States, Hagerty stated before the intelligence division of the Internal Revenue Service, with regard to his name and address that "[my] name is William Joseph Hagerty, 1820 Portage Avenue, South Bend, Indiana, Zip 46616." Petitioners intended to return to Europe after each visit to the United States. 9 Hagerty and Carol returned to the United States on June 25, 1966, due to the American corporation's substantial drop in sales during the previous year. Subsequently, Hagerty worked strenuously to improve the sales activities 133 and financial condition of the American corporation. Carol did little if any work for the American corporation as she was pregnant. The petitioners, following their June arrival in South Bend, did not intend to return to Europe. For the year ended December 31, 1965, Carol received a salary from the American corporation of $21,200. In 1966 she reported income paid by the American corporation of $10,000. Hagerty's compensation for 1966 totaled $30,000. The salaries (with the exception of $1,200 received by Carol in 1965) for both years were awarded at board of directors' meetings held November 23, 1965 and December 23, 1966, respectively. The payments were made by the transfer of bonds held by the American corporation in its Switzerland account since the corporation had a shortage of cash. The Federal income tax returns of petitioners for 1966 indicate that Carol and Hagerty received "Liechtenstein Trust Corporation [Distributions]" of $13,000 and $6,000 respectively. Carol excluded $20,000 of the $21,200 received in 1965 from her income. Both petitioners excluded 176/365 (allocable portion of the year spent in Europe) of the total remuneration received in 1966. 10 OPINION 134 We are required to determine whether the income received by Carol during 1965 and 1966, and the income received by Hagerty in 1966 is excludable under the provisions of section 911. The statute provides in pertinent part: SEC. 911. (a) GENERAL RULE. - The folloiwng items shall not be included in gross income and shall be exempt from taxation under this substitle: (1) Bona fide resident of foreign country. - In the case of an individual citizen of the United States who establishes to the satisfaction of the Secretary or his delegate that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such uninterrupted period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c). Respondent contends that petitioners were not bona fide residents of a foreign country for one entire taxable year, and further that the income received does not 135 constitute earned income attributable to services performed in a foreign country. Petitioner, to the contrary, maintains that the section 911 requirements have been met. The question of residence is solely one of fact. Frederick F. Hack, 33 T.C. 1089">33 T.C. 1089 (1960). "[Each] new case must be decided on the basis of its own unique attendant 11 circumstances." Donald H. Nelson, 30 T.C. 1151">30 T.C. 1151, 1153 (1958). While the statute does not define the phrase "bona fide resident", the regulations at 1.911-2(a) (2) 3 direct us to section 871 and its applicable regulations for guidance. Section 871 concerns the taxation of nonresident aliens present in the United States. Regulation 1.871-2(b) which contains the pertinent provisions applicable herein, required that the individual not be "a mere transient or sojourner." Such is determined "by his intentions with regard to the length and nature of his stay." Further, "[one] who comes * * for a definite purpose which in its nature may be promptly accomplished is a transient; but if his purpose is * * * such * * * that an extended stay may be necessary for its accomplishment, * * * he becomes a resident, though it may be his intention at all times 12 to 136 return to his domicile abroad when the purpose for which he came has been consummated or abandoned." 4137 The Court of Appeals for the Seventh Circuit in Sochurek v. Commissioner, 300 F. 2d 34 (C.A. 7, 1962) revg. 36 T.C. 131">36 T.C. 131 (1961), compiled a list of factors considered in determining whether an individual has satisfactorily established his claim of a bona fide foreign residence. They include: 138 13 (1) intention of the taxpayer; (2) establishment of his home temporarily in the foreign country for an indefinite period; (3) participation in the activites of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment; (4) physical presence in the foreign country consistent with his employment; (5) nature, extent and reasons for temporary absences from his temporary foreign home; (6) assumption of economic burdens and payment of taxes to the foreign country; (7) status of resident contrasted to that of transient or sojourner;(8) treatment accorded his income tax status by his employer; (9) marital status and residence of his family; (10) nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time; (11) good faith in making his trip abroad; whether for purpose of tax evasion. Applying these factors to the instant cases, it is our conclusion that on balance, they favor a holding that both petitioners were bona fide residents of France for a period that included an entire taxable year. Petitioners traveled 139 to Europe to assist their customers in selling the Hagerty products so as to stimulate the payment of the almost $240,000 of accounts receivable, to create and test various advertising programs and to form a European sales office. Clearly these goals were not likely to be accomplished in a short period of time. Hagerty's own correspondence indicated his intention to remain in Europe for at least 1 year. Carol and Hagerty departed for Europe in October of 1964 settling in France during the month of December. They 14 did not permanently return to the United States until June of 1966. During that period they rented a home, opened several bank accounts, sent their children to school and generally became involved in community life. Finally, we note that the parties' ultimate return in 1966 was not a planned event but rather was caused by the American corporation's drastic decline in sales. Thus, we conclude that petitioners intended to become foreign residents and were not mere transients. Respondent notes however that petitioners have failed to introduce evidence with regard to the payment of foreign income taxes. Such fact is relevant but not controlling. Section 911 was enacted 140 to aid the American businessman abroad. There is nothing to indicate that the statute's purpose was to avoid double taxation. Leigh White, 22 T.C. 585">22 T.C. 585 (1954); David E. Rose, 16 T.C. 232">16 T.C. 232 (1951); Carpenter v. United States, 348 F. Supp. 179">348 F. Supp. 179 (N.D. Tex., 1972); see Scott v. United States, 432 F. 2d 1388 (Ct. Cl., 1970), for a full discussion of the legislative purpose and history. We further note that petitioners' short trips to the United States do not deprive them of a foreign residence. As respondent's regulations state: 15 Sec. 1.911-2(a) (2). What constitutes bona fide residence. Though the period of bona fide foreign residence must be continuous and uninterrupted, once bona fide residence in a foreign country or countries has been established, temporary visits to the United States or elsewhere on vacation or bsuiness trips will not necessarily deprive the citizen of his status as a bona fide resident of a foreign country. Such is consistent with the applicable legislative history. See Senate Rept. No. 1631, 77th Cong., 2d Sess. (1942), p. 116. The facts noted above indicate that petitioner's visits were motivated by business necessities and a desire to see Hagerty's family. 141 They always intended and did in fact return to Europe. We therefore conclude that the various trips do not adversely affect our conclusion regarding the parties' foreign residence. See Carpenter v. United States, supra; David E. Rose, supra, and the cases cited therein. We must next decide whether the income recieved by petitioners was earned while in a foreign country. Preliminarily we note that: An amount constituting earned income which is derived from sources without the United States shall not be included in gross income solely because it is received within the United States, since the place of receipt is immaterial in determining whether any items shall be excluded from gross income. [Sec. 1.911-2(c) (4)] Andrew O. Miller, Jr., 52 T.C. 752">52 T.C. 752 (1969). 16 Respondent contends however that the payments received by the petitioners from the American corporation during the years in issue do not represent income attributable to foreign services. In support of this contention he relies on the fact that the American corporation substantially reduced its European selling activities prior to 1965 and therefore, concludes respondent, the American corporation's payments must represent activities 142 performed in the United States (petitioners' European activities were on behalf of the proprietorship or Trust). We cannot agree.While it is true that the American Corporation's European selling activities declined greatly at the end of 1964, it had at that time almost $240,000 of outstanding accounts receivable. The record indicates strenuous activities on the part of petitioners to assist their customers in merchandising the products sold in 1963 and 1964 in an effort to stimulate the payment of these unpaid accounts. While such amounts were at least almost fully collected by the conclusion of 1965, the evidence presented further demonstrates petitioners' continuous efforts to create and test new forms of marketing and advertising programs as well as their attempt to increase the American corporation's goodwill through the promotion of various letter writing campaigns from European customers to their American counterparts. 17 While there can be little doubt that petitioners devoted some efforts to the selling of products on behalf of the European Trust, we feel the record as a whole clearly demonstrates substantial activities in Europe by petitioners on behalf of the American 143 corporation. We therefore conclude that the salary received did in fact represent income attributable to foreign services. The Court must next determine what portion of the salary received is excludable under section 911. Regulation 1.911-2(c) (4) provides that no amount received from services performed within the United States is excludable under section 911. 5*144 The above cited regulation refers to sections 861 through 864 and the regulations thereunder with regard to a proper allocation. Regulation 1.861-4(b) states that, if no accurate allocation can be made, income earned within 18 the United States shall be determined by a ratio of days' labor performed within the United States to the total number of days' services provided. 6 We believe that our findings of fact are sufficiently detailed to permit the parties to work out the mathematics of the allocation in a Rule 50 computation. Decisions will be entered under Rule 50. Footnotes1. Cases of the following petitioners are consolidated herewith: Carol Patton Hagerty (Formerly Mrs. Carol Patton), docket No. 4792-70, and William J. Hagerty, docket No. 5497-70. ↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, unless other-wise indicated. ↩3. Sec. 1.911-2(a) (2) provides: (2) What constitutes bona fide residence. Though the period of bona fide foreign residence must be continuous and uninterrupted, once bona fide residence in a foreign country or countries has been established, temporary visits to the United States or elsewhere on vacation or business trips will not necessarily deprive the citizen of his status as a bona fide resident of a foreign country. Whether the individual citizen of the United States is a bona fide resident of a foreign country shall be determined by the application, to the extent feasible, of the principles of section 871↩ and the regulations thereunder, relating to what constitutes residence or nonresidence, as the case may be, in the United States in the case of an alien individual. 4. Sec. 1.871-2(b) states: (b) Residence defined. An alien actually present in the United States who is not a mere transient or sojourner is a resident of the United States for purposes of the income tax. Whether he is a transient is determined by his intentions with regard to the length and nature of his stay. A mere floating intention, indefinite as to time, to return to another country is not sufficient to constitute him a transient. If he lives in the United States and has no definite intention as to his stay, he is a resident. One who comes to the United States for a definite purpose which in it nature may be promptly accomplished is a transient; but, if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the United States, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned. An alien whose stay in the United States is limited to a definite period by the immigration laws is not a resident of the United States within the meaning of this section, in the absence of exceptional circumstances. 5. Sec. 1.911-2(c) (4). No amounts received for services performed within the United States shall be excluded from gross income under such paragraphs. For the allocation or segregation as between sources wtihin, and sources without, the United States in the case of compensation for labor or personal services, see sections 861, 862, 863 and 864↩ and the regulations thereunder. 6. Sec. 1.861-4(b).Amount includible in gross income. If a specific amount is paid for labor or personal services performed in the United States, that amount (if income from sources wtihin the United States) shall be included in the gross income. If no accurate allocation or segregation of compensation for labor or personal services performed in the United States can be made, or when such labor or service is performed partly within and partly without the United States, the amount to be included in the gross income shall be determined by an apportionment on the time basis; that is, there shall be included in the gross income an amount which bears the same relation to the total compensation as the number of days of performance of the labor or services within the United States bears to the total number of days of performance of labor or services for which the payment is made. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622709/	JONATHAN RICHARD BARNES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; GLORIA C. BARNES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBarnes v. CommissionerDocket Nos. 4647-82, 10323-82.United States Tax CourtT.C. Memo 1985-397; 1985 Tax Ct. Memo LEXIS 230; 50 T.C.M. (CCH) 653; T.C.M. (RIA) 85397; August 7, 1985. 230 Held: The fair rental value of lodging furnished in a house owned by one of the petitioners (and not the mortgage payments made by that petitioner) is to be taken into account in determining which petitioner furnished more support to each of petitioners' children. Jonathan Richard Barnes, pro se, in Docket No. 4647-82. Gloria C. Barnes, pro se, in Docket No. 10323-82. Robert J. Foley, for the respondent. CHABOTMEMORANDUM OPINION CHABOT, Judge: Respondent determined deficiencies in Federal individual income taxes against petitioners for 1977 in the amounts of $939 (Jonathan Richard Barnes, Docket. No. 4647-82) and $448 (Gloria C. Barnes, Docket. No. 10323-82). These cases have been consolidated for trial, briefs, and opinion. After concessions, the issue for decision is whether, for dependency deduction purposes under section 152, 1231 the amount of support that petitioner Gloria C. Barnes provided to petitioners' children is to be determined by reference to (1) the fair rental value or (2) the current mortgage payments for the lodging she provided in the house she owned. The instant case has been submitted fully stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference. When the petitions were filed in the instant cases, petitioner Jonathan Richard Barnes (hereinafter sometimes referred to as "Jonathan") resided in Santa Clara, California, and petitioner Gloria C. Barnes (hereinafter sometimes referred to as "Gloria") resided in Fremont, California. Petitioners were divorced in 1970. The judicial custody decree granted Gloria custody of petitioners' three children--Thomas, Vivian, and Paul. Thomas and Vivian resided with Gloria for all of 1977. Paul resided with Gloria in 1977 until the end of June and with Jonathan for the rest of 1977. The fair rental value of Gloria's home was $5,400 for 1977. Gloria paid $250 per month in mortgage payments on this home in 1977. Between them, petitioners provided over half of the support of each of the three children in 1977. Jonathan provided at least $1,200 for the support of each of the three children and provided more of the support of Paul than Gloria did in 1977. On their respective tax returns for 1977, each of the petitioners claim 232 all three of the children as dependents. As to each petitioner, respondent disallowed all the claimed dependency deductions "because it has not been established that during this taxable year you furnished more than one-half of the support for any of them". Section 151(e) provides, in relevant part, an "exemption of $750 for each dependent (as defined in section 152)". 2233 Section 152(a) 3 defines a dependent to include a child over half of whose support for the calendar year was received from the taxpayer. In determining whether this support test has been met, section 152(e) 4234 235 provides that, in the absence of an agreement to the contrary, if a child receives over half of his or her support during the calendar year from the child's divorced parents, the custodial parent is treated as providing over half of the child's support. However, if the noncustodial parent provides $1,200 or more for the support of the child for the calendar year, then the noncustodial parent is treated as having provided over half the support for that child unless the custodial parent clearly establishes that the custodial parent provided more for the support of that child during the calendar year. Since Jonathan provided at least $1,200 for the support of each of the children in 1977, he is entitled to treat each of the children as his dependent for that year, unless Gloria (or respondent) clearly establishes that Gloria provided more support than Jonathan did for that child. We have interpreted "clearly establish", as used in the statute, to mean a showing by a "clear preponderance" of the evidence. , affd. . As a result of the parties' stipulations, it is clear--and we hold--that Jonathan (and not Gloria) is entitled to treat Paul as his dependent for 1977. Furthermore, as a result of the parties' stipulations we are faced with the following situation: (1) if Gloria's support for Thomas and Vivian is to be determined by taking into account the fair rental value of her home, then she (and not Jonathan) is entitled to treat both Thomas and Vivian as her dependents, but (2) if that support is determined by taking into account the mortgage payments that Gloria made, then Jonathan 236 (and not Gloria) is entitled to treat both Thomas and Vivian as his dependents. Jonathan contends that the statute and regulations require that the value of the lodging provided by Gloria to the children must be its "fair market value" and that this can be determined only by reference of Gloria's actual expenses for the lodging, and not by fair rental value. It is respondent's and Gloria's 5 position that, when the lodging is furnished by way of ownership, the fair market value of the lodging is its fair rental value. We agree with respondent and Gloria. In , the parties thereto agreed as to the amounts of the taxpayers' out-of-pocket expenses and the fair rental value of the lodging. In Blarek, respondent argued that "in computing petitioners' contribution to Mary Sabo's support, only the actual out-of-pocket expenses incurred in supplying quarters to her--not the fair rental value thereof--are properly to be employed." (.) The taxpayer there argued that "what the dependent receives as lodgings must be measured 237 by the amount such dependent would be required to pay on the open market for comparable items of support, i.e., the fair market value thereof or, as here, the fair rental value." (.) Our opinion in Blarek, reviewed by the Court and with only two dissenters, concluded that "petitioners' contention is amply justified." (.) We held "that in determining the amount of support which Mary Sabo received from the taxpayers in the taxable year, the fair rental value of the room furnished her in the house owned by the taxpayers will be included as the equivalent of cash expended." (.) The position we took in Blarek, under the Internal Revenue Code of 1939, continues to be our position under the Internal Revenue Code of 1954. . We hold that Gloria (and not Jonathan) is entitled to treat Thomas and Vivian as her dependents for 1977. Decisions will be entered under Rule 155.Footnotes1. Unless indicated otherwise, all section references are to sections of the Internal Revenue Code of 1954 as in effect for the year in issue.2. The subsequent amendments of this provision (by sec. 102(a) of the Revenue Act of 1978, Pub. L. 95-600, 92 Stat. 2763, 2771; and by sec. 104(c)(1) of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 172, 189) do not affect the instant cases. 3. Section 152(a) provides in relevant part as follows: SEC. 152. DEPENDENT DEFINED. (a) General Definition.--For purposes of this subtitle, the term "dependent" means any of the following individuals over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer (or is treated under subsection (c) or (e) as received from the taxpayer): (1) A son or daughter of the taxpayer, or a descendant of either, * * * ↩4. Section 152(e) provides in relevant part as follows: SEC. 152. DEPENDENT DEFINED. * * * (e) Support Test in Case of Child of Divorced Parents, Et Cetera.-- (1) General rule.--If-- (A) a child (as defined in section 151(e)(3)) receives over half of his support during the calendar year from his parents who are divorced * * * and (B) such child is in the custody of one or both of his parents for more than one-half of the calendar year, such child shall be treated, for purposes of subsection (a), as receiving over half of his support during the calendar year from the parent having custody for a greater portion of the calendar year unless he is treated, under the provisions of paragraph (2), as having received over half of his support for such year from the other parent (referred to in this subsection as the parent not having custody). (2) Special rule.--The child of parents described in paragraph (1) shall be treated as having received over half of his support during the calendar year from the parent not having custody if-- * * * (B)(i) the parent not having custody provides $1,200 or more for the support of such child (or if there is more than one such child, $1,200 or more for each of such children) for the calendar year, and (ii) the parent having custody of such child does not clearly establish that he provided more for the support of such child during the calendar year than the parent not having custody. For purposes of this paragraph, amounts expended for the support of a child or children shall be treated as received from the parent not having custody to the extent that such parent provided amounts for such support. [The subsequent revision of this provision, by sec. 423(a) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 799, does not affect the instant cases.]5. Gloria did not file a brief; apparently she is content to rely on the benefit of respondent's efforts against Jonathan.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622712/	M & N CIGAR MANUFACTURERS, INC., CLEVELAND, OHIO, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.M & N Cigar Mfrs., Inc. v. CommissionerDocket No. 100679.United States Board of Tax Appeals42 B.T.A. 1091; 1940 BTA LEXIS 908; October 29, 1940, Promulgated 908 Petitioner is a corporation which during the taxable years 1934 and 1935 was engaged in the processing of tobacco and paid in each of the taxable years certain amounts of processing taxes under the Agricultural Adjustment Act, declared unconstitutional January 6, 1936. In May 1939 petitioner received a refund in compromise of part of the processing taxes which it had paid in prior years. Held, petitioner is entitled to a deduction as taxes paid of the amounts of such processing taxes which it incurred and paid in each of the taxable years 1934 and 1935. Cartex Mills, Inc.,42 B.T.A. 894">42 B.T.A. 894 followed. Charles M. Trammell, Jr., Esq., and Marion C. Toomey, Esq., for the petitioner. R. H. Transue, Esq., for the respondent. BLACK1091 OPINION. BLACK: The Commissioner has determined deficiencies against petitioner as follows: 19341935Income tax$1,229.12$379.69Excess profits tax195.121092 The petitioner assigns two errors as follows: a. The Commissioner erroneously disallowed for the calendar year 1934 a deduction for taxes paid in the taxable year in the amount of $8,938.98, 909 in the form of processing taxes. b. The Commissioner erroneously disallowed for the calendar year 1935 a deduction for taxes paid in the taxable year in the amount of $2,761.36, in the form of processing taxes. Petitioner in support of the foregoing assignments of error alleged the following facts: a. The taxpayer included in the total sum of taxes deducted in its income tax return for the calendar year 1934 the sum of $8,938.98. b. The sum of $8,938.98, supra, was processing tax attributable to items processed by the taxpayer in the calendar year 1934. c. The taxpayer included in the total sum of taxes deducted in its income tax return for the calendar year 1935 the sum of $2,761.36. d. The sum of $2,761.36, supra, was processing tax attributable to items processed by the taxpayer in the calendar year 1935. e. Taxpayer in due course filed claims for refund of processing taxes on tobacco for 1933, 1934, 1935 and 1936 pursuant to Title VII of the Revenue Act of 1936. f. In May, 1939, taxpayer's claim for refund of processing taxes on tobacco was compromised for 1933, 1934, 1935 and 1936, whereby taxpayer received the sum of $14,000.00, without interest, 910 for its claim of $17,004.97, with interest. Respondent in his amended answer admitted the foregoing allegations of fact and also admitted that in determining petitioner's net income for 1934 he disallowed a deduction claimed for processing taxes in the amount of $8,938.98 and for 1935 he disallowed a deduction claimed for processing taxes in the amount of $2,761.36. All the essential facts having been admitted by the respondent in his amended answer, the question to be decided becomes one of law only. Petitioner states the issue which we have to decide as follows: "Is the deduction of taxes paid by petitioner under the Agricultural Adjustment Act and later refunded to petitioner on basis of unconstitutionality of the Act a proper deduction for the year in which paid?" We think this question must be answered in the affirmative, and hence in petitioner's favor. If we had before us the question: "Is the refund of $14,000, which petitioner received in 1939 of processing taxes paid in prior years and which petitioner had deducted in determining its net income for such prior years, taxable income to petitioner in 1939?", we would have to answer it in the affirmative. 911 ; affd., ; ; ; affd., . 1093 In Estate of William H. Block, among other things, we said: Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs. No other system would be practical in view of the statute of limitations, the obvious administrative difficulties involved, and the lack of finality in income tax liability, which would result. * * ; affd., , is a case which we think strongly supports the contention of petitioner. In that case, taxpayer, on accrual basis of accounting, took deduction under the Revenue Act of 1928, section 23, in the years 1928, 1929, and 1930 for personal property taxes charged against it but not paid912 at the end of those years. Suits were filed for the purpose of enjoining collection on the basis that the tax was illegally discriminatory. These taxes were later compromised in the year 1932 and taxpayer reported as income for 1932 the amount saved by compromise. The Commissioner held that this could not be done and readjusted taxpayer's returns for years 1929 and 1930 so as to allow deductions only for the amounts accrued for those years as reduced by the compromise in 1932. The Board sustained the taxpayer's treatment of the taxes and overruled the Commissioner. In this we were affirmed by the United States Circuit Court of Appeals. The Board recently decided, in , that processing taxes imposed by the Agricultural Adjustment Act were deductible by a corporation on the accrual basis in the year when such taxes accrued, even though in a later year such taxes were declared by the Supreme Court of the United States to be unconstitutional. It is true that in the Cartex Mills, Inc., case, no refund of the processing taxes paid by the taxpayer in prior years had as yet been made by the Bureau of Internal Revenue, whereas in913 the instant case the facts show that in 1939 petitioner received a refund of $14,000 without interest in compromise of its claim for refund of $17,004.97 of processing taxes paid by petitioner in prior years. We think that the fact that a refund has been made to petitioner does not serve to distinguish it from the Cartex Mills, Inc., case. The instant case is distinguishable from , because in that case the taxpayer was resisting the taxes in the years in which they were accrued on its books and never did make payment of them, due to the fact that the law imposing such taxes was later declared unconstitutional. Decision will be entered for petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622715/	WILLIAM H. STAYTON, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. A. J. TOWNSEND, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. W. S. TOWNSEND, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Stayton v. CommissionerDocket Nos. 71867, 73186, 74541.United States Board of Tax Appeals32 B.T.A. 940; 1935 BTA LEXIS 870; July 12, 1935, Promulgated 870 Withdrawals in 1930 by petitioners from corporation of which they were officers or employees held to have been loans and not taxable income to petitioners in that year. Lorenzo C. Dilks,15 B.T.A. 1294">15 B.T.A. 1294, followed. Virgil Y. Moore, Esq., for petitioner W. S. Townsend; C. M. Charest, Esq., for petitioner A. J. Townsend; and William H. Stayton, Jr., pro se. Elden McFarland, Esq., for the respondent. LEECH940 OPINION. LEECH: The respondent determined deficiencies in 1930 income taxes, of $1,391.19 as to Stayton, $6,041.53 as to A. J. Townsend, and $31,400.32 as to W. S. Townsend. These proceedings for redetermination of those deficiencies have been formally consolidated. The controversy is common to all and involves the single question of fact as to whether certain sums received by petitioners from the National Pipe Products Corporation are income for 1930 or 1931. In 1929, W. S. Townsend transferred all territorial rights vested in him by virtue of a certain contract with the Fairyland Manufacturing Co., for the manufacture and sale of "Tom Thumb" golf courses, to National Pipe Products, for 25 percent of871 the net profits arising from that source. 941 By resolution of the directors of National Pipe Products of March 21, 1930, there was to be paid to A. J. Townsend, president of the company, for 1930, a bonus equal to 10 percent of the net profits for that year. During 1930, Stayton was employed by National Pipe Products as its general manager, under a prior arrangement whereby he was paid a salary and a bonus equal to 5 percent of the annual net profits of the company. The selling agreement between W. S. Townsend and National Pipe Products under which those parties acted, though the written agreement was never executed, did not fix the time or manner of the payment to Townsend of the amounts due thereunder. By resolution of the directors of the company of March 21, 1930, the treasurer of the corporation was authorized to loan to each of the three petitioners an amount not exceeding 80 percent of their then accrued bonuses, taking their promissory notes to the corporation, at 6 percent interest, as security. In October 1930, the several notes of each petitioner for withdrawals to the end of September were consolidated in a single note and the three consolidated notes872 and those subsequently given for additional withdrawals were entered on the company's books and treated as true bills receivable. In February 1931, the books of National Pipe Products for 1930 were finally closed and the directors, by resolution, directed the treasurer "to pay, without recourse, bonuses and divisions of profits for the year 1930" to these petitioners, among others, of certain specified amounts. The amounts directed to be paid to W. S. Townsend and Stayton were, in each instance, greater than their withdrawals in 1930, while the amount of A. J. Townsend's withdrawals in that year exceeded the amount so directed to be paid him. A. J. Townsend then gave his note to the corporation for the amount of this excess, a part of which note has been paid, and the unpaid balance is now carried as an asset by the corporation, payee, in receivership. The notes given by petitioners covering their withdrawals were then canceled and destroyed, and A. J. Townsend gave the company a new note for the amount of his excess withdrawals. In the cases of W. S. Townsend and Stayton it is the amounts which they actually withdrew during 1930 that are in controversy, while in the case of873 A. J. Townsend it is the amount directed to be paid by the resolution of February 1931, which is less than the amount of his withdrawals in 1930, that is in controversy. The corporation kept its accounts on the accrual system and accrued monthly these "bonus accounts" as well as Federal taxes. The petitioners, who filed their 1930 returns on a cash basis, treated the disputed amounts as income for 1931, and returned no part thereof in their 1930 returns. 942 The respondent held that these amounts were income for 1930. These proceedings resulted. The Revenue Act of 1928, section 42, provides that all items of gross income are to be returned as gross income for the year in which received by the taxpayer, unless, under permitted methods of accounting, any such items are to be properly accounted for as of a different period. These petitioners computed net income in their returns on a cash basis, and, therefore, they were obliged to include all items of gross income in the gross income of the year in which received. But the petitioners contend that the questioned amounts were received as loans and not as outright and unqualified payments of income, and that they received874 no income as such until the corporate resolution of February 1931 directed the payments of the amounts due them "as bonuses" and their promissory notes covering their 1930 withdrawals against anticipated "bonuses" were canceled and destroyed. We agree with petitioners. The right of each petitioner to the bonus rested entirely on the corporate resolution of March 21, 1930. This resolution, though ambiguous, we have found, was intended to and did authorize the treasurer of the corporation to loan, during that year to each petitioner, not exceeding 80 percent of his agreed percentage of net profits of the company, then accrued. The net profits, if any, upon which the bonuses were to be computed for 1930, the pending tax year, were not determinable until after the close of that year. The monthly accrual of these bonuses on the corporate books were obviously merely estimates of that item, as were the similarly accrued Federal taxes. The accrual served here only as a means of measuring the amounts to be loaned to each petitioner, as authorized by the corporate resolution. The fact that Stayton, one of the petitioners, did not draw the amount to which he was entitled under that875 resolution, is significant of a loan. The treatment of the disputed payments on the corporate books as loans in 1930, converted into absolute payments of income in 1931 upon the adoption of the corporate resolution in February of that year, authorizing the then payment of the bonuses without recourse, supports petitioners' position. Likewise do petitioners' income tax returns for both 1930 and 1931. In the case of Lorenzo C. Dilks,15 B.T.A. 1294">15 B.T.A. 1294, the petitioner, Dilks, was employed by the George A. Fuller Co. under a contract calling for a salary of $20,000 and a bonus of 10 percent of the "net profits earned" by the Wilmington office. In arriving at the net profits the value of the plant was to be ascertained by sale or otherwise and profit or loss on the same to be taken into account. 943 The company kept accurate costs of all work, monthly computations being made of the progress of the work. During the year 1920, the George A. Fuller Co. paid Dilks various sums in addition to his annual compensation of $20,000. These sums were carried by the company as an account receivable. Profits were finally determined on December 30, 1921, and the company*876 credited petitioner's account with $87,500 ($82,000 had been advanced to him, $74,000 of this amount in 1920). We held there that the payments to Dilks in 1920 constituted loans or advances. The petitioners' position here is stronger than that there presented. Petitioners here gave their promissory notes to the payor corporation for their 1930 withdrawals, and such withdrawals were authorized in the corporate minutes as loans. We conclude the disputed payments were received by petitioners as loans and not income in 1930. Such payments did not become income to petitioners until the cancellation of those loans in 1931 by authority of the corporate resolution then adopted. Lorenzo C. Dilks, supra; Lorenzo C. Dilks,19 B.T.A. 646">19 B.T.A. 646; cf. United States v. Kirby Lumber Co.,284 U.S. 1">284 U.S. 1. Reviewed by the Board. Decision will be entered for petitioners William H. Stayton, Jr., Docket 71867, and A. J. Townsend, Docket 73186; and decision will be entered pursuant to Rule 50 in respect to the proceeding W. S. Townsend, Docket 74541.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622717/	MICHAEL H. AND DORCAS S. COTTRELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCottrell v. CommissionerDocket No. 14559-90United States Tax CourtT.C. Memo 1992-73; 1992 Tax Ct. Memo LEXIS 81; 63 T.C.M. (CCH) 2006; T.C.M. (RIA) 92073; February 6, 1992, Filed 81 Decision will be entered for respondent Michael H. Cottrell, pro se. John Aletta, for respondent. CANTRELCANTRELMEMORANDUM FINDINGS OF FACT AND OPINION CANTREL, Special Trial Judge: This case was assigned and heard pursuant to section 7443A(b)(3) and Rules 180, 181, and 183. 1In his joint notice of deficiency issued to petitioners, respondent determined a deficiency in petitioners' Federal income tax and additions to tax for the calendar year 1987 as follows: Addition to TaxYearDeficiencySec. 6653(a)(1)(A)Sec. 6653(a)(1)(B)1987$ 1,004$ 5050% of the interestdue on $ 1,004The issues for decision are: (1) Whether petitioners failed to report on their 1987 Federal income tax return $ 2,834.80 in nonemployee compensation received by Michael H. Cottrell, hereinafter called petitioner; and (2) whether petitioners 82 are liable for the additions to tax. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and related exhibits are incorporated herein by this reference. Petitioners resided at 11 Redwood Street, Newport, Rhode Island, on the date they filed their petition herein. They filed a joint 1987 Federal income tax return with the Internal Revenue Service. During part of 1987 petitioner worked for String Instrument Workshop and Newport Woodworks, both of which were owned and operated by Kevin Murphy (Mr. Murphy). For the first 7 weeks of his employment petitioner was a salaried employee. His gross salary was $ 400 per week with a take home pay of approximately $ 307. Thereafter, beginning on or around June 26, 1987, until his termination in late August, he was treated as an independent contractor. Prior to filing the 1987 return, petitioner received a Form W-2, Wage and Tax Statement, from String Instrument Workshop showing wages received of $ 2,800, from which $ 336 in Federal income tax was withheld. Both of these amounts were reported on the return and the Form W-2 was appended thereto. Also prior to filing the 1987 return, petitioner83 received a Form 1099-MISC, Miscellaneous Income, from Newport Woodworks showing that he received $ 2,834.80 in nonemployee compensation in 1987. 2 This amount was not reported on the return, which was prepared by a representative of H&R Block. No copy of the Form 1099-MISC was attached to the return. The Form 1099-MISC contained the following warning: This is important tax information and is being furnished to the Internal Revenue Service. If you are required to file a return, a negligence penalty or other sanction will be imposed on you if this income is taxable and the IRS determines that it has not been reported.Petitioner worked for the businesses owned by Mr. Murphy for some 5 months in 1987. According to him, he does not know how much he was84 paid during that period as sometimes he received salary checks with stubs showing that Federal income tax had been withheld; sometimes he received salary checks from which Federal income tax had not been withheld; sometimes his wages were paid in cash out of Mr. Murphy's pocket; and sometimes they were paid in cash from the cash register. The nonemployee compensation amount of $ 2,834.80 is based upon six invoices submitted by petitioner to Mr. Murphy, reflecting amounts paid by cash and three other checks issued to petitioner. OPINION Section 61 provides that income from whatever source derived, including compensation for services, must be included in gross income. In his notice of deficiency, respondent determined that petitioner received nonemployee compensation of $ 2,834.80, which was not reported on the 1987 return. Petitioners have the burden of proving that respondent's determination is incorrect. Rule 142(a); ; . They have wholly failed in that burden. Indeed, the unrefuted evidence shows petitioner did receive said unreported income in 1987. 85 We sustain respondent's determination on the nonemployee compensation issue. We now turn to the additions to tax. Section 6653(a)(1)(A) imposes an addition to tax if any part of an underpayment of tax is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(3) defines negligence to include "any failure to make a reasonable attempt to comply with" the tax laws, and "'disregard' includes any careless, reckless, or intentional disregard" of the rules or regulations. Section 6653(a)(1)(B) imposes another addition to tax in the amount of 50 percent of the interest due on the portion of the underpayment attributable to negligence or intentional disregard of rules or regulations. Negligence under section 6653(a) is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. . Petitioners bear the burden of proving respondent's determinations that they were negligent or intentionally disregarded the rules or regulations for the year in issue, were erroneous. Rule 142(a); .86 Petitioner stipulated that, prior to filing the 1987 return, he received a Form 1099-MISC from Newport Woodworks showing that $ 2,834.80 was paid to him in 1987. It appears that petitioner discussed this Form 1099-MISC with his return preparer who was curious as to why petitioner, who began his employ as a salaried employee, would at some time thereafter be treated as an independent contractor. Without checking into the matter further, the preparer had petitioners sign the return, send it in," and have the IRS straighten it out." In these circumstances, we think both petitioner and his return preparer should have contacted Newport Woodworks to verify the income set forth in the Form 1099-MISC. We find that a reasonable and prudent taxpayer would have done so. Petitioner did not, nor did he satisfactorily explain why not. Furthermore, it may be that Newport Woodworks incorrectly classified petitioner as an independent contractor, but that is hardly a basis for intentionally ignoring the income received. On this record as a whole, respondent's determinations with respect to the additions to tax are sustained. Decision 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.↩2. The correct amount of nonemployee compensation received by petitioner appears to have been $ 3,174.80. However, due to a bookkeeping mistake, the amount entered on the Form 1099-MISC was only $ 2,834.80. Respondent does not seek an increased deficiency.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622718/	WENDY L. PARKER REHABILITATION FOUNDATION, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWendy L. Parker Rehabilitation Foundation, Inc. v. CommissionerDocket No. 855-85X.United States Tax CourtT.C. Memo 1986-348; 1986 Tax Ct. Memo LEXIS 272; 52 T.C.M. (CCH) 51; T.C.M. (RIA) 86348; August 4, 1986. Sidney Meyers, for the petitioner. Kevin C. Reilly, for the respondent. GERBERMEMORANDUM OPINION GERBER, Judge: Petitioner seeks a declaratory judgment, pursuant to section 7428, 1 that it is an organization273 exempt from taxation under section 501(c)(3). The issue presented for our consideration is whether petitioner meets the section 501(c)(3) requirement that no part of its net earnings inure to the benefit of a private individual. This case was submitted for decision pursuant to Rules 122 and 217(b) on the basis of the administrative record as defined in Rule 210(b)(11). For purposes of this proceeding the facts contained in the administrative record are assumed to be true. Rule 217. Petitioner was incorporated, as a not-for-profit corporation, under the laws of New York State on August 16, 1983. As stated in the certificate of incorporation, petitioner was formed for the following purposes: [T]o aid the victims of coma, resulting from motor vehicular accidents, stroke, drowning, and other related causes; to provide such coma victims, who are in various stages of rehabilitation and recovery, with funds and therapeutic equipment and devices used in conjunction with accepeted coma recovery programs; to run fund-raising274 affairs and social functions in aid of coma victims; to exchange and disseminate information concerning the care and treatment of coma victims in all stages of recovery. Petitioner's officers and directors are: President, George H. Parker (father of Wendy L. Parker); Secretary-Treasurer, Phyllis Parker (mother of Wendy L. Parker); and Vice President, Perry Parker (brother of Wendy L. Parker). The Parkers reside in New York City. Wendy Parker, a recovering coma patient, lives in New York City with her father, mother and brother. On September 15, 1983, petitioner, by George Parker as "Organizer," submitted to respondent Form 1023, "Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code." By letter dated November 2, 1983, respondent requested additional information pertaining to petitioner's application. In response to respondent's request, petitioner provided estimated budgets for its taxable years ending August 31, 1984, and August 31, 1985, as follows: August 31, 1984August 31, 1985IncomeVoluntary Contributions$7,500$7,500ExpendituresTo Coma Recovery Associations,Head Injury Foundations, andSupport Organizations$1,500$1,500Purchase and Donation of MedicallyRelated Equipment and RehabilitationDevices2,0002,000Payments to RN's, Physical Therapists,Speech Therapists, and OccupationalTherapists2,0002,000Examination and Treatment Fees ofPhysicians and Clinical Psychologists2,0002,000Total Expenditures$7,500$7,500Excess contributions over expenditures00275 The evidence, as presented by petitioner in support of its section 501(c)(3) qualification, established that the specific procedures used to select recipients of funds are as follows: [W]e are members of the Coma Recovery Association of Nassau County, a support group meeting twice monthly at South Nassau Community Hospital. At such meetings we are constantly informed of the current (medical) status of each family's patient, both old and new, as well as their medical and social needs. There is no shortage of worthy, needy recipients. Petitioner further represented that its expected source of income if from contributions, and disbursements are for contributions to other coma recovery organizations; purchase of related equipment and devices; and payments to nurses and physicians. Twenty percent of the income will be distributed to organizations and 80 percent to coma patients. Thirty percent of petitioner's income is expected to be expended for the benefit of Wendy L. Parker. On February 2, 1984, respondent issued an initial adverse ruling on petitioner's application. Petitioner protested this ruling. On October 16, 1984, respondent issued a final adverse ruling as to petitioner's276 exempt status under section 501(c)(3). Respondent therein advised petitioner that an adverse determination was made because "a child of the founder and chief operating officer of the Foundation is a substantial beneficiary of the services contemplated by the organization. This constitutes inurement which is prohibited under Code Section 501(c)(3) and the Regulations thereunder." Section 501(a) exempts from taxation organizations described in section 501(c). To qualify as an exempt organization under section 501(c)(3), an organization, inter alia, must operate exclusively for exempt purposes, and no part of its net earnings can inure to the benefit of any private individual. 2Triune of Life Church, Inc. v. Commissioner,85 T.C. 45">85 T.C. 45, 52 (1985), on appeal (3rd Cir., Sept. 12, 1985); Church of the Transfiguring Spirit v. Commissioner,76 T.C. 1">76 T.C. 1, 4 (1981). 277 An organization is not operated exclusively for exempt purposes if its "net earnings inure in whole or in part to the benefit of private * * individuals." Sec. 1.501(c)(3)-1(c)(2), Income Tax Regs. A "private individual" is a person having a personal and private interest in the activities of the organization. Sec. 1.501(a)-1(c), Income Tax Regs. Inurement of "net earnings," as interpreted in section 501(c)(3) and the regulations promulgated thereunder, includes more than a benefit derived from net profits. Inurement of contributions is as fatal to exempt status as inurement of "net earnings." See People of God Community v. Commissioner,75 T.C. 127">75 T.C. 127 (1980). In addition, this Court has held that net earnings may inure to an individual in ways other than through the distribution of dividends.See Unitary Mission Church v. Commissioner,74 T.C. 507">74 T.C. 507, 512-513 (1980), affd. without published opinion 647 F.2d 163">647 F.2d 163 (2d Cir. 1981); Lowry Hospital Association v. Commissioner,66 T.C. 850">66 T.C. 850, 857 (1976). The burden of proof with respect to the grounds set forth in respondent's notice of determination is on petitioner. Rule 217(c)(2)(i); 278 Hancock Academy of Savannah, Inc. v. Commissioner,69 T.C. 488">69 T.C. 488, 492 (1977). To prevail herein petitioner must prove that no part of its net earnings inure to the benefit of any private individual. We conclude that petitioner has failed to carry its burden of proof. Petitioner argues that its activities fall within the broad outline of charity and do not violate the prohibition against inurement of net earnings to private individuals. Petitioner seeks to support this argument by reference to "background facts" not contained in the administrative record. We cannot consider such "background facts." In this type of declaratory judgment proceeding the only relevant evidence is that which is submitted and certified as the administrative record. 3 See Rule 217(a); General Conference of the Free Church v. Commissioner,71 T.C. 920">71 T.C. 920, 929 (1979); Houston Lawyer Referral Service, Inc. v. Commissioner,69 T.C. 570">69 T.C. 570 (1978). 279 Respondent argues that petitioner fails the private inurement test for section 501(c)(3) because of its projected expenditures for the benefit of Wendy Parker. Petitioner maintains that respondent should have considered actual disbursements before making any determination. We agree with respondent. Approval or denial of tax-exempt status may be based on projected as well as actual operations. See La Verdad v. Commissioner,82 T.C. 215">82 T.C. 215, 219 (1984); Dumaine Farms v. Commissioner,73 T.C. 650">73 T.C. 650, 664-665 (1980). Accordingly, respondent was not required to adopt a "wait and see" approach before ruling on petitioner's application. We find from the administrative record that petitioner anticipates disbursing 30 percent of its funds for the benefit of Wendy Parker. Wendy Parker is one of an unspecified number of recovering coma patients. She is the daughter of both the petitioner's President and the Secretary-Treasurer, and the sister of petitioner's Vice President. George Parker, Phyllis Parker and Perry Parker, as officers and directors of a foundation formed to benefit coma patients, including Wendy Parker, have a personal interest in petitioner's280 affairs to provide assistance, including financial aid, to Wendy Parker and other coma patients. In addition, they are "private individuals" within the meaning of section 1.501(a)-1(c), Income Tax Regs.The distribution of funds for the benefit of Wendy Parker assists the Parker family in providing for her care. These funds will be used to pay for the medical and rehabilitative care of Wendy Parker. This relieves the Parker family of the economic burden of providing such care. Consequently, there is a prohibitive benefit from petitioner's funds that inures to the benefit of private individuals. See Founding Church of Scientology v. United States,188 Ct. Cl. 490">188 Ct.Cl. 490, 412 F.2d 1197">412 F.2d 1197 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009 (1970) (payments made to family members of organization's founder); Charleston Chair Company v. United States,203 F. Supp. 126">203 F. Supp. 126 (E.D.S.C. 1962) (scholarship aid given to son of officer and director); Rueckwald Foundation, Inc. v. Commissioner,T.C. Memo. 1974-298 (payments made for nursing home and medical expenses of mother and college expenses of son of officer and director). The Parker family's control281 over petitioner is not in itself fatal to petitioner's cause. However, petitioner's selection of Wendy Parker as a substantial beneficiary of its disbursements is the determinative factor in this case.Inurement of a benefit to "private individuals," whether monetary or not, as a result of contributions made to a purportedly exempt organization is proscribed. 4 See Lowry Hospital Association v. Commissioner,supra at 857 n. 8; People of God Community v. Commissioner,supra at 133; Horace Heidt Foundation v. United States,145 Ct. Cl. 322">145 Ct.Cl. 322, 170 F. Supp. 634">170 F. Supp. 634, 638 (1959). The benefit to the Parker family is no less tangible because payment is directed not to be Parkers but to others for Wendy Parker's care. We do not doubt that the Parkers are sincere in their efforts to help coma patients, but these good intentions cannot rectify petitioner's*282 failure to meet the standards for tax exemption. We cannot say that respondent has erred in its determination and we so hold. Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended, and all rule references are to the Tax Court Rules of Practice and Procedure.↩2. The "operated exclusively for exempt purposes" test and the "private inurement" test are separate requirements, although there is substantial overlap. Church of the Transfiguring Spirit v. Commissioner,76 T.C. 1">76 T.C. 1, 5 (1981). To operate exclusively for exempt purposes, an organization must serve a public rather than a private interest; consequently, an organization that operates for the benefit of private interests such as the creator or his family does not operate exclusively for exempt purposes. Sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs. An organization operates exclusively for exempt purposes if it engages primarily in activities which accomplish such purposes. Sec. 1.501(c)(3)-1(c)(1), Income Tax Regs. The prohibition against private inurement, in contrast, is complete, and the amount and extent of such inurement is not determinative. Church of the Transfiguring Spirit v. Commissioner,supra↩ at 5.3. Rule 210(b)(11) provides that the administrative record in the case of a determination relating to an exempt organization includes the request for determination, all documents submitted to the Internal Revenue Service by the applicant in respect of the request for determination, all protests and related papers submitted to the Internal Revenue Service, all written correspondence between the Internal Revenue Service and the applicant in respect of the request for determination or such protests, all pertinent returns filed with the Internal Revenue Service, the notice of determination by the Commissioner, the charter or articles of incorporation or association, or trust indenture or agreement, and any similar or related documents of the organization and any modifications thereof.↩4. Petitioner maintains that the source of its income, voluntary contributions, is a decisive factor in its favor. The source of an organization's income has nothing to do with whether it is disbursed to private individuals in contravention of sec. 1.501(c)(3)-1(c)(2), Income Tax Regs.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622719/	WILBURN SMITH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Smith v. CommissionerDocket No. 26113.United States Board of Tax Appeals18 B.T.A. 289; 1929 BTA LEXIS 2091; November 19, 1929, Promulgated 2091 1. The respondent mailed to the petitioner a notice of deficiency for the year 1922. Before the expiration of the 60-day period within which a petition could have been filed with the United States Board of Tax Appeals the petitioner waived the right to file such petition and none was filed. The additional tax asserted in said deficiency notice was assessed. Subsequently the respondent mailed to the petitioner a second deficiency notice for the year 1922 asserting a further deficiency. Held that the second deficiency notice was valid. 2. The petitioner as the beneficiary of the trust involved herein is not entitled to any deduction from gross income for depletion of the trust property. Theodore B. Benson, Esq., for the petitioner. Maxwell E. McDowell, Esq., and Frank B. Schlosser, Esq., for the respondent. MARQUETTE 290 This proceeding is for the redetermination of a deficiency in income tax asserted by the respondent for the year 1922 in the amount of $1,586.08. The facts have been stipulated by the parties and we find them to be as follows: FINDINGS OF FACT. The petitioner is an individual residing at Los Angeles, Calif.2092 He and his wife, Laura Kittle Smith, formerly Laura A. Kittle, filed a joint return of income for the calendar year 1922. Said return was made on the basis of cash receipts and disbursements. The petitioner's wife was during the year 1922 and until her death on June 30, 1928, a beneficiary under a certain declaration of trust made by her father, Gilbert B. Goff, Sr., on March 9, 1911. Said declaration of trust is in part in the words and figures following, to wit: THIS INDENTURE, Made this 9th day of March, in the year of our Lord one thousand nine hundred and eleven, BETWEEN Gilbert B. Goff, a widower of the City and County of Saginaw, State of Michigan, of the first part, and Ernest A. Goff of the same place of the second part, WITNESSETH, that the said party of the first part, for and in consideration of the sum of One Dollar and other good and valuable consideration to him in hand paid by the party of the second part, the receipt whereof is hereby confessed and acknowledged, does by these presents grant, bargain, sell, remise, release, alien and confirm unto the said party of the second part, in trust, however, and to his successors in trust for the uses and purposes2093 and with the powers hereinafter set forth, an undivided one-ninth interest in and to all mineral deposits of whatever kind or nature, now known or hereafter discovered contained within the limits of the following described land, situated in the County of St. Louis and State of Minnesota, viz: * * * Excepting and reserving, however, unto the said party of the first part the right to the use and occupation of said premises and estate, together with the right to all of the rents, issues, profits, income and royalties of said property accruing and arising for and during the natural life of the said party of the first part, together with the right and power to collect, have, receive and use all such rents, issues, profits, income and royalties as his own during his natural life. The said party of the first part intending by said exception and reservation to retain in himself for and during his natural life the right to the use and occupation of said premises and the right to collect, have and receive as his own all of the rents, issues, profits, income and royalties of every kind arising or accruing from said property. Subject to the foregoing exceptions and reservations and said2094 life estate this conveyance is made by first party to second party, and his successors in trust together with all and singular the hereditaments and appurtenances thereunto belonging or in anywise appertaining: TO HAVE AND TO HOLD the said premises as herein described with the appurtenances, unto the said party of the second part and his successors in trust, but in trust, however, for the following uses and purposes, and with the following powers, viz: - 291 (a) From and after the termination of said life estate second party, and his successors in trust shall have the right to the use and occupation of said premises together with the right and power to collect, receipt for, have and receive all of the rents, issues, profits, income, and royalties accruing or arising out of or from the premises hereby conveyed during the existence of the trust estate and trust hereby created. * * * (c) After the deduction of the items provided for in the preceding paragraph "b," party of the second part and his successors in trust, shall pay and turn over to Mrs. Laura A. Kittle, of Flint, Michigan, daughter of first party, one-half of the residue of all rents, issues, profits, income2095 and royalties collected, had or received from the premises hereby conveyed as soon as the same is so collected, had or received by such trustee. Such payments to said Laura A. Kittle to continue during the continuance of the trust hereby created, or during her life, if she die before the termination of said trust. (d) The other one-half of the residue of all rents, issues, profits, income and royalties so collected, had and received by second party and his successors in trust, he shall invest and reinvest and keep invested together with the profits, income and increase thereof in good safe investments of such character as the law sanctions and authorizes trust funds to be invested in, for the use and benefit of the children of the said Laura A. Kittle, now in being, or that may hereafter be born, in equal shares and portions as hereinafter provided: Provided that the living issue of any deceased child shall be entitled to the share or portion that the parent would have been entitled to under this instrument if living. * * (e) When the youngest surviving child of the said Laura A. Kittle, now in being or hereafter born, shall have attained the age of twenty-one years, but2096 in no event at a date later than twenty years after the death of the survivor of the children of the said Laura A. Kittle, now in being, the said trustee and his successors in trust shall pay and turn over to the children of the said Laura A. Kittle, then living and to the then living issue of any deceased child of the said Laura A. Kittle, the rest and residue of all the rents, issue, profits, income and royalties collected, had and received by such trustee together with the income, increase and profits thereof and property acquired therewith then in his hands, possession, custody and control, in such sums, portions and amounts so that the aggregate amounts received by each such child and the living issue of any deceased child hereunder, including all prior payments and advances made, shall be equal as near as may be; and in figuring and ascertaining the amount that shall be so paid and turned over to each such child and the living issue of any deceased child, interest shall be charged at the rate of 3% per annum on all payments and advances theretofore made to them or on their account respectively. The living issue of any deceased child under this paragraph shall take the same share2097 or portion that the parent would have taken if living; and such trustee shall at the same time deed and convey to the said Laura A. Kittle, if then living, an undivided one-half of the property and real estate and interest in real estate and minerals hereby conveyed to the party of the second part, and the other one-half thereof he shall deed and convey to the children of the said Laura A. Kittle, then living, and to the then living issue of any deceased child of the said Laura A. Kittle in equal shares and portions; Provided that the then living issue of any such deceased child shall take the share or portion that the parent would have 292 taken if living; but if the said Laura A. Kittle is not then living then the whole thereof shall be so deeded and conveyed to the then living children of the said Laura A. Kittle, and the then living issue of any of her deceased children in shares and portions above provided: Provided further that if the said Laura A. Kittle shall survive all of her said children and the issue thereof before any final division is made of the trust estate under this paragraph, then and in that event, the said trustee and his successors in trust shall deed2098 and convey, assign, pay and turn over to the said Laura A. Kittle, all of the rest and residue of the trust estate then on hand and remaining in the possession, custody and control of such trustee; Provided further that if it shall so happen that there shall be an entire failure by reason of death of beneficiaries under this paragraph as hereinbefore provided before the trust estate is divided and wound up under this paragraph, then and in that event the said trustee and his successors in trust shall deed and convey, pay and turn over all of the rest, residue and remainder of the trust estate hereby created then in the hands, possession, custody and control of such trustee to the legal heirs of the said Gilbert B. Goff, in the shares and portions as fixed by the laws of inheritance of the State of Michigan, then in force. * * * Ernest A. Goff, the trustee named in said declaration of trust, died prior to the year 1922 and was succeeded as trustee by the Detroit Trust Co., a corporation organized and existing under the laws of Michigan, with authority to act as trustee, which did during the year 1922 and still does, act as such trustee in the place and stead of the said Ernest2099 A. Goff. During the year 1922 said trustee received income in the form of royalties and made distributions thereof to the petitioner's wife, in the amount of $26,951.93. In the return filed by the petitioner and his wife for the year 1922 a deduction for depletion of ore lands held under the declaration of trust was claimed in the amount of $15,922.26. The respondent upon audit of the return allowed depletion for said trust property in the amount of $10,750.88, and determined a deficiency in tax of $530.89. The petitioner was notified of said deficiency by letter mailed August 31, 1926. Before the expiration of the 60-day period indicated in said deficiency letter a conference was held by the petitioner's attorney with a proper official of the Bureau of Internal Revenue and as a result thereof the petitioner waived his right to file a petition with the United States Board of Tax Appeals and no petition was filed by the petitioner within said 60-day period. Said additional tax was assessed on the January, 1927, list. The respondent thereafter determined that the petitioner and his wife were not entitled to any deduction from gross income for the depletion of said trust2100 property. He therefore disallowed the amount of said depletion theretofore allowed and determined that there is a further deficiency in tax in the amount of $1,586.08. The petitioner was notified thereof by letter mailed February 7, 1927. *293 OPINION. MARQUETTE: The facts and issues in this proceeding are identical with those in , and on the authority of that decision our judgment is in favor of the respondent. Reviewed by the Board. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622720/	A. L. FARNSWORTH and ESPERANZA FARNSWORTH, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Farnsworth v. CommissionerDocket Nos. 8267-71, 8268-71, 8269-71.United States Tax CourtT.C. Memo 1973-195; 1973 Tax Ct. Memo LEXIS 92; 32 T.C.M. (CCH) 902; T.C.M. (RIA) 73195; September 4, 1973, Filed Larry R. Adamson and Richard C. Briney, for the petitioners. Wayne A. Smith, for the respondent. 93 FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined the following Federal income tax deficiencies against petitioners during the years in issue: 2 Additions to Tax PetitionerYearDeficiency§6651(a)§6653(a) A. L. & Esperanza Farnsworth1966$11,950.78$1,792.64$ 597.54196747,449.10none2,372.45Ralph C. & Wanda M. Farnsworth196611,425.801,713.87570.931967192.51none9,62E. D. & Lenna Farnsworth19673,132.17none156.61Petitioners have conceded on brief that the notices of deficiency issued to each of the petitioners for each of the years in issue were timely and that the applicable statutory period of limitations on assessment as governed by section 6501 of the Internal Revenue Code of 19542 had not expired at the time of issuance of these notices of deficiency. The issues remaining for disposition by this Court are: (1) whether petitioners have sustained their burden of proving that the deficiencies as determined by respondent94 were invalid; (2) whether petitioners are liable for additions to tax under section 6653(a) on the grounds that their respective underpayment of tax was due to negligence or intentional disregard of rules and regulations; and (3) whether petitioners A. L. and Esperanza Farnsworth and Ralph C. and Wanda M. Farnsworth are liable for additions to tax under section 6651(a) for 1966 on the grounds that they willfully neglected to file timely Federal income tax returns in 1966. 3 FINDINGS OF FACT Some of the facts have been stipulated; the stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. A. L. and Esperanza Farnsworth, husband and wife, resided in Nogales, Arizona, at the time they filed their petition herein. They filed joint Federal income tax returns for the years 1966 and 1967 with the district director of internal revenue for the District of Arizona. They filed their 1966 Federal income tax return on June 22, 1967. Ralph C. and Wanda M. Farnsworth, husband and wife, resided in Nogales, Arizona, at the time they filed their petition herein. They filed joint Federal income tax returns for the years 1966 and 1967 with the95 district director of internal revenue for the District of Arizona. They filed their 1966 Federal income tax return on June 10, 1967.E. D. and Lenna Farnsworth, husband and wife, resided in Nogales, Arizona, at the time they filed their petition herein. They filed a joint Federal income tax return for the year 1967 with the district director of internal revenue for the District of Arizona. During the year 1966 A. L. Farnsworth ("A. L.") and Ralph C. Farnsworth ("Ralph") were equal sole partners in Richt-Renoir Fine Crafts ("Richt-Renoir").During the year 1967 A. L. and E. D. Farnsworth ("E. D.") were the 4 sole partners in Richt-Renoir. Eighty-two percent of Richt-Renoir's net income for 1967 was distributed to A. L. and the remaining 18 percent was distributed to E. D. Esperanza Farnsworth, A. L.'s wife; Wanda Farnsworth, Ralph's wife; and Lenna Farnsworth, E. D.'s wife, were not connected with any of Richt-Renoir's partnership business and are petitioners herein only by reason of filing joint income tax returns with their respective husbands. Accordingly, collective references hereinafter to petitioners will be to A. L. and Ralph for the year 1966 and A. L., Ralph, 96 and E. D. for the year 1967. Richt-Renoir's business operations in 1966 and 1967 consisted of the importation into Mexico of such luxury consumer items as liquor and cigarettes, and the exportation out of Mexico of silver. Richt-Renoir avoided paying the import duty imposed by the Mexican government during 1966 and 1967 on liquor and cigarettes by flying the goods to secret airstrips in the interior of Mexico. Richt-Renoir avoided paying the duty imposed by the Mexican government on silver exported from Mexico during 1966 and 1967 by flying the silver from secret airstrips in the interior of Mexico to Nogales, Arizona. Richt-Renoir's Mexican liquor enterprise for 1966 and 1967 operated as follows: 5 Richt-Renoir would receive a telephone order for liquor from one of Richt-Renoir's Mexican connections. Richt-Renoir would buy the liquor from one of its Arizona wholesale liquor contacts. The liquor would then be transported by truck to the Nogales airport where it would be loaded on planes owned and operated by Richt-Renoir. The planes would leave the Nogales airport and fly to one of several unimproved landing strips in the vicinity of Hermosillo, Mexico. The planes97 would be met and unloaded by employees of the partnership. The liquor would then be taken to a warehouse where a portion would be repackaged for shipment by trucks to points further south in Mexico. The remainder of the liquor would be delivered to Hector Pina for ultimate sale by him of the liquor. The portion which had been repackaged for shipment south would be loaded on trucks owned by Isaac Rocha. Rocha was paid $2 per case for delivering the liquor to Obregon and Culiacan, Mexico. The price for delivery to Guadalajara and Mexico City, Mexico, was $2.80 and $4.00 per case, respectively. Richt-Renoir was responsible for delivering the following approximate numbers of cases of liquor to the indicated Mexican cities during the years in issue: 6 Number of Cases City19661967 Hermosillo1,000- 1,5001,500- 1,700Obregon & Culiacan3,000- 3,2002,000- 2,500Guadalajara3,000- 3,5003,000- 3,500Mexico City3,000- 3,5003,500- 4,000Total10,000-11,70010,000-11,700Neither Richt-Renoir nor its respective partners kept a precise record of the number of cases of liquor which were delivered by Richt-Renoir to the various Mexican98 cities during 1966 and/or 1967. A. L. informed Tunis Parsons, Richt-Renoir's accountant for 1966 and 1967, that Richt-Renoir's "net" profit from its liquor operations for 1966 and 1967 was $4 per case. Richt-Renoir maintained no records for either 1966 or 1967 that would substantiate this "net" income per case of liquor computation. Richt-Renoir reported net partnership income from all of its partnership operations for the taxable years 1966 and 1967 in the amounts of $24,259.78 and $41,446.09, respectively. Richt-Renoir operated approximately 300 flights each in 1966 and 1967 for purposes of delivering liquor and other consumer luxury items (i.e., cloth and cigarettes) to Mexico. Only approximately 25 percent of these return flights (i.e., 75) were utilized by Richt-Renoir for purposes of exporting silver out of Mexico. The substantial majority of all of 7 Richt-Renoir's overall flights to Mexico (i.e., at least 75 percent) were utilized for Richt-Renoir's liquor operations. Richt-Renoir paid its pilots an average of $25 per hour for the flights conducted during 1966 and 1967. The average aggregate flight time for Richt-Renoir's flights to and from Mexico in 196699 and 1967 was approximately 2 hours. Richt-Renoir's partnership Federal income tax return for 1966 reflected the following income and expense schedules: Gross IncomeSilver$2,132,743.41Whiskey (net)40,596.00Cloth7,062.50Cigarettes900.00$2,181,301.91Cost of SalesSilver$1,962,005.37Cigarettes867.40$1,962,872.77Other DeductionsContract Flying$25,078.74Contract Trucking10,068.28Secretarial Services2,320.00Refining Charges87,698.97Mining Expenses5,600.00Customs3,305.72Brokerage3,487.50Insurance803.88Telephone9,383.65Legal & Accounting760.00Airplane Lease26,541.46Gas, Oil, Maintenance2,858.08Travel & Entertainment853.15Miscellaneous829.91$179,589.34 8 Richt-Renoir's partnership Federal income tax return for 1967 reflected the following income and expense schedules: Gross IncomeSilver$2,738,294.64Whiskey222,069.00Cloth28,025.00Cigarettes & Other1,121.00$2,989,509.64Cost of SalesSilver$2,493,577.41Cigarettes & Other106.40$2,493,683.81OtherRefining Charges$95,583.21Contract Flying20,507.44Contract Trucking169,469.44Loading & Shipping Costs5,660.96Gas, Oil, Maintenance61,937.79Customs2,865.28Brokerage7,878.54Insurance4,244.43Telephone7,100.45Office, Postage, Misc.1,031.96Travel & Entertainment1,130.01Mining Expenses14,623.04$392,032.55100 Isaac Cherem ("Cherem"), who is now deceased, and Alfonso Cuevas ("Cuevas") acquired silver in Mexico City pursuant to the operation of two money exchange houses owned by Cherem and Cuevas during the years in issue. Upon the accumulation of specified quantities of silver, Cherem and Cuevas would ship the silver to Hermosillo. They would telephone petitioners and advise them as to when the shipment would arrive, the composition of the shipment, and the 9 "silver venture silver "cost"." The silver was loaded aboard Richt-Renoir's planes at remote airstrips near Hermosillo and flown to Nogales. The silver was examined by U.S. Customs officials and the U.S. Customs officials issued a "release" for the silver shipment. The silver shipment was boxed and then transported to Tucson International Airport and shipped, freight collect, by common carrier to a domestic refinery in the United States, usually Englehart Industries ("Englehart") in Newark, New Jersey. On the day the silver was shipped to Englehart, A. L. would prepare a sales invoice to Englehart with the amount constituting the computed pure silver quantity times the world market price of silver on that day. On the same101 day, A. L. would write a bank draft on Englehart for 90 percent of the invoice price. A. L. would then write a partnership check to the bank and have the bank wire Cherem or Cuevas a certain amount, this amount being the "silver venture silver "cost"." Five to 20 days later Englehart would send a "liquidation check" for the balance due on the particular shipment. The balance due was computed as follows (the number representing a hypothetical transaction): 10 Weight of pure silver, after refining, times world market price of silver on date received$73,000.00Less collect freight paid and refining charge3,000.00Net$70,000.00Less amount of the 90% bank draft written by A. L.65,700.00Liquidation check$4,300.00A. L., Cherem, and Cuevas agreed among themselves that the cost of delivering the silver to Hermosillo was $1,161. They further agreed that Cherem and Cuevas would be reimbursed for the full amount of the $1,161 delivery cost. If the actual delivery cost was less than, or more than, $1,161, the resultant savings or losses would be shared only by Cherem and Cuevas. There were different prices for silver on the world market, on the retail102 market in Mexico, and in the wholesale market in Mexico. A hypothetical example of these price differences would be as follows: World market price$1.29 per ounceMexico standard price (the price at which the large money exchange houses sold silver)1.00 per ounceMexico's consumer price (the price at which silver was purchased from the public by the money exchange houses)0.90 per ounceMexico's standard price or the price at which silver was sold by the money exchange houses was a price set by 11 Baron's, which is the largest money exchange house in Mexico. In the computations of the division of profits between petitioners and Cherem and Cuevas, the "cost of silver" used was that price established by Baron's, that is, the price at which Baron's sold silver, or $1 per ounce in the above example. The "profit or loss" on each silver shipment was divided equally between Cherem, Cuevas, A. L., and Ralph in 1966, and equally between Cherem, Cuevas, and A. L. in 1967. (A. L.'s share in reality constituted Richt-Renoir's share in 1967.) The profit or loss on each silver shipment was computed in the following manner (the amounts being a hypothetical transaction): 103 Bank draft (for 90% of invoice, e.g., 90% X $73,000)$65,700Liquidation check4,300Total proceeds$70,000Silver venture "cost"$60,000Agreed charge1,16161,161Net profit$8,839Profit to each partner (1967) ($8,839 3)$2,946The timing of a typical silver venture transaction is illustrated by the following hypothetical model: 12 Feb. 9 Cherem buys silver for $60,000 Cherem pays money exchange house $60,000 cash 10 Cherem ships the $60,000 of silver to A. L. near Hermosillo 12 A. L. receives the $60,000 shipment A. L. air transports shipment from near Hermosillo to Nogales U.S. Customs examines shipment and issues a customs "release" A. L. delivers silver to American Airlines in Tucson for transport to New JerseyEnglehart picks up silver in New Jersey12 or 13 A. L. wirtes draft on Englehart for 90% of price expected to be paid by Englehart ($73,000 X 90%, or $65,700) and deposits same in Richt-Renoir's bank account A. L. writes partnership check for $60,000, payable to Southern Arizona Bank, for transfer to Cherem's account in a bank in Mexico City, to pay cherem for his silver "cost" 14 Cherem receives104 money from his bank in Mexico City 17 A. L. receives liquidation check from Englehart for $4,300, computed as follows: Value of pure silver on date of receipt$73,000C.O.D. charge and refining charge(3,000)Draft(65,700)Liquidation check$4,300 13 Mar. 25 Cherem to NogalesCherem and A. L. approve settlement of $2,946 to each partner A. L. writes $2,946 check to Cherem and to Cuevas (in fact, several shipments may be settled at one time and one check would, therefore, be written to each partner for aggregate amount resulting from the component shipments) Richt-Renoir deducted $15,000 in 1967. Although the $15,000 was characterized as a gas, oil and/or maintenance expenditure, the $15,000 in reality was expended as a downpayment on an Aztec airplane purchased by Richt-Renoir and, thus, should properly have been reflected as a capital expenditure. Ivan W. Horne ("Horne"), the revenue agent who conducted the audit in the instant case, prepared a statement in 1969 detailing his understanding of Richt-Renoir's operations. Horne presented this statement to A. L. on May 12, 1969. After reading the statement and suggesting some changes, A. 105 L. signed the statement. A. L. signed the statement due to his fear that Horne would be further antagonized by his refusal to do so. A. L. and Ralph rationalized the late filing of their respective Federal income tax returns for 1966 as resulting from the lack of availability of requisite information. No 14 data was supplied either as to the nature of this information or as to why the information was not obtained prior to its ostensible availability. Respondent in his notices of deficiency dated September 17, 1971, determined that Richt-Renoir had understated its net partnership income for 1966 and 1967 in the amounts of $182,047.42 and $202,961.91, respectively. The exhibits attached thereto indicated that the respective deficiencies reflected adjustments based partially on a bank deposits analysis and partially on the theory that purported illegal bribes paid to Mexican government officials were in effect erroneously deducted from Richt-Renoir's gross liquor income during the years in issue. ULTIMATE FINDINGS OF FACT The payment of the purported bribes to Mexican officials during the years in issue with respect to Richt-Renoir's operations in Mexico was made by106 independent contracters and not by Richt-Renoir's agents or employees. Richt-Renoir had net income during the years in issue of $90,451.42 in 1966 and $99,961.91 in 1967. Since Richt-Renoir reported net income on its partnership tax returns for 1966 and 1967 in the respective amounts of $24,259.78 and $41,446.09, Richt-Renoir understated its net income for both 1966 and 1967 in the amounts of $66,191.64 and $58,515.82, respectively. 15 OPINION Petitioners and respondent have directed the primary focus of their arguments at trial and on brief to the bribery issue. Petitioners contend that respondent has not sustained his burden under section 162(c) (1) of proving that petitioners directly or indirectly made bribery payments during the years in issue to Mexican government officials that would be illegal under the laws of the United States. Respondent contends that he has satisfied the burden of proof imposed by section 162(c) (1) and further contends that petitioners in effect erroneously deducted the alleged bribes by excluding them from the computation of the net income derived from Richt-Renoir's Mexican liquor operations. After carefully reviewing the record in107 this proceeding, we have concluded that regardless of which party had the burden of proof with respect to the bribery issue, the evidence introduced at trial clearly establishes that the portion of the deficiency determination that resulted from Richt-Renoir's purported payment of bribes to Mexican officials is inaccurate. We recognize the the statement prepared by Horne was signed by A. L. on May 12, 1969, and that this statement contains admissions by A. L. inferring that Richt-Renoir did authorize the payment of the purported bribes by its alleged agents or employees. However, these admissions are not 16 judicially conclusive, but, to the contrary, are only one of the evidentiary factors to be considered in resolving the bribery issue. See Corpus Juris Secundum, Evidence, § 270, p. 695. A. L.'s testimony, as corroborated by the testimony of a multitude of witnesses at trial, has convinced us that any bribes that were made to Mexican officials in connection with Richt-Renoir's Mexican operations were made by independent contractors and not by Richt-Renoir's agents or employees. Moreover, we are satisfied that the statement signed by A. L. on May 12, 1969, should properly108 be given only minimal consideration due to the circumstances surrounding its preparation by Horne and its signature by A. L. A. L. was cognizant that Horne was already antagonized by the difficulties he had encountered in attempting to clarify the extent of Richt-Renoir's Mexican operations. A. L. realized that the statement prepared by Horne inaccurately inferred that Richt-Renoir paid bribes to Mexican officials through its agents or employees. However, since he believed that these bribes were deductible in any event, and since he was afraid that his refusal to sign the statement would be detrimental to Richt-Renoir's and his interests by inducing further antagonism on Horne's part, A. L. did ultimately sign the statement. 17 Although petitioners have negated respondent's theory that part of the deficiency resulted from Richt-Renoir's purported payment of bribes, petitioners have not negated the apparent inferences existing in the record that Richt-Renoir did understate its partnership income for 1966 and 1967. For example, a schedule attached to Richt-Renoir's partnership return for 1966 reflected that Richt-Renoir received approximately $41,000 of its net income 3 from109 its 1966 Mexican liquor operations. However, this same schedule also stated that Richt-Renoir incurred the following approximate expenses in 1966: $25,000 for contract flying; $10,000 for contract trucking; $26,500 for airplane leasing; and $3,000 for gas, oil and maintenance. The record reflects that Richt-Renoir operated approximately 300 flights to Mexico during each of the years in issue for purposes of delivering liquor and other consumer luxury items and that the substantial majority of these trips were for the delivery of liquor to Richt-Renoir's Mexican connections. The record further reflects that only approximately 25 percent of the return flights to the 18 United States were utilized by Richt-Renoir for purposes of exporting silver out of Mexico. Accordingly, since the substantial majority of Richt-Renoir's flights to Mexico during 1966 and 1967 were utilized for Richt-Renoir's Mexican liquor operations, a pro rata portion of the contract flying, contract trucking, airplane leasing, and gas, oil and maintenance expenses (the airplane and truck expenses) for these years should properly have been allocated to the liquor operations. Nevertheless, although the 1966110 schedule reflects that the liquor income is included at its net figure, the evidence certainly suggests that the airplane and truck expenses reflected on the 1966 schedule also included the portion of airplane and truck expenses that were allocable to Richt-Renoir's Mexican liquor operations. 4111 19 This analysis lead to the inexorable conclusion that Richt-Renoir derived a double deduction in 1966 for the pro rata portion of the airplane and truck expenses allocable to its Mexican liquor operations; i.e., the contract flying and contract trucking expenses were deducted both in the computation of Richt-Renoir's net liquor income and in the separate computation of Richt-Renoir's net income from its total operations (including its liquor operations). Accordingly, Richt-Renoir's taxable income for 1966 would have been understated at least to the extent of the benefit derived from the double deductions taken for the pertinent airplane and truck expense items. With respect to 1967, the schedule attached to Richt-Renoir's 1967 partnership Federal income tax return reflects that Richt-Renoir incurred contract trucking expenses for 20 1967 in the amount of approximately $169,500. Again, since the record gives us no basis to assume otherwise, we can only conclude that most (if not all) of the amount is properly allocable to Richt-Renoir's liquor operations. Yet, in attempting to corroborate the validity of the total amount claimed as contract trucking expenses, we are112 confronted with a patent inconsistency. A. L. testified at trial that Richt-Renoir paid varying rates to Rocha for Rocha's transporting the liquor from Hermosillo to Obregon, Culiacan, Guadalajara and Mexico City. A. L. further testified (1) that Richt-Renoir imported approximately 10,000-11,700 cases of liquor into Mexico in 1967 and (2) that Rocha's highest rate for delivery of liquor from Hermosillo was the $4 per case rate charged for delivery of liquor to Mexico City (i.e., Mexico City was further in distance from Hermosillo than Obregon, Culiacan or Guadalajara). Even if we were to assume (and this assumption is patently invalid) that all of the maximum 11,700 cases of liquor imported by Richt-Renoir into Mexico in 1967 were delivered by Rocha to Mexico City, the total contract trucking expense would have been $46,800. This amount is approximately $122,600 less than the amount claimed by Richt-Renoir as contract trucking expenses for 1967. Since Richt-Renoir did not maintain adequate books and records regarding its liquor operations for 1967, and since there 21 is no evidence in the record that would permit substantiation of the amount claimed for 1967 as contract trucking113 expenses, we can only conclude that this item was greatly overstated and that Richt-Renoir's resultant net income from its liquor operations for 1967 was therefore greatly understated. Moreover, our conclusion with respect to 1967 is further supported by the fact that Richt-Renoir claimed on its 1967 partnership return a $15,000 item within the category of gas, oil and maintenance expenses. Petitioners' accountant conceded at trial that this $15,000 in actuality was expended for the purchase of an airplane and that it should properly have been capitalized rather than deducted as a current expenditure. Although Richt-Renoir would be entitled to a depreciation deduction for the acquired airplane, the amount of the deduction would still be far less than the full $15,0000 that was taken as a current expense. Thus, the erroneous treatment of this item further contributed to the understatement of Richt-Renoir's income for 1967. Accordingly, after considering that Richt-Renoir maintained no records with respect to its Mexican liquor operations for 1966 and 1967 and that petitioners have not dispelled the unexplained discrepancies existing in the record itself, we have found, and so114 hold, that Richt-Renoir's actual net income for 1966 and 1967 was $90,451.42 and $99,961.91, respectively, and that, to the extent reflected 22 by comparing these amounts with the amounts reported by Richt-Renoir as net income on its partnership tax returns for 1966 and 1967, Richt-Renoir did understate its income for 1966 and 1967 in the respective amounts of $66,191.64 and $58,515.82. See Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); and Geiger v. Commissioner, 440 F.2d 688">440 F.2d 688 (C.A. 9, 1971), affirming per curiam a Memorandum Opinion of this Court, certiorari denied 404 U.S. 851">404 U.S. 851 (1971). Respondent further determined that petitioners are liable for the years in issue for additions to tax under section 6653(a), which provides that If any part of any underpayment * * * is due to negligence or intentional disregard of rules and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment.Respondent asserts that 115 section 6001 and section 1.6001-1, Income Tax Regs., require the taxpayer to keep adequate books and records for the purpose of reflecting taxable income. In this context, respondent contends that petitioners negligently or intentionally failed to comply with this requirement for the years in issue. Petitioners have the burden of proving that respondent erred in his determination. See J. T. S. Brown's Son Co., 10 T.C. 840">10 T.C. 840 (1948); and Elsie SoRelle, 22 T.C. 459">22 T.C. 459 (1954). Petitioners in the instant case maintained no records whatsoever during the years in issue with respect to Richt-Renoir's Mexican liquor operations. Moreover, petitioners offered no credible justification for failing to maintain 23 such records. Accordingly, we sustain respondent's section 6653(a) determinations for 1966 and 1967. 5Finally, respondent determined that petitioners116 A. L. and Esperanza, and Ralph and Wanda, are liable for additions to tax under section 6651(a) for failure to timely file their respective joint Federal income tax returns for the taxable year 1966. Petitioners contend that the involved 1966 tax returns were filed late because certain partnership information was not timely available. Petitioners have made no attempt to explain either what partnership information was involved or why this information was not available for timely filing of their 1966 tax returns. Therefore, we are compelled to conclude that petitioners have not satisfied their burden of proving that the failure to timely file their 1966 returns was attributable to reasonable cause and was not due to willful neglect. See C. Fink Fischer, 50 T.C. 164">50 T.C. 164, 177 (1968). Accordingly, respondent's section 6651(a) determinations for 1966 are sustained. Decisions will be entered under Rule 50. Footnotes1. The cases of the following petitioners are consolidated herein: E. D. Farnsworth and Lenna Farnsworth, Docket No. 8268-71; and Ralph C. Farnsworth and Wanda M. Farnsworth, Docket No. 8269-71. ↩2. All section references are to the Internal Revenue Code of 1954, unless otherwise indicated. ↩3. Richt-Renoir maintained no records for its Mexican liquor operations for 1966 and 1967. In computing Richt-Renoir's income from the liquor operations for Federal income tax purposes, A. L. simply reported the net income from Richt-Renoir's liquor business. Due to the lack of records, A. L. was unable to substantiate with precision either the gross income from the liquor operations or the actual expenses incurred in this business. ↩4. It is inconceivable that we could conclude otherwise. Even if we assumed that 25 percent of Richt-Renoir's Mexican flight operations were utilized exclusively for importation of nonliquor consumer items into Mexico and for exportation of silver out of Mexico, this would yield only an approximate figure of 75 flights (i.e., 25% X 300 approximate flights). In this context, the allocation of the aggregate $25,000 contract flying expense for 1966 to only 75 flights appears grossly unreasonable, since this would amount to approximately $334 per flight. The unreasonableness of this computation is apparent when we consider A. L.'s testimony at trial that each flight took approximately 2 hours of total flight time and that the pilot's wages averaged $25 per hour. Even if we were to assume that each flight averaged 4 hours instead of the 2 hours, the contract flying cost of each of the 75 exclusively nonliquor flights should still be only approximately $100 (4 hours flight time X $25 per hour) and not $334. The same conclusion would also apply to the contract trucking expenses indicated in the 1966 schedule. The record reflects no evidence that contract trucking expenses were incurred in Richt-Renoir's silver operations. Although Cherem and Cuevas did sustain trucking expenses in delivering the silver to Hermosillo for pick up by Richt-Renoir, A. L.'s and Cuevas' testimony at trial asserted that this expense was solely that of Cherem and Cuevas and was not an expense incurred by Richt-Renoir. Moreover, since the income indicated on the 1966 schedule as being derived from Richt-Renoir's nonliquor and nonsilver operations is negligible (i.e., approximately $7,000 from cloth and $900 from cigarettes) there is no basis in the record for assuming that all of the contract trucking expense should be allocated to Richt-Renoir's cloth and cigarettes operations. Thus, as with respect to the contract flying item, we can only conclude that a substantial portion of the contract trucking expenses were deducted twice, i.e., in the computation of Richt-Renoir's net liquor income and in the separate computation of Richt-Renoir's net from total operations (including its liquor operations). ↩5. In any event, Richt-Renoir's erroneous characterization of the $15,000 expended for airplanes in 1967 as an oil, gas and/or maintenance expense constituted sufficient negligence or intentional disregard of the rules to sustain the sec. 6653(a)↩ determination for 1967.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622721/	THOMAS L. HOBART, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHobart v. CommissionerDocket No. 25649-93.United States Tax CourtT.C. Memo 1995-517; 1995 Tax Ct. Memo LEXIS 516; 70 T.C.M. (CCH) 1117; October 30, 1995, Filed 516 Decision will be entered for respondent. Gregory Daniel Smith, for petitioner. Linda J. Wise, for respondent. COHEN, Judge COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined a deficiency in the amount of $ 132,675 in petitioner's Federal income tax for 1988 and an addition to tax pursuant to section 6653(b)(1) in the amount of $ 101,783. Respondent asserted the delinquency and negligence additions to tax under sections 6651 (a) (1) and 6653 (a) (1), respectively, in the alternative to the fraud addition to tax. Unless otherwise noted, 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. After concessions, the issues for decision are: (1) Whether petitioner had unreported income in 1988 and, if so, in what amount and (2) whether petitioner is liable for the fraud addition to tax for 1988 or, in the alternative, the delinquency and negligence additions to tax. FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. At the time the petition was filed, petitioner517 resided in Pensacola, Florida. Petitioner met Linda Nelson (Nelson) around 1987, and they became engaged to marry. After their engagement, petitioner encouraged Nelson to quit her job so that she would have more time to make wedding plans. Petitioner promised Nelson that he would make sure she had access to funds to cover her expenses. Petitioner and Nelson were married in September 1988. Nelson filed for divorce in March 1989, and the divorce was final July 2, 1990. During 1988, petitioner was employed by Zebrowski and Associates, Inc. (Zebrowski). Zebrowski was engaged in the demolition business. Edward Timothy Sullivan (Sullivan) was the owner and president of Zebrowski. Petitioner was in charge of the day-to-day operations of Zebrowski's Gulf Coast Division. Zebrowski sold the scrap from its demolition jobs to scrap companies, including Southern Scrap (Southern). Demolition companies and other scrap producers would deliver scrap to Southern. The scrap would be weighed, and a scale ticket would be issued indicating the type and the weight of the scrap. The scrap seller would take the scale ticket to Southern's office to request payment. Southern made payments for scrap by both518 check and cash. Often, a seller requested a large cash payment when Southern had insufficient cash available in its office. When this occurred, Southern would make a check payable to Barnett Bank for the appropriate amount and an employee would go to Barnett Bank to cash the check. The cash would be brought back to Southern, counted, and distributed to the scrap seller. When Zebrowski began selling scrap to Southern, the payments were made by check and mailed to Zebrowski's Michigan office. This procedure changed, however, at some point in 1988. Southern's payments for Zebrowski scrap then included checks made payable to petitioner and to Nelson, as well as cash. During 1988, numerous checks were issued by Southern in payment for Zebrowski scrap. Approximately 41 checks were issued payable to petitioner by Southern in payment for Zebrowski scrap. At least 17 Southern checks were made payable to Nelson. Many of these checks were deposited into a joint bank account maintained by petitioner and Nelson. Because of Southern's practice of cashing checks payable to Barnett Bank in order to make cash payments for scrap, 32 cash payments for Zebrowski scrap during 1988 are indicated by 32519 checks payable to Barnett Bank. These checks correspond with various scale tickets relating to Southern's purchase of Zebrowski scrap. These cash payments were delivered to petitioner by Southern employees. Petitioner often handled personal transactions in cash, although he claimed during an interview with a revenue agent to keep only $ 100 in cash on hand at any given time. Nelson's engagement ring was purchased with approximately $ 8,000 in cash. During 1988, petitioner used a combination of cash and credit cards to take Nelson on a $ 10,000 shopping spree. Nelson's $ 7,000 wedding dress was paid for by petitioner. Petitioner paid various wedding expenses totaling approximately $ 13,000, including the reception, lodging for some guests, the cost of tuxedo rentals for the groomsmen, and the cost of several bridesmaids' dresses. The couple took a honeymoon trip to Puerto Vallarta, where they purchased approximately $ 1,500 of jewelry. Petitioner bought Nelson's daughter a car. Before moving into their own home, petitioner and Nelson lived in a hotel suite that cost $ 1,800 per month for approximately 3 months in 1988. On October 14, 1988, petitioner and Nelson purchased a 1.41-acre520 lot, paying $ 500 as a deposit, $ 12,500 at the closing, and the balance as a deferred note. Funds from the joint bank account were used to pay various expenses, including credit card bills, doctors' bills, car payments, groceries, traveler's checks for the honeymoon, and legal expenses for a business in which petitioner was involved. On September 25, 1989, a one-count information was filed in the Circuit Court of Escambia County, Florida, charging petitioner with theft of property valued at over $ 100,000. The charges stemmed from petitioner's misappropriation of Zebrowski funds. Also on September 25, 1989, a three-count information was filed charging petitioner with check forgery, uttering forged instruments, and theft of property valued between $ 300 and $ 20,000. This information related to petitioner's forgery of a check in the amount of $ 5,695 made payable to Sullivan. Both informations related to petitioner's activities between January 1, 1988, and March 31, 1989. The charges against petitioner carried a possible jail sentence of over 30 years. All charges against petitioner were consolidated for trial. The jury returned verdicts of guilty on all counts. On April 11, 1990, 521 the court entered its judgment and sentence in petitioner's case. Petitioner was placed on probation for 20 years, directed to perform 50 hours of community service for each year of probation, and ordered to pay court costs of $ 284.50 and to pay restitution of $ 446,571. Zebrowski subsequently filed a civil suit seeking restitution relating to petitioners's criminal convictions. Summary judgment was entered in favor of Zebrowski on March 2, 1993. Petitioner's 1988 Federal income tax return was filed on July 19, 1991. Petitioner filed in 1988 using single status but has since conceded that his filing status should have been married. Petitioner reported income of $ 31,400 from wages, salaries, tips, etc., on his return, as well as $ 218 of taxable interest income. Petitioner did not include any of the funds he had misappropriated from Zebrowski in his income reported for 1988. The Internal Revenue Service (IRS) began an investigation of petitioner during 1992. Petitioner failed to provide any income records other than four or five bank statements and a copy of a tax return in response to IRS document requests. OPINION Unreported IncomeRespondent has argued that the doctrine522 of collateral estoppel bars petitioner from denying the receipt and the amount of unreported income set forth in the notice of deficiency. Because of the lack of identity of issues and uncertainty of when the misappropriated amounts determined in the prior litigation were taken, the application of collateral estoppel in this case is problematic. Detailed analysis of that issue is less efficient than simply deciding the case on the evidence otherwise in the record. Under section 61, gross income includes "all income from whatever source derived." It is well established that stolen funds are includable in the year in which they are misappropriated. ; , affg. . As a general rule, petitioner has the burden of proving that respondent's determination is erroneous. Rule 142 (a); , affg. . In cases involving unreported income, the Court of Appeals523 for the Eleventh Circuit has stated that the deficiency determination must be supported by "some evidentiary foundation linking the taxpayer to the alleged income-producing activity." (quoting , revg. , affg. . The required showing is minimal. . The evidence here clearly connects petitioner to the receipt of funds diverted from Zebrowski. Thus, petitioner must show that the amount of unreported income determined by respondent is excessive. Petitioner argues that the indictment under which he was convicted related to activities during 1988 and 1989. Because the 1989 tax year is not before the Court, petitioner asserts that respondent cannot rely on petitioner's conviction to establish theft activity during 1988. The evidence presented at trial, however, demonstrates that petitioner was involved in theft activity during 1988. 524 In order to misappropriate Zebrowski funds, petitioner used his position with Zebrowski to request changes in the way Southern paid for Zebrowski scrap. Instead of having Southern make the checks payable to Zebrowski and mailing the payments to the Michigan office, petitioner requested that payment be made by checks payable to petitioner or Nelson. During the trial, respondent introduced 58 Southern checks dated during 1988 made payable to petitioner or Nelson that represent payments for Zebrowski scrap. Petitioner also requested that Southern make cash payments for Zebrowski scrap. As was Southern's practice, large cash payments were often obtained from checks made payable to Barnett Bank. Respondent introduced 32 Southern checks made payable to Barnett Bank during 1988 that represented payments for Zebrowski scrap. Testimony at trial indicated that petitioner was the recipient of these cash payments. Petitioner produced no reliable evidence at trial to show that respondent's determination is incorrect. Although petitioner initially denied the receipt of any unreported income, in the alternative, petitioner asks us to include in his income only those amounts that are represented525 by checks payable to him. We reject this argument, because he controlled all of the misappropriated funds. Petitioner asserts that a number of individuals, including Sullivan, Nelson, and Southern employees, received the funds in question. Sullivan denied receiving any of the proceeds from the Southern checks. Although from the record none of the witnesses seems completely innocent, the preponderance of the evidence is that Sullivan was a victim of petitioner's misappropriation. Petitioner was convicted not only of misappropriating funds from Sullivan's company, Zebrowski, but also of forging the endorsement on a check payable to Sullivan. Sullivan, on behalf of Zebrowski, filed a civil suit seeking restitution from petitioner. Petitioner produced no evidence in support of his contention that other Southern employees received some of the funds in question. Petitioner argues that the checks payable to Nelson should not be included in his income. "The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment, and hence the realization, of the income by him who exercises it." .526 A taxpayer is not relieved of the obligation to pay taxes on income merely by a transfer of that income to another. . Petitioner was the "force and fulcrum" behind the thefts that made the benefits to Nelson, as well as petitioner, possible. See . Petitioner has failed to offer any credible evidence that he did not receive the amounts determined by respondent. Respondent's determination of the deficiency will be sustained. FraudThe 75-percent addition to tax in the case of fraud is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud. Sec. 6653 (b) (1); . Respondent has the burden of proving, by clear and convincing evidence, that some part of an underpayment for 1988 was due to fraud. Sec. 7454 (a); Rule 1423 (b). This burden is met if it is shown that the taxpayer intended to conceal, mislead, 527 or otherwise prevent the collection of such taxes. ; , affg. . Once the Commissioner has established that some portion of an underpayment is due to fraud, the entire underpayment is treated as attributable to fraud unless the taxpayer can show that some portion of the underpayment is not due to fraud. Sec. 6653 (b) (2). The existence of fraud is a question of fact to be resolved upon consideration of the entire record. , affd. without published opinion . Fraud will never be presumed. . Fraud may be proved, however, by circumstantial evidence because direct proof of the taxpayer's intent is rarely available. The taxpayer's entire course of conduct may establish the requisite fraudulent intent. ;528 ; . The following facts that indicate fraud in this case have been established by clear and convincing evidence: (1) Petitioner's misappropriation of funds from Zebrowski (see, e.g., , affd. ; (2) petitioner's understatement of his taxable income by failing to report the misappropriated funds on his 1988 return (see ); (3) petitioner's frequent dealings in cash ( , affg. ; ; (4) petitioner's implausible denial of the receipt of the misappropriated funds and failure to explain expenditures that far exceeded his reported income (see, e.g., ,529 affg. ); and (5) petitioner's failure to provide complete and accurate income records to the tax authorities ( . Because respondent has proven by clear and convincing evidence that some portion of the underpayment is due to fraud, the burden is on petitioner to prove the amount of the underpayment not attributable to fraud. Petitioner has stated two arguments in this regard: (1) That he did not receive any of the stolen funds or (2) that, if he did receive any of the funds, his unreported income was only in the amount of the Southern checks payable to him. We have rejected both of these arguments. Respondent's determination regarding the addition to tax for fraud will be sustained. Because we have upheld respondent's fraud determination, we need not examine the alternative additions to tax asserted by respondent. Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622723/	Patience C. Jacklin (formerly Patience C. Rivkin), Petitioner v. Commissioner of Internal Revenue, Respondent; Dewey K. Rivkin, Petitioner v. Commissioner of Internal Revenue, RespondentJacklin v. CommissionerDocket Nos. 4722-79, 7554-79United States Tax Court79 T.C. 340; 1982 U.S. Tax Ct. LEXIS 49; 79 T.C. No. 21; August 17, 1982, Filed 49 Rule 121, Tax Court Rules of Practice and Procedure. -- Motions for summary judgment by petitioner W and respondent, seeking a decision that petitioner H's payments under the spouses' written separation agreement are not deductible as a matter of law. For purposes of her motion only, W concedes that she and H were separated and that they executed the separation agreement. Held: Where the written separation agreement is not wholly without some standard for W's support, it is not insufficient as a matter of law under sec. 71(a)(2), I.R.C. 1954, for failing to state a definite amount for her support. Motions will be denied, and the issue will be decided on the basis of all of the facts and circumstances of the case, including the terms of the agreement. Douglas E. McKinley, for the petitioner in docket No. 4722-79.Paul A. Burns, for the petitioner in docket No. 7554-79.Patrick Putzi, for the respondent. Parker, Judge. Whitaker, J., concurring. Tannenwald, Featherston, Sterrett, Wiles, and Nims, JJ., agree with this concurring opinion. PARKER340 OPINIONRespondent determined deficiencies in petitioners' 1975 Federal income taxes in the amounts of $ 3,007.36 in docket No. 4722-79 and $ 12,260.39 in docket No. 7554-79. Petitioner Patience C. Jacklin (formerly Patience C. Rivkin) (Patience or the wife) filed a motion for summary judgment in her favor in docket No. 4722-79, under Rule 121, Tax Court Rules of Practice and Procedure, and respondent at the same time filed a motion for summary judgment in his favor in docket51 No. 7554-79. 1 Patience and respondent filed briefs in support of their respective motions, and petitioner Dewey K. 341 Rivkin (Dewey or the husband) filed a brief in opposition to both motions.The issue for decision is whether payments made to the wife during 1975 constitute alimony deductible by the husband under section 215 and includable in income by the wife under section 71(a). To resolve this question, we must decide whether the husband made the payments under a "written separation agreement" within the meaning of section 71(a)(2).The pertinent facts have been stipulated for purposes of our ruling on the motions for summary judgment. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.Patience resided in McLean, 52 Va., at the time she filed her petition in docket No. 4722-79. Dewey also resided in McLean, Va., at the time he filed his petition in docket No. 7554-79. Both petitioners timely filed individual Federal income tax returns for the year 1975 with the Internal Revenue Service Center in Memphis, Tenn.Dewey and Patience were married on May 8, 1965, in Arlington, Va. No children were born or adopted of their marriage.Due to marital difficulties that subsequently developed, Dewey and Patience executed a written "Separation Agreement" dated April 3, 1973. 2 The preamble to the agreement recited certain facts surrounding its execution and stated its purpose as follows:Whereas the parties have separated and are now living apart and choose to remain apart, andWhereas the Wife is working and chooses to remain working and independent, andWhereas the parties desire to confirm their separation and make arrangements in connection therewith, including the settlement of their property rights, and the support and maintenance of the Wife * Paragraph 4 of the agreement stated that the parties had 342 divided their personal effects and property between them. In paragraphs 6 and 53 7 of the agreement, respectively, Dewey promised to retain Patience as beneficiary of a life insurance policy on his life and to reimburse her for "all medical and dental expenses" incurred by her and her two minor children by a previous marriage as long as they were covered by the medical reimbursement program of the husband's business.In addition, the agreement contained54 the following provisions for Patience's support:(5) The Husband shall pay the Wife for her assistance and maintenance whatever supplementary funds are necessary to sustain a standard of living equivalent to that which obtained before the separation. The Wife intends to work and be independent. If the Wife ceases to work, payment will increase to meet the needs of the Wife. The payments will be at least quarterly and will continue until one of the following events should first occur: (a) the death of the Husband; (b) the remarriage of the Wife; (c) the death of the Wife.* * * (9) The Wife acknowledges that the provisions of this Agreement for her support and maintenance are fair, adequate, and satisfactory to her, and in keeping with her accustomed standard of living and her reasonable requirements. The Wife, therefore, accepts these provisions in full and final settlement and satisfaction of all claims and demands for alimony or for any other provision for support and maintenance, and fully discharges the Husband from all such claims and demands except as provided in this Agreement. * * (11) If the parties hereto are divorced and the Wife thereafter remarried [sic], all55 obligations of the Husband to provide for the support and maintenance of the Wife shall cease.Finally, paragraph 10 expressly provided that the agreement was to be incorporated in any decree of divorce later entered, but that the agreement would not merge in such decree and would survive such a decree and be forever binding and conclusive on the parties.Dewey and Patience filed separate individual Federal income tax returns for 1973, 1974, and 1975. On his 1973 return, Dewey deducted $ 7,000 for separate maintenance payments to Patience, but the record does not show how Patience treated any such payments on her 1973 tax return. 356 343 In 1974, Dewey made payments to Patience totaling $ 21,325 and deducted that entire amount as separate maintenance payments. Patience received amounts totaling $ 21,325 from Dewey in 1974 and reported that entire amount as alimony on her return. The 1974 payments are evidenced in part by 39 personal checks made out at irregular intervals and in varying amounts from $ 110 to $ 2,100. 4 All of the checks were payable to Patience with the exception of one $ 900 check to Hicks Realty and one $ 201.35 check to McGuire Appliances, Inc. The only check showing a purpose for any of the payments was the check to Hicks Realty which bore a notation about a month's rent and deposit.During the taxable year 1975, Dewey made payments to Patience by personal checks in amounts totaling $ 24,250. The payments are evidenced by 30 checks made out at irregular 57 intervals and in varying amounts ranging from $ 50 to $ 3,900. The checks list Patience as the payee but do not specify a purpose for any of the payments. Dewey also paid $ 129.20 for medical services for Patience by a personal check to Holy Cross Hospital dated May 14, 1975.On his 1975 tax return, Dewey claimed a deduction of $ 24,379.20 labeled "Separate Maintenance Agreement" for the full amount of the payments he made to Patience during 1975. On her 1975 tax return, Patience reported $ 14,400 as alimony received from Dewey.On October 1, 1976, the parties executed a written property settlement agreement with terms substantially different from the terms of their earlier separation agreement. This agreement contained a provision fixing definite monthly amounts payable for Patience's support beginning on October 1, 1976, and ending on February 1, 1987. Those payments were to terminate upon the death or remarriage of Patience. Dewey and Patience were divorced on January 5, 1977, and the 344 divorce decree affirmed, ratified, and incorporated petitioners' property settlement agreement of October 1, 1976. The characterization of payments made under the 1976 agreement is58 not in issue in this case.The present dispute concerns the proper treatment for Federal tax purposes of payments made by Dewey to Patience during 1975. In his notices of deficiency, respondent took inconsistent positions in order to protect the revenue and to insure consistent treatment of the payments in question. 5 Respondent determined that the full amount of payments by Dewey to Patience during 1975 was includable in income by Patience under section 71(a)(2) and was not deductible by Dewey under section 215. However, in the motions for summary judgment now before us, respondent and Patience argue that Dewey's 1975 payments are not deductible because they were not made under a "written separation agreement" within the meaning of section 71(a)(2).59 In order for us to grant the motions for summary judgment, Patience and respondent must show that there is no genuine issue as to any material fact and that they are entitled to a decision in their favor as a matter of law. Rule 121(b); 6Shiosaki v. Commissioner, 61 T.C. 861">61 T.C. 861, 863 (1974). Because this burden is on the moving party in a motion under rule 121 or rule 56 of the Federal Rules of Civil Procedure (Fed. R. Civ. P. 56), the factual materials presented and the inferences therefrom must be viewed in the light most favorable to the party opposing the motion. Adickes v. Kress & Co., 398 U.S. 144">398 U.S. 144, 157 (1970); United States v. Diebold, Inc., 369 U.S. 654">369 U.S. 654, 655 (1962); Hoeme v. Commissioner, 63 T.C. 18">63 T.C. 18, 20 (1974).In the60 present case, Dewey and Patience filed separate returns for the taxable year 1975. Furthermore, Patience has 345 conceded for purposes of the present motions that she and Dewey separated in 1973, that they executed the 1973 separation agreement, and that Dewey made the disputed 1975 payments to her under that agreement and because of the marital or family relationship. The courts have held it proper to grant summary judgment under Fed. R. Civ. P. 56 where the moving party concedes that there is no genuine issue as to any material fact if his legal theory is accepted, but at the same time maintains that there is such an issue if his theory is rejected or his opponent's theory is adopted. Cram v. Sun Insurance Office, Ltd., 375 F.2d 670">375 F.2d 670, 674 (4th Cir. 1967); American Fidelity & Cas. Co. v. London & Edinburgh Ins. Co., 354 F.2d 214">354 F.2d 214, 216 (4th Cir. 1965); McLain v. Commissioner, 67 T.C. 775">67 T.C. 775, 778 (1977). Accordingly, Patience as the moving party has conceded the absence of any factual issue and the truth of Dewey's allegations only for purposes of her own motion. Begnaud v. White, 170 F.2d 323">170 F.2d 323, 327 (6th Cir. 1948);61 McLain v. Commissioner, supra at 778; C. Wright & A. Miller, Federal Practice and Procedure, Civil sec. 2720 n. 83 (1973).Therefore, based on Patience's concessions and viewing the evidence most favorably to Dewey, we also must treat the statements in the 1973 agreement and the inferences therefrom as true for purposes of the present motions. Thus, we assume the facts and inferences conceded by Patience include (1) that the parties were living separate and apart as of April 3, 1973, (2) that the parties executed the written separation agreement dated April 3, 1973, (3) that Dewey made payments in 1975 totaling $ 24,379.20 under that agreement, (4) that Dewey's 1975 payments to Patience under paragraphs 5 and 7 of the agreement were "periodic," 7 and (5) that the payments were made because of their marital or family relationship.62 This leaves for decision the legal question raised in the motions of whether the payments were made under a "written separation agreement" within the meaning of section 71(a)(2). Patience and respondent argue that in order for a written separation agreement to qualify under section 71(a)(2), it must contain a definite statement of the amount of support to be 346 paid to the wife. Dewey argues that the 1973 agreement qualifies under section 71(a)(2) notwithstanding its failure to provide for a specific amount of support payable to Patience.Neither section 71(a)(2) nor the regulations promulgated thereunder define what constitutes a "written separation agreement." 865 The predecessor of section 71 was enacted to tax support payments to the recipient spouse and to relieve the payor spouse from the burden of being taxed on such payments by making them deductible by him. H. Rept. 2333, 77th Cong., 2d Sess. 46 (1942), 2 C.B. 427">1942-2 C.B. 427; S. Rept. 1631, 77th Cong., 2d Sess. 83-87 (1942), 2 C.B. 568">1942-2 C.B. 568. Initially, this benefit was available only in the case of divorce or a legal separation. Sec. 71(a)(1). 9Section 71(a)(2)63 extended this benefit to spouses who are not divorced or legally separated under a court decree but who are in fact separated and enter into a written separation agreement. H. Rept. 1337, 83d Cong., 2d Sess. 9 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 10 (1954). The regulations under section 71(a)(2) provide that such payments 347 are includable in the wife's gross income whether or not the written separation agreement is a legally enforceable instrument. Sec. 1.71-1(b)(2), Income Tax Regs. The regulations for both section 71(a)(1) and section 71(a)(2) also require such an agreement to make specific the husband's obligation to support the wife. Section 1.71-1(b)(4), Income Tax Regs., provides that:(4) Scope of Section 71(a). Section 71(a) applies only to payments made because of the family or marital relationship in recognition of the general obligation to support which is made specific by the decree, instrument, or agreement. Thus, section 71(a) does not apply to that part of any periodic payment which is attributable to the repayment by the husband of, for example, a bona fide loan previously made to him by the wife, the satisfaction of which is specified in the64 decree, instrument, or agreement as a part of the general settlement between the husband and wife.Respondent and Patience argue that the periodic payments made by Dewey in this case cannot, as a matter of law, be viewed as having been made under a "written separation agreement" within the meaning of section 71(a)(2) "because the written separation agreement does not contain a definite statement as to the amount of support to be paid to Patience." In support of their arguments, Patience and respondent cite certain memorandum opinions of this66 Court involving questions as to whether or not certain documents, such as a letter from the husband, constituted a written separation agreement. 10 Respondent asserts, and properly so, that those cases stand for the proposition that the unilateral actions of one spouse do not constitute a written separation agreement and are merely a unilateral offer on the part of that spouse. That is not the case before us. For purposes of these motions, we have a written separation agreement executed by both Dewey and Patience. None of those cases involved an agreement executed by both spouses.Respondent places great reliance on certain language in those memorandum opinions. 11 However, that language was 348 directed to the existence vel non of a written agreement reflecting a67 meeting of the minds of the spouses, i.e., whether or not the parties had entered into a written agreement. In Saniewski, there was a letter written by the husband to which the wife never agreed and with which the husband, himself, failed to comply. In Garner, there was proof only of an oral agreement.68 Certainly, the absence of a stated amount of support is a factor to consider in determining whether or not there is an agreement (written or oral) between the spouses. However, it is quite another matter to say that the absence of a stated amount of support in a written separation agreement completely vitiates the parties' agreement as a matter of law. The Court's language in those memorandum opinions, quoted in note 11, does not purport to lay down a rule that an agreement executed by both spouses and providing for spousal support payments is not a "written separation agreement" as a matter of law if it fails to set out a definite amount of support.Neither section 71(a) nor the regulations thereunder expressly require that a written separation agreement contain a definite statement of the amount of support. Only section 71(b) dealing with child support requires that the decree or agreement "fix" the sum payable for support of the minor children of the husband "in terms of an amount of money or a part of the payment." Sec. 71(b); Commissioner v. Lester, 366 U.S. 299 (1961). That strict requirement is only for purposes of distinguishing between payments69 for the wife's support which are taxable to her and payments for child support which are not. Failure to "fix" an amount for child support results in the entire payment's being taxed to the wife, but it does not render 349 the written agreement otherwise legally insufficient. Here, there are no children and no child support payments involved. The payments to Patience were entirely for spousal support.The statutory requirements under section 71(a)(2) are that the payments be "periodic," be "made under such agreement," and be made "because of the marital or family relationship." Absent a statement of a definite dollar amount or some formula for determining the amount properly payable under paragraph 5 of the agreement in this case, petitioners face a difficult task of proving that the payments in question qualify under section 71(a)(2). That practical problem is not our concern at the moment. Here, for purposes of their motions, respondent and Patience have conceded that the payments were made under the 1973 separation agreement and were made because of the family or marital relationship.The parties have not cited, and the Court has not found, any case exactly like the 70 present one. However, a case arising under the predecessor to section 71(a)(1) provides some guidance. Jefferson v. Commissioner, 13 T.C. 1092">13 T.C. 1092 (1949). Section 71(a)(1) and its predecessor, like section 71(a)(2), requires that payments be made under the decree or written instrument and because of the marital or family relationship. In Jefferson, the husband agreed in a letter whose terms were accepted by the wife (and, hence, a written instrument incident to the divorce) to pay the wife:a sum sufficient, according to the full measure of the standard of living to which you have become accustomed, to cover all amounts required for your suitable maintenance, support and comfort during each year. * * The letter agreement went on to state that at that time (1941), $ 6,000 a year would seem to be sufficient, but that more would be paid if necessary. 13 T.C. at 1094-1095. The amounts actually paid by the husband to the wife during the years before the Court were less than the $ 6,000 figure mentioned, but the Court found as a fact that the payments of $ 4,217 in 1942 and $ 4,813.14 in 1943 were for the wife's support71 and maintenance and were made under a written instrument incident to divorce (the letter agreement). 12 The Court squarely 350 rejected respondent's argument that there was no legal obligation on the part of the husband to make the payments, and held that the payments were deductible by him.Another somewhat analogous case lends support to our approach here. Bogard v. Commissioner, 59 T.C. 97">59 T.C. 97 (1972). Like the present case, Bogard involved a written agreement between the spouses providing for the wife's support and72 maintenance. However, the agreement itself made no reference to the spouses' separation. Respondent argued that the agreement did not constitute a "written separation agreement" within the meaning of section 71(a)(2) because the document did not state that the parties had separated and were living apart. The Court declined to follow such a formalistic approach and held that the statute merely required an actual separation which could be established by extrinsic evidence. The husband was permitted to prove that he and his wife were in fact separated. The Court declined to hold that the agreement was insufficient as a matter of law.In the Bogard case, we discussed the general requirements of section 71(a)(2), stating (59 T.C. at 101) that:Logically, it appears Congress was interested in a clear statement in written form of the terms of support where the parties are separated. In this manner it is administratively convenient for the Commissioner to apprise himself of the amount of gross income to the wife and the corresponding deduction allowable to the husband. Since the statute requires an actual separation, formal expression of this in the separation73 agreement is supererogatory. To insist that the parties confirm in writing the demonstrable fact of their continuous separation is to elevate form over substance by concentrating on a tree to the exclusion of the forest. What matters is that the parties executed a written agreement in contemplation of a separation status which status in fact continued to exist throughout the years in question. Moreover, the "boiler-plate" requirement advocated by the respondent and Bridget seems unduly harsh and unreasonable, especially where the parties are often unfamiliar with legal intricacies as in the present case. A principal result would be to snare the unwary or uninformed.In the present case, the failure to recite a dollar amount for the support payments also creates administrative inconvenience for the Commissioner and problems of proof for the 351 husband. As with the fact of separation in Bogard, here, too, the nature of the payments should be resolved as a matter of fact and not as a matter of law. 13 We agreed in Bogard that making the matter a question of law would "elevate form over substance" and would "snare the unwary or uninformed." We think that is true74 here also.As in Jefferson v. Commissioner, supra,75 the agreement in the present case is not wholly without some standard for the wife's support and maintenance. Under paragraph 5 of their agreement, Dewey is to --pay the Wife for her assistance and maintenance whatever supplementary funds are necessary to sustain a standard of living equivalent to that which obtained before the separation * * And in paragraph 9 of the agreement, Patience acknowledges that the provisions for her support and maintenance are in keeping with "her accustomed standard of living and her reasonable requirements." For the administrative convenience of the Commissioner and for the domestic tranquility of the spouses, it would certainly be better if the terms of the written separation agreement were more explicit. An agreement such as this one foments disputes and provides another battlefield on which the warring spouses can renew hostilities. However, that the agreement may be unwise or poorly drafted does not mean that it is necessarily insufficient as a matter of law under section 71(a)(2).The failure to provide for a definite amount of support creates problems of proof as to whether or not the payments were made under the agreement for support76 or made for other purposes such as repayment of a loan or a settlement of property rights. Generally, we resolve questions as to whether payments are "alimony" or something other than alimony based on all the facts and circumstances of the particular case, 352 including the terms of the spouses' agreement or divorce decree. However, we are not bound by the labels used in the spouses' written agreements or in the divorce decrees. See Beard v. Commissioner, 77 T.C. 1275">77 T.C. 1275 (1981), on appeal (9th Cir., June 15, 1982); Schottenstein v. Commissioner, 75 T.C. 451 (1980); Westbrook v. Commissioner, 74 T.C. 1357 (1980); Warnack v. Commissioner, 71 T.C. 541">71 T.C. 541 (1979); Mirsky v. Commissioner, 56 T.C. 664">56 T.C. 664 (1971).Dewey paid $ 24,379.20 to Patience in 1975. If he can establish that he and Patience were in fact separated and living apart, that they executed the written separation agreement dated April 3, 1973, that the $ 24,379.20 was paid pursuant to that agreement, and that the payments were made because of the marital or family relationship77 (and not as a repayment of a loan, settlement of property rights, etc.), we think he should receive the deduction and that Patience should include the amount in her income.This case should be resolved on its facts and not as a matter of law. The motions for summary judgment filed by respondent and Patience will be denied.An appropriate order will be entered. WHITAKERWhitaker, J., concurring: I agree with the majority that the agreement here is not insufficient as a matter of law for failure to state within the four corners of the instrument a definite amount for the support payments. I think it important, however, to go beyond the comment of the majority that the agreement here is "not wholly without some standard for the wife's support and maintenance." The narrow issue which we have resolved in these motions for summary judgment is whether section 71(a)(2) requires that the agreement state explicitly the dollar amount of the support obligation. We have determined that it does not. However, if the document did not provide some mechanism for determination of the support obligation, which would be deemed to be sufficient under general principles of contract law to create78 an enforceable bilateral contract, we should, nevertheless, find at this juncture 353 that the agreement in this case does not constitute a "written separation agreement," and, therefore, hold for the movants. I conclude that this contract is sufficient as a matter of law, and I believe that the majority has reached the same conclusion. 1 We should affirmatively so hold on the rationale set forth herein.Section 71(a)(2) uses the terminology "written separation agreement." One would normally assume that such a document would be required to reflect a meeting of the minds of the parties enforceable under applicable contract law in the appropriate State forum. 2 However, the legislative history underlying section 71 includes a statement that payments under such an agreement are taxable to the spouse "whether or not the agreement is an instrument79 enforceable in a court of law." S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 171 (1954); H. Rept. 1337, 83d Cong., 2d Sess. A21 (1954). The regulations simply parrot the legislative history. Sec. 1.71-1(b)(2), Income Tax Regs. Neither the Committee reports nor the regulations give us any help as to the intent of Congress in directing that we should not be concerned with "legal enforceability." However, some indication of congressional intent may come from the Senate report 3 on the 1939 Code predecessor provision which explains that uniformity of treatment of alimony or payments in the nature of alimony is intended "regardless of variance in the laws of the different states concerning the existence or continuation of an obligation to pay alimony."I do not believe that payments made by one spouse80 to another under an instrument wholly unenforceable under normal rules of contract law were intended to be deductible by the payor and taxable to the payee. The majority recognizes that there is a distinction between the facts of this case and a situation where one spouse makes payments gratuitously or voluntarily as a unilateral act and not pursuant to "a written separation agreement executed by both" parties. Where the 354 language of an "agreement" is so vague as to indicate there was no meeting of the minds on the amount of support and no basis for determining the nature or extent of the obligation, any payment would be gratuitous. The Court of Appeals for the Fifth Circuit has recognized this distinction. See Taylor v. Campbell, 335 F.2d 841">335 F.2d 841, 846 (5th Cir. 1964).We cannot and should not ignore the use in the statute of the term "written separation agreement." Neither should we be misled by the brief and obscure reference to the issue of enforceability under State law. One can surmise with some foundation that Congress was concerned with oddities of State laws such as those of Texas, which are discussed in Taylor v. Campbell, supra.81 Thus, it makes sense to ignore peculiar quirks of State divorce law, but still to apply normal contract law principles. Since we do not have a Federal common law, we are dependent upon the common law principles recognized in State court decisions. Unless we can find that the parties have intended to make a contract, as the term "contract" is normally used, we should not find that they have entered into a written separation agreement. However, "that the parties have left some matters to be determined in the future should not prevent enforcement, if some method of determination independent of a party's mere 'wish, will, and desire' exists, either by virtue of the agreement itself or by commercial practice or other usage or custom." 1 A. Corbin, Contracts sec. 95, at 401-402 (West 1963). Extraneous facts are frequently pertinent in the interpretation of a contract.Under the facts of this case, the omission of a fixed amount of support is immaterial since there is in the written separation agreement an obligation referable to the existing standard of living of the wife, which fact is capable of independent proof. I believe that the foundation of the Court's opinion must be that 82 the standard set forth in paragraph 5 of the agreement herein is sufficiently measurable that it can be applied by the Court to determine the amount of alimony. Therefore, we can, and should, characterize the instrument as an enforceable bilateral contract (assuming, of course, that it is what it purports to be). 1 A. Corbin, supra at sec. 9. 4 See and compare 355 Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151 (1929); State Street Bank & Trust Co. v. United States, 313 F.2d 29">313 F.2d 29 (1st Cir. 1963).83 Footnotes1. Unless otherwise indicated, all Rule references herein 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 during the taxable year here involved.↩2. Patience has conceded, solely for purposes of our ruling on her motion for summary judgment, that she executed this agreement. In the event her motion is denied, however, she maintains that she did not execute that written agreement. Patience also alleged in her petition that she and her husband were not separated until August of 1975 and that the only valid, written separation agreement that ever existed between her and her husband was not executed or operative until Oct. 1, 1976. In the parties' stipulation of facts, Patience continues to maintain those positions, but concedes to the contrary solely for purposes of her motion for summary judgment.↩3. The parties' stipulation on this matter is even more equivocal than the Court's paraphrase thereof. Dewey takes the position that he made payments of $ 7,000 to Patience in 1973 and deducted that amount on his return. Patience takes the position that she did not receive any amount from Dewey during 1973 and that she does not recall whether she reported any amount as alimony on her 1973 return. For purposes of the pending motions for summary judgment, the Court will disregard these conflicts and will draw no inferences in regard to 1973.↩4. The 1974 checks attached to the stipulation total only $ 18,886.35. The record does not indicate how the balance of the $ 21,325 was paid to Patience in 1974.↩5. Respondent disallowed the $ 24,379.20 deduction claimed by Dewey and increased Patience's alimony income to a total amount of $ 24,379.20. Patience had reported alimony income of $ 14,400 on her return, and, during the audit, agreed to an additional amount of $ 1,729.20, the tax on which was assessed before the statutory notice of deficiency was issued to her. The statutory notice increased her alimony income by an additional $ 8,250. Dewey here claims the full deduction of $ 24,379.20, and Patience asserts that none of that amount is includable in her income and that she has in fact overpaid her taxes for 1975.↩6. The Notes to Rule 121 (71 T.C. 1204">71 T.C. 1204) state that the summary judgment procedure is adopted from rule 56 of the Federal Rules of Civil Procedure↩.7. Assuming that Dewey's 1975 personal checks represented payments to Patience under pars. 5 and 7 of the agreement, the fact that those payments were made at irregular intervals does not prevent them from being "periodic." Sec. 71(a)(2)↩.8. Sec. 71(a)(2) provides:(2) Written separation agreement. -- If a wife is separated from her husband and there is a written separation agreement executed after the date of the enactment of this title, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such agreement is executed which are made under such agreement and because of the marital or family relationship (or which are attributable to property transferred, in trust or otherwise, under such agreement and because of such relationship). This paragraph shall not apply if the husband and wife make a single return jointly.Sec. 1.71-1(b)(2), Income Tax Regs., provides:(2) Written separation agreement. (i) Where the husband and wife are separated and living apart and do not file a joint income tax return for the taxable year, paragraph (2) of section 71(a) requires the inclusion in the gross income of the wife of periodic payments (whether or not made at regular intervals) received by her pursuant to a written separation agreement executed after August 16, 1954. The periodic payments must be made under the terms of the written separation agreement after its execution and because of the marital or family relationship. Such payments are includible in the wife's gross income whether or not the agreement is a legally enforceable instrument. Moreover, if the wife is divorced or legally separated subsequent to the written separation agreement, payments made under such agreement continue to fall within the provisions of section 71(a)(2)↩.9. SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS.(a) General Rule. -- (1) Decree of divorce or separate maintenance. -- If a wife is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such decree in discharge of (or attributable to property transferred, in trust or otherwise, in discharge of) a legal obligation which, because of the marital or family relationship, is imposed on or incurred by the husband under the decree or under a written instrument incident to such divorce or separation.↩10. See Saniewski v. Commissioner, T.C. Memo. 1979-337; Auerbach v. Commissioner, T.C. Memo. 1975-219; Garner v. Commissioner, T.C. Memo. 1973-79↩.11. Respondent quotes the following language from Saniewski v. Commissioner, T.C. Memo. 1979-337:"Clearly the statute contemplates that the parties enter into an agreement. As such, there must be a meeting of the minds or understanding between the parties as to the terms. In addition, to have any resemblance of a support agreement, the document must set forth the amount of the support, the duration of the payments, and the support items covered by the payments."Similarly, respondent relies on the following statement from Garner v. Commissioner, T.C. Memo. 1973-79:"A written↩ instrument, therefore, has always been required under the statute. Congress was interested in requiring a clear statement of the separation agreement so it could be determined with certainty the amount of payments to be included in the wife's income and the allowable corresponding deduction available to the husband * * [Emphasis in original.]"12. In Saniewski v. Commissioner, T.C. Memo. 1979-337↩, we considered the fact that the husband's letter stated an amount of $ 800 per month, whereas he actually sent his wife $ 800 per month, then $ 150 per week, and finally $ 75 per week. We considered those differing amounts as factors showing that the husband's letter was merely a unilateral offer to enter into an agreement and did not constitute an agreement between the parties.13. In Bogard v. Commissioner, 59 T.C. 97">59 T.C. 97 (1972), we declined to follow a revenue ruling that required that a written separation agreement must recite that the parties have separated and are living apart. 59 T.C. at 102. Here, too, there is a revenue ruling. In Rev. Rul. 73-409, 2 C.B. 19">1973-2 C.B. 19, respondent ruled that a written separation agreement, to be valid under sec. 71(a)(2), must contain a definite statement as to the amount of the wife's support. Revenue rulings do not have the force of law and are merely statements of the Commissioner's litigating and administrative position. See Stubbs, Overbeck & Associates v. United States, 445 F.2d 1142">445 F.2d 1142, 1146-1147 (5th Cir. 1971); Estate of Lang v. Commissioner, 64 T.C. 404">64 T.C. 404, 406-407 (1975), affd. on this point 613 F.2d 770">613 F.2d 770, 776↩ (9th Cir. 1980).1. There remains for decision at trial on the merits several fact questions conceded by the wife for purposes of this proceeding only. See note 2 in the majority opinion.↩2. See generally 1 A. Corbin, Contracts sec. 9 (West 1963).↩3. S. Rept. 1631, to accompany H.R. 7378 (Pub. L. 753), 77th Cong., 2d Sess. 83 (1942), 2 C.B. 568">1942-2 C.B. 568↩.4. "In the process of negotiating an agreement, a term that is most frequently left indefinite and to be settled by future agreement, or by some other specified method, is the price in money -- the compensatory exchange for the subject matter of purchase. This is true both of agreements for the rendition of service and of those for the purchase and sale of goods. If the parties provide a practicable, objective method for determining this price or compensation, not leaving it to the future will of the parties themselves, there is no such indefiniteness or uncertainty as will prevent the agreement from being an enforceable contract. * * * [A. Corbin, supra sec. 97, at 423-425. Fn. ref. omitted.]""An agreement is not unenforceable for lack of definiteness of price or amount if the parties specify a practicable method by which the amount can be determined by the court without any new expression by the parties themselves. [A. Corbin, supra↩ sec. 98, at 433-434. Fn. ref. omitted.]"	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622726/	Edgcomb Steel Corporation v. Commissioner.Edgcomb Steel Corp. v. CommissionerDocket No. 2935.United States Tax Court1944 Tax Ct. Memo LEXIS 21; 3 T.C.M. (CCH) 1309; T.C.M. (RIA) 45101; December 4, 194421 Herbert C. Smyth, Jr., Esq., for the petitioner. Jonas M. Smith, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion The Commissioner has determined deficiencies against petitioner for the taxable year 1941, as follows: Declared Value ExcessExcessIncome TaxProfits TaxProfits Tax$10,283.03$488.09$35,066.25Certain adjustments made in the notice of deficiency are not contested by petitioner. The sole issue is whether salaries paid by petitioner to its principal officers were reasonable within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code. Income and Declared Value Excess-Profits tax return and Excess Profits tax return for the taxable year 1941, were filed by petitioner with the Collector of Internal Revenue for the fifth district of New Jersey. Findings of Fact Petitioner, a New Jersey corporation, organized in 1926, conducts a business as mill agent, sales agent, and territorial distributor for steel manufacturers. Its business office and warehouses are located at Hillside, New Jersey. H. L. Edgcomb, whose name petitioner bears, together with J. H. Roberts, M. O. Kopperl, and G. L. Tillson, promoted and organized22 the petitioner corporation, and have continuously been its principal officers. Petitioner commenced business with a capital of approximately $100,000. Its plan of operation has been to provide a warehouse and, upon an agreement with various steel manufacturers, to put in stocks of steel on a consignment basis. Petitioner has also purchased and resold for its own account and has sold for various manufacturers on commission. It maintains a sales force and has installed precision machinery for cutting and sewing, and for testing the temper of steel. During the earlier years of its operation petitioner had a difficult time financially. Its capital was invested principally in a warehouse and equipment. From the outset of its organization it was necessary that petitioner obtain sources of supply of steel under an arrangement whereby it could use the resources of the suppliers to help finance its own business. Its officers obtained money from banks and from their life insurance to keep the business running. They took little in the way of executive compensation compared to the services they rendered and their worth to the company. The success of the enterprise required a knowledge of the23 industry and also it required business connections. Edgcomb, the president, started in the industry in 1912, and had held important positions with other corporations engaged in the same line of business as petitioner. Roberts, the petitioner's vice president, was a metallurgical engineer and since 1910, he had held numerous important positions in the steel industry. Kopperl, the secretary, and Tillson, petitioner's treasurer, were also well experienced. Tillson had been in the steel business since 1919, and Kopperi for a lesser length of time. The ultimate success of petitioner is due largely to the ability and reputation of the above officers and to the confidence of the industry in their integrity. Petitioner's gross sales rose steadily from $983,245 in 1935, except for a slight recession in 1938, to $6,829,177 in 1942, and amounted to $4,848,363 in 1941. Net invested capital and surplus rose from the initial investment to a total of $405,260 in 1941. The increase was provided principally from earnings. Very little outside capital was paid in. Total salaries paid officers since 1937 ranged from $53,405 in that year, with a low of $42,588 in 1938, to $140,005 in 1941. In 1940 petitioner24 paid salaries in the total sum of $80,061, and in 1942 the salaries of the officers totaled $137,666.42. On December 31, 1941, petitioner had outstanding 3,257 shares of common stock. Of that number 2,797 shares were owned by Messrs. Edgcomb, Roberts, Kopperl, and their families, including brothers and sisters, and by Tillson. The remaining shares were owned largely by employees of petitioner. On the same date there were outstanding 375 shares of $100 par value, six per cent cumulative, preferred stock. In 1941 petitioner paid dividends on its common stock in the cash amount of $28,698, and it also paid two stock dividends during the year, one of 25 per cent and another of 10 per cent. By resolutions, dated March 15, 1941, June 3, 1941, and August 13, 1941, petitioner's board of directors voted to pay the above officers bonuses of one month's, two months', and one month's salaries, respectively. In these same resolutions the board authorized bonus payments to other employees of the corporation and resolved that the final salaries to be paid the officers should be fixed after further consideration. On October 21, 1941, the board passed a resolution fixing the salaries of the officers25 at $25,000 for the president, $20,000 for the vice president, $12,500 for the secretary, and $12,500 for the treasurer. At the same time it voted a bonus of $69,437.70 for all salaried employees of the corporation. The bonuses were to be paid in cash, common stock, preferred stock, or combination thereof, at the option of the individual employee. The amount of bonus to be paid each employee was ascertained and specified by the board. The amounts of the bonuses provided for the officers were: Edgcomb, $18,333.48, Roberts $15,000, Tillson $9,166.68, and Kopperl $8,750. Each of the above officers chose to take a part of their bonus in preferred stock at $100 per share. Edgcomb received $5,800 in preferred stock, Roberts received $5,000, Kopperl $2,600, and Tillson $2,900. The total compensation paid to the officers by petitioner during the taxable year 1941 were as follows: Edgcomb $49,999.66, Roberts $39,999.79, Kopperl $24,999.99, and Tillson $25,005.99. Throughout the taxable year the officers whose salaries are being considered, devoted their full time and attention to the affairs of the company. Edgcomb discharged the duties of his office as president, Roberts, in addition to being26 vice president, was in charge of sales. Kopperl had charge of the stainless steel end of the business, as well as being the corporation's secretary. Tillson, the company's treasurer, was in charge of the warehouse department and the accounting department, including credits and collections. During 1941, petitioner constructed nine new buildings, the principal one being a warehouse which was designed by Kopperl. Tillson supervised the construction of this building and the moving of stocks and equipment into it when completed. These duties were performed by Kopperl and Tillson in addition to their usual duties and they were regarded as an incident to their regular work. In fixing the total compensation to be paid the officers, petitioner's board of directors took into account the past services rendered by these officers and the fact that in some past years inadequate salaries were paid them. The salaries paid the officers in 1941 were not proportionate with the stockholdings of the individual officers, nor were they distributions of profits. The salary paid each officer by petitioner in 1941, was reasonable compensation for services actually rendered by him. In the notice of deficiency27 the respondent determined that reasonable allowances for the salaries of the respective officers were as follows: Edgcomb $30,792.28, Roberts $23,094.48, Kopperl $13,087.24, and Tillson $13,087.30. Opinion ARUNDELL, Judge: We have here the familiar question whether the salaries paid to the officers of a closely held corporation may be regarded as reasonable within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code. As is usual in such cases, we have the determination of the Commissioner that the salaries are excessive and the testimony offered on behalf of the taxpayer that they are reasonable. The salaries have been fixed by the board of directors. We have found that they bear no close relationship to stockownership and may not be regarded as a distribution of earnings in disguise. The treasurer of the American Rolling Mill Company, and a certified public accountant, familiar with companies engaged in a similar business, both testified that they regarded the salaries as being in line with those paid by companies similarly situated and operating related businesses. It seems clear that there was a large measure of personal service in petitioner's activities and that28 the success of the enterprise was due almost entirely to the ability, personality, and drive of these four men. While the salaries were higher in the current year than in former years, the business had been increasing at a rapid rate, with both the gross and net profits much higher than in former years. Measured by gross sales the salaries amounted to only 2.9 per cent. A liberal dividend policy was followed in the current year, and the salaries carried a recognition of the fact that those paid in earlier years were inadequate. Ox Fibre Brush Co. v. Commissioner, 281 U.S. 115">281 U.S. 115, 74 L. Ed. 733">74 L. Ed. 733, 50 S. Ct. 273">50 S. Ct. 273. We regard the salaries as reasonable in the circumstances. Cf. Capitol-Barg Dry Cleaning Co. v. Commissioner, 131 F.2d 712">131 F.2d 712; General Smelting Co. v. Commissioner, 4 T.C. 313">4 T.C. 313; Toledo Grain & Milling Co. v. Commissioner, 62 F.2d 171">62 F.2d 171. The respondent presents the further contention that the compensation paid these four officers in preferred stock of petitioner may in no event be deducted, as there is no evidence in the record as to the value of such shares. The notice of deficiency29 and the answer to the petition certainly do not specifically put this point in issue, although in the respondent's opening statement at the time of the trial he gave notice that he would raise the question. We think there is no merit in this contention. The bonuses were payable in cash, common stock, preferred stock, or any combination thereof solely at the option of the employees. The fact that each of the officers saw fit to take some part of the bonus in preferred stock, accepting the same at its par value, is of no consequence. Petitioner does not seek a deduction in an amount greater than it was obligated to pay in cash, and the salaries being otherwise reasonable, we have no doubt that the deduction was allowable in the circumstances. Liquid Carbonic Corp., 34 B.T.A. 1191">34 B.T.A. 1191. Nor do we think there is any merit in respondent's contention that some part of the salaries paid to Kopperl and Tillson should be disallowed by reason of the fact that they gave some time to supervision of the construction of the warehouse. Respondent's argument that this sum should be capitalized and not allowed as a deduction is, on the facts here, without merit. Decision30 will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622728/	Clif E. Rankin and Jane McK. Rankin v. Commissioner.Rankin v. CommissionerDocket No. 33798.United States Tax Court1953 Tax Ct. Memo LEXIS 38; 12 T.C.M. (CCH) 1367; T.C.M. (RIA) 53385; December 4, 195338 Advances made to a controlled corporation resulting in loss to principal stockholder held deductible by stockholder only as a nonbusiness bad debt. Wm. J. Adams, Jr., Esq., Jefferson Standard Building, Greensboro, N.C., for the petitioners. D. Z. Cauble, Jr., Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The respondent determined deficiencies in income tax for the calendar years 1944, 1945, and 1946, in the respective amounts of $120.41, $1,627.58, and $7,462.09. The sole issue presented is whether the petitioners are entitled to a deduction of $48,484.28 as a business bad debt in 1946, resulting in an operating loss carry-back to 1944 and 1945. Some of the facts are stipulated. The petitioners filed joint returns for the calendar years 1944, 1945, and 1946, on the cash basis with the collector of internal revenue at Greensboro. North Carolina. Findings of Fact The stipulated facts are so found. The petitioners are husband and wife. They reside at Fayetteville, North Carolina. Rankin was engaged in business as a distributor of products of The Texas Company for about 12 years prior to 1944. This business occupied39 the major part of his time and attention until he sold it on September 1, 1944. In June 1945 he acquired a two-thirds interest in a partnership doing business as Rankin Lumber Co. He operated this business throughout 1946. There were some 75 employees in this business and Rankin devoted about ten hours a day to it. Frederick C. Owen operated a machine shop in Fayetteville. Owen invented a welding machine on which he secured a number of patents, the earliest in 1926 and the latest in 1943. L. N. Whitted became interested in the commercial possibilities of this welder in 1936 and sought to interest Rankin in financing the manufacture and sale of welders of this type. On February 18, 1936, Rankin and Owen entered into a written contract whereby Rankin loaned $2,600 and agreed to lend further sums up to $8,000 and Owen agreed to use the funds for the manufacture of welders and to repay Rankin from the proceeds of sales. Pursuant to this, Rankin loaned Owen about $8,000, which was repaid. From about 1937 to 1941 Rankin, as sole proprietor, operated a business under the name of Owen Electric Sales Company selling on a commission basis, or at a markup, welders manufactured by Owen. 40 Income tax returns of Owen Electric Sales Company show the following gross sales and operating losses for the years 1937 to 1940, inclusive: YearGross SalesOperating Loss1937$9,120.22$ 674.6319385,219.983,211.2919394,677.264,784.5219403,952.874,299.27In May 1940 Whitted, acting for Rankin, by contract with Owen secured the exclusive right to manufacture and sell the welders, upon payment of an annual royalty of $7,500 and additional royalties on welders in excess of 500 built in any one year. The contract was assignable and in 1941 was assigned to Owen Electric Company. Owen Electric Company was incorporated February 6, 1941. The stock was of a par value of $1 per share. Of 37,200 shares issued, 31,200 were issued to Rankin or his nominee. Rankin paid for his shares by contributions of inventory, machinery, organization expenses, and good will. The item of good will represented the value placed by Rankin on the Owen contract. Two other stockholders paid in $6,000 in cash for 6,000 shares. One of these sold his 1,000 share holding to Rankin in April 1943. Owen Electric Company engaged in the business of manufacturing and selling41 the welders invented by Owen. It had the following gross sales and operating losses for the years 1941 to 1945, inclusive: YearGross SalesOperating Loss1941$16,600.01$ 2,461.93194217,817.5123,231.3619437,111.6415,403.031944927.5011,125.6219451,221.5611,254.23In 1946 Owen Electric Company had gross sales of $50 and sustained a total loss on liquidation of $25,023.11, of which $18,761.57 was a loss from sale of assets. Rankin advanced the following amounts to Owen Electric Company in the years 1941 to 1946, inclusive: 1941$ 5,795.00194213,942.5019436,050.0019448,880.00194510,625.0019465,691.78These were recorded on the books of the Company. Owen Electric Company carried on business in a building 40 by 100 feet in area built by Rankin on property he owned in Fayetteville. The Company had one office employee and eight to ten other employees including one graduate electrical engineer and some men experienced in electrical work. The building housed the office, machinery and equipment for building the welders. Rankin was president and treasurer of the Company and in charge of its operations. 42 He attended to all financial matters and supervised the shop in a general way and stopped at the plant nearly every day. Whitted was in charge of sales and was on the road most of the time. Rankin made some trips on business of the Company. A preliminary certificate of dissolution of Owen Electric Company was issued by the Secretary of State of North Carolina in May 1946. After due advertisement, a public sale of the remaining assets of the corporation was held on September 20, 1946. Rankin purchased these assets at the sale for $2,500 and the Company thereupon became completely liquidated. Rankin's advances to the Company were used to pay current operating expenses including principally the royalty payments to Owen. The advances were not used for investment in land or buildings. They were unsecured. At the time the amounts were advanced Rankin's stock was fully paid for. The difference between the aggregate amount of the advances, $50,984.28, and the amount paid by Rankin for the assets on liquidation of the Company, $2,500, or $48,484.28, has never been repaid to Rankin. The debt created by Rankin's advances to the Company became worthless in 1946 when the Company was dissolved43 and liquidated. The petitioners' income tax return for 1944 showed income of commissions from The Texas Co., rents, and hauling income. Their return for 1945 showed income of rent from service stations, and from Rankin Lumber Company, and a loss from Owen Electric Company. Their return for 1946 showed Rankin's occupation as "Partner-Rankin Lumber Co." and reported income from the lumber company and rentals, and a loss from a bad debt. Rankin also was interested in certain inventions of Charles F. Harris. Harris devised a mechanical insurance vendor to issue policies in public places such as bus stations, and a coin changing device for use in vending machines such as soft drink dispensers to deliver the merchandise and make change. Rankin loaned Harris $600 in 1939 secured by an assignment of one-half interest in the insurance vendor, and gave Harris some small parts to help him. With two other men, Dixon and Olive, Rankin backed Harris with financial support in efforts to perfect and market these inventions. These three men purchased a half interest in these devices after 1939 and by written agreement provided for financing them. Patents were secured by Harris in 1941 and 1942. 44 In 1941 Harris, Rankin, Dixon, and Olive entered into an agreement licensing Johnson Fare Box Company to manufacture and sell the coin changing device for payment of stated royalties. Rankin received a share of such royalties in the taxable years. Rankin furnished Harris some $5,000 in promoting these two devices. In this connection Rankin conferred with Dixon and Olive two or three times a week or whenever Harris wrote them. Rankin made loans to a service station in 1936 and 1938. He made various other loans. In January 1945 Rankin bought a franchise for the manufacture of an orange drink. Opinion Rankin advanced certain funds to a controlled corporation which year by year sustained losses. In 1946 he caused the corporation to be liquidated. The taxpayers claim a loss as a business bad debt of the net amount advanced. There is no dispute as to the amount nor as to the year of loss. The respondent contends (1) that the loss was a nonbusiness bad debt to be treated as a short term-capital loss, or (2) that the amount represents an additional cost of Rankin's stock in the corporation. The question is whether the loss from the worthlessness of the debt was incurred in the petitioners' 45 trade or business. "Business" has been defined as "that which occupies the time, attention and labor of men for the purpose of a livelihood or profit." (C.A. 6, 1943). Whether Rankin was engaged in business in connection with his advances to the Company is a question of fact. In , it was held that the controlling stockholder of a corporation was an employee of the corporation and its business was not his own, hence a loss from worthlessness of its stock was not incurred in the trade or business of the stockholder. See also, . This rule has generally been followed where the issue concerns the "trade or business" of a stockholder of a corporation. See Charles G. Berwind, 20 T.C. - (No. 114, July 9, 1953); ; ; ; and , reversing . Rankin's business in 1944 until September was that of a distributor46 of products of The Texas Company. This occupied the major part of his time and attention. His tax return for 1944 reported this as his business. From June 1945 and throughout 1946 his principal business was directing the operations of a lumber company in which he had a two-thirds partnership interest. This business had about 75 employees and required about ten hours per day of Rankin's time. His returns for 1945 and 1946 indicate that this business was his principal occupation. The petitioners contend that Rankin was engaged in one or more of the following businesses during the taxable years in addition to his principal businesses: (a) promoting, exploiting and developing patents, or patented inventions and novel devices; (b) promoting and participating actively and continuously in various enterprises and ventures; (c) making loans; and (d) organizing, operating and financing Owen Electric Company. A taxpayer may be engaged in more than one business, but that is not the case here. The activity of Rankin with reference to the operations of Owen Electric Company was nothing more than the usual participation of a corporation officer-stockholder in the business of the corporation, 47 plus the advancing of funds to meet the royalty requirements and other expenses. The petitioners rely on , affirming Tax Court Memorandum Opinion [. In that case the taxpayer was held to be in the business of exploiting patents; the activity involved the major part of his lifetime, was a full-time occupation and was engaged in continuously and regularly throughout his business career. The evidence here does not warrant a similar conclusion. Although Rankin took part in financing various inventions, this was not his principal activity, and it did not occupy the major part of his time and attention. The petitioners also cite . In that case, as in the Stokes Estate case, the loss arose out of one of many ventures undertaken by the taxpayer, which ventures were held to be of such extent and frequency as to amount to the taxpayer's business. similarly involves loans to one of a number of corporations which were organized, operated, and financed by the taxpayers. A similar situation*48 existed in . We do not consider these cases applicable here. The petitioners have attempted to show the multiple nature of Rankin's various investments to support the argument that they collectively were of such an extent as to constitute a trade or business. We are not convinced that they were sufficient for this purpose and we hold that the debt which became worthless in 1946 was a non-business bad debt. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622730/	ATLANTA ATHLETIC CLUB, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAtlanta Athletic Club v. CommissionerDocket No. 28512-88United States Tax CourtT.C. Memo 1991-83; 1991 Tax Ct. Memo LEXIS 97; 61 T.C.M. (CCH) 2011; T.C.M. (RIA) 91083; February 28, 1991, Filed 97 Decision will be entered under Rule 155. Petitioner is a social club which is exempt from Federal income tax. Petitioner had unrelated business taxable income for the years in issue. Petitioner offset losses from nonexempt, nonmember undertakings against its investment income. Petitioner did not report gain on the sale of property, claiming that such property was used directly in the performance of its exempt function. Held: Petitioner is not entitled to offset losses from nonexempt, nonmember undertakings against investment income because petitioner did not enter into such undertakings with an intent to profit. Held further: Petitioner's undertakings, excluding investment income, constitute a single activity in which petitioner is entitled to offset the losses from all undertakings against the gross receipts from all undertakings, excluding investment income. Held further: Petitioner is not entitled to deduct certain expenditures made to comply with P.G.A. requirements to host the 1981 P.G.A. Championship tournament because they are capital expenditures. Held further: Petitioner must recognize and report the gain from the sale of property as unrelated business98 taxable income because petitioner did not directly use the property for exempt purposes. Terence J. Greene and Sidney O. Smith, for the petitioner. Eric B. Jorgensen, for the respondent. WHITAKER, Judge. WHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in petitioner's Federal income taxes for the taxable years ended March 31, 1980, through March 31, 1986, as follows: Tax Year EndedDeficiencyMarch 31, 1980$ 6,054March 31, 19813,558March 31, 1982321,225March 31, 19836,367March 31, 1984127March 31, 1985658,063March 31, 198610,796The issues for decision are: (1) Whether petitioner is entitled to offset losses from nonexempt, nonmember undertakings against its investment income for the taxable years ended March 31, 1980, through March 31, 1986 (the loss issue). We hold that petitioner is not entitled to offset the losses from such undertakings against its investment income for the taxable years in issue because petitioner did not enter into such undertakings with an intent to profit. We hold that petitioner's undertakings, excluding investment income, constitute one activity; and, therefore, petitioner99 is entitled to offset its losses from all such undertakings against its gross receipts from all such undertakings. (2) Whether petitioner is entitled to deduct expenditures in the amount of $ 265,033 for redesigning of certain golf course greens, for constructing a new practice green, and for reworking the drainage system on its golf course, in order to comply with P.G.A. requirements to host the 1981 P.G.A. Championship tournament, from its unrelated business taxable income for the taxable year ended March 31, 1982 (the capitalization issue). We hold that petitioner is not entitled to deduct these expenditures from its unrelated business taxable income for the taxable year ended March 31, 1982, because the expenditures are capital expenditures. (3) Whether petitioner should have recognized and reported gain in the amount of $ 2,330,889 for its taxable year ended March 31, 1985, as unrelated business taxable income from the sale of 108 acres of property (Tracts A and B) owned by petitioner (the gain issue). We hold that petitioner must recognize and report the gain from the sale of Tracts A and B for its taxable year ended March 31, 1985, because petitioner did not directly100 use the property for exempt purposes.FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations and attached exhibits are incorporated herein by this reference. Petitioner, the Atlanta Athletic Club (the Club), is a social club organized for pleasure and recreation and is and at all times during the taxable years in issue has been exempt from Federal income tax under section 501(c)(7). 1 Petitioner is and was a Georgia nonprofit corporation with its principal office at Athletic Club Drive, Duluth, Georgia, at the time the petition was filed on October 31, 1988. Petitioner was incorporated on August 15, 1898. Petitioner timely filed Forms 990 and 990-T with the Internal Revenue Service Center in Atlanta, Georgia, in each of the taxable years ending March 31, 1975, through March 31, 1986. Petitioner's exempt activities are the provision101 of pleasure and recreation to its members. Petitioner operates two 18-hole golf courses, a clubhouse, a swimming pool, tennis courts, and other recreational facilities for the benefit of its members and their guests. In addition to maintaining facilities for its members, from time to time, petitioner also makes its facilities and services available to nonmembers. For example, from time to time, petitioner hosts nonmember wedding receptions and banquets, nonmember amateur golf and tennis tournaments, and other Monday nonmembers activities. Petitioner also hosted two professional golf tournaments, the 1976 U.S. Open and the 1981 P.G.A. Championship tournaments. These events are a regular and continuous part of the nonmember activity of petitioner. Since one of the issues in this case is whether these various nonexempt, nonmember events constitute one activity or separate activities, at this point, we will refer to these nonexempt, nonmember events described above as undertakings. It will be understood that when we use the term "undertaking," we are referring to a nonexempt, nonmember function of petitioner. The original site of the Club was at East Lake Country Club. In the102 early 1960's, after determining that the membership was moving away from the Club's location at East Lake to the north and northeast of Atlanta, the Board of Directors (the Board) decided, with the approval of the stockholders, to purchase land in the north and northeast area of Atlanta for the future site of their Club. Petitioner purchased 617.12 acres of land (the Property) on February 14, 1964. The majority of the land or 425.61 acres are situated east of Highway 141 (the Eastside Property). The remaining acreage or 191.51 acres are situated west of Highway 141 (the Westside Property). Petitioner named the Club at this new site The River Bend Country Club. Petitioner did not have the opportunity to buy the Property in pieces. At the time of purchase, the Board considered that the entire Property would be necessary for what they wanted. The Board informed the stockholders that the Property had been inspected and endorsed by a noted golf course architect and by all members of the Board. After the purchase of the Property, one of the experts hired by petitioner to analyze the Property determined that the Eastside Property was the best place to build a golf course. The River103 Bend golf course which is located on the Eastside Property was opened on May 27, 1967. Petitioner also constructed a clubhouse, swimming pool, and another nine-hole golf course on the Eastside Property. In 1968, petitioner purchased an additional 30.5954 acres adjacent to the northern boundary of the Eastside Property and constructed an additional nine holes on that acreage which completed the second golf course known as the Highland Course. In the early 1960's, when the Property was purchased, Highway 141 was a two-lane country road with little traffic. The area around the Highway was forest and was not heavily populated. Consultants advised the Board that the Westside Property would be suitable for additional golf facilities, either a none-hole course or a par-three course. Petitioner made preliminary plans for an outdoor fitness area on the Westside Property. On November 8, 1967, when members inquired about purchasing property from the Club for housing, petitioner notified members that the Club had no property for sale. In 1976, during the U.S. Open tournament, petitioner used the Westside Property for parking. Petitioner sought advice from the Georgia Fish and Forestry104 Commissioner regarding stocking and maintaining the Club's lakes to provide good fishing to the members. Both the Eastside and Westside Properties contain lakes. In 1974, petitioner obtained rezoning of the Westside Property from agricultural to Community Unit Development zoning which would allow for the development of condominiums or cluster housing. In 1981, the Westside Property was rezoned again to provide for agricultural use. Petitioner offered two reasons for this reversion. First, petitioner did not have any specific plans to develop or sell the Westside Property; and for the next 5 years or so, petitioner only planned to use the Westside Property for recreational purposes. Second, the current zoning distorted the overall planning of the county. During the late 1970's and early 1980's, traffic on Highway 141 increased to the point that crossing Highway 141 between the Eastside and Westside Properties became extremely hazardous. The highway has since been enlarged to three lanes; and, at rush hour, the traffic is bumper-to-bumper. On August 1, 1984, to finance the construction of a tennis center and for substantial renovation of its clubhouse on the Eastside Property, 105 the Club sold a portion of the Westside Property (Tracts A and B). Petitioner retained approximately half of the Westside Property (Tract C) which is maintained, but not developed. This property is held by petitioner as a buffer for the Club against other developments. The gain realized on the sale was $ 2,330,889, which was not recognized or reported during the taxable year ended March 31, 1985. The proceeds were applied to the renovation of the clubhouse and construction of the tennis center within 3 years after the sale. The clubhouse and tennis center are used directly in the performance of petitioner's exempt function. In return for hosting the two professional golf tournaments, petitioner received a percentage of income from admissions, program advertising and program sales, and all of the income from food and beverage sales, parking, and other sources of tournament income. Petitioner was required, as a condition to hosting the 1981 P.G.A. Championship tournament, to maintain, recondition, and remodel its golf course in accordance with P.G.A. directives. In connection with hosting this tournament, petitioner was required: (1) To repair the irrigation system, (2) to repair106 the golf cart paths damaged by television equipment trucks during the tournament, (3) to construct a parking lot adjacent to the golf course for tournament spectators, (4) to construct a new practice green, (5) to redesign six golf course greens on the Highland course, and (6) to rework the drainage system. The costs for these repairs and renovations totaled $ 576,197, which were incurred during the taxable year ended March 31, 1982. Petitioner also hosted 23 amateur nonmember golf tournaments and a number of amateur nonmember tennis tournaments during the years in issue. These tournaments were generally held on Monday, the day the Club was closed, and are referred to as "Monday outings." Greens fees and cart rentals in the golf area account for a substantial portion of the income from Monday outings. Income from Monday outings was also derived from user fees for the tennis, athletic, and aquatic centers. The prices charged by the Club for Monday outings were set at levels necessary to produce a profit to the Club after direct expenses were subtracted from the gross receipts associated with the Monday outings. Petitioner sold food and beverage items to nonmembers during the 107 various undertakings. Petitioner's prices for food and beverage items sold to nonmembers were the same as its prices for such items sold to members. The prices charged for food and beverage items sold to nonmembers were set at levels necessary to produce a gross profit to the Club after direct expenses were subtracted from gross receipts associated with the undertaking. Income and expenses from food and beverage sales during the 1976 U.S. Open and the 1981 P.G.A. Championship tournaments were reported separately from other food and beverage sales to nonmembers in other undertakings on petitioner's Forms 990-T. As long as an undertaking generated revenue in excess of its direct costs, petitioner realized a benefit from the positive cash flow. Direct expenses of an undertaking are those which increase in direct proportion to the volume of that undertaking. Each dollar of direct expense is traceable to a particular undertaking and would not have been incurred but for that undertaking. Indirect expenses of an undertaking are those which are not traceable to that undertaking. Indirect expenses include overhead and fixed expenses. Fixed expenses, such as property taxes and depreciation, 108 are incurred whether or not there is an undertaking. Many of petitioner's fixed expenses relate to maintenance and minimum staff requirements of operating its facilities. Overhead includes utilities, general administration, and clubhouse expenses. Petitioner incurred both direct and indirect expenses in all of its undertakings. For the taxable years in issue, an allocable portion of petitioner's indirect expenses was attributable to and directly connected with the generation of income in its undertakings. For purposes of computing unrelated business taxable income, petitioner consistently deducted an allocable portion of the indirect expenses as well as the direct expenses associated with the production of such income. In computing the allocable portion of indirect expenses deductible from petitioner's unrelated business taxable income on its Forms 990-T, petitioner allocated indirect expenses based on the ratio that sales from all undertakings bore to total sales of the Club. 2 This method is referred to as the gross-to-gross method. 109 Petitioner prepared an Analysis of Direct and Indirect Expenses Related to Non-Member Activities for the taxable years ended March 31, 1975, through March 31, 1986. Petitioner allocated revenues and direct and indirect expenses to three categories: Food and beverage sales to nonmembers, hosting Monday outings, and hosting the 1976 U.S. Open and the 1981 P.G.A. Championship tournaments. On its books and records, petitioner did not allocate general administrative expenses to the three categories. 3Petitioner kept a complete and accurate set of books and records of its undertakings. Petitioner's undertakings were overseen by the Board which consists of business and professional people from various backgrounds. The Board supervises and reviews the actions of the full-time general manager who controls the undertakings and implements Board policy on a day-to-day basis. 110 During the taxable years in issue, James E. Petzing was the general manager of the Club. As the chief operating officer of the Club, Mr. Petzing was responsible for operations, financial results, and member satisfaction. During the taxable years in issue, and the taxable years from which certain loss carrybacks are disallowed in the notice of deficiency, some of petitioner's unrelated business taxable income was derived from investments resulting in interest income on certificates of deposit and savings accounts. In each of the taxable years ended March 31, 1975, through March 31, 1986, except the taxable year ended March 31, 1982, a loss (excess expenses over income) resulted when the net income or net loss from each undertaking was aggregated. Petitioner reported such losses on its Forms 990-T. For the taxable year ended March 31, 1982, income from hosting the 1981 P.G.A. Championship tournament was sufficient to produce a gross profit after deduction of direct expenses and produced a net profit after deduction of indirect expenses. In each of the taxable years ended March 31, 1975, through March 31, 1986, income from Monday outings and nonmember tournaments, excluding the111 1976 U.S. Open and the 1981 P.G.A. Championship tournaments, was sufficient to produce a gross profit after deduction of direct expenses but produced a net loss after deduction of indirect expenses. In each of the taxable years ended March 31, 1975, through March 31, 1986, income from food and beverage sales to nonmembers was sufficient to produce a gross profit after deduction of direct expenses but produced a net loss after deduction of indirect expenses. In the notice of deficiency, respondent determined that petitioner's undertakings, excluding the 1981 P.G.A. Championship tournament and investment income, produced losses after subtracting both direct and indirect expenses from the income of such undertakings. Respondent disallowed those losses for the years in issue. In the notice of deficiency, respondent included in petitioner's unrelated business taxable income for the taxable years in issue interest income and the income from hosting the 1981 P.G.A. Championship tournament, but disallowed the deductions claimed by petitioner for losses on petitioner's other undertakings. Respondent also disallowed petitioner's loss carryovers from such prior years for losses similar 112 to the losses claimed in the years in issue, net of investment income and income from the 1976 U.S. Open tournament. In its taxable year ended March 31, 1981, petitioner realized a capital loss in the amount of $ 85,793 upon the sale of a portion of its irrigation system. Petitioner determined that $ 12,045 of such capital loss was allocable to petitioner's undertakings and deducted such amount in computing its unrelated business taxable income for such taxable year. Petitioner and respondent stipulate that the portion of the capital loss of $ 85,793 allocable to petitioner's nonmember Monday outings and tournaments is $ 12,045. Respondent disallowed this loss in its entirety in the notice of deficiency. In the notice of deficiency, respondent disallowed petitioner's deduction in the amount of $ 265,032.81 for the taxable year ended March 31, 1982, after determining that the expenditures incurred to redesign the greens, to construct a new practice green, and to rework the drainage system are capital expenditures. In the notice of deficiency, respondent also included in petitioner's unrelated business taxable income for the taxable year ended March 31, 1985, gain in the amount113 of $ 2,330,889 realized by petitioner upon the sale of Tracts A and B. OPINION Issue 1. The Loss IssuePetitioner is exempt from Federal income tax under section 501(c)(7). 4114 However, section 511 provides that the unrelated business taxable income of organizations described in section 501(c) shall be taxed at the ordinary corporate rate. Section 512(a)(3)(A) provides that: In the case of an organization described in paragraph (7), * * * of section 501(c), the term "unrelated business taxable income" means the gross income (excluding any exempt function income), less the deductions allowed by this chapter which are directly connected with the production of the gross income (excluding exempt function income), both computed with the modifications provided in paragraphs (6), (10), (11), and (12) of subsection (b). * * * 5Recently, the United States Supreme Court decided Portland Golf Club v. Commissioner, 497 U.S. 154">497 U.S. 154, 110 S. Ct. 2780">110 S. Ct. 2780, 111 L. Ed. 2d 126">111 L. Ed. 2d 126 (1990), affg. 876 F.2d 897">876 F.2d 897 (9th Cir. 1989), revg. and remanding without opinion T.C. Memo 1988-76">T.C. Memo 1988-76. In Portland Golf Club, the Supreme Court held "that any losses incurred as a result of [the taxpayer's] nonmember sales may be offset against its investment income only if the nonmember sales were undertaken with an intent to profit." 6Portland Golf Club v. Commissioner, 110 S. Ct. at 2790. The Supreme Court also held that "in demonstrating the requisite profit motive, [the taxpayer] must employ the same method of allocating fixed 115 expenses as it uses in calculating its actual loss." Portland Golf Club v. Commissioner, 110 S. Ct. at 2790. 116 In Portland Golf Club, the taxpayer was required to demonstrate an intent to earn gross receipts in excess of indirect expenses (fixed expenses) and direct expenses (variable expenses) with an applicable share of the indirect expenses being determined by an allocation method where indirect expenses are used in computing its actual profit or loss. Where the intent to profit is not established, the taxpayer can only deduct indirect and direct expenses directly connected with the gross receipts up to the amount of gross receipts and cannot offset any resulting losses against its investment income. Before we can determine whether petitioner's undertakings were entered into with an intent to profit, we must address the parties' arguments with respect to whether it is appropriate to treat all of the undertakings as one activity or separate activities. Respondent characterizes petitioner's undertakings as three separate activities: (1) Two professional golf tournaments (the 1976 U.S. Open and the 1981 P.G.A. Championship tournaments), (2) Monday outings and amateur tournaments for nonmembers, and (3) food and beverage sales to nonmembers. Petitioner characterizes all of these undertakings117 as one activity. Respondent maintains that the losses from the nonmember golf Monday outings and amateur tournaments and from the food and beverage sales cannot be used to offset the net income from the 1981 P.G.A. Championship tournament because these undertakings are separate and different activities using different parts of petitioner's club. Respondent points out that on petitioner's tax return, books and records, and financial statements for the taxable year ended March 31, 1982, petitioner separately accounted for the income and expenses of the 1981 P.G.A. Championship tournament. Petitioner seeks to combine the losses from all the undertakings and offset this loss against the net income from the 1981 P.G.A. Championship tournament. Petitioner argues that respondent's division of its undertakings into separate activities is improper. Petitioner argues that petitioner's undertakings represent the same source of income production and, consequently, the same undertaking or activity. Petitioner contends that the undertakings are similar, have a common business purpose, and have a high degree of organizational and economic interrelationship. Petitioner points out that all 118 of petitioner's undertakings consisted of making its clubhouse and recreational facilities and services available to nonmembers. As support for its position, petitioner refers to section 1.183-1(d)(1), Income Tax Regs., and 1.469-4T, Temporary Income Tax Regs., 54 Fed. Reg. 20528 (May 12, 1989).7 Petitioner argues that there is nothing in the law to support respondent's position. Respondent contends that this Court and other courts have refused to combine separate undertakings or activities or to allow the expenses for one activity to be offset against the income of another activity, citing Ye Mystic Krewe of Gasparilla v. Commissioner, 80 T.C. 755">80 T.C. 755, 765-767 (1983), and Iowa State University of Science & Tech. v. United States, 205 Ct. Cl. 339">205 Ct. Cl. 339, 500 F.2d 508">500 F.2d 508 (1974). Respondent argues that, in this case, the losses incurred from the119 nonmember golf Monday outings and amateur tournaments and from the nonmember food and beverage sales, including banquets and wedding receptions, are not "directly connected" within the meaning of section 512(a)(3)(A) to the net income generated by the 1981 P.G.A. Championship tournament. Respondent also argues that petitioner has failed to meet its burden of proof to show that the separate undertakings should be combined as one activity. Respondent argues that petitioner's reliance on section 1.183-1(d)(1), Income Tax Regs., and section 1.469-4T, Temporary Income Tax Regs., is misplaced because these regulations are not applicable to nonprofit corporations. Respondent argues that the undertakings should not be treated as a single activity merely because they involved nonmembers. Respondent also argues that a professional golf tournament, which is awarded each year to different golf clubs is different from the nonmember Monday golf outings, amateur tournaments, and banquets which are regular and continuous activities of the Club. The professional tournament charges admission, is broadcast on television, attracts huge crowds, and adds prestige to the Club. According to respondent, 120 amateur tournaments are held as a public service; whereas, the professional tournament is held for the purpose of realizing substantial revenue and prestige for the Club. Petitioner argues that respondent's approach is incorrect. Petitioner argues that even though the 1981 P.G.A. Championship tournament drew more spectators and was more profitable than the other nonmember tournaments and events, the size and profitability of an event does not define it. According to petitioner, size and profitability are matters of degree, not of kind and, therefore, are not proper criteria for defining the scope of an activity. Petitioner maintains that the same business purpose, to make the Club more attractive to members and potential members, was served by hosting the 1981 P.G.A. Championship tournament and by hosting all the other undertakings. Petitioner points out that undertakings result in greater public exposure leading to higher ratings and prestige for the Club. Petitioner maintains that while the two professional tournaments are not held each year, they are a regular part of petitioner's undertakings and have a continuing impact on the Club's ongoing undertakings. According to 121 petitioner, all of the tournaments are an integral part of sports promotion and participation, the very purpose of the Club. Petitioner maintains that the professional and amateur golf tournaments are similar in function, purpose, and form. Respondent's reliance upon Ye Mystic Krewe of Gasparilla v. Commissioner, supra, to argue that this Court has refused to combine separate undertakings or activities is misplaced. In Ye Mystic Krewe of Gasparilla v. Commissioner, supra, this Court had to decide whether the expenses of an exempt activity could be offset against the income of a nonexempt function. We determined that the expenses of the exempt activity were not directly connected with the income of a nonexempt function, and, therefore, such expenses could not be offset against such income under section 512(a)(3)(A). We also determined that the purpose of section 512(a)(3) required that we treat the exempt activity and the nonexempt activity separately so that nonexempt function income could not be used to subsidize the exempt activities of the members. The opinion in Ye Mystic Krewe of Gasparilla v. Commissioner122 , supra, is distinguishable from this case because petitioner, in this case, seeks to combine as one activity only nonexempt undertakings and to offset the losses from these undertakings against the net income of other nonexempt undertakings. The opinion in Iowa State University of Science & Tech. v. Commissioner, supra, is also distinguishable because in that case the taxpayer also sought to offset expenses of an exempt activity against unrelated income of a nonexempt activity. Even though respondent is correct that section 183 is inapplicable to a nonprofit corporation, section 1.183-1(d)(1), Income Tax Regs., does provide some guidance in determining what an activity is. See Portland Golf Club v. Commissioner, 497 U.S. 154">497 U.S. 154, 110 S. Ct. 2780">110 S. Ct. 2780, 2787, 2790 nn.15, 22, 111 L. Ed. 2d 126">111 L. Ed. 2d 126 (1990). 8Section 1.183-1(d)(1), Income Tax Regs., provides that all the facts and circumstances of a case must be taken into account in ascertaining what an activity is and provides that the most significant facts and circumstances are: the degree of organizational and economic interrelationship of various undertakings, the business purpose which is (or might be) served by carrying on123 the various undertakings separately or together in a trade or business or in an investment setting, and the similarity of various undertakings. * * We agree with petitioner that the undertakings have a common business purpose, to provide nonmember interest in the Club, and that the undertakings are economically interrelated. Petitioner did separate these undertakings in its books and records; however, we do not believe that that fact is sufficient alone to 124 justify treating each undertaking as a separate activity. We conclude that the undertakings constitute one activity for the purpose of determining whether petitioner entered into the activity with an intent to profit and for the purpose of determining whether the losses from one undertaking can be offset against the net income from another undertaking. We will now decide whether or not petitioner's activity was undertaken with a profit motive. Petitioner contends that the activity was entered into with an intent to profit. Petitioner presented various arguments in support of its position that it entered into the activity with an intent to profit. However, none of these arguments are relevant in light of the opinion of the Supreme Court in Portland Golf Club. Therefore, we will not discuss them. Respondent contends that the nonmember undertakings, excluding the 1981 P.G.A. Championship tournament, were not entered into with the intent to make a profit. Accordingly, respondent argues that petitioner may not offset losses from the undertakings against income from investments. In determining the actual profit or loss of the activity, petitioner subtracted both direct and indirect125 expenses from gross receipts, where indirect expenses were allocated using the gross-to-gross method. This is the same allocation method used by the taxpayer in Portland Golf Club. Respondent has stipulated that the results of such a method in this case are reasonable. Therefore, under the test enunciated by the Supreme Court in Portland Golf Club, in order to prove that petitioner had an intent to profit in the activity, petitioner must establish that for each year in issue petitioner intended to earn net income from its activity. Net income is determined by subtracting the direct and indirect costs of that activity from the gross receipts of that activity, where indirect expenses are allocated using the gross-to-gross method. After applying the test in Portland Golf Club, a loss results for each year in issue except the taxable year ended March 31, 1982. The fact that petitioner incurred losses in 5 out of the 6 years in issue indicates that it is unlikely that petitioner intended to earn net income in the taxable year ended March 31, 1982. Thus, we conclude that petitioner did not enter into the activity with an intent to profit in any of the years in issue. 126 Therefore, we hold that petitioner is not entitled to offset the losses from the activity against its investment income for the years in issue. Respondent agrees with petitioner, that even without a profit motive, petitioner is entitled to deduct the expenses of each undertaking from the gross receipts of each undertaking. We have already decided that the undertakings constitute a single activity for the purposes of offsetting losses against gross receipts. Therefore, we conclude that petitioner is entitled to offset the losses from the activity against the net income from the activity for each year in issue. However, as decided earlier, petitioner may not deduct any excess losses from the activity against its investment income. Issue 2. The Capitalization IssueSection 1.162-4, Income Tax Regs., provides that: The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as an expense, * . Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, shall127 either be capitalized and depreciated in accordance with section 167 * * .Section 263(a) provides that "No deduction shall be allowed for -- (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate." Section 1.263(a)-1(b), Income Tax Regs. provides that: amounts paid or incurred (1) to add to the value, or substantially prolong the useful life, of property owned by the taxpayer, such as plant or equipment, or (2) to adapt property to a new or different use. Amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures * Section 1.263(a)-2(a), Income Tax Regs., provides that an example of a capital expenditure is "The cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year." We must decide whether expenditures incurred to redesign six golf course greens, add a new practice green, and add a new drainage system in the total amount of $ 265,032.81 for the taxable year ended March 31, 1982, are expenses which are128 deductible in the year the expenditures were incurred or are capital expenditures which must be capitalized. Petitioner argues that the redesign of six golf course greens by the Club to comply with P.G.A. requirements did not increase the value of any property beyond the period of the tournament, and, therefore, the expenditures are deductible as claimed. Petitioner maintains that the redesign of the greens was not desired by the membership, and such costs were incurred solely to receive income from hosting the tournament. Petitioner maintains that the useful life of the changes expired at the end of the tournament which is within the taxable year. Respondent argues that the expenditures are capital expenditures because the tournament renovations were permanent improvements and had useful lives greater than the taxable years in which they were constructed. Respondent points out that the record establishes that petitioner believed the renovations made the Club's golf course more valuable and added prestige because the renovations produced a golf course of professional championship calibre. Respondent maintains that petitioner has not established that the renovations have a useful129 life or are depreciable under section 167, and, therefore, petitioner is not entitled to any depreciation deduction for the renovations. We agree with respondent. Petitioner did not restore the golf course to its original design immediately after the 1981 P.G.A. Championship tournament. In fact, petitioner waited until 1987 before redesigning the course. In 1987, not all of the greens that were redesigned for the tournament in 1981 were redesigned. The practice green was not changed. The evidence indicates that continuing drainage problems on the golf course were an important consideration in petitioner's decision to renovate the golf course in 1987. Petitioner often referred to these expenditures as permanent and capital expenditures. The evidence indicates that the renovations to the golf course had a useful life greater than the taxable year in which the expenses were incurred. Further, the renovations added value to the Club. We hold that the expenditures in the total amount of $ 265,032.81 incurred in the taxable year ended March 31, 1982, are capital expenditures under section 263(a). Issue 3. The Gain IssuePetitioner asserts that Tracts A and B were used directly130 in the performance of the exempt function of the Club. Respondent asserts that Tracts A and B were not used for pleasure or recreation, and that, instead, petitioner held the property for investment purposes. Therefore, according to respondent, the realized gain on the sale constitutes unrelated business taxable income. Section 512(a)(3)(D) provides that: If property used directly in the performance of the exempt function of an organization described in paragraph (7), * * * of section 501(c) is sold by such organization, and within a period beginning 1 year before the date of such sale, and ending 3 years after such date, other property is purchased and used by such organization directly in the performance of its exempt function, gain (if any) from such sale shall be recognized only to the extent that such organization's sales price of the old property exceeds the organization's cost of purchasing the other property. * * The parties agree that, within 3 years after the sale of Tracts A and B, petitioner reinvested the funds into facilities on the Eastside Property and such facilities are used directly for exempt functions. We must decide whether petitioner used Tracts131 A and B directly in the performance of its exempt function. If petitioner used Tracts A and B for the pleasure and recreation of its members, then the gain from the sale of Tracts A and B shall be recognized only to the extent that the sale price of the property exceeded petitioner's cost of purchasing the other property. If petitioner did not use Tracts A and B for its exempt functions, petitioner must realize and recognize the gain from the sale of Tracts A and B in full. Petitioner purchased the Westside Property as part of a single transaction. Petitioner maintains that the entire Property was purchased and actually used as the site for the Club's golf course, clubhouse, and other recreational facilities, or exempt functions. Petitioner maintains that, at the time of the purchase, petitioner believed that both the Westside and Eastside Properties would be required for future development and that no land was purchased for speculation. Petitioner points out that in 1967, when club members inquired whether any of the Property was for sale, petitioner responded that no property was for sale. Petitioner maintains that the Club considered making improvements on the Westside Property132 but abandoned these plans only after the traffic situation on Highway 141 worsened. Petitioner relies on the testimony of various members and Board members of the Club to establish that activities were held on Tracts A and B. Testimony from various members of the Club indicates that during the years prior to the sale, the type of activities that took place on the Westside Property included: Easter-egg hunts, pasture parties that involved bonfires, hot dog cookouts, marshmallow roasts for the kids, hot-air balloon rides, kite-flying contests, fishing, running, jogging, other sporting activities, and all types of participatory functions for the members. Respondent maintains that when Congress referred to property used directly in the performance of an exempt function, Congress meant that "the property was in actual, direct, continuous, and regular usage for exempt purposes rather than property that is maintained for its appreciating value and used only once or twice a year, if at all." Respondent argues that the evidence establishes that petitioner considered the Westside Property as a valuable asset, that the Westside Property remained undeveloped for 20 years, that no capital improvements133 were considered for the Westside Property from 1964 until the time Tracts A and B were sold in 1984, and that the Club actually held only a few activities a year on Tract C. Respondent relies on contemporaneous Club records from 1964 to 1984, including the monthly newsletter "Club Times," to document what activities actually took place on Tracts A and B. In response to respondent's argument, petitioner argues that the fact that Tracts A and B were used less extensively than Tract C is irrelevant. According to petitioner, section 512(a)(3)(D) does not prescribe any requisite level of use. Therefore, as long as Tracts A and B were used directly for exempt functions, petitioner argues that the gain on the sale of Tracts A and B should go unrecognized under section 512(a)(3)(D). During the years petitioner owned Tracts A and B, petitioner's intentions with regard to the potential use of Tracts A and B appear to have included both investment uses and exempt function uses. The Westside Property was often referred to as a valuable asset or a good investment. When the Property was purchased, the Board admitted that the Club purchased more property than would be needed for future development, 134 but the Board wanted to hold onto the Westside Property as a valuable asset. Petitioner even considered building housing on the Westside Property at one point. Later, petitioner decided that the Westside Property would be used for recreation or Club purposes. However, section 512(a)(3)(D) does not require that we establish what the intent of petitioner was. Instead, section 512(a)(3)(D) requires that petitioner directly use Tracts A and B for exempt functions prior to its sale. The record establishes that Tracts A and B were not used directly in the performance of the Club's exempt functions. A review of the evidence indicates that most of the fishing tournaments, pony rides, Easter-egg hunts, and turkey trot races were held on the Eastside Property. There is no evidence other than the testimony offered by members of the Club as to the location of the hot-air balloon rides. The kite-flying contests were held on the Eastside Property and on Tract C. Tracts A and B were used for nonmember parking during the two professional golf tournaments, both nonexempt functions. The evidence indicates that pasture parties or picnics were held directly "across the roadside," or on Tract135 C. The turkey trot races were held on the Eastside Property and Tract C. Invitational road races were held on the roads or on the golf course on the Eastside Property. The Club attempted to construct a jogging trail on Tract C and part of Tract B. However, the trail was abandoned. Members ran on the golf course, and in 1983, a running trail was constructed on the Eastside Property. Petitioner claims that Tracts A and B were used to grow trees or was a source of top soil and pulpwood. However, the evidence indicates that most of the landscaping was performed by outside contractors. In light of the evidence, we are not convinced from the testimony of members that the Club held activities on Tracts A and B. The only activities which may have occurred on Tracts A and B were running and jogging. We believe that this activity was not an activity directly sponsored by the Club as part of its exempt function. Instead, it appears that many of the members used Tracts A and B independently of the Club's programs. Such activity is not sufficient to establish that the Club directly used Tracts A and B for exempt functions. We hold that petitioner must recognize and report the gain136 in the amount of $ 2,330,889 from the sale of Tracts A and B as unrelated business taxable income for the taxable year ended March 31, 1985. 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.↩2. Respondent objected to the propriety of petitioner's allocation method, but stipulated that the results of such method of allocation in this case are reasonable. Respondent used other methods when performing the audit and came out with roughly the same results.↩3. Respondent objected to this method of allocation, but stipulated that the method of allocation was reasonable for the same reasons stated in n. 2.↩4. Section 501(a) provides that "An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503." Section 501(c)(7) provides that "Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder."↩5. Section 512(a)(3)(B) defines exempt function income as: gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services in furtherance of the purposes constituting the basis for the exemption of the organization to which such income is paid. * *↩6. The Supreme Court stated that section 512(a)(3)(A) limits deductions from unrelated business taxable income to expenses allowable as deductions under Chapter 1 of the Internal Revenue Code. Therefore, the deductions claimed by the taxpayer were allowable only under section 162. Section 162 provides a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." The Supreme Court has ruled that a taxpayer's activities fall within the scope of section 162 only if an intent to profit has been shown. Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. 23, 35, 94 L. Ed. 2d 25">94 L. Ed. 2d 25, 107 S. Ct. 980">107 S. Ct. 980 (1987). In Portland Golf Club v. Commissioner, 497 U.S. 154">497 U.S. 154, 110 S. Ct. 2780">110 S. Ct. 2780, 2787, 111 L. Ed. 2d 126">111 L. Ed. 2d 126 (1990), the Supreme Court stated that investment income of a social club should be subject to the same tax consequences as for any other taxpayer. Therefore, losses from another nonexempt activity could not offset investment income unless the nonexempt activity was entered into by the taxpayer with an intent to profit, as required under section 162. Portland Golf Club v. Commissioner, supra↩ at 2787.7. These regulations provide the definition of an activity for purposes of section 183 and section 469, respectively.↩8. Even though section 183 is inapplicable to nonprofit corporations, the Supreme Court referred to the regulations promulgated thereunder as guidance for determining whether the taxpayer had engaged in an activity for profit. Petitioner also suggested we look to section 1.469-4T, Temporary Income Tax Regs., 54 Fed. Reg. 20528↩ (May 12, 1989), for the definition of an activity. If we were to apply such a definition, the only result would be to combine all of petitioner's nonmember undertakings, except investment income, into one activity.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622731/	MARY ANN KOLLAR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKollar v. Comm'rNo. 15928-05United States Tax Court131 T.C. 191; 2008 U.S. Tax Ct. LEXIS 30; 131 T.C. No. 12; November 25, 2008, Filed30 P filed a joint 1996 Federal income tax return reporting zero income tax liability. Before Dec. 20, 2006, P amended that return and paid the income tax reported on the amended return. P did not pay any statutory interest that had accrued as to that tax. R assessed accrued interest, and P requested from R equitable relief from the assessed interest pursuant to sec. 6015(f), I.R.C. After R determined that P was not entitled to the requested relief, P petitioned the Court to review that determination under former sec. 6015(e)(1), I.R.C. Relying upon Billings v. Commissioner, 127 T.C. 7">127 T.C. 7 (2006), which held that former sec. 6015(e)(1), I.R.C., did not give the Court jurisdiction to decide a case such as this where R did not assert a deficiency against a taxpayer requesting relief under sec. 6015(f), I.R.C. (nondeficiency sec. 6015(f) case), R moved the Court to dismiss this case for lack of jurisdiction. Before the Court decided that motion, Congress enacted the Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408, 120 Stat. 3061">120 Stat. 3061 (TRHCA sec. 408). TRHCA sec. 408(a) and (c), 120 Stat. 3061">120 Stat. 3061, 3062, amended former sec. 6015(e)(1), I.R.C., to clarify that the Court has jurisdiction 31 to decide a nondeficiency sec. 6015(f) case involving the taxpayer's "liability for taxes arising or remaining unpaid on or after" Dec. 20, 2006. R argues that the Court continues to lack the requisite jurisdiction because P paid her reported income tax before Dec. 20, 2006, and the quoted word "taxes" refers only to income tax and not to any related interest.Held: The quoted word "taxes" includes the accrued interest related to P's 1996 income tax; thus, the Court has jurisdiction under sec. 6015(e)(1), I.R.C., as amended by TRHCA sec. 408(a), to review R's denial of equitable relief under sec. 6015(f), I.R.C., from P's liability for the accrued interest.Jonathan P. Decatorsmith, for petitioner.Gregory J. Stull, for respondent.Marvel, L. PaigePAIGE L. MARVEL192 MARVEL, Judge: Respondent moves the Court to dismiss this case for lack of jurisdiction, asserting that the Court lacks jurisdiction under section 6015(e)(1) to review respondent's determination that petitioner is not entitled to equitable relief under section 6015(f) (section 6015(f) relief). 1 Petitioner requests section 6015(f) relief from her liability for accrued interest owed with respect to her 1996 Federal income tax paid 32 in full before December 20, 2006. We decide whether section 6015(e)(1) gives the Court jurisdiction to decide this case. We hold it does.BackgroundDuring 1996 petitioner was married to Robert J. Kollar. On April 20, 1997, Mr. Kollar died unexpectedly. On October 21, 1997, petitioner filed a joint 1996 Federal income tax return on behalf of herself and her deceased husband. The return reported zero income tax liability.On or about November 12, 1999, petitioner filed an amended joint 1996 Federal income tax return on behalf of herself and her deceased husband. The amended return reported an income tax liability of $ 409,156, which petitioner paid with the return. On January 3, 2000, respondent assessed the income tax reported on the amended return and pursuant to section 6601 assessed $ 98,417.37 of accrued interest owed on the untimely paid income tax. That same day respondent issued to petitioner a notice and demand for payment of the unpaid interest.On or about July 25, 2000, petitioner filed Form 8857, Request for Innocent Spouse Relief (And Separation of Liability and 33 Equitable Relief), requesting section 6015(f) equitable relief from the unpaid interest. More than 5 years later, 193 respondent mailed to petitioner a notice of determination denying her request. Thirty days after that mailing, petitioner through a nondeficiency stand-alone petition asked the Court to review respondent's determination. 234 Petitioner resided in Illinois when she petitioned the Court.DiscussionIn general, spouses who file a joint Federal income tax return are each responsible for the accuracy of the return and are jointly and severally liable for the tax reported or reportable thereon. Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C. 276">114 T.C. 276, 282 (2000). In certain circumstances a spouse may obtain relief under section 6015 from such liability. One type of relief under section 6015 is provided in section 6015(f) as equitable relief "for any unpaid tax or any deficiency (or any portion of either)".This Court is a court of limited jurisdiction, and we may exercise our jurisdiction only to the extent authorized by Congress. See sec. 7442; Moore v. Commissioner, 114 T.C. 171">114 T.C. 171, 175 (2000); Naftel v. Commissioner, 85 T.C. 527">85 T.C. 527, 529 (1985). Before December 20, 2006, former section 6015(e)(1) provided this Court with jurisdiction to review the Commissioner's denial of relief under section 6015 only "In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply". In Billings v. Commissioner, 127 T.C. 7">127 T.C. 7 (2006), we held that former section 6015(e)(1)35 did not provide this Court with jurisdiction to review a nondeficiency stand-alone petition for relief under section 6015; i.e., a petition for relief under section 6015 filed by an individual against whom the Commissioner had not asserted a deficiency. Shortly thereafter, Congress amended former section 6015(e)(1) to provide this Court with jurisdiction over such stand-alone petitions by adding to that section 194 the words "or in the case of an individual who requests equitable relief under subsection (f)". 336 See Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408(a), 120 Stat. 3061">120 Stat. 3061 (TRHCA sec. 408). 4 This amendment applies "with respect to liability for taxes arising or remaining unpaid on or after the date of the enactment of this Act." Id.sec. 408(c), 120 Stat. 3062">120 Stat. 3062. TRHCA was enacted on December 20, 2006. See 120 Stat. 2922.Respondent asserts that the amendment to former section 6015(e)(1) does not apply to the setting at hand because petitioner paid her 1996 Federal income tax before December 20, 2006, and thus on or after that date petitioner had no remaining unpaid tax for 1996 so as to trigger an application of the amendment. According to respondent, the word "taxes" in TRHCA section 408(c) refers only to income tax and does not refer to any related interest. We disagree. Because TRHCA does not define the word "taxes" for purposes of TRHCA section 408(c), we apply that word 37 in accordance with the meaning that we ascertain was intended by Congress. See Conn. Natl. Bank v. Germain, 503 U.S. 249">503 U.S. 249, 253-254, 112 S. Ct. 1146">112 S. Ct. 1146, 117 L. Ed. 2d 391">117 L. Ed. 2d 391 (1992); United States v. Am. Trucking Associations, 310 U.S. 534">310 U.S. 534, 542, 60 S. Ct. 1059">60 S. Ct. 1059, 84 L. Ed. 1345">84 L. Ed. 1345 (1940). Because Congress's use of the word "taxes" in TRHCA section 408(c) is in the setting of Federal income tax and of various amendments that TRHCA section 408 made directly to section 6015, we believe that Congress's intent for the meaning of the word "taxes" is best gleaned from Congress's understanding of the firmly established meaning of that word as used in the Code (and, as discussed below, applicable to section 6015(f)) when TRHCA was enacted. See Stewart v. Dutra Constr. Co., 543 U.S. 481">543 U.S. 481, 487-488, 125 S. Ct. 1118">125 S. Ct. 1118, 160 L. Ed. 2d 932">160 L. Ed. 2d 932 (2005) (applying the established meaning under general maritime law of the word "seaman" where the applicable statute did not define 195 that word). We do not believe that Congress intended that the word "taxes" have a meaning in the context of TRHCA section 408(c) different from its meaning in the context of the provisions of the Code to which TRHCA section 408 relates.As of the time when TRHCA was enacted, Congress had provided specifically in sections 6601(e)(1) and 6665(a) that "tax" 38 for purposes of the Code included interest and penalties, except in certain cases that are not relevant to our discussion. 5 In addition, Congress had provided in section 6015(b)(1) that the word "tax" included "interest, penalties, and other amounts". 640 Given these expansive definitions of the word "tax" for purposes of the Code and the fact that we cannot fathom why Congress would have chosen a narrower definition of the word "taxes" in the setting of TRHCA section 408, a remedial provision designed to benefit taxpayers who were precluded by Billings v. Commissioner, supra, from having their claims to section 6015(f) relief decided by this Court, we conclude that "taxes" as used in TRHCA section 408(c) includes the accrued interest at hand. See Leahy v. Commissioner, 129 T.C. 71">129 T.C. 71, 72 & n.3 (2007) (stating that the reference in section 7463(f)(2) to the word "tax" includes interest and penalties on account of sections 6601(e)(1) and 6665(a)); Petrane v. Commissioner, 129 T.C. 1">129 T.C. 1, 4 (2007) (stating that the reference in section 6015(f) to "tax" includes interest and penalties on account of sections 6601(e)(1) and 6665(a)); see also Helvering v. Bliss, 293 U.S. 144">293 U.S. 144, 150-151, 55 S. Ct. 17">55 S. Ct. 17, 79 L. Ed. 246">79 L. Ed. 246, 2 C.B. 191">1934-2 C.B. 191 (1934) (stating 39 that remedial provisions should not be construed narrowly). We are not unmindful that our conclusion as to the meaning of "taxes" in TRHCA section 408(c) also fits squarely within an ordinary, everyday meaning of "tax". The noun "tax" denotes "a charge usu. of money imposed by authority on persons or property for public purposes", Merriam-Webster's Collegiate Dictionary 1208 (10th ed. 196 1999), and statutory interest payable on income tax is as much such a "charge" as income tax is.Respondent does not reference any legislative history underlying TRHCA section 408 in support of a contrary conclusion; nor do we read any such legislative history to lead to a contrary conclusion. Respondent supports with two assertions his conclusion that "taxes" in TRHCA section 408(c) includes only income tax. First, respondent asserts, the Court in Washington v. Commissioner, 120 T.C. 137">120 T.C. 137, 158-159 (2003), acknowledged that the "tax" referred to in section 6015(f) is simply the "tax reported on the return, but not paid with the return." Second, respondent asserts, interest and penalties are not separate items for which the Commissioner may grant a taxpayer relief under section 6015(f); in other words, respondent asserts that a taxpayer may receive relief under section 6015 from interest and penalties only as a mechanical adjustment flowing from the Commissioner's granting of relief from income tax.Respondent's reliance on those two assertions to support his conclusion is misplaced. First, respondent takes the quotation from Washington out of context. In Washington, the Commissioner argued that section 6015(f) applied only to the portion of tax remaining uncollected 41 after the effective date of that section. We disagreed, relying upon the quoted text in the setting of that case as partial support for our disagreement. We did not state as respondent now argues that the "tax" referred to in section 6015(f) is limited to the income tax reported on the return. In fact, as discussed above, we have indicated to the contrary. See Petrane v. Commissioner, supra at 4. Second, we read nothing in section 6015(e)(1), nor has respondent pointed to any text in that section, that persuades us to conclude that the Commissioner's ability to grant section 6015(f) relief from interest and penalties without granting relief from income tax is a function of our jurisdiction under section 6015(e)(1). To the contrary, we conclude it is not. Cf. Demirjian v. Commissioner, T.C. Memo 2004-22">T.C. Memo 2004-22 (holding that the taxpayer was not eligible for section 6015(f) relief from accrued statutory interest with respect to her 1989 Federal income tax, after holding that the taxpayer had no unpaid income tax for that year); Rowe v. Commissioner, T.C. Memo 2001-325">T.C. Memo 2001-325 (holding that the Court has jurisdiction to review the Commissioner's 197 denial of section 6015(f) relief from additions to tax 42 and penalties).We hold that "taxes" in TRHCA section 408(c) includes the accrued interest at hand and that we therefore have jurisdiction over this case. We have considered all arguments for a contrary holding, and we reject all arguments not discussed herein as without merit. Accordingly, to reflect the foregoing,An appropriate order will be issued.Footnotes1. Unless otherwise indicated, section references are to the applicable versions of the Internal Revenue Code (Code).↩2. In this Court an individual has three ways to request sec. 6015(f) relief. First, when an individual petitions the Court to redetermine a deficiency, the individual may allege as an affirmative defense that he or she is entitled to sec. 6015(f) relief. Second, the individual may request sec. 6015(f) relief in a collection case commenced under sec. 6330(d)(1). Third, where an individual like petitioner has requested sec. 6015(f) relief and the Commissioner has denied that request (or failed to rule on the request within 6 months of its filing), the individual may request sec. 6015(f) relief by filing a stand-alone petition pursuant to sec. 6015(e)(1). See Drake v. Commissioner, 123 T.C. 320">123 T.C. 320, 323 (2004). In a nondeficiency case commenced through the filing of a stand-alone petition, the only relief under sec. 6015 available to the petitioning taxpayer is sec. 6015(f)↩ relief.3. As amended, sec. 6015(e)(1) provides in relevant part:SEC. 6015(e). Petition for Review by Tax Court. --(1) In general. -- In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply, or in the case of an individual who requests equitable relief under subsection (f) -- (A) In general. -- * * the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section * * *4. TRHCA sec. 408 includes three subsections. Subsec. (a) sets forth the amendment to sec. 6015(e)(1) just discussed. Subsec. (b) sets forth seven "Conforming Amendments" to various provisions of sec. 6015. Subsec. (c) sets forth the effective date of TRHCA sec. 408↩, stating that "The amendments made by this section shall apply with respect to liability for taxes arising or remaining unpaid on or after the date of the enactment of this Act."5. Sec. 6601 generally sets forth rules for the payment of interest on the underpayment of tax. Sec. 6601(e)(1) provides that "Any reference in this title (except subchapter B of chapter 63, relating to deficiency procedures) to any tax imposed by this title shall be deemed also to refer to interest imposed by this section on such tax." Sec. 6665 sets forth certain applicable rules. Sec. 6665(a)(2)↩ provides that "any reference in this title to 'tax' imposed by this title shall be deemed also to refer to the additions to tax, additional amounts, and penalties provided by this chapter."6. Sec. 6015(b)(1) allows a spouse who meets certain requirements to "be relieved of liability for tax (including interest, penalties, and other amounts)".	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622733/	AUDREY BILLER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBiller v. CommissionerDocket No. 2200-74.United States Tax CourtT.C. Memo 1976-97; 1976 Tax Ct. Memo LEXIS 305; 35 T.C.M. (CCH) 406; T.C.M. (RIA) 760097; March 29, 1976, Filed Joseph E. Johnson and B. J. Smith, for the petitioner. Dudley W. Taylor, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in the Federal income tax of petitioner and her husband, Morris Biller, and additions to tax under section 6653(b), I.R.C. 1954, 1 for the years and in the amounts as follows: Addition to TaxTax Year EndedDeficiencyUnder Sec. 6653(b)Dec. 31, 1964$ 111.05$ 0Dec. 31, 19673,364.581,682.29Dec. 31, 196845,844.2522,922.13Dec. 31, 1969111,443.4355,721.72Dec. 31, 197018,630.249,315.12306 307 Petitioner has agreed that the understatement of income as determined by respondent in the statutory notice of deficiency is correct for all of the years here in issue and respondent has agreed that no part of such underpayment for any of the years here in issue is due to fraud by this petitioner. This leaves for our decision only whether petitioner is entitled to be relieved from the portion of the deficiency that results from understatement of income for each of the years 1968, 1969 and 1970 under the provisions of section 6013(e). FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Audrey Biller (petitioner) resided in Memphis, Tennessee at the time her petition in this case was filed. Petitioner and her husband, Morris Biller, filed a joint Federal income tax return for the calendar year 1964 with the District Director of Internal Revenue, Nashville, Tennessee. They filed joint Federal income tax returns for the calendar years 1967, 1968, 1969 and 1970 with the Southeast Service Center, Chamblee, Georgia. Next to the signature of Morris Biller on the 1968 return appeared the date July 7, 1969. No date appears next to petitioner's signature.308 The 1968 return was filed on July 11, 1969. 2 The 1970 return shows next to the signature of Morris Biller the date of October 13, 1971. No date appears on this return next to petitioner's signature. The return for 1970 shows October 8, 1971, as the date it was signed by the preparer and this return was filed on October 15, 1971. The return for 1968 reported under adjusted gross income a loss of $ 1,247.50. The return for 1969 reported under adjusted gross income the amount of $ 28,275.38, of which $ 7,500 was salary received by petitioner and $ 3,909.37 the taxable portion of capital gains, total long-term and short-term capital gains being shown as $ 6,021.25. The 1970 return reported under adjusted gross income a loss of $ 25,374.78. Petitioner married Morris Biller in 1949. They have two daughters, Sharon and Brenda, who were 25 and 20 years old in April 1975, respectively. Sharon entered college at Memphis State University in 1968. Petitioner received a Bachelor's degree with a major in309 business management from Memphis State College in 1951. While in college she took one year of basic accounting. Petitioner has been employed by Memphis Concrete Silo Company, a corporation owned by petitioner and members of her family, since her graduation from college. Since some time in 1954 she has been secretary-treasurer of the corporation. Petitioner does all the posting of the records of the corporation and prepares the quarterly reports, and in addition signs most of the checks on behalf of the corporation. She keeps all of the normal day-to-day records which she furnishes once each month to a C.P.A. who is retained by the corporation. Petitioner has been engaged in the same type of occupation since she first became employed by her family-owned business. For her services to the corporation petitioner in the years here before the Court received a yearly salary of $ 7,500 to $ 9,500. Generally she would endorse her salary checks and turn them over to her husband who either cashed them or deposited them in the joint checking account maintained by petitioner and her husband. Mr. Biller's formal education ended in the tenth grade in high school. Prior to 1967 he had been employed310 for approximately 13 years as a salesman for Palmolive-Colgate Company. In 1967 he purchased and began to operate a grocery store in Memphis, Tennessee known as Big Star Food Store No. 9. A loss was incurred on the operation of this store in 1967 and 1968. The returns of petitioner and Mr. Biller for these years reported the losses from the grocery store operation as $ 14,026.41 and $ 14,810.89, respectively. Late in 1967 Mr. Biller began operating a business as a sole proprietorship under the name of Mid-South Marketing Services (Mid-South). The business of Mid-South consisted of acting as a clearing house between retail grocers and manufacturers for discount coupons. Various manufacturers would issue coupons which provided for a stated discount from retail price upon the purchase of various products. These coupons would be distributed to purchasers of products handled by grocery stores for use when purchasing the product at retail. The coupons would be collected by Mr. Biller or employees of Mid-South from the grocery stores which had honored them as part of the purchase price of the article. Mid-South would forward the coupons to the appropriate manufacturer for redemption. Mid-South311 would receive the payment for redemption from the manufacturer and would send a weekly or monthly check to each retail grocer for the total amount of the coupons which had been collected from that grocer. In this way the grocer would receive checks ranging in amounts from $ 25 to $ 150 or upward for a number of coupons instead of having to redeem small 10( to 25( coupons with various manufacturers. When Mid-South sent the coupons collected from the grocers to the various manufacturers it would receive the face value plus 3 percent of face value. The 3 percent covered a payment which was made by Mid-South to the grocer of 1-1/2 percent of the face value of the coupon for handling expense of the grocer and 1-1/2 percent which was retained by Mid-South as compensation for its services. Mid-South also acquired coupons at large discounts from the face value of the coupons from persons engaged in the illegal sale of such coupons. Some coupons would be placed in trash receptacles or otherwise disposed of unused by the person to whom they had been sent by the manufacturer. These coupons would be collected by someone engaged in the illegal sale of such coupons. Mr. Biller, after purchasing312 these coupons, would intermingle them with coupons he had obtained from retail grocers and would redeem them under various fictitious names of grocery stores. Generally Mr. Biller would do this intermingling himself in the evening. Although at the height of the operation of Mid-South the business employed up to 30 persons, Mr. Biller had none of the employees intermingle the illegally acquired coupons with the coupons obtained legitimately from grocers. Mid-South maintained a bank account in its name. Both petitioner and Mr. Biller had authority to draw checks on that account. When checks were returned for coupons Mr. Biller would himself remove certain checks which he would cash. He would retain the cash received from these checks in cash. The checks which he personally removed and cashed were his estimate of the amounts covered by the illegally acquired and redeemed coupons. However, it was difficult to keep the payments for the illegally redeemed coupons separate from the amounts of legitimately redeemed coupons, so some of the funds from the illegally redeemed coupons went into Mid-South's bank account. At times Mr. Biller would make a draw on Mid-South's bank account for his313 personal use and the funds which he drew would be placed in the joint account which he and petitioner maintained. He viewed the draw as being in the nature of a salary. He used some of the cash received from checks he withdrew and cashed without putting them through the bank account of Mid-South to buy additional coupons from illegal sources. At the beginning of Mid-South's operation petitioner assisted her husband with the bookkeeping and prepared checks on Mid-South's account for payment to grocers. She at times signed checks that she prepared on Mid-South's account and would post these checks to the check record and reconcile bank records of Mid-South. Petitioner's authority to sign checks on Mid-South's account continued throughout Mid-South's existence. However, approximately 2 years after commencement of Mid-South's operation a full-time bookkeeper was employed by the business and petitioner ceased to assist with the check writing and posting and reconciling of the bank statements. On April 9, 1969, Mr. Biller purchased a Piper PA-32 aircraft for $ 16,800 and paid this purchase price in currency. The certificate of title for the aircraft was issued in the names of "Morris314 or Audrey Biller." On April 21, 1969, this aircraft was traded by Mr. Biller on another Piper PA-32 aircraft. This second aircraft had an automatic pilot and other equipment which was not on the Piper PA-32 initially purchased. In addition to the trade-in, Mr. Biller paid $ 3,500 in currency for the second Piper PA-32. On the same day that the second aircraft was purchased application was made to put the certificate of title in the names of "Morris and/or Audrey Biller." On May 16, 1969, Mr. Biller traded in the second Piper PA-32 on a Piper PA-23 aircraft. The Piper PA-23 was a twin-engine plane which cost $ 38,800. In addition to trading in the Piper PA-32 acquired on April 21, 1969, Mr. Biller paid $ 18,500 in currency for the Piper PA-23. The certificate of title to the Piper PA-23 was in the name of "Morris and/or Audrey Biller." Petitioner knew of the purchase of the three aircraft in 1969 and knew the location of the hangar in which the aircraft were maintained. Petitioner did not inquire as to the amounts paid for the three aircraft, whether the payments were in cash, or how much was paid for hangar space, fuel, and other up-keep on the aircraft. Mr. Biller had obtained315 a pilot's license in either 1958 or 1959 and shortly thereafter he went into partnership on a small plane with another person and paid $ 750 on the plane. He kept his interest in the plane around 6 or 7 months and then purchased a plane either in his own name or in his name jointly with his wife for $ 3,800. He disposed of that plane and a year or more later purchased a Cessna 170 for which he paid $ 4,500. He traded the Cessna 170 on a plane he bought in partnership with a Mr. Walker. The plane he bought with Mr. Walker cost $ 11,000 and he and Mr. Walker each paid 50 percent of the price, Mr. Biller being credited for the amount received on the trade-in of his Cessna 170 and paying the difference between that amount and his one-half of the cost of the new plane. Mr. Biller kept his interest in this plane for about a year and sold his interest to Mr. Walker around 1961 when he and petitioner built a home. Petitioner and her husband took several weekend trips in the Piper PA-23 aircraft in 1969 and 1970 and petitioner accompanied Mr. Biller on one business trip he took in the plane. The Piper PA-23 was sold in 1970 for $ 27,500. Petitioner and her husband both wrote checks on the316 joint bank account they maintained in the years here in issue, although Mr. Biller wrote more checks on this account than petitioner. When petitioner wrote checks on the joint bank account she was aware of the balances in that account. In 1967 petitioner owned a 1967 Chrysler automobile and throughout the years here in issue petitioner owned the 1967 Chrysler automobile. Mr. Biller also owned a Chrysler automobile during the years here in issue. Petitioner and her husband bought a new automobile for their daughter, Sharon, when she entered college in 1968. The residence owned by petitioner and her husband during the years here in issue was built in 1961. The house was built on a lot which had been given to petitioner by her mother. Petitioner and her husband sold a house they owned and were living in and used the funds received from that sale plus funds received from a mortgage on the new house to pay for the new house. Petitioner and her husband later added a swimming pool to the property. Petitioner had charge accounts at most of the stores in Menphis during the years here in issue. As a result of his transactions involving illegally acquired coupons, Mr. Biller was indicted317 for mail fraud under Title 18, U.S.C. sec. 1341, prior to March 29, 1971. Petitioner learned of the charges in this indictment with respect to her husband's traffic in illegally acquired coupons at the time it was returned. Trial under the indictment was commenced in June 1970 and part way through the trial Mr. Biller pleaded guilty to nine counts of the indictment and was setenced to nine months in a Federal prison. On March 29, 1971, Mr. Biller transferred to petitioner his interest in the residence which they owned jointly. The transfer was without consideration. On the same day, March 29, 1971, petitioner deeded this residence to Frank Vego, a half-brother of her husband. Mr. Vego gave petitioner $ 10,000 and a note in the face amount of $ 34,000, and in addition assumed the existing mortgage on the residence. The stated sales price of the residence was approximately $ 70,000. Mr. Vego has never made any payments on the $ 34,000 note given to petitioner and petitioner still holds this note. Petitioner has lived continuously in the residence deeded to Mr. Vego from March 29, 1971 through April 1975, the time of the trial of this case. Petitioner turned over318 to her husband the $ 10,000 given to her by Mr. Vego when she deeded the residence to Mr. Vego to be used to pay for legal fees in the criminal proceedings which had been instituted against her husband. The records maintained on behalf of Mid-South by Mr. Biller consisted primarily of a cash disbursement journal and a general ledger. At the end of the year these records were turned over to an accountant for the preparation of the tax returns of petitioner and Mr. Biller. During the years 1967 and 1968 the records of Big Star Food Store No. 9 were also utilized by the accountant in the preparation of the Federal income tax returns of petitioner and Mr. Biller. These records were generally maintained for the store by Malone and Hyde Retail Services, a food broker. On May 13, 1971, Mr. Biller was notified by a letter from a special agent of the Internal Revenue Service that an offical investigation was commencing of the joint Federal income tax returns filed by him and petitioner for the years 1967, 1968, and 1969. In the notice of deficiency respondent computed the taxable income of petitioner and Mr. Biller for the years here in issue as follows: 19641967196819691970Taxable IncomeasPreviously$ 2,619.85 1AdjustedAdjusted GrossIncomeAs Reported$ 16,130.63$ 3,118.74$ 28,275.38($ 25,374.78)Taxable IncomeAsReported8,412.2720,942.77Adjustments(SeeAttached List)16,046.73115,277.42189,449.1676,556.31Taxable IncomeAsRevised8,412.2719,165.47117,897.27210,391.9351,181.53Total Tax1,576.884,081.7844,720.68116,212.9018,092.04Investment1,139.60120.5975,069.00Credit319 The attached list referred to in this computation disclosed the following: 1967196819691970(a) Additional Income$ 23,972.33(b)%additional Income$ 95,519.45$ 204,649.47$ 63,565.93(c) Schedule C Expenses14,492.14(124.06)(d) Contributions(410.00)(e) Interest Expense(3,614.73)(f) Miscellaneous Expenses(10.00)(g) Medical Expense(497.87)386.881,063.88(h) Taxes(993.00)(i) Personal Exemptions(2,400.00)(2,500.00)(j) Coupon Purchases13,948.8815,571.702,289.10(k) Loss on Operation ofGrocery Store(8,708.40)(l) Sales Taxes(361.53)(287.60)(m) Postage Expense(1,132.50)(n) Depreciation Expense(240.83)(578.01)(o) Change of AccountingMethod(30,424.33)30,424.33(p) Payroll Taxes780.28(658.08)(q) Long Term Capital Gain469.09(r) Loss on Worthless Note(1,000.00)(s) Legal Expense(12,500.00)(t) Itemized Deductions(3,362.90)The explanation of item (a) for 1967 was that "[in] the absence of adequate records, your adjusted320 gross income has been computed upon the basis of increase in net worth during the taxable year 1967, with adjustment for nontaxable items of income, if any, and for personal and other non-deductible amounts. Accordingly, your taxable income is increased in the amount of $ 23,972.33." Item (b) for the years 1968, 1969 and 1970 was explained as follows: "It is determined that you received additional income in the amount of $ 95,519.45, $ 204,649.47 and $ 63,565.93 for the taxable years ended December 31, 1968, December 31, 1969 and December 31, 1970, respectively, * ." OPINION Section 6013 (e) 3 entitled "Spouse Relieved of Liability in Certain Cases" provides that if a joint return has been made for a taxable year and on such return there was omitted from gross income an amount properly includable which is attributable to one spouse and which is in excess of 25 percent of the amount of gross income stated in the return, the other spouse may where specified conditions are established be relieved from liability for the tax attributable to the omission of such income. One of the facts which must be established is that the spouse seeking to be relieved of the tax did not know321 of and had no reason to know of such omission at the time of signing the return. Another requirement is that the spouse seeking relief establish that, taking into account whether she significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold her liable for the deficiency attributable to such omission. Petitioner in the instant case claims that she should be relieved of liability under the provisions of this section for the years 1968, 1969 and 1970. 322 Initially, it might be pointed out that even if petitioner were able to establish that she came within the provisions of section 6013 (e), she would not be relieved from all of the deficiencies in tax for the years here in issue. From the facts we have set forth, it is clear that certain of the adjustments which gave rise to additional tax in each of these years were not the result of omissions from gross income. To the extent of the other adjustments petitioner is liable for the resulting deficiencies because of having joined in a joint return with her husband. Jennie Allen,61 T.C. 125">61 T.C. 125, 131-132 (1973), affirmed on this issue, reversed and remanded on another issue, 514 F. 2d 908 (5th Cir. 1975). The record here is clear and respondent agrees with petitioner that there has been an omission from gross income on the joint returns filed by petitioner and her husband in each of the years 1968, 1969 and 1970 in an amount in excess of 25 percent of the amount of gross income stated on the return and that the omission is attributable to petitioner's husband and not to petitioner. The record shows that the omissions resulted principally from failure to include323 in income the amounts received by petitioner's husband from proceeds of checks of Mid-South's which he cashed and did not deposit in the bank account of Mid-South. The checks totaled approximately the amounts of payments for redemption of coupons illegally acquired by Mr. Biller. Our issue, therefore, is limited to whether the other requirements of section 6013(e) are met. In order to qualify for the relief from tax liability provided for under section 6013 (e) (1) petitioner must establish that all the conditions for such relief set forth in that section are met. Raymond H. Adams,60 T.C. 300">60 T.C. 300 (1973). In our view the record is clear that petitioner either knew, or had reason to know, of the omission of income for the year 1970 at the time of signing the return for that year. Although no date appears next to petitioner's signature on the 1970 return, the return shows a date of October 8, 1971, next to the signature of the preparer. This return was obviously signed by petitioner on or after that date and a reasonable inference is that the October 13, 1971 date appearing next to the signature of petitioner's husband is also the date the return was signed by petitioner. 324 Prior to March 29, 1971 petitioner's husband had been indicted for mail fraud in connection with his illegal activities in redeeming coupons and in June of 1971 had been convicted under this indictment. Petitioner testified that she did not find out about her husband's illegal activities until his indictment. If we accept this testimony as being equivalent to a statement that she had no reason to know of his receipt of more income from the coupon business than was reported on the tax returns, which we do not, it does not explain why after the indictment and conviction of her husband she was not on notice of the activities in which he had engaged and that these activities resulted in receipts of income which was not included in the books and records of Mid-South and was therefore omitted from income reported on the 1970 return. Petitioner is an educated and intelligent woman with business experience. With the knowledge she acquired after her husband's indictment and conviction, she certainly reasonably should have known of omissions from income in 1970 of the amounts resulting from his illegal activities. She had up to some time in 1969 assisted with the Mid-South bookkeeping and therefore325 knew how receipts were included in those books and records. She understood bookkeeping. The facts with respect to the years 1968 and 1969 are not as unmistakably clear as are the facts with respect to the year 1970. We note from the record that while petitioner testified of lack of knowledge of her husband's business activities and her lack of knowledge of his illegal activities until the time of the indictment, she at no juncture specifically stated that she did not know of the omission from gross income on the returns for 1968 and 1969. Petitioner asks us from her testimony as to her lack of knowledge of her husband's business to draw an inference that she did not know of these omissions and had no reason to know of them. In our view the inference which petitioner asks us to draw from her testimony as to her lack of knowledge of her husband's business affairs is not warranted by this record. She had assisted with record keeping for Mid-South in 1968 and part of 1969. She gave no explanation of why she made no inquiry as to the costs of operating the business as compared to the receipts from the operation while she was doing bookkeeping for the business. It appears from this record326 that she may have studiously avoided checking into the omissions of income from the Mid-South business. See Sanders v. United States,509 F.2d 162">509 F. 2d 162, 169 (5th Cir. 1975). On the basis of the record as a whole we conclude that petitioner reasonably should have known of these omissions from income at the time she signed the 1968 and 1969 returns. Apparently petitioner signed the 1968 return in early July 1969. In April and May 1969 her husband had paid $ 38,800 in cash for the aircraft he bought. Petitioner testified that she did not inquire of him about these expenditures. In our view we are not warranted from her lack of inquiry about these expenditures to infer that she was not reasonably aware of the cost of the type of aircraft which her husband acquired and the cost of maintaining such an aircraft. Petitioner took several trips with her husband in the most costly of these aircraft. Her husband had previously owned interests in much less costly aircraft. In our view even though petitioner did not inquire from her husband as to the cost of the aircraft she reasonably must have been aware in a general way of the cost of the type of aircraft acquired by her husband327 and the cost of maintaining such aircraft. When this type of cost is compared with her salary and the small income or losses reported by petitioner and her husband on their 1967 and 1968 tax returns, in our view the inference is that pettrioner reasonably should have known that income was being omitted from the joint income tax return. Particularly is this true in light of the fact that petitioner and her husband maintained a home on which they were making mortgage payments, supported two teenage daughters, and each drove a Chrysler automobile. In 1968 they purchased an automobile for one daughter they were sending to college. Had petitioner been a woman of limited education and without business experience it would be difficult to believe that she should not have known of the omission of income from the joint tax return. However, she not only was an educated person with business experience but even was knowledgeable in the areas of business management and accounting. On this record petitioner has totally failed to meet her burden of showing that she, at the time of the signing of the returns for the years 1968 and 1969, had no reason to know of the omissions from gross income and therefore328 she does not qualify for relief under section 6013(e). Howard B. Quinn,62 T.C. 223">62 T.C. 223, 231 (1974). Respondent also argues that petitioner has failed to establish that she did not significantly benefit directly or indirectly from the omitted income. Petitioner points out that the payment of ordinary living expenses is not to be considered as a significant benefit from the omitted income. Petitioner relies on Dakil v. United States,496 F. 2d 431 (10th Cir. 1974), in which the Court held that three automobiles of indeterminate value, a country club membership, vacation trips, and private schools for children were not necessarily to be considered a benefit from a lavish life-style for a doctor's wife. In that case the spouse who had omitted the income was dead and the record showed that his widow had nothing from his accumulation but was living on a small Social Security monthly payment and earnings received as a part-time outreach worker with senior citizens. The circumstances in the instant case are substantially different from those in Dakil v. United States,supra.Here, after his indictment, petitioner's husband transferred329 full ownership of their residence to petitioner. The reason for this transfer is never satisfactorily explained in the record. Petitioner stated that her husband's half-brother was considering coming to Nashville to live and needed a house. Even if this were a fact, there is no explanation of why her husband's interest in the house needed to be transferred to her for the house to be sold to his half-brother. There is no satisfactory evidence in this record to show that the transfer of the house to petitioner was not a means of letting her retain assets which might otherwise be subject to repayment of some of her husband's illegally procured receipts which were omitted from reported income. Mr. Biller's half-brother has never moved into the house nor paid any amount on the mortgage given to petitioner. Apparently either he has been paying the mortgage which petitioner and her husband had on the house, which he supposedly assumed with so-called rent paid by petitioner for the house, or petitioner has been making these payments. The record on this point is not clear. Petitioner and her husband were still married at the time of the trial of this case. Other than petitioner's statement330 that she just bought the things she and the daughters needed with money given her by her husband and that she did not live extravagantly, this record is devoid of evidence that petitioner has not significantly benefited from the omitted income. process which is vested exclusively in the discretion of a The record does not show what use was made of the omitted funds other than Mr. Billers' testimony that some of these funds were used to purchase more illegal coupons. From this record we might assume some of these funds were used to buy aircraft. As far as this record shows some of the omitted funds may have been used for petitioner's benefit in years after the years here in issue. The burden is on petitioner to show that she did not significantly benefit from the omitted funds. Jerome J. Sonnenborn,57 T.C. 373">57 T.C. 373, 383 (1971). However, since we have held that in our view petitioner reasonably should have known of the omitted income at the times she signed the returns, we need not decide the issue of whether petitioner received either directly or indirectly any significant benefit from the omitted income. Decision will be entered for the respondent.Footnotes1. All references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated. The petition also places in issue the years 1964 and 1967. However, on brief petitioner argues only that she should be relieved from a portion of the deficiency for 1968, 1969 and 1970. The deficiency notice shows that respondent made no change in the reported income of petitioner and her husband in the year 1964 but merely disallowed an investment credit. Therefore, obviously section 6013(e) would have no application to this year. For the year 1967 respondent determined the tax of petitioner and her husband on the basis of increase in net worth. Since in this year petitioner's husband was conducting a grocery business from which he reported gross receipts in excess of approximately $ 553,000 but sufficient costs and deductions to result in a reported loss from this grocery business of approximately $ 14,000, it is obvious, as petitioner apparently recognizes, that the record affords no basis of determining whether the deficiency for 1967 resulted from understatement of income or overstatement of expenses. See H.A. Hurley,22 T.C. 1256">22 T.C. 1256, 1264-1265 (1954), affd. 233 F.2d 177">233 F.2d 177↩ (6th Cir. 1956).2. The date next to the signature of the preparer of the 1968 return is not completely legible. The date of "27" and the year of "69" can be read, but the month is totally illegible.↩1. The return as filed for 1968 shows adjusted gross income as a loss of $ 1,247.50.↩3. SEC. 6013. JOINT RETURNS OF INCOME TAX BY HUSBAND AND WIFE. * *(e) Spouse Relieved of Liability in Certain Cases.-- (1) In general. Under regulations prescribed by the Secretary or his delegate, if-- (A) a joint return has been made under this section for a taxable year and on such return there was omitted from gross income an amount properly includable therein which is attributable to one spouse and which is in excess of 25 percent of the amount of gross income stated in the return, (B) the other spouse establishes that in signing the return he or she did not know of, and had no reason to know of, such omission, and (C) taking into account whether or not the other spouse significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such omission, then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent that such liability is attributable to such omission from gross income. (2) Special rules. -- For purposes of paragraph (1)-- (A) the determination of the spouse to whom items of gross income (other than gross income from property) are attributable shall be made without regard to community property laws, and (B) the amount omitted from gross income shall be determined in the manner provided by section 6501(e)(1)(A).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622734/	ROBERT F. AND PATRICIA E. SCHURWAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSchurwan v. CommissionerDocket No. 19114-82.United States Tax CourtT.C. Memo 1983-699; 1983 Tax Ct. Memo LEXIS 97; 47 T.C.M. (CCH) 395; T.C.M. (RIA) 83699; November 23, 1983. John J. Vassen and Patrick B. Mathis, for the petitioners. Michael J. Cooper and James A. Kutten, for the respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: This case was assigned to and heard by Special Trial Judge John J. Pajak pursuant to the provisions of section 7456(c) of the Internal Revenue Code1 and Rules 180 and 181. 2 The Court agrees with and adopts his opinion which is set forth below. 98 OPINION OF THE SPECIAL TRIAL JUDGE PAJAK, Special Trial Judge: Respondent determined a deficiency in petitioners' 1980 Federal income tax in the amount of $1,958.00. After concessions by the parties, the sole issue for decision is whether under section 162(a) petitioners are entitled to deduct petitioner-husband's costs of traveling between his residence and place of work. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners, husband and wife, resided in Florissant, Missouri, when their petition in this case was filed.Petitioner Robert F. Schurwan (petitioner) is an insulator and a member of Local #1, International Association of Heat and Frost Insulators and Asbestos Workers (union). Prior to joining the union in August 1982, petititoner had been classified as a "permit worker." 3 As such, he was subject to being "bumped" from his job by union members seeking work.99 Petitioner was employed on several occasions by Daniel International Corporation (Daniel) as an insulator at the Callaway Nuclear Power Plant project (Callaway). Callaway is a major project being built by Union Electric Company (UEC). The site was located near Fulton, Missouri, approximately 100 miles from each of petitioners' two residences during 1980. 4Petitioner was first employed by Daniel in October 1977. After working for approximately six months, he was laid off pursuant to a reduction of force. On March 5, 1979, petitioner was rehired and worked until March 21, 1979 when he was laid off due to a reduction in force. The critical period in this case began on March 26, 1979 when petitioner was again rehired by Daniel. He worked until April 14, 1981. Except for two brief periods when petitioner was laid off due to work stoppages by other crafts, 5 this period of employment by Daniel at Callaway lasted in excess of two years. On July 31, 1980, Daniel's personnel office advised a savings and loan association with respect to a credit application that petitioner's100 probability of continued employment was good. The original plan for Callaway was to build two nuclear powered generating units (Units 1 and 2). Daniel was the general contractor for the entire project, with the exception of the main cooling tower. Construction of Callaway began in late 1975 with ground breaking and site preparation work. At that time, Unit 1 was scheduled to be completed by October 1981 and Unit 2 by April 1983. Due to a number of unforeseen problems, the estimated completion dates were extended on several occasions. In 1978 the estimated completion date was October 1982 for Unit 1 and April 1987 for Unit 2. These revisions were generally made public by UEC through various press releases and news conferences. In 1981, plans for the construction of Unit 2 were cancelled. This had no effect on Unit 1's estimated completion date. At the time of trial, construction of Unit 1 had not been completed. A referendum, "Proposition 11", was defeated in Missouri on November 4, 1980. If successful, the referendum would have prevented101 the operation of a nuclear power plant within Missouri until a permanent disposal site for radioactive waste could be approved by the Federal government. Even if the proposition passed, UEC intended to continue construction at Callaway. The proposition had no effect on the construction of Unit 1 or on the estimated completion date of Unit 1. Insulators at the Callaway project were hired by Daniels pursuant to an agreement with the union. Based on work requirements, an employee of Daniel would prepare a manpower request for a certain number of workers. The necessary insulators would be supplied from the union's referral list. 6 The decision to lay off a particular insulator due to a reduction of force at Callaway was solely within the discretion of Daniel. The pertinent102 period of petitioner's employment by Daniel began on March 26, 1979. He was given no indication of how long employment would be available by Daniel, although one union official said it might last a couple of months.At that time Unit 1 was less than 40 percent complete and did not reach near that stage of completion until about November 5, 1979. A worker, such as petitioner, was required to attend an orientation lecture about Callaway each time he was hired by Daniel. During the lecture, the worker was informed of the then estimated time of completion. During 1980, Daniel had a substantial need for insulators. In addition to significant amounts of work on temporary facilities, insulation work was required in buildings for which Daniel was responsible. Such work was not seasonal in nature. A person in petitioner's craft could reasonably expect to remain employed for as long as work remained available and he maintained a good work record. Although the number of insulators at Callaway fluctuated in 1980, 7 the prospects for continued employment for a good worker were substantial throughout 1980. 103 The parties introduced two joint exhibits containing figures showing the total number of insulators employed at Callaway, one apparently as of each given Tuesday and the other on a weekly basis. From the time petitioner was hired on March 26, 1979, both exhibits show a pattern of increasing need for insulators at the site until mid-August 1979 by which time a substantial number were employed. Thereafter, there were fluctuations in the upper ranges of total employment of insulators and on two short occasions there were drastic reductions in force of insulators due to work stoppages by other crafts. Petitioner was one of those laid off due to work stoppages by the other crafts. None of the fluctuations in the upper ranges of total employment affected petitioner's employment nor his prospects of employment. Petitioner was employed by Daniel for more than two years after March 26, 1979, whith the two brief breaks described above, despite the fluctuations at the upper ranges of total employment of insulators. Daniel was obviously satisfied with his performance. Petitioner's March 21, 1979 layoff slip had noted that he was a good worker, had good attendance, and that he should be104 rehired when possible. He was rehired one week later. He was also promoted to forman on November 20, 1980. Petitioner was in the group of Daniel employees at Callaway who could expect to remain employed throughout 1980. At the time of trial, petitioner was still working at Callaway although for a different contractor. On their 1980 return, petitioners claimed an ajustment to income for employee business expenses in the amount of $6,509.00. There is no dispute that this amount represents the costs incurred by petitioner in commuting by automobile between his residence and the Callaway site. Respondent disallowed the claimed adjustment in full. OPINION The essential facts herein do not differ from those in Van Horn v. Commissioner,T.C. Memo. 1983-693, 8 issued on the same day this opinion was issued, although there are some differences in the detail. The most significant difference is that petitioner was hired on March 26, 1979 after a one-week layoff from a job lasting only two weeks. Whatever his status was when petitioner began the critical period of work for Daniel at Callaway, there is no question but that by January 1, 1980, his prospects for continued105 employment for an indefinite period were excellent. Frederick v. United States,603 F.2d 1292">603 F.2d 1292 (8th Cir. 1979); Norwood v. Commissioner,66 T.C. 467">66 T.C. 467 (1976); Kroll v. Commissioner,49 T.C. 557">49 T.C. 557 (1968). We are satisfied for the reasons set forth in Van Horn v. Commissioner,supra, that petitioner's employment during 1980 was indefinite, and not temporary. Accordingly, respondent's disallowance of the claimed automobile expense must be sustained. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954 in effect during the taxable year in issue, unless otherwise indicated. All references to Rules are to the Tax Court Rules of Practice and Procedure. ↩2. Pursuant to the order of assignment, on the authority of the "otherwise provided" language of Rule 182, the post-trial procedures set forth in that rule are not applicable in this case.↩3. Although the stipulation of facts states that petitioner was a member of the union during the year in question, the testimony of petitioner was to the contrary. Since we do not deem this fact critical, we have based our findings as to union membership on that testimony. Rule 91(e).↩4. Petitioners resided in St. Louis, Missouri, until October 1980 at which time they moved to Florissant.↩5. The first period was the three weeks from April 7, 1980 to April 28, 1980 and the second was from May 28, 1980 to June 4, 1980.↩6. During the period 1976 through 1981, the union found that its members were almost all fully employed in various projects within its jurisdiction, causing it to allow permit workers to satisfy the demands of various employers. The number of union insulators employed during that period ranged from a low of 298 to a high of 320. The number of insulators employed as permit workers ranged from 241 to 370.↩7. Fluctuations were the result of various factors such as voluntary quits, no-shows, firing due to violation of project rules, reductions in force due to the needs of the employer, and work stoppages by other crafts.↩8. The instant case was consolidated for trial and briefing with that case and one other case and for trial with two other cases with respect to common witnesses.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622735/	GUARANTY STATE SAVINGS & LOAN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Guaranty State Sav. & Loan Co. v. CommissionerDocket No. 12039.United States Board of Tax Appeals14 B.T.A. 72; 1928 BTA LEXIS 3037; November 7, 1928, Promulgated 3037 1. Petitioner held not a building and loan association entitled to exemption from taxation during the year 1923 within the meaning of section 231(4) of the Revenue Act of 1921. 2. Amounts paid by the petitioner (as dividends) to owners of its withdrawable stock held not allowable as interest or expense deductions from income. Herbert W. Nauts, Esq., Cleaveland R. Cross, Esq., and W. E. Lewis, C.P.A., for the petitioner. J. Arthur Adams, Esq., for the respondent. VANFOSSAN 72 This proceeding is an appeal from the determination of the Commissioner that the petitioner is not entitled to exemption under the provisions of section 231(4) of the Revenue Act of 1921 for the year 1923. If it is held that the petitioner is not so exempt there is a further issue as to whether or not the amounts paid by the petitioner (as dividends) to owners of its withdrawable stock are allowable as interest or expense deductions from income. At the hearing the respondent amended his answer so as to increase the petitioner's net taxable income from $12,482.86 to $47,090.05 by adding the amount of $34,820.28, representing the dividends paid on its3038 stock. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of Ohio and has its principal office at Cleveland, Ohio. It was organized on January 16, 1916, with an authorized capital stock of $1,000,000, divided into 10,000 shares of the par value of $100 each. On or about January 1, 1922, its capital stock was increased to $5,000,000, divided into 50,000 shares of a par value of $100 each. The charter of the petitioner shows that it was formed "for the purpose of raising money to be loaned to its members and others on such terms, conditions and securities as may be provided for by its by-laws; receiving money on deposit from time to time to the extent necessary to meet the demands made upon it by its members and others, and generally doing all things and transacting all business authorized by the laws of Ohio to be done and transacted by Building & Loan Companies." The comparative balance sheets of the petitioner as of December 31, 1922, and December 31, 1923, respectively, are as follows: Dec. 31, 1922Dec. 31, 1923ASSETSCash$46,312.63$31,616.37Loans on mortgage security891,535.561,142,592.03Loans on stock, certificate, and pass-book security46,940.1439,068.90Furniture and fixtures3,600.001,500.00Real estate - office building101,000.00101,000.001,089,388.331,315,777.30LIABILITIESRunning stock and dividend credits230,575.79225,777.51Paid-up stock63,900.0087,200.00Permanent stock211,300.00221,000.00Deposits and accrued interest and certificates of deposit305,437.64436,040.96Reserve fund55,000.0057,500.00Undivided profit fund89.328,979.33Borrowed money and accrued interest60,000.0015,000.00Due borrowers - unfinished buildings116,354.75186,779.50Deposits - other building and loan companies31,317.7477,500.00Reserved for Jan. 1, 1924, dividend15,413.091,089,388.331,315,777.303039 73 The statement of its cash receipts and disbursements during the year 1923 is as follows: ReceiptsAmountDues on running stock$95,526.00Paid-up stock35,000.00Permanent stock19,200.00Deposits655,738.33Credits on mortgage loans339,128.22Loans on stock, certificates and passbook security61,014.20Unfinished building account602,344.07Borrowed money200,000.00Deposits - other building and loan companies80,000.00Interest84,162.50Premium on loans - inspection fee Loan fees:Loan fee$5.00Appraisal fee16.6021.60Rents - company's real estate - gross5,200.00Miscellaneous earnings658.282,181,439.70Cash received for company checks on depositories406,911.512,588,351.21DisbursementsAmountLoans - mortgage security$590,184.69Loans - stocks, certificate and passbook security53,142.96Unfinished building account531,919.32Withdrawals of running stock100,324.28Withdrawals of paid-up stock11,700.00Withdrawals of deposits525,135.01Withdrawals of borrowed money245,000.00Dividends on paid-up stock4,989.40Dividends on permanent stock15,212.31Interest on deposits20,578.22Interest on borrowed money2,520.10Salaries of officers and directors7,720.00Office help, rent and legal expense5,862.25All other expenses7,522.44Taxes975.58Deposits by other building and loan companies withdrawn33,817.74Reserved for Jan. 1, 1924, dividend15,413.09Permanent stock withdrawn9,500.00Dividends - running stock14,618.572,196,135.96Checks on company depositories issued for cash or private check406,911.512,603,047.473040 The difference in the cash receipts and cash disbursements is reflected in the decrease of cash on hand on January 1, 1924, from the amount on hand on January 1, 1923. Summarized, the petitioner derived its funds from the following sources: Dec. 31, 1922Dec. 31, 1923Paid-up stock$63,900.00$87,200.00Permanent stock211,300.00221,000.00Deposits - savings accounts305,437.64436,040.96Deposits - other loan companies31,317.7415,000.00Borrowed money60,000.0077,500.00Other sources230,575.79225,777.5174 During the year 1923, the petitioner paid interest on deposits and dividends as follows: DividendsInterestPer centPer centRunning stock7Paid-up stock7Permanent stock7Deposits - savings accounts5Deposits - certificate of deposit6Deposits - other loan companies6Borrowed money6The capital stock of the petitioner was subscribed for and certificates therefor issued pursuant to the following sections of the by-laws: SECTION 16. Members who do not pay the face value of their stock at the time of subscribing, may pay the same in installments of not3041 less than 50 cents per month on each $100.00 thereof, for which payments credit shall be given them in a pass-book, and a certificate of paid-up stock may be issued for the even hundred thereof. SECTION 17. Where the face value of the stock is paid at the time of subscribing, a certificate therefor shall be executed by the President and Secretary, and delivered to the member. SECTION 18. Permanent stock of the par value of $100.00 per share may be issued which shall constitute the permanent capital of the Company and can not be withdrawn until the final dissolution of the Company. SECTION 18 (as amended Aug. 6, 1923). Permanent stock of the par value of $100.00 per share may be issued, which shall constitute the permanent capital of the company and may be withdrawn by the holders thereof at the discretion of the Board of Directors under the general withdrawal rules of the Company. SECTION 19. Loan stock may be issued at the option of the Board of Directors to any one desiring to make a mortgage loan. Each owner of this stock shall make such payment thereon as shall be agreed upon in making the mortgage loan. The dividends were paid by the petitioner on its withdrawable3042 stock pursuant to the following sections of its by-laws: SECTION 28. At the first regular meeting of the Board of Directors in January and July of each year such dividend as the Board may declare shall be divided among the members in proportion to the amount of money paid on stock by each and length of time the same has been held by the Company, less the withdrawals, except as may be otherwise provided in these By-Laws. SECTION 29. Dividends shall be computed on all payments made from the first to the tenth of each month. On all payments made after the tenth of each month, dividends shall be computed from the first of the following month. * * SECTION 32. The dividends declared shall be credited on the pass books of the members in January and July of each year, and holders of certificates of paid-up stock shall be entitled to receive the dividends thereon in cash within ten days after the same have been declared, at the office of the Company. 75 Section 26 of the petitioner's by-laws, governing the withdrawal of stock or deposits, is as follows: GENERAL WITHDRAWAL RULE SECTION 26. Members and special depositors whose stock or deposits are not pledged3043 to this Company may, as a general rule, upon written application to the Secretary, withdraw all or any part of their stock, credits or deposits at any time without previous notice, but to protect the interest of depositors and borrowers and avoid sacrifices of securities notices of withdrawal may at any time be required and the liability to pay further dues, and the right to dividend on stock credits and interest on special deposits shall cease with any application to withdraw. All persons withdrawing shall be entitled to receive the amount of all credits at the time of the application to withdraw, less any member's share of the Company's loss in excess of the reserve fund. The required notices to withdraw shall be filed in the order in which they are received and paid from the regular receipts of the Company in the order in which they are filed as fast as 25 per cent of the regular receipts of the Company will pay them, but the Board of Directors may, at its discretion, use all the regular receipts of the Company to pay withdrawals. During the year 1923 the petitioner made 67 real estate mortgage loans to stockholders in the aggregate amount of $589,250, as follows: Number of loansAmountPer centTo enable borrowers to build or purchase homes for their own use and occupancy20$120,950.0020,53To building contractors for construction of 1-family homes, 2-family homes or apartments, and 4-family homes or apartments42436,550.0074.0For constructing a building consisting of 2 stores on the first floor and 3 apartments above122,000.003.73To purchase vacant lots49,750.001.65671 589,250.00100.003044 The mortgage loans outstanding at the beginning and end of the year 1923 were as follows: Jan. 1, 1923Dec. 31, 1923Number of loansAmountPer centNumber of loansAmountPer centNonstockholders12$97,808.1710.9711$81,065.527.09"Loan stockholders"108700,455.5378.57137923,695.6780.85Running stockholders426,550.402.97323,884.322.09Paid-up stockholders19,500.001.070Unaccounted for57,221.466.42113,946.529.97891,535.56100.001,142,592.03100.00The petitioner held title to leasehold shown on the balance sheet of a value of $101,000. The income during 1923 from the rentals of a portion of the office building located on the leased property was $5,200. 76 The receipts from deposits and payments on stock may be classified further as follows: Jan. 1, 1923Dec. 31, 1923Per centAmountPer centAmountNonstockholders74.90$228,782.7073.28$319,540.22So-called loan stockholders.742,269.64.522,273.73Running stockholders3.109,459.055.5724,303.38Paid-in stockholders11.9936,612.2911.3449,420.67Permanent stockholders9.2728,313.969.2940,502.96100.00305,437.64100.00436,040.963045 The petitioner paid dividends to its various classes of stockholders, as follows: Permanent stock$15,212.31Paid-up stock4,989.40Running stock14,400.87Loan stock217.7034,820.28It was the policy of the petitioner to require all borrowers to subscribe to "loan stock." During the year 1923 all loans, except one, were made to loan stock subscribers. It does not appear that the borrowers were required to subscribe to more than one share of loan stock. The loans were made on a basis to yield the petitioner 8 per cent. Borrowers paid initial amounts varying from $5 to $25 on their subscriptions to loan stock. The petitioner did not require the borrowers to pay any additional installments on their loan stock but permitted them to do so if they so desired. In only a few cases did the borrowers pay additional sums on their loan stock accounts and in a number of instances they withdrew a major part, if not all, of their payments and credits thereon. No stock was ever issued to them - they merely made application for that stock. No membership fee was charged to the borrowers, but the holders of the regular classes of stock were required to pay from3046 $2 to $5 per share as an issuance fee. Borrowers were credited with so-called dividends on the amount actually paid in by them on their so-called loan stock at the rate which installment and other stockholders received. No objection was made by the petitioner to the withdrawal of a part or all of the amounts paid by borrowers on their loan stock. OPINION. VAN FOSSAN: The Board has recently had occasion in other cases to consider the primary question involved in the instant proceeding. 77 In those cases we have observed that when Congress provided that certain domestic building and loan associations should be exempt from tax it used the term in its ordinary and accepted meaning and that to qualify under this exception petitioner must establish a bona fide compliance with the intendment of the law. Among the well recognized attributes of a building and loan association is mutuality. This mutuality relates generally to the control and management of the business and its assets and in a larger and more fundamental sense to the opportunity and means it affords the members for saving and borrowing for home owning. Though isolated or infrequent exceptions to this rule might3047 not defeat a claim for exemption, we are of the opinion that such exceptions must not be so considerable in number or amount as to alter the true nature and character of the corporation's business. Where a building and loan association does not substantially meet these requirements it is not such an association as is entitled to exemption under the statute, however it may style itself. The name is no safe criterion by which to judge the true character of the business. See ; ; ; ; affd. . The stipulated record discloses that during the year 1923 the petitioner made 67 real estate mortgage loans to stockholders, aggregating $589,250, and that 42 of such loans, aggregating $436,550, or 74.09 per cent, were made to building contractors for the purpose of constructing one-family and two-family houses and four-family houses or apartments. Five additional loans, aggregating $31,750, or 5.38 per cent, were made for the3048 purpose of constructing a store building (also containing apartments) and for purchasing vacant lots. Hence, during that year only 20 loans, aggregating $120,950, or 20.53 per cent, were made for the purpose of enabling the borrowers to build and purchase homes for their own use and occupancy. On January 1, 1923, the mortgage loans of the petitioner were 125 in number and totaled $891,535.56. Of these loans twelve, aggregating $97,808.17, had been made to nonstockholders, while 108 thereof, aggregating $700,455.53, were in the names of persons who had attempted to qualify as members by subscribing to so-called "loan stock," on which they had made a nominal payment, and, except in very few instances, had made no further payments during the life of their loans. By the end of 1923 the loans to "loan stock" subscribers had increased substantially in both number and amount, while the loans to nonstockholders had decreased by one in number and by over $16,000 in amount. 78 It will also be observed that a large proportion of the petitioner's revenue was derived from the deposits made by nonmembers, borrowed money, and other sources - activities of a kind apt to undermine3049 and destroy the aims, purposes and reasons for existence of a true building and loan association. In view of the facts as above stated and under the cases cited, we are clearly of the opinion that the petitioner is not entitled to exemption from taxation for the year 1923 under the provisions of section 231(4) of the Revenue Act of 1921. The second issue presented is whether or not the amounts paid by the petitioner as dividends on withdrawable stock should be allowed as deductions from gross income as either business expenses or interest on borrowed money. It will be observed that the petitioner does not ask to be classified as a mutual savings bank under section 231(2) of the said Act, but maintains that its so-called withdrawable stock, paid for either in full or in part, is not the capital stock of the corporation but is in the nature of deposits subject to withdrawal at the will of the depositor. Included in the classification of such stock payments or deposits as described by the petitioner are the payments made on the above-mentioned "loan stock." Careful examination of the by-laws of the petitioner, quoted above, convinces us that the holders of the paid-up and3050 running stock were in fact members of the association and as such entitled to all the rights and privileges of stockholders therein. From the provisions of the by-laws relating to the payment of dividends it is evident that dividends are to be paid out of the earnings of the association in proportion to the amounts paid by the stockholders or members on the installment and full paid capital stock of the association. The "General Withdrawal Rule" (section 26 of the petitioner's by-laws) clearly distinguishes between the stock credits accruing to the members or stockholders and the interest payable to depositors. In the former class "all persons withdrawing shall be entitled to receive the amount of all credits at the time of the application to withdraw, less any member's share of the Company's loss in excess of the reserve fund." (Italics ours.) As to these classes of stock the rule laid down in , governs. As to the so-called loan stock, however, we are constrained to a different view. It is our opinion that the makers of such applications were not bona fide stockholders of the petitioner either actually or potentially. They3051 were under no obligation to make any payments subsequent to the initial one. The facts strongly indicate that the petitioner merely attempted to qualify its borrowers as members under the provisions 79 of section 231(4) of the Revenue Act of 1921 and that there was no true intent on the part of either the petitioner or the borrowers themselves to establish them as actual participating members of the association. This conclusion is supported by the fact that even the small initial payments were frequently withdrawn and that only in rare instances were further payments made toward the acquisition of the so-called stock. Therefore, we conclude that the $217.70 alleged to represent dividends on loan stock was in the nature of interest paid to the borrowers for the use of the money required to be deposited by them at the time their loans were granted. The facts as to this stock distinguish it from the case of Judgment will be entered under Rule 50.Footnotes1. One additional loan of $1,000 was made to a nonstockholder. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622737/	O'Mealia Research & Development, Inc., 1 Petitioner v. Commissioner of Internal Revenue, RespondentO'Mealia Research & Development, Inc. v. CommissionerDocket No. 7003-73United States Tax Court64 T.C. 491; 1975 U.S. Tax Ct. LEXIS 121; June 26, 1975, Filed 121 Decision will be entered under Rule 155. Petitioner, a research subsidiary of an outdoor advertising corporation, had net operating losses. The parent corporation arranged for the acquisition of certain outdoor advertising assets, to be transferred to the petitioner, in exchange for the assumption of the liabilities incurred by the parent in the acquisition of those assets. The purpose of the transaction was to provide petitioner with income-producing assets in order to take advantage of its net operating losses. Held: The parent corporation was merely a conduit and not a "transferor corporation" within the meaning of sec. 269(a)(2), I.R.C. 1954. The basis of the outdoor advertising assets in the hands of the petitioner should be determined by reference to the cost of those assets. YOC Heating Corp., 61 T.C. 168 (1973), followed. Edward G. Hearn, for the petitioner.Kenneth G. Gordon, for the respondent. Quealy, Judge. QUEALY492 The respondent has determined deficiencies in the income tax of O'Mealia Research & Development, Inc., for the fiscal years ending October 31, 1969, and October 31, 1970, in the amounts of $ 47,957 and $ 53,971.Due to concessions by the parties, the sole question remaining for decision is whether petitioner is barred by section 269(a)(2)2 from utilizing net operating losses incurred during123 its fiscal years 1964 through 1967 against profits realized in its fiscal years ending 1969 and 1970 where such profits were attributable to assets acquired by petitioner in 1968 through its parent corporation, O'Mealia Outdoor Advertising Corp. (hereinafter referred to as O'Mealia).FINDINGS OF FACTSome of the facts have been stipulated. Such facts and the exhibits attached thereto are incorporated herein by this reference.O'Mealia Research & Development, Inc. (hereinafter referred to as petitioner), is a New Jersey corporation whose principal place of business at the time of the filing of the petition herein was Jersey City, N.J. Petitioner timely filed its Federal corporate income tax returns for the fiscal years ending October 31, 1967, through October 31, 1970, with the District Director of Internal Revenue, Newark, N.J.Petitioner was incorporated in 1963. From its inception until June of 1968, petitioner124 was engaged in the business of experimenting and developing various outdoor advertising devices that included lighting fixtures adaptable for use in outdoor advertising signs for illumination purposes, development of a photographic process to copy advertising copy that could be applied directly to outdoor advertising signs thus reducing the need for hand-painting, and development of a coordinated direct mail and outdoor advertising promotion scheme.The issued and outstanding stock of petitioner was initially held and owned in the following proportions: 493 PercentEndre Fazekas25Thomas J. Nokes19Joseph Barrett5O'Mealia51100In 1967, as a result of various acquisitions not relevant herein, O'Mealia became the owner of all the outstanding stock of petitioner.O'Mealia was incorporated on May 1, 1954. At all times pertinent herein, it was engaged in the outdoor advertising business. Its business encompassed the erection and rental of poster panels, painted bulletin boards, and painted outdoor advertising displays, all of which required the periodic painting of advertising copy by the company's employees.As of December 31, 1967, the following individuals125 owned and held all the issued and outstanding stock of O'Mealia:StockholderNumber of sharesHarry O'Mealia4,370.75Annette Daley2,222.75Grace Nokes2,222.75Hugh F. McLaughlin2,211.75Irene V. Malone1,872.00Thomas J. Nokes1.00George Hagemiester1.00Martin J. Loftus1.00Total issued and outstanding shares12,903.00Subsequently, in 1968, 2 other shares of stock of O'Mealia were issued, one each to August Barberi and John M. Stanton.During the years in question, Harry O'Mealia was the president and chief executive officer of O'Mealia. Annette Daley and Grace Nokes were his sisters. Hugh F. McLaughlin was his nephew, Irene V. Malone, his aunt, and Thomas J. Nokes, his brother-in-law. George Hagemiester, John M. Stanton, Martin J. Loftus, and August W. Barberi were not related by blood or marriage to any of the other shareholders of O'Mealia.On August 15, 1968, O'Mealia entered into an agreement with Outdoor Displays, a partnership, for the purchase of all its assets for the sum of $ 150,000. The agreement was effective as of June 1, 1968. Outdoor Displays was engaged in the business of leasing, maintaining, and renting bulletin boards and signs 126 for outdoor 494 advertising. The assets of Outdoor Displays, including 69 bulletin boards, were transferred directly to petitioner who recorded such assets on its books and credited the sum of $ 150,000 as a liability owing to its parent, O'Mealia.That same day and simultaneously therewith, O'Mealia also contracted to purchase 40 shares of stock in both Federal Advertising Corp. (hereinafter referred to as Federal) and Industrial Land & Development Co. (hereinafter referred to as Industrial) for the sums of $ 1,100,000 and $ 100,000, respectively. The agreement was effective as of June 1, 1968. The acquired stock represented 43 percent and 40 percent, respectively, of the issued and outstanding stock of the above corporations.The agreement provided for the payment of $ 150,000 in cash, a promissory note in the sum of $ 91,500 payable on March 19, 1969, and a promissory note in the sum of $ 958,500 payable in 83 monthly installments commencing on April 1, 1969. The sellers of the above stock were neither related by blood or by marriage to any of the shareholders of O'Mealia.Part of the above funds used by O'Mealia to pay for the stock of Federal was obtained by way of a127 loan from First Jersey National Bank in the amount of $ 350,000. The loan agreement recites that such money was to be used "to cover the cost of a down payment and related expenses for the purchase of the assets of Federal Advertising Corporation." Harry O'Mealia personally guaranteed the loan.Both Federal and Industrial had two separate lines of business, outdoor advertising and real estate. Pursuant to the above purchase agreement, it was provided that as of June 1, 1968, the business and affairs of both corporations would be divided into an "advertising division," consisting of all the outdoor advertising assets and a "real estate and investment division," containing all the other assets exclusive of the outdoor advertising business assets. Separate books of account and records were to be kept for each division as of June 1, 1968.It was provided by the parties to the agreement that in the event of any dispute concerning the application of income and the charging of expenses between the respective advertising divisions and real estate and investment divisions, the resolution thereto was to be made in accordance with the intent that the divisions would, as of June 1, 1968, be128 considered as separate entities. Pursuant to the above agreement, O'Mealia was entitled to place 495 two directors on the board of directors of each corporation. In addition, effective as of June 1, 1968, Harry O'Mealia was appointed general manager in charge of the advertising divisions of both corporations.The agreement further provided that at any time subsequent to January 1, 1969, and prior to May 31, 1969, O'Mealia had the right to have its stock in Federal and Industrial redeemed in exchange for all the assets of the respective advertising divisions, subject to all the liabilities of said divisions, incurred after June 1, 1968. In the event that O'Mealia did not exercise its right to have the stock redeemed, the other stockholders of Federal and Industrial had the right, at any time subsequent to June 1, 1969, to cause the complete liquidation of Federal and Industrial. Upon such complete liquidation, O'Mealia agreed to accept, in lieu of its pro rata liquidating distributions, the assets of the respective advertising divisions subject to the liabilities incurred by said divisions after June 1, 1968.In the event that O'Mealia acquired the assets of the respective129 advertising divisions of Federal and Industrial, it agreed to operate the same in conjunction with the assets and business of Outdoor Displays, which had been acquired contemporaneously with the execution of the above agreement. Initially, O'Mealia had wanted only to acquire the advertising assets of each corporation but the sellers were only willing to sell a portion of the stock which could then be specifically allocable to such assets.In December of 1968, O'Mealia transferred the stock of Federal and Industrial to petitioner in consideration for the assumption by petitioner of the notes issued by O'Mealia in connection with its purchase of said stock. Such notes totaled $ 1,387,500 and included the sum of $ 337,500 then outstanding on its loan from First Jersey National Bank. Of the above liabilities assumed by petitioner, the sum of $ 187,500 was credited on O'Mealia's books against the $ 150,000 liability owing from petitioner on account of the transfer of the assets from Outdoor Displays.On January 2, 1969, pursuant to the above agreement, petitioner acquired the assets of the advertising divisions of Federal and Industrial through the redemption of the stock transferred130 to it by O'Mealia. The parties have stipulated that the sequence of events which culminated in the receipt by petitioner of the assets of Outdoor, Federal, and Industrial was part of a single plan 496 aimed at the acquisition of such assets by petitioner with O'Mealia providing the necessary funds and financial backing. The parties have further stipulated that of the total purchase price paid for the acquisition of these assets, the sum of $ 1,225,000 was allocable to the billboards, signs, and other depreciable assets while the balance of $ 125,000 was allocable to goodwill.For its fiscal years ending October 31, 1963, through October 31, 1968, petitioner's reported taxable income and losses on its corporate tax returns were as follows:FYE Oct. 31 --Taxable income1963($ 67,665.47)1964(31,182.05)1965(26,317.81)19667,911.86 1967(218,810.96)1968(10,691.24)As a result of the 5-year limitation on the carryforward of losses, the total net operating loss available for petitioner's fiscal year ending October 31, 1969, was $ 287,002.06.For its fiscal years ending October 31, 1969 and 1970, petitioner reported taxable income of $ 86,333 and $ 131 93,378, respectively. It utilized its net operating losses from 1964 through 1967 to offset, to the fullest extent, the taxable income reported for each of these years. Respondent has denied petitioner the benefit of such claimed net operating loss carryovers for the years in question.In paragraph 32 of the stipulation of facts, the parties stipulated as follows:The parties agree that the only issue in dispute is whether Research is entitled to deduct the net operating loss carryover, attributable to those fiscal years prior to the receipt of the assets of Outdoor, Federal and Industrial, in its fiscal years ending October 31, 1969 and 1970, respectively, pursuant to Int. Rev. Code of 1954, § 172 and the following language of Int. Rev. Code of 1954, § 269(a)(2):(2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, 132 *497 OPINIONPetitioner is engaged in the business of experimenting with and developing various outdoor advertising media. Its parent corporation, O'Mealia, is engaged in the outdoor advertising business involving the erection and rental of posters, bulletin boards, and other outdoor advertising displays.In August of 1968, O'Mealia entered into an agreement with Outdoor Displays for the purchase of all its assets for the sum of $ 150,000. These assets, which included 69 bulletin boards, were transferred directly to petitioner who credited the purchase price on its books as a liability owing to its parent.Simultaneously therewith, O'Mealia acquired approximately 40 percent of the issued and outstanding stock of Federal and Industrial each of whose businesses was divided into outdoor advertising and real estate activities. O'Mealia wanted to acquire the advertising assets of each of the corporations but the sellers were only willing to sell O'Mealia the stock specifically allocable to such assets. The purchase price of such stock was $ 1.2 million, payable $ 150,000 in cash and the balance in promissory notes.In December of 1968, O'Mealia transferred the stock acquired133 from Federal and Industrial to petitioner with the petitioner assuming liability for the notes issued by O'Mealia in connection with such purchase. On January 2, 1969, petitioner acquired the advertising assets of Federal and Industrial through the redemption of stock pursuant to the terms of the original purchase agreement.The parties have stipulated that the sequence of events which culminated in the receipt by petitioner of the goodwill and assets of Outdoor Displays, Federal, and Industrial, was part of a single plan aimed at the acquisition of such assets with O'Mealia providing the necessary funds and financial backing. The parties have further stipulated that the basis of these assets in the hands of petitioner was $ 1,225,000 with the balance of $ 125,000 allocable to goodwill.The sole question before the Court, as limited by the parties in the stipulation of facts, is whether the basis of the assets acquired by petitioner as described above is determined "by reference to the basis in the hands of the transferor corporation" within the 498 meaning of section 269(a)(2). 3134 Despite the stipulation of facts, respondent argues that the purchase of assets and stock by O'Mealia and their subsequent transfer to petitioner by O'Mealia should be treated as separate and distinct transactions. Thus viewed, the transfer of the assets and stock to petitioner would be governed by section 351, with the basis of such items in the hands of petitioner determined by reference to O'Mealia. See sec. 362. The transfer would then fall within the above-cited language of section 269(a)(2).It is apparent that if petitioner had purchased the assets itself, section 269(a)(2) would not apply. The statute itself requires this result where the basis of the acquired assets is a cost basis as opposed to a carryover basis applicable in cases of a nontaxable acquisition where the tax attributes flow with the acquisition. Further, respondent has ruled that he will not invoke the rationale of the decision in Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382 (1957), in this situation to ban the use of preacquisition net operating losses against postacquisition profits arising from the newly acquired assets where there has been no change in the stock ownership135 of the acquiring corporation during or after the period in which it incurred losses. See Rev. Rul. 63-40, 1 C.B. 46">1963-1 C.B. 46. This is despite the fact that the acquiring corporation subsequently discontinues the business activity which produced these losses.Based on the record as a whole and on the stipulation of facts, we find that the steps through which petitioner acquired the assets of Outdoor Displays, Federal, and Industrial fall within the "integrated transaction" doctrine as recently enunciated by this Court in YOC Heating Corp., 61 T.C. 168">61 T.C. 168 (1973). Thus, the basis of such assets in the hands of petitioner should be determined by reference to the cost of the assets and not by reference to the basis 499 of the assets in the hands of O'Mealia as respondent contends. As such, we hold that section 269(a)(2) does not apply.In view of the foregoing, we need not reach the further questions under section 269 of whether the proscribed purpose existed on the part of petitioner and if it did, whether the factual pattern in issue was the type whereby petitioner secured the benefit of a "deduction, credit, or136 other allowance" which it otherwise might not enjoy.Decision will be entered under Rule 155. Footnotes1. The case of O'Mealia Outdoor Advertising Corp., docket No. 7004-73, was originally consolidated herewith. However, pursuant to an agreement between the parties, all the disputed issues have been settled and an order of decision has been entered pursuant thereto.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩3. Insofar as material herein, sec. 269 provides as follows:SEC. 269. ACQUISITIONS MADE TO EVADE OR AVOID INCOME TAX.(a) In General. -- If -- * * (2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation,↩and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then the Secretary or his delegate may disallow such deduction, credit, or other allowance. * * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622739/	Thompson Engineering Company, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentThompson Engineering Co. v. CommissionerDocket No. 9471-77United States Tax Court80 T.C. 672; 1983 U.S. Tax Ct. LEXIS 97; 80 T.C. No. 32; April 11, 1983, Filed 97 Decision will be entered under Rule 155. Petitioner, a construction subcontractor, needed to retain earnings and profits to assure adequate bonding capacity; also, it had a reasonable business need to expand its plant. Petitioner had outstanding loans to its sole shareholder; the balance of these loans increased during the years in issue. Held:1. Petitioner's retentions of earnings and profits exceeded the reasonable needs of its business.2. Petitioner was availed of for the purpose of avoiding the income tax with respect to its shareholder and is liable for the accumulated earnings tax. Sec. 531, I.R.C. 1954. Charles R. Hembree and Philip E. Wilson, for the petitioner.Robert J. Kastl, for the respondent. Chabot, Judge. CHABOT672 Respondent determined deficiencies in Federal corporate income tax (accumulated earnings tax imposed 673 by sec. 5311) against petitioner for fiscal years ended August 31, 1972, and August 31, 1973, 298 in the amounts of $ 18,744.83 and $ 26,996.75, respectively.The issue for decision is whether petitioner was availed of for the purpose of avoiding the income tax with respect to its shareholder by permitting its earnings and profits to accumulate beyond the reasonable needs of its business (and, if so, what the amount is of the accumulated taxable income).FINDINGS OF FACTSome of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.When the petition in this case was filed, petitioner's principal place of business was in Lexington, Ky.Petitioner was incorporated in Kentucky on September 23, 1959. Throughout its existence, petitioner has been a construction subcontractor engaged primarily in the general plumbing, heating, and air-conditioning business, as well as doing related sheet metal work. During the period 1971 through 1974, this business was highly competitive.Billy R. Thompson (hereinafter sometimes referred to as Thompson) was petitioner's sole shareholder and president from some time in the mid-1960's through at least the time of trial. 3 During the years in issue, Thompson, 99 his wife, and his parents were petitioner's directors; his mother and his wife were petitioner's vice president and secretary-treasurer, respectively. As president, Thompson was responsible for all general decisions for petitioner from 1971 on, including all financial and dividend policies.From 1959 through at least 1974, petitioner's volume of business increased almost uninterruptedly, and its reputation 674 was excellent. About 95 to 98 percent of petitioner's work was in connection with public works sector contracts (i.e., contracts with Government agencies) involving schools, hospitals, office buildings, boiler plants, utilities, sewer plants, water plants, and federally funded housing. In most public works contracts the mechanical and electrical subcontractors were the two principal types of subcontractors. Petitioner was a mechanical subcontractor. Such contracts were awarded on the basis of a bidding process in which the general (or "prime") contractor solicited bids 100 from subcontractors (as well as materials suppliers) several weeks in advance of submitting its bid for the contract, analyzed the bids, selected the subcontractors (and materials suppliers) on whose bids it would rely, and formulated and submitted its own bid (listing therein for the contracting agency the names of the selected subcontractors). The subcontractor's bid to the general contractor remained in force for a fixed period of time as set forth in the contract specifications. Once the general contractor was awarded a contract, subcontracts were awarded to the subcontractors. In preparing its bid, the general contractor was not required to use the lowest bidding subcontractor. Along with the amount of the bid, the general contractor considered the subcontractor's financial capability, physical capacity to perform, available personnel, existing workload, and prior knowledge of the type of work involved.The general contractor in a public works contract was required to provide a performance and bid bond. At the option of the general contractor, the subcontractor might be required to provide a performance and payment bond. If the subcontractor was unable to provide a bond required 101 by the general contractor, the latter would obtain permission from the contracting agency to change the subcontractor listed in the bid to the next acceptable subcontractor, and would be reluctant to use the initially selected subcontractor in future bidding until it was certain that the subcontractor was bondable.Most public works contracts of the size in which petitioner was involved took from 1 to 2 years to complete, with the average being about 18 months. Ordinarily, on a public works contract, 10 percent of each proportional progress payment to the general contractor was retained by the payor until the 675 contract was completed (on some contracts the retainage was reduced to 5 percent when more than one-half of the contract was completed). Usually, the general contractor applied the same retainage rule as to its payments to the subcontractors.A mechanical subcontractor's work and involvement typically lasted from the beginning to the end of the construction project and might last beyond that of the general contractor. For example, if the project ended in winter and the airconditioning system had to be tested and corrected for deficiencies in the equipment and installation, the 102 subcontractor's involvement might last until summer and a portion of the retainage might be withheld until testing or correction (if necessary) occurred. The subcontractor was in a position of greater risk than the general contractor because (1) the latter subcontracted a substantial portion of the work to be performed under the contract, as to which the risk was shifted, and (2) the subcontractor was directly responsible for the cost of material and equipment used. Petitioner subcontracted out only one item involved in its work (temperature control material and wiring) and this amounted to less than one-tenth of its cost of sales for each of the years in issue.Starting in 1972 and accelerating during 1973 and 1974 in the Lexington, Ky., area, the building industry in general and mechanical contractors and subcontractors in particular experienced dramatic increases in materials and equipment prices, along with a shortage of supply. Many items needed by mechanical contractors and subcontractors increased in price 15 percent or more a year, but some items increased as much as 300 percent in a year. This was also a period when mechanical contractors and subcontractors in this area 103 experienced financial difficulty. Petitioner's contracts with general contractors did not have escalator clauses protecting against increases in costs of materials, equipment, and labor. In order to hedge against such cost increases, petitioner sometimes bought materials as soon as it submitted its bids. During the years in issue, petitioner suffered losses on four or five of its contracts; many of its competitors went bankrupt. The price increases also caused bonding companies to want subcontractors, as well as contractors, to have greater amounts of cash and quick assets. From 1971 through 1974, many subcontractors experienced cash flow problems, which caused them to 676 lower their bids, reducing their profit margins, in order to get new jobs to get cash to pay off past accounts on completed jobs. This increased competition on smaller jobs and caused petitioner to bid on larger jobs in order to avoid this new aspect of competition.A. Business Needs1. BondingThe decision to bid on larger jobs caused petitioner to need additional bonding capacity. Before 1972, petitioner had not achieved its objective of lower bond premium rates and Thompson's objective of eliminating personal 104 indemnity requirements. In 1972, Thompson transferred petitioner's performance and payment bonding business to a different agent, the Progressive Insurance Co. (hereinafter sometimes referred to as Progressive). The president and majority shareholder of Progressive was Russell E. Davis (hereinafter referred to as Davis). With Davis, Thompson wanted petitioner to be in a sufficiently strong position (vis-a-vis net worth and working capital considered by the bonding company) to obtain the necessary bonds at "preferred rates" (reduced from the rates petitioner was paying) and without personal indemnity.In evaluating a contractor for performance and payment bonding purposes, a bonding company is subjective and considers many factors, including the contractor's personnel, reputation, pay record, working capital, 4 net worth, and prior experience. Initially, Davis wrote petitioner's bonds with the United States Fidelity & Guaranty Co. and was not able to do so at preferred rates or without personal 105 indemnity. Sometime during 1972, Davis started writing petitioner's bonds with the American States Insurance Co. (hereinafter referred to as States). States charged standard rates, but had a subsidiary, American Economy Insurance Co. (hereinafter referred to as Economy), which charged preferred rates.On July 6, 1972, States authorized Progressive to write 677 bonds for petitioner without home office referral. This authority did not apply to contracts of more than $ 250,000 and did not apply if petitioner's total contracts in force at any one time (whether or not bonded) exceeded $ 2,500,000.Subsequently, Davis was able to write bonds for petitioner with Economy at preferred rates and without personal indemnity because of Progressive's experience with petitioner, petitioner's increased net worth and working capital, and petitioner's greater work experience. On February 13, 1973, Economy authorized Progressive to write bonds for petitioner without home office referral, on the same terms as set forth in States' authorization of July 6, 1972, except that (1) the amount of the maximum single contract price was increased to $ 750,000, and (2) the amount of the permitted contracts in force 106 was increased to $ 3 million.Bonding companies generally used rules of thumb for setting maximum limits on total outstanding contracts at any one time. Bonding companies generally set the limit at a range between 4 to 5 times net worth and 10 times working capital, for a general contractor. Because of their greater risk, subcontractors were limited to a range between 4 to 5 times net worth and only 6 1/2 to 7 times working capital. (For example, to grant a bond for $ 1 million in work, as a rule, a bonding company required that a subcontractor have about $ 150,000 in working capital or $ 200,000 to $ 250,000 net worth.) Bonding companies required contractors and subcontractors to have exceptional financial strength before granting bonds without personal indemnity.The bonding company concept of working capital emphasized cash flow and excluded certain assets considered to be current assets for accounting purposes. In analyzing working capital, Davis: (1) Verified cash deposits reflected on unaudited financial statements; (2) verified and aged accounts receivable, giving little consideration to those more than 6 months old; 5 (3) took into account inventory purchased for (or on the 107 work site of) a particular job, and generally excluded from working capital the value of any other inventory held by the contractor; (4) eliminated certain prepaid expenses from consideration 678 (for example, the contractor's prepaid interest generally would be eliminated because the contractor would have to pay off the underlying debt in order to get a refund of the prepayment); (5) gave little consideration to stocks and other securities shown on the financial statement; (6) examined the promptness with which the contractor paid its bills as an indication of cash flow problems; and (7) tried to determine if the contractor overbilled or underbilled its jobs in progress.Generally, bonding companies would not give a contractor a maximum work load figure. In many cases, one who applied for a bond or prequalified to submit a bid had to disclose whether that person had ever been turned down for a bid. In order to avoid any such refusal, Thompson spoke with Davis before submitting bids. If Davis questioned petitioner's 108 bidding on a particular job, or if issuing a bond for the job would have exceeded Davis' authority, Thompson would not submit the bid.Petitioner was not awarded any contracts that Progressive declined to bond. Davis never referred any additional amounts, over the amount of his authority for bonding, to the home office for approval. For Progressive to execute a bond for an additional job without home office referral, petitioner's "contracts in force" (i.e., the total of all outstanding uncompleted work, including contracts under consideration whether bonded or not bonded) were subject to the $ 2.5 million and $ 3 million limitations in the July 6, 1972, and February 13, 1973, authorizations of States and Economy, respectively. There may have been times when petitioner's bids exceeded the applicable limitation, or when it would not need a bond for a particular job, but when petitioner requested a bond from Progressive, petitioner had to meet the applicable limitations in order for Progressive to execute the bond without home office referral.As of the end of each of fiscal years 1971 through 1974, petitioner had total amounts of work completed during the year, uncompleted work in process, 109 and (for fiscal years 1972 and 1973) bids outstanding in the amounts set forth in table 1: 679 TABLE 1WorkUncompletedBidsFiscal yearcompleted1110 work in process outstanding1971$ 1,495,964 $ 1,074,975N.A.19721,819,936 1,453,819 $ 669,20019731 1,913,8641,853,234 13,274,70019742,136,444 523,701 N.A. The numbers and aggregate amounts of the contracts petitioner was awarded, and contracts petitioner bid on at any time during the year but was not awarded, in fiscal years 1972 and 1973, are shown in table 2.TABLE 2Number of contractsAggregate dollar(percentage)amounts (percentage)Fiscal year 1972Contracts awarded1 231 $ 2,198,780 to petitioner Contracts bid on96 8,146,200 by petitioner but not awarded to it Awards as percent(19%)(21%) of total bids Fiscal year 1973Contracts awarded2111 212 2,313,279 to petitioner Contracts bid on84 11,342,700 by petitioner but not awarded to it Awards as percent(20%)(17%) of total bids 680 On the average, petitioner's bids remained outstanding about 60 days. The largest aggregate dollar amount of bids for any period of 2 consecutive calendar months in fiscal year 1972 was $ 2,119,000 for May and June. Of this total, $ 1,702,300 was bid on contracts not awarded to petitioner and $ 416,700 (about 20 percent) was bid on contracts awarded to petitioner.The largest aggregate dollar amount of bids for any period of 2 consecutive calendar months in fiscal year 1973 was $ 3,419,000 for June and July. None of these bids resulted in contracts being awarded to petitioner during fiscal year 1973 and the record fails to reflect how many of these bids were subsequently awarded to petitioner.Petitioner had reasonable business needs to establish a bonding capacity of $ 3 million and $ 3.5 million at the end of fiscal years 1972 and 1973, respectively. For this purpose, (a) for 1972, petitioner had a reasonable business need of $ 445,000 working capital or $ 675,000 net worth, and (b) for 1973, petitioner had a reasonable business need of $ 520,000 working capital or $ 785,000 net worth.2. Operating CycleDuring the years in issue, 112 petitioner's business was seasonal insofar as wintertime inclement weather affected construction work.Petitioner's annual cost of goods sold, average of quarter-ending inventories, and peak quarter-ending inventory for fiscal years 1972 through 1974 are shown in table 3.TABLE 3Cost ofAveragePeakFiscal yeargoods soldinventoriesinventory1972$ 835,443$ 72,473$ 109,8931973871,016 107,600 140,507 19741,010,830125,894 140,507 Petitioner's annual sales, fiscal-year-ending accounts receivable (related to enumerated jobs), average of month-ending accounts receivable, and peak month-ending accounts receivable, for fiscal years 1972 through 1974 are shown in table 4. 681 TABLE 4Fiscal year-endingAverage accountsPeak accountsFiscal yearAnnual salesaccounts receivablereceivablereceivable1972$ 2,036,2461113 $ 561,150 $ 504,316$ 685,50919732,007,681 2 614,479 514,206 614,479 19742,133,313 2 740,993 568,927 740,993 Table 5 reflects the age of petitioner's accounts receivable as of the ends of fiscal years 1972 and 1973.TABLE 51 to 6061 to 9091 days toOver 6 monthsOverFiscal yeardaysdays6 monthsto 1 year1 year1972$ 159,080$ 62,729$ 150,273$ 50,980$ 138,0871973240,743 44,216 113,892 67,345 148,284 Substantially all of these amounts consist of retainages.The total amount of petitioner's cost of goods sold plus cash operating expenses (before Federal income tax), and petitioner's average of quarter-ending accounts payable for fiscal years 1972 through 1974 are shown in table 6.TABLE 6Cost of goods sold plusAverageFiscal yearcash operating expensesaccounts payable1972$ 1,676,590$ 142,90119731,755,607 186,830 19741,928,690 178,613 Petitioner's Federal estimated income tax payments were $ 90,300 and $ 122,400 in fiscal 114 years 1972 and 1973, respectively.3. Building Expansion and EquipmentDuring the years in issue, petitioner operated from a building located at 837 Floyd Drive, Lexington, Ky. The 682 building's floor area was about 5,000 square feet, of which about 1,200 square feet was used for office space, about 1,250 square feet was used for a sheet metal shop, and the remaining space was used for storage. The tract of land at the 837 Floyd Drive address consists of three subdivision lots (designated and hereinafter individually referred to as lots 17, 18, and 19, and collectively referred to as the original tract).Because of growth in work volume, petitioner had planned to add to its facilities before and during the years in issue. At a special meeting on August 10, 1968, petitioner's board of directors authorized Thompson as president to (1) purchase an additional lot in the rear of the original tract, and (2) proceed with plans for a new building (including obtaining bids on related subcontracts and the building permit) and construction thereof "as soon as time and money would permit." At this meeting, Thompson estimated the cost of the building to be $ 55,750.At a special meeting of petitioner's 115 board of directors on August 9, 1969, Thompson as president (1) reported that he had purchased a lot adjoining petitioner's existing building, and (2) outlined the need for expansion in the size and production of the sheet metal shop and storage (which would necessitate constructing a building and purchasing new equipment estimated to cost $ 103,000 and $ 35,000, respectively), as well as for expansion in the electrical field (which would necessitate purchasing tools, equipment, and inventory estimated to cost $ 51,000 and hiring a qualified person to head the department). At this meeting, petitioner's board of directors authorized Thompson, as president, to pursue acquisition of another adjoining lot and new equipment, as well as construction of "additional facilities."Petitioner purchased three additional lots (designated, and hereinafter individually referred to as lots 47, 48, and 49, and collectively referred to as the second tract), which abut on the rear of the original tract and front on Contract Street (a street which is more or less parallel to Floyd Drive).Petitioner also negotiated for the purchase of three other lots (designated, and hereinafter individually referred 116 to as lots 50, 51, and 52, and collectively referred to as the third 683 tract), which front on Contract Street, adjoin a portion of the rear property line of the original tract, and are adjacent to the second tract.Petitioner contemplated constructing a building which would be added to the back end of its existing building and would extend into lots 48 through 51. This building would be used for expansion of petitioner's sheet metal shop, office space, and storage. In May 1973, petitioner was given a quotation, "preliminary in scope," of $ 93,750 for the cost of this building.In 1974, the construction industry problems that had been affecting the Lexington, Ky., area created a severe slump, and petitioner's backlog of work decreased dramatically (see table 1 supra), which caused petitioner to place the building plans in abeyance. Petitioner maintained its basic work force and subsequently was ready to renew operations at an increased workload. When the industry began to turn around, petitioner again proceeded with expansion plans and negotiations to purchase the third tract. In May 1975, petitioner was quoted a price of $ 140,400 to "up-date" the 1973 proposal. The 1975 quotation 117 was "a preliminary estimate."At some point before 1977, Thompson purchased three other lots (designated as lots 53, 54, and 55, and hereinafter collectively referred to as the fourth tract) jointly with the owner of the third tract. The fourth tract fronts on Contract Street and is adjacent to the third tract, but is not adjacent to any of the tracts petitioner owned.Thompson did not succeed in his efforts (including negotiations with respect to Thompson's interest in the fourth tract) to obtain the third tract for petitioner. As a result of this, and difficulties with a utility easement on the original tract, petitioner modified its plans to provide for a smaller addition to its existing building, which would fit entirely on the original tract. The owner of the third tract gave petitioner oral permission to use the third tract for access to the modified building and to use some parts of the third tract for outdoor storage. Because of petitioner's inability to effectuate its earlier expansion plans, it has used barns, warehouses, and trailers for indoor storage.In late 1977, petitioner began to convert about 1,250 square feet of the storage area in its existing building into finished 118 offices for office personnel.684 By August 1978, petitioner had detailed blueprints of an addition to its existing building, which blueprints were revised on June 1, and August 3, 1979. In 1978, petitioner purchased the steel beams for the roof of the addition but they were stolen. Construction on the addition started in 1979.B. Financial DataPetitioner's accumulated earnings and profits as of the ends of fiscal years 1971 through 1973, and its current earnings and profits ("taxable income adjusted in the manner provided in sec. 535(b)") for the years in issue, are set forth in table 7.TABLE 7AccumulatedCurrent earningsFiscal yearearnings and profits1 and profits retained 1971$ 535,6011972727,507 $ 191,9791973864,583 137,257 Petitioner's balance sheets as of the ends of fiscal years 1971 through 1974 are shown in table 8 on page 685.Table 9 reflects the type of analysis of financial data for the ends of petitioner's fiscal years 1972 and 1973 made by Progressive in executing bonds for petitioner on behalf of States and Economy, respectively. The analysis 119 for each of these fiscal years was made about 6 months to 1 year after that fiscal year's end.TABLE 9Current assets1972 1973 Cash $ 85,367$ 166,364Temporary investments 1 Accounts receivable 483,156472,887Inventory Prepaid expenses Prepaid income tax 9,810Deposits on plans 331Totals 568,523649,392Current liabilities295,531341,236"Working capital" 272,992308,156685 TABLE 8Balance SheetAs of the Fiscal Year End Aug. 31Assets1971 1972 Current assets Cash $ 178,666$ 85,367Temporary investments 50,9511 24,309Accounts receivable 401,085561,150Interest receivable 3,7005,743Inventory 132,731109,893Deposits on plans 349654Prepaid expenses 11,10913,903Total current assets 778,591801,019Plant and equipment Net value (cost less depreciation) 108,153121,133Other assets Notes receivable -- officers 83,052151,850Accounts receivable -- Officers Employees 4,0163,204Officers' life insurance -- Cash surrender value 3,4683,950Investment in partnership Total other assets 90,536159,004Total assets 977,2801,081,156Liabilities and shareholder's equityCurrent liabilities Accounts payable 189,743111,888Notes payable 7,5005,500Mortgages payable -- current portion 2,9423,123Accrued wages, salaries, and bonuses 88,40684,557Accrued interest payable 471497Payroll taxes payable 5,407Accrued income taxes -- Federal and State 91,37684,559Total current liabilities 380,438295,531Long-term liabilities Mortgages payable 29,36826,245Total liabilities 409,806321,776Shareholder's equity Capital stock 127,625127,625Retained earnings 439,849631,755Total shareholder's equity 567,474759,380Total liabilities and shareholder's equity 997,2801,081,156120 TABLE 8Balance SheetAs of the Fiscal Year End Aug. 31Assets1973 1974 Current assets Cash $ 166,364$ 160,875Temporary investments 1 24,30124,301Accounts receivable 2 614,9292 742,572Interest receivable 9,21010,846Inventory 140,50782,056Deposits on plans 331556Prepaid expenses 24,72815,839Total current assets 980,3701,037,045Plant and equipment Net value (cost less depreciation) 110,240104,953Other assets Notes receivable -- officers 160,200188,400Accounts receivable -- Officers 282304Employees 5,1074,155Officers' life insurance -- Cash surrender value 4,4224,901Investment in partnership 30,787Total other assets 170,011228,547Total assets 1,260,6211,370,545Liabilities and shareholder's equityCurrent liabilities Accounts payable 245,776160,719Notes payable 2,000Mortgages payable -- current portion 3,3153,516Accrued wages, salaries, and bonuses 87,77793,868Accrued interest payable 259113Payroll taxes payable 2522,780Accrued income taxes -- Federal and State 1,85680,696Total current liabilities 341,235341,692Long-term liabilities Mortgages payable 22,92919,413Total liabilities 364,164361,105Shareholder's equity Capital stock 127,625127,625Retained earnings 768,832881,815Total shareholder's equity 896,4571,009,440Total liabilities and shareholder's equity 1,260,6211,370,545121 686 From the date of its incorporation through fiscal year 1973, petitioner did not pay a cash dividend. In September 1974, petitioner elected to be taxed as an electing small business corporation under subchapter S (secs. 1371 et seq.) of chapter 1. On November 15, 1974, petitioner paid a cash dividend of $ 112,986.63.Table 10 shows the dates and amounts of loans from petitioner to Thompson, repayments by Thompson relating thereto, the outstanding principal balance of the loans, and interest paid by Thompson relating to the loans, from August 31, 1971, through October 31, 1973.TABLE 10Loans fromRepaymentOutstandingpetitionerof loans by ThompsonprincipalInterestDateto Thompsonto petitionerbalance of loanspaidAug. 31, 1971 $ 83,051.68Sept. 17, 1971$ 1,50084,551.68 Oct. 29, 1971 2,500 87,051.68 Nov. 12, 1971 7,500 94,551.68 Nov. 15, 1971 $ 35,401.6659,150.02 $ 3,700.11Dec. 29, 1971 30,000 89,150.02 Feb. 9, 1972 3,000 92,150.02 Mar. 21, 1972 3,000 95,150.02 Apr. 14, 1972 1,200 96,350.02 May 15, 1972 3,000 99,350.02 July 3, 1972 25,000 124,350.02 July 6, 1972 500 124,850.02 July 18, 1972 1,000 125,850.02 July 28, 1972 20,000 145,850.02 Aug. 10, 1972 1,000 146,850.02 Aug. 22, 1972 5,000 151,850.02 Oct. 17, 1972 3,500 155,350.02 Nov. 3, 1972 6,000 161,350.02 Nov. 15, 1972 12,150.02 149,200.00 5,720.62 May 15, 1973 1,500 150,700.00 June 8, 1973 3,000 153,700.00 June 28, 1973 6,500 160,200.00 Oct. 31, 1973 4,000 164,200.00 122 The outstanding loans from petitioner to Thompson shown in table 10 supra, were reflected as "notes receivable -- officers" 687 on petitioner's balance sheet (see table 8 supra) and were evidenced by demand notes. All but two of these notes state a 6-percent interest rate. The other two notes do not state any interest rate. Thompson had sufficient personal assets to obtain a personal loan to repay the principal amount of the loans from petitioner, plus interest, and was assured by his bank that on very short notice he could get such a personal loan.In working sessions with bonding agents, Thompson was told to keep control over petitioner's working capital and invest it on a demand or short-term basis. 6123 Davis and Thompson discussed the loans in the context that (1) for bonding purposes, the notes receivable of Thompson would be taken into account in determining petitioner's net worth, but not in determining petitioner's working capital, and (2) it would be necessary at some point to subordinate "this note receivable" to the bonding company, making it an asset of petitioner's available to the bonding company and not subject to petitioner's general creditors. Petitioner's independent accountant prepared funds statements (also known as statements of sources and uses of working capital) for petitioner for the years in issue, which reflected the increases in the net notes receivable due from Thompson as uses of funds or reduction in working capital.Thompson used all but about $ 55,000 of the amounts loaned for the purchase of his house, a farm, and a lot. He used the remainder to start a new business called Quickset Fasteners, Inc., which was to sell fasteners, anchors, bolts, nuts, drilling devices, masonry, saw blades, and tools, and eventually to become a supplier of plumbing materials. Thompson intended to obtain a more secure supply of materials used by petitioner (some of which were difficult to obtain) at discount prices through volume purchasing.After October 31, 1973, through September 24, 1974, petitioner made four loans to Thompson (in addition to those shown on table 10 supra), aggregating $ 69,200. On November 15, 1974, Thompson repaid all the pre-September 17, 1971, loans that 124 had not previously been repaid, as well as the first 688 10 notes listed in table 10 (those from August 31, 1971, through July 6, 1972), for a total of $ 112,700.Table 11 reflects petitioner's gross revenue from sales, net profit before taxes, and net profit after taxes for fiscal years 1966 through 1974. (P. 689.)Thompson's compensation as petitioner's president was $ 69,665 and $ 73,268 for fiscal years 1972 and 1973, respectively.For 1972 and 1973, Thompson and his wife reported taxable income on their joint Federal income tax returns of $ 53,485.50 and $ 50,571.34, and the marginal rates at which additional income would be taxed to them were 53 percent and 50 percent, respectively.Respondent determined that petitioner retained current earnings and profits, had business needs for such retentions, and had accumulated taxable income for each of the years before the Court in the amounts set forth in table 12.TABLE 12Fiscal year1972 1973 Current earnings andprofits retained $ 191,979$ 137,257Current earnings andprofits retained for reasonable needs of the business 1125 123,81639,087Accumulated taxable income68,16398,170ULTIMATE FINDING OF FACT In each of the years before the Court, petitioner was availed of for the purpose of avoiding income tax with respect to Thompson, by permitting earnings and profits to accumulate instead of being divided or distributed.OPINIONA. GeneralPetitioner contends that its earnings and profits were not accumulated in excess of its reasonable business needs and in 689 TABLE 11Fiscal year1966 1967 1968 1969 1970 Sales$ 710,265$ 1,072,763$ 1,016,901$ 1,166,617$ 1,361,940Net profitbefore taxes 64,38795,913155,600155,254143,665Net profitafter taxes 38,64755,04880,38878,79168,390TABLE 11Fiscal year1971 1972 1973 1974 Sales$ 1,906,319$ 2,036,246$ 2,007,681$ 2,133,313Net profitbefore taxes 262,770372,165264,571215,520Net profitafter taxes 137,662191,906137,076112,983690 any event, it was not formed or availed of for the purpose of avoiding income tax with respect to Thompson. Respondent contends to the contrary to the extent that $ 68,163 and $ 98,170 constituted accumulated taxable income subject to the section 531 tax for fiscal years 1972 and 1973, respectively (see table 12 supra). 7126 We agree with respondent as to the accumulations (with some modification in amount) and as to the prohibited purpose.Section 5318 imposes the accumulated earnings tax on the "accumulated taxable income" of every corporation described in section 532. 9128 In general, section 535 10129 defines "accumulated 691 taxable income" as taxable income, with certain adjustments, less earnings and profits retained for the reasonable needs of the business. Section 533(a) provides as follows:SEC. 533. EVIDENCE OF PURPOSE TO AVOID INCOME TAX.(a) Unreasonable Accumulation Determinative of Purpose. -- For purposes of section 532, the fact that the earnings and profits of a corporation are permitted to 127 accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders, unless the corporation by the preponderance of the evidence shall prove to the contrary.The foregoing framework focuses on whether the corporation's earnings and profits for a year were accumulated in excess of the amount necessary to meet its reasonable business needs at the end of the year. The courts have refined this concept by not looking simply to the amount of earnings and profits accumulated but instead by looking to the assets available measured by available working capital to meet these reasonable business needs. Faber Cement Block Co. v. Commissioner, 50 T.C. 317">50 T.C. 317, 328-329 (1968). See Atlas Tool Co. v. Commissioner, 70 T.C. 86">70 T.C. 86, 120 (1978), affd. 614 F.2d 860">614 F.2d 860 (3d Cir. 1980). The courts look to the nature of the assets to which the accumulated earnings and profits are committed. 11Atlas Tool Co. v. Commissioner, supra; Faber Cement Block Co. v. Commissioner, 50 T.C. at 328; Bremerton Sun Publishing Co. v. Commissioner, 44 T.C. 566">44 T.C. 566, 582-583 (1965); see Ivan Allen Co. v. United States, 422 U.S. 617">422 U.S. 617, 628-629 (1975); Battelstein Investment Co. v. United States, 442 F.2d 87">442 F.2d 87, 89 (5th Cir. 1971). The 130 amounts of the assets available to meet the reasonable business needs are compared to the amounts of the needs.B. Burden of ProofPursuant to section 534(b), respondent notified petitioner that a proposed notice of deficiency included an amount with respect to the accumulated earnings tax imposed by section 531 for fiscal years 1972 and 1973. Petitioner, pursuant to 692 section 534(c), timely submitted a statement of grounds on which it relied to establish that its earnings and profits for fiscal years 1972 and 1973 had not been permitted to accumulate beyond the reasonable needs of its business.In its statement, petitioner asserts that it needed to retain all of its earnings and profits in order to (1) enable it to develop performance bond capacity, and (2) have sufficient funds to operate and to finance the construction of a proposed storage warehouse. As to the former need, petitioner's 131 statement mentions the amount of "uncompleted work in process" and outstanding bids as of each of the fiscal year's end in issue, but specifically states that "there are no set rules of thumb that determine the contractor's maximum bonding capacity, 12 but rather the decision is made by the bonding company as a value judgment." The statement fails to notify respondent of petitioner's factual basis for quantifying that value judgment. The statement does not indicate either the amount of bonding capacity petitioner sought to achieve or the amount of assets required to attain a desired bonding capacity. As to the latter need, the only information regarding cost of the proposed storage warehouse is the mention of a "price quotation" of $ 93,750 dated May 10, 1973, for construction of the warehouse. The statement does not provide specific facts justifying the need for the proposed warehouse vis-a-vis work volume or the basis for estimating its cost of construction before May 10, 1973. 13 The statement asserts that petitioner's need for operating funds varies substantially from year to year and that adequate bonding capacity is "The most important and all inclusive need." Petitioner's 132 statement asserts that inflation and retainages as to petitioner's contracts will affect its needs to retain earnings and profits, but fails to adequately indicate to what extent petitioner's needs would be so affected, or how petitioner proceeded to determine the extent, or how respondent could determine the extent on the basis of the information in the statement.693 This Court determined that the burden of proof was not shifted to respondent, concluding that the statement (particularly the failure to provide supporting information) was not sufficiently substantial, material, definite, and clear to permit determination of an amount of accumulation of earnings and profits for which there were reasonable business needs. J. Gordon Turnbull, Inc. v. Commissioner, 41 T.C. 358">41 T.C. 358, 370-371 (1963), 133 affd. 373 F.2d 87">373 F.2d 87 (5th Cir. 1967). 14C. Business NeedsA determination of reasonable business needs is critical in two respects: (1) To compute the section 535(c) credit in calculating the accumulated taxable income, and (2) to decide whether the presumption of a tax-avoidance purpose under section 533 applies. The determination is a factual one ( Cheyenne Newspapers, Inc. v. Commissioner, 494 F.2d 429">494 F.2d 429, 432 (10th Cir. 1974), affg. a Memorandum Opinion of this Court; 15Herzog Miniature Lamp Works, Inc. v. Commissioner, 481 F.2d 857">481 F.2d 857, 861 (2d Cir. 1973), affg. a Memorandum Opinion of this Court; 16Battelstein Investment Co. v. United States, 442 F.2d at 88; Magic Mart, Inc. v. Commissioner, 51 T.C. 775">51 T.C. 775, 790 (1969); Faber Cement Block Co. v. Commissioner, 50 T.C. at 329, and cases cited therein), as to which we are reluctant to substitute our business judgment for that of corporate management unless the facts and circumstances warrant our 134 doing so ( Atlantic Properties, Inc. v. Commissioner, 62 T.C. 644">62 T.C. 644, 656 (1974), affd. 519 F.2d 1233">519 F.2d 1233 (1st Cir. 1975); Faber Cement Block Co. v. Commissioner, 50 T.C. at 329, and cases cited therein).Section 537(a)(1) provides that "the term 'reasonable needs of the business' includes -- (1) the reasonably anticipated needs of the business." In accord with the legislative history of the enactment of the Internal Revenue Code of 1954, 17Treasury Regulations section 1.537-1(b)(1) states that to justify an 694 accumulation, plans for its future use must be "specific, definite, and feasible" rather than "uncertain or vague."The instant case presents us with two overwhelming factual elements, and these elements point in opposite directions.Petitioner lent money to its sole shareholder, Thompson. Most of the loans continued throughout the period before the Court. The outstanding loan balances were substantial; they exceeded the amounts respondent seeks to tax in any one year. The loans indicate that petitioner did not need the money for its day-to-day 135 operations. Of perhaps even greater importance is the fact that petitioner's sole shareholder was thereby able to make use of the money without having to take it into income as a dividend. See sec. 532(a) (note 9 supra).On the other hand, a basic need of petitioner's business is bonding capacity. An adequate level of net assets is a basic requisite to a healthy construction subcontracting business. The accumulated earnings tax does not require that such a basic requisite be financed solely from sources outside the corporation's earnings.With this preface, we examine the record and the parties' contentions, in order to determine whether petitioner has carried its burden of proving that it did not accumulate its earnings and profits beyond the reasonable needs of its business (sec. 533(a)) or, failing that, that any such excess accumulations were less than the amounts determined by respondent in the notice of deficiency (thereby increasing the amount of petitioner's accumulated earnings credit under sec. 535(c)(1)).1. BondingAlthough ability to secure bonds in petitioner's business depends on many factors, the evidence in the record indicates a primary focus on rules of thumb based 136 on a special definition of "working capital" (6 1/2 to 7 times) and net assets (4 to 5 times), in order to establish a range for maximum bonding capacity levels.The record makes it clear that petitioner's loans to Thompson were not taken into account for purposes of applying the special working capital test. In other words, each dollar of loans to Thompson reduced -- by $ 6.50 to $ 7 -- petitioner's bonding capacity to the extent that this capacity depended on 695 the special working capital test. Nevertheless, petitioner increased its outstanding loan balance to Thompson by $ 68,798.34 during fiscal year 1972 and by an additional $ 8,349.98 during fiscal year 1973. If petitioner needed to bolster its working capital in order to increase bonding capacity, it could have done so by demanding repayment of its loans to Thompson, rather than adding to the outstanding balance. As to the working capital test, petitioner was in no stronger position by lending to Thompson than it would have been had it paid out the loans as dividends to Thompson.It appears that, during the years before the Court, petitioner's bonding capacity was more sensitive to the net assets test than to the working capital 137 test. For purposes of the net assets test, the petitioner's loans to Thompson did not diminish its bonding capacity. On the other hand, payment of dividends would have diminished petitioner's net assets and so might have diminished petitioner's bonding capacity.The question then is what level of bonding capacity petitioner reasonably needed, and what amount of net assets or working capital petitioner reasonably needed in order to achieve the appropriate bonding capacity.As indicated supra, we are loath to second-guess a taxpayer's business decisions in such matters. However, we have not been shown that petitioner decided to establish, or set a goal for, any particular level of bonding capacity. Put another way, petitioner has failed to show that it made a business decision which we should be loath to second-guess.In determining how much bonding capacity petitioner needed, we take into account the amounts of petitioner's uncompleted work in process and its outstanding bids still in effect. (See tables 1 and 2, and the text following them, supra.)Petitioner's position is that it had to increase its bonding capacity in order to be able to meet its potential commitments, as illustrated 138 by table 13, which is taken from petitioner's brief. 696 TABLE 13Aug. 31, 1972Aug. 31, 1973Uncompleted work on hand$ 1,453,900$ 1,853,200Average amount of bidsoutstanding but not awarded 1,357,700 1,890,450 Total2,811,600 3,743,650 Bonding authority2,500,000 3,000,000 Petitioner also asserts that in fiscal year 1972 it may have had as much as $ 2,119,000 in outstanding bids at one time and in fiscal year 1973, as much as $ 3,274,700 in outstanding bids at one time. Petitioner asserts that it had a reasonable business need to be able to secure bonds for all its outstanding bids, and also to plan for continued growth.Although it was theoretically possible for petitioner to have been awarded all of its outstanding bids at any one time, the record indicates (see table 2 supra) that, during each of the years before the Court, petitioner was awarded only about one-fifth of the contracts it bid on, in terms of both numbers of contracts and dollar amounts. It obviously would have been prudent for petitioner to be prepared for a greater degree of success in bidding than it had hitherto experienced. However, nothing in the record persuades us that petitioner ever decided to achieve bonding 139 capacity to meet a possibility of 100-percent success in bidding. In fact, nothing in the record persuades us that petitioner decided to achieve any particular level of bonding capacity, on any set of assumptions.Doing the best we can with the record before us, we conclude and have found as follows:(1) As of the end of fiscal year 1972, petitioner had a reasonable business need to establish a bonding capacity of $ 3 million, and for that purpose had a reasonable business need of $ 445,000 working capital or $ 675,000 net worth; and(2) As of the end of fiscal year 1973, petitioner had a reasonable business need to establish a bonding capacity of $ 3,500,000, and for that purpose had a reasonable business need of $ 520,000 working capital or $ 785,000 net worth.2. Bardahl FormulaRespondent determined the amount of petitioner's reasonable business needs by applying the "Bardahl formula." 18140 697 For the notice of deficiency, respondent calculated petitioner's needs under the Bardahl formula to be $ 589,154 for fiscal year 1972 and $ 701,014 for fiscal year 1973. On brief, respondent calculates the Bardahl formula needs to be only $ 417,806 and $ 479,632, respectively. 19Petitioner contends that the Bardahl approach has "little or no value when applied to a mechanical contracting business that lacks a routine operating cycle." Petitioner also maintains that respondent made numerous errors in applying the Bardahl formula and that correction of these errors would result in computing 141 petitioner's needs as $ 868,898 for fiscal year 1972 and $ 943,711 for fiscal year 1973.Respondent concedes "that the operating cycle approach is not universally applicable and agrees with petitioner that such a computation is a guide rather than a rule of law." Nevertheless, respondent insists that the Bardahl (operating cycle) approach is appropriate in the instant case and that petitioner has not shown that any other approach is appropriate.We agree with petitioner that the Bardahl formula is not appropriate to measure petitioner's business needs. We note that the Bardahl formula is an attempt to inject a degree of objectivity into a quantification of business needs; it is a tool to be used when helpful and its use is not mandated in all events. This approach focuses on the amount of liquid assets likely to be necessary to carry a business through a normal operating cycle because of expected differences between the timing of expenditures and the timing of receipts.In the instant case, as petitioner points out, there does not 698 appear to be a routine operating cycle. Also, in the instant case, the fact of petitioner's outstanding loans to Thompson -- demand loans which were not 142 demanded (see table 10 supra) -- suggests that petitioner had substantial liquid assets in excess of what it needed under an analysis focusing on current receipts and expenditures. Finally, we are persuaded that petitioner is correct in its contention that its needs (whether measured as working capital or net worth) to support bonding capacity exceeded its needs for assets for operating cycle purposes.In Ready Paving & Construction Co. v. Commissioner, 61 T.C. 826">61 T.C. 826 (1974), both sides considered that the need of the taxpayer therein for working capital for normal operations overlapped its need for capital to procure performance bonds. The taxpayer therein did not contest the applicability of the Bardahl approach, but merely how certain items should be taken into account under that approach. (61 T.C. at 837.) By contrast, in the instant case, petitioner has contested the applicability of the Bardahl approach. In Ready Paving, we made an allowance for possible mismatches in the timing of normal operation needs and performance bonds needs. (61 T.C. at 839.) In the instant case, respondent does not concede the appropriateness of any such allowance. No showing has been made, in the 143 instant case, for any such mismatching allowance on account of petitioner's normal operations, in addition to petitioner's bonding capacity needs.We conclude that, in the instant case, petitioner's bonding capacity needs and its normal operation needs overlap, petitioner's bonding capacity needs are the more significant needs, and petitioner did not have normal operation needs that should be added to the bonding capacity needs determined in the immediately preceding section of this opinion.3. Building Expansion and EquipmentPetitioner contends that $ 138,000 of the accumulation was needed during each of the years in issue "to finance its expansion needs" for a new building and equipment. Respondent contends that petitioner's plans for a new building and equipment were at a preliminary stage or indefinite during the years in issue and the plans could not be expected to be executed in a reasonable time because additional property had 699 to be acquired before the building could be built. Respondent suggests that references in corporate minutes to construction plans and seeking of preliminary cost estimates are responses to a concern about liability for accumulated earnings taxes, especially 144 in light of petitioner's loans to Thompson.We agree in part with petitioner and in part with respondent.For purposes of the accumulated earnings tax, section 537(a)(1) provides that "the term 'reasonable needs of the business' includes -- (1) the reasonably anticipated needs of the business." In particular, it includes accumulations to provide for expansion of the business or replacement of its plant; however, the plans for the expansion or replacement must be sufficiently specific, definite, and feasible to prove that the project was a real consideration during the years before the Court. Faber Cement Block Co. v. Commissioner, 50 T.C. at 331-334, and cases cited therein; sec. 1.537-2(b)(1), Income Tax Regs.The record as a whole discloses that petitioner's growth made it reasonable to expand the building from which it operated. This need for expansion was anticipated as early as 1968. The expansion program was developed and executed in fits and starts, with construction beginning in 1979. The expansion was needed in order to properly deal with petitioner's business, and not to expand into a new line of activity.Although we have found that petitioner and Thompson took steps at 145 various times to acquire property on which to build, the record does not disclose when many of these steps were taken. The record does not disclose what basis, if any, there was for Thompson's 1968 estimate of $ 55,750 for a building and his 1969 estimate of $ 103,000 for a building and $ 35,000 for equipment. The May 1973 "preliminary" quotation of $ 93,750 for construction of the building is an indication that by then petitioner had some more-or-less specific, definite, and feasible plans to expand. Petitioner's fiscal year 1972 had ended on August 31, 1972, more than 8 months before the May 1973 quotation. We find no persuasive evidence that petitioner had specific, definite, and feasible plans to expand as of the end of fiscal year 1972. We find no persuasive evidence that petitioner had specific, definite, and feasible plans to purchase 700 new equipment as of the end of fiscal year 1973. See Atlas Tool Co. v. Commissioner, 70 T.C. at 119.We conclude that petitioner has failed to carry its burden of proof with regard to expansion for fiscal year 1972; we conclude that petitioner has carried its burden of proving that it had reasonable business needs for expansion for fiscal 146 year 1973, but only to the extent of $ 93,750.Funds used for building construction clearly would not be available as working capital. Consequently, petitioner's building construction need is to be treated as an addition to its bonding capacity need, if the latter is calculated in terms of working capital.However, the record does not indicate that petitioner's then-existing fixed assets were excluded from consideration when bonding capacity limits were determined on the basis of net assets. From this we conclude that funds used for building construction would also be of benefit to petitioner in attaining increased bonding capacity. Since petitioner's building construction need and net assets bonding capacity need overlap, it would be double counting to merely add the two needs. Also, we note that petitioner's loans to Thompson amounted to $ 160,200 at the end of fiscal year 1973 (table 10 supra), well in excess of the construction need of $ 93,750 as of that time. Thus, the entire expansion could have been financed out of repayment of the loans by Thompson, with substantial funds left over.We conclude that petitioner's building construction need should not be added to its bonding 147 capacity need, if the latter need is calculated in terms of net assets.4. Other NeedsPetitioner also contends that because respondent's computation of business needs vis-a-vis working capital available to meet the needs is based on the Bardahl formula, it does not account for needs for (1) inflation, (2) growth, (3) retaining key employees through periods of temporary downturns in its business, or (4) purchasing materials and equipment in advance of their need, in order to avoid price increases. Petitioner contends that it needed to accumulate amounts equaling (1) 25 percent of its gross sales (or $ 509,062 and $ 501,920) for inflation and (2) 30 percent of the total annual cost of sales and 701 expenses (or $ 503,914 and $ 528,745) for growth in fiscal years 1972 and 1973, respectively. Respondent asserts that these contended needs are all speculative and petitioner managed to grow and retain key employees despite the lack of availability of the funds loaned to Thompson during the years in issue.We agree with respondent's conclusion.We have agreed with petitioner that the Bardahl formula is not useful in the instant case. Whatever may be the merits of petitioner's contentions under 148 the Bardahl formula, we conclude that any business needs on account of inflation or growth (the first two of petitioner's contentions) are already taken into account under our bonding capacity analysis (and, in the case of growth, under our building expansion analysis). We will not double-count by treating these items as additional business needs.Petitioner's contentions as to key personnel and advance purchases of materials and equipment fail because of burden of proof. There is no persuasive evidence that petitioner anticipated a need for excess funds to retain key personnel, nor is there persuasive evidence as to whether any amount was projected as necessary to accomplish such a purpose. There is no persuasive evidence that petitioner planned to increase its advance purchases of materials and equipment nor is there persuasive evidence as to whether any amount was projected to accomplish such a purpose.We conclude that none of petitioner's four contentions are a basis for determining any additional business needs.D. Business Needs Compared to AvailabilitiesRespondent, in determining petitioner's business needs and availabilities, used the Bardahl formula as the basic business 149 need calculation and made the sort of availabilities determination that is usually used in connection with the Bardahl formula. Petitioner criticizes respondent's use of the Bardahl formula for determining business needs. Petitioner focuses on business needs primarily in terms of its need to assure sufficient bonding capacity. Much of the testimony and other evidence relating to bonding capacity focuses on the working capital rule-of-thumb. Relatively little of the evidence and even less of the parties' analysis deal with the net assets rule-of-thumb. 702 Notwithstanding petitioner's objection to the Bardahl formula for determining needs, petitioner appears to accept the availabilities analysis, with certain exceptions.We have agreed with petitioner that bonding capacity, and not the Bardahl formula, is the major consideration in determining petitioner's business needs. We have found Davis' testimony to be credible. Davis was quite clear that the loans to Thompson were not taken into account under the working capital approach. It is clear from Davis' testimony that the working capital approach fell far short of justifying the bonding level capacity authorized by States and Economy. 150 The working capital determined by Davis for 1972 (see table 9 supra) would justify a bonding capacity level of $ 1,800,000 to $ 1,900,000 as of the end of fiscal year 1972. Yet Davis was authorized to bond petitioner up to $ 2,500,000 without consulting with States. The discrepancy for fiscal year 1973 is even greater. On the basis of working capital, the bonding capacity level should have been about $ 2 million to $ 2,150,000. Yet Davis was authorized to bond petitioner to a maximum of $ 3 million at preferred rates and without further clearance from Economy.From the foregoing, we conclude that petitioner's net assets constituted the most significant element determining petitioner's maximum bonding capacity during the years before the Court. In the context of the instant case, given the contradictions of the evidence and the contentions of both parties, we conclude that the appropriate comparison to be made is the comparison between (1) petitioner's business needs using the net assets test and (2) petitioner's net assets.Our starting points for availabilities are the amounts shown on petitioner's balance sheets as "Total Shareholder's Equity" (table 8 supra). 20 In accordance 151 with Ivan Allen Co. v. United States, 422 U.S. at 627-628, 632-635, we account for petitioner's marketable securities at fair market value (table 8, note 1 supra) in determining availabilities. 21703 Davis substantially discounted petitioner's accounts receivable for purposes of applying the working capital rule-of-thumb. He made no comment as to the proper treatment of this asset for net assets purposes. We note that petitioner deducted bad debts of only $ 2,940.86 and $ 456 on its income tax returns for fiscal years 1972 and 1973, respectively. We conclude that there is no basis for adjusting the accounts receivable amounts shown on petitioner's balance sheets.Davis testified that the notes receivable from Thompson were properly taken into account in determining petitioner's net worth; we also take this asset into 152 account.Table 14 compares our conclusions as to the reasonable needs of petitioner's business with our conclusions as to petitioner's availabilities (in the instant case, its net assets as adjusted) as of the ends of each of the years before the Court.TABLE 141972 1973 Availabilities(notes 20 & 21 supra) $ 754,611$ 878,519Needs675,000785,000Excess1 79,61193,519 E. Purposes and ConclusionRespondent maintains that petitioner was availed of for the purpose of avoiding the income tax with respect to its sole shareholder by permitting earnings and profits to accumulate instead of being divided or distributed. Petitioner asserts that it did not have this purpose.We agree with respondent.Section 532(a) provides, in effect, that the accumulated earnings tax is to apply only if there is 153 both (1) an accumulation and (2) a prohibited purpose for the accumulation. Section 533(a) provides that the fact that a corporation accumulates its earnings and profits beyond its reasonable needs shall be determinative of the purpose to avoid the income tax with 704 respect to its shareholders unless the corporation proves to the contrary by a preponderance of the evidence. For the accumulated earnings tax to apply, it is enough if the prohibited purpose is one of the purposes behind the accumulation, even if it is not the "dominant, controlling, or impelling" one. United States v. Donruss Co., 393 U.S. 297 (1969).Our conclusions as to business needs and availabilities (table 14 supra) indicate that petitioner accumulated its earnings and profits beyond the reasonable business needs which it established herein, for the years in issue. In addition, petitioner did not pay a cash dividend from the date of its incorporation through the end of the years in issue. Also, Thompson's marginal income tax bracket was 53 percent for 1972 and 50 percent for 1973.Finally, we consider petitioner's loans to Thompson. Although not necessarily determinative of the prohibited purpose (see B. Bittker 154 & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.03, at 8-22 (4th ed. 1979)), these loans did have the effect of enabling Thompson, petitioner's sole shareholder, to have the personal use of a substantial part of petitioner's assets and yet to "avoid the income tax" with respect to petitioner's accumulations. (See sec. 532(a).) These loans also disabled petitioner from satisfying the working capital alternative in its efforts to increase its bonding capacity. Notwithstanding this consequence of the loans, their outstanding balance was increased by $ 68,798.34 in fiscal year 1972 and by an additional $ 8,349.98 in fiscal year 1973. We conclude that the loans constitute additional significant evidence of petitioner's prohibited purpose in the years before the Court. Helvering v. Nat. Grocery Co., 304 U.S. 282">304 U.S. 282, 293-294 (1938); Brookfield Wire Co. v. Commissioner, 667 F.2d 551">667 F.2d 551, 556 (1st Cir. 1981), affg. a Memorandum Opinion of this Court; 22Cataphote Corp. v. United States, 210 Ct. Cl. 125">210 Ct. Cl. 125, 147, 535 F.2d 1225">535 F.2d 1225, 1237-1238 (1976); Herzog Miniature Lamp Works, Inc. v. Commissioner, 481 F.2d at 863; United Business Corp. v. Commissioner, 62 F.2d 754">62 F.2d 754, 75523 (2d Cir. 1933), 155 affg. 19 B.T.A. 809">19 B.T.A. 809 (1930).705 Thus, independently of the presumption prescribed in section 533(a), there is ample evidence leading us to conclude that petitioner permitted its earnings and profits to accumulate, instead of being divided or distributed, for the purpose of avoiding the income tax with respect to Thompson; we so hold.In order to take account of the effect of the foregoing on the accumulated earnings credit (sec. 535(c)(1)),Decision will be entered under Rule 155. Footnotes1. Unless indicated otherwise, all section, subchapter, and chapter references are to sections, subchapters, and chapters of the Internal Revenue Code of 1954 as in effect for the years in issue.↩2. Unless indicated otherwise, all references to fiscal years are to petitioner's fiscal years ended Aug. 31.3. From 1959 until the mid-1960's, Thompson had been a 50-percent shareholder. The other 50-percent shareholder was killed in an automobile accident in the mid-1960's and Thompson acquired all of petitioner's stock.↩4. The term "operating capital" was used in testimony at trial interchangeably with "working capital," both of which terms focus on "net quick assets" and "cash flow" for purposes of bonding capital.↩5. This included estimating the expected period for collection of retainages, taking account of any disputes as to given jobs affecting the time or amount of expected receipt.↩1. Petitioner requested that we make the findings set forth in table 1 (except that we have rounded off to the nearest whole dollar). Respondent stated that he had no objections to these findings. The uncompleted-work-in-progress amounts so requested and found differ from the parties' stipulations. Further, both the 1973 work-completed amount and the 1973 uncompleted-work-in-progress amount differ from the aggregates of the amounts shown on a contract-by-contract basis in the exhibit on which the requested finding of fact assertedly was based. (For example, the total of the work-completed amounts on the exhibit differed by more than $ 180,000 from the amount in the requested finding.) The parties have not favored us with an explanation of any of these differences. The record does not appear to include information from which we could deduce any such explanation. Under these circumstances, we have treated the agreed-to requested findings as equivalent to stipulations superseding previous stipulations and exhibits.1. These totals include one contract for $ 193,700 as to which work was begun in fiscal year 1972 but the contract was not signed until Oct. 7, 1972.↩2. These totals include (1) one contract for $ 447,514 as to which a letter of intent to award the contract was issued in fiscal year 1973 but the contract was dated Oct. 15, 1973, and (2) four contracts for a total of 414,303 as to which work was begun in fiscal 1973 but the contracts were not signed until fiscal 1974.1. Both parties requested that we find the amount as set forth in table 4 (except that we have rounded off to the nearest whole dollar). An exhibit stipulated as showing petitioner's accounts receivable as of Aug. 31, 1972, differs by $ 450 from the amount in table 4. Consistent with note 1 to table 1, supra↩, our finding on this point is in accordance with the parties' requests.2. The accounts receivable for fiscal year 1973 were composed of trade accounts and other accounts equaling $ 614,479 and $ 450, respectively; the accounts receivable for fiscal year 1974 were composed of trade accounts and other accounts equaling $ 740,993 and $ 1,579, respectively.↩1. The parties have stipulated that these amounts are equal to "taxable income adjusted in the manner provided in section 535(b)."↩1. Accounts receivable as shown in table 8 supra↩, less (1) accounts receivable more than a year old and (2) accounts receivable written off after the end of the year.1. The fiscal yearend market values of the securities listed as Temporary investments were $ 19,540 and $ 6,363 for fiscal years 1972 and 1973, respectively.↩2. See table 4, note 2 supra↩.6. In order to earn interest before the years in issue, petitioner had invested working capital "in the stock market" on a short-term basis, which had resulted in a sizable loss.1. Includes $ 65 deduction for long-term capital gain, under sec. 535(b)(6), as determined in the notice of deficiency.7. On brief, respondent urges the Court to conclude that petitioner had excess accumulations "at least in the amount of the loans to its sole shareholder." The amount of these loans outstanding at the end of each fiscal year before the Court (see table 10 supra) exceeded the amount of accumulated taxable income determined by respondent for that year (see table 12 supra↩). Nevertheless, respondent does not ask us to redetermine the increased deficiencies that presumably would be warranted by the finding respondent asks us to make. See sec. 6214(a).8. SEC. 531. IMPOSITION OF ACCUMULATED EARNINGS TAX.In addition to other taxes imposed by this chapter, there is hereby imposed for each taxable year on the accumulated taxable income (as defined in section 535) of every corporation described in section 532, an accumulated earnings tax equal to the sum of -- (1) 27 1/2 percent of the accumulated taxable income not in excess of $ 100,000, plus(2) 38 1/2 percent of the accumulated taxable income in excess of $ 100,000.↩9. SEC. 532. CORPORATIONS SUBJECT TO ACCUMULATED EARNINGS TAX.(a) General Rule. -- The accumulated earnings tax imposed by section 531 shall apply to every corporation (other than those described in subsection (b)) formed or availed of for the purpose of avoiding income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.(b) Exceptions. -- The accumulated earnings tax imposed by section 531 shall not apply to -- (1) a personal holding company (as defined in section 542),(2) a foreign personal holding company (as defined in section 552), or(3) a corporation exempt from tax under subchapter F (section 501 and following).↩10. SEC. 535. ACCUMULATED TAXABLE INCOME.(a) Definition. -- For purposes of this subtitle, the term "accumulated taxable income" means the taxable income, adjusted in the manner provided in subsection (b), minus the sum of the dividends paid deduction (as defined in section 561) and the accumulated earnings credit (as defined in subsection (c)). * * *(c) Accumulated Earnings Credit. --(1) General Rule. -- For purposes of subsection (a), in the case of a corporation other than a mere holding or investment company the accumulated earnings credit is (A) an amount equal to such part of the earnings and profits for the taxable year as are retained for the reasonable needs of the business, minus (B) the deduction allowed by subsection (b)(6). For purposes of this paragraph, the amount of the earnings and profits for the taxable year which are retained is the amount by which the earnings and profits for the taxable year exceed the dividends paid deduction (as defined in section 561) for such year.11. Of course, investment in nonliquid assets which are unrelated to, or unnecessary for, the corporation's business will not enable the corporation to avoid the section 531 tax. See Ivan Allen Co. v. United States, 422 U.S. 617">422 U.S. 617, 630 n. 11 (1975); Faber Cement Block Co. v. Commissioner, 50 T.C. 317">50 T.C. 317, 328↩ (1968).12. We note that at trial and on brief petitioner urges us to give great weight to "rules of thumb," in its effort to persuade us that its accumulations were retained for the reasonable business need of increasing its bonding capacity.↩13. The 2-year period before the Court is from Sept. 1, 1971, through Aug. 31, 1973. Substantially all of this period had already elapsed by the date of the price quotation.↩14. Neither of the cases cited by petitioner ( Oman Construction Co. v. Commissioner, T.C. Memo. 1965-325, or Vuono-Lione, Inc. v. Commissioner, T.C. Memo. 1965-96↩) as to the sufficiency of sec. 534(c) statements by contractors convinces us otherwise.15. T.C. Memo. 1973-52↩.16. T.C. Memo. 1972-173↩.17. S. Rept. 1622, 83d Cong., 2d Sess (1954) at 69; H. Rept. 1337, 83d Cong., 2d Sess. (1954) at A173.↩18. Derived from analysis in Bardahl Manufacturing Corp. v. Commissioner, T.C. Memo. 1965-200, this formula is used to measure the amount of working capital needed for one operating cycle. See generally B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.03, at 8-17 through 8-20 (4th ed. 1979), and cases there cited.19. Respondent's recalculations of petitioner's operating cycle needs, together with his recalculations of petitioner's availabilities, would (if agreed to by the Court) result in the conclusion that petitioner's excess accumulations for each of the years before the Court were more than 4 times as great as the amounts determined in the notice of deficiency. Nevertheless, respondent does not ask us to redetermine the increased deficiencies that presumably would be warranted if we were to agree with respondent's position on brief. See sec. 6214(a).↩20. $ 759,380 and $ 896,457 for fiscal years 1972 and 1973, respectively. On brief, petitioner appears to agree that these are the relevant figures for a net worth evaluation of petitioner's bonding capacity needs.↩21. This results in downward adjustments of $ 4,769 ($ 24,309 less $ 19,540) and $ 17,938 ($ 24,301 less $ 6,363) for fiscal years 1972 and 1973, respectively.↩1. This amount exceeds the amount used by respondent in making the determination in the notice of deficiency. Since respondent does not ask us to redetermine an increased deficiency for fiscal year 1972 pursuant to sec. 6214(a), the amount taken into account under Rule 155 is to be the amount stipulated to by the parties as having been used in arriving at the deficiency determined in the notice of deficiency.↩22. T.C. Memo. 1980-321↩.23. "Smith paid taxes upon a substantial income in 1918 and 1920, and borrowed largely from the petitioner in 1920 and 1921. These loans are incompatible with a purpose to strengthen the financial position of the petitioner, but entirely accord with a desire to get the equivalent of his dividends under another guise."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622740/	Elizabeth F. Wade, Petitioner, v. Commissioner of Internal Revenue, RespondentWade v. CommissionerDocket No. 5206United States Tax Court5 T.C. 394; 1945 U.S. Tax Ct. LEXIS 126; July 12, 1945, Promulgated 126 Decision will be entered under Rule 50. A portion of the current income of a trust for 1940 which the trustee withheld from the life beneficiary and paid over to the executor of the grantor's estate for payment of interest due on an estate tax deficiency determined against the grantor's estate, held, not taxable to the life beneficiary of the trust as income distributable to her. Carter T. Louthan, Esq., for the petitioner.Clay C. Holmes, Esq., for the respondent. Smith, Judge. SMITH 394 OPINION.This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1940 in the amount of $ 21,654.14. Certain of the issues have been settled by stipulations of the parties. The sole remaining issue is whether the respondent has properly included in petitioner's income, as distributable income of a trust of which she was life beneficiary, a portion of the income of the trust for the taxable year which the trustee transferred to the executor of the grantor's estate to pay interest on an additional Federal estate tax determined to be due from the estate.The principal facts have been stipulated.The petitioner is a resident of Santa Barbara, 127 California. Her income tax return for the calendar year 1940 was filed with the collector of internal revenue for the third district of New York.Petitioner's husband, Jeptha H. Wade, Jr., created a revocable trust in 1930, naming the Union Trust Co. as trustee and the Cleveland Trust Co. as successor trustee. Thereafter he amended the trust from time to time, pursuant to powers reserved in the original trust agreement. The last amendment was made on September 14, 1935. The Cleveland Trust Co. was then acting as trustee. As so amended the trust agreement provided that after the grantor's death the trust estate should be divided into two equal parts, A and B, and that all of the income from both parts should be paid to the grantor's wife, petitioner herein, for life. In addition to such income the trustee was authorized to pay to the petitioner so much of the principal of part A as she might from time to time request by written instrument, and so much of the principal of part B as the trustee might deem "necessary, proper or fit to provide for her maintenance, support, comfort and enjoyment." Petitioner was given the right to dispose of the remainder of part A by will.395 128 The trust agreement as amended further provided:The Trustee Shall Have Power: * * 3. To determine whether money or property coming into its possession shall be treated as principal or income, and to charge or apportion gains, expenses and losses to principal or income, according as it may deem just and equitable; * ** * * As soon as practicable after my decease the Trustee shall determine the value of the trust estate by making an appraisal of all of the trust assets and by deducting from the gross value so determined the total amount of all indebtedness of the trust assets or for which the trust assets may in any way be pledged or charged and the total amount of all succession, estate and inheritance taxes paid or payable under the provisions hereinafter made. * * Any succession, estate, or inheritance taxes that may be levied or assessed by reason of any gifts, either of income or principal hereunder, shall be paid by the Trustee out of the principal of the trust estate.It was further provided that the trust should be administered under the laws of the State of Ohio.The trust as amended continued in effect up to and during the taxable year 1940. The grantor died129 December 3, 1936, a resident of the State of New York. In the estate tax return filed by his executor the assets of the trust were included in the grantor's estate at a value on the optional valuation date provided by section 302 (j) of the Revenue Act of 1926, as amended, of $ 1,431,018.76. The total value of the gross estate as reported was $ 1,474,784.49. The return showed an estate tax liability of $ 231,175.77, which the executor paid on August 5, 1938. Thereafter the Commissioner determined an additional estate tax liability of $ 167,609.79. That deficiency resulted from an increase of $ 357,101.04 in the value of certain of the assets of the estate, the inclusion of $ 213,695.49 of income received from the trust assets between the date of death of the decedent and the optional valuation date, and the disallowance of a deduction of $ 56,500 of executor's commissions and counsel fees.Recognizing the liability of the trust for payment of the estate tax deficiency, the trustee, upon the advice of Ohio counsel, withdrew $ 167,609.79 from the principal of the trust fund and transferred it to the executor for that purpose, together with $ 26,604.08 of accrued interest on the130 deficiency. The trustee charged the $ 26,604.08 to trust income of 1940, believing that to be in accordance with the proper construction of the trust agreement and the laws of the State of Ohio governing the administration of the trust estate. The executor paid those funds to the collector on December 10, 1940.In her income tax return for 1940 the petitioner reported $ 89,212.72 of taxable income received from the trust. That amount did not include the $ 26,604.08 which the trustee transferred to the executor to 396 pay the interest on the estate tax deficiency. In determining the deficiency herein the respondent treated the $ 26,604.08 as distributable income of the trust for 1940 and included it in petitioner's gross income. Whether his action in so doing was proper is the only question now remaining for our determination.The pertinent provisions of the statute are as follows:SEC. 161. IMPOSITION OF TAX.(a) Application of Tax. -- The taxes imposed by this chapter upon individuals shall apply to the income of estates or of any kind of property held in trust, including --* * * (2) Income which is to be distributed currently by the fiduciary to the beneficiaries, 131 and income collected by a guardian of an infant which is to be held or distributed as the court may direct.SEC. 162. NET INCOME.* * * (b) The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that -- * * There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the legatees, heirs, or beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs, or beneficiaries whether distributed to them or not. As used in this subsection, "income which is to be distributed currently" includes income for the taxable year of the estate or trust which, within the taxable year, becomes payable to the legatee, heir, or beneficiary. * The income beneficiary of the trust is required to report all the income properly distributable to him during the taxable year, whether it is actually distributed or not. Freuler v. Helvering, 291 U.S. 35">291 U.S. 35. The132 question as to what income is distributable and what is not is one that must be determined in accordance with the provisions of the trust agreement and the local law. Freuler v. Helvering, supra.The trust agreement here provided that all "succession, estate, or inheritance taxes" should be paid out of the principal of the trust estate, but nothing was said of the interest on such taxes. The trustee was given the power to determine whether other payments made out of trust funds were to be charged to principal or to income, "according as it may deem just and equitable." The trustee, in the exercise of his discretionary power and upon the advice of counsel, charged the interest in dispute to current income of 1940.A trustee's action in exercising such discretionary power is not reviewable by the courts except where the trustee has acted arbitrarily and in abuse of the power. See Restatement of the Law of Trusts, sec. 187 (e). See also Frye v. Burk, 57 Ohio App. 99">57 Ohio App. 99; 12 N. E. (2d) 397 152. We can not find that the trustee here acted arbitrarily and in abuse of its power in charging133 the interest on the estate tax deficiency against current income.In Penrose v. United States, 18 Fed. Supp. 413, it was held that the interest paid on an estate tax liability by the trustee of a testamentary trust was properly paid out of the income of the life beneficiary. That case was followed in Forrest G. Pearson, 4 T. C. 218. While those cases arose in the Commonwealth of Pennsylvania, we think that the same rule applies to the administration of trusts under the law of Ohio.The taxpayer here did not receive the income in dispute and, for all the record shows, could not have acquired it. We think that the purpose of the statute is not to tax her on such income.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622741/	FRANCES B. ELDREDGE, J. HAMPDEN DOUGHERTY, JR., AND CITY BANK FARMERS TRUST COMPANY, EXECUTORS OF THE ESTATE OF SENECA D. ELDREDGE, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MYRON G. DARBY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. NATT T. WAGNER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ROBERT F. HAWKINS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eldredge v. CommissionerDocket Nos. 52988, 52989, 53378, 53379, 62887, 62922, 63191, 64502.United States Board of Tax Appeals31 B.T.A. 111; 1934 BTA LEXIS 1156; August 29, 1934, Promulgated 1156 A partnership, a dealer in securities, including securities the income from which is exempt from Federal income tax, purchased such securities directly in the open market from the state or municipality issuing the same and resold them at a profit. Held, the profit arising to the respective members of the partnership from such resales is taxable income to them. Held, further, that the partnership, in the circumstances of the instant cases, was an independent contractor, not an employee, agent, or an instrumentality of the state or municipality from which the securities were purchased, and that the taxing of the profits of such a dealer on the resale of the securities so purchased is too remote to be an interference with or restriction upon the governmental functions of the state and does not cast a substantial burden on the state. Held, further, that there is no arbitrary classification or improper or illegal discrimination against such dealer because of the imposition of an income tax on the profits on the dealer's sale of such securities when the dealer is not permitted to deduct from income the interest paid on loans made to purchase or carry such securities. Denman v. Slayton,282 U.S. 514">282 U.S. 514.1157 Abraham Lowenhaupt, Esq., Stanley Waite, Esq., and J. Hampden Dougherty, Jr., Esq., for the petitioners. Brooks Fullerton, Esq., for the respondent. SEAWELL112 OPINION. SEAWELL: The respondent determined deficiencies, now in controversy, as follows: DocketYearNo.19271929Estate of Seneca D. Eldredge53378$28,694.28---------- Do64502----------$27,125.37Myron G. Darby5298813,042.86---------- Do62922----------4,175.91Natt T. Wagner533794,462.60---------- Do62887----------1,931.55Robert F. Hawkins5298910,226.85---------- Do63191----------4,648.59A stipulation and accompanying exhibits contain the facts upon which the cases were submitted. The stipulation provides: 1. That the eight above captioned cases be consolidated for the purpose of hearing and decision. 2. Eldredge & Company was a partnership formed in 1919 and was, during the years 1927 to 1929, inclusive, a dealer in securities, including securities the income from which is exempt from Federal Income Tax. 3. During the year 1927, the firm of Eldredge and Company consisted1158 of four partners whose interests in the net income, after partners' drawing accounts and interest on capital had been deducted from net income, were as follows: $95,000.00 of such incomeRemainderSeneca D. Eldredge55%49 1/2%Myron G. Darby25%22 1/2%Robert F. Hawkins20%18%Natt T. Wagner-------------10%4. During the year 1929, the firm of Eldredge and Company consisted of four partners whose interests in the net income, after partners' drawing accounts and interest on capital had been deducted from net income, were as follows: Seneca D. Eldredge40%Myron G. Darby25%Robert F. Hawkins20%Natt T. Wagner15%5. During the year 1927, Eldredge and Company realized net gain in the amount of $353,263.30 from the purchase from states or subdivisions thereof of securities (the interest from which was exempt from Federal Income Tax) issued by such states or subdivisions thereof and the sale of such securities at a profit, and during the year 1929 realized net gain in the sum of $276,872.27 from the same sources. Transactions of the kind referred to in this paragraph are sometimes herein referred to as gains from1159 dealing in tax-free securities. 6. It is customary for a state, city or other governmental unit or subdivision, which desires to raise funds by issuing tax-free securities, to sell such securities to a dealer or group of dealers. This method of disposing of securities is, and in 1927 to 1929 was, almost invariably utilized by government bodies in order to be certain of obtaining the desired amount of funds upon a definite date. 113 7. An arrangement by the body politic for a sale of its securities to a dealer facilitates the projects of the public officials with respect to determining the rate of interest, the maturity date and the other provisions to be set out in tax-free securities which are about to be issued. 8. The business of acting as a dealer in tax-free securities consists of purchasing such securities from the governmental body or unit by which the same are issued, as obligor, and reselling such securities to the investing public. 9. Tax-exempt securities are disposed of by governmental bodies by sale in the open market which is usually the result of negotiation or competitive bidding. An imposition of income tax upon the gain derived from a resale1160 of such securities is a factor in the determination of the amount the dealer will bid, and tends to decrease the amount of the bid. 10. In the event that the gains from tax-free securities mentioned in paragraph 5 are taxable under the applicable revenue statutes, the deficiencies as shown by the deficiency notices attached to the petitions in the above entitled cases are correct. 11. In the event that said gains are not taxable under the applicable revenue statutes, the respective "net income corrected" of the respective petitioners, as shown in the deficiency notices, should be decreased by their respective portions, as above shown, of the gains thus determined not to have been taxable. 12. Photostatic copies of the Federal Income Tax Returns for the partnership of Eldredge and Company for 1927 and 1929 and for each of the said four partners for 1927 and 1929 are submitted herewith, hereby referred to and made a part of this stipulation of fact. Seneca D. Eldredge, a resident of the State of New York, died testate about October 9, 1931, and shortly thereafter the petitioners in Docket Nos. 53378 and 64502 were duly appointed and qualified as executors of his estate1161 and have since so served and are still acting as such. The only issue raised by the pleadings which is insisted upon by the petitioners is stated in brief in their behalf, as follows: These cases raise just one legal question, namely: Can the Commissioner of Internal Revenue oblige the partners in Eldredge & Company to pay an income tax upon such profits of said firm as result from the business of purchasing direct from the issuing states or municipalities the public obligations of such governmental bodies and reselling these identical securities to the investing public? The Commissioner ruled that such profits are subject to Federal income tax. Petitioners appeal to the Board, contending that the Commissioner's ruling is erroneous and that such a tax would be unconstitutional. The respondent asserts that the Constitution does not prohibit Congress from passing acts authorizing the imposition of an income tax on gains derived by a dealer who purchases in the open market directly from a state or municipality public obligations or bonds issued by it and later sells them at a profit, under the same or similar circumstances as existed in the instant cases. In behalf of the1162 petitioners, it is insisted that the issuing and selling of bonds of their own issue by states or their municipalities is an essential governmental function and the sale of such bonds, therefore, is not subject to interference or restriction by the Federal 114 Government, by taxation or otherwise. It is further insisted, and is stated in the stipulation, that it is customary for a governmental unit or subdivision thereof, which desires to raise funds by issuing tax-free securities, to sell such securities to a dealer or group of dealers and that an imposition of an income tax upon the gain derived by a dealer from a resale of such securities is a factor in the determination of the amount the dealer will bid and tends to decrease the amount of his bid. In support of petitioners' contention several authorities are cited. , is cited to sustain the assertion made in the brief that it is clear that the imposition of a tax on the dealer's profits "must operate on the power to borrow before it is exercised" and shows that the Federal income tax can not constitutionally be applied to the gains or profits here1163 in question. The above partial quotation is from the Pollock case, supra, wherein Chief Justice Marshall is quoted as saying in , "The right to tax the contract to any extent, when made, must operate upon the power to borrow before it is exercised and have a sensible influence on the contract." In our opinion there is quite a difference in the imposition of a Federal tax on the profits of a dealer who realizes the profit from the resale of securities he has purchased directly from a state or municipality, and the imposition of such a tax on any bond or contract of the state or municipality itself. The fact that the imposition of such a tax in the latter case would be unconstitutional, in our opinion, does not warrant the conclusion drawn by petitioner's counsel that a Federal tax imposed on a dealer's profits from the resale of such securities would likewise be unconstitutional, on the theory that it would place a burden upon the state, county, or municipality in the disposal of such bonds or securities. In our opinion, the taxing of the dealer's profits arising from resale of bonds, though1164 a possible factor in the determination of the amount the dealer may bid for the bonds, is a very minor item in such determination. The major factors by which the dealer would be influenced almost entirely would be (1) the amount he believes the public will pay for the bonds and (2) the amount which his competitors may bid, both being matters of opinion and the exercise of good judgment. In our opinion, and we so hold, the interference with governmental functions of the state or municipality, under the circumstances shown by the record, is so remote and insignificant that the imposition of the tax in question is not unconstitutional. The petitioners' counsel in their brief cite , and, as sustaining their insistence, quote therefrom as follows: "this Court has repeatedly held that those agencies through 115 which either government immediately and directly exercises its sovereign powers, are immune from the taxing power of the other." (p. 522.) Immediately preceding the quotation is this statement by the Court: "Just what instrumentalities of either a state or the Federal government are exempt from taxation by1165 the other cannot be stated in terms of universal application. But" - (then follows petitioners' quotation). The fallacy of the petitioners' argument and reliance on the brief quotation from , is in the assumption that Eldredge & Co. in the purchase and sale of the securities was an agency or instrumentality through which certain states or subdivisions thereof were immediately and directly exercising their sovereign powers. The facts stipulated, in our opinion, show that the partnership of Eldredge & Co. was not an instrumentality of the states or municipalities in the purchase of bonds or securities in which the partnership was dealing. The partnership was clearly an independent contractor. It acquired the bonds or securities by arm's length negotiations or as the result of competitive bidding. As shown by the record, except for the actual purchase of the bonds or securities by the partnership of Eldredge & Co., there was no contractual relation between the states or municipalities and the partnership. The contract of purchase was consummated at the time the offer was accepted, the bonds delivered, and payment made. 1166 There was no executory contract in effect. There was no occasion or right on the part of the states to exercise any supervision over the partnership. There was nothing in the contract of purchase which would give the states any such right. When the purchase was effected the partnership was at liberty to hold or sell the bonds as it chose. Its election to do the one or the other did not in any way affect the obligations of the states on the bonds. It is obvious that the partnership was not an officer, employee, or instrumentality of the states or municipalities. Numerous authorities are cited by the respondent to sustain his contentions and the validity of the tax imposed in the instant cases, but we do not think much discussion of them necessary. The principles which are controlling herein are, in our opinion, so fully discussed and clearly enunciated in ; ; ; 1167 ; ; , and other cases cited, as to make further discussion of them unnecessary. The petitioners in their reply brief undertake to show that the facts in the instant cases are so different from those in , that the principles enunciated in the latter and approved in later cases are not applicable to the former. Some points of difference are indicated and emphasized, but, in our opinion, they are not such as to render inapplicable the principles enunciated in the cases above enumerated. The tax in question is not imposed because the petitioners or the partnership of Eldredge & Co. purchased bonds or securities from any state or municipality. The immediate transaction or contract between the state or municipality and Eldredge & Co. with respect to the bonds purchased does not give rise, as we have before indicated, to any taxable income. The tax is imposed on the profits reaped by the dealer when he sells the bonds in the open market to the buying public. The tax does not operate1168 upon the state's contract the instant it was made and has no sensible influence upon such contract. The petitioners complain and assert that there is discrimination against them in the imposition of a tax on the profits on the dealer's sale of tax-exempt bonds when the dealer is not permitted to deduct from income the interest paid on a loan which was made to purchase or carry such bonds or securities. Congress has taken the view that when income (interest) earned by the bonds is exempt from tax, interest paid on loans to carry the bonds may not be deducted from income, and in so enacting, we discover nothing illegal or discriminating in such law. The question so raised by the petitioners has been too long and too often decided adversely to petitioner's insistence to require discussion. "The classification complained of is not arbitrary, makes no improper discrimination, does not result in defeating any guaranteed exemption, and was within the power of Congress," as was said by the Supreme Court, in deciding the same principle or question on facts similar to those in the instant cases, in 1169 . Having thoroughly considered the authorities cited and arguments presented by counsel on both sides, we are of the opinion and hold that the partnership of Eldredge & Co. was not an employee or instrumentality of the states or municipalities from which it purchased securities he income from which is exempt from Federal income tax, but was an independent contractor, and that the taxing of the profits arising from the resale of such securities purchased directly from a state or municipality in the open market is too remote to constitute an interference with or restriction upon the governmental functions of the state and does not cast a substantial burden upon it. Judgment will be entered for the respondent in each of aforesaid dockets.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622744/	ROY MILLER and ARTIE MILLER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Miller v. CommissionerDocket No. 7378-70.United States Tax CourtT.C. Memo 1973-68; 1973 Tax Ct. Memo LEXIS 218; 32 T.C.M. (CCH) 294; T.C.M. (RIA) 73068; March 26, 1973, Filed 218 Held: That section 1239 of the I.R.C., 1954, does not require that the gain realized upon the sale of depreciable property by one corporation to another, both of which are controlled by the same individual, be considered as ordinary income. 10-42 Corp., 55 T.C. 593">55 T.C. 593 (1971), followed. Warren Wertheimer, for the petitioners. John Gigounas, for the respondent. BRUCE MEMORANDUM OPINIONBRUCE, Judge: 219 Respondent determined a deficiency in the 1967 income tax of petitioners Roy and Artie Miller in the amount of $1,299.50. The sole question is whether section 1239(a)1 applies to a sale between two corporations, where 2 more than 80 percent in value of each corporation's outstanding stock is owned by the same individual. All the facts have been stipulated, and the stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners Roy and Artie Miller were, during the taxable year involved, husband and wife. They filed a joint Federal income tax return for the year 1967 with the district director of internal revenue, San Francisco, 220 California. At the time the petition in this proceeding was filed, the Millers resided in Chico, California. Throughout all the years in issue, petitioners owned 98.354 percent of the outstanding stock of Miller's Market (Miller's), which amounts to an ownership interest of more than 80 percent in value of the outstanding stock in Miller's. From the date of its incorporation, including the years in issue, Miller's was a bona fide corporation operating retail food stores, and it had a taxable status as a small business corporation under subchapter S of the 1954 Code. Throughout all the years in issue, the petitioners owned more than 80 percent in value of the outstanding stock of Carsan Investment Company (Carsan), a corporation. Carsan was incorporated on February 23, 1954, and ever since the date 3 of its incorporation it has been a bona fide corporation. Carsan's basic activity was acquisition and leasing of various types of equipment. This equipment was leased to individuals, unrelated businesses and to Miller's. In August, 1967, Carsan purchased equipment from Miller's for $21,490.00. The sale of this equipment was part of a general plan to have Miller's lease221 and not own the equipment in all its stores. The purchased equipment, during the entire time it was possessed and owned by Miller's and Carsan, was subject to the allowance for depreciation provided for in section 167. A gain of $19,009.25 was reported by Miller's on the sale, as follows: Selling price$21,490.00Original Cost$69,136.12Less depreciation (allowed or allowable)66,665.37Adjusted basis of property sold2,480.75Gain realized on sale$19,009.25Reported as ordinary income (pursuant to the recapture provisions of section 1245)$16,072.15Reported as long-term capital gain2,937.10Total gain reported$19,009.25 4 Since Miller's was a subchapter S corporation, petitioners reported their proportionate share of the ordinary income and long-term capital gain of Miller's shown above, on the joint income tax return filed by them for 1967. Petitioners' share of the long-term capital gain was $2,889.00 and $1,444.00 of this amount was included in their taxable income as long-term capital gain. Respondent increased petitioners' taxable income by $1,445.00 and explained this adjustment in the notice of deficiency as follows: 222 Since you own more than 80% in value of the stock of both corporations, it is determined that the sale of equipment in 1967 by Miller's Markets to Carsan Investment Company was indirectly a sale between you and the transferee corporation within the meaning of section 1239 of the Internal Revenue Code. Accordingly, your taxable income has been increased by $1,445.00 to take into account as ordinary income that portion of the gain of $19,009.25 which was reported by you as a capital gain. Section 1239 provides as follows: SEC. 1239. GAIN FROM SALE OF CERTAIN PROPERTY BETWEEN SPOUSES OR BETWEEN AN INDIVIDUAL AND A CONTROLLED CORPORATION. (a) Treatment of Gain as Ordinary Income. - In the case of a sale or exchange, directly or indirectly, of property described in subsection (b) - (1) between a husband and wife, or (2) between an individual and a corporation more than 80 percent in value of the outstanding stock of which is owned by such individual, his spouse, and his minor children and minor grandchildren; 5 any gain recognized to the transferor from223 the sale or exchange of such property shall be considered as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231. (b) Section Applicable Only to Sales or Exchanges of Depreciable Property. - This section shall apply only in the case of a sale or exchange by a transferor of property which in the hands of the transferee is property of a character which is subject to the allowance for depreciation provided in section 167. (c) Section Not Applicable With Respect to Sales or Exchanges Made on or Before May 3, 1951. -This section shall apply only in the case of a sale or exchange made after May 3, 1951. As already noted, the question presented is whether section 1239(a) applies to a sale between two corporations, where more than 80 percent in value of each corporation's outstanding stock is owned by the same individual. As the above facts indicate, petitioners owned more than 80 percent in value of the outstanding stock of both Millers' and Carsan. Respondent contends that the purpose of the section is to prevent the realization of capital gain upon the sale of a depreciable asset to a controlled corporation. Such224 a sale would establish a higher depreciable base for the asset at the expense of a capital gain to the transferor while there would be no loss of control over the asset by the transferor. Respondent maintains that a transaction between two corporations controlled by the same individual displays the abuses which 6 Congress sought to curb. It is argued that such a transaction contravenes the policy considerations behind section 1239 and thus is within the ambit of that section. In 10-42 Corp., 55 T.C. 593">55 T.C. 593 (1971) (a Court Reviewed opinion), we considered the precise issue now before us. We held there that section 1239(a) did not apply to a transaction between two corporations controlled by the same individual so as to convert capital gain into ordinary gain. Respondent asserts that the Court erroneously decided the question and that we should now reverse our earlier decision. We disagree. The plain words of section 1239 clearly state that the affected transactions are between two individuals and between an individual and a controlled corporation. Moreover, as noted in our earlier opinion, "Both committee reports focus on the danger of allowing individuals to sell depreciable225 assets to their controlled corporations." 10-42 Corp., supra, at 598. [Emphasis added.]Nevertheless, respondent urges that the word "indirectly" in the introductory sentence of the section extends the reach of the provision to transactions between two corporations controlled by the same individual. It is said that because of the common ownership of the corporations, the individual indirectly transfers an asset to a controlled corporation. The 7 Commissioner has taken this position in Rev. Rul. 69-109, 1 C.B. 202">1969-1 C.B. 202. However, as noted in 10-42 Corp., supra, the only indirection mentioned in the committee reports is the familiar one involving the use of a strawman. There is no mention in the statute or in the committee reports of transactions between two controlled corporations. 2 We observed in our earlier opinion that respondent's position "would deny capital gains treatment to bona fide intercorporate transactions where there is no inkling of tax avoidance." 55 T.C. at 598. Thus we are disinclined to think that Congress intended the word "indirectly" to reach a bona fide transaction between two corporations. Because of the language of the226 statute and its legislative history, we cannot say that "individuals" means "corporation." 3Respondent's argument is that the broad conceptual policy considerations behind section 1239 are contravened here. However, it is not inevitable that the section as written was 8 designed to encompass every conceivable transaction which might display some of the basic elements of the tax avoidance which prompted Congress to legislate. It is apparent that Congress intended to restrict the application of this provision. The predecessor of section 1239 was section 117(o) of the Internal Revenue Code of 1939 and was227 part of the Revenue Act of 1951. Section 328(a), Revenue Act of 1951, Ch. 521, 65 Stat. 452. The bill originally passed by the House of Representatives contemplated a more far-reaching provision than the section eventually enacted. That bill denied capital gains treatment to the proceeds from the sale or exchange, directly or indirectly, of depreciable property "between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly of indirectly, by or for such individual * * * ." H.R. 4473, 82d Cong., 1st Sess., pp. 97-98 (1951). The bill further contained extensive stock attribution rules providing, for example, that "stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust, shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries * * * ." Id., at 98. 9 The Senate rejected the House bill because it "would deny capital gains treatment to some bona fide transactions while failing to deny such treatment in cases of clear avoidance." S. Rept. No. 781, 82d Cong., 1st Sess. (1951), 2 C.B. 507">1951-2 C.B. 507. This rejection by the Senate*228 resulted in the enactment of the present provision which is more limited in its scope than was the House bill. We are not persuaded that this provision was designed to encompass the present transaction. In view of the plain words of the section and its legislative history, we can only conclude that 10-42 Corp., supra, was properly decided. Our adherence to that decision settles the question presented here. The two corporations involved in this proceeding were viable, and the sale of assets between them was a bona fide transaction. The transferor corporation was not a sham entity or a strawman established to allow an individual to sell an asset indirectly, within the meaning of section 1239, to a controlled corporation. Decision will be entered for the petitioners. Footnotes1. All statutoty references are to the Internal Revenue Code of 1954. ↩2. There is no need in the present opinion to engage in an extensive discussion of the legislative history of section 1239. That history was discussed in 10-42 Corp., supra, and also in both Court opinions in Calvin D. Mitchell, 35 T.C. 550">35 T.C. 550 (1960), revd. 300 F. 2d 533↩ (C.A. 4, 1962). 3. Not without significance perhaps is the section's use of the term "individual" rather than the term "person." Section 7701(a) (1) defines "person" "to mean and include an individual, a trust, estate, partnership, association, company or corporation." ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622746/	FRANK AND MARIANNE OWEN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Owen v. CommissionerDocket Nos. 41476-86; 13374-87; 18050-87; 18052-87; 32313-87; 37014-87; 39079-87United States Tax CourtT.C. Memo 1990-172; 1990 Tax Ct. Memo LEXIS 198; 59 T.C.M. (CCH) 290; T.C.M. (RIA) 90172; March 29, 1990Towner Leeper and John Leeper, for the petitioners. Phillip A. Pillar and Lewis J. Hubbard, Jr., for the respondent. COLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: The primary issues for decision are: (1) Whether certain petitioners may amend their petitions to conform to the proof. We hold they may. (2) Whether the joint stipulation that a document is true and correct establishes as a fact the truth of the contents of the document. We hold it does not. (3) Whether petitioners may deduct their distributive shares of prepaid intangible drilling and development costs (hereinafter "IDCs") in the year of payment under section 263(c). 2 We hold they may not. 201 (4) Whether petitioners are at risk beyond their cash contributions. We hold they are not at risk beyond their cash contributions. (5) Whether certain legal, management, and finance fees are deductible. We hold the fees are not deductible, but may be amortized under section 709. (6) Whether reliance on accountants and prospectuses shields petitioners from additions to tax for negligence under section 6653(a). We hold it does not. (7) Whether additions to interest under section 6621(c) are applicable. We hold they are. Respondent determined deficiencies in Federal individual income tax against petitioners as follows: Name/Docket No.YearEntityDeficiencyAdditionsOwen41476-861982None$ 3,895.00-Holland13374-871980Willow44,506.00-Hermann18050-871981Carnegie1,667.00$ 83.35 plus amounts toto be determined undersections 6653(a)(2) and6621(c)Crocker18052-87 31981Carnegie2,321.00$ 116.05 * plus amountsto be determined undersections 6653(a)(2) and6621(c)Thomas32313-871981Carnegie9,814.00$ 490.70 * plus amountsto be determined undersections 6653(a)(2) and6621(c) Henderson37014-871980Willow9,159.00An amount to bedetermined undersection 6621(c)1981Carnegie13,058.00$ 652.90 * plus amountsto be determined undersections 6653(a)(2) and6621(c)Owen39079-871981Carnegie91,737.35$ 4,586.87 * plus amountsto be determined undersections 6653(a)(2) and6621(c)202 These cases were consolidated for decision and submitted fully stipulated under Rule 122. The relevant facts are so found and are summarized below. FINDINGS OF FACT Petitioners are individuals who resided in El Paso, Texas, when these petitions were filed. These cases generally involve parties who set up two oil and gas partnerships, 4Willow Drilling, Ltd. (Willow) and Carnegie Drilling, Ltd. (Carnegie), near the end of each taxable year in which they deducted prepaid IDCs. Petitioners invested in one or both of the partnerships as limited partners. On their income tax returns, petitioners deducted their distributive shares of IDCs and certain losses. Respondent disallowed these deductions. 203 We will examine each partnership separately, beginning with Willow. 1. Willow Drilling, Ltd.Willow was established by a limited partnership agreement dated December 2, 1980. Its stated purpose was primarily to engage in development drilling for natural gas in Greer County, Oklahoma. a. The PrincipalsCharles A. Moeri, III (Moeri) was Willow's general partner. His business experience began with International Paper Company. In 1970, he joined John Hancock Insurance Company in El Paso, Texas. Four years later he entered into an insurance and investment partnership where he did research and marketing. In 1978, he founded Diversified Financial Planning, which researched and marketed oil and gas investments, tax-exempt securities, investment-grade diamonds, and other tax-oriented investments. Moeri is registered with the National Association of Securities Dealers, is a Certified Diamond Counselor, and is a member of the International Association of Financial Planners. Before 1980, he had no experience as a general partner. He served as general partner in another 1980 drilling program called Fentress County Investors, Ltd. (Fentress). Moeri's driller in both the204 Willow and Fentress programs was Quadrant Exploration, Inc. (Quadrant). Quadrant's principal was Thomas D. Hogan (Hogan). Hogan owned 80 percent of Oil Funds Management, Inc., which, in 1980, wholly owned Quadrant. Hogan also owned Oil Funds Investment, Inc., and TDH Consulting Corporation in 1980. The letters, TDH, are the initials of Thomas D. Hogan. Oil Funds Management, Inc., and its subsidiaries were acquired by Penn Pacific Corp. (Penn Pacific) in 1980. Penn Pacific owned the oil and gas lease that Willow was to acquire and exploit. The law firm of Kass & Fried, P.A. represented both Willow and Moeri. They prepared documents and rendered tax advice in connection with the Willow offering. They also represented Hogan's company, Quadrant. Mortimer Kass (Kass), an attorney with the firm Kass and Fried, P.A., was one of the Willow partners. b. Offering MemorandumA Willow prospectus and offering memorandum dated December 5, 1980, was prepared by Hogan's Oil Funds Investment, Inc. and Kass and Fried, P.A. and distributed to prospective investors. According to the offering, Willow was to raise $ 720,000 by selling 36 units at $ 20,000 each. An additional $ 500 per205 unit would be allocated for legal and organizational expenses. To purchase a unit, an investor was required to pay $ 10,000 in cash and $ 10,000 in the form of a promissory note due December 31, 1985. Willow could either negotiate the notes with an unaffiliated lender, or pay a portion of the turnkey drilling contract with the notes. The offering further stated that Willow did not have drilling sites, but that it was to acquire a drilling site or sites from Penn Pacific. Willow actually acquired drilling sites from Penn Pacific in August 1981. c. Partner ContributionsPetitioners made the following contributions to Willow in December 1980: CashNotesHolland$ 42,000$ 40,000Henderson$ 10,500$ 10,000Of the cash portion of petitioners' investments, $ 2,000 paid by Holland and $ 500 of the cash paid by Henderson represent legal expenses. The notes include the following provision: This Note is being delivered to the Partnership as partial payment for the Maker's purchase of a limited partnership interest in the Partnership. In consideration of the Partnership's agreement to accept payment by delivery of this Note in lieu of cash, the206 Maker hereby agrees that the Partnership shall have the unrestricted right to set off and apply, as a required prepayment hereunder, 75% of all amounts otherwise distributable to the Maker in his capacity as a limited partner of the Partnership. All prepayments shall be applied first to accrued but unpaid interest and then to principal. * * Partners Moeri, Hogan, and Kass contributed no cash to Willow. Instead, they contributed promissory notes similar to those contributed by petitioners, in the original principal sums of $ 20,000, $ 10,000, and $ 10,000, respectively. These notes were given by Moeri, Hogan and Kass to meet the stated contract price for three wells. On December 29, 1980, Willow assigned all limited partner notes, totalling $ 110,000, to K and S Associates, Inc. (K and S). K and S was partly owned by attorney Kass. Petitioners never made any payment of principal or interest on the notes held by K and S. K and S never made demand on the Willow limited partner notes that it held on behalf of Quadrant or its assignees. Willow filed an Amended Certificate of Partnership dated December 29, 1980, with the Secretary of State of Texas to reflect capital contributions207 of its partners. d. Turnkey Drilling ContractMoeri, for Willow, and Hogan, for Quadrant, executed a Willow turnkey drilling contract dated December 29, 1980. The specific terms of the turnkey drilling contract were determined by Hogan or Kass. Under the Willow turnkey contract, three wells were to be drilled. "Commercially productive" wells were required. The contract defines a commercially productive well as one that will generate net income sufficient to return its turnkey price of $ 94,000 (turnkey price per well) within three years. The turnkey contract also provided: In the event an initial well drilled pursuant to Paragraph 1 is not deemed to be commercially productive, the Driller shall be required to replace such well. In making such replacement: (1) the driller in its sole discretion may acquire on behalf of the Owner either drill sites, fractional working interests on other leasehold interests in prospective oil and gas properties anywhere in the continental United States; * * The contract also required the driller to obtain drilling risk insurance. The turnkey fee was $ 94,000 per initial well, including $ 79,000 to be paid at the execution of208 the contract. The driller was to begin drilling within 90 days, or be liable to Willow for $ 100 per day in liquidated damages. The turnkey contract also included a recital that Willow subleased three drilling sites. Under the turnkey contract Willow executed a nonrecourse promissory note in the amount of $ 45,000 ($ 15,000 each for 3 wells) to Hogan's company, TDH Consulting Corporation, on December 29, 1980, for tangible equipment and completion costs. e. The Money TrailOn December 31, 1980, Willow deposited $ 115,701.63 in its checking account at Valley Bank, El Paso, Texas. Of this amount, $ 115,000 represents cash contributions of the limited partners. Willow made several disbursements by checks dated December 31, 1980. Willow paid $ 90,636.37 to Hogan's company, Quadrant. That amount was deducted as IDCs. Willow paid $ 14,600 and $ 1,000 to Moeri as general partner. Willow paid $ 1,090.83 to Hogan's Oilfunds Investment, Inc., 5 as the cost of preparing the offering memorandum. Willow paid $ 1,000.11 to Kass' K & S Associates as interest on the notes. Willow paid $ 5,500 to Kass & Fried as legal fees. Willow paid $ 517 to T-Bird Travel, Inc., for Moeri's209 travel. Moeri's father-in-law, who withdrew as a limited partner after Willow's formation, received $ 100. A check for $ 1,200 was paid to the Texas Secretary of State for filing fees. Willow also executed a nonrecourse note to TDH Consulting Corporation in the original principal sum of $ 45,000 for tangible equipment and drilling costs. Of the $ 90,636 paid to Hogan's company, Quadrant, Quadrant apparently paid $ 6,200 to Hogan's TDH Consulting Corporation, but Hogan does not recall why. Willow transferred to Quadrant the $ 110,000 Willow received from K and S in exchange for the assignment of the limited partner notes and $ 90,636. Hogan does not know how Quadrant spent either the $ 110,000 or the $ 90,636 claimed as IDCs. Kass does not know how either the $ 110,000 or $ 90,636 claimed as IDCs was spent. There is no evidence in the record accounting for these sums. f. Income Tax ReturnsIn its Federal partnership tax return for taxable year 1980, Willow deducted $ 240,636210 in IDCs as follows: ITEMAMOUNTLimited Partners' Notes$ 110,000Check to Quadrant90,636Willow Note to Quadrant40,000Total$ 240,636Each petitioner's individual Federal income tax return was prepared by the certified public accounting firm of Peat, Marwick, Mitchell & Company. Petitioners relied on the prospectus in determining tax treatment. Petitioners Holland claimed $ 75,963 in deductions from Willow for taxable year 1980. Respondent allowed $ 2,662 in deductions for 1980 representing petitioners' share of deductible organizational expenses. Petitioners Henderson claimed $ 18,990 in deductions for 1980 from Willow. Respondent allowed $ 666 in deductions as the Hendersons' share of deductible organizational expenses. Respondent allowed Willow $ 80,212 for tangible drilling and development costs for taxable year 1981. g. The BusinessWillow's only activities in 1980 were to enter into contracts and to issue checks. It did not do any drilling or preparatory work in 1980. In January or February 1981, Quadrant subcontracted its Willow contract to Penn Pacific. Willow and Quadrant had intended at the time211 the turnkey contract was executed that it would be assigned to Penn Pacific by Quadrant. Quadrant was acquired by and became a wholly-owned subsidiary of Penn Pacific in December 1980 or sometime in 1981. In March 1981, Penn Pacific began drilling a well known as "Kopecek No. 1-5." Although Hogan advised Moeri in late April 1981 that the Kopecek No. 1-5 well was prepared to be completed and tied into the line, the Kopecek well continued to experience difficulties. On June 5, 1981, while having problems with the Kopecek well, Penn Pacific offered to furnish "sufficient production from wells in the Willow field" to Willow to complete the drilling program in lieu of drilling wells. This offer was rescinded two weeks later. On June 22, 1981, Moeri wrote to Penn Pacific demanding that Penn Pacific either "furnish sufficient production to replace KOPECEK #1-5" or "complete original well as contracted." By April 1982, the Kopecek No. 1-5 well was still not in production. Oilfunds Management, Inc., and its subsidiaries went into Chapter 11 bankruptcy sometime in 1981. Effective April 1, 1982, Penn Pacific purportedly assigned its rights in the operating agreement of the Kopecek 1-5 leasehold212 in Greer County, Oklahoma, to American Energy Corporation (AEC). Moeri was notified of this assignment in a letter from AEC dated September 28, 1982. The Kopecek No. 1-5 well was plugged by the State of Oklahoma on September 5, 1984. It was the only one of the three wells specified in the Willow prospectus which was drilled. The limited partners did not make any payment of interest or principal on their notes contributed to Willow. None of the petitioners received any demand or request for payment on any of their notes. No serious effort was made to collect on any of the notes made by Willow or by the partners. 2. Carnegie Drilling Ltd.The Carnegie partnership was operated and financed in much the same manner as Willow. Carnegie was syndicated by means of a limited partnership offering in late 1981. Its stated purpose was primarily to engage in development drilling for oil in Caddo County, Oklahoma. a. The PrincipalsIn addition to serving as general partner for the 1980 Willow and Fentress programs, Moeri was the general partner for the 1981 programs for Carnegie and for Caddo-Drilling, Ltd. Carnegie's driller was to be Command Petroleum Corporation (Command). 213 Oilfunds Investments, Inc., owned by Hogan, owned Command preferred stock. Hogan described himself as the chairman of Command, although he signed correspondence for Command in other capacities, such as president. Hogan also owned Security Oil and Gas, Inc., another entity that later became a Carnegie driller. The law firm of Kass & Fried, P.A., represented Carnegie. Although petitioner Crocker knew Moeri previously, none of the petitioners investing in Carnegie had ever done business with Moeri or any of the companies with which Carnegie did business. b. Offering MemorandumThe Carnegie offering memorandum given to petitioners, dated October 26, 1981, was substantially identical to the Willow memorandum. According to the prospectus, the partnership would offer up to 48 units at $ 20,000 per unit. Each unit required payment of $ 8,000 in cash and $ 12,000 in a series of notes payable in the principal sum of $ 4,000 on August 1, 1982, and $ 8,000 on December 31, 1986, subject to the terms stated therein. The offering also provided that Carnegie would pay $ 1,200 per unit for an "Initial Management Fee." Moeri was paid $ 75,600 for marketing the Carnegie offering. 214 At the time of the offering, Carnegie did not have a drilling site. According to the offering, the drilling site would be acquired from or through Hogan's company, Oilfunds Investment, Inc. It is not clear if and when Carnegie obtained rights to a drilling site. c. Partner ContributionsPetitioners characterized amounts contributed to Carnegie in December 1981, when the partnership was formed, as follows: Legal Fees andPetitioner(s)Cash PaymentOrganization CostsNotesCrocker$ 4,275$ 275$ 6,000Owen111,1507,150156,000Herman2,1371373,000Henderson17,0001,00024,000Thomas8,55055012,000The series of notes executed by petitioners were essentially identical. d. Turnkey Drilling ContractMoeri, for Carnegie, and Hogan, for Command, executed the turnkey drilling contract on December 30, 1981. The contract required Command to drill 21 wells in the Pontotoc formation to depths stated. It also required "commercially productive" wells to be produced by Command. The contract defines a commercially productive well as one that will generate net income sufficient to return215 its turnkey price of $ 62,500 (based on 21 wells) within 3 years. The turnkey contract also provided: In the event an initial well drilled pursuant to Paragraph 1 is not commercially productive, the Driller shall be required to replace such well. In making such replacement: (1) the Driller, with the consent of the General Partner, may acquire on behalf of the Owner either drill sites, fractional working interests on other leasehold interests in prospective oil and gas properties anywhere in the continental United States; (2) replacement property shall be no less than the Driller's actual cost of drilling, testing and completing an initial well, as contemplated herein; and (3) the percentage of production revenues payable to Owner and reasonable anticipated gross revenues to Owner from such replacement well shall not be less than those associated with, or anticipated from the initial well. * * * The contract also required the driller to obtain drilling risk insurance. The turnkey contract stated that Carnegie owned, as sublessee, drilling sites in Caddo County, Oklahoma. The contract called for Carnegie to pay Command $ 62,500 per well, of which $ 52,000 represented IDCs. 216 The required 21 commercially productive wells were never drilled by Command or any assignee. Four wells were drilled. Carnegie did not have any drill site acreage in 1981. Carnegie did not acquire any drill site acreage in Caddo County, Oklahoma, during 1981 or 1982. On April 6, 1983, Security Oil & Gas, Inc., assigned two wells in Pontotoc County, Oklahoma, to Carnegie. It is not clear whether the wells were drilled by others and purchased by Security for Carnegie, or whether they were drilled specifically for Carnegie. e. The Money TrailAs partial payment for the IDCs, Carnegie executed two promissory notes dated December 30, 1981, in the principal sums of $ 252,000 and $ 504,000. The notes state that no limited partner is personally liable for principal or interest except to the extent of the assumption of personal liability pursuant to the limited partnership agreement and to the extent of personal liability on promissory notes pledged as collateral. The partnership agreement provides that limited partners are directly liable for notes of the limited partners to the partnership for their capital contribution or to any assignee up to the amount of their capital217 contribution with no further liability, but not until receipt by the partnership of the proceeds of the limited partners' notes. In a document titled "Assignment Separate From Notes," Carnegie assigned to Command the $ 756,000 in limited partner notes. As of the date these cases were submitted, no payment of interest or principal had been made on any limited partner note given to Carnegie and assigned thereafter by Carnegie. Carnegie has not made any payment of principal or interest on its notes to Command as of the date these cases were submitted. K and S held the Carnegie limited partner notes as of the date these cases were submitted and had not initiated suit to collect on these notes. f. Income Tax ReturnsOn its 1981 income tax return, Carnegie deducted $ 1,102,500 in IDCs. This included promissory notes totalling $ 756,000, discounted to $ 735,000, and cash of $ 367,500. The cash was all of the cash contributions from limited partners. Carnegie also deducted $ 30,240 as management fees, and $ 11,150 as legal fees. Carnegie further deducted financing fees of $ 31,500, including $ 21,000 for the discount of the notes referred to above and $ 10,500. Each petitioner's218 individual Federal income tax return was prepared by the certified public accounting firm of Peat, Marwick, Mitchell & Company. Petitioners relied on the prospectus in determining tax treatment. All petitioners took their pro rata share of deductions claimed above. Respondent denied all deductions except for $ 323 for amortization costs. g. The BusinessAs required by the turnkey contract, Carnegie obtained drilling risk insurance on December 28, 1981. Carnegie did not have an active trade or business in 1981. It did not perform any drilling or preparatory work in 1981. By letter dated January 5, 1982, Oilfunds Investments, Inc., sent, among other things, a "copy of the * * assignments of leases from Command Petroleum Corp. to * * * Carnegie Drilling Ltd., which [has] not yet been filed" with an enclosure representing a purported assignment of an oil and gas lease from Command to Carnegie dated January 8, 1982. By letter dated May 11, 1982, Hogan, for Command, wrote Moeri to provide a "Status Report" on Carnegie, which included a description of "three alternatives" involving leases in Texas and Oklahoma. In an apparent letter agreement dated September 15, 1982, Carnegie219 and Command admitted that the wells to be drilled according to the turnkey contract had been "delayed" and Command offered to substitute certain wells for the wells to be drilled under the turnkey contract. By letter dated September 15, 1982, Command wrote to Moeri. Command claimed that "a new and proven replacement lease" had been agreed to be provided to Carnegie and asked Carnegie to make a payment on the note due August 1, 1982. By letter dated October 22, 1982, Carnegie agreed with Hogan's company, Security Oil and Gas (Security), that Security would assume the turnkey contract and that Security would drill certain wells based on the condition that the notes would be brought current. On October 29, 1982, Moeri wrote to Command, stating that he had "not received leases or any other information relating to the drilling" or "any reports" concerning the wells to have been drilled by Command. By letter dated November 11, 1982, and signed by Fred G. Luke, Field Management Company apparently agreed to assume, among other things, the Carnegie/Command drilling contract. By letter from Security to Moeri, dated April 21, 1983, Security represented that "two wells * * assigned220 to your limited partnership" were in production and that assignments and division orders would be forthcoming. Security enclosed an apparent assignment of two wells known as Lucy Harjo Nos. 101 and 115 from Security to Carnegie, dated April 6, 1983. In a letter from Security to Moeri, dated March 4, 1983, Security reported that four of the wells were in production with assignments to be made. Oil Field Management, Inc., did the actual drilling in 1983. According to a letter dated May 24, 1984, Security further assigned the Carnegie turnkey drilling contract to Reliance Petroleum Corporation (Reliance). Reliance claimed to hold the Carnegie contract as of the date of the letter. The letter also represents that Reliance understands its obligation to Carnegie to "assign three wells to Carnegie Drilling." By letter dated August 22, 1984, Reliance wrote to Moeri and enclosed documents evidencing the admission of Carnegie as a limited partner "in the Kansas Offset Program." In a letter dated August 14, 1985, to an investor, Moeri stated that Reliance assigned an interest in a partnership called "Kansas Offset Drilling Ltd." to Carnegie "to fulfill their initial drilling obligation. 221 " Security was wholly owned by Hogan during the years at issue. Hogan does not know how any of the $ 367,500 was spent by Command. None of the petitioners received any demand or request for payment with respect to any of the notes. OPINION I. Petitioners' Motion to Amend to Conform to ProofWe first address the Motions to Amend Petitioners [sic] to Conform to Evidence filed on behalf of petitioners Owen in docket No. 41476-86 and Henderson in docket No. 37014-87. The motions were filed when these cases were submitted. Petitioners Owen filed two petitions as a result of two notices of deficiency: (1) docket No. 41476-86, which alleges that respondent erred in disallowing a charitable contributions carryover for taxable year 1982 (neither Willow nor Carnegie was mentioned in the notice of deficiency for 1982); and (2) docket No. 39079-87, which alleges that respondent erred in determining a deficiency for taxable year 1981 by disallowing deductions associated with Carnegie. Petitioners Henderson filed one petition, docket No. 37014-87, which alleges that respondent erred in determining a deficiency for taxable year 1980 by disallowing deductions associated with222 Willow, and for taxable year 1981 by disallowing deductions associated with Carnegie. In the motions, petitioners Owen and Henderson seek to amend their petitions to claim that deductions which were originally claimed for Willow in 1980 and for Carnegie in 1981 should be allowed instead for Willow in 1981 and for Carnegie in 1982. In support of the motions, petitioners argue that they should be allowed to amend their petitions to conform to the evidence and to the position argued by respondent. This is based on respondent's position that Willow was not an operator in 1980 because it did not own a mineral interest until 1981, if at all; and Carnegie was not an operator in 1981, but may have become an operator in 1982 or later. Respondent claims surprise and prejudice if the motion to amend the pleadings is granted in that no attempt was made to disprove operator status for Willow in 1981 and for Carnegie in 1982 because those matters were not at issue. Rule 41(a) provides that parties may amend their pleadings only by leave of Court or by written consent of the adverse party; and that223 leave shall be given freely when justice so requires. Rule 41(a) also provides that no amendment which confers jurisdiction not otherwise conferred by the petition then on file shall be permitted. However, respondent concedes on brief that the Owens' petition in docket No. 41476-86 places taxable year 1982 before the Court. The Hendersons' petition, docket No. 37014-87, is from a notice of deficiency concerning adjustments for Willow in 1980 and Carnegie in 1981; thus both taxable years 1980 and 1981 are before the Court. Rule 41(b) provides in 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. The Court, upon motion of any party at any time, may allow such amendment of the pleadings as necessary to cause them to conform to the evidence and to raise these issues, but failure to amend does not affect the result of trial of these issues. Because the facts necessary to resolution224 of the issue were fully stipulated under Rule 122, we do not believe that respondent is prejudiced if the motion is granted. We will allow the pleadings to be amended so the Court may reach the issues to which stipulated facts relate. II. Intangible Drilling and Development CostsThe next issue for decision is whether Willow and Carnegie are entitled to deduct payments made for turnkey drilling contracts as IDCs. We have described a "turnkey contract" as: a contract in which an independent drilling contractor undertakes to furnish all materials and labor and to do all the work required to complete a well in a workmanlike manner, place it on production, and turn it over ready to "turn the key" and start oil [or gas] running into the tanks [or pipelines] for an amount stipulated in the contract. * * Burns v. Commissioner, 78 T.C. 185">78 T.C. 185, 188 n. 7 (1982). Section 263(c)6 allows taxpayers to elect to currently deduct, rather than capitalize, IDCs in the case of oil and gas wells and geothermal wells. Stradlings Building Materials, Inc. v. Commissioner, 76 T.C. 84">76 T.C. 84, 86 (1981); sec. 1.612-4, Income Tax Regs.225 (implementing section 263(c)). Each of the petitioners elected to deduct IDCs under section 263(c) in connection with his or her partnership in Willow and/or Carnegie. The deductions were disallowed by respondent. 226 Deductions are a matter of legislative grace and entitlement thereto must by shown by the taxpayer. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). Section 263(c) should be construed narrowly. Levy v. Commissioner, 732 F.2d 1435">732 F.2d 1435, 1436 (9th Cir. 1984); see Commissioner v. Jacobson, 336 U.S. 28">336 U.S. 28, 49 (1949); Holt v. Commissioner, 364 F.2d 38">364 F.2d 38, 40 (8th Cir. 1966), cert. denied 386 U.S. 931">386 U.S. 931 (1967). Petitioners have the burden of proof. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a). A. Operator Status1. Requirement of Ownership of an Operating InterestOnly an "operator" may deduct IDCs. Stradlings Building Materials, Inc. v. Commissioner, supra at 86; sec. 1.612-4(a), Income Tax Regs. An operator is "one who holds a working or operating interest in any tract or parcel of land either as a full owner or under a lease or any other form of contract granting working or operating interests." Stradlings Building Materials, Inc. v. Commissioner , supra at 86;227 sec. 1.612-4(a), Income Tax Regs.7A working or operating interest is generally the right to the mineral interest generated by an oil or gas lease where the lessee acquires the right to work on the leased property to search, develop, and produce oil and gas and where the lessee has the obligation to pay costs. 1 Polevoi, Federal Taxation of Oil and Gas Transactions, section 9.04, pp. 9-49-9-52 (1988). The regulations applicable to section 263(c) provide: In accordance with the provisions of section 263(c), intangible drilling and development costs incurred by an operator (one who holds a working or operating interest in any tract or parcel of land either as a fee owner or under a lease or any other form of contract granting working or operating rights) in the development of oil and gas properties may at his option be chargeable to capital or to expense. * * Included in this option are all costs of drilling and development undertaken (directly or through a contract) 228 by an operator of an oil and gas property whether incurred by him prior or subsequent to the formal grant or assignment to him of operating rights (a leasehold interest, or other form of operating rights, or working interest); * * Sec. 1.612-4(a), Income Tax Regs.The first quoted excerpt from the regulation gives operators the option to expense IDCs if they hold the requisite working or operating interest. The second quoted excerpt makes the expensing option available even if the formal grant of operating rights is made after IDCs are paid or incurred. In Haass v. Commissioner, 55 T.C. 43">55 T.C. 43 (1970), IDCs were allowed for partners who executed written documents after IDCs were paid, but who had earlier informally committed to buy an interest before the IDCs were paid. Following Haass, we will look for petitioners to show that there was at least an informal grant of an operating interest before IDCs were paid or incurred. As is discussed next, we find that petitioners have not shown the existence of an informal grant of operating rights when IDCs were paid or incurred. 2. Willow - Stipulation of FactsPetitioners229 did not address the issue of whether the partnerships were operators in their opening brief. In their reply brief petitioners argued that the stipulated facts establish that Willow and Carnegie owned property rights as sublessees of drilling sites and that this ownership qualifies them as operators. If Willow and Carnegie were sublessees of drilling sites, they would be operators. The only evidence noted by petitioners to support their contention that Willow and Carnegie were sublessees is a statement in the preamble of the Willow and Carnegie turnkey contracts. A copy of the Willow turnkey drilling contract is contained in the record, and the parties stipulated that the copy is true and correct. The preamble to the Willow turnkey contract states that Willow is sublessee of certain drilling sites. For reasons discussed below, we find that the stipulation to the correctness of the copy of the Willow turnkey contract is not a stipulation by the parties to the truth of the contents of the contract. Paragraph 4 of the stipulation of facts states: 4. Attached hereto and marked Exhibit 4 is a true and correct copy of the turnkey drilling contract between Willow Drilling, Ltd.230 and Quadrant Exploration, Inc., dated December 29, 1980. Exhibit 4, the Willow turnkey drilling contract, includes the statement: "Whereas, Owner [Willow] is sublessee of 3 drilling sites in Greer County, Oklahoma * * ." Petitioners offer no corroboration for the conclusion set forth in the statement. Petitioner argues that paragraph 4 is a stipulation by the parties to the facts asserted in Exhibit 4. We disagree based on our reading of paragraph 4 of the stipulation of facts and the other stipulations in these cases. Paragraph 4 of the facts merely establishes that Exhibit 4 is a true and correct copy of the turnkey drilling contract. Reference to paragraphs 1-3 of the stipulation of facts illustrates why we disagree with petitioner. Paragraph 1 similarly states that "attached is a true and correct copy of petitioners' tax returns." Stipulations do not mean the parties have stipulated to the correctness of the contents of the returns. Paragraphs 2 and 3 are similar. We cannot imagine that these paragraphs represent respondent's agreement to the correctness of the contents of the returns. Likewise, we do not believe respondent conceded the correctness of231 the assertions in the turnkey drilling contract by agreeing the copy was true and correct. Further, there is a stipulated fact in the record inconsistent with the assertion in the turnkey contract. Paragraph 6 of the stipulation of facts provides that: 6. Attached hereto and marked Exhibit 6 is a true and correct copy of an assignment of oil and gas lease which represents the interest which Willow owned and was obligated by Exhibit 4 to drill upon. Exhibit 6 is an apparently unrecorded assignment of an oil and gas lease to Willow, dated August 31, 1981. It represents the interest in the Kopecek lease in Greer County, Oklahoma, which Willow was obligated by the turnkey drilling contract to drill. The only well drilled under the Willow drilling contract was Kopecek 1-5. Except for the Kopecek lease, Willow had no other interest which could support a claim for operator status. In a letter dated May 10, 1982, Moeri wrote to Kass regarding Willow, stating, "On March 8th, 1981, our Partnership's first well (KOPECEK 1-5) had actually been drilled, but to this date has not been properly completed." Petitioners cite no evidence to show that this Penn Pacific assignment is a different232 interest than that claimed for Willow in 1980. Other than the turnkey contract, petitioners cite nothing to show that they had any interest in Kopecek before August 31, 1981. Moreover, the Penn Pacific assignment document of August 1981, is, we believe, entitled to more weight than the assertion in the preamble. Thus, Willow was not an operator before August 31, 1981. Respondent made no specific objection to the truth of the contents of the stipulated Willow turnkey drilling contract. In contrast, in several other stipulation paragraphs, respondent explicitly stipulated only to the authenticity of and not to the facts contained in an attached exhibit. However, we do not view this as a concession by respondent that the facts asserted in the turnkey contract are true. For the foregoing reasons, we find that petitioners have not carried their burden of proving that Willow owned a working or operating interest before IDCs were paid or incurred, or even in the same taxable year. 3. Carnegie - Deemed AdmissionThe Carnegie turnkey contract is not a part of the stipulation of facts. Instead, it is an exhibit to respondent's request for admissions which were deemed admitted233 under Rule 90 after petitioners failed to respond to respondent's request for admissions. For reasons discussed below we find that a statement in the preamble to the Carnegie turnkey contract which provides that Carnegie is sublessee of certain drilling sites does not prove that Carnegie was in fact a sublessee of the drilling sites where the turnkey contract is in evidence as an exhibit to a request for admission. Request for admission number 4 provides, "Attached hereto and marked Exhibit D is a true and correct copy of the turnkey drilling contract between Carnegie Drilling, Ltd. and Command Petroleum Corp., dated December 30, 1981." That turnkey contract executed on December 30, 1981, by Carnegie and Command, includes the statement: "Whereas, Owner is sublessee of drilling sites in Caddo County, Oklahoma, * * ." Rule 90(f) provides in pertinent part: (f) Effect of Admission. Any matter admitted under this Rule is conclusively established unless the Court on motion permits withdrawal or modification of the admission. * * Thus, while the authenticity of the Carnegie234 turnkey contract is conclusively established, the admission does not necessarily establish as a fact the recitals within the Carnegie turnkey contract. Our reasons are similar to those given above regarding the contents of the Willow turnkey contract. Further, the record includes evidence which is inconsistent with the Carnegie turnkey contract recital. The stipulation of facts indicates that the first attempt to assign an operating interest by Command to Carnegie occurred in January 1982. Moreover, a recorded lease was not delivered to Carnegie until April 1983. Unlike Willow, the record contains no stipulated assignment document for Carnegie. Accordingly, petitioners have not borne their burden of proving that Carnegie was an operator in 1981 or 1982. 4. Operator Status - ConclusionBecause Willow did not have operator status in 1980, the year IDCs were incurred, it is not eligible to elect to expense IDCs. Willow is not entitled to deduct IDCs for 1981 because payments were made in 1980. Sec. 1.461-1(a), Income Tax Regs.Similarly, because Carnegie did not have operator status in 1981, the year IDCs were incurred, or in 1982, it is235 not eligible to elect to expense IDCs . III. At RiskThe next issue for decision is whether the petitioners have any amount at risk in the Willow and Carnegie partnerships beyond their cash contributions. The at risk rules apply to oil and gas property as defined under section 614. Sec. 465(c)(2)(D). An investor's loss is limited to amounts at risk at the close of the taxable year in which the loss would otherwise be deductible reduced by losses allowed in prior years. Sec. 465(b)(5). A. Willow. Petitioners argue that the at risk rules of section 465 do not limit losses here because the notes they executed for Willow are recourse notes on their face. The Willow partnership agreement limited partners' liability to their capital contribution, including these notes. On December 29, 1980, the $ 110,000 of notes of the Willow partners were assigned to K and S. Thus, K and S became a creditor of the Willow partners. One of the partners was Mortimer Kass. He was also one of the owners of K and S. Thus, Kass had an interest as a creditor (through his interest in K and S), 236 and as a limited partner, and thus as an investor in Willow. Kass' law firm of Kass & Fried, P.A., represented both Willow and Willow's general partner, Moeri. They prepared documents and rendered tax advice in connection with the Willow offering. They also represented Hogan's company, Quadrant. Section 465(b)(3) provides that an investor is not at risk on a recourse note held by a creditor with an interest in the activity other than as a creditor. An extensive analysis for the reason for this rule is provided in Bennion v. Commissioner, 88 T.C. 684">88 T.C. 684, 697-698 (1987). In that case we said: Creditors who hold recourse obligations, but who also have certain other interests in the activity, might disregard their rights thereunder in favor of protecting or enhancing their other interests in the activity. In light of that eventuality and in spite of the otherwise recourse nature of the debt, taxpayers who owe recourse debt obligations to such creditors are not to be regarded as at risk with respect thereto. Bennion v. Commissioner, supra at 698.237 Thus, a creditor with an interest other than as a creditor would not act independently with respect to the debt. Petitioners' only argument to counter the prohibited creditor rule is that K and S received the Willow promissory notes as a result of a sale and not a loan; therefore, the prohibited creditor rule does not apply. We disagree. Petitioners offer no authority for their position. We note that petitioners refer to the assignment document as proof of a sale. It provides on its face: For Value Received, the undersigned Willow Drilling, Ltd. hereby sells, assigns, and transfers unto K&S Associates, Inc. without recourse, all right, title, and interest in and to the Promissory Notes of the Limited Partners of Willow Drilling, Ltd. in aggregate principal amount of $ 110,000, which are listed on Schedule "A" annexed hereto. We are not convinced that a sale occurred. Moreover, in light of the above-stated reason for the rule, even if some type of sale had taken place, K and S remains a creditor with a prohibited interest. We believe there was never any intent to enforce238 the recourse nature of the Willow notes. No demand was ever made for payment. There was no suit to enforce payment on the notes. We take this to show that the notes which were nominally recourse were never intended to be recourse. Porreca v. Commissioner, 86 T.C. 821">86 T.C. 821, 840 (1986). We suspect if any repayment was contemplated, it was not for more than any payments received from production on wells drilled for Willow. We note that the promissory notes provide that three-fourths of the production payments could go to payment of the notes. The presence of drilling risk insurance also affects the at risk question. The turnkey contract names the partnership as a co-owner of the drilling risk insurance. This gives the partnership and partners the right to receive proceeds of any claim paid on nonproductive wells. This feature was admittedly significant to the investors. A taxpayer is not at risk to the extent he is protected against economic loss by the purchase of insurance. Bennion v. Commissioner, supra at 692. Because the insurance company bore239 the risk of an initially unproductive well, not the partnership or partners, the limited partners were effectively protected against loss to the extent of the drilling risk insurance coverage. We note also that the Willow turnkey drilling contract further limits risk with a commercially productive well requirement which provides: The term "commercially productive" shall refer to an oil or gas well which, when tested prior to casing, is determined to be capable of producing sufficient quantities of oil or gas to return to Owner the turnkey price per well (as specified in Paragraph 2, hereof) within a thirty-six (36) month period commencing on the date oil or gas production begins. We hold that petitioners are not at risk beyond their cash contributions to Willow. B. Carnegie. The Carnegie partners executed notes that purport to be recourse. The partnership agreement limited the partners' liability to their capital contribution, including these notes. The notes were assigned to the driller, Command, in December 1981. There is no indication they were negotiated as opposed to assigned. The notes were not transferred to an independent lender. The notes were never converted240 into proceeds which could be used for Carnegie. Even the tax opinion in the Carnegie prospectus warns that, without transfer to an independent lender, use of funds in the partnership, and personal liability for the notes, the limited partners would not generally be at risk. No amounts were ever borrowed. Nor was there any effort to collect on the Carnegie notes. We conclude that the notes were shams. Capek v. Commissioner, 86 T.C. 14">86 T.C. 14 (1986). We hold that the Carnegie investors are not at risk beyond their cash contribution. IV. Deductions for Carnegie's Legal, Financing, and Management FeesExcept for docket Nos. 41476-86 (petitioners Owen) and 13374-87 (petitioners Holland) petitioners took deductions in taxable year 1981 for their distributive shares of legal, financial, and management fees. Respondent disallowed those deductions on the theory that petitioners have not shown that such fees were incurred as ordinary and necessary expenses while engaged in an active trade or business. Petitioners note that respondent could make the same argument with respect to Willow in 1980, but did not do so. We agree that it appears that Willow would be subject241 to the identical concerns, but since respondent, for whatever reason, did not disallow deductions for legal, financial, and management fees paid by Willow in 1980, we do not address the issue here. On brief, respondent argues, "Alternatively, if any of these expenses were properly incurred, their treatment is mandated by Section 709, resulting in amortization of organizational expenses and capitalization of other expenses." Petitioners concede that Carnegie's deductions for legal, financial, and management fees should not be deducted and adopt respondent's alternative position. We agree and so find. V. Additions to Tax Under Sections 6653(a)(1) and (a)(2)Respondent determined additions to tax for negligence under sections 6653(a)(1) and (a)(2) in docket Nos. 18050-87, 18052-87, 32313-87, 39079-87, and 37014-87 with respect to Carnegie. Section 6653(a)(1) imposes an addition to tax of 5 percent of an underpayment of tax if any part of the underpayment is due to negligence or intentional disregard of the rules and regulations. In addition, section 6653(a)(2) imposes a further addition to tax of 50 percent of the interest payable on the portion of the underpayment attributable242 to negligence. Except for docket Nos. 41476-86 (petitioners Owen; taxable year 1982) and 13374-87 (petitioners Holland; taxable year 1980), respondent determined that petitioners are liable for additions to tax for negligence or intentional disregard of rules and regulations pursuant to sections 6653(a)(1) and (a)(2). Petitioners bear the burden of proving that their underpayment of tax was not due to negligence. Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 860-861 (1982); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791-792 (1972); Soares v. Commissioner, 50 T.C. 909">50 T.C. 909, 914 (1968); Rule 142(a). Under section 6653(a), negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Marcello v. Commissioner , 380 F.2d 499">380 F.2d 499, 506 (5th Cir. 1967); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioners contend that they are not subject to the additions243 to tax under section 6653(a) because Federal income tax returns were prepared by the nationally known accounting firm, Peat, Marwick, Mitchell & Company, Certified Public Accountants, for all petitioners. As a general rule, the duty of filing accurate returns cannot be avoided by placing responsibility on a tax return preparer. Pritchett v. Commissioner, 63 T.C. 149">63 T.C. 149, 174-175 (1974); Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 802 (1972). However, good faith reliance on the advice of counsel or a qualified accountant can be, under certain circumstances, a defense to the addition to tax for negligence. Conlorez Corp. v. Commissioner, 51 T.C. 467">51 T.C. 467, 475 (1968). We have held taxpayers liable for additions to tax for negligence when they argued reliance on an attorney, accountant, tax advisor, or tax return preparer where there was no showing of the information that the taxpayer gave to the advisor. Enoch v. Commissioner, supra at 803; Pessin v. Commissioner, 59 T.C. 473">59 T.C. 473, 489 (1972); Lester Lumber Co. v. Commissioner , 14 T.C. 255">14 T.C. 255, 263 (1950). Petitioners did not provide any evidence244 as to the information that they gave to their accountants and lawyers. 8 Accordingly, we do not know what information and documents petitioners' accountants had to prepare the subject returns. Petitioners also argue that the additions to tax for negligence are avoided because they relied on the prospectuses provided by the promoters as would be expected of a reasonable, prudent person. We disagree. Each prospectus included several caveats with respect to the Federal income tax consequences of the transactions and included the warning, "Accordingly, each prospective Limited Partner is urged to consult his own tax advisor with respect to the Federal * * income tax consequences to him of his investment in the Partnership." Petitioners have failed to prove that respondent's determinations with respect to additions to tax under section 6653(a) are in error. They have not convinced us that any part of the underpayment was not due to negligence. Accordingly, we find that all of the underpayments are due to negligence except for docket Nos. 41476-86 and 13374-87. V. Additions to Interest Under Section245 6621(c)Except for docket Nos. 41476-86 and 13374-87, respondent determined that petitioners are liable for additional interest on an underpayment attributable to a tax-motivated transaction as defined in section 6621(c). Additional interest at the increased rate of 120 percent of the statutory rate imposed on underpayments is imposed on tax-motivated transactions under section 6621(c) with respect to interest accruing after December 31, 1984, regardless of when the return was filed. Section 6621(c) provides in pertinent part: (c) INTEREST ON SUBSTANTIAL UNDERPAYMENT ATTRIBUTABLE TO TAX MOTIVATED TRANSACTIONS. -- (1) In General. -- In the case of interest payable under section 6601 with respect to any substantial underpayment attributable to tax motivated transactions, the annual rate of interest established under this section shall be 120 percent of the underpayment rate established under this subsection. (2) Substantial Underpayment Attributable to Tax Motivated Transactions. -- For purposes of this subsection, the term "substantial underpayment attributable to tax motivated246 transactions" means any underpayment of taxes imposed by subtitle A for any taxable year which is attributable to 1 or more tax motivated transactions if the amount of the underpayment for such year so attributable exceeds $ 1,000. (3) Tax Motivated Transactions. -- (A) In General. -- For purposes of this subsection, the term "tax motivated transaction" means -- * * * (ii) any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8), * * * (v) any sham or fraudulent transaction. The additional interest applies after December 31, 1984, even if the transaction was entered into before that date. Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). As discussed above, losses were disallowed by reason of section 465(a). Thus, section 6621(c) is applicable. In accordance with the foregoing, Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: John A. Holland and Clo R. Holland, docket No. 13374-87; Charney Hermann, docket No. 18050-87; Robert Crocker and Bobby Crocker, docket No. 18052-87; John P. Thomas, III and Polly A. Thomas, docket No. 32313-87; Donald S. Henderson and Marjorie L. Henderson, docket No. 37014-87; Frank Owen and Marianne Owen, docket No. 39079-87.↩2. All section references are to the Internal Revenue Code, as amended and in effect for the years at issue, unless otherwise noted. All Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩3. In docket No. 18052-87, petitioners' income tax return for the year at issue showed $ 1,900.92 owed in tax. This amount was incorrect due to a math error. Petitioner was assessed tax in the sum of $ 1,890. Petitioner was paid a refund of $ 3,182.78 instead of $ 3,171.86 which was the refund shown to be paid on the return. * These amounts reflect additions to tax under section 6653(a)(1)↩.4. The only issue in docket No. 41476-86 was whether petitioners Frank and Marianne Owen were entitled to a charitable contributions carryover for taxable year 1982. Respondent disallowed the carryover in the statutory notice of deficiency. No additions to tax were determined. The petition in that case alleged as error the disallowance of the charitable contributions carryover. Petitioners did not address this issue in either of the briefs that they submitted in these cases. Accordingly, we find that petitioners have abandoned this issue.↩5. Oilfunds Investments, Inc., as is used in the Exhibits, and Oil Funds Investments, Inc., as is used in the stipulations of fact, both being owned by Hogan, are treated as the same entity.↩6. Section 263(c) provides: (c) INTANGIBLE DRILLING AND DEVELOPMENT COSTS IN THE CASE OF OIL AND GAS WELLS AND GEOTHERMAL WELLS. -- Notwithstanding subsection (a), regulations shall be prescribed by the Secretary under this subtitle corresponding to the regulations which granted the option to deduct as expenses intangible drilling and development costs in the case of oil and gas wells and which were recognized and approved by the Congress in House Concurrent Resolution 50, Seventy-ninth Congress. Such regulations shall also grant the option to deduct as expenses intangible drilling and development costs in the case of wells drilled for any geothermal deposit (as defined in section 613(e)(3)↩) to the same extent and in the same manner as such expenses are deductible in the case of oil and gas wells.7. See also Hutchinson v. Commissioner, T.C. Memo. 1980-551↩.8. See Samp v. Commissioner, T.C. Memo. 1981-706↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622747/	Peter R. and Joan B. Shibley v. Commissioner.Shibley v. CommissionerDocket No. 5094-69.United States Tax CourtT.C. Memo 1971-139; 1971 Tax Ct. Memo LEXIS 194; 30 T.C.M. (CCH) 597; T.C.M. (RIA) 71139; June 15, 1971, Filed Lyman T. Burgess, for the petitioners. Joel Gerber, for the respondent. RAUMMemorandum Findings of Fact and Opinion The Commissioner determined deficiencies and additions to tax in petitioners' income tax as follows: Addition to Tax,Sec. 6653(a),YearDeficiencyI.R.C. 19541965$ 2,013.94$100.69196613,697.44684.87The principal issue is whether two apartment houses owned by petitioner Peter R. Shibley195 were held "primarily for sale to customers in the ordinary course of his trade or business" within the meaning of section 1221, I.R.C. 1954, with the consequence that gain upon sale would be treated as ordinary income rather than capital gain. Findings of Fact The parties have filed a stipulation of facts which, together with accompanying exhibits, is incorporated herein by this reference. The petitioners, Peter R. and Joan B. Shibley, are husband and wife. They filed joint Federal income tax returns for calendar years 1965 and 1966 with the district director of internal revenue at Boston, Massachusetts, and resided in Agawam, Massachusetts, at the time the petition in this case was filed. Petitioners reported their income and deductions for the years in issue on the cash method of accounting. For a number of years prior to 1964 and until October, 1967, petitioner Peter R. Shibley ("Shibley") was in the business of selling used automobiles. It was a small used car sales business and he "never handled more than six or seven $200 or $300 cars" at any one time. He operated the business on a lot at 721 Springfield Street in Agawam, Massachusetts, a suburb of Springfield. In late196 1963 Agawam had a population of around 12,000 to 14,000 people and Springfield Street was one of the two major streets in the town. Although Shibley originally leased the lot at 721 Springfield Street for a term of five years this lease had expired 598 by late 1963 and he continued to lease the property thereafter on a month to month basis. Shibley believed that the person from whom he leased the lot on which he conducted his used car business intended to build a shopping center on the land. Because he wanted to maintain his used car business on the same street, he purchased another lot in late 1963 at 619 Springfield Street for $2,200. When he purchased this lot, it was his intention to move his business on to this property if he should be forced to vacate 721 Springfield Street. However, about seven or eight months after purchasing the lot at 619 Springfield Street, Shibley decided to build a small apartment building on the vacant property instead. At that time he thought that an apartment house was a good investment because of the rentals which such property returned. Construction of the apartment building began in May or June, 1964, and Shibley acted as his own general contractor.197 It was completed in October, 1964, and as completed the apartment building ("Stockdale Apartments") consisted of ten fully furnished efficiency apartments. Shibley financed the building through a long-term mortgage loan obtained from a bank. A provision of the mortgage loan required Shibley to pay a penalty to the bank if he sold the property within four years after completion of the building. This provision was intended to protect the bank against an early loss of the mortgage loan because of the possible refinancing of the property by the purchaser with another institution. In December, 1964, about two months after completion of the Stockdale Apartments, Shibley purchased another lot at 873 Springfield Street for $7,500. At the time he purchased this lot he understood that a permissible use of the land, under the applicable zoning laws or regulations, was for business purposes, and he also intended to use this lot in his used car sales business. After purchasing the property he made inquiries of a member of the Board of Selectmen of Agawam about the possibility of using the property for a used car lot. He was told that the previous owner had made a similar request and was refused198 permission. As a result Shibley made no formal application of his own to the Board of Selectmen concerning such use of the land. During the period when he was building the Stockdale Apartments Shibley devoted most of his time to the project, though he did continue in the used car sales business as well. After the building was completed management of the apartment house also occupied much of his time. Shibley thought that a second apartment building would allow him to "get out of the car business and just be in the apartment business." Accordingly, in 1965 he built a 28-unit apartment on the vacant lot at 873 Springfield Street. This building was completed in November, 1965. He again acted as his own general contractor, and also financed this building in the same manner as the Stockdale Apartments. When it was completed, the apartment building ("Town Crier Apartments") consisted of about 20 fully furnished efficiency apartments and several fully furnished, small, one-bedroom apartments. During the construction of the Town Crier Apartment building in 1965 Shibley again was required to devote most of his time to the project. While he was building and operating the two apartment buildings199 Shibley regarded himself as being, and was in the "apartment business" - the ownership and management of apartments. However, management of the buildings presented many difficulties with which Shibley found himself unable to cope. Moreover, during the period of time that he owned the Stockdale Apartments he incurred a loss in its operation of $369. He had net rental income of $2,875 in 1965 from the Town Crier Apartment building; but he sustained a $3,040 net loss in 1966 on that property prior to its sale as hereinafter set forth. Sometime before August, 1965, while he was involved in construction of the Town Crier Apartments, Shibley was approached by a real estate agent named Binda about selling the Stockdale Apartments. Shibley indicated to Binda that he was interested in selling the property, and after some negotiations with a prospective buyer, he sold the property in August, 1965, 1 for $66,592, and the furnishings within for $5,040. One provision of the sales agreement required that Shibley have the building 599 fully rented at the time of the sale. Shibley took no active part himself in seeking out a purchaser for the property. He placed no signs on the building indicating200 that it was for sale, nor did he otherwise personally advertise for the sale of the property. Sometime in January or February, 1966, Shibley was approached by another real estate agent named Kenneth Foot ("Foot") concerning the sale of the Town Crier Apartments. Shibley indicated that he would be willing to sell "if the price was right." He also gave Foot permission to advertise the property as well as to show it to prospective buyers. However, Shibley did not permit any "For Sale" signs to be placed on the property because he felt such signs detracted from the appearance of the apartment building. He took no active part himself in seeking out a purchaser for the property. He did not seek out Foot originally, nor did he ever consult any other real estate broker concerning the sale of this property. Moreover, he never personally advertised in any manner that the property was for sale. Around201 April Shibley received a formal offer on the property which was acceptable to him. However, before entering into a contract for the sale he communicated with his accountant and inquired about the tax consequences of selling the property. The accountant advised Shibley that if he held the property for more than six months any gain realized would qualify for capital gain treatment. In April Shibley entered into a sales agreement for the apartment building and the purchaser gave a deposit on the property to Foot, but the sale did not become effective immediately. Then on May 9, 1966, more than six months after the apartment building had been completed, Shibley concluded the sale of the Town Crier Apartments for $209,000 and the furnishings within for $30,000. 2Shibley's reason for selling both the Stockdale Apartments and the Town Crier Apartments stemmed from his dissatisfaction with the problems of apartment202 house management, and he has not thereafter built or operated any more apartment buildings. At the time Shibley owned the lots at 619 and 873 Springfield Street and the apartment buildings thereon, the Stockdale and Town Crier apartments, respectively, he owned his own home and had two other investment interests which involved real estate held for rental purposes, as follows: (1) Since 1957 (and at least until the time of the trial herein), Shibley and his brother owned all the stock in the Shibley Realty Corporation, which owned a commercial building containing three separate stores from which it earned rental income. (2) Sometime in 1965 or 1966 Shibley purchased a lot on Main and Reed Streets in Agawam on which he subsequently built a "professional" office building in association with another person; Shibley purchased the land and built the office building as an investment, and he and his associate still owned the property at the time of the trial herein. Aside from these investments made either before or during the period when he owned the apartment houses, Shibley engaged in several real estate transactions after he sold both the Stockdale and Town Crier Apartments. Sometime203 in late 1966 or 1967 he purchased a vacant lot in Westfield, Massachusetts. The lot was zoned for a business use and at one time Shibley considered constructing a motel on the land but never did so. He continued to own the property at least until the time of the trial herein. In addition, sometime in 1966 or 1967 Shibley purchased a "house lot" on James Street, also in Westfield, with the intention of some day building a house thereon for his own use. However, after he retired from the used car sales business in October, 1967, he decided instead to use the lot in the construction of a house which he would hold for sale. Beginning with this one house in late 1967 or early 1968, Shibley then went into the business of building and selling houses. In 1968, he purchased three more lots in Westfield and built a house on each which he held for sale. Also in 1968, Shibley, acting as a general contractor, built one house in another community. In all, he built and sold, or merely constructed as a contractor, five or six houses from late 1967 until the end of 1969. During this period Shibley regarded himself as a "builder" of homes. Similarly, he regarded the income he derived therefrom as204 ordinary income, and reported it as such on his income tax returns. 600 On their 1965 tax return petitioners reported $8,152 as a long term capital gain arising out of the sale of the Stockdale Apartments, and no gain or loss in connection with the sale of the appurtenant furnishings. Petitioner reported long term capital gains on their 1966 return of $50,702 from the sale of the Town Crier Apartments and $10,146 from the sale of the appurtenant furnishings. Shibley has executed a partial agreement with the Commissioner in which he agreed that the basis of the Stockdale Apartments was overstated on the 1965 return and that the basis of the Town Crier Apartments was overstated on the 1966 return. Pursuant to the partial agreement he has paid taxes for 1965 and 1966 in the respective amounts of $2,413.04 and $14,937.62. He has also paid additions to tax under section 6653(a), I.R.C. 1954, for 1965 and 1966 in the respective amounts of $120.65 and $746.88. 3205 In his deficiency notice the Commissioner determined that the gain realized by Shibley from the sale of the Stockdale Apartments in 1965 and the Town Crier Apartments in 1966 along with the furnishings within were taxable as ordinary income rather than capital gain. The Commissioner further determined that additions to tax should be assessed under section 6653(a), I.R.C. 1954, for underpayments of tax in 1965 and 1966 "due to negligence or intentional disregard of rules and regulations". Opinion RAUM, Judge: Petitioners reported gains realized by Peter R. Shibley from the sale of two apartment houses - one in 1965 and another in 1966 - as capital gains on their 1965 and 1966 income tax returns. The Commissioner determined that the gains in question constituted ordinary income. The issue turns on whether the apartment buildings, together with the lots and furnishings, were "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business" (as argued by the Commissioner) within the meaning of section 1221, I.R.C. 1954. The question is resolved by determining the relationship of the property sold to Shibley's trade or business. If, on206 the one hand, it was in the ordinary course of Shibley's trade or business to build and sell apartment houses and these particular apartment houses were held by him for that purpose, then these gains represent ordinary income. If, on the other hand, the two apartment houses were either "capital assets" (section 1221) or "property used in the [taxpayer's] trade or business" (section 1231) then the treatment of gain is governed by sections 1201 and 1202, I.R.C. 1954. The question whether property is held primarily for sale to customers in the ordinary course of a taxpayer's trade or business is entirely factual, and each case must be examined with reference to its own circumstances. Randolph D. Rouse, 39 T.C. 70">39 T.C. 70, 76; S. O. Bynum, 46 T.C. 295">46 T.C. 295, 299; Royce W. Brown, 54 T.C. 1475">54 T.C. 1475, 1487, on appeal (C.A. 10). A number of factors have been taken into account in the resolution of this factual issue. See, e.g., Robert W. Pointer, 48 T.C. 906">48 T.C. 906, 915-916, affirmed 419 F. 2d 213 (C.A. 9); Maddux Construction Co., 54 T.C. 1278">54 T.C. 1278, 1284. However, no single factor is determinative. Ralph J. Oace, 39 T.C. 743">39 T.C. 743, 747;207 Royce W. Brown, supra; Maddux Construction Co., supra.Furthermore, whether property is held primarily for sale to customers in the ordinary course of a taxpayer's trade or business depends on whether it was "principally" held for that purpose. Malat v. Riddell, 383 U.S. 569">383 U.S. 569, 572. It would serve no useful purpose to engage in a detailed explication of the factors considered in the many cases in this area. It is sufficient to state that we have carefully considered all the evidence and that it is our conclusion that the apartment properties were not held by Shibley for sale to customers in the ordinary course of his trade or business. Shibley originally purchased the lot at 619 Springfield Street for use in his used car sales business. Subsequent to the purchase of the lot, however, he decided that contruction of an apartment building (the Stockdale Apartments) on the vacant land would be a good investment. He purchased the second lot at 873 Springfield Street for the same purpose he had originally purchased the first lot - for use in his business of selling used automobiles. Because 601 struction and management of the Stockdale Apartments208 consumed so much of his time he decided instead to build an even larger apartment building (the Town Crier Apartments) on the second lot and thereby to enter into what he termed the "apartment business" - the ownership and management of apartments. Eventually, he discovered that he was unable to cope with the problems of either the investment in or the business of apartment house ownership. Though he did not solicit for the sale of either the Stockdale or Town Crier Apartments, he was willing to sell each apartment house when approached by a real estate agent because of the difficulties he had experienced. He never again built, owned or sold any other apartment buildings. We are satisfied that he did not hold these properties for sale in his trade or business. Shibley originally held the lots in question for use in his used car sales business. Later he held the apartment houses, which he had constructed on the lots, for investment purposes. And still later he entered into the "apartment business" and held the property for use in the business of owning and managing such "income-producing" property. It is unncessary to decide whether Shibley's ownership and management of the apartment209 buildings constituted a "trade or business" for all the purposes of section 1231. See M. A. Paul, 18 T.C. 601">18 T.C. 601, 603, vacated on another point, 206 F. 2d 763 (C.A. 3); Rosalie W. Post, 26 T.C. 1055">26 T.C. 1055, 1056-1057, 1060-1061. Nor is it necessary to decide at which particular moments in time his investment and business-use purposes began and ended. On these facts it is sufficient to state that at no time did Shibley hold the properties principally, or at all, "for sale to customers in the ordinary course of his trade or business" within the meaning of sections 1221 and 1231. Cf. Camp Wolters Enterprises, Inc., 22 T.C. 737">22 T.C. 737, 754, affirmed 230 F. 2d 555 (C.A. 5), certiorari denied, 352 U.S. 826">352 U.S. 826. Moreover, Shibley's other real estate related interests at the time he owned the Stockdale and Town Crier Apartments were also rental properties. It was only after he sold the two apartment houses in 1965 and 1966 and left the used car sales business in October 1967, that he engaged in the business of building and selling houses. The apartment houses were not part of his subsequent business of selling real estate, the gains210 from which he did report as ordinary income. See Heller Trust v. Commissioner, 382 F.2d 675">382 F. 2d 675, 679-680 (C.A. 9), reversing 24 T.C.M. (CCH) 1663">24 T.C.M. 1663, and 25 T.C.M. (CCH) 634">25 T.C.M. 634; cf. Randolph D. Rouse, supra, 39 T.C. 70, 76. Because we have decided that the apartment houses in question were not property held for sale in the ordinary course of Shibley's trade or business, it is unnecessary to reach the question of the section 6653(a) additions to tax determined by the Commissioner. Decision will be entered under Rule 50. Footnotes1. Shibley was not required to pay the penalty under his mortgage loan for selling the property within four years (see p. , supra) because the apartment building was refinanced by the same bank. He did pay approximately $2,500 to Binda as a commission for selling the Stockdale Apartments.↩2. The record does not disclose whether Shibley was required to, and in fact did pay any penalty under his mortgage loan (see pp. - and , supra) for selling the property within four years. He did pay $10,000 to Foot as a commission for selling the Town Crier Apartments.↩3. Subsequent to these payments made under the partial agreement Shibley has also paid tax and an addition to tax for 1965 in the respective amounts of $126.70 and $6.34, and for 1966 in the respective amounts of $321.71 and $16.09.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622749/	CHARLIE DAVID PRUITT AND CLARICE PRUITT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPruitt v. CommissionerDocket Nos. 12863-90, 21986-90United States Tax CourtT.C. Memo 1991-398; 1991 Tax Ct. Memo LEXIS 427; 62 T.C.M. (CCH) 491; T.C.M. (RIA) 91398; August 14, 1991, Filed 427 Decision will be entered under Rule 155. Charlie David Pruitt and Clarice Pruitt, pro se. Scott D. Anderson, for the respondent. DINAN, Special Trial Judge. DINANMEMORANDUM OPINION These cases were heard pursuant to the provisions of section 7443A(b) and Rules 180, 181, and 182. 1Prior to trial these cases were consolidated for trial, briefing, and opinion. Respondent determined the following deficiencies in and additional to petitioners' Federal income taxes: Additions to TaxYearDeficiency§ 6653(a)(1)(A)§ 6653(a)(1)(B)1985$ 627.00----19863,411.00$ 171.0019872,998.00----428 Concessions having been made by the parties, the issues presented for decision are: (1) Whether the notice of deficiency for 1985 was timely issued; and (2) whether interest on the deficiency to be redetermined for 1987 may be abated in part. Some of the facts have been stipulated. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioners resided in Rustburg, Virginia, at the time they filed their petitions. The first issue for decision is whether the notice of deficiency was timely issued for the tax year 1985. Petitioners filed a Form 5213 (Election To Postpone Determination as To Whether the Presumption That an Activity is Engaged in for Profit Applies) on April 14, 1988. On said form petitioners identified the tax year 1985 as the first year in which they engaged in the activity in respect of which they elected to postpone a determination. Petitioners contend that the Form 5213 was filed as a result of incorrect advice given by an Internal Revenue Service employee. In particular, Mrs. Pruitt testified that she went to a local Internal Revenue Service office to obtain a Schedule F. At the office, Mrs. Pruitt claims that one of 429 respondent's employees told her that if she filed a Form 5213 she would be temporarily relieved from audit and allowed an automatic extension. Petitioners claim that they acted on the basis of this advice and that they were never informed that the filing of the Form 5213 would extend the statute of limitations. As a result, they argue that the notice of deficiency for 1985 was issued after the statutory period expired. Section 6501(a) generally provides that respondent may assess deficiencies in income tax within three years after the return is filed. In this case, petitioners timely filed their 1985 return. Accordingly, the period of limitations applicable to the assessment of tax pertaining to petitioners for the year 1985 would expire three years from the return due date of April 15, 1986, see section 6501(b)(1), unless there is an exception which extends the period of limitations. Respondent argues that the period of limitations was in fact extended pursuant to section 183. Section 183 contains one of the exceptions to the general three year statute of limitations found in section 6501(a). In particular, section 183(e) allows a taxpayer to elect to postpone a determination430 as to whether the presumption that an activity is engaged in for profit applies. Further, section 183(e)(4) provides that the statutory period for assessment of a deficiency attributable to such an activity will not expire before 2 years after the date for filing a return for the last taxable year in the period of years to which the election applies. As noted earlier, petitioners made such an election on April 14, 1988. The election applies to certain horse-related activities in which petitioners have engaged since 1985. Since petitioners were engaged in the breeding and training of horses, the period of years to which the election relates is a 7-year period beginning in 1985, the first year of the activity, and expiring in 1991. Section 183(e)(2). Accordingly, since the date on which a return for 1991 must be filed (without extensions) is April 15, 1992, the time for assessing a deficiency with regard to any of the years which are included in the election was extended 2 years therefrom, or until April 15, 1994. Section 183(e)(4). The notice of deficiency issued to petitioners with respect to their 1985 income tax liability was issued on July 30, 1990. While this date is 431 past the normal 3-year limitations period of section 6501(a), it is well within the April 15, 1994, time frame allowed by section 183(e). Petitioners' argument that they should not be subject to this extension of the period for assessing a deficiency provided by section 183(e) is not persuasive. While petitioners claim that they received advice from an Internal Revenue Service employee concerning Form 5213 which was questionable, they do not offer any other reason why we should disregard the lawful effect of their filing of the election. Further, petitioners have offered no explanation for their failure to read or understand the clear language of the Form 5213 which they filed. While the record only contains the front side of the Form 5213 which petitioners filed, we take judicial notice of that language which is expressed on the back side of the form. Included in the explanations on the back of the Form 5213 is one with the heading, in bold print, "Automatic Extension of Period of Limitations." Following this heading the form explains in detail, and by way of example, the impact that the election will have upon the statute of limitations for issuing a deficiency notice. The 432 language explaining the extension of the period for assessing a deficiency is clear and is contained on the form which petitioners filed. As a result, we find there are no grounds for petitioners' claim that they did not understand the impact of the filing of the election. Therefore, we conclude that the notice of deficiency was timely issued for the year 1985. The last issue for decision is whether interest on the deficiency to be redetermined for 1987 may be abated in part. Petitioners request that a portion of the interest which has accumulated on any deficiency for which they might be liable for the year 1987 be abated. Petitioners' argument is predicated upon activities of respondent which petitioners claim were dilatory in nature. Specifically, petitioners claim that respondent delayed the determination of their liability by refusing to meet with petitioners to discuss and settle the issues in an orderly manner. Generally, this Court has no jurisdiction to determine interest on a deficiency redetermined by it. . However, there are limited circumstances in which we do have jurisdiction over issues involving433 interest. . This case does not present such limited circumstances, and we do not have jurisdiction over the interest applicable to the deficiency to be computed under Rule 155. Decisions will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩*. 50% of the interest due on the amount of the deficiency.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622750/	C. L. STARR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Starr v. CommissionerDocket No. 12739.United States Board of Tax Appeals9 B.T.A. 886; 1927 BTA LEXIS 2490; December 27, 1927, Promulgated 2490 Petitioner contracted to sell real estate for an amount greater than cost to him, but received in cash an amount less than cost, the balance to be paid in subsequent years. The contract had no readily realizable market value. Petitioner held entitled to recover the cost of the property before any taxable gain arises. I. F. Phipps, Esq., for the petitioner. Warren F. Wattles, Esq., for the respondent. ARUNDELL886 A deficiency in income taxes for the calendar year 1923 in the amount of $1,675.19 has been determined by the Commissioner. FINDINGS OF FACT. During the year 1920 petitioner purchased certain timber lands situated in Lincoln County, Oregon. The total cost of the lands, including the cost of abstracts, filing fees and miscellaneous expenses, was $24,166.30. 887 On March 1, 1923, petitioner entered into a contract for the sale of these timber lands to the Multnomah Lumber & Box Co. of Portland, Oreg. The contract reads as follows: THIS AGREEMENT, made and entered into on this 1st day of March, A.D., 1923, by and between C. L. Starr and Hallie E. Starr, his wife, herein called the parties of the first part, 2491 and Multnomah Lumber and Box Company, a corporation, incorporated, organized and existing under and by virtue of the laws of the State of Oregon, herein called the party of the second part, witnesseth: That the parties of the first part for and in consideration of the convenants and agreements hereinafter contained, agree to sell unto the party of the second part that certain real property situate in the County of Lincoln and State of Oregon, described as follows, to-wit: [Description of the land] for the sum of Sixty Thousand ($60,000) Dollars in United States gold coin to be paid at United States National Bank, Portland, Oregon, as follows: Twenty-Three Thousand ($23,000) Dollars in cash, the receipt whereof is hereby acknowledged; Eighteen Thousand Five Hundred ($18,500) Dollars on or before June 1, 1924, and the further sum of Eighteen Thousand Five Hundred ($18,500) Dollars on or before January 1, 1925; deferred payments to bear interest from the date hereof at the rate of six and one-half per cent per annum, payable annually. It is understood by the parties that portions of said described premises are encumbered by certain mortgages and taxes, which encumbrance the parties2492 of the first part agree to pay out of the aforesaid cash payment. The parties of the first part agree that when full payment and performance shall have been made by the party of the second part, as herein provided, they will make, execute and deliver to the party of the second part, its successors and assigns, a good and sufficient warranty deed, conveying all of the above described real property subject to any taxes existing against said premises subsequent to the taxes assessed for the year 1922, it being understood and agreed that the party of the second part shall pay the taxes assessed against said premises for the year 1923, and also all subsequent taxes against said property. It is further understood and agreed that the parties of the first part shall retain the possession of said premises until said consideration shall be fully paid, and that if the party of the second part shall undertake to go upon said premises and cut and remove any timber therefrom before said consideration shall be fully paid, the balance of said consideration shall, at the option of the parties of the first part become immediately due and collectible. It is further understood and agreed between2493 the parties hereto that time is of the essence of this contract, and in case the party of the second part shall fail to make the payments above named, and each and every one of them punctually, within thirty days of the time limited and such default shall continue for a period of thirty days, then this agreement shall become null and void, and all rights and interests created or then existing in favor of the party of the second part as against the parties of the first part hereunder, or to any payments theretofore made, pursuant to this agreement shall utterly cease and determine, and any and all rights acquired by the party of the second part hereunder shall revert to and revest in the parties of the first part, without any act by them or either of them to be performed, and without any right of the party of the second part of return, reclamation or compensation for moneys paid on account of the proposed purchase or sale of said property, as absolutely, fully and perfectly as if this contract and such payments had never been made. 888 IN WITNESS WHEREOF, the parties of the first part have hereunto set their hands and seals, and the party of the second part, pursuant to a2494 resolution of its Board of Directors, duly and legally adopted, have caused these presents to be executed by its President and Secretary and its corporate seal to be hereto affixed the day and year first above written. C. L. STARR (SEAL) HALLIE E. STARR (SEAL) MULTNOMAH LUMBER AND BOX COMPANY By F. A. DOUTY, Its PresidentMULTNOMAH LUMBER AND BOX COMPANY By H. G. PLATT, Its SecretaryMade, Executed and delivered in the presence of: M. A. ZOLLINGER GERTRUDE ZOLLINGER As to C. L. Starr and Hallie E. Starr.C. B. ADAMS L. M. HENNING As to Second Party.Under the terms of the contract petitioner agreed to sell and convey title to the property to the Multnomah Lumber & Box Co. upon payment by the latter of the sum of $60,000. Petitioner was well acquainted with the affairs of the Multnomah Lumber & Box Co. and believed at the time the contract was made that the company was assuming more obligations than it could successfully bear. By reason of this fact and as a protection to himself petitioner required the payment to him in cash, at the time of the execution of the contract, of $23,000, of which amount it was understood between the parties2495 that $11,700 was to be used by petitioner for the purpose of effecting payment of outstanding encumbrances against the land. This amount was in fact so used by petitioner for that purpose within a few days after its receipt. Under the terms of the contract petitioner retained legal title to and possession of the timber lands described herein and the purchaser had no right of possession or use of the premises in any manner whatsoever until the final payment of the purchase price was made. Petitioner was required to deliver to the purchaser his warranty deed conveying the premises to the purchaser only upon payment of the entire purchase price. The contract has never been fully performed and the purchaser has never been given title to nor possession of the property. Petitioner made several efforts to sell the contract, but was unable to secure a purchaser. He offered the contract for sale to men of ample means who were familiar with the value of the lands and were able to purchase the contract. He attempted to borrow money upon the contract, but was unable to secure a loan upon the security 889 of the contract. The doubtful financial responsibility of the purchaser2496 under the contract, the danger from fire upon the property due to the presence of logged-over lands in the vicinity of the timber lands covered by the contract and the fact that the sale price of the timber lands was greater than the intrinsic value of the lands were largely responsible for lack of a market for the contract. In his original income-tax return for the year 1923 petitioner reported income from the sale of these lands in an amount representing a proportionate part of the total profit to be derived from the entire transaction upon the payment actually received by him in 1923. The Commissioner held that the transaction entered into in 1923 was a completed one and that the entire profit to be derived from the sale of the property was taxable income to petitioner in that year. Petitioner kept his accounts and reported his income on a cash receipts and disbursements basis. OPINION. ARUNDELL: The property in question cost $24,166.30; the sales price under the contract was $60,000 and the initial payment was $23,000, of which latter amount it was understood between the parties $11,700 would be used to pay off certain outstanding obligations against the land sold. 2497 The Commissioner has determined a profit by the simple process of deducting from the sales price set forth in the contract of sale entered into by petitioner with the Multnomah Lumber & Box Co. the cost of the land. The remainder to obtained is said to constitute cash income on which a tax must be paid. This is, of course, true if the contract obligation, unevidenced as it is even by promissory notes, is the equivalent of cash. . However, efforts made to sell the contract were unsuccessful and efforts to hypothecate it for a loan were equally futile. The doubtful status of the obligee, the fact that the property was sold originally at a higher price than its intrinsic value, because of its strategic situation, and the hazards of fire in that particular locality all tended to make the contract obligation unmarketable. It is too much to say under such circumstances that petitioner at the date of entering into the contract was in receipt of cash income. We believe that petitioner is entitled to recover his capital before it may be said that he is in receipt of taxable income and we so hold. 2498 . The parties presented and argued this case on the theory that the transaction between petitioner and the Multnomah Lumber & Box Co. served to effect as sale of the property and the foregoing opinion is based on that hypothesis. In view of the fact that both title and 890 possession are reserved by petitioner until final payment, the question may well arise whether or not the contract is not one to sell rather than a contract of sale. In view of the fact that our conclusion would be no different if such were the case, we pass the matter with no more than this comment. In view of the conclusion reached it becomes unnecessary to determine whether or not petitioner may resort to the installment sales method of reporting income. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622751/	Estate of Spencer K. Mulford, Jr., deceased, Dorothy L. Mulford, Administratrix, and Dorothy L. Mulford, surviving wife v. Commissioner.Estate of Spencer K. Mulford, Jr. v. CommissionerDocket No. 17232.United States Tax Court1949 Tax Ct. Memo LEXIS 141; 8 T.C.M. (CCH) 628; T.C.M. (RIA) 49168; June 27, 1949141 George F. Shinehouse, Jr., Esq., for the petitioner. William D. Harris, Esq., for the respondent. MURDOCKMemorandum Findings of Fact and Opinion The Commissioner determined a deficiency in income tax of the decedent and his wife for the year 1940 in the amount of $37,307.12. The issue for decision is whether it was error on the part of the Commissioner to include in the decedent's income for 1940 $111,600, representing the fair market value of 3,100 shares of Link-Belt Company common stock received by the decedent in that year, and to include $16,196.37 as a net long-term capital gain from the sale of a one-fourth interest in the Josephine Kern Dodge Trust. The petitioner contends that there was only one transaction whereby the decedent realized a net long-term capital gain of $14,893.70. Findings of Fact Spencer K. Mulford, Jr., referred to herein as the decedent, died on October 8, 1945 survived by his wife, Dorothy L. Mulford. The decedent and his wife filed a joint income tax return for 1940 with the collector of internal revenue for the first district of Pennsylvania. The decedent was formerly married to Fayelle Dodge. The latter was the daughter of142 Josephine Kern Dodge. Josephine Kern Dodge created a trust in 1917 naming her son, Kern Dodge, and the Pennsylvania Company for Insurance on Lives and Granting Annuities (hereafter called Pennsylvania Company) trustees. She transferred certain property to the trust. It was provided in the trust that the income therefrom should be paid to the grantor for life. One-fourth of the principal of the trust, after the death of the grantor, was to be held in trust and the income thereof paid to Fayelle Dodge for her life, and at her death the principal was to be disposed of as she might direct in her last will and testament. Josephine Kern Dodge was living at all times material hereto. Fayelle Dodge, while the wife of the decedent, was indebted to the Pennsylvania Company in the amount of $191,306.64, and she assigned to her creditor, on or about September 22, 1934, securities having a market value of $56,604.13, a mortgage in the principal amount of $30,000, and one-half of her one-fourth interest in the Josephine Kern Dodge Trust in satisfaction of the indebtedness. The one-eighth interest in the trust was taken at a stipulated value of $104,906.96 and the creditor gave to Fayelle, her143 heirs or assigns, an option or right to redeem or repurchase, inter alia, the one-eighth interest in the trust at any time within five years upon the payment of $104,906.96, plus interest at the rate of 4 per cent per annum. Fayelle died on January 16, 1935 and bequeathed her estate to her husband, the decedent herein. Her one-eighth interest in the trust was valued for estate tax purposes at $121,906.30, and it is stipulated herein that that was the value of that interest at that time. The option or right to redeem the one-eighth interest which Fayelle had assigned to her creditor was not reported in her estate tax return or taxed as a part of her estate. The decedent exercised the option and repurchased the one-eighth interest of Fayelle in the trust from the Pennsylvania Company on November 14, 1935 for $104,906.96, plus interest in the amount of $4,762.39 and thereafter he was the owner of a one-fourth interest in the trust. The decedent was informed in May 1940 of the intention of Kern Dodge, one of the trustees, to withdraw a number of shares of Link-Belt Company stock from the principal of the trust and pay it over to Josephine Kern Dodge in accordance with a provision144 of the trust instrument. The withdrawal of that stock would have reduced the decedent's interest in the trust materially and he objected to the proposed withdrawal and questioned the right or power of Kern Dodge to withdraw the stock on the grounds of estoppel, and he also disputed the amount of stock subject to withdrawal, assuming that estoppel did not apply. Negotiations for the settlement of these differences were conducted by counsel for the parties from May until December 1940. No litigation was commenced and the only legal action that was available was such as would prevent any improper depletion of the corpus of the trust. A settlement was reached on December 14, 1940 whereby the decedent received in 1940 7,600 shares of Link-Belt Company stock having a value of $36 per share and he sold and transferred his entire one-fourth remainder interest in the trust. 3,100 of the shares were furnished by Josephine Kern Dodge and 4,500 shares were furnished by Kern Dodge and Josephine Dodge Wilkinson, each of whom had one-fourth interests in the trust. The record does not show how the decedent and his wife reported the above transaction on their income tax return for 1940. The Commissioner, 145 in determining the deficiency, added to income as reported on the return $111,600 representing the fair market value of 3,100 shares of the common stock of Link-Belt Company "received by you as consideration for the abandonment of legal action" and $16,196.37 as a net capital gain on the sale of a one-fourth interest in a trust. The decedent's basis for gain or loss on the one-fourth interest in the trust which he sold in 1940 was $243,812.60, consisting of $121,906.30, the value of a one-eighth interest in the trust which he received under Fayelle's will, $109,669.35 which he paid to Pennsylvania Company for the other one-eighth interest, and $12,236.95, the value of the option or right to repurchase the one-eighth interest, which option or right the decedent also acquired under the will of Fayelle. The transaction in which the decedent disposed of his one-fourth interest in the trust was a single indivisible transaction from which he realized a gain of $29,787.40 representing a net long-term capital gain of $14,893.70. The stipulation of facts is incorporated herein by this reference. Opinion MURDOCK, Judge: The Commissioner states in his brief that the decedent's basis146 for his one-fourth interest in the trust was $231,575.65. The petitioner takes the position that this figure is correct as far as it goes, but there should be added to it the value of the option to repurchase the one-eighth interest from the Pennsylvania Company which the decedent received under Fayelle's will and exercised shortly after her death. The respondent makes no argument in opposition to this contention. The stipulated figures indicate that the decedent did acquire a valuable option under Fayelle's will and the evidence justifies the figure found as its value. The Commissioner contends that the transaction whereby the decedent settled with the members of the Dodge family was effected by two separate contracts, one whereby the decedent transferred his one-fourth interest in the trust to Kern Dodge and Josephine Dodge Wilkinson for 4,500 shares of Link-Belt Company stock, resulting in a capital loss, and the other a settlement of the "litigation" for 3,100 shares received from Josephine Kern Dodge, all of which represented ordinary taxable income. He relies upon a statement in a letter from the attorney for the Dodges that Josephine Kern Dodge would turn over to the decedent147 3,100 shares "in settlement of the litigation which has been going on for the last several months" and Kern Dodge and Josephine Dodge Wilkinson would turn over to the decedent 4,500 shares as consideration for the decedent's assignment to them or their nominees of his one-fourth interest in the trust. However, that letter indicates that the agreement had been made previously by a telephone conversation and the letter itself states, in effect, that the agreement was indivisible. The decedent did not reply to the letter. There was no pending litigation to be settled and all that the decedent did was to transfer his one-fourth interest and all that he cared about was that he would receive 7,600 shares. Those things were done. The attorney for the decedent gave testimony which indicates that the decedent surrendered his one-fourth interest for 7,600 shares of Link-Belt Company stock in one single indivisible transaction. The decedent had no interest in income from the trust. His only interest was in one-fourth of the corpus of the trust after the death of Josephine Kern Dodge. His efforts throughout were merely to protect that capital asset, and whatever he received in this transaction148 would have to be offset against his basis for gain or loss on that capital asset because in the transaction he disposed of that property. ; , in which the Court said: "The case is not to be confused with one where the basis of the suit is an injury to capital, with the result that the recovery is never income, no matter when collected." The respondent has cited no cases to the contrary. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622752/	Ryan Construction Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Feigel Construction Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentRyan Constr. Corp. v. CommissionerDocket Nos. 58802, 58803United States Tax Court30 T.C. 346; 1958 U.S. Tax Ct. LEXIS 185; May 23, 1958, Filed 185 Decision will be entered under Rule 50 in Docket No. 58802.Decision will be entered for the petitioner in Docket No. 58803. The president of both petitioner corporations, Roy Ryan, was killed in an accident; and shortly thereafter the board of directors of each corporation passed a resolution which authorized the payment to Roy's widow of an amount equal to his salary for 2 years, as a memorial to him. Petitioners paid such amounts during their excess profits tax base period years, and took deductions therefor in their income tax returns, which in the case of each petitioner were in excess of 115 per cent of the average amount of deductions of such class for the 4 previous taxable years. Held, that such deductions, which were "abnormal" for excess profits tax purposes within the meaning of section 433 (b) (9), I. R. C. 1939, were not, in the case of either petitioner corporation, a cause or consequence of an increase in gross income or of a decrease of some other deduction in the base period, and were not a consequence of a change at any time in the type, manner of operation, size, or condition of the business, within the meaning of section 433 (b) (10) (C) (i) and 186 (ii), I. R. C. 1939; and, accordingly, that such abnormal deductions of each petitioner should be eliminated in computing its excess profits tax credit. Stuart E. White, Esq., for petitioners.Towner S. Leeper, Esq., for the respondent. Pierce, Judge. PIERCE 346 OPINION.Respondent determined deficiencies in excess profits tax in these two cases which were consolidated for trial, as follows: In Docket No. 58802 (Ryan Construction Corporation), $ 9,642.47 for 347 the fiscal year ended February 29, 1952; in Docket No. 58803 (Feigel Construction Corporation), $ 3,780 for the calendar year 1951.One of the issues in Docket No. 58802, which was raised by amended petition, has been conceded by the respondent.The sole question for decision in each of the cases is whether payments made by each petitioner to the widow of its deceased president, as a memorial, are abnormal deductions which should be eliminated in the petitioner's base period years in computing its excess profits tax credit for the taxable year, pursuant to sections 433 (b) (9) and 433 (b) (10) (C) (i) and (ii), I. R. C. 1939. 1187 All facts were submitted on a stipulation of facts and jointly introduced exhibits. Said stipulation and exhibits are incorporated herein by this reference and constitute our findings of fact. The material portions of the same may be summarized as follows:Both petitioners are Indiana corporations. Ryan Construction Corporation (hereinafter sometimes called Ryan) was engaged in the business of construction and earth moving; and Feigel Construction Corporation (hereinafter sometimes called Feigel) was engaged in the paving and construction business. Each corporation filed its income and excess profits tax return for its taxable year involved, with the collector of internal revenue for the district of Indiana, at Indianapolis. Ryan kept its books and filed its returns on the basis of fiscal years ending on the last day of February, while Feigel was on a calendar year basis. Both Ryan and Feigel used the completed contract method of accounting.Roy and Mike Ryan, who were brothers, had since about 1923 been engaged in the construction business. From 1934 to 1940, during which time their business grew and prospered, they operated as a partnership. In 1940, they organized the Ryan188 Construction Corporation 348 which acquired their partnership assets. Thereafter, in 1942, these brothers purchased the controlling interest in Feigel. Through the personal efforts of Roy and Mike, the corporations obtained numerous profitable contracts and expanded their operations. Roy was president of both corporations until January 1, 1948, when he was killed in a train wreck. Thereupon Mike succeeded him.As regards stockholdings in the two petitioner corporations, Roy was the majority stockholder of Ryan from the time of its incorporation until 1945, when he transferred sufficient shares to Mike to give him control. Feigel had outstanding 210 shares of common stock and 196 shares of preferred stock; and from 1942 through 1947, Roy and Mike each owned 88 shares of common and 84 shares of preferred. Upon Roy's death, all his shares of stock in both corporations descended to his wife and children.On January 13, 1948, following Roy's death, the board of directors of Ryan adopted the following resolution:Resolved that this Corporation pay to Carrie E. Ryan, widow of the late Roy Ryan, Sr., the sum of Fifty Thousand Dollars ($ 50,000.00) which sum represents two years189 salary of Mr. Ryan as president of the corporation. Said sum to be payable in twenty-four monthly payments of $ 2,083.33 each, beginning with the month of January 1948, and continuing through the month of December 1949. This sum payable to Mrs. Ryan as a memorium [sic] and in recognition of the long and faithful services rendered by said Roy Ryan, Sr., as president of this Corporation.On the same date the board of directors of Feigel adopted a similar resolution, as follows:Resolved, that the Feigel Construction Corporation pay to Carrie E. Ryan, widow of Roy Ryan, the sum of $ 1,250.00 per month beginning with the month of January 1948 and continuing for a two year period through the month of December 1949 as a memorium [sic] and in recognition of the valuable services rendered by Roy Ryan to said corporation. This resolution was passed by all voting directors, Carrie E. Ryan not voting.Pursuant to such resolutions, Roy's widow, Carrie Ryan, received from Ryan Construction Corporation $ 4,166.66, $ 25,000, and $ 20,833.34 in its base period fiscal years ending February 28 or 29, 1948, 1949, and 1950; and she received from Feigel Construction Corporation $ 15,000 in190 each of its base period calendar years 1948 and 1949.Both Ryan and Feigel deducted said payments to Carrie E. Ryan, in their income tax returns for the above-mentioned base period years, as a business expense. The Commissioner initially denied such deductions, on the ground that the payments had no reasonable relationship to the services rendered by Roy Ryan; but subsequently he conceded allowance of the same in full, in prior proceedings before this Court.349 The amounts of officers' salaries paid by Ryan Construction Corporation from 1942 through 1952, were as follows:Year ended Feb. 28 or 29RoyMikeRyan1Ryan1942$ 25,000.00$ 25,000.00194340,000.0040,000.00194440,000.0040,000.00194540,000.0040,000.00194625,000.0025,000.00194725,000.0025,000.001948$ 20,833.33$ 25,000.00194925,000.00195025,000.00195143,145.19195273,056.02The amounts of officers' salaries paid by Feigel Construction Corporation from 1942 through 1952, were as follows:YearRoyMike RyanJ. R. FeigelRyan11943$ 15,000$ 15,000.00$ 10,868.43194415,00015,000.0010,452.65194512,50012,500.007,758.33194615,00015,000.0011,323.83194715,00015,000.0011,431.801948$ 15,000.00$ 16,160.60194915,000.0012,416.00195031,440.1026,925.14195131,285.4226,925.14195231,125.3526,925.14191 Ryan Construction Corporation's gross income for the years 1946 through 1954 was as follows:Year endedFebruary28 or 29Gross income 11946$ 92,158.171947270,755.231948172,949.951949365,357.811950273,412.441951$ 472,070.161952561,474.651953803,774.451954471,789.92Feigel's gross income for the same period, 1946 through 1954, was:YearGross income 11946$ 153,483.661947147,048.381948223,999.811949157,576.601950230,174.111951$ 297,618.371952298,404.051953256,894.451954271,918.66Following Roy's death, his heirs and Mike continuously disagreed over petitioners' management policies. As a result, Mike in 1952 bought all of the shares of Roy's family in both corporations. Subsequently, in 1954 or shortly thereafter, Ryan Construction Corporation was liquidated.350 Each petitioner corporation, in computing its excess profits net income for the base period years and in establishing its excess profits192 credit for the taxable year involved, eliminated or added back to its normal tax net income for certain of the base period years, 2 as abnormal deductions, the amounts paid to Carrie Ryan in those years, pursuant to the above-mentioned resolutions; and it thereby increased its excess profits credit, and reduced its excess profits tax liability. The respondent, however, in his notice of deficiency to each petitioner, determined that the payments to Carrie should not be eliminated through application of section 433 (b) (10) (C). 3193 In Arrow-Hart & Hegeman Electric Co., 7 T.C. 1350">7 T. C. 1350, this Court held that gratuity payments made by a corporation to widows of its deceased employees constituted a class of deductions which was "separate and distinct" from the deductions for "routine salaries." In the instant case, the parties have stipulated that the payments made by each of the petitioner corporations in 1948, 1949, and 1950 to the widow of its deceased president, were in excess of 115 per cent of the average amount of any payments of such class for the 4 previous taxable years; and it is evident therefore that the deductions taken for such payments qualify as "abnormal deductions" within the meaning of section 433 (b) (9). Thus, in such situation, the issue before us is reduced to the narrow question of whether these deductions, even though they are abnormal, should not be eliminated under the provisions of subparagraphs (C) (i) and (ii) of section 433 (b) (10). These subparagraphs provide, in substance and so far as here material, that deductions of any class, even though they are abnormal, shall not be eliminated unless the taxpayer establishes that the increase in such deductions194 --(a) Is not a cause or a consequence of an increase in the gross income of the taxpayer in its base period years;(b) Is not a cause or a consequence of a decrease in the amount of some other deduction in its base period years; and(c) Is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.We think that petitioners have successfully borne their burden of proof as to each of these provisions.1. As regards the first provision, which raises the question of whether the payments to Carrie were a cause or consequence of an 351 increase in gross income, respondent argues (1) that prior to Roy's death, he performed services for each of the petitioners, which caused increases in their gross incomes; (2) that petitioners paid Carrie for such services of Roy; and (3) that the payments for such services bore the cause or consequence relationship to the increased gross incomes, which is comprehended by section 433 (b) (10) (C) (i).We find no merit in such argument. It is true that the increased gross income of each petitioner was, in part, traceable to Roy's services in procuring construction contracts195 upon which profits were realized in the base period years that followed Roy's death. But, by no stretch of the imagination, can the payments to Carrie be regarded as a cause of such gross income increases.Also, we are satisfied that the payments to Carrie were not a consequence of such increased gross income. Rather, they were a consequence of Roy's death and of the decision of petitioners' boards of directors to pay to Carrie a gratuity, as a memorial to Roy. Had Roy continued to live any increased compensation to him might conceivably have been a consequence of the increased gross income which his services produced. But the sums paid to Carrie were not compensation to anyone, for Carrie was not an employee, and Roy had been fully compensated prior to his death. Although the amounts of the gratuities paid to Carrie happened to be measured by what had been Roy's salary, the legal result is no different than if they had been determined in some other manner, without regard to his salary rate. Nothing in the wholly stipulated record indicates, or tends to indicate, that either petitioner was in any way obligated to make or did make any further payment in respect of Roy's196 services, or that its gross income had any relationship to the gratuity payments to his widow.2. The second of the above-mentioned provisions of the statute raises the question of whether the payments to Carrie were a cause or consequence of a decrease in some other deduction. Respondent argues, in regard to this, (1) that petitioners voted to pay Roy's salary to Carrie, for a period of 2 years; (2) that their officer salary accounts and their payments to Carrie fluctuated in converse unison, one decreasing as the other increased, as is shown by the tables above set forth; and (3) that this relationship between the accounts is within that portion of section 433 (b) (10) (C) (i) which pertains to a decrease in some other deduction.Here again, we must reject respondent's argument. The reduction in the officers' salary accounts of the petitioners was caused by Roy's death, and not by the payment of the gratuities to Carrie. Both the reduction in the officers' salary accounts and the payments to Carrie stemmed from Roy's death, but this does not make the gratuity payments the cause or consequence of the reduced salaries. 352 The two accounts did fluctuate in converse unison, 197 because Roy had died and no one was employed to replace him, and also because the amount of the gratuity to Carrie happened to be fixed in relation to his former salary. The fluctuation in the two accounts was parallel, but there was no cause or consequence relationship between them.The authorities relied upon by respondent in connection with this point are readily distinguishable. In the first case cited, Concord Cab Corporation, 18 T.C. 1009">18 T. C. 1009, the taxpayer had used the declining balance method in depreciating its taxicabs and meters; and this method had resulted in a deduction which was abnormal, as to amount, for its first base period year. This Court refused, however, to eliminate the excess portion of such abnormal deduction, and stated:deductions for depreciation allowed for each of the four base period years * * * were part of an integral plan, were interdependent, and were mutually consequential. * * * Thus, the deduction taken in each year was a consequence of an integral plan involving, as components, the deductions for the other years, and each deduction was dependent upon and a result of the other. If any one was large, that was 198 a consequence of smaller ones being taken in other years. * In the instant case, there was no integral plan embracing, as components, the payments of the gratuities to Carrie and the decrease in officers' salaries; and the two accounts were not interdependent or mutually consequential.The second case relied upon by respondent is R. C. Harvey Co., 5 T. C. 431. There, we suggested that an abnormal deduction for a lump-sum payment made to a former purchasing agent in settlement of a lawsuit for breach of a contract of employment, might have been the cause of a subsequent decrease in the commissions paid to a successor purchasing agent. Obviously, the lump-sum settlement and the decreased commissions were closely related, because the functions and services of both the party settled with and his successor were the same. No similar close relationship exists in the case at bar, between the amounts paid to Carrie, which were gratuities, and the amounts paid to petitioners' officers, which were for personal services.As before stated, we regard both of the above-mentioned cases to be distinguishable from the present case.3. We come now to the last provision199 of section 433 (b) (10) (C), which gives rise to the question of whether the payments of the gratuities to Carrie were a consequence of a change at any time in the type, manner of operation, size, or condition of the businesses engaged in by the petitioners. We are satisfied that they were not.In the first place, no change in the type, manner of operation, or size of the business of either petitioner occurred at any time. Both petitioners engaged in the same type of business after the death of 353 Roy as they had before; and there was no substantial change in the size of either. Also, both petitioners employed the same manner of operation. Mike had been active in the affairs of Ryan since its incorporation, and active in the affairs of Feigel since he and Roy acquired the controlling interest therein in 1942; and he had been the majority stockholder in Ryan since 1945. His activities had included both the procurement of contracts for each petitioner and participation in the management of each. It is our opinion that, in the light of such circumstances, Mike's election as president of each corporation after Roy's death, did not constitute any change in the 200 manner of operation of either business.As for any change in the condition of the business, the only such change which conceivably could be here relevant was the purchase by Mike, in September 1952, of all shares of each corporation that were held by members of Roy's family, and the subsequent liquidation of Ryan. But the gratuities paid to Carrie had been authorized almost 5 years prior to such change, and all payments of these gratuities had been completed almost 3 years prior thereto. Accordingly, such payments could not possibly have been a consequence of said change occurring in later years; and, even if they might have been a cause of the change (which is in no way shown or suggested by the record), it is to be observed that subparagraph (C) (ii) of section 433 (b) (10), with which we are here concerned, speaks only in terms of consequence and not of cause. We must take the statute as we find it. R. C. Harvey Co., supra.In Arrow-Hart & Hegeman Electric Co., supra, we held that payments to widows of the taxpayer's deceased employees were not a consequence 4 of either an increase in gross income, 201 or of a decrease in some other deduction, or of a change in the type, manner of operation, size, or condition of the business. The facts in the present case are similar to those in the Arrow-Hart case; and we adhere to the holding there made. In the instant case we further hold, for the reasons above stated, that the payments made to the widow here involved were not a cause, either of an increase in gross income or of a decrease in some other deduction of either petitioner corporation.By reason of all the foregoing, we decide the present issue in favor of the petitioners.Decision will be entered under Rule 50 in Docket No. 58802.Decision will be entered for the petitioner in Docket No. 58803. Footnotes1. SEC. 433. EXCESS PROFITS NET INCOME.(b) Taxable Years in Base Period. -- For the purposes of computing the average base period net income, the excess profits net income for any taxable year shall be the normal tax net income * * increased or decreased by the following adjustments * * : * * (9) Judgments, intangible drilling and development costs, casualty losses, and other abnormal deductions. -- If, for any taxable year or years within, or beginning or ending within, the base period, any class of deductions for the taxable year exceeded 115 per centum of the average amount of deductions of such class for the four previous taxable years (not including deductions arising from the same extraordinary event which gave rise to the deduction for the taxable year), the deductions of such class shall, subject to the rules provided in paragraph (10), be disallowed in an amount equal to such excess. * (10) Rules for application of paragraph (9). -- For the purpose of paragraph (9) -- * * * (C) Deductions of any class shall not be disallowed under such paragraph unless the taxpayer establishes that the increase in such deductions --(i) is not a cause or a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, which increase or decrease is substantial in relation to the amount of the increase in the deductions of such class, and(ii) is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.↩1. Served as president until his death on Jan. 1, 1948; succeeded by Mike Ryan.↩1. Served as president until his death; succeeded by Mike Ryan.↩1. Difference between gross receipts and direct construction costs.↩1. Difference between gross receipts and direct construction costs.↩2. Because the amount which Ryan paid Carrie in its fiscal year 1948 ($ 4,166.66) was less than 5 per cent of its average excess profits net income, it did not add back such payment to its excess profits net income for such year. See sec. 433 (b) (10) (B)↩. However, for the base period fiscal years 1949 and 1950 in the case of Ryan, and for the base period calendar years 1948 and 1949 in the case of Feigel, the payments to Carrie exceeded the requisite 5 per cent of the average excess profits net income, and were added back.3. The respondent, in his original answer to the petition of each corporation, relied only on subparagraph (C) (i) of said section; but thereafter, in amended answers, he indicated reliance also on subparagraph (C) (ii).↩4. The Arrow-Hart & Hegeman case involved section 711 (b) (1) (K) (ii) of the now repealed World War II xcess Profits Tax Law. This section required the taxpayer to prove only that the abnormal deduction was not a consequence of the specified factors, and made no reference to cause↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622754/	McCulley Ashlock, Petitioner, v. Commissioner of Internal Revenue, RespondentAshlock v. CommissionerDocket No. 29859United States Tax Court18 T.C. 405; 1952 U.S. Tax Ct. LEXIS 181; May 28, 1952, Promulgated 181 Decision will be entered under Rule 50. 1. By contract of sale on April 18, 1945, petitioner purchased real property for $ 40,000 and the seller retained possession and rents until August 15, 1947. Held, since the seller retained legal ownership as well as control, benefits, and unfettered command of the rents, petitioner is not taxed on the rental income which was paid to the sellers by the tenant in 1945 and up to February 7, 1946.2. On February 7, 1946, the parties executed a "Receipt and Release" agreement upon the execution of which petitioner paid the sellers $ 23,527.64. It was stated in this agreement, among other things, that "the purchaser of said property has requested the privilege of paying the balance of the purchase consideration in cash at this time and assuming the immediate possession of the premises and the right to receive all rentals to accrue hereafter * ." Held, that petitioner is not entitled to deduct the $ 23,527.64 as amortization of the cost of a lease over the remaining term of the lease, but that the $ 23,527.64 is to be added as additional cost to petitioner of the property and is to be recovered only through depreciation or by the 182 disposition of the property as the Commissioner has determined. Carl T. Smith, Esq., and Ivan M. West, C. P. A., for the petitioner.Frank M. Cavanaugh, Esq., for the respondent. Black, Judge. BLACK 405 Respondent determined deficiencies in petitioner's income tax for the calendar years and in the amounts as follows:YearDeficiency1945$ 2,441.6119465,980.5419472,947.41Total $ 11,369.56This controversy arises out of petitioner's purchase of real property, while the vendor was to retain rental income for a period of time. The primary question is whether those rents were taxable income to petitioner. Subsidiary questions dependent on the primary issue involve the proper depreciation basis and whether the subsequent purchase price of the assignment of the lease and surrender of possession can be amortized separately. 183 In the deficiency notice the Commissioner explained the contested adjustments as follows:Taxable Year Ended December 31, 1945Your income is increased $ 7,172.36 to include rental income on the property located at 650 East Gilbert, Wichita, Kansas. It is held that, inasmuch as you 406 were the owner of the property, payments made to the vendors by the lessee and applied against the purchase price, represent rental income taxable to you. * Taxable Year Ended December 31, 1946Rental income from the property located at 650 East Gilbert, Wichita, Kansas is increased $ 3,000.00 to include the payments made to the vendors by the lessee and applied by them against the purchase price of the property.The deduction claimed on your return as "Amortization of Basis of Acquiring Lease" in the amount of $ 13,444.36 is disallowed. Inasmuch as you were the owner of this property, the amount paid to the vendors in settlement of the unpaid balance on the purchase price may not be amortized. If it should be held that the rights to receive the rents represented an interest separate and apart from your purchase of the fee title to the property, then it is held that the payments, 184 upon which the amortization deduction is based, represents additional cost of the property to be recovered only through depreciation or by the disposition of the property. Depreciation claimed in your return, for 10 months, on the property at 650 East Gilbert, Wichita, Kansas, in the amount of $ 875.00 is increased $ 1,075.00 to allow 3% of $ 65,000.00. It is considered that the cost basis of the depreciable improvements on the property is $ 65,000 and inasmuch as the property was acquired in 1945 depreciation is allowed for 12 months in 1946.A similar explanation for the disallowance of $ 10,083.28 amortization claimed by petitioner as was made for 1946 is here made for 1947. A similar explanation of a $ 900 increase in allowance for depreciation as was made for 1946 is here made for 1947.FINDINGS OF FACT.The petitioner McCulley Ashlock resides in Newton, Kansas. His tax returns involved here were filed with the collector for the district of Kansas and were prepared on the cash basis.Petitioner had been engaged in the grocery business prior to February 1945, at which time he sold the business and invested his money in real estate. Petitioner was interested in purchasing 185 a large one-story brick and concrete factory or warehouse building located at 650 East Gilbert Street in Wichita, Kansas, hereinafter called the property. The property was owned by three co-trustees consisting of the Wheeler Kelly Hagny Trust Company, Walter Innes, Jr., and Betty Innes, hereinafter called the trustees. The Cessna Aircraft Company, a Government-financed aircraft manufacturer had leased the property for $ 1,500 per month under a 4-year noncancelable lease expiring on August 15, 1947, subject to a 1-year renewal option. There were negotiations and several offers by each side prior to reaching an agreement. Two of the rejected offers were the following: On March 27, 1945, the trustees submitted a written offer to sell the property for a consideration of $ 75,000. On April 17, 1945, petitioner submitted a written offer of $ 40,000, the seller to retain the property until August 15, 407 1947, the tentative expiration date of the Cessna lease. On April 18, 1945, the parties entered into a contract of sale which included the following provisions:* * * for and in consideration of Forty Thousand Dollars ($ 40,000.00) to be paid as follows, to-wit:Two Thousand186 Dollars ($ 2,000.00) cash upon the execution of this agreement, the receipt whereof is hereby acknowledged, and the balance of Thirty-eight Thousand Dollars ($ 38,000.00) to be paid in cash upon approval of title and delivery of deed.* * * It is further mutually understood and agreed by and between the parties hereto that the property and premises above described is now under written lease, the primary term of which expires the 15th day of August, 1947, and which lease carries an option in favor of lessee for an additional one (1) year term. As a further consideration for the sale and conveyance of the property above described, second party has, and by these presents does, agree that the parties of the first part shall be entitled to retain the possession of the above described premises and all rents and income accrued and to accrue under the lease above mentioned and for the period ending August 15, 1947. In event the lessee under said lease exercises the option of renewal and extends the original or primary term of said lease for the additional term of one (1) year, the rents reserved and to be paid during said extended period shall be paid to and received by second party herein. 187 Parties of the first part agree that during the period expiring August 15, 1947, they will pay all taxes levied upon the property and premises above described to and including the taxes for the year 1946 and shall, in addition thereto, pay all premiums of insurance which shall mature and become payable under policies of insurance now in force and covering improvements upon said property and will pay all normal maintenance items and expenses for and during said period of time and will deliver possession of said premises to second party herein, subject only to the lease and option herein referred to, on the 15th day of August, 1947, in as good condition as the premises now are, the ordinary wear and tear alone excepted.Pursuant to the contract of sale a deed dated June 6, 1945, was drawn which included the following provisions:WITNESSETH, That the said parties of the first part, in consideration of the sum of One Dollar and other good and valuable considerations to it duly paid, the receipt of which is hereby acknowledged, have sold, and by these presents do grant and convey to the said party of the second part, his heirs and assigns, all of that tract or parcel of land situated 188 in the County of Sedgwick and State of Kansas, described as follows, to-wit: * * together with the buildings and improvements thereon and with the appurtenances, and all the estate, title and interest of said parties of the first part therein. And the said grantors hereby covenant and agree that at the delivery hereof, they are the lawful owners of the premises above granted, and seized of a good and indefeasible estate of inheritance therein, free and clear of all encumbrances, and that they will warrant and defend the same in the quiet and peaceable possession of the said party of the second part, his heirs and assigns, forever, against all persons lawfully claiming the same.408 Under the contract of sale and deed the trustees continued their retention of the Cessna lease. A subsequent agreement dated June 11, 1945, which was five days after the execution of the deed, was drawn up and included the following provisions:KNOW ALL MEN BY THESE PRESENTS, That whereas, the undersigned McCulley Ashlock, party of the first part, is now the owner of the fee to the real property hereinafter described, as evidenced by deeds of conveyance executed by the Wheeler Kelly Hagny Trust189 Company and W. P. Innes, Jr., co-trustees, and the Wheeler Kelly Hagny Trust Company and Betty S. Innes, co-trustees, the parties of the second part herein, and * * WHEREAS, under the terms of the sale and the conveyance under deeds hereinabove mentionel and as a part of the purchase consideration for said property and premises, the second parties herein were to have and reserve the right of possession of said premises and all of the rents and income accrued and to accrue under the lease above mentioned for the period ending August 15, 1947, and * * does hereby ratify and confirm unto the second parties herein the right of possession of the above described property and premises for the term ending August 15, 1947, subject only to the outstanding lease now on said property and premises to Cessna Aircraft Company and first party by these presents assigns, transfers and sets over as a part of said purchase consideration all of the rents and income accrued and to accrue under the lease herein mentioned and for the period ending August 15, 1947, and authorizes Cessna Aircraft Company to make payment of all rentals during said period of time to the second parties herein.It is190 by the parties further agreed that in the event of the damage to or destruction of the improvements upon the premises above described, the proceeds of all insurance in force at the time of said loss shall, subject only to the conditions hereinafter set forth, be devoted to the repair or restoration of the improvements so damaged or destroyed but first party shall not be liable to second parties for the loss of use or income from the damaged or destroyed premises during the period of their repair or reconstruction.It is further agreed that in event of the total destruction of the improvements upon said premises prior to the 15th day of August, 1947, first party shall have the option of rebuilding or restoring said premises or of retaining the proceeds of the policies of insurance covering such loss and destruction and applying the proceeds as follows: by distribution to second parties of an amount equal to the rentals that shall remain unpaid from the date of loss until the expiration of the Cessna Aircraft Company lease on August 15, 1947, and distribution of the remaining portion to the first party herein.On its books and tax returns the trustees treated the rents collected under191 the lease as payments on an unpaid balance of a $ 75,000 sale price. Petitioner on his books and tax returns assumed that the property was purchased for $ 40,000, the trustees retaining a term of years in the property.On February 7, 1946, the parties entered into an agreement which was termed "Receipt and Release." This written instrument included the following terms:409 WHEREAS, the said purchaser paid to sellers the initial consideration of Forty Thousand Dollars ($ 40,000.00) as provided under said contract; andWHEREAS, subsequent to the date of said agreement, the sellers have received and credited upon the sales consideration the monthly installments of rents reserved and payable under the lease outstanding upon the premises above described; and* * * WHEREAS, under the terms of said agreement of April 18, 1945, the sellers reserved and are entitled to the continued possession of the above described premises and all rents and income accrued and to accrue under the lease outstanding upon said premises and for the period ending August 15, 1947, but are obligated to pay all taxes upon said property and premises to and including the taxes for the year 1946; andWHEREAS, 192 the purchaser of said property has requested the privilege of paying the balance of the purchase consideration in cash at this time and assuming the immediate possession of the premises and the right to receive all rentals to accrue hereafter under the lease upon said premises, which request the sellers have, under the conditions hereinafter stated, agreed to.* * * * 1. Party of the Second Part shall concurrently with the execution of this Receipt and Release pay to First Parties the sum of Twenty-three Thousand Five Hundred Twenty-seven Dollars and Sixty-four Cents ($ 23,527.64).2. The First Parties agree and do hereby surrender the possession of the premises above described to Second Party and assign to Second Party all rentals reserved and hereafter payable under the terms of the lease now outstanding upon the demised premises.* * * On the execution of this agreement the First Parties acknowledge and agree that the full purchase consideration as provided under said agreement of April 18, 1945, shall have been fully paid and the title to the property described therein to be fully vested in the Party of the Second Part, including the full right of possession thereof, and193 to all rents hereafter to accrue under the outstanding lease on said property.Subsequent to February 7, 1946, the lessee paid the rent to the petitioner and he was thereafter vested with the right of possession to the premises. As consideration for the execution of this "Receipt and Release," petitioner McCulley Ashlock, who was designated as party of the second part, paid to the trustees, who were designated as parties of the first part, the sum of $ 23,527.64.Petitioner's income tax returns for the years 1945 and 1946 contained an explanatory statement which recited that petitioner had purchased the title to the property in question and that the rents received by the co-trustees under the Cessna lease prior to February 7, 1946, were not his income. Petitioner's income tax returns for 1946 and 1947 returned as income the rents which he received from the Cessna Aircraft lease subsequent to the execution of the "Receipt and Release" agreement by the parties on February 7, 1946. Also, in his income tax return for the year 1946 petitioner claimed a deduction from income in the amount of $ 13,444.36 as "Amortization of Basis 410 of Acquiring Lease." In his return for the year194 1947 petitioner claimed a similar deduction in the amount of $ 10,083.28.In his determination of the deficiencies, the respondent added to petitioner's gross income for each of the years 1945 and 1946, the rent paid to the co-trustees by the Cessna Aircraft Company. Also, for the years 1946 and 1947, the respondent disallowed as a deduction from gross income the amounts claimed as "Amortization of Basis of Acquiring Lease" and determined that such amounts represented additional cost of the property to be recovered only through depreciation or by the disposition of the property. In each of the years 1945, 1946, and 1947, respondent in his determination of the deficiencies has allowed petitioner a deduction for depreciation based on a cost of $ 65,000 for the improvements on the property which is here involved.OPINION.This proceeding raises two issues arising out of petitioner's purchase of property from trustees who continued to receive rental income until February 7, 1946. These two issues may be stated as follows:1. Were the amounts of rentals paid to the sellers of the property by the lessee, Cessna Aircraft Company, during 1945 and up to February 7, 1946, taxable to petitioner195 because they were applied in part payment of the purchase price which petitioner had agreed to pay for the property?2. Is petitioner entitled to have deducted from his gross income in 1946 and 1947, amortization of $ 13,444.36 and $ 10,083.28, respectively, on account of a payment of $ 23,527.64 which he paid to the sellers of the property upon the execution of a "Receipt and Release" agreement executed February 7, 1946?Issue 1.Respondent determined that the entire property was purchased on April 18, 1945, for $ 75,000; $ 40,000 was paid in cash and petitioner assigned the rents to the sellers until August 15, 1947, to be applied toward the purchase price. But petitioner contends that the total consideration for his purchase on April 18, 1945, was $ 40,000 and that the trustees, under written agreement, retained the income and possession of the property until August 15, 1947.The proposed and rejected offers, testimony, and accounting-tax treatment indicate that each party intended or at least hoped that the Cessna rents would not be taxable income to him. Equally clear is the fact that the rental income is taxable to one, but only one, of the parties. In deciding who is196 taxable on these rental payments in 1945 and up to February 7, 1946, we are concerned with the contracts 411 which were executed by the parties in arm's length transactions. "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." See .The essential agreement that governed the original transfer of the property in question to petitioner was the contract of sale on April 18, 1945, and the deed on June 6, 1945. The deed and contract of sale are to be construed together. ; . The contract of sale is not ambiguous. The "consideration" was $ 40,000, and the trustees were "entitled to retain the possession of the above described premises and all rents and income accrued and to accrue under the lease above mentioned and for the period ending August 15, 1947." Thus, under this language the trustees retained possession and rents until August 15, 1947, and transferred 197 the remainder interests to petitioner. Under real property law interests may be carved up and any quantity may be transferred. The grantor can reserve rents for a term of years while transferring the fee and all other interests in Kansas. ; Tiffany, Real Property, 3d ed. vol. 3 sec. 881, p. 532.The subsequent agreement dated June 11, 1945, merely confirms the retention of rents by the trustees and adds some new terms. That agreement could not constitute an assignment of rental income by petitioner until August 15, 1947, since petitioner did not own those rights at that time. He had never acquired them. "It is the general rule that an assignment at law will not be sustained unless the subject-matter has an actual or potential existence when the assignment is made * * ." .The conclusion that the rental income was legally retained by the trustees and initially only a remainder interest was purchased by petitioner does not by itself absolve petitioner from income taxes. In ,198 Mr. Justice Holmes stated:But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed -- the actual benefit for which the tax is paid. * * * The income that is subject to a man's unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not. * * Here, the trustees not only retained the rents legally but they also retained control and benefits of ownership. Under the contract of sale on April 18, 1945, the trustees specifically agreed to pay property taxes, insurance premiums, and "all normal maintenance items and expenses," so that the property would be delivered to petitioner in the present condition except for normal wear and tear. Furthermore, the June 11, 1945, agreement stated that in the event that the 412 property was damaged or destroyed, and loss of income during the period of repair or reconstruction would be the trustees' loss. It further provided that insurance proceeds would be devoted to restore and repair the property, except in the event of total destruction petitioner would have the option of rebuilding the premises199 or compensating the trustees for unpaid rent. Thus the trustees bore the risks of ownership of the rents and managed the property. Larger expenses or a cessation of rents were risks incurred by the trustees. Petitioner did not guarantee any fixed net profit nor have any other obligation to support the trustees' contention that rents were payments on a $ 75,000 consideration. The rental income was not part of a debtor-creditor relationship; it was subject to the trustees' unfettered command.A legal owner of property is not taxed on income which he has no legal rights to claim and does not control or receive any benefits therefrom. Similar conclusions were reached in the following cases. The owner of real estate who transferred rents only while retaining a reversion was not taxed on rents. ; , affirming in part and reversing in part a Memorandum Opinion of this Court, February 26, 1944; , affd. ; .200 A purchaser of oil interests was not taxed on income which was retained either by a seller, , or by a mortgagee of a mortgage which was not assumed, .We hold that petitioner is not taxable on the $ 7,172.36 rents which the Commissioner added to the income reported on his return for the year 1945. We also hold that he is not taxable on the $ 3,000 rentals which the Commissioner added to the income reported by petitioner on his return for 1946 and which $ 3,000 represented rentals collected by the sellers prior to the execution of the written instrument of February 7, 1946, designated as "Receipt and Release."Issue 2.Petitioner returned as income on his 1946 and 1947 returns the amounts of the rentals which he received from Cessna subsequent to the execution of the "Receipt and Release" agreement of February 7, 1946. He, however, claims that these amounts represented income to him under a lease which he acquired from the sellers by assignment and that inasmuch as the lease with Cessna was to expire August 15, 1947, the $ 23,527.64 which he paid to201 the sellers upon the execution of the "Receipt and Release" instrument is amortizable over the remaining term of the lease. In pursuance of this claim, petitioner has deducted from the gross income reported on his 1946 return 413 the sum of $ 13,444.36 as "Amortization of Basis of Acquiring Lease." He has deducted from gross income reported on his 1947 return $ 10,083.28 as amortization with the same explanation as that given for 1946. The Commissioner has disallowed the foregoing amortization deductions. In disallowing the deductions, the Commissioner stated in his deficiency notice:The deduction claimed on your return as "Amortization of Basis of Acquiring Lease" in the amount of $ 13,444.36 is disallowed. Inasmuch as you were the owner of this property, the amount paid to the vendors in settlement of the unpaid balance on the purchase price may not be amortized. If it should be held that the rights to receive the rents represented an interest separate and apart from your purchase of the fee title to the property, then it is held that the payments, upon which the amortization deduction is based, represents additional cost of the property to be recovered only through202 depreciation or by the disposition of the property.As has already been explained under Issue 1, we have held that the rents prior to February 7, 1946, had been reserved by the sellers and did represent an interest separate and apart from petitioner's purchase of the land and were not taxable to petitioner. However, we do not think that the same may be said of the rents which Cessna paid to petitioner after the execution of the "Receipt and Release" agreement. That agreement contains, among others, the following provisions:WHEREAS, the purchaser of said property has requested the privilege of paying the balance of the purchase consideration in cash at this time and assuming the immediate possession of the premises and the right to receive all rentals to accrue hereafter under the lease upon said premises, which request the sellers have, under the conditions hereinafter stated, agreed to. * * On the execution of this agreement the First Parties acknowledge and agree that the full purchase consideration as provided under said agreement of April 18, 1945, shall have been fully paid and the title to the property described therein to be fully vested in the Party of the Second203 Part, including the full right of possession thereof, and to all rents hereafter to accrue under the outstanding lease on said property.Under the foregoing provisions of the "Receipt and Release" agreement, we think it should be held that the $ 23,527.64 payment which petitioner made on February 7, 1946, was made as respondent has determined, as "additional cost of the property" and is to be recovered through depreciation in so far as the improvements are concerned and not by way of amortization deductions over the remaining life of the Cessna lease, as petitioner claims in this proceeding.For tax purposes of depreciation, we see no difference between this situation and one in which real property, including the right to collect rent, was purchased subject to an outstanding lease. Petitioner here has done substantially the same thing, but in two steps. Subsequent to petitioner's purchase under the "Receipt and Release" agreement 414 of February 7, 1946, petitioner owned the fee simple of real property with all rights of possession except as to the Cessna lease. Respondent has allowed petitioner in each of the years 1946 and 1947 depreciation deductions of 3 per cent based204 upon a cost basis of $ 65,000 for the improvements on the property which petitioner purchased from the sellers. The pleadings do not raise any issue as to this rate of 3 per cent or the cost basis of $ 65,000 for the improvements situated on the property. Therefore, the allowances for depreciation which respondent has allowed in his determination of the deficiencies for the years 1946 and 1947 will remain undisturbed in a recomputation under Rule 50.The Commissioner is sustained in his disallowance of amortization of $ 13,444.36 for the year 1946 and in his disallowance of amortization of $ 10,083.28 for the year 1947.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622755/	HUEY & PHILP HARDWARE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Huey & Philip Hardware Co. v. CommissionerDocket No. 92801.United States Board of Tax Appeals40 B.T.A. 781; 1939 BTA LEXIS 799; October 24, 1939, Promulgated 799 Petitioner and a realty corporation, owning and holding real estate which petitioner rented and used in its business, had substantially the same stockholders and officers, though there were some differences and the two corporations were operated as separate entities. , petitioner had loaned the realty company money in prior years and in 1934 took its demand promissory note secured by a second mortgage in settlement of its indebtedness. In November 1935, the realty company being in default, petitioner instituted foreclosure proceedings and petitioner purchased the property at foreclosure sale subject to the first mortgages which were held against it by outside parties. Petitioner credited the bid price on the note which it held against the realty company. The realty company, being without further assets, dissolved. Petitioner during the taxable year ascertained the balance of its indebtedness against the realty company to be worthless and charged it off. After receiving a deed for the properties purchased at foreclosure sale, petitioner conveyed them to two newly organized corporations in consideration of cash and deferred payment notes secured by a second mortgage and subject800 ot the first mortgage liens against the properties. Held there was no plan of reorganization in contemplation when petitioner purchased the properties at foreclosure sale and the sale was not a part of any plan of reorganization and must be given its usual consequences, and petitioner is entitled to the deduction which it claims as a debt ascertained to be worthless and charged off during the taxable year. Alvin H. Lane, Esq., for the petitioner. J. L. Backstrom, Esq., for the respondent. BLACK781 The Commissioner has determined a deficiency of $6,435.33 in petitioner's income tax liability for the calendar year of 1935. This deficiency results from four adjustments made by the Commissioner in auditing petitioner's income tax return for the year 1935. Three 782 of these adjustments add to petitioner's income and one reduces it. The major adjustment consists of a disallowance of $53,741.15 deducted by the petitioner as a debt ascertained to be worthless and charged off during the taxable year. In disallowing this bad debt diduction, the Commissioner stated in his deficiency notice: The decrease in the amount of $53,741.15801 represents a so-called bad debt resulting from advances made by you to Huey and Philp Realty Company, a corporation whose outstanding capital stock was principally owned by your stockholders. After careful consideration of the evidence presented, it is held that the transaction through which all of the assets of Huey and Philp Realty Company were acquired by you was, in substance, a reorganization resulting in no gain or loss, under provisions of section 112 of the Revenue Act of 1934. It is also held that the fair market value of the properties acquired by you was at least $302,502.91, the amount of the indebtedness against the properties. The amount of the so-called bad debt deduction is, therefore, disallowed. By an appropriate assignment of error in its petition, the petitioner contests the foregoing action of the Commissioner. At the hearing, counsel for petitioner stated that petitioner no longer claimed a deduction of $53,741.15 as a bad debt charged off, but $49,504.72 instead, the reason for the reduction in the amount claimed being that the larger figure included interest on the indebtedness which petitioner had never taken into taxable income and which it, therefore, 802 conceded it had no right to deduct as a bad debt. FINDINGS OF FACT. 1. Petitioner herein, the Huey & Philp Hardware Co., sometimes hereinafter referred to as the hardware company, is a Texas corporation, originally organized about 68 years ago as a partnership, but for the past 40 years or longer it has been incorporated under the laws of the State of Texas, having as its authorized purpose "To purchase and sell goods, wares and merchandise and agricultural and farm products." In September 1926 its authorized capital stock was $1,000,000, and its net assets were substantially in excess of $1,100,000. 2. For some years prior to 1927, the hardware company had been leasing a building for its office and principal warehouse. In 1926, however, condemnation by the city of Dallas of a portion of this building necessitated the acquisition of new quarters. The directors decided to build a warehouse, but did not wish to add mortgage indebtedness on the building to the indebtedness owed by the hardware company in the operation of its business, and for this reason, decided to incorporate a separate and distinct company to own the building and lease it to the hardware company. 783 803 3. On November 20, 1926, pursuant to authority granted by the stockholders of the Huey & Philp Hardware Co. on September 28, 1926, and by the directors of the hardware company on October 26, 1926, the Huey & Philp Realty Co., sometimes hereinafter referred to as the realty company, was granted a charter by the State of Texas and authorized to engage in the business of owning and operating real property and other things incident thereto. It was capitalized at $100,000, which capital stock was paid for out of the surplus of the hardware company, and stock in the realty company was issued to the persons who were record stockholders of the hardware company, as of the date of the incorporation of the realty company, in the ratio of one share of $10 par value in the realty company for each share of $100 par value in the hardware company then owned by such persons. The property which was used to pay up the capital stock of the realty company was a part of block 60 in the city of Dallas, theretofore owned by the hardware company and valued for incorporation purposes at $100,000. 4. At the time the realty company was organized, the same persons were stockholders of both companies, and804 in the same proportions. By November 1935, however, this was no longer true. Out of 109 persons who owned stock in both companies in the aggregate (i.e., they either owned stock in both companies, or in one or the other) 12 persons had stock in one company, but no stock in the other, and 11 persons had stock in both companies, but not in the same proportions. A complete list of the stockholders and number of shares owned by each of both the hardware company and the realty company was incorporated in the record by agreement and is made a part of these findings of fact by reference. The companies were managed as entirely separate entities, each had its own stockholders' meetings and elected its own directors and officers, and they dealt with each other as separate entities. 5. In December 1926 the realty company borrowed $100,000 from the Praetorians, a life insurance company, giving a mortgage on its property in block 60 as security, and used the proceeds of this loan to purchase the property situated in block 220 of the city of Dallas, upon which it subsequently erected the office and warehouse building used by the hardware company as its principal office. This property in805 block 220 was purchased in 1926 at a total cost of $96,483.62. 6. In 1927 the realty company borrowed $135,000 from the Minnesota Mutual Life Insurance Co., giving a first mortgage on the property in block 220 as security therefor, and used a portion of the proceeds of the loan to erect the first unit of its warehouse and office building on that property at a cost of $124,477.36. This was a straight 10-year loan. In 1930 a second unit was added to the warehouse at a cost of $57,719.27, and at that time an additional $25,000 was borrowed 784 from the Minnesota Mutual Life Insurance Co. The $25,000 loan was payable at the rate of $5,000 per annum, and on November 5, 1935, $5,000 of that loan was still owed to the insurance company, so that on November 5, 1935, the realty company owed ot the insurance company $140,000 as a first lien against the block 220 property. 7. In 1930 the property in block 60 was remodeled at an expense of approximately $42,000, $25,000 of which was secured from the Praetorians as an additional loan, to be repaid at the rate of $5,000 per annum, and the balance of which was advanced by the hardware company to the realty company. Certain payments806 were made by the realty company from time to time on its indebtedness to the Praetorians. On November 5, 1935, the first mortgage indebtedness owed by the realty company to the Praetorians on the property in block 60 was $88,761.76. 8. In 1930 the hardware company began lending money to the realty company to enable the latter to build the second unit of the hardware building and to remodel the property in block 60. Some money for those purposes was borrowed by the realty company from banks in Dallas, and these bank loans were eventually paid by the hardware company as a further loan to the realty company. By June 1934 the total indebtedness owed by the realty company to the hardware company had grown to approximately $70,000, and on June 10, 1934, at the instance of the hardware company, the realty company executed its demand note for $70,000, bearing 6 percent interest, payable to the hardware company, and on the same date executed a second mortgage deed of trust lien on all of its properties as security therefor. 9. By October 1935 it had become the opinion of the board of directors of the hardware company that they had no substantial equity as security for their second807 lien note. Accordingly, they directed the trustee to post notices to foreclose their mortgage, and directed their agent who attended the sale to offer a bid of $20,000 for the properties, subject to the first liens, with further instructions that if any third party should show up at the sale and offer more than $20,000 as a cash bid he should let such higher bidder purchase the properties. 10. P. H. Speaker, the trustee designated in the deed of trust executed June 10, 1934, by the Huey & Philp Realty Co., as security for its promissory note in the sum of $70,000 payable to the order of Huey & Philp Hardware Co., more than 21 days prior to November 5, 1935, prepared and signed notices in proper legal form advertising that he would sell the property described in said deed of trust and belonging to the Huey & Philp Realty Co., on November 5, 1935, between the hours of 10 a.m. and 4 p.m., and posted three of said notices, one at the courthouse door in Dallas, Dallas County, Texas, 785 one elsewhere within the city limits of Dallas, and the third notice out in Dallas County, which notices were prepared and posted in full accordance with the statutes of the State of Texas governing808 such foreclosure sales. On Tuesday, November 5, 1935, about 2:15 p.m., the said trustee, P. H. Speaker, and Alvin H. Lane, attorney and agent for the Huey & Philp Hardware Co. went to the courthouse door of Dallas County, and there Speaker read his notice of sale in a distinct tone of voice, loud enough to be heard by any third party who might be standing in that vicinity, and offered said property for sale. When Speaker called for bids, Lane, on behalf of the Huey & Philp Hardware Co., submitted a bid against both tracts of property, subject to the first liens which existed against each of them in the sum of $20,000. Speaker then called for any other bids, and when no other bids were made, he announced that the property was sold to the Huey & Philp Hardware Co. for $20,000, and subject to the first mortgages against the property. Thereafter, and upon the same day, P. H. Speaker, as trustee, executed his trustee's deed conveying said property to the Huey & Philp Hardware Co., which deed is recorded in volume 1929, page 226, of the deed records of Dallas County, Texas. This deed contained, among other things, the following: Now, THEREFORE, in consideration of the premises809 and of the said Twenty Thousand ($20,000.00) Dollars, to me in hand paid by the said Huey & Philp Hardware Company, the receipt of which is hereby acknowledged and confessed, I, the said P. H. Speaker, Trustee as aforesaid, do by these presents bargain, grant, sell and convey to the said Huey & Philp Hardware Company the above described tract of land, together with all and singular the rights, members and appurtenances to the same in any manner belonging. This conveyance, however, is made subject to mortgages which are outstanding against the first tract, consisting of six contiguous tracts of land as above described, in favor of Minnesota Mutual Life Insurance Company, and subject to mortgage in favor of The Praetorians on the second tract, consisting of two tracts of land hereinabove described, it being expressly understood that the grantee herein does not assume the payment of any of said mortgages. The $20,000 paid by petitioner at foreclosure sale for these several tracts of land, plus the amounts of the first mortgages which were held against them, represented their fair market value at that time. 11. Following the foreclosure in November 1935 the realty company was stripped810 of assets. Its stockholders, at a special meeting, in December 1935 authorized its dissolution, which was accomplished on the records of the Secretary of State of Texas on January 4, 1936. The hardware company ascertained the balance of $49,504.72 owed by the realty company to it after crediting the $20,000 bid upon the $70,000 note to be worthless and charged it off on its books as an 786 uncollectible bad debt. The charge-off was duly entered on the hardware company's books during the year 1935. 12. Subsequent to the purchase by the hardware company of the above described real estate at foreclosure sale, it organized two corporation - the Magna Realty Co. and Griffin Realty Co. - the capital stock of which was subscribed by and issued to the petitioner. Petitioner transferred to the Magna Realty Co. the six tracts of land which were under a mortgage to the Minnesota Mutual Life Insurance Co. The consideration for this transfer was $850 in cash and $9,150 in deferred payments secured by a second mortgage and was made subject to the first mortgage lien held by the Minnesota Mutual Life Insurance Co. The two tracts of land and buildings thereon which were under mortgage811 to the Praetorians were transferred to the Griffin Realty Co. The consideration of this transfer was $850 in cash and $9,150 deferred payments secured by a second mortgage and was made subject to the first lien held by the Praetorians. 13. The foreclosure sale in November 1935 was not preceded by any discussion between the two companies of any plan for reorganization of the realty company. No reorganization of the realty company in any way was ever discussed, and neither it nor its stockholders secured or were granted any character of interest in the hardware company by reason of the foreclosure sale or in any corporation subsequently organized to hold title to the real estate acquired by the hardware company at the foreclosure sale. OPINION. BLACK: The only issue involved in this proceeding is whether petitioner is entitled to a deduction for a bad debt which it alleges it ascertained to be worthless and charged off during the taxable year. There is no issue as to the amount of the debt or that it was charged off during the taxable year. Petitioner originally claimed $53,741.15 as the amount of the bad debt, but now concedes that this figure should be reduced to $49,504.72. 812 The respondent has denied the deduction on two grounds: First, that the purchase of the real estate at foreclosure sale by the hardware company and its subsequent transfer to two newly organized corporations, the Magna Realty Co. and Griffin Realty Co., was all part of a plan for the reorganization of the realty company and that all the above named corporations were parties to such reorganization and that petitioner is, therefore, not entitled to the deduction which it claims; second, that even if there were no reorganization of the realty company, nevertheless the fair market value of the property in question was far in excess of what petitioner paid for it at the foreclosure sale and petitioner, therefore, did not ascertain its debt against the realty company to be worthless, as it claims. 787 We shall take up respondent's first ground for disallowing the deduction. It is respondent's contention that petitioner sustained no loss within the purview of section 112(b)(3) of the Revenue Act of 1934. It is respondent's contention that the $70,000 demand note executed by the Huey & Philp Realty Co. to petitioner (described in our findings of fact) was a "security" within813 the meaning of section 112(b)(3) of the Revenue Act of 1934. Section 112(b)(3) of the Revenue Act of 1934 provides: * * * No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. The reorganization provisions of the Revenue Act of 1934 relied upon by the respondent are printed in the margin. 1814 The respondent cites the following authorities in support of his contention that there was a reorganization: ; certiorari denied, ; ; ; certiorari denied, ; ; ; ; ; . To these authorities may be added . We shall not attempt to review each of the above authorities but we have read and carefully considered them. In substance they hold that, where the bondholders of a corporation which has defaulted in its bonds form a protective committee and agree upon a plan to purchase the property of the defaulting corporation at a foreclosure sale and transfer it to a new corporation organized as a part of the plan of reorganization, in815 exchange in whole or in part for the new corporation's stock or bonds or debentures, such transactions constitute a reorganization and gain or loss is to be recognized only to the extent provided in section 112. 788 In the first place, we doubt if the $70,000 demand note of petitioner against the realty company dated June 10, 1934, secured by a second mortgage and foreclosed upon in November 1935, can be held to be a "security" within the meaning of section 112(b)(3), cited above. Cf. . . But even if we assume that the $70,000 demand note in question was a "security" within the meaning of the quoted statute, in order for the transactions in question to be within the nonrecognition provisions of the statute in question, and the authorities above cited, petitioner must have purchased the property at foreclosure sale and transferred it to the newly organized corporations in exchange for their capital stock or securities, all as a part of a plan of reorganization previously agreed upon. In the instant case there is no evidence of816 any plan to reorganize the realty company. On the contrary, certain of petitioner's officers who were in control of its affairs at the time of the foreclosure sale testified that there was no plan of reorganization; that the hardware company simply realized that it had a loss on the realty company and under the then set-up, the loss would in all probability continue to increase; and that the hardware company decided to foreclose its second lien and purchase the property at $20,000 if no one bid the property in at a higher price than that and take its loss by charging off the remainder of its debt as a bad debt. These officers testified that at the time of the foreclosure sale, there had been no plans made to organize two new corporations and transfer the purchased property to them; that these plans were agreed upon and consummated after the foreclosure sale. There is no evidence in the record to the contrary, such as minutes of the corporations or letters to stockholders outlining a plan of reorganization. Therefore, we conclude from the evidence that the real estate in question was not purchased by petitioner at foreclosure sale as part of a plan to reorganize the realty company, 817 but was simply a sale and must be so treated. As a further reason for coming to this conclusion, aside from the reasons which we have already stated, petitioner apparently did not exchange the property purchased at the foreclosure sale for the stock of the two newly organized corporations. Apparently each of these two newly organized corporations was organized with a capital stock of $1,000 paid in cash by petitioner. Subsequently the real estate on which the Minnesota Mutual Life Insurance Co. held a first mortgage lien was conveyed to the Magna Realty Co. for $850 in cash and $9,150 deferred payments secured by a second mortgage and subject to the first mortgage held by the Minnesota Mutual Life Insurance Co. In the same manner and for 789 the same consideration, petitioner conveyed to the Griffin Realty Co. the real estate upon which the Praetorians held a first mortgage lien. It is not necessary for us to decide whether the conveyance to the two newly organized corporations by petitioner of the real estate purchased by it at foreclosure sale was one in which gain or loss is recognized or is one in which gain or loss is postponed, either because of the reorganization818 provisions of section 112 of the Revenue Act of 1934 or of section 112(b)(5) of the same act. Apparently there was neither gain nor loss to petitioner in these transactions with the two newly organized corporations in any event, because it appears to have conveyed the properties to the newly organized corporations for exactly what it paid for them at the foreclosure sale. But we have not that question before us. As we have already stated, the only question which we have before us to decide is whether or not petitioner is entitled to the deduction of a debt which it alleges it ascertained to be worthless in the taxable year and charged off. In line with what we have said above, we hold that it is so entitled unless it is precluded from doing so by reason of the second reason assigned by the Commissioner in his deficiency notice. , the statute which authorizes a taxpayer to take a deduction for a debt ascertained to be worthless and charged off in the taxable year is section 23(k) and is so familiar that it need not be quoted. Article 23(k)-3 of Regulations 86, dealing with the phase of the question which we have here to decide, is in part printed in the margin. 2819 The petitioner contends that, under the doctrine promulgated by the Supreme Court of the United States in , the sale price at foreclosure is conclusive proof as to the fair market value of the property at the time of sale, and that no independent inquiry as to fair market value of the property at such time is permissible. We do not think the Supreme Court went as far in the Midland Mutual Life Insurance Co. case as petitioner contends, but we do not think it is necessary for us to decide how far it went in this respect. 790 At the hearing, evidence was admitted from both parties as to the fair market value of the property in question. Upon a weighing of that evidence we have found that the fair market value of the property in question at the time of sale was the $20,000 which petitioner bid for it, plus the amounts of the outstanding first mortgages against it. We consider that it is unnecessary to discuss this evidence in detail. It is simply an ordinary instance where witnesses differ in their opinion as to value and it is unnecessary to believe that any of them testified in bad820 faith. We simply conclude that the usual presumption that the bid price at the duly advertised public sale represented the fair market value of the property at that time, coupled with petitioner's evidence at the hearing as to value, discharges its burden of proof in that respect and justifies our above finding as to its fair market value. Therefore, petitioner's basis for gain or loss on the future sale or exchange of the property was the purchase price paid for it at the foreclosure sale. Petitioner will, of course, not be entitled to have any of the $49,504.72 that is charged off as a bad debt carried forward as a part of its cost basis of the property, as would have been the case if we had held that the transactions showed a reorganization and petitioner could not take its bad debt deduction because of section 112(b)(3). Petitioner is now getting a deduction for this $49,504.72 bad debt loss and as a matter of course can not use it as a part of the cost of the real property purchased at the foreclosure sale for the purpose of determining gain or loss or depreciation on the property in the future. We, therefore, hold that petitioner is entitled to a deduction of $49,504.72821 as a debt ascertained to be worthless and charged off during the taxable year. Decision will be entered under Rule 50.Footnotes1. SEC. 112. (g) DEFINITION OF REORGANIZATION. - As used in this section and section 113 - (1) The term "reorganization" means * * (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock: of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. * * * (2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another * * * (h) DEFINITION OF CONTROL. - As used in this section the term "control" means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation. ↩2. * * * If mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. In addition, if the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. * * * ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622756/	MABEL A. ASHFORTH, H. ADAMS ASHFORTH, ALBERT B. ASHFORTH, JR., AND GEORGE T. ASHFORTH, EXECUTORS, ESTATE OF ALBERT B. ASHFORTH, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL revenue, respondent.Ashforth v. CommissionerDocket Nos. 47190, 48009, 49354.United States Board of Tax Appeals26 B.T.A. 1188; 1932 BTA LEXIS 1176; October 12, 1932, Promulgated 1176 Where the grantor of a trust reserved the power to revoke the trust and revest in himself title to the trust property upon giving notice of his intention to the trustees within the first fifteen days in December in the year preceding the contemplated revocation, held, such notice not having been given, the income of the trust is not taxable to the grantor under section 219(g) of the Revenue Act of 1926. Paul L. Peyton, Esq., for the petitioners. C. C. Holmes, Esq., for the respondent. SMITH 1188 These proceedings, duly consolidated, are for the redetermination of deficiencies in the decedent's income tax for the years and amounts as follows: Docket No.YearDeficiency471901925$358.56480091926873.924935419271,747.331189 The only issue for our determination is whether the income of a certain trust is taxable to the decedent grantor under section 219(g) of the Revenue Act of 1926. The facts were stipulated. FINDINGS OF FACT. The petitioners are residents of New York City, and are the duly qualified executors of the estate of Albert B. Ashforth, who died September 4, 1929, a resident1177 of the City, County and State of New York. As of December 31, 1924, the decedent granted, conveyed, assigned and delivered to the Bankers Trust Company, a New York Corporation, and Mabel Adams Ashforth, as trustees, 92 shares of Title Guarantee & Trust Company stock and 5 shares of City of New York Insurance Company stock, to hold such property in trust subject to the terms and conditions of an indenture, which, in so far as material here, provided: NINTH: This indenture and the trusts then existing and the estates and interests in property hereby created, may not be modified or altered in any manner, or revoked in whole or in part in any calendar year, unless and until, - 1. The Trustees shall have received from the party of the first part during the first fifteen days in December in the calendar year next preceding a written notice stating in general terms the intention of the party of the first part to modify, alter or revoke this indenture during the following month of January; and 2. The party of the first part shall deliver to the Trustees within such month of January an instrument in writing executed and acknowledged in the manner required for a deed of real property, 1178 os as to enable it to be recorded in the State of New York, which instrument shall state specifically in what respect this indenture is modified or altered (including change of beneficiaries) or revoked in whole or in part, but in no event shall the party of the first part so modify or alter the conditions hereof as to provide for the receipt by him of any part of the income during the existence of this trust. In case of such revocation, said instrument shall direct the disposition to be made of the trust fund, or of the portion thereof affected by such revocation, and the Trustees shall make, execute and deliver such instruments, if any, and make such conveyance and transfers of property as may be necessary or proper in order to carry the same into effect, and no one shall have any right, interest or estate under this indenture, except subject to the proper modification, alteration or revocation thereof. For the calendar years 1925, 1926 and 1927 the trustees duly filed fiduciary returns of income on the calendar year basis. The gross income of the said trust during these years consisted entirely of 1190 dividends on stocks of domestic corporations as follows: 1925, 1179 $1,992; 1926, $4,599.61; and 1927, $8,372, which amounts the Commissioner added to the decedent's income in determining the deficiencies for these years. Albert B. Ashforth did not at any time during the calendar years 1925, 1926, and 1927 give notice to said trustees, pursuant to paragraph ninth of said indenture of December 31, 1924, of any intention to modify, alter or revoke said trust. OPINION. SMITH: The respondent has taxed the income of the trust property to the decedent under section 219(g) of the 1926 Act, which is as follows: Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor. The petitioners contend that the terms of the trust agreement prevented the decedent from revesting in himself title to any part of the corpus of the trust at any time within the taxable year, since in order to do so he must give formal notice of such intention to the trustees prior to the1180 beginning of the taxable year, or within the "first fifteen days in December in the calendar year next preceding such contemplated revocation." The respondent argues that this requirement of the trust agreement did not render the trust irrevocable within the taxable year. The above provision of the statute was new in the Revenue Act of 1924, the legislative history of which indicates that the grantor's "power to revest in himself title to any part of the corpus of the trust" was limited to the existence of that power "at any time during the taxable year," and further that the limitation was a material consideration in determining the taxability of the income from the trust. As originally written, section 219(g) made the income taxable to the grantor where he "reserved a power of revocation which, if exercised, would revest in him title to the corpus of the trust." Committee Prints Nos. 1 and 2, H.R. 6715. The Senate resrote this provision, except for the descriptive phrase "not a beneficiary of the trust" following the word "person," which was added by the Conference Committee on this bill. See Committee Print No. 3, Senate Amendment No. 62, and Committee Print Agreed in Conference. 1181 In the Senate Finance Committee Report No. 398, 68th 1191 Cong., 1st sess., is the explanation of this new provision of the statute and the Senate's change in the House proposal, as follows: (2) Paragraph (g) of this section provides that where the grantor of a trust reserves the right to change the trust in favor of himself the income is taxed to the grantor. The subdivision of the House bill has been rewritten in order that there shall not be taxed to the grantor the income of a trust as to which the grantor has a power of revocation subject, however, to a condition which has not happened. The creation of a revocable trust constitutes nothing but an assignment of the right to receive future income. Since such an assignment does not operate to increase [sic - decrease] the taxable income of the assignor, the creation of a revocable trust should not so operate, but the income of such a trust should be included in the income of the grantor. The bill so provides. In construing this provision of the statute, the District Court for the District of Massachusetts, in 1182 , reviewed its legislative history and said: These proceedings indicate that the words "at any time during the taxable year" were inserted for a definite purpose. They limited the application of the statute to those cases where the grantor had reserved in the trust agreement an unconditional power by the exercise of which during any taxable year he could control or appropriate the income derived from the trust during that year and which was payable to another. According to the section, as originally proposed, the were reservation of the power of revocation was sufficient to render the income from the trust taxable to the grantor, and it was deemed wise to add provisions excepting from the operation of the law income of a trust as to which the grantor's power of revocation was subject to a condition that had not happened. It is this power to reach and apply the income at the grantor's option that renders it subject to the tax, regardless of whether or not he exercised the power. It was the reservation of this power, control, or "command over the property taxed" that was advanced in 1183 , as adequate grounds upon which to base the constitutionality of section 219(g). The scope of the statute, as the Commissioner construed it, would be as wide as the scope of the section originally proposed by the House. Under such a construction it would make no difference when the power of revocation could be exercised, whether during the taxable year or prior to the taxable year; if the power of revocation is there, it is sufficient. To accept this interpretation of the act is to impart no significance whatever to the words of limitation introduced into the law by the Senate amendment. The provision was held constitutional in , and the income of the trust involved in that case and the one in ; affd., , taxed to the grantors because the revocation in each case was capable of consummation during the taxable year. Those cases are thus distinguishable from the instant proceedings, in which the power of revocation was conditioned upon notification in the preceding taxable year. In 1184 , the trust instrument could be revoked on or after January 1 in any year "only upon condition that 1192 and provided the Trustor shall in the preceding calendar year have notified in writing the trustees of his intention so to revoke, alter and/or amend this instrument." The court there held that the grantor could not during the taxable year "by any amendment or revocation, revest in himself title to any part of the corpus of the trust" and the income thereof was not taxable to him. The petitioners' contention is sustained. The income of the trust here involved should not be taxed to the grantor, who, although reserving the power of revocation, subjected that power to a condition, to wit, notification to the trustees "during the first 15 days of December in the calendar year next preceding such contemplated revocation," which has not happened. After the beginning of each of the taxable years under consideration, the decedent having failed to notify the trustees of an intention to revoke or change the trust within either taxable year, the income was not subject to his "unfettered command" and he was not free to enjoy it during the*1185 taxable year. This holding is consistent with the decisions in ;; and fully supported by , holds to the contrary, although the facts are not distinguishable. That case erroneously disregarded the condition of notice, which if not given we believe is the "condition which has not happened" and the kind that makes the income not taxable to the grantor. That case is therefore overruled. Reviewed by the Board. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622757/	LAWRENCE S. CHARFOOS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCharfoos v. CommissionerDocket No. 14056-88United States Tax CourtT.C. Memo 1991-292; 1991 Tax Ct. Memo LEXIS 338; 62 T.C.M. (CCH) 32; T.C.M. (RIA) 91292; July 2, 1991, Filed 338 Decision will be entered for the respondent. John B. Curcio, for the petitioner. Margaret A. Satko and Eric M. Nemeth, for the respondent. HAMBLEN, Judge. HAMBLENMEMORANDUM FINDINGS OF FACT AND OPINION By statutory notice of deficiency, dated March 22, 1988, respondent determined deficiencies in, and additions to, petitioner's Federal income tax as follows: Additions to TaxTaxableSectionSectionSectionSectionYearDeficiency6653(a) 16653(a)(1)6653(a)(2)66611980$ 95,792.00$ 4,789.60------1981$ 70,555.45--$ 3,527.77 --1982$ 52,844.43--$ 2,642.22 *$ 13,211.11The issues for decision are: (1) Whether operating losses generated339 by petitioner's yacht-chartering activity are attributable to petitioner as an individual or to a separately taxable corporation that petitioner organized; (2) if the losses are attributable to petitioner as an individual, whether he is entitled to deduct them from his gross income because he engaged in the chartering activity with an actual and honest profit objective as required by section 183; (3) assuming the losses are attributable to petitioner and petitioner engaged in the yacht-chartering activity with the requisite profit objective, whether respondent nonetheless properly disallowed certain Schedule C deductions because petitioner failed to properly establish his entitlement to them; (4) whether petitioner accurately reported income and a depletion expense from a drilling partnership on his 1981 tax return; (5) whether petitioner was entitled to an $ 8,562 casualty loss deduction on his 1981 tax return; and (6) whether petitioner is liable for the additions to tax determined by respondent for negligence and for the substantial understatement of income tax. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached340 exhibits are incorporated herein by this reference. Lawrence S. Charfoos, hereinafter petitioner, was residing in Detroit, Michigan, when the petition in this case was filed. Petitioner is a prominent trial attorney who has handled large, technically complex personal injury and products liability cases. He has also published three books, two of which are law textbooks. During the years in issue, petitioner was a partner in the Detroit law firm of Charfoos & Charfoos. Petitioner first became interested in the yacht-chartering business in June 1979 when he and three friends chartered a 79-foot motor yacht, named Colinga, for a 2-week vacation cruise on the French Riviera. The Colinga was built in England in 1969 and, at the time of petitioner's cruise, had two double cabins, two single cabins, adjoining bathrooms, separate crew quarters, spacious living room, dining room, modern galley, air conditioning, after deck, flying bridge, sunbathing area, and many modern conveniences. In 1979, the Colinga had been used as a charter yacht only occasionally by her owners. The Colinga's first owner, an elderly Englishman named Evelyn Jones, used the yacht with his family for recreational341 purposes until 1975, when he decided to renovate her for possible use as a charter yacht in the Mediterranean yacht charter market. He hired Barry Piggin, an experienced English seaman and personal friend, to be the Colinga's skipper and to begin the repairs and renovations. In 1976, Mr. Jones chartered the Colinga to several parties for overnight trips, even though the planned repairs had not yet been completed. Captain Piggin's wife, Heather, worked as the Colinga's cook during these chartered trips. In 1977, before the Colinga's renovations were completed, Mr. Jones sold her to Hroar Hansen, a Norwegian citizen. Although Mr. Hansen chartered the Colinga to paying guests a few times in 1977 and 1978, he and his family used the yacht primarily for their own recreation. Mr. Hansen retained Captain Piggin as the Colinga's skipper, and Heather Piggin as the yacht's cook and bookkeeper. Captain and Heather Piggin thought that the interior of the yacht was becoming shabby and that a lot of money needed to be spent in order to properly maintain the Colinga's hull, engine, and mechanical parts. The Piggins tried to convince Mr. Hansen to complete the renovations that the first owner342 had begun. However, in the fall of 1978, Mr. Hansen suffered some large, unrelated business losses, and became financially unable to pay the Piggins' salaries or any of the bills that the boat incurred, or to complete the repairs that Captain Piggin felt were necessary to make the Colinga competitive in the Mediterranean charter market. Captain and Heather Piggin began to pay the Colinga's operating expenses and invested their own money to complete the mechanical repairs Captain Piggin felt were essential. The Piggins believed they could recoup their investment in the approaching Mediterranean charter season which runs from May through October. The Piggins also began to keep an eye out for a prospective buyer with enough money and the desire to complete other mechanical repairs, as well as renovations to the Colinga's interior that the Piggins felt were much needed. Petitioner and his three friends were one of the first groups to charter the Colinga in 1979. During their cruise, petitioner began talking with Captain and Heather Piggin about the business of yacht chartering in general. Captain Piggin told petitioner that the Colinga could probably be purchased at a very low 343 price due to the financial position of Mr. Hansen. In the 1960's petitioner and a friend had co-owned a 35-foot cabin cruiser which they used for recreational purposes in Detroit. Petitioner has also previously owned several small speed boats and chartered a yacht for a Caribbean vacation. However, before 1979, petitioner had never owned a large yacht nor operated any form of yacht-chartering business. The opportunity to buy the Colinga at a low price and obtain what petitioner believed to be an ongoing charter business, piqued his interest. Petitioner was also very impressed by the Piggins' yachting experience, as well as their reputation and demeanor as professional crew members. During the cruise, petitioner's discussions with the Piggins became focused on the Colinga's average operating expenses and charter revenues, marketing ideas, and the specific repairs and renovations that the Piggins felt were necessary. During one of these discussions, petitioner jotted down four pages of notes summarizing the Piggins' estimates of the Colinga's yearly operating expenses. The Piggins based their estimates of expenses on their general familiarity with the operation of the Colinga; 344 the yacht's operating expenses and repairs which they had paid out of their own pockets when Mr. Hansen began having financial difficulties in the fall of 1978; and on the yacht's bank statements, bank journal, and petty cash book, all of which were kept on board by Heather Piggin. Petitioner was allowed to view these records during their discussions. Petitioner's informal, four-page estimate included some of the larger fixed costs associated with operating a charter business such as water, electricity, moorage, chandlery, daily maintenance, and the crew's salaries, uniforms, and food. Petitioner determined that he could offset these expenses if he had at least 8 weeks of yacht rentals each charter season. Petitioner was aware that in order to adapt the Colinga for continuous charter service, a number of expensive improvements would be required, including the overhaul of the engines and the replacement of the anchor, air conditioning system, and speed boat. However, petitioner did not take the cost of these needed improvements into account when initially estimating his expenses. Nor did he consider the full cost of maintenance, insurance, interest on a mortgage loan, his air345 travel, and the potential of fluctuations in the foreign currency exchange rates. By the end of his 2-week vacation cruise, petitioner decided that, if he could negotiate a low price, he would like to purchase the Colinga and utilize her as a Mediterranean charter yacht. He also told the Piggins that he wanted to hire them as the Colinga's crew, pursuant to a 5-year employment contract. In July 1979, after petitioner had returned to the United States, but prior to his purchase of the Colinga, Captain Piggin sent him a detailed, typewritten estimate of the all expenditures needed to upgrade and restore the yacht. The estimate was broken down in terms of "winter" and "summer" running expenses and "necessary" and "suggested" improvements. The estimates were in French currency and were not converted to dollar figures. Petitioner did not verify or investigate the estimates made by Captain Piggin and Heather. However, petitioner felt that he could rely on the accuracy of the Piggins' estimates for expenses and improvements because of their expertise with yachts, the fact that they shopped for many of the spare parts and refurbishings themselves, and because Captain Piggin performed346 many of the Colinga's repairs. In negotiating the purchase price of the Colinga, petitioner consulted Yachting Partners International Ltd. (hereinafter Yachting Partners), an international yacht charter and brokerage firm based in Sussex, England. The seller, Mr. Hansen, had used Yachting Partners in booking charters for the Colinga. The principal of Yachting Partners, Alex Braden, was a good friend of Captain Piggin. On August 10, 1979, Yachting Partners sent petitioner a letter advising him that the Colinga's records for the 1978-79 season would not be of "great assistance" to him in estimating operating expenses because they showed an unrealistically low picture. According to the letter, the original purchase survey, slipping, and work expenses were not included in the 1978-79 records. Furthermore, all other expenses, such as the replacement of the radar, winter slipping, and various repairs, were carried forward to the following season. Thus, the 1978-79 records only showed income and a few of the day-to-day expenses. Prior to his purchase of the Colinga, petitioner did not obtain a written appraisal of the fair market value of the yacht or an independent market study 347 of the profit potential of the Mediterranean yacht-chartering business. On September 24, 1979, petitioner executed a sales contract in which he agreed to buy the Colinga from Mr. Hansen for # 120,000, which is approximately $ 265,000. Clauses four and five of the sales contract state that petitioner had 28 days from signing the agreement to conduct a survey of the yacht and, if any material defects were found, petitioner could recover the purchase price or obtain a price reduction sufficient to cover the defects. Petitioner hired Lockyer & Rich Limited, an English marine consulting firm, to perform an exhaustive survey of the Colinga's condition which was completed on September 31, 1979. After reading the survey, petitioner felt that it conformed to the Piggins', Mr. Hansen's, and Yachting Partners' representations of the Colinga's condition. In October 1979, petitioner's purchase of the Colinga became final. Immediately after title to the Colinga was transferred to petitioner, he purchased a 12-month insurance policy for the yacht from Sedgwick Marine Limited (hereinafter sometimes referred to as Sedgwick). The policy, dated October 12, 1979, was renewed in October 1980 and348 October 1981. All three yearly policies list petitioner as the assured owner of the Colinga. Each insurance policy form states petitioner was to immediately advise Sedgwick if the policy was incorrect in any way. While petitioner held title to the yacht Colinga, he purchased, in his own name, a yacht berth at Port Vauban, in the city of Antibes, located near Nice on the southern coast of France. Petitioner hired Captain Piggin to be the Colinga's skipper and to oversee the repair and renovation of the yacht. He also hired Captain Piggin's wife, Heather, to be the Colinga's cook, bookkeeper, and interior designer. The Piggins only wanted to be associated with a yacht that was used solely for charters during the charter season because they required a 5-percent commission on "net charter income." Net charter income is the gross charter income less a 15-percent commission for the agent who found the charterer. Petitioner had a verbal agreement with the Piggins that they would work for petitioner for at least 5 years. After petitioner's purchase of the Colinga, he was in frequent contact with Captain Piggin to discuss the yacht's repairs, renovations, and related budgeting. In349 order to protect a vessel from possible terrorism and to comply with various international laws, it is customary for the owner of an ocean-going vessel to officially enroll the vessel on the ship register of a home country. When petitioner purchased the Colinga, it was registered under the Norwegian flag, but due to the change in the Colinga's ownership, the yacht had to be re-registered. The Colinga could have been registered in the United States, France, Great Britain, Liberia, Malta, or Panama. Captain Piggin wanted the Colinga to fly the flag of Great Britain, since he and his wife were English. He also thought the British flag would be helpful in marketing the yacht to charterers. Initially, petitioner wanted to register the Colinga in the United States but discovered that, in order to do so, a vessel's owner must transport the vessel to the United States for inspection by the Coast Guard. Because of the expense and impracticality of transporting the Colinga to the United States, and the fact that Captain Piggin wanted to fly the British flag at the yacht's stern, petitioner decided to try to qualify the yacht to be registered in Great Britain. A vessel may only be listed350 on the British Ship Registry by its owner, who must be either a resident person in the United Kingdom or a corporation organized under the laws of the United Kingdom. Since petitioner was an individual residing in Detroit, Michigan, he could not legally register the Colinga on the British Ship Registry in his own capacity. Petitioner, therefore, at the suggestion of Yachting Partners, contacted Bachmann & Co. Ltd. (hereinafter Bachmann & Co.), an international marine management consulting firm that specializes in qualifying vessels to be listed on ship registers of various countries, including Great Britain. Bachmann & Co. is based in the town of St. Peters Port on the British island of Guernsey, which is part of the Channel Islands chain situated off the coast of France. Bachmann & Co. sent petitioner a brochure entitled "International boat ownership and registration in the Channel Islands." The brochure outlines two alternative methods, "Programme A" and "Programme B," by which petitioner, as a foreign client, could qualify the Colinga for British ship registration by either organizing a corporation or establishing a discretionary trust, to which the title of the yacht would351 be transferred. The brochure explains that, under Programme B, a foreign individual client could qualify for British ship registration by incorporating a company in Guernsey, "beneficially owned through the medium of nominees by their main Holding Company or by themselves privately." However, page four of the brochure states that under Guernsey law, if a corporation is beneficially owned by a foreign resident, "appropriate authorization must be obtained from the Exchange Control Department of the Bank of England." Programme A, as outlined in the brochure, requires the foreign yacht owner to establish a trust into which beneficial ownership of a yacht could be transferred. The brochure states, however, that under the laws of Guernsey and the terms of Bachmann & Co.'s standard deed of trust, the trust beneficiaries have no fixed rights to capital or income of the trust, "but merely have the right to be considered by the Trustees when they decide to distribute income or capital. As a result, beneficiaries of a Discretionary Trust have no legal right to any particular portion of the capital or income." The last page of the brochure contains the following caveat: "It must be made clear352 that professional advice cannot be given to clients on their tax positions in Guernsey or elsewhere and that they should take advice from their own professional advisors as appropriate." In order to qualify the Colinga to be listed on the British Ship Registry, petitioner decided to organize a corporation under the laws of Guernsey. On November 26, 1979, petitioner executed a contract with Bachmann & Co., entitled "Management Agreement," instructing Bachmann & Co. to use the incorporation procedure outlined in the brochure that was sent to petitioner. On December 13, 1979, a corporation by the name of Charter Company Limited 2 was registered in Guernsey, Channel Island, United Kingdom. "Articles of Association" for the corporation, which are standard forms drafted by Bachmann & Co., were filed. According to the Articles of Association, the corporation's stated capital account is $ 10,000, divided into 10,000 shares worth $ 1.00 each; its registered office is located in Guernsey; and, at the time of registration, it had seven initial shareholders, who each held one share, and three directors. Petitioner did not personally know any of Charter Company Limited's shareholders or353 directors who were all Bachmann & Co. personnel. During the years in issue, the corporation held no regular meetings of the shareholders or the directors at which decisions concerning the Colinga's operation were made, no shareholder votes were taken, and no minutes of meetings were kept. The Articles list the objectives of the corporation, which include the managing and chartering of boats and the carrying on of "businesses commonly carried on by ship-owners." Petitioner sent Bachmann & Co. annual fees for managing Charter Company Limited. The fees for Bachmann & Co.'s services were paid out of a checking account held in the name "Colinga II" which was maintained at City National Bank in Detroit, Michigan. Petitioner was the signatory for the checking account and deposited its funds. There is nothing in the record to indicate that petitioner followed the instruction appearing354 on page four of Bachmann & Co.'s brochure, directing him to obtain appropriate authorization from the Exchange Control authorities of Guernsey, so as to be regarded as the beneficial owner of the corporation by the Guernsey government officials. At some point, petitioner, in the presence of his attorney, Eugene Gargaro, Jr., executed a document entitled "Settlement between Lawrence S. Charfoos & Charter Company Limited." The document purports to establish a trust and names petitioner as the settlor and Charter Company Limited as the trustee. However, the document is undated and does not name petitioner as a beneficiary. By the document's terms, the trust was initially funded with $ 100. Neither the Colinga, nor any other yacht, is mentioned in the document. On March 14, 1980, petitioner executed a bill of sale which purports to convey "64/64th shares" in the yacht Colinga to Charter Company Limited for a stated consideration of # 120,000, which is equal to approximately $ 263,888. The bill of sale was recorded with the British Port of Registry. Petitioner never collected the consideration recited in the bill of sale for the transfer of the Colinga's title to the corporation. 355 In March 1980, Charter Company Limited borrowed SwF320,000, equal to approximately $ 182,440, from Hill Samuel & Co. Limited (hereinafter Hill Samuel & Co.) to finance the purchase of the Colinga. The Colinga was pledged as security for the loan. In December 1979, petitioner had signed a separate agreement with Hill Samuel & Co. personally guaranteeing any future advances of funds lent to the corporation. On March 10, 1980, a certificate of British Registry was issued to Charter Company Limited. The Colinga remained on the British Ship Registry until the yacht was sold in 1986. The certificate of registration listed the corporation as the Colinga's owner. On April 3, 1980, Charter Company Limited officially changed its name to Colinga Limited in the Royal Court of the Island of Guernsey. For convenience and clarity, we shall hereinafter refer to the corporation as Colinga Ltd. Petitioner never advised his insurance company, Sedgwick Marine Limited, that he had transferred title to the yacht Colinga to the corporation, Colinga Ltd. After he sold the Colinga to the corporation, petitioner was advised by Yachting Partners that the assured in the insurance policies should not356 be "Lawrence S. Charfoos," but rather, "Lawrence S. Charfoos and/or Colinga Limited, as their respective rights and interests may appear." Petitioner took no action pursuant to Yachting Partner's recommendation. During the winters of 1979-80 and 1980-81, major improvements and repairs on the Colinga were made at the direction of petitioner. The yacht was improved structurally by converting two single cabins into one large double cabin, making it more suitable for charter use. Mrs. Piggin obtained new cutlery, crockery, linens, carpets, curtains, and other items for the interior. Petitioner required Captain and Mrs. Piggin to obtain quotes for all the repairs and materials, and he subsequently approved or disapproved of their budgets. After the initial repairs and renovations were completed, the Piggins held a cocktail party for charter agents on the Colinga to attract charter business for the 1980 season. An American Express account was maintained by Captain Piggin in France for all the repair, renovation, entertaining, and numerous miscellaneous expenses incurred on the yacht Colinga. The American Express account was held in the name of "M.Y. Colinga II" and Captain Piggin357 was the account's signatory. Petitioner regularly made deposits to the account. Whenever Captain Piggin needed additional money, he would telephone petitioner who would send additional funds to the account from Detroit. Captain and Heather Piggin regarded petitioner as the owner of the Colinga and took their directions from him. However, when the Piggins began booking charters for the Colinga in 1980, they consistently used the name of the corporation, Colinga Ltd., and not that of petitioner, in all their business dealings. Whenever Captain Piggin signed a charter contract with a booking agent or a chartering party, he signed on behalf of "Colinga Ltd." and not in the name of petitioner. Colinga Ltd. incurred expenses and obtained a radio license in its own name. In 1980, 1981, and 1982, Colinga Ltd. filed its Guernsey tax return, called an "annual list," with the registry office in Guernsey and paid its yearly # 300 corporate tax. In the 1980 and 1981 charter seasons, the Colinga charter operation generated cash losses of $ 117,840 and $ 64,051, respectively. Despite the losses, petitioner decided to add a second, smaller yacht to the operation in order to target the middle358 class charter market. On October 14, 1981, Colinga Ltd., pursuant to a written yacht sale agreement, purchased a second yacht named the Sea Crest I (hereinafter Sea Crest) from the Walft A.G. Company. The stated purchase price was # 30,000, equal to approximately $ 55,590. Captain Piggin signed the sales agreement in the name of the corporation as owner. Petitioner's name does not appear on the Yacht Sale Agreement. Subsequently, when the Sea Crest was listed on the British Ship Registry, Colinga Ltd. was listed as her owner. The Sea Crest is a 58-foot motor yacht with charter accommodations for up to four people. Petitioner obtained no written appraisal of the fair market value of the Sea Crest prior to its purchase. The day-to-day chartering operations of the Colinga and the Sea Crest were carried on by their respective captains and crew who communicated regularly over the telephone with petitioner. Most of the Colinga's records and invoices kept by the Piggins were furnished to petitioner's law office in Detroit, Michigan, where his bookkeeper, Winifred Kissick, summarized them at the end of the year for petitioner's accountants. Petitioner did not submit any receipts359 or records of expenses generated by the Sea Crest in 1981 and 1982. During the years in issue, petitioner personally used the yacht Colinga three times. He took 1-week cruises on the yacht in September 1980, May 1981, and September 1981. After the cruises, petitioner usually stayed for several days in France, where he had an apartment. On one occasion, petitioner gave his parents a 2-week cruise aboard the Colinga as a gift for their 50th wedding anniversary. On June 16, 1987, the Colinga was sold to Mari-Franc Property Inc. for $ 250,000. On November 17, 1986, the Sea Crest was sold to John L. Hurford for $ 47,934. On both occasions, Captain Barry Piggin signed the bills of sale in the name of the corporation, Colinga Limited, as the owner-seller. From 1980 through 1987, petitioner claimed deductions totalling $ 915,579 for the net yacht-chartering losses on his individual tax returns. In filing his individual tax returns for 1980, 1981, and 1982, petitioner consulted with his attorney, Mr. Eugene Gargaro, Jr., and also employed a certified public accountant, Mr. Donovan Miller. On his individual tax returns for 1980, 1981, and 1982, petitioner reported wage income from360 his law firm, Charfoos & Charfoos, in the amounts of $ 624,173, $ 325,000, and $ 361,846, respectively. Petitioner claimed deductions for net losses from the yacht-chartering activity of $ 176,729, $ 114,980, and $ 148,804, for 1980, 1981, and 1982, respectively. Respondent disallowed petitioner's claimed deductions for the yacht-chartering losses on all three returns. On his 1980, 1981, and 1982 tax returns, petitioner claimed certain deductions for expenses related to his yacht-chartering activity, including depreciation of the yachts, business travel expenses, legal and professional fees, and "fitting out" expenses for renovation of the yacht Colinga. In the deficiency notice, respondent disallowed the deductions claiming that the expenses were attributable to the corporation, Colinga Ltd., in 1980, 1981, and 1982, and thus were not ordinary and necessary expenses attributable to a trade or business of petitioner. Alternatively, if the yacht-chartering losses are petitioner's losses, respondent disallowed the following deductions claimed by petitioner, resulting in increases to his taxable income. 198019811982Fitting-out expenses$ 24,466-- -- Depreciation51,875$ 40,287$ 31,901Travel7,30710,752-- Legal/professional5,339-- -- fees361 On his 1981 return, petitioner reported income from the Chandler Drilling 1978 Partnership in the amount of $ 13,324 and claimed a casualty loss deduction of $ 8,562 for damage to a boat other than the yachts Colinga and Sea Crest. In the notice of deficiency, respondent increased petitioner's share of income from the partnership by $ 9,923 and reduced his depletion expense in the amount of $ 2,173. Respondent also disallowed $ 4,000 of petitioner's claimed casualty loss on the ground that petitioner failed to establish that his basis in the boat was greater than $ 17,000. Finally, respondent imposed additions to tax for negligence and intentional disregard of the rules and regulations, pursuant to section 6653(a), and for the substantial understatement of income tax, pursuant to section 6661. OPINION Respondent asserts that petitioner was not entitled to deduct the net operating losses from the yacht-chartering activity on his 1980, 1981, and 1982 tax returns because in those years the losses are attributable to Colinga Ltd., a separate taxable corporation that petitioner organized, and not to petitioner as an individual. If we determine that the yacht-chartering losses are362 attributable to petitioner individually, respondent asserts that petitioner is nonetheless not entitled to deduct the losses because he did not engage in the yacht-chartering activity with an objective to make a profit as required by section 183. In the event we determine that the losses are attributable to petitioner and that his yacht-chartering activity was carried on for profit, respondent argues that certain adjustments must be made to the Schedule C deductions petitioner claimed for the yachts' depreciation, the "fitting out" or yacht renovation expenses, and the travel, legal, and professional fee expenses incurred in connection with the yacht-chartering operation. Finally, respondent asserts that petitioner is liable for additions to tax for negligence and for substantially understating his income tax. Petitioner admits that in 1979 he created a foreign corporation, Charter Company Limited, later renamed Colinga Company Limited, and that the corporation held legal title to the yachts, "Colinga" and "Sea Crest," during the years in issue. Generally, income and deductions generated by property are taxable or deductible by the taxpayer who owns the property. Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 119, 85 L. Ed. 75">85 L. Ed. 75, 61 S. Ct. 144">61 S. Ct. 144 (1940);363 Britt v. United States, 431 F.2d 227">431 F.2d 227, 229 (5th Cir. 1970). Petitioner contends, however, that the operating losses sustained in the yacht-chartering activity are attributable to himself because the corporation was merely functioning as petitioner's agent and never held any beneficial interest in the yachts Colinga and Sea Crest. Petitioner further argues that there is plenty of evidence in the record to show he engaged in the yacht-chartering activity to make a profit and that he, therefore, is entitled to deduct the operating losses on his individual tax returns. Finally, petitioner asserts that respondent's determination of additions to tax is improper because he was not negligent and did not substantially understate his income tax for any of the years in issue. We must first determine whether the net operating losses and the Schedule C expenses generated by the yacht-chartering activity, and for which petitioner took deductions on his individual tax returns, are attributable to petitioner as an individual, or to Colinga Ltd., a corporation that petitioner formed and essentially controlled. In general, the statutory notice of tax deficiency is presumed to364 be correct and petitioner bears the burden of proving respondent's determinations are in error. Rule 142(a). In particular, deductions are a matter of legislative grace and entitlement thereto must be shown by petitioner. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 78 L. Ed. 1348">78 L. Ed. 1348, 54 S. Ct. 788">54 S. Ct. 788 (1934). We find it significant that petitioner took deliberate steps to incorporate his yacht-chartering operation. He hired Bachmann & Co., an international marine management consulting firm, to help him organize Charter Company Limited, which in December 1979 was registered as a corporation in Guernsey, Channel Islands, United Kingdom. The formalities of incorporation were followed: articles of incorporation were filed and directors and shareholders were named in the incorporation documents. Petitioner admits that in March 1980 he conveyed the Colinga's record title to the newly formed corporation and that in October 1981 the corporation purchased a second yacht, Sea Crest, in its own name. The corporation had a bona fide business purpose. By petitioner's own admission, its "sole purpose" was to qualify the yachts to be listed on the British Ship Registry, which could be accomplished only365 by an individual owner residing in the United Kingdom or a corporation organized under the laws of the United Kingdom. Petitioner argues however, that given the corporation's limited purpose, to treat it as the owner of the yachts for tax purposes would be to exalt the corporate form over its substance. Petitioner's argument is not without some appeal, but we conclude it should not be accepted. It is fundamental that a corporation is a separate entity from its inception. We have said that "a corporate 'straw' may be used to separate apparent from actual ownership of property, without incurring the tax consequences of an actual transfer; but to prevent evasion or abuse of the two-tiered tax structure, a taxpayer's claim that his controlled corporation should be disregarded will be closely scrutinized. If the corporation was intended to, or did in fact, act in its own name with respect to property, its ownership thereof will not be disregarded." Strong v. Commissioner, 66 T.C. 12">66 T.C. 12, 24 (1976), affd. 1977 U.S. App. LEXIS 14744">1977 U.S. App. LEXIS 14744, 39 A.F.T.R.2d (RIA) 934, 77-1 U.S. Tax Cas. (CCH) P 9240">77-1 U.S. Tax Cas. (CCH) P9240 (2d Cir., Feb. 14, 1977).3366 In Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436, 87 L. Ed. 1499">87 L. Ed. 1499, 63 S. Ct. 1132">63 S. Ct. 1132 (1943), the U.S. Supreme Court refused to ignore the corporate form for tax purposes even though the corporation involved was completely dominated by its shareholder and appeared to lack beneficial ownership of its assets and income. The Supreme Court stated its rule of decision as follows: The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. * * In Burnet v. Commonwealth Improvement Co., 287 U.S. 415">287 U.S. 415, 77 L. Ed. 399">77 L. Ed. 399, 53 S. Ct. 198">53 S. Ct. 198, * * * [it was held that] The choice of the advantages of incorporation to do business, * * * required the acceptance of the tax disadvantages. [319 U.S. at 438-439. Fn. refs. omitted.]Petitioner concedes in his reply brief that "Colinga Ltd. is a separate entity367 in conformity with Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436, 87 L. Ed. 1499">87 L. Ed. 1499, 63 S. Ct. 1132">63 S. Ct. 1132 (1943)," but argues that the yacht-chartering losses are nonetheless attributable to him individually because (1) the corporation functioned only as petitioner's agent and (2) the corporation never owned any beneficial interest in the yachts Colinga and Sea Crest. Generally, we agree that, if Colinga Ltd. were merely petitioner's agent or if petitioner had retained all but the bare legal title to the yachts, any income or expenses generated by the corporation's assets would be income and expenses of petitioner, as principal. Commissioner v. Bollinger, 485 U.S. 340">485 U.S. 340, 99 L. Ed. 2d 357">99 L. Ed. 2d 357, 108 S. Ct. 1173">108 S. Ct. 1173 (1988). However, in this situation we find petitioner's claims to be inconsistent with his admission that Colinga Ltd. was a valid corporation in conformity with Moline Properties, Inc. v. Commissioner, supra.Petitioner states that the corporation's business purpose was to qualify the yachts to be registered on the British Ship Registry, which by law could only be accomplished by the yachts' owner who had to be either an individual residing in Great Britain or a corporation organized368 under the laws of Great Britain. Furthermore, the Colinga and the Sea Crest were the only assets that were placed in the corpus of the corporation when it was registered. To now treat petitioner as the owner of the yachts for tax purposes appears to contravene Colinga Ltd.'s corporate existence. Even disregarding the inconsistencies in petitioner's argument, we find that the facts in this case do not support his claim that Colinga Ltd. functioned as his agent with respect to the yacht-chartering activity. The U.S. Supreme Court has stated that evidence of a purported agency relationship between a corporation and its principal must be unequivocal, Commissioner v. Bollinger, 485 U.S. at 349, and the Court in National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, 437-438, 93 L. Ed. 779">93 L. Ed. 779, 69 S. Ct. 726">69 S. Ct. 726 (1949), listed six conditions or factors that must be considered: (1) Whether the corporation operates in the name and for the account of the principal, (2) whether the corporation binds the principal by its actions, (3) whether the corporation transmits money received to the principal, (4) whether receipt of income is attributable to the services of employees of the principal369 and to assets belonging to the principal, (5) whether the corporation's relations with its principal are dependent upon the fact that it is owned by the principal, and (6) whether its business purpose is the carrying on of the normal duties of an agent. In Commissioner v. Bollinger, supra, the Supreme Court upheld the six National Carbide factors, but added a further gloss for determining whether an agency relationship exists. In addition to the six National Carbide factors, the genuineness of an agency relationship is "adequately assured" when the fact that the corporation is acting as agent for its shareholders with respect to a particular asset is (1) set forth in a written agreement at the time the asset is acquired, (2) the corporation functions as agent and not as principal with respect to the asset for all purposes, and (3) the corporation is held out as the agent and not principal in all dealings with third parties relating to the asset. 4Commissioner v. Bollinger, 485 U.S. at 349-350. 370 In the record before us, we find no unequivocal evidence that Colinga Ltd. functioned as petitioner's agent with respect to the yacht-chartering activity. To the contrary, most of the six National Carbide factors that should be present to support a finding of an agency/principal relationship between a corporation and a taxpayer do not exist. First, Colinga Ltd. acted for its own account, not in the name of petitioner as its principal. National Carbide Corp. v. Commissioner, 336 U.S. at 437. The corporation purchased the yacht Colinga in its own name. It borrowed sufficient funds in its own name for the purchase and mortgaged the yacht Colinga as security for the loan. The yacht sale agreement to purchase the Sea Crest was executed by Captain Piggin on behalf of "Colinga Limited," not on behalf of petitioner. The corporation dealt with the British Government as principal and owner of the yachts Colinga and Sea Crest. Registry and licenses were acquired by the corporation in its own name for its own account. The corporation incurred its own debts, entered into contracts with third parties for the purchase of goods and services on its own account, and371 sold property, including the yachts Colinga and Sea Crest, in its own name and not as petitioner's agent. Secondly, the corporation, Colinga Ltd., did not bind petitioner by its actions. National Carbide Corp. v. Commissioner, 336 U.S. at 437. The contracts entered into between charters and the corporation did not impose any duty or liability on petitioner. There is no evidence that the loans obtained and the property pledged by the corporation made petitioner personally liable on the debts. To the contrary, we note that in December 1979 the corporation's lending bank, Hill Samuel & Co., contracted with petitioner to personally guarantee the debts of the corporation, Colinga Ltd. Had petitioner been the principal, and Colinga Ltd. his agent, this guarantor contract would have been unnecessary. Third, it is unclear whether the gross receipts generated by the yachts were transmitted to petitioner. National Carbide Corp. v. Commissioner, 336 U.S. at 437. The corporation maintained a bank account in France. Captain Piggin, who had signatory authority for the corporation, had signatory authority over this account. Charter revenues were372 deposited and expenses paid from this account. Books and records showing income and expenses, labeled "company a/c," were also maintained in France. The record before us does not persuade us that the fourth, fifth, and sixth National Carbide criteria for finding a corporate agency relationship exist in petitioner's case. The money petitioner received is not attributable to assets that he owned as principal. To the contrary, the corporation held the titles to both the Colinga and the Sea Crest. Moreover, Colinga Ltd. did not carry on the normal duties of an agent. Rather, its business purpose was to represent itself as the yachts' owner to Guernsey government officials so that the yachts could be enrolled on the British Ship Registry. Subsequently, the corporation held itself out as the yachts' owner to numerous business people and charter clients and transacted business in its own name. Petitioner claims that a document entitled "Management Agreement" between himself and Bachmann & Co., dated November 26, 1979, constitutes an agency agreement. However, we find that the terms of the management agreement do not support petitioner's assertion. The document only empowers373 Bachmann & Co. to incorporate and administer Charter Company Limited, later renamed Colinga Ltd. The agreement does not provide that either the corporation or Bachmann & Co. will be the agent or nominee of petitioner. In contrast, the agency agreement in Commissioner v. Bollinger, 485 U.S. at 345, "expressly provided that the corporation would 'hold such property as nominee and agent for' the partnership * * and that the partnership would have sole control of and responsibility for the * * * [asset]." No such written agreement exists in petitioner's case. Moreover, Colinga Ltd. did not have a corporate existence when the management agreement was executed and signed. Since the corporation was not registered until December 1979, 1 month after the management agreement was executed, the management agreement could not effectively bind the corporation to an agency relationship with petitioner, regardless of its terms. The evidence submitted by petitioner to support his claim that Colinga Ltd. functioned as his agent with respect to the yacht-chartering activity is unpersuasive and would require us to speculate as to actual events. Because such evidence of an 374 agency relationship is not only conjectural, but falls far short of being unequivocal, as required by the Supreme Court, we reject this claim. We are similarly unpersuaded by petitioner's second claim that the net operating losses from the yacht-chartering activity are attributable to himself individually because he, not the corporation, was the beneficial owner of the vessels utilized in the chartering operation. Specifically, petitioner asserts that no beneficial interest in the Colinga or the Sea Crest was transferred to the corporation and that it purchased only record title to the yachts. Again, we find that petitioner's assertion lacks a factual basis. "A significant element in determining ownership is the location of title to the property." Coleman v. Commissioner, 87 T.C. 178">87 T.C. 178, 201 (1986), affd. without opinion 833 F.2d 303">833 F.2d 303 (3d Cir. 1987). All the pertinent documentary evidence clearly shows that title to both yachts was unconditionally vested in the corporation. When petitioner sold the Colinga to the corporation, he executed a sales contract and bill of sale, in the presence of his attorney, Eugene Gargaro, Jr., specifically and unconditionally375 transferring "64/64th shares in the ship" to the corporation. If petitioner, an experienced and seasoned products liability attorney, had meant to retain beneficial ownership of the Colinga, certainly one of these sales documents would refer to that fact. To the contrary, we find that the yacht sale contract and bill of sale unambiguously evince an intent to transfer the entire ownership interest in the Colinga to the corporation. Colinga Ltd. was also the legal and beneficial owner of the yacht Sea Crest. Pursuant to a written yacht sale agreement, dated October 14, 1981, Colinga Ltd. purchased the Sea Crest from Walft A.G. Company for a stated purchase price of # 30,000. Although petitioner claims he was the beneficial owner of the Sea Crest, we observe that petitioner's name does not appear in the yacht's chain of title or in the yacht sale agreement. Moreover, there is no evidence in the sales agreement that the seller, Walft A.G. Company, was transferring only legal title and retaining beneficial ownership of the yacht. The first clause on the second page of the agreement states that "the Seller shall sell and the Buyer shall purchase free from all charges and encumbrances376 the Yacht specified in the Sale Particulars * * subject to the terms and conditions of this Agreement including, where applicable, the Special Conditions specified." Under the section of the sales agreement entitled "Special Conditions" there is no indication that the parties intended the seller of the yacht to retain beneficial ownership. Petitioner asks us to ignore the form of the yacht sales documents and to find, based on the alleged substance or economic reality of the transactions, that no sale of the vessels to Colinga Ltd. ever took place. In support of his proposition that substance over form should control the determination of who owned the yachts for tax purposes, petitioner cites Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 55 L. Ed. 2d 550">55 L. Ed. 2d 550, 98 S. Ct. 1291">98 S. Ct. 1291 (1978); Karme v. Commissioner, 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982), affg. 73 T.C. 1163">73 T.C. 1163 (1980); Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332 (1985); Sundance Ranches, Inc. v. Commissioner, T.C. Memo 1988-535">T.C. Memo 1988-535. However, these cases do not stand for the proposition that a taxpayer may disregard the form of his transaction. Rather, in each of the cases relied upon377 by petitioner, it was the Commissioner who was challenging the form of the transactions. In the instant case, it is the taxpayer, not the Government, which seeks to disavow the form of the transaction. As we observed in Bolger v. Commissioner, 59 T.C. 760">59 T.C. 760, 767 n. 4 (1973): "the taxpayer may have less freedom than the Commissioner to ignore the transactional form that he has adopted." We think this is particularly true where the yachts were transferred to the corporation in order to fulfill petitioner's specific desire to qualify them to be listed on the British Ship Registry and to fly the British flag at their sterns. The ability of a taxpayer to avoid the consequences of the form of a transaction is especially restricted in the Court of Appeals for the Sixth Circuit to which an appeal in this case would lie. The Sixth Circuit has adopted the rule of Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771, 775 (3d Cir. 1967), cert. denied 389 U.S. 858">389 U.S. 858, 19 L. Ed. 2d 123">19 L. Ed. 2d 123, 88 S. Ct. 94">88 S. Ct. 94 (1967), which provides that "a party can challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the378 agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc." Schatten v. United States, 746 F.2d 319">746 F.2d 319, 321-322 (6th Cir. 1984) (applying the rationale of Commissioner v. Danielson, supra, to property settlement agreement.) Under Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940, 30 L. Ed. 2d 254">30 L. Ed. 2d 254, 92 S. Ct. 284">92 S. Ct. 284 (1971), we are bound to apply the rule of the Sixth Circuit in this case. Thus, we find that the terms of both yacht sales agreements clearly and unambiguously transferred the legal and beneficial interests in the yachts Colinga and Sea Crest to the corporation, Colinga Ltd. We are not persuaded by petitioner's argument that the document which he executed purporting to be a settlement of trust, requires us to find that he held a beneficial interest in the yachts. The alleged trust is undated and appears to have only $ 100 in its corpus. Petitioner is not named as a beneficiary of the trust. Accordingly, we shall disregard it. We have found that petitioner organized the corporation, Colinga379 Ltd., for the business purpose of registering the yachts in Great Britain, that the corporation was the legal and beneficial owner of the yachts Colinga and Sea Crest, and that the corporation conducted the yacht-chartering business in its own name. Having set up a separate entity through which to conduct his affairs, petitioner must live with the tax consequences of that choice. Indeed, the very exigency which led to his use of the corporation serves to emphasize the entity's separate existence. The tide of judicial history is too strong to enable petitioner to prevail on this issue, albeit that the purpose of the corporation was limited in scope. Therefore, we hold that the corporation, Colinga Ltd., was the owner of the yachts and the yacht-chartering operation for tax purposes and that the yacht-chartering losses are attributable to it, rather than petitioner in his individual capacity. Accordingly, we sustain respondent's disallowance of petitioner's claimed deductions of the chartering losses. Because we have determined that petitioner was not entitled to claim deductions for the yacht-chartering losses on his 1980, 1981, and 1982 individual tax returns, there is no need380 for us to address the second issue of whether petitioner had the objective to make a profit in the yacht-chartering activity as required by section 183. The third issue we must decide is whether petitioner was entitled to deduct certain Schedule C expenses on his tax returns, disallowed by respondent in the following amounts. 198019811982Fitting-out expenses$ 24,466-- -- Depreciation51,875$ 40,287$ 31,901Travel7,30710,752-- Legal & professional5,339-- -- feesIn the deficiency notice, respondent first asserts that the deductions are not allowable because the expenses are attributable to the corporation, Colinga Ltd., and not to a trade or business owned by petitioner. In the alternative, respondent asserts that the deductions are not allowable because the yachting operation was not carried on by him for profit. If it is determined that petitioner owned the yacht-chartering operation and that the activity was carried on by him for profit, respondent asserts that: (1) the fitting-out expense deduction is nonetheless not allowable because it is a capital expenditure within the meaning of section 263; (2) the depreciation deduction381 is not allowable because the Colinga has a salvage value equal to or greater than the cost and improvements to the yacht, or it has a useful life of 20 years instead of 10 years as reported on petitioner's returns; and (3) the travel, legal, and professional expense deductions are not allowable because petitioner failed to establish that they were ordinary and necessary expenses or expended for the purpose designated. In general, petitioner has the burden of establishing both his right to and the amount of a deduction. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 78 L. Ed. 1348">78 L. Ed. 1348, 54 S. Ct. 788">54 S. Ct. 788 (1934). Specifically, petitioner must show why he is entitled to deduct an amount greater than that allowed by respondent. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8 (1933); Rule 142(a). Since we have determined that the corporation Colinga Ltd. owned the yachts Colinga and Sea Crest and the yacht-chartering operation in 1980, 1981, and 1982, the deductions claimed by petitioner for the above expenses related to the chartering operation are not allowable since they are the corporation's and not petitioner's expenses. Moreover, petitioner failed to introduce any documentary evidence or382 give specific testimony explaining the specific nature and how he arrived at the specific amounts of his claimed deductions for travel expenses and the legal and professional fees. Therefore, we sustain respondent's determinations regarding these deductions. Welch v. Helvering, supra; Rule 142(a). The fourth issue for our decision is whether petitioner accurately reported income and a depletion expense from the Chandler Drilling 1978 partnership on his 1981 tax return. In the deficiency notice, respondent increased petitioner's share of income from the partnership by $ 9,923 and reduced petitioner's depletion expense by $ 2,173 for 1981. Petitioner failed to submit any documentary evidence to support the position taken on his tax return. "The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable. This is especially true where, as here, the party failing to produce the evidence has the burden of proof." (Citations omitted.) Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 1165 (1946),383 affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Thus, petitioner has not carried his burden of proving that respondent erroneously adjusted the partnership income and depletion expense reported on his 1981 tax return. Welch v. Helvering, supra; Rule 142(a). Accordingly, we hold that respondent's determinations regarding the partnership must be sustained. The fifth issue for our decision is whether petitioner correctly deducted $ 8,562 as a casualty loss for damage to a boat other than the Colinga or the Sea Crest on his 1981 tax return. In the deficiency notice, respondent disallowed $ 4,000 of petitioner's claimed casualty loss on the ground that petitioner failed to establish that his basis in the boat was greater than $ 17,000. Again, respondent's determination regarding the amount of the casualty loss is presumed to be correct and petitioner has the burden of proving otherwise. Welch v. Helvering, supra; Rule 142(a). Section 165 provides that a deduction may be taken for a casualty loss but limits the deduction to the lesser of (1) the decrease in the fair market value of the property due to the loss or (2) the taxpayer's384 basis. Sec. 1.165-7(b)(1), Income Tax Regs. Since petitioner failed to introduce any evidence substantiating the casualty loss, he has not carried his burden of proving his entitlement to the casualty loss deduction. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. at 1165. Accordingly, we sustain respondent's disallowance of the deduction. The sixth issue for our decision is whether petitioner is liable for additions to tax under section 6653(a) in 1980 and section 6653(a)(1) and (2) in 1981 and 1982. Section 6653(a) and 6653(a)(1) provide that where any part of the underpayment of income tax is due to negligence or intentional disregard of the rules and regulations, an additional amount equal to 5 percent of the underpayment may be added to the tax. Section 6653(a)(2) imposes an addition to tax equal to 50 percent of the interest computed on the portion of the underpayment that is attributable to negligence or the intentional disregard of the rules and regulations. Negligence under these sections is defined as the lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985)385 (quoting Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 506 (5th Cir. 1967)). As with respondent's determination of petitioner's underlying tax deficiencies, his determination of negligence or intentional disregard of the rules is presumed correct, and petitioner has the burden of proof to the contrary. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972). After considering the particular circumstances of this case, we find that petitioner's underpayment of tax was not the result of a totally honest mistake; rather, it was caused by his negligence. Petitioner deliberately organized the corporation out of a business necessity. He signed numerous documents listing Charter Company, Limited, later renamed Colinga Ltd., as the owner of the yachts. He represented to the British Government that the corporation owned the yachts. It was not reasonable or prudent for him to then claim himself to be the owner of the yachts on his tax returns. We find it especially significant that petitioner is a seasoned attorney who specializes in personal injury and products liability law. His reputation as an attorney has allowed him to publish at least two law textbooks. 386 He also retained several experienced business advisers. Petitioner's expertise persuades us that he must have known that a corporation, if properly formed, takes on its own life as a separate entity for liability and taxation purposes. In short, petitioner must have been aware of the risk he was taking when he deducted the large yacht-chartering losses on his personal tax returns. Petitioner argues that he was not negligent in claiming the yacht-chartering deductions on his individual returns since he relied upon the advice of several attorneys and a certified public accountant in doing so. We have recognized that additions to tax for negligence are inappropriate where a taxpayer, in good faith, reasonably relies on his tax advisers. 5 The record, however, fails to establish that petitioner reasonably relied on a professional's advice after full disclosure. Petitioner testified that he consulted with his attorney, Eugene Gargaro, Jr., in claiming the chartering loss deductions. However, despite Mr. Gargaro's availability in Court, petitioner chose not to call him to the witness stand. The only reasonable inference from petitioner's failure to do so is that Mr. Gargaro's testimony387 would have been unfavorable to petitioner. Wichita Terminal Elevator Co. v. Commissioner, supra.Donovan Miller, the certified public accountant who prepared petitioner's 1980, 1981, and 1982 tax returns, did testify. However, Mr. Miller did not state that he independently made any determinations upon which petitioner could have relied. Rather, he testified that petitioner and his bookkeeper, Winifred Kissick, provided him with lists of items which he simply transferred to the returns. Petitioner has failed to carry his burden of proving that he was not negligent in claiming the deductions related to the yacht-chartering operation. Accordingly, we sustain the additions to tax as determined by respondent under section 6653(a) for 1980 and paragraphs (1) and (2) for 1981 and 1982. Finally, we must decide whether petitioner is liable for an addition388 to tax of $ 13,211.11 under section 6661 for substantially understating his income tax on his 1982 return. Section 6661, as originally enacted in 1982, set the amount of the addition at 10 percent of the amount of any underpayment attributable to the substantial understatement. Section 8002 of the Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509, 100 Stat. 1874, 1951, amended section 6661(a) to increase the amount of the addition to 25 percent for additions assessed after October 21, 1986. An understatement is "substantial" if it exceeds the greater of 10 percent of the tax required to be shown on the return for the taxable year or $ 5,000. An "understatement" does not include an amount attributable to "the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment." Sec. 6661(b)(2)(B)(i). Additionally, an understatement does not include any item for which there was adequate disclosure. Sec. 6661(b)(2)(B)(ii). We note that petitioner has not argued that respondent erroneously determined an addition to tax under section 6661 because petitioner adequately disclosed the yacht-chartering losses. Respondent asserts that he correctly389 determined the addition to tax under section 6661 because substantial authority did not exist for petitioner's claim to the deduction of the yacht-chartering losses on his individual tax return. We have held that the yacht-chartering losses are attributable to the separately taxable corporation that petitioner created and not to petitioner in his individual capacity. The case law in existence in 1982 does not constitute substantial authority for petitioner's treatment of the yacht-chartering losses as his own. To the contrary, the Supreme Court in Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436, 87 L. Ed. 1499">87 L. Ed. 1499, 63 S. Ct. 1132">63 S. Ct. 1132 (1943), held that a corporation is a separate taxable entity if it was incorporated to take advantage of the laws of the State of incorporation or for another business purpose, or if it is followed by the carrying on of business activity. Charter Company Ltd., later named Colinga Ltd., was organized to take advantage of the laws of the United Kingdom governing the registry of yachts on the British Ship Registry, and subsequently carried on business activities in its corporate name. Clearly, petitioner created a "separate taxable entity" which, for tax purposes, 390 became owner of both the yachts and the yacht-chartering operation. Moline Properties Inc. v. Commissioner, supra.Petitioner's arguments that the corporation functioned merely as his agent, and did not own any beneficial interest in the yachts, is also contrary to the weight of authority. In National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, 93 L. Ed. 779">93 L. Ed. 779, 69 S. Ct. 726">69 S. Ct. 726 (1949), the Supreme Court established six criteria for determining whether "unequivocal" evidence of a true agency or nominee relationship between a corporation and a principal exists. Applying those criteria, we found that the evidence of petitioner's alleged agency relationship with the corporation inadequate, unpersuasive, and certainly not "unequivocal." The evidence of petitioner's relationship with the corporation, Colinga Ltd., does not amount to the "adequate assurance" of a corporate agency relationship that existed under the facts of Commissioner v. Bollinger, 485 U.S. 340">485 U.S. 340, 99 L. Ed. 2d 357">99 L. Ed. 2d 357, 108 S. Ct. 1173">108 S. Ct. 1173 (1988). Here, there is no unambiguous, written agency agreement between the corporation and petitioner as there was in Bollinger, and the corporation was not held out as an agent in all its391 dealings with third parties. Moreover, there is no substantial authority to support petitioner's argument that the corporation never held any beneficial interest in the yachts. Rather, the pertinent legal authorities, as well as the documentary evidence and other facts, persuade us that petitioner transferred all of his interest in the Colinga to the corporation for a valid business purpose and that the corporation subsequently bought the legal and beneficial interests in the Sea Crest. Schatten v. United States, 746 F.2d 319">746 F.2d 319, 321-322 (6th Cir. 1984) (following Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771 (3d Cir. 1967)); Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Therefore, we hold that substantial authority did not exist for petitioner's treatment of the yacht charter operating losses as his own losses on his 1982 tax return. Accordingly, we sustain the addition to tax determined by respondent under section 6661. To reflect the foregoing, Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue, and Rule references are to the Tax Court Rules of Practice and Procedure. 50 percent of the interest due on $ 70,555.45. ** 50 percent of the interest due on $ 52,844.43.↩2. On April 3, 1980, Charter Company Limited officially changed its name to Colinga Limited in the Royal Court of the Island of Guernsey.↩3. See also Sparks Farm, Inc. v. Commissioner, T.C. Memo 1988-492">T.C. Memo 1988-492, 1988 Tax Ct. Memo LEXIS 518">1988 Tax Ct. Memo LEXIS 518, 56 T.C.M. (CCH) 464">56 T.C.M. (CCH) 464↩, 473, T.C.M. (RIA) 88492, at 2522, 2532.4. In their briefs, both parties erroneously assume that the three factors enunciated in Commissioner v. Bollinger, 485 U.S. 340">485 U.S. 340, 349-350, 99 L. Ed. 2d 357">99 L. Ed. 2d 357, 108 S. Ct. 1173">108 S. Ct. 1173 (1988), is a dispositive test of an agency relationship between a corporation and its principal. However, we have recently stated that the language in Bollinger does not list requirements for agency status, but rather describes factors which lead to the conclusion that agency status existed in that case. See Advance Homes, Inc. v. Commissioner, T.C. Memo 1990-302">T.C. Memo 1990-302, 1990 Tax Ct. Memo LEXIS 320">1990 Tax Ct. Memo LEXIS 320, 59 T.C.M. (CCH) 906">59 T.C.M. (CCH) 906↩, 909, T.C.M. (RIA) 90302 at 1421, 1424.5. See Kozikowski v. Commissioner, T.C. Memo 1986-364">T.C. Memo 1986-364; Horstmier v. Commissioner, T.C. Memo 1983-409">T.C. Memo 1983-409↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622758/	Charles M. Shaw and Joyce J. Shaw, Petitioners v. Commissioner of Internal Revenue, RespondentShaw v. CommissionerDocket No. 5654-76United States Tax Court69 T.C. 1034; 1978 U.S. Tax Ct. LEXIS 144; March 30, 1978, Filed 144 Decision will be entered for the respondent. On Mar. 1, 1973, Ps sold their old principal residence and moved to Fox Creek Ranch, which they had acquired in 1963 and had reconstructed between Mar. 1, 1972, and Mar. 1, 1974. Held, under sec. 1034, I.R.C. 1954, only the cost attributable to the actual reconstruction of the Fox Creek Ranch can be included in Ps' "cost of purchasing the new residence." Charles M. Shaw, pro se.James C. Lanning, for the respondent. Simpson, Judge. SIMPSON1035 OPINIONThe Commissioner determined a deficiency of $ 10,260.20 in the petitioners' 145 Federal income tax for 1973. The only issue to be decided is whether the fair market value of the petitioners' new principal residence which was acquired more than 1 year prior to the sale of their old principal residence can be included in "the cost of purchasing the new residence," within the meaning of section 1034 of the Internal Revenue Code of 1954. 1All of the facts have been stipulated, and those facts are so found.The petitioners, Charles M. Shaw and Joyce J. Shaw, husband and wife, maintained their legal residence in Pacific, Mo., at the time they timely filed their petition in this case. They filed their joint Federal income tax return for 1973 with the Internal Revenue Service Center, Kansas City, Mo.Before March 1, 1973, the petitioners' principal residence was at 26 Portland Drive, Frontenac, Mo. (old residence). On such date, they sold such residence for $ 145,000 and incurred selling expenses146 of $ 8,702.25.Thereafter, they moved to their property known as Fox Creek Ranch (new residence) and used it as their principal residence. They had acquired the new residence on November 15, 1963. Between March 1, 1972, and March 1, 1974, they spent $ 98,791.29 altering, adding to, and reconstructing the new residence, all of which was chargeable to capital account. On September 20, 1973, a qualified appraiser of property in St. Louis County, Mo., valued the new residence at $ 182,000, of which $ 100,000 represented the value of the land and the remainder represented the value of improvements thereon.On their 1973 Federal income tax return, the petitioners did not report any gain from the sale of the old residence. In his notice of deficiency, the Commissioner determined that the 1036 petitioners' gain on the sale of the old residence should be recognized to the extent that the adjusted sales price of such residence exceeded the cost of purchasing the new residence. For this purpose, he determined that the cost of purchasing the new residence included only the costs of reconstructing the property which were paid between March 1, 1972, and March 1, 1974.Section 1034 was147 designed to mitigate the financial burden associated with taxing the gain on the sale of a taxpayer's principal residence by deferring recognition of the gain where the taxpayer, for one reason or another, sells his principal residence and in effect uses the proceeds of such sale to acquire another principal residence within a relatively short period of time. H. Rept. 586, 82d Cong., 1st Sess. (1951), 2 C.B. 357">1951-2 C.B. 357, 378, 435-439; S. Rept. 781, 82d Cong., 1st Sess. (1951), 2 C.B. 458">1951-2 C.B. 458, 482-483; S. Rept. 781 (Part 2), 82d Cong., 1st Sess. (1951), 2 C.B. 545">1951-2 C.B. 545, 566-570; Conf. Rept. 1213, 82d Cong., 1st Sess. (1951), 2 C.B. 622">1951-2 C.B. 622, 629; 2 see H. Rept. 1337, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess., 79, A269 (1954); S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 109, 427 (1954). Accordingly, section 1034(a) provides generally that if a taxpayer's principal residence (old residence) is sold, and within 1 year before or after such sale, other property is purchased and used by the taxpayer as his principal residence (new residence), 148 then the gain recognized on the sale of the old residence shall be limited to the lesser of the gain realized on such sale or the amount by which the adjusted sales price of the old residence exceeds the cost of purchasing the new residence. Sec. 1.1034-1(a), Income Tax Regs.; H. Rept. 586, at 377, 435-436; S. Rept. 781, at 482; S. Rept. 781 (Part 2), at 566; Elam v. Commissioner, 58 T.C. 238">58 T.C. 238, 240 (1972), affd. per curiam 477 F.2d 1333">477 F.2d 1333 (6th Cir. 1973). The parties do not dispute that the petitioners' old residence was sold, when it was sold, the selling price, the gain realized on the sale, and the adjusted sales price. However, they do dispute the petitioners' "cost of purchasing the new residence." The petitioners argue that such cost includes the fair market value of the new residence just prior to its reconstruction and use as their principal residence and the amounts paid for reconstruction of such residence between 1037 March 1, 1972, and March 1, 1974. The Commissioner, on the other hand, argues that the petitioners' cost of purchasing the new residence includes only the costs of reconstructing it because only149 those costs were paid within 1 year before or after the sale of the old residence.Section 1034(c)(2) provides:(2) A residence any part of which was constructed or reconstructed by the taxpayer shall be treated as purchased by the taxpayer. In determining the taxpayer's cost of purchasing a residence, there shall be included only so much of his cost as is attributable to the acquisition, construction, reconstruction, and improvements made which are properly chargeable to capital account, during the period specified in subsection (a).The relevant Treasury regulations provide:Sec. 1.1034-1 Sale or exchange of residence.(b) Definitions. * (7) "Cost of purchasing the new residence" means the total of all amounts which are attributable to the acquisition, construction, reconstruction, and improvements constituting capital expenditures, made150 during the period beginning * * * one year in the case of a sale of an old residence prior to January 1, 1975 * * * before the date of sale of the old residence and ending * * * one year in the case of a sale of an old residence prior to January 1, 1975 * * * after such date in the case of a new residence purchased but not constructed by the taxpayer * * ** * * (9) "Purchase" (of a residence) means a purchase or an acquisition (of a residence) * * or the partial or total construction or reconstruction (of a residence) by the taxpayer * * . However, the mere improvement of a residence, not amounting to reconstruction, does not constitute "purchase" of a residence.(c) Rules for application of section 1034 * (4) Cost of purchasing new residence. * (ii) The taxpayer's cost of purchasing the new residence includes only so much of such cost as is attributable to acquisition, construction, reconstruction, or improvements made within the period of * * two years or 30 months in the case of a sale of an old residence prior to January 1, 1975 * * * in which the purchase and use of the new residence must be made in order to have gain on the sale of the old residence not recognized151 under this section. Thus, if the construction of the new residence is begun three years before the date of sale of the old residence and completed on the date of sale of the old residence, only that portion of the cost which is attributable to the last * * year in the case of a sale of an old residence prior to January 1, 1975 * * * of such construction constitutes the taxpayer's cost of purchasing the new residence, for purposes of section 1034. * * Under the statute and regulations, it is clear that only the 1038 costs paid by the petitioners within 1 year before or after the sale of their old residence are to be treated as the cost of purchasing the new residence for purposes of section 1034. By enacting section 1034, Congress allowed taxpayers who were selling one residence and acquiring another to defer recognition of any gain realized on the sale of the old residence, but Congress circumscribed the conditions under which such tax relief is available. It applies only to the sale and purchase of principal residences, and the sale and purchase must both take place within a relatively short period of time. Moreover, not all costs of purchasing the new residence may152 be taken into consideration; only those paid within that relatively short period of time may be included.The limitations of section 1034 have been challenged before, and each time the courts have recognized and given effect to them. See, e.g., United States v. Sheahan, 323 F.2d 383">323 F.2d 383 (5th Cir. 1963); Kern v. Granquist, 291 F.2d 29">291 F.2d 29 (9th Cir. 1961); Elam v. Commissioner, supra;O'Barr v. Commissioner, 44 T.C. 501">44 T.C. 501 (1965); Bayley v. Commissioner, 35 T.C. 288">35 T.C. 288, 294-297 (1960); McCall v. Patterson, 155 F. Supp. 405">155 F. Supp. 405 (N.D. Ala. 1957). For example, in Kern v. Granquist, supra, the court recognized that by applying the time limitations of section 1034, the result appeared to be harsh; nevertheless, after examining the statute, regulations, and legislative history, the court concluded that it was constrained to hold that costs paid after the described period could not be included. Similarly, in McCall v. Patterson, supra, the court held that the amount153 paid for the purchase of property before the beginning of the described period could not be included in applying section 1034. To be entitled to the benefit of section 1034, the petitioners have the burden of proving that they have satisfied its requirements. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142, Tax Court Rules of Practice and Procedure. Here, we do not know how they acquired their new residence, but they offered no evidence showing that they paid anything to acquire it during the period described in section 1034. Accordingly, we hold that the cost of purchasing the new residence includes only those costs of reconstruction paid between March 1, 1972, and March 1, 1974.The petitioners attempt to avoid the time limitations by arguing that they did not "acquire" their new residence within the meaning of section 1034 until 1973 when they commenced 1039 using it as their principal residence and that, therefore, its value at such time should be included in the cost of purchasing it. They maintain that they acted in good faith in moving to a residence acquired by them at an earlier time, and they rely upon Belin v. United States, 313 F. Supp. 715">313 F. Supp. 715 (M.D. Pa. 1970),154 to support their contention. However, in Belin, the court merely decided whether a residence qualified as the taxpayer's principal residence, and clearly, that case has no relevance to the issue of this case. The petitioners point to no authority supporting their interpretation of the term "acquire," and indeed, in view of the legislative history, the regulations, and court decisions, there could be no such authority.The petitioners also contend that if section 1034 is interpreted so as not to allow them to treat the value of their new residence as a part of the cost of purchasing it because it was acquired before 1972, such an interpretation is arbitrary and discriminates against them. Yet, it has been repeatedly held that the courts are to sustain the regulations unless they are arbitrary. Commissioner v. South Texas Co., 333 U.S. 496">333 U.S. 496, 501 (1948). Here, the regulations are supported by the legislative history. H. Rept. 586, at 377-378; S. Rept. 781, at 482-484; S. Rept. 781 (Part 2), at 566-570; see Kern v. Granquist, supra.That legislative history reveals that the purpose of section 1034 is to allow a taxpayer*155 to defer the recognition of gain when the proceeds of selling an old residence are invested in the purchase of a new one. Section 1034(c)(2) and the regulations interpreting it are consistent with that objective; that is, section 1034 applies only to the costs which are paid in purchasing the new residence at or about the same time as the taxpayer receives the proceeds from the sale of the old residence. Consequently, we find no merit in the petitioners' arguments.Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect for the year in issue.↩2. All references to H. Rept. 586, S. Rept. 781, S. Rept. 781 (Part 2), and Conf. Rept. 1213 are to the pages in the Cumulative Bulletin where such reports are published.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622760/	John G. Scherf, Petitioner, v. Commissioner of Internal Revenue, Respondent. George H. Barnes and Ada E. Barnes, Petitioners, v. Commissioner of Internal Revenue, RespondentScherf v. CommissionerDocket Nos. 2703, 2780United States Tax Court7 T.C. 346; 1946 U.S. Tax Ct. LEXIS 129; July 11, 1946, Promulgated 129 Decision will be entered for the respondent. Partnership between petitioners and their children for carrying on a manufacturing business not recognized for Federal income tax purposes where the capital contributions of the children originated with the petitioners, the children took no part in the management or control of the business, and the services performed by them were not of vital importance. W. H. Albritton, Esq., and R. B. Albritton, Esq., for the petitioners.F. L. Van Haaften, Esq., for the respondent. Tyson, Judge. TYSON 346 The Commissioner determined deficiencies in income tax for 1940 of $ 4,498.75 against John G. Scherf and $ 4,125 against George H. Barnes and Ada E. Barnes. The sole issue presented is whether, for Federal income tax purposes, recognition should be accorded a partnership consisting of petitioner John G. Scherf and his two sons and petitioner George H. Barnes and his two daughters. The proceedings were consolidated.FINDINGS OF FACT.In 1940 and at all times material hereto the petitioners, John G. Scherf and George H. Barnes and his wife Ada E. Barnes, were residents of Andalusia, Alabama. John G. Scherf filed a separate130 return 347 and George H. Barnes and his wife filed a joint return for the year 1940. The returns were filed with the collector for the district of Alabama.Petitioners John G. Scherf and George H. Barnes were partners engaged in the manufacture and sale of work pants at Andalusia, Alabama, under the firm name of S & B Manufacturing Co. The partnership was formed in November 1938 and they each owned a one-half interest therein. At the beginning of 1940 they were operating factories at Andalusia and Brantley, Alabama, in buildings occupied under lease, and they employed about 200 workers, including machine operators, examiners, pressers, and foremen. Scherf ran the office and looked after the financial matters and Barnes operated the factories. Scherf and Barnes also were officers and stockholders of the Andala Co. and the Alabama Textile Products Co., Scherf and Barnes being vice presidents of the Andala Co. and Scherf being president of the Alabama Textile Products Co., in which he also owned a controlling interest. The former manufactured work shirts and the latter dress shirts and underwear. These two companies, and the Southern Textile Commission Co., a partnership131 composed of Scherf and Barnes which acted as selling agent for the Alabama Textile Products Co., occupied a single office in Andalusia, together with the S & B Manufacturing Co., and the office work of all 4 organizations was performed by one set of bookkeepers and office employees.The S & B Manufacturing Co. had assets at the close of the year 1939 of the total amount of $ 47,163.15, and its net worth as shown by its balance sheet was $ 32,321.30. The assets included about $ 25,000 worth of machinery and equipment and $ 20,000 of cash accounts receivable.John G. Scherf had two sons, Paul W. Scherf and John G. Scherf, Jr. In the latter part of 1939 he proposed to Barnes that they be taken into the S & B Manufacturing Co. as partners. Barnes stated that he would also like to bring his daughters, Mildred E. Barnes and Ruth E. Barnes, into the business. They agreed that all this should be done and instructed their attorney to prepare papers necessary to effect the change as of January 1, 1940. Due to other engagements, the attorney was unable to prepare the papers until May 16, 1940.On May 16, 1940, Scherf and Barnes executed instruments of assignment transferring to their respective132 children a one-sixth interest each in the business and assets of the S & B Manufacturing Co. The assignment to Paul, which is identical with that to each of the others except as to the assignee and assignor, reads as follows:In Consideration of love and affection the undersigned J. G. Scherf, owner of an undivided one-half (1/2) interest in the partnership business and assets 348 of S & B Manufacturing Company, a partnership composed of J. G. Scherf and George H. Barnes, does hereby give, assign, transfer and convey unto Paul W. Scherf as a gift, an undivided one-sixth (1/6) interest in the business of said partnership * , including all the stock, raw material and finished products, machinery, equipment, fixtures, accounts and all other assets of said partnership of every nature and kind whatsoever, including the leasehold interest on the premises in which said business is now conducted.On May 16, 1940, Scherf and Barnes and Paul W. Scherf signed an agreement of partnership, and John G. Scherf, Jr., Mildred E. Barnes, and Ruth E. Barnes signed it shortly thereafter. The pertinent provisions of the agreement are as follows:Agreement made this 1st day of January, 1940, 133 at Andalusia, Alabama, between J. G. Scherf, George H. Barnes, John G. Scherf, Jr., Mildred E. Barnes, Paul W. Scherf and Ruth E. Barnes, all of Andalusia, Alabama.Witnesseth:Whereas, by an agreement dated the 3rd day of February, 1939, J. G. Scherf and George H. Barnes became partners in the business of manufacturing pants, play suits, shirts, underwear and other apparel of whatsoever kind or character, for the term of ten years, and have continued to be partners from the day of the date of said agreement to the present time, each of said partners owning an undivided one-half (1/2) interest in said partnership business, andWhereas, J. G. Scherf has conveyed an undivided one-sixth (1/6) interest in and to said partnership business and assets to the undersigned John G. Scherf, Jr., and also an undivided one-sixth (1/6) interest to the undersigned Paul W. Scherf, and George H. Barnes has conveyed an undivided one-sixth (1/6) interest each to the undersigned Mildred E. Barnes and Ruth E. Barnes, andWhereas, the parties have agreed to continue the operation of the partnership business and be and become partners therein.Now, Therefore, in consideration of the mutual covenants and 134 agreement herein contained and in consideration of the premises the parties hereto do make this partnership agreement on the following terms and conditions, viz:1. The partnership shall be for the purpose of carrying on the business of manufacturing and selling, of factoring the manufacture and sale of pants, play suit, shirts, underwear, and other apparel and textile products of whatsoever kind or character.2. The partnership shall continue until dissolved by mutual agreement.3. Said partnership shall be conducted and carried on under the partnership name, style and firm of "S & B Manufacturing Company."4. The place of business of said partnership shall be in the City of Andalusia, in Covington County, Alabama, or at such other place or places as the partners shall hereafter determine.5. The capital of said partnership shall consist of the net capital account and assets of said partnership of J. G. Scherf and George H. Barnes doing business under the name of S & B Manufacturing Company as of December 30, 1939 and in the amount of Thirty Two Thousand Three Hundred Twenty One and 30/100 ($ 32,321.30) Dollars, said capital account and assets being made up of cash, machinery and 135 equipment and other property, supplies, etc., provided, however, the items composing said net capital account may be changed or altered in varying proportions as may be deemed advisable so long as the aggregate 349 amount shall remain the sum of Thirty Two Thousand Three Hundred Twenty One and 30/100 ($ 32,321.30) Dollars.6. It is agreed that each partner shall share equally in all the profits and losses that may arise out of or occur in the prosecution of the said partnership operations from and after January 1, 1940, subject only to the limitations herein contained. None of the partners shall be entitled to draw any compensation or any part of the profits or principal of said business so long as the partnership is indebted to any corporation other than a bank, in which either of the partners is a stockholder. In the event the partnership is not indebted to any such corporation, then upon the first day of each year hereafter, if the books of the said partnership disclose a balance of funds over and above all outstanding claims and charges, the accrued profits of said business as shall appear by the books shall be equally divided between the said parties and withdrawn from136 said business, leaving however, the original capital intact; or, such accrued profits or any portions thereof may be added to the original capital by agreement between the parties.7. J. G. Scherf and George H. Barnes shall be the managing partners and the other parties hereto shall be investing partners. Said J. G. Scherf and George H. Barnes shall diligently employ themselves in the business of the said partnership and be faithful to all parties hereto in all transactions relating to the firm and give, whenever required, a true account of all business transactions arising out of or connected with the operation of the partnership business. None of the partners shall at any time, without the written consent of the other partners, employ either the capital or the credit of the partnership in any manner other than in the regular conduct and operation of the partnership business.8. J. G. Scherf shall have charge of the office, shall see that the books of the partnership are properly kept, shall have exclusive charge of all the financial details of the partnership, including the receiving and collecting of all monies due the partnership and the payments due from said partnership to137 others, whether in the general conduct of said business or otherwise, with full and complete rights and powers to borrow such money or funds and at such times as may be needed for use in operation and conduct of the partnership business and evidence said loans by executing promissory notes for and in the name of the partnership and secure said notes and loans by mortgages on any or all of the partnership property, said notes and mortgages to be binding on the partnership and partnership property without the signatures of the other partners. George H. Barnes shall have the actual outside work and management of the business and shall be the general manager in all things that pertain to the manufacture, production and general operation of the manufacturing plant.In March 1941 Scherf and Barnes filed gift tax returns covering the assignments of an undivided one-sixth interest in the business to each of the four children. The one-sixth interests were valued at $ 7,635.64 each in those returns, which value was computed on the basis of the net capital account of $ 32,321.30 as of January 1, 1940, plus the net income of the business from that date up to May 16, 1940. Paul Scherf and John138 G. Scherf each filed a donee's information return of the gifts covered by the assignments to them.In assigning the undivided interests in the assets of the S & B Manufacturing Co. to their children Scherf and Barnes intended that 350 the assets should remain in the business, and the children so understood when they received the assignments. The children made no contribution of capital to the business other than that of their respective interests in the assets which they acquired from their fathers.Prior to the assignments and the formation of the partnership, the Scherf and Barnes children were not employed by, nor did they render any service to, the partnership. When the partnership agreement was signed Paul W. Scherf was 28 years of age and married; John G. Scherf, Jr., and Mildred E. Barnes were each 20 years of age and were attending college outside of Andalusia; and Ruth E. Barnes was 18 years of age and attending a preparatory school. Paul W. Scherf was working for the Alabama Textile Products Co. at a salary.After the partnership was formed, the business was continued in the same manner as before, and Scherf continued to manage the office and financial affairs and139 Barnes continued to supervise the operation of the factories. Scherf was the only member authorized to draw checks against the partnership funds, except that one of the clerks in the office had authority to draw checks to pay ordinary business expenses. Paul W. Scherf continued in the employ of the Alabama Textile Products Co. throughout 1940 and received a salary of $ 3,400 from it for that year. He knew nothing about the manufacturing operations of the S & B Manufacturing Co. and up to the latter part of the year 1940 his activities were limited to learning about the business and keeping some personnel files. There is no evidence that he took an active part in the manufacturing operations of the S & B Manufacturing Co. during 1940 or that he devoted much of his time thereto. His activities in 1941 and subsequent years were directed to keeping personnel records and doing welfare work for employees. He also after 1940 supervised the keeping of production records and operated a "suggestions" system for employees.John G. Scherf, Jr., left college in September 1940 and began to work in the office of the four companies. He was employed by the Alabama Textile Products Co. and received140 a salary from it of $ 312.97 during 1940. He learned to operate a billing machine and did some billing for S & B Manufacturing Co. in 1940. Mildred and Ruth Barnes remained in school until 1943. They did some clerical work in the office during the summer vacation of 1940.The net income of the S & B Manufacturing Co. for the year 1940 was $ 36,213.42. On the partnership income tax return for 1940 one-sixth of that amount, or $ 6,035.57, was allocated to each of the six partners.The following statement was attached to the partnership return:A partnership under this trade name was originally organized November 8, 1938. J. G. Scherf and George H. Barnes were the partners. A new partnership 351 was subsequently formed, effective between the partners as of January 1, 1940, with J. G. Scherf, John G. Scherf, Jr., Paul W. Scherf, George H. Barnes, Mildred E. Barnes and Ruth E. Barnes as partners. However, the actual conveyance of property interest and execution of new partnership agreement was not completed until May 16, 1940. Since the partnership business was to continue, effective between the partners as of January 1, 1940, the books of the partnership were not closed 141 and this return shows operation for entire year. However, for tax purposes allocations have been made to old partnership and new partnership and will be reported in returns of individual partners, as follows:Total net income$ 36,213.42136/365 allocated to old partnership$ 13,492.56J. G. Scherf$ 6,746.28G. H. Barnes6,746.28229/365 allocated to new partnership22,720.86J. G. Scherf3,786.81John G. Scherf, Jr3,786.81Paul W. Scherf3,786.81G. H. Barnes3,786.81Mildred E. Barnes3,786.81Ruth E. Barnes3,786.81On their several income tax returns the petitioners and their children reported income from the partnership in accordance with the allocation set out in the statement attached to the partnership return and paid taxes thereon.The books of the partnership of Scherf and Barnes were not closed when the new partnership was formed on May 16, 1940, but were continued in use. Each of the six members of the new partnership withdrew $ 2,467.67 during 1940. Mildred and Ruth Barnes each withdrew $ 200 in July 1940, $ 800 in September 1940, and $ 1,467.67 on December 14, 1940. The other members each withdrew $ 2,467.67 on December142 14, 1940. Capital accounts were set up on the books for each of the four children at the time when each made his or her first withdrawals. In closing the partnership books for 1940, in January 1941, an accountant credited the capital accounts of each of the children as of January 1, 1940, with one-sixth of the net worth of the old partnership, or $ 5,386.88, and credited each of the partners with one-sixth of the 1940 net income of the partnership of $ 36,213.42, or $ 6,035.57.After the books had been closed and the partnership tax return had been prepared with the memorandum allocating the income for tax purposes, the bookkeeper adjusted the credits to the capital accounts by debiting the accounts of Paul W. Scherf and John G. Scherf, Jr., in the amount of $ 2,248.16 each and crediting the account of John G. Scherf in the amount of $ 4,497.52; and by making identical debits and credits in the accounts of Mildred and Ruth Barnes and George H. Barnes. The amount of $ 4,497.52 so credited to John G. Scherf and George H. Barnes is the difference between their distributive shares 352 of $ 6,035.57 (appearing on the partnership income tax return) and the $ 10,533.09 allocated143 to each of them in the memorandum attached to the partnership return, set forth above. Later, upon learning that these adjustments were erroneous, the bookkeeper made correcting entries, debiting the accounts of Paul W. Scherf, John G. Scherf, Jr., Mildred E. Barnes, and Ruth E. Barnes in the amount of $ 2,248.76 each, and crediting the accounts of John G. Scherf and George H. Barnes in the amount of $ 4,497.52 each.During 1941, 1942, and 1943 the capital accounts of each of the six parties to the partnership agreement dated January 1, 1940, were credited with one-sixth of the profits. Each of the parties withdrew the same amount of cash in each of those years, and the net credit balance in each of the capital accounts as of October 1, 1944, was $ 16,141.49.In determining the deficiencies, the respondent held that petitioners John G. Scherf and George H. Barnes were each taxable on the amount of $ 18,106.71, representing one-half of the 1940 net income of the business of the S & B Manufacturing Co. and he increased the net income of $ 10,533.09 reported by each of them by the amount of $ 7,573.62.OPINION.The sole issue presented is whether all of the 1940 net income of the S144 & B Manufacturing Co. is taxable to petitioners John G. Scherf and George H. Barnes, as partners each having a one-half interest in the business, or whether the partnership formed by them and Paul W. Scherf, John G. Scherf, Jr., Mildred E. Barnes, and Ruth E. Barnes on May 16, 1940, should be recognized so that, with respect to so much of the 1940 net income as is allocable to the period May 16 to December 31, 1940, the petitioners are each taxable only on one-sixth thereof.In cases like the present one we are not concerned with whether the Scherf and Barnes children were the legal owners under the laws of Alabama of a one-sixth interest each in the capital of the business, for the issue for Federal income tax purposes is, Who earned the income? The answer to that question depends upon whether the petitioners and their children really intended to carry on business as a partnership. . Where a husband and his wife, or a husband and his wife and children, have entered into a partnership arrangement and it appears from the facts that the wife and children made no investment of capital originating with them, that 145 they have no voice in the management or control of the business, and that they contribute no vital services, those circumstances will justify this Court in concluding that a real 353 partnership between them and the husband and father does not exist in so far as the Federal income tax law is concerned. ;; ; ; ; ; ; and .The evidence shows quite plainly that the children contributed no capital originating with them and contributed nothing to the management or control of the business. Their investment in the business was the one-sixth undivided interest in the assets which they each received from their respective fathers by way of gift contemporaneously with the formation of the partnership. The partnership146 agreement excluded the children from any voice in the management of the business. It provided that Scherf and Barnes should be managing partners and the children should be investing partners, and it gave Scherf complete control of the office and financial matters, while it placed Barnes in charge of all things pertaining to the manufacture of goods and the operation of the factories; and Scherf and Barnes testified that, in the separate spheres thus allotted to them, they exercised the powers of management exclusively. Nor does the evidence disclose any services by the children which can be said to be "vital" to the business. John G. Scherf, Jr., and the Barnes girls were inexperienced minors and devoted a small part of their time to the performance for the S & B Manufacturing Co. of simple clerical service. Paul W. Scherf received a substantial salary from the Alabama Textile Products Co. in 1940, and what little time he devoted to the S & B Manufacturing Co. was utilized in learning about the business. In our opinion he was not an active partner in 1940. His services were negligible in so far as they tended to produce income. It is true that he became more active in 1941 *147 and later years, but the evidence indicates that those activities were along the line of welfare work among the employees. As to all four children, we think their services contributed little, if anything, to the earning of the income.We conclude that in 1940 there was no real partnership between the petitioners and their children for Federal income tax purposes, and, upon the authority of the cases cited above, we hold that the respondent did not err in taxing the petitioners on their respective one-half shares in the net income of the S & B Manufacturing Co.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622763/	Katrina Van Oss v. Commissioner. Murray M. Salzberg v. Commissioner.Van Oss v. CommissionerDocket Nos. 3945-63, 2880-64.United States Tax CourtT.C. Memo 1966-72; 1966 Tax Ct. Memo LEXIS 209; 25 T.C.M. (CCH) 403; T.C.M. (RIA) 66072; April 7, 1966209 Held: The total of the amounts paid by petitioner Salzberg to his divorced wife, petitioner Van Oss, pursuant to a divorce settlement agreement, was alimony taxable to Van Oss and deductible by Salzberg. The settlement agreement did not specifically designate or "fix" any portion of such payments as child support within the meaning of section 71(b), I.R.C. 1954. Commissioner v. Lester, 366 U.S. 299">366 U.S. 299 (1961), controls. Louis Mandel and Arthur A. Anderman, 1501 Broadway, New York, N. Y., for the petitioner in Docket No. 3945-63. Jacob I. Goodstein and Benjamin Wm. Mehlman, for the petitioner in Docket No. 2880-64. Stephen M. Miller and Joel Kamens, for the respondent. HOYTMemorandum Findings of Fact and Opinion HOYT, Judge: Respondent determined deficiencies in petitioners' income tax as follows: Dkt.No.Petitioner195819593945-63Katrina Van Oss$ 3,540.13$ 4,621.672880-64Murray M. Salz-berg11,932.1711,273.44The only issue for our decision in these consolidated cases is whether certain paycents made by petitioner Salzberg to petitioner Van Oss during the years in question are includable in their entirety in the gross income of the latter as alimony or whether petitioner Van Oss correctly excluded a portion of said payments from her gross income as child-support payments. The deductibility211 of the subject payments by petitioner Salzberg is solely dependent upon our determination of the extent to which they constituted alimony income to petitioner Van Oss. 1Findings of Fact The stipulated documents and orally stipulated facts are incorporated herein by this reference. Petitioners Katrina Van Oss and Murray M. Salzberg each duly filed Federal income tax returns for their respective taxable years 1958 and 1959, Van Oss with the district director of internal revenue, Brooklyn, New York, and Salzberg with the district director of internal revenue, New York, New York. Van Oss and Salzberg were married on February 1, 1951. There are three children of the marriage: Harry and Hedie, both born January 17, 1952, and Dana, born January 19, 1955. On January 15, 1958, Van Oss and Salzberg entered into a separation agreement. The two were subsequently divorced on January 24, 1958, and the separation agreement was incorporated in the decree of divorce by reference. The pertinent provisions of the separation agreement applicable to the issue involved212 herein are as follows: * 13. a. The Husband shall pay to the Wife as alimony the sum of $24,000.00 per year until July 15, 1973, at which time the alimony will be reduced to $16,000.00 per year. On February 1, 1976, the alimony shall be further reduced to $12,000.00 per year. [There is here included a provision for adjusting the payments to conform to advances in the cost of living.] The Wife will defray all costs and expenses necessary to support, maintain, care for and educate the children. b. It is contemplated that the Wife shall support the children in a fair and proper manner and see to their proper care and upbringing. If they attend private schools and at the request of the Husband they will be sent to private schools, and the tuition exceeds $1,000.00 per year per child, the Husband will reimburse the Wife for any excess, providing they go to such private schools as he designates or agrees upon with the Wife. In the event that the children attend a boarding school where they receive board and meals, and the cost of such boarding schools, including tuition and board exceeds $1,250.00 per year per child, the Husband will reimburse the Wife for the amount of such213 difference, providing they go to such boarding school as he designates or agrees upon with the Wife. In the event the children attend a private school the parents will confer for the purpose of trying to agree upon a school which is best suited for the children and to their best interests. c. The WIFE WILL PAY THE COST OF ANY EXPENSES INCIDENTAL TO THE USUAL CARE OF THE CHILDREN, INCLUDING ORDINARY DENTAL AND MEDICAL CARE. In the event that extraordinary dental care is required, such as orthodontia, or in the event of illness which requires special care, such as surgery or hospitalization, the Husband will reimburse the Wife for the cost of such illness. The Wife will pay the cost of the ordinary illnesses to which children ordinarily are subjected. * * 17. In the event that the parties be divorced and the Wife should remarry within ten years after the making of this agreement, the Husband shall have sole custody of the children, but the Wife shall have all the rights of visitation of the children now given by this agreement to the Husband, and all payments hereunder provided to be made to the Wife shall cease and determine. If the Wife should remarry after ten years from214 the date of this agreement, it shall have no effect upon the custody of the children. In the event that the Wife shall remarry and retain custody of the children, the amount to be paid by the Husband to the Wife shall be limited to the sum of $12,000.00 annually for the care, custody and education of the children. On July 15, 1973, this amount will be reduced to $4,000.00 per year, and on February 1, 1976, such payments shall cease. In the event that the Husband shall remarry before the Wife, the subsequent marriage of the Wife shall have no effect on the custody of the children. * * 20. The Wife recognizes and acknowledges that the foregoing provisions for her benefit are satisfactory and that they are reasonable and adequate for her support and maintenance, past, present and future, and in keeping with her accustomed mode of living, reasonable requirements and station in life. * In accordance with the above provisions of the separation agreement, which were incorporated into the divorce decree, Salzberg made regular payments to Van Oss during the years here in issue. On her tax returns for the years 1958 and 1959, Van Oss reported alimony income of $11,500 and215 $12,000, respectively. In his tax returns for the years 1958 and 1959, Salzberg deducted as alimony the amounts of $22,000 and $26,100, respectively. Respondent has disallowed these deductions to the extent of $11,000 for 1958, and $14,100 for 1959. Respondent also determined that Van Oss had understated alimony income by $11,500 in 1958, and $14,100 in 1959. At trial it was stipulated that for 1959 the amount paid by Salzberg to Van Oss was $24,000 not $26,100, and that, therefore, his deduction for that year should be reduced accordingly and the understated alimony income of Van Oss should only be $12,000. Opinion Van Oss contends that $11,500 of the 1958 payments and $12,000 of the 1959 payments represented nontaxable child-support payments. On the other hand, Salzberg contends that such payments (with the exception noted in footnote 1 above) in each of the years represented alimony and are therefore fully deductible by him. Respondent has taken a protective position between the parties, determining as to petitioner Van Oss that the payments in question were taxable as alimony and as to petitioner Salzberg that the payments in question were nondeductible child-support payments. 216 On brief, however, respondent has taken the position in agreement with petitioner Salzberg that no portion of the amounts in question represented child-support payments. Alimony payments are includable in gross income by recipients thereof under section 71(a) of the 1954 Code. Payments to a divorced spouse are deductible by the taxpayer making such payments only if the amounts paid are includable as alimony in the gross income of the recipient. Section 215(a), Internal Revenue Code of 1954. Section 71(b) of the Code provides in pertinent part as follows: (b) Payments to Support Minor Children. - Subsection (a) [which includes in gross income payments received pursuant to a divorce decree or separation agreement] shall not apply to that part of any payment which the terms of the decree, instrument, or agreement fix, in terms of an amount of money or a part of the payment, as a sum which is payable for the support of minor children of the husband. * Section 71(b) requires that the operative instrument must specify or "fix" a sum certain or percentage of the payment for child support before any of the payment may be excluded from the former wife's217 income. The separation agreement in the instant case does not so specify or fix any amount or percentage as child support. Petitioner Van Oss argues, however, that although the payments were not specifically broken down as to designation in the separation agreement, nonetheless, an examination of the provisions of the agreement makes such a breakdown apparent by irrebuttable inference. Initially, Van Oss was to receive $24,000 annually. This was to be reduced by $12,000 if she subsequently remarried. It was to be reduced by $4,000 shortly after each child reached age 21. We agree with petitioner Van Oss that these provisions create a strong inference that of the total $24,000 annual payments, the $12,000 which was to be cut off upon remarriage was intended as alimony, and the $12,000 which was to be cut off ratably as the children reached age 21 was intended as child support. Just such an approach to the application of section 71(b) was urged upon the Supreme Court in Commissioner v. Lester, 366 U.S. 299">366 U.S. 299 (1961), and was clearly rejected. Petitioner Van Oss argues that the Lester case is distinguishable from the instant situation since the agreement in that case not218 only provided for cut-off of portions of the payments as the children reached majority (or were married or died) but also for cut-off of all payments (even during minority of children) if the wife remarried, the latter provision being inconsistent with the inference that a portion of the payments was for child support. Van Oss argues here the amount the husband is required to pay after the wife's remarriage fixes the amount of child support. It is urged that the conflict in inferences in Lester produced an uncertainty which was the basis for the Lester decision, but that no such uncertainty is present in the instant case. It appears clear to us that the decision in Lester is not based on the inability to draw conclusive inferences from the operative agreement there involved, but rather upon the broader underlying principle that in no case can an allocation to child support be fixed by inference - no matter how impelling such an inference might appear. 2 The statutory scheme in this area requires strict literal compliance. 219 Our interpretation of Lester, as establishing a strict rule, is supported by the majority opinion in that case holding that child support payments must be "specifically designated," and also by Justice Douglas' concurring opinion (366 U.S. at 306, 307): I agree with the Court that this agreement did not "fix" any such amount. To be sure, an amount payable in support of minor children may be inferred from the proviso that one-sixth of the payment shall no longer be due, if the children marry, become emancipated, or die. But Congress in enacting this law realized that some portion of alimony taxable to the wife might be used for support of the children, as the opinion of the Court makes clear. The present agreement makes no specific designation of the portion that is intended for the support of the children. It is not enough to say that the sum can be computed. Congress drew a clear line when it used the word "fix." * * * Petitioner Van Oss refers to paragraph 13. b. of the separation agreement, which provides that if the children attend private school, Salzberg will reimburse Van Oss for tuition costs in excess of $1,000 per year per child. She contends that this220 provision fixes a sum certain allocable to child support of $3,000 per year, and that to the extent of $3,000 per year she was a mere conduit for payments from Salzberg to the children, citing Emmons v. Commissioner, 311 F. 2d 223 (C.A. 6, 1963), affirming 36 T.C. 728">36 T.C. 728 (1961). We find the Emmons case completely distinguishable. As petitioner Van Oss points out, the court in Emmons held that as to the $5,000 portion of the payments designated for the benefit of the daughters, the wife had no control and got no personal benefit. She was obligated specifically under a supplemental agreement to expend this sum for her two daughters, or to place any unexpended balance each year in a savings account in the daughters' names. Quite to the contrary here! Van Oss had complete control and beneficial use of all monies received from Salzberg, and she was in no sense a conduit for payment of any specifically fixed sums from Salzberg to the children, nor was she bound to spend a specified amount for the children or remit the unexpended balance to them as in Emmons. We hold that all of the payments here in controversy were alimony payments within the meaning of sections221 71 and 2153 Of the 1959 payments claimed by Salzberg in his return but conceded at trial, $2,100 was not income to Van Oss and not deductible by Salzberg. Decisions will be entered under Rule 50. Footnotes1. Petitioner Salzberg conceded at trial that $2,100 of the total $26,100 deduction claimed for 1959 is not deductible.↩2. We note that in fact the provisions of the agreement in the instant case are not conclusive of but one permissible inference (that $12,000 of the $24,000 annual payments was for child support) as petitioner Van Oss urges in distinguishing her case from Lester. While the provision here for partial cut-off of payments as children reach age 21 does create the inference that the portions subject to cut-off in this way were intended as child support, the absence of a provision cutting off payments in the same manner if a minor child should die or marry tends to create a contrary inference - just as the complete cut-off upon remarriage of the wife during minority of the children created a contrary inference in Lester.↩3. For the year 1958, Salzberg deducted only $22,000, as alimony. Van Oss reported $11,500, as alimony income, and in his notice of deficiency respondent increased alimony income by another $11,500, determining in effect that Van Oss received $23,500 (or $1,000 more than the amount deducted by Salzberg). Although the record indicates that the 1958 payments were less than the annual $24,000 provided in the agreement because the agreement did not take effect until January 15, the discrepancy between the $23,000 and $22,000 figures is not explained. Since the taxpayer must prove error in a determination made in a notice of deficiency, it was incumbent upon Van Oss to prove that total payments received were less than $23,000 if that was in fact the case. Van Oss not having attempted such proof, we must sustain the determination as made in the notice of deficiency as to the year 1958.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622765/	Corinne S. Koshland v. Commissioner. Eleanor H. Koshland v. Commissioner. Walter A. Haas v. Commissioner. Estate of John C. Altman, Deceased, Bess G. Altman and Daniel E. Koshland, Executors v. Commissioner. Robert J. Koshland v. Commissioner. Ruth H. Lilienthal v. Commissioner. Fannie K. Haas v. Commissioner. Walter S. Heller v. Commissioner Koshland v. CommissionerDocket Nos. 111302, 111311, 111303, 111312, 111305, 111313, 111306, 112711.United States Tax Court1943 Tax Ct. Memo LEXIS 65; 2 T.C.M. (CCH) 972; T.C.M. (RIA) 43472; October 30, 194365 Willard L. Ellis, Esq., 615 Russ Bldg., San Francisco, Calif., for the petitioners. Harry R. Horrow, Esq., for the respondent. SMITH Memorandum Findings of Fact and Opinion SMITH, Judge: These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax for 1938 as follows: Docket No.PetitionerDeficiency111302Corinne S. Koshland$ 416.93111303Eleanor H. Koshland896.56111305Walter A. Haas389.12111306Estate of John C. Altman72.71111311Robert J. Koshland222.63111312Ruth H. Lilienthal1,226.03111313Fannie K. Haas716.81112711Walter S. Heller3,690.47Some of the issues raised by the petitioners have been abandoned and others have been disposed of by stipulation. The sole issue presented for the determination of the Tax Court is whether the distributions of certain voting trust certificates to petitioners by the Santa Inez Company were taxable dividends to the extent of the fair market value of such certificates at the date of receipt. Findings of Fact Petitioners, including John C. Altman prior to his decease, were in 1938 residents of San Francisco, California, or of the immediate vicinity. They66 all filed their income tax returns for 1938 with the collector of internal revenue for the first district of California at San Francisco. During 1938 the Santa Inez Company, hereinafter referred to as Santa Inez, was a California corporation with its principal place of business at San Francisco. Its issued and outstanding capital stock consisted of 2,000 shares of common stock. Each of the petitioners owned 80 shares of Santa Inez except John C. Altman and Robert J. Koshland, who each owned 40 shares, and Walter S. Heller, who owned 160 shares. During 1938 Santa Inez owned certain voting trust certificates for 1,074 shares of stock in Sacramento Medico Dental Building Company, a California corporation. Of these shares all but 66 were acquired by Santa Inez at no cost in connection with the acquisition of first mortgage bonds of the Building Company, said 66 shares having been purchased for cash by Santa Inez at a total cost of $468.97. At January 1, 1938, Santa Inez had no accumulated earnings or profits. Its earnings and profits for 1938 available for the payment of dividends, exclusive of earnings and profits, if any, attributable to the distribution in kind of the voting trust67 certificates, as hereinafter referred to, amounted to $10,074.05. The board of directors of Santa Inez on October 4, 1938, adopted the following resolution: RESOLVED that there be distributed on this date, pro rata, in kind, to the shareholders of this Corporation on this date, voting trust certificates for 1,074 shares of the capital stock of Sacramento Medico Dental Building Company, a California corporation; * * * Pursuant to the above resolution there were distributed to each of the petitioners voting trust certificates for shares of stock of the Sacramento Medico Building Company as follows: Corinne S. Koshland42.96Eleanor H. Koshland42.96Walter A. Haas42.96John C. Altman21.48Robert J. Koshland21.48Ruth H. Lilienthal42.96Fannie K. Haas42.96Walter S. Heller85.92On December 15, 1938, pursuant to a resolution of the board of directors of Santa Inez, there was paid to and received by each of the petitioners as a stockholder of Santa Inez a cash dividend of $6.25 per share. No dividends or distributions were made by Santa Inez to any of the petitioners herein during 1938 other than the aforementioned distributions of voting trust certificates 68 and cash. The fair market value on October 4, 1938, of each share of stock of the Building Company represented by voting trust certificates was $27.50. None of the distributions made by Santa Inez to its stockholders during 1938 was in partial or complete liquidation nor out of increase in value of property accrued before March 1, 1913. Immediately prior to the distribution by Santa Inez to its stockholders on October 4, 1938, of voting certificates representing an aggregate of 1,074 shares of Building Company stock, the adjusted basis to each stockholder of Santa Inez of his or her Santa Inez stock amounted to $10.501365 per share. In their income tax returns for 1938 the petitioners reported as taxable income received from the distributions made by Santa Inez only a part of the sum of the cash and fair market value of the voting trust certificates received by them. The respondent has determined the deficiencies upon the theory that each petitioner received taxable income from the distributions equalling the sum of the cash and fair market value of the voting trust certificates received. Opinion The respondent submits that the question presented by these proceedings is whether69 he erred - * * * in determining that the increase in value of certain voting trust certificates, distributed as a dividend by the Santa Inez Company to petitioner stockholders, should be included in the earnings and profits of said corporation for purposes of determining the taxability of said distribution to petitioners? He further states: * * * The sole issue presented for determination is whether the distributions in question are taxable as dividends only to the extent of the proportionate share of each stockholder in the amount of $10,074.05 [net earnings available for the payment of dividends in 1938], as contended by petitioners. * * * The statute involved is the Revenue Act of 1938, which reads in material part as follows: SEC. 115. DISTRIBUTIONS BY CORPORATIONS. (a) Definition of Dividend. - The term "dividend" when used in this title (except in section 203 (a) (3) and section 207 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of70 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. (c) Source of Distributions. - For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113. * * * (d) Other Distributions from Capital. - If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not a dividend, then the amount of such distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable71 in the same manner as a gain from the sale or exchange of property. The petitioners as stockholders of Santa Inez received during the taxable year as distribution of voting trust certificates of the Sacramento Medico Dental Building Company stock and a cash dividend of $6.25 per share. It is stipulated that the earnings of Santa Inez for 1938 available for the payment of a dividend amounted to $10,074.05. The petitioners do not deny that they received taxable income from the two distributions equalling their aliquot part of the $10,074.05 available for distribution. They do contend, however, that as to the excess distribution received they are taxable only upon the excess of the amount received over their investment in shares of stock of Santa Inez, the basis of which has been stipulated to be $10.501365 per share. It is the contention of the respondent that upon the distribution by Santa Inez of the voting trust certificates which had a stipulated fair market value at the date of distribution of $27.50, Santa Inez realized taxable income represented by the difference between the total value of the voting trust certificates distributed and the cost to it of the Building Company *72 shares, namely, $468.97, and that by reason of the distributions the stockholders of Santa Inez received taxable income of $10,074.05 plus the profit realized by Santa Inez from the distribution. The contention made by the respondent in these proceedings is like that made in . We rejected his contention there upon the authority of . He made the same contention in . We there held that the excess of fair market value of an asset distributed in kind over its cost to the distributing corporation, petitioner's wholly owned foreign subsidiary, did not augment earnings or profits of the subsidiary. It appears to us that the facts in these proceedings bring them squarely within the purview of section 115 (d) of the Revenue Act of 1938, quoted above. The excess of the distributions received by each petitioner is to be taxed "in the same manner as a gain from the sale or exchange of property." Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1681881/	966 So.2d 124 (2007) STATE of Louisiana, Appellee, v. Anderson BAKER, Appellant. No. 42,428-KA. Court of Appeal of Louisiana, Second Circuit. September 19, 2007. 125 William Jarred Franklin, Louisiana Appellate Project, for Appellant. Schuyler Marvin, District Attorney, C. Sherburne Sentell, III, Assistant District Attorney, for Appellee. Before GASKINS, CARAWAY and DREW, JJ. GASKINS, J. The defendant, Anderson Baker, appeals as excessive his sentence to ten years at hard labor, without benefit of parole, probation, or suspension of sentence after his plea of guilty to sexual battery. For the following reasons, we affirm the defendant's conviction and sentence. FACTS In December 2005, the defendant committed sexual battery of a minor by intentionally inserting his fingers in the victim's vagina and sucking or biting her breast.[1] The defendant's DNA was found on the child's breast. At the time of the offense, the victim was 13 years old and the defendant was 27. The defendant was originally charged with one count of forcible rape and one count of sexual battery. On September 9, 2006, the defendant entered a plea of guilty to the charge of sexual battery. In exchange for the plea, the charge of forcible rape was dismissed. A presentence investigation (PSI) report was ordered by the trial court. On November 8, 2006, the defendant appeared before the court for sentencing. The defendant asked to make a statement to the court. He was sworn and stated that the victim lived in his household and, on the night of the incident, she was pulling his hair while he was frying potatoes. He said that he turned around and bit her in the chest. 126 The court noted that the defendant was a first felony offender. A previous simple burglary charge had been reduced to misdemeanor theft and the defendant also had a conviction for disturbing the peace. The court recognized that the defendant was not eligible for probation in this case due to the very nature of the charge. The court ordered the defendant to serve ten years at hard labor, without benefit of parole, probation, or suspension of sentence, and ordered that the sentence be served consecutively with any other sentence imposed. The defendant was given credit for time served and was properly informed of the time for applying for post conviction relief. The defendant filed a motion to reconsider sentence which was denied by the trial court. The defendant then appealed, claiming that his sentence is excessive. EXCESSIVE SENTENCE Law In reviewing claims of excessive sentence, an appellate court uses a two-step process. First, the record must show that the trial court took cognizance of the criteria set forth in La.C.Cr.P. art. 894.1. The articulation of the factual basis for a sentence is the goal of La.C.Cr.P. art. 894.1, not a rigid or mechanical compliance with its provisions. A trial judge shall exercise his sentencing discretion to impose sentences according to the individualized circumstances of the offense and the offender. State v. Rogers, 405 So.2d 829 (La.1981). In tailoring the sentence to the individual, the important elements which should be considered are the defendant's personal history (age, family ties, marital status, health, employment record), prior criminal record, seriousness of offense and the likelihood of rehabilitation. State v. Jones, 398 So.2d 1049 (La.1981); State v. Bradford, 29,519 (La.App.2d Cir.4/2/97), 691 So.2d 864. Second, whether the sentence imposed is too severe depends on the circumstances of the case and the background of the defendant. A sentence violates La. Const. art. 1, § 20 if it is grossly out of proportion to the seriousness of the offense or nothing more than a purposeless and needless infliction of pain and suffering. State v. Dorthey, 623 So.2d 1276 (La.1993). A sentence is considered grossly disproportionate if, when the crime and punishment are viewed in light of the harm done to society, it shocks the sense of justice. State v. Bradford, supra. As a general rule, maximum or near maximum sentences are reserved for the worst offenders and the worst offenses. State v. Robinson, 36,147 (La.App.2d Cir.12/11/02), 833 So.2d 1207. However, in cases where the defendant has pled guilty to an offense which does not adequately describe his conduct, the general rule does not apply and the trial court has great discretion in imposing the maximum sentence possible for the pled offense. State v. Black, 28,100 (La.App.2d Cir.2/28/96), 669 So.2d 667, writ denied, 96-0836 (La.9/20/96), 679 So.2d 430; State v. Rankin, 41,128 (La.App.2d Cir.8/23/06), 938 So.2d 1172. A trial court has broad discretion to sentence within the statutory limits. Absent a showing of manifest abuse of that discretion, we may not set aside a sentence as excessive. State v. Guzman, XXXX-XXXX (La.5/16/00), 769 So.2d 1158; State v. June, 38,440 (La.App.2d Cir.5/12/04), 873 So.2d 939. Discussion At sentencing, the defendant addressed the court and admitted the sexual battery, but denied raping the victim. He *127 argues that the physical evidence did not support the victim's claim that she was raped. According to the defendant, plea bargains should not be used to justify imposition of the maximum sentence for the lesser charge to which a defendant pleads guilty. The defendant maintains that the trial court based his sentence on the rape charge which was dismissed and which the defendant denies. The defendant claims that he is not a "worst offender" and therefore the imposition of the maximum sentence for sexual battery was excessive. He argues that the trial court failed to consider that he had no prior felony convictions and that he had no misdemeanor convictions for violent or sexual crimes. In sentencing the defendant, the court referred to the PSI report which, according to the court, showed that the victim had been raped. According to the court, the defendant took advantage of a family member who was a minor. The court also specifically pointed out that the defendant was being sentenced for sexual battery and not for any other offense. The court noted that the defendant was not eligible for probation due to the nature of the charge.[2] The court acknowledged that the victim's mother encouraged the imposition of the maximum sentence possible in this case due to the long-term effects of the defendant's actions on the victim and her family. As reflected in the PSI report, the defendant had a prior criminal history. Originally charged with simple burglary in 1996, the defendant pled guilty to misdemeanor theft. The defendant also had a prior conviction for disturbing the peace. The court recognized that the present offense represented the defendant's first felony conviction. Based upon these factors, we find that the trial court adequately complied with La.C.Cr.P. art. 894.1 and set forth the factual basis for the sentence. Even though the defendant received the maximum sentence possible for sexual battery, under the facts of this case, the sentence is not excessive. The victim was only 13 years old at the time of this non-consensual offense and was a close relative of the defendant. The defendant received the benefit of a favorable plea bargain agreement, which is a valid consideration in sentencing. The sentence imposed does not shock the sense of justice, is not grossly out of proportion to the seriousness of the offense, and does not needlessly inflict pain and suffering. The sentence is tailored to both the offender and the offense. CONCLUSION For the reasons stated above, we affirm the conviction and sentence of the defendant, Anderson Baker, for sexual battery. AFFIRMED. NOTES [1] The victim's name is not used in this opinion due to the confidentiality requirements applicable to this case under La. R.S. 46:1844(W). [2] La. R.S. 14:43.1 provides in pertinent part: C. (1) Whoever commits the crime of sexual battery shall be punished by imprisonment, with or without hard labor, without benefit of parole, probation, or suspension of sentence, for not more than ten years.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4537715/	NOTICE: This opinion is subject to motions for reargument under V.R.A.P. 40 as well as formal revision before publication in the Vermont Reports. Readers are requested to notify the Reporter of Decisions by email at: JUD.Reporter@vermont.gov or by mail at: Vermont Supreme Court, 109 State Street, Montpelier, Vermont 05609-0801, of any errors in order that corrections may be made before this opinion goes to press. 2020 VT 37 No. 2019-069 State of Vermont Supreme Court On Appeal from v. Superior Court, Caledonia Unit, Criminal Division Loren Kandzior December Term, 2019 Michael S. Kupersmith, J. (Ret.), Specially Assigned David Tartter, Deputy State’s Attorney, Montpelier, for Plaintiff-Appellee. Matthew Valerio, Defender General, and Dawn Seibert, Appellate Defender, Montpelier, for Defendant-Appellant. PRESENT: Reiber, C.J., Robinson, Eaton and Carroll, JJ., and Wesley, Supr. J. (Ret.), Specially Assigned ¶ 1. CARROLL, J. Defendant, Loren Kandzior, challenges his conviction on one count of sexual assault in violation of 13 V.S.A. § 3252(a) on two grounds. First, defendant argues that the trial court erred by excluding evidence of a prior false rape allegation. Second, defendant argues that his right to a fair trial was violated because the jury was exposed to “extraneous, highly prejudicial information”—namely, the substance of an undetermined number of bench conferences that occurred during the three-day trial. We conclude that the trial court committed plain error by failing to investigate when it became aware that the jury may have overhead numerous bench conferences during defendant’s trial. We accordingly vacate defendant’s conviction and remand for a new trial.1 I. Facts ¶ 2. In July 2017, defendant was charged with one count of sexual assault. A three-day trial was held in August 2018. On the third day of trial, during defense counsel’s cross- examination of the alleged victim, the prosecutor asked to approach the bench. The court conducted a bench conference (hereinafter the “specific bench conference”) during which counsel discussed the relevance of a particular line of questioning. Immediately after the specific bench conference, the prosecutor asked to approach again and informed the court that someone had told her that “she could hear everything we were saying” at the bench conferences.2 Defense counsel quickly asked the court to instruct the jury to strike anything they may have heard. After an indiscernible exchange, defense counsel repeated that she did not “have a problem with [the court] just telling [the jury] if they heard us up here, to strike whatever they heard.” ¶ 3. After the bench conference concluded, the court had the following exchange with the jury: The Court: Jurors, have you all been able to hear us? Yes? Don’t pay attention to it. Unidentified Juror: Can hear the white noise, but— The Court: I don’t understand. I’ve got my hand on the mute button. We have the white noise machine. Have you heard us throughout the trial? No? Unidentified Juror: Yeah. The Court: Yes. Some could, yes. 1 Because we conclude that the trial court committed plain error by failing to investigate the jury taint, we do not address defendant’s argument regarding the prior false rape allegation. State v. Dubaniewicz, 2019 VT 13, ¶ 13 n.2, ___ Vt. ___, 208 A.3d 619. 2 It is not clear from the record who the prosecutor was referring to. Defendant alleges the prosecutor was referring to the victim advocate. The State, on the other hand, says only that “someone” told the prosecutor. Who exactly the prosecutor was referring to is irrelevant to our analysis. 2 Unidentified Juror: You can hear noise. I haven’t been able to hear what you’re saying. The Court: Just shows you how good this equipment is. (Indiscernible) wrong. I should turn it off. I don’t know. Okay, well, the reason we huddle up here is so you can’t overhear us. So you can’t unring the bell, but do the best you can. ¶ 4. Following this exchange, defense counsel did not move for a mistrial. Instead, she said “[a]ll right, Judge” and proceeded with her cross-examination of the alleged victim. That same day, the jury returned a guilty verdict. Following conviction, defense counsel filed several post-trial motions, including a motion for a new trial pursuant to Vermont Rule of Criminal Procedure 33. In the motion, defense counsel alleged that the “jury overheard every bench conference” and argued that this fact alone entitled defendant to a new trial. ¶ 5. In a written decision and order, the trial court denied the motion for a new trial for several reasons. First, the court pointed out that upon learning the jury may have overheard bench conferences throughout the trial, the only remedial action defense counsel requested was an instruction asking the jury to strike whatever they heard. The court complied and defense counsel made no other objection. ¶ 6. Second, the court emphasized that it was not clear what bench conferences the jury overheard. The court explained that when it asked the jury members what they heard, they gave equivocal answers. Although one juror responded that he heard the specific bench conference, he stated that he could not hear what was said. From this response, the court assumed that it was unlikely the jury overheard the words spoken at bench conferences because other persons besides the jury were in the courtroom—namely, court personnel and trial assistants for the State and defendant. Given the presence of these other people, the court concluded that “if the actual conversations were overheard, these persons would have called that fact to the [c]ourt’s attention.” ¶ 7. Finally, assuming the jury overheard bench conferences throughout the trial, the court concluded that defendant failed to demonstrate he was prejudiced. The court explained that 3 many of the bench conferences were not prejudicial. It cited as an example the specific bench conference, which “involved only a discussion about what counsel hoped to develop during a line of cross-examination.” ¶ 8. Defense counsel moved for reconsideration, arguing that the court should either order a new trial or hold an evidentiary hearing to determine what the jurors heard. The court denied the motion to reconsider. It concluded that it cured any possible prejudice by instructing the jury to strike whatever they may have heard. It also concluded that defendant “waived” his right to have the jurors questioned because he did not ask the court to voir dire the jury when he learned of the problem. Finally, the court reiterated that defendant was not prejudiced because it was “confident that the only bench conference that the jury might have overheard was the ‘specific’ conference.” Defendant timely appealed. ¶ 9. On appeal, defendant argues that he did not waive his right to a fair trial by an untainted jury. Citing State v. Woodard, 134 Vt. 154, 158, 353 A.2d 321, 323 (1976), defendant argues that “the right to a fair trial by jury is so fundamental that it can be raised at any time.” Second, regardless of any action—or lack thereof—taken by defense counsel, defendant maintains that “the trial court had an independent duty to investigate the taint.” Moving to the merits, defendant argues he is entitled to a new trial because the record establishes that an irregularity occurred—i.e., the jurors overheard bench conferences throughout the trial—that had the capacity to affect the verdict. Alternatively, defendant argues that under the plain-error standard, “[t]he mere capacity for extraneous influence upon the jury warrants reversal.” ¶ 10. In response, the State argues that defendant waived the jury-taint claim because he did not immediately move for a mistrial. “Nothing in Vermont law,” the State asserts, “suggests that defense counsel’s conduct cannot operate as a waiver of further investigation into juror taint.” Regardless, on the merits, the State contends that the trial court correctly determined that a new trial was not required. The State emphasizes that the record is unclear as to which bench conferences the jury heard and, assuming the jurors heard the bench conferences, it disputes their 4 prejudicial nature. Alternatively, the State argues that the case should be remanded for a hearing to determine what the jurors heard. ¶ 11. Because defense counsel did not immediately move for a mistrial upon learning that the jury may have overheard various bench conferences, the jury-taint claim was not preserved. Nevertheless, we hold that the trial court committed plain error by failing to voir dire the jury when it learned of the possible jury taint. Without a voir dire, the trial court lacked an evidentiary basis to determine whether defendant was prejudiced. We accordingly vacate defendant’s conviction and remand for a new trial. II. Analysis ¶ 12. Defendant argues that the trial court erred in denying his post-trial motion for a new trial because the jury heard highly prejudicial, extraneous information. Rule 33 permits the trial court, on motion from a defendant, to “grant a new trial . . . if required in the interests of justice.” The decision on a motion for a new trial “is normally entrusted to the discretion of the trial court.” State v. McKeen, 165 Vt. 469, 472, 685 A.2d 1090, 1092 (1996). Under the abuse-of-discretion standard, “a claim of error can be supported only where the trial’s court discretion was either totally withheld, or exercised on clearly untenable or unreasonable grounds.” State v. Messier, 2005 VT 98, ¶ 15, 178 Vt. 412, 885 A.2d 1193. ¶ 13. Where a defendant fails to timely move for a new trial, however, we review for plain error. See Woodard, 134 Vt. at 156, 353 A.2d at 322 (assuming that defense counsel failed to raise issue before trial court and reviewing for plain error). Plain error consists of “glaring error so grave and serious that it strikes at the very heart of the defendant’s constitutional rights.” State v. Oscarson, 2004 VT 4, ¶ 27, 176 Vt. 176, 845 A.2d 337 (quotation omitted). “To reverse on plain error, we must find not only that the error seriously affected substantial rights, but also that it had an unfair prejudicial impact on the jury’s deliberations.” Id. 5 ¶ 14. We conclude that defendant failed to timely move for a mistral and review for plain error. Nevertheless, we conclude that this is one of the “rare and extraordinary cases” where plain error occurred. State v. Turner, 145 Vt. 399, 403, 491 A.2d 338, 340 (1985). A. Preservation ¶ 15. The trial court denied the post-trial motion for a mistrial in part because the only remedial action defense counsel requested was an instruction asking the jury to strike whatever they heard. The court elaborated on this reasoning in denying the motion to reconsider, explaining that defendant “waived” his right to have the jurors questioned because defendant did not ask the court to voir dire the jury when he learned of the problem. ¶ 16. Although the trial court used the word “waived,” defendant’s failure to timely move for a mistrial is a preservation—not a waiver—issue. While often used interchangeably, waiver and preservation are different concepts. Preservation refers to whether a litigant specifically raised an issue with the trial court, thereby giving the court “a fair opportunity to rule on it.” State v. Ben-Mont Corp., 163 Vt. 53, 61, 652 A.2d 1004, 1009 (1994). The “purpose of the preservation rule is to ensure that the original forum is given an opportunity to rule on an issue prior to our review.” In re White, 172 Vt. 335, 343, 779 A.2d 1264, 1270-71 (2001); see also State v. Griffin, 152 Vt. 41, 44, 563 A.2d 642, 644 (1989) (explaining that raising issues before trial court gives it an opportunity to take “remedial action” that could “minimize or eliminate any prejudice”). ¶ 17. Waiver, on the other hand, “is the intentional relinquishment or abandonment of a known right.” United States v. Olano, 507 U.S. 725, 733 (1993) (quotation omitted). “[O]ur decisions authorize a defendant to waive virtually any right, constitutional or statutory, as long as the waiver is knowing, intelligent, and voluntary.” State v. Hance, 157 Vt. 222, 224, 596 A.2d 365, 366 (1991); see also Olano, 507 U.S. at 733 (“Because the right to trial is waivable, and because the defendant who enters a valid guilty plea waives that right, his conviction without a trial is not ‘error.’ ”). 6 ¶ 18. Here, although the trial court referred to waiver, it was discussing preservation. The court denied the motion for a new trial in part because defendant did not timely move for a mistrial or ask the court to voir dire the jury and therefore did not preserve his jury-taint claim. The parties’ briefing is less than precise and similarly employs the word waiver. The parties appear to agree, however, that the issue on appeal is one of preservation. Defendant argues that “the right to a fair trial by jury is so fundamental that it can be raised at any time.” The State, citing a series of cases from other jurisdictions, appears to argue that unpreserved jury-taint claims should be treated no differently than other unpreserved claims—that is, failure to preserve leads to plain- error review. ¶ 19. We agree with the State that defendant failed to preserve his jury-taint claim. “A defendant cannot gamble on a favorable verdict, but must make prompt objection and motion for mistrial.” State v. Bartlett, 137 Vt. 400, 405, 407 A.2d 163, 166 (1979). Accordingly, a defendant must timely move for a mistrial upon learning of possible jury taint. See Bartlett, 137 Vt. at 405, 407 A.2d at 166 (holding that juror-misconduct claim was unpreserved because “defendant did not move for a mistrial when the facts about [the juror] became known”)3; Silva v. Stevens, 156 Vt. 94, 111, 589 A.2d 852, 862 (1991) (holding that jury-taint claim was unpreserved because defendants “failed to object to the court’s curative instruction at trial”). ¶ 20. State v. Woodard does not, as defendant suggests, hold that jury-taint claims can be raised at any time. Rather, in Woodard, the Court assumed that defendant did not preserve a jury-taint claim and engaged in plain-error review. 134 Vt. at 156, 353 A.2d at 322. In sum, to preserve a jury-taint claim, a defendant must timely move for a mistrial. ¶ 21. In this case, defendant did not move for a mistrial when he learned that the jury may have overheard various bench conferences throughout trial. In fact, defendant did not move for a mistrial until after he was convicted. But, as we have previously cautioned, “[a] defendant 3 In Bartlett, despite using the word waiver, we were addressing a preservation issue. 7 may not gamble on a favorable verdict before urging prejudicial conduct as grounds for a mistrial.” State v. Curtis, 145 Vt. 552, 553, 494 A.2d 143, 144 (1985). Because defendant did not timely move for a mistrial, the jury-taint claim was not preserved. We accordingly review for plain error. B. Plain Error ¶ 22. Vermont Rule of Criminal Procedure 52(b) provides that “[p]lain errors or defects affecting substantial rights may be noticed although they were not brought to the attention of the court.” However, “raising a plain error argument on appeal is not a substitute for raising a timely objection below and it should not be used as such.” State v. Erwin, 2011 VT 41, ¶ 14, 189 Vt. 502, 26 A.3d 1. “If this Court were indiscriminately to entertain claims of error which defense counsel expressly—perhaps, strategically—declined to pursue before the trial court, it would encourage counsel, at times when correction is simple, to convey the impression that all is well while preparing to seek reversal in the event of an adverse verdict.” Turner, 145 Vt. at 403-04, 491 A.2d at 340-41. ¶ 23. Plain error consists of “glaring error so grave and serious that it strikes at the very heart of the defendant’s constitutional rights.” Oscarson, 2004 VT 4, ¶ 27. “To reverse on plain error, we must find not only that the error so seriously affected substantial rights, but also that it had an unfair prejudicial impact on the jury’s deliberations.” Id. In determining whether plain error occurred, we are guided by “cases where we have applied the abuse-of-discretion standard.” See State v. Ray, 2019 VT 51, ¶ 9, ___ Vt. ___, 216 A.3d 1274. The “more concrete federal plain- error test” is also a helpful “guide for applying our own plain-error standard.” State v. Yoh, 2006 VT 49A, ¶¶ 39-40, 180 Vt. 317, 910 A.2d 853. ¶ 24. Both the United States and Vermont Constitutions guarantee the right to trial by an impartial jury. U.S. Const. amend. VI; Vt. Const. ch. I, art. 10. “This right is coterminous under the United States and Vermont Constitutions.” State v. Johnson, 2013 VT 116, ¶ 14, 195 Vt. 498, 90 A.3d 874. Under the abuse-of-discretion standard, a defendant seeking “a mistrial based on alleged jury taint must show that an irregularity—i.e., anything creating any suspicion of 8 extraneous influences—had the capacity to influence jury deliberations.” State v. Amidon, 2018 VT 99, ¶¶ 14-15, 208 Vt. 360, 198 A.3d 27 (quotation omitted). “If an irregularity is shown . . . the opposing party must show that the irregularity in fact had no effect on the jury.” State v. Herrick, 2011 VT 94, ¶ 13, 190 Vt. 292, 30 A.3d 1285. Under this abuse-of-discretion standard, we “will not readily overturn the trial court’s denial of a motion for new trial.” State v. Richards, 144 Vt. 16, 20-21, 470 A.2d 1187, 1190 (1983). “[A] claim of error can be supported only where the trial’s court discretion was either totally withheld, or exercised on clearly untenable or unreasonable grounds.” Messier, 2005 VT 98, ¶ 15. ¶ 25. Our abuse-of-discretion case law underscores the high burden a defendant has in demonstrating that a trial court committed plain error in denying a motion for a new trial. We are reluctant to overturn a trial court’s denial of a motion for a new trial under the abuse-of-discretion standard. See Richards, 144 Vt. at 20-21, 470 A.2d at 1190. And although “[a]buse-of-discretion is a highly deferential standard of review, . . . plain error is even more highly deferential.” United States v. Montez, 858 F.3d 1085, 1089 (7th Cir. 2017) (quotation omitted). ¶ 26. Having said that, our jury-irregularity case law, including those cases reviewing for abuse of discretion, helps illustrate why plain error occurred in this case. When we review a trial court’s decision using the jury-irregularity framework, the trial court has investigated the possible taint and established the necessary evidentiary basis for determining “if in fact any prejudice has been created.” United State v. Onorato, 142 Vt. 99, 106, 453 A.2d 393, 396 (1982); see also, e.g., State v. Mead, 2012 VT 36, ¶¶ 13-15, 192 Vt. 1, 54 A.2d 485 (applying jury-irregularity framework where trial court conducted post-trial hearing, which included testimony from juror who had extrajudicial contact with one of state’s witnesses); Herrick, 2011 VT 94, ¶ 14 (applying jury- irregularity framework because trial court created basis for determining whether prejudice had occurred by conducting “general and individual[ized] voir dire of the jury”); State v. FitzGerald, 165 Vt. 343, 349-50, 683 A.2d 10, 15 (1996) (explaining that trial court established “a basis for reviewing whether prejudice had been created” in part because it “examined the juror suspected of 9 misconduct under oath”); Onorato, 142 Vt. at 106, 453 A.2d at 396-97 (applying jury-irregularity framework because trial court “exposed the necessary basis . . . through voir dire of the jury”). ¶ 27. When a trial court fails to investigate possible jury taint, however, we cannot apply the jury-irregularity framework because the trial court, and this Court on appeal, has no “basis for determining if any prejudice exists.” Onorato, 142 Vt. at 106, 453 A.2d at 396. We cannot assess whether or how a jury was affected if the trial court does not investigate and establish an evidentiary basis regarding what the jury may have heard. See Woodard, 134 Vt. at 156-58, 353 A.2d at 323-24. Accordingly, the failure to investigate possible jury taint and establish an evidentiary basis for determining if the jury was fair and unbiased amounts to plain error. See, e.g., id. (holding that trial court committed plain error by failing to investigate possible jury taint); Onorato, 142 Vt. at 106, 453 A.2d at 396 (recognizing principle that when trial court fails to voir dire jury, it “lacks a basis for determining if any prejudice exists”); State v. Lafleur, No. 2002-257, 2003 WL 25746029, *3 (Mar. 1, 2003) (unpub. mem.), https://www.vermontjudiciary.org/sites/ default/files/documents/eo02257.pdf [https://perma.cc/5WSF-D2Z6] (concluding that trial court’s failure to investigate potential jury taint was plain error because “absent some examination of the jury by the trial court upon discovering the possibility of any prejudice, the trial judge lacks a basis for determining if any prejudice exists, and consequently this Court has no record from which it can determine if the jury was fair and unbiased” (quotation omitted)). ¶ 28. Normally, to reverse on plain error we must determine that the error affected defendant’s substantial rights and had a prejudicial impact on the jury. Oscarson, 2004 VT 4, ¶ 27. In Woodard, however, we held that when a trial court fails to investigate possible jury taint, plain error occurs regardless of any prejudice. 134 Vt. at 156-58, 353 A.2d at 323-24. The clear import of this case is that the failure to investigate possible jury taint is a structural error that affects substantial rights and can be corrected without a specific showing of prejudice. ¶ 29. The United States Supreme Court has speculated that “[t]here may be a special category of forfeited errors that can be corrected regardless of their effect on the outcome.” Olano, 10 507 U.S. at 735. A majority of federal appeals courts have recognized that one of those categories of forfeited error is structural error. See, e.g., United States v. Lockhart, 947 F.3d 187, 200 (4th Cir. 2020) (Wynn, J., concurring) (“Under Rule 52(b) plain-error review, this Court has held that . . . structural errors necessarily affect substantial rights . . . .” (quotations omitted)); Arthur v. United States, 986 A.2d 398, 413 (D.C. Cir. 2009) (“[I]f [the error] is structural in nature, the defendant’s substantial rights will be deemed to have been affected, without need for further analysis in the context of the particular trial.”). ¶ 30. Structural error involves defects that “ ‘affect[] the framework in which the trial proceeded, and thus, prevent[] the trial from serving its function as a vehicle for determining the guilt or innocence of the defendant.’ ” State v. Muscari, 174 Vt. 101, 116-17, 807 A.2d 407, 419 (2002) (quoting In re Hunt, 163 Vt. 383, 387, 658 A.2d 919, 922 (1995)). Structural error is distinguished from mere “trial error,” which is error that “occurred during the presentation of the case to the jury, and which may therefore be quantitatively assessed in the context of other evidence presented in order to determine whether its admission was harmless.” Arizona v. Fulminante, 499 U.S. 279, 307-08 (1991). ¶ 31. This case law makes clear that a trial court’s failure to voir dire the jury after learning of the possibility of jury taint amounts to a structural error that affects substantial rights without regard to prejudice. When the trial court conducts an investigation into a claim of jury taint and establishes an evidentiary basis, we have a record from which we can determine if the jury was fair and unbiased. Without this evidentiary basis, however, there is no record from which we can determine how the jury was affected. Onorato, 142 Vt. at 106, 453 A.2d at 396. In other words, structural error occurs because we cannot “quantitatively assess[]” how the jury was affected. Fulminante, 499 U.S. at 307-08. In this circumstance, “a rule requiring the defendant to show prejudice, or one requiring the state to show lack of prejudice, makes no sense.” United States v. Noushfar, 78 F.3d 1442, 1445 (9th Cir. 1996) (quotation omitted). 11 ¶ 32. In sum, we apply two distinct analyses to jury-taint claims depending on whether the trial court investigated the possible taint and established an evidentiary basis regarding what the jury may have heard. When a trial court investigates possible jury taint, we apply the jury- irregularity framework because the trial court has established an evidentiary basis for reviewing whether prejudice occurred. FitzGerald, 165 Vt. at 349-50, 683 A.2d at 15. When a trial court fails to investigate upon discovering the possibility of jury taint, however, plain error occurs because there is no basis for determining whether or how the jury was affected. Such failure amounts to a structural error that affects substantial rights and can be corrected without a specific showing of prejudice. ¶ 33. There are two important caveats to the failure-to-investigate analysis. First, the duty to investigate occurs only when the trial court discovers the possibility of jury taint. See, e.g., Onorato, 142 Vt. at 105-06, 453 A.2d at 396 (explaining that trial court learned of possible jury taint when juror told the court that he learned “this was a second trial”); FitzGerald, 165 Vt. at 347, 349-50, 683 A.2d at 14-15 (explaining that trial court discovered possible jury taint when public defender “told the court that one of his clients claimed than an alternative juror had discussed the case with neighbors”); Woodard, 134 Vt. at 155-57, 353 A.2d at 322-24 (explaining that “suspicion” of jury taint arose where jury member told court he heard defendant making incriminating statements outside of court). ¶ 34. Second, given the “diverse array of juror-irregularity cases,” Mead, 2012 VT 36, ¶¶ 14-15, trial courts retain broad discretion in how they choose to investigate possible jury taint. Although trial courts must investigate upon discovering possible jury taint, the method and scope of investigation depends on the circumstances. Compare Onorato, 142 Vt. at 106, 453 A.2d at 396-97 (holding that trial court established evidentiary basis by conducting voir dire of jury), with FitzGerald, 165 Vt. at 349-50, 683 A.2d at 15 (holding that court did not have “to conduct individual voir dire” because it “examined the juror suspected of misconduct under oath”). 12 ¶ 35. In this case, the issue is whether the trial court committed plain error in denying defendant’s post-trial motion for a new trial based on alleged jury taint. There is no dispute that the trial court was aware of possible jury taint: the prosecutor informed the court that someone had told her that “she could hear everything we were saying” at the bench conferences. Based on the principles outlined above, the remaining inquiry in our plain-error analysis is whether the trial court investigated and established an evidentiary basis to support its conclusion that the jury was fair and unbiased. If the court failed to investigate, plain error occurred. ¶ 36. The State argues that the trial court established an evidentiary basis because it made an inquiry of the jury and three jurors gave ambiguous responses about what they heard. We cannot agree. Although the trial court asked the jurors two questions about what they may have heard, this was an insufficient investigation because the trial court, by its own admission, failed to establish an evidentiary basis regarding what the jury may have heard. ¶ 37. The court asked the jurors two rather confusing questions about whether they had been able to hear the bench conferences throughout the trial. First, the court asked, “have you all been able to hear us? Yes? Don’t pay attention to it.” Then the court asked if the jury could hear the bench conferences “throughout the trial” and ended the question with, “No?” The record indicates that there were three responses from an “Unidentified Juror”: one response was could “hear white noise,” another response was “[y]eah,” and a third was you could “hear noise” but could not hear what “you’re saying.” Because all three responses are identified as coming from an “Unidentified Juror,” we are unable to determine whether these responses came from the same juror or multiple jurors. The court did not follow up with any of the jurors to determine what exactly they heard. ¶ 38. The court’s denial of defendant’s post-trial motion for a mistrial illustrates the inadequacy of the court’s investigation. The court acknowledged that it was “not clear what the jury heard” and that it “did not specifically inquire.” Furthermore, the court repeatedly relies on speculation about what the jurors could or could not hear. For example, the court says that it 13 “doubts that the bench conversation were actually overheard” and was “confident that the jurors did not overhear any other bench conferences either before or after the specific bench conference.” (Emphasis added.) ¶ 39. “No right is more fundamental to a defendant than a fair trial by jury . . . .” Woodard, 134 Vt. at 158, 353 A.2d at 323. Given the significance of this right, the trial court’s limited questioning of the jury, speculation about what the jury may have heard, and “confidence” that the jury did not overhear bench conferences do not provide a sufficient record for determining “if the jury was fair and unbiased,” Onorato, 142 Vt. at 106, 453 A.2d at 396. Indeed, as the trial court itself admitted in denying the post-trial motion for a mistrial, “[i]t is not clear what the jury heard, either with respect to the specific bench conference or with respect to other bench conferences.” Accordingly, we hold that the trial court committed plain error by failing to investigate and establish an evidentiary basis regarding what the jury heard. Defendant’s conviction is vacated, and the case is remanded for a new trial. FOR THE COURT: Associate Justice 14	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622768/	ISABEL G. SPROEHNLE, EXECUTRIX, ESTATE OF ALBERT W. SPROEHNLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. JOHN R. SPROEHNLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sproehnle v. CommissionerDocket Nos. 24859, 30362, 24860.United States Board of Tax Appeals20 B.T.A. 417; 1930 BTA LEXIS 2133; July 30, 1930, Promulgated 2133 The principal stockholder of a corporation having acquired all its assets and assumed all its liabilities upon dissolution, immediately transferred the assets to a partnership formed by him and a third person, and the partnership assumed and paid the liabilities, but paid no other consideration either to the principal stockholder or the corporation. Held, the partnership was liable for a deficiency, proposed after the formation of the partnership, in income and profits taxes of the dissolved corporation to the extent of its validity, and counsel fees paid in contesting the deficiency were proper deductions of the partnership. Frederick D. Silber, Esq., for the petitioners. B. M. Coon, Esq., for the respondent. STERNHAGEN 417 OPINION. STERNHAGEN: The respondent determined deficiencies in income taxes against the decedent Albert W. Sproehnle of $1,800.66 for 1922 and $4,257.24 for 1923, and against John R. Sproehnle of $100.98 for 1922. The proceedings were submitted together upon the following stipulation of facts: 1. Prior to December 31, 1919, Sproehnle & Company was an Illinois corporation engaged in Chicago in the wholesale2134 watch movement business. A. W. Sproehnle (now deceased) owned ninety per cent (90%) of the stock of the corporation and George E. Jacobson owned ten per cent (10%) of the stock. Said corporation on December 31st, 1919, had net assets of sufficient value to pay the deficiency of $80,703.86, as hereinafter set forth. 418 2. Said corporation was dissolved, pursuant to the provisions of the laws of Illinois, on December 31st, 1919. On that date it executed a bill of sale to A. W. Sproehnle for all of its assets, property, credits and effects, including the good will of its business, and by said bill of sale he expressly assumed the payment of all of its outstanding debts, liabilities and obligations, but paid no further consideration. Copy of said bill of sale is attached to the stipulation. 3. Concurrently with the receipt of said bill of sale by the said A. W. Sproehnle, a partnership was formed between said A. W. Sproehnle and his son, John R. Sproehnle. Articles of copartnership between the two were executed as of January 1st, 1920, under the name of Sproehnle & Co., and said partnership took over all of the assets, property, credits and effects of the dissolved2135 corporation the day following the dissolution thereof, and assumed the payment of its debts, liabilities and obligations. The following are the material provisions of the partnership agreement: 1. The parties hereto hereby form a partnership, to be known under the name and style of SPROEHNLE & COMPANY, to conduct a wholesale watch movement business in the City of Chicago, to succeed the late corporation known as Sproehnle & Company, heretofore dissolved. 2. The first party hereby sells to the second party an equal interest in the assets, property, credits and effects, tangible and intangible, of the said business of Sproehnle & Company, for the sum of Eighty Six Thousand Six Hundred & eighty-nine 89/100 Dollars * * 3. It is further convenanted and agreed that the parties hereto shall share equally in the profits and the losses of said business of Sproehnle & Company, and that neither of the parties shall make himself personally liable upon obligations outside of the business, such as becoming surety upon bonds, guaranties or undertakings for any third person, or incurring any personal liabilities beyond those for usual and ordinary current and family expenses, without2136 the express consent of the other partner. * * 6. The first party shall act as general manager of the business of the partnership, including the supervising of the purchase and sale of merchandise. * * * * * * Said partnership continued on the basis of an equal interest in profits and losses by the said partners until January 1st, 1923, when a new partnership agreement was entered into under which A. W. Sproehnle received ninety per cent (90%) of the profits and John R. Sproehnle ten per cent (10%). 4. An audit of the books of the dissolved corporation was made by the Income Tax Unit as of April 10th, 1922, and the Field Audit Division, as a result thereof, recommended additional taxes against the dissolved corporation for 1917, 1918 and 1919, aggregating $124,092.81. In addition to said proposed deficiencies, a fifty per cent (50%) penalty was proposed to be added. Counsel were engaged by A. W. Sproehnle to defend against the imposition of the additional taxes and penalties. As a result of defenses made, the penalties were not assessed and the proposed deficiency was reduced to a total of $80,783.06. A. W. Sproehnle deducted from his personal tax return for 1922, 2137 as a business expense, the sum of $7,652.50, representing actual acounsel fees and expenses of said litigation paid in that year, and deducted from his personal return for 1923 the sum of $25,000.00 actually paid as attorney's fees in said 419 year for the services so rendered. Upon a field audit of the books of the partnership of A. W. Sproehnle and John R. Sproehnle, for the years 1922 and 1923, made on or about May 5th, 1927, and June 1st, 1927, the Field Division recommended that the deduction made by A. W. Sproehnle for the payment of said fees and expenses in 1922 and 1923 be disallowed, but be allowed as a deduction for business expense of the partnership on the partnership return. The Bureau refused to adopt said recommendation of the Field Audit Division and held that while the payment of said fees and expenses was a proper business expense of the dissolved corporation, that neither the successor partnership nor A. W. Sproehnle, personally, was entitled to deduct the payments so made as a business expense of either, and as the dissolved corporation was not in existence in 1922 and 1923, no allowance of such payments could be made to anyone in interest. After A. 2138 W. Sproehnle died, August 26th, 1926, the Commissioner made an assessment against the executrix of his estate for additional taxes for 1922 of $1,800.66, and for 1923 of $4,257.24, and made an assessment against John R. Sproehnle for 1922 of $100.98. 5. The partnership between the deceased and his son, which took over all of the assets, property, credits and effects of the dissolved corporation, paid no other consideration either to the deceased or to the dissolved corporation therefor, but assumed and paid all debts, liabilities and obligations of the dissolved corporation. The corporation transferred its assets subject to all liabilities, including that for income and profits taxes, to Albert W. Sproehnle and he immediately transferred the same to the partnership, which assumed such liabilities. When the deficiency of $124,092.81 was proposed, the partnership was liable therefor to the extent of its validity. The counsel fees paid by the partnership in contesting it were proper deductions of the partnership. . From the stipulation it appears that A. W. Sproehnle paid the entire amount of such fees. Since, however, the liability2139 was that of the partnership, the contest would, strictly speaking, be conducted by the partnership at partnership expense. It does not appear what partnership adjustment of the counsel fees was made, but petitioners' attorney has expressed approval of the treatment of the amount as a partnership deduction. This we think is the correct treatment. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622773/	SILVERCREST MANOR NURSING HOME, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Silvercrest Manor Nursing Home v. Comm'rDocket No. 24578-14L United States Tax Court2017 U.S. Tax Ct. LEXIS 30; May 31, 2017, FiledDecision text below is the first available text from the court; it has not been editorially reviewed by LexisNexis. Publisher's editorial review, including Headnotes, Case Summary, Shepard's analysis or any amendments will be added in accordance with LexisNexis editorial guidelines.Docket No. 24578-14L. Filed May 31, 2017.David J. Looby, for petitioner.Ann Louise Darnold, for respondent.MEMORANDUM OPINIONPARIS, Judge: In this collection due process (CDP) case, petitioner seeksreview pursuant to section 6330(d)(1)1 of the determination by the Internal1Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.- 2 -[2] Revenue Service (IRS or respondent) to uphold a notice of intent to levy.Petitioner timely petitioned this Court with respect to the notice of determination,and petitioner and respondent have each filed motions for summary judgmentunder Rule 121. The questions for decision are whether IRS Settlement OfficerAlcorte (SO Alcorte) abused her discretion in rejecting petitioner's proposedinstallment agreement and sustaining the collection action and whether she hadany prior involvement with respect to the unpaid tax. For the reasons explainedbelow, the Court will grant respondent's motion for summary judgment and denypetitioner's.BackgroundThe following facts are based on the parties' pleadings and motion papers,including the attached exhibits and affidavits.2 SeeRule 121(b). Petitioner oper-ates a nursing home facility in a rural community of fewer than 7,000 residents.Its principal place of business was in Oklahoma at the time the petition was filed.2Each party requests that certain of the other's affidavits and exhibits be stricken from the record because they were not part of the original administrative record. Although there exists conflicting authority as to whether the Court's review in CDP cases is limited to the administrative record, neither the U.S. Court of Appeals for the Tenth Circuit nor the U.S. Court of Appeals for the D.C. Circuit has specifically ruled on the issue. The Court denies both requests.- 3 -[3] The case at issue relates to petitioner's outstanding tax liability from Form941, Employer's Quarterly Federal Tax Return, for the period ending December31, 2013. Petitioner timely filed this Form 941, but failed to pay the self-reportedtax liability of $63,683.30. On April 14, 2014, respondent assessed the taxreported on the return and began collection efforts.On April 24, 2014, respondent issued to petitioner a Letter 1058, FinalNotice--Notice of Intent to Levy and Notice of Your Right to a Hearing. Inresponse petitioner timely submitted a Form 12153, Request for a Collection DueProcess or Equivalent Hearing, seeking to enter into a $6,000-per-monthinstallment agreement for its unpaid employment tax liability. This request statedthat if respondent were permitted to levy, petitioner's difficulty with Medicare andMedicaid collections would render it unable to pay either its employment taxbalance or its current taxes. Petitioner's request, however, did not dispute theunderlying employment tax liability; petitioner checked the collection alternativeboxes for "Installment Agreement" and "I Cannot Pay Balance".Respondent mailed petitioner a letter dated June 6, 2014, acknowledgingreceipt of petitioner's hearing request, and SO Alcorte subsequently mailedpetitioner a letter scheduling a CDP hearing for August 27, 2014. SO Alcorte'sletter advised petitioner that it did not qualify for consideration of an installment- 4 -[4] agreement because it was not in compliance with its employment tax depositrequirements for the taxable period ending June 30, 2014. The letter furtheradvised petitioner that to qualify for a collection alternative it had to provide to SOAlcorte the following items no later than August 14, 2014: (1) a completed Form433-B, Collection Information Statement for Businesses, and (2) evidence that ithad made the required Federal employment tax deposits for the current taxableperiod. SO Alcorte informed petitioner that respondent could not considercollection alternatives without the information requested.Petitioner did not submit the requested Form 433-B until August 25, 2014,two days before the scheduled hearing, asserting that the proposed levy wouldresult in "economic hardship" and, therefore, "this situation * * mandate[s] therelease of the proposed levy". The Form 433-B was signed by petitioner'spresident, Sam Jewell, and listed among petitioner's assets accounts receivablefrom Private Pay, Medicaid Oklahoma, and Medicare--with a combined balance of$123,212.42--for the period April 30 through June 30, 2014.3 The Form 433-Balso listed petitioner's monthly income of $188,297.29 and monthly expenses of$209,170.56, for a monthly net loss of $20,873.27.3The record reflects that $110,298.99 of petitioner's total accounts receiv-able was owed by the Federal and State Government agencies referenced above.- 5 -[5] In preparation for the CDP hearing SO Alcorte reviewed the administrativerecord and noted in her case activity report that petitioner did not appear to qualifyfor an installment agreement because its assets were sufficient to pay theoutstanding liability in full. She also noted that petitioner offered no explanationregarding how it would make its proposed monthly installment agreementpayments while its net monthly revenue was negative.On August 27, 2014, the parties held a CDP hearing. Petitioner'srepresentative did not contest petitioner's underlying tax liability but insteadreiterated that it would suffer economic hardship if the proposed collection actionwere sustained. SO Alcorte explained that she would not consider petitioner'seconomic hardship argument because the economic hardship exception undersection 6343(a)(1)(D) does not apply to corporations. She noted that because(1) petitioner's accounts receivable were sufficient to pay its outstanding liabilityin full, (2) petitioner was not in compliance with its Federal employment taxdeposit obligations, and (3) section 6343(a)(1)(D) relief was unavailable tocorporations, she would be sustaining the proposed collection action and closingthe case.SO Alcorte verified that the assessment was properly made and that all otherrequirements of applicable law and administrative procedure had been met. She- 6 -[6] thereupon closed the case and, on September 17, 2014, issued to petitioner anotice of determination sustaining the notice of intent to levy for its employmenttax liability for the period ending December 31, 2013.DiscussionI. Summary Judgment and Standard of ReviewThe purpose of summary judgment is to expedite litigation and avoidunnecessary and time-consuming trials. Fla. Peach Corp. v. Commissioner, 90T.C. 678, 681 (1988). The Court may grant summary judgment when there is nogenuine dispute as to any material fact and a decision may be rendered as a matterof law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518">98 T.C. 518, 520 (1992),aff'd, 17 F.3d 965">17 F.3d 965 (7th Cir. 1994). If a moving party properly makes and supportsa motion for summary judgment, "an adverse party may not rest upon the mereallegations or denials of such party's pleading" but must set forth specific facts, byaffidavit or otherwise, showing that there is a genuine dispute for trial. Rule121(d).Upon due consideration of the parties' motions, supporting declarations,and responses thereto, the Court concludes that no material facts are in dispute andthat judgment may be rendered for respondent as a matter of law.- 7 -[7] Where the validity of the underlying tax liability is properly at issue in acollection case, the Court will review the matter on a de novo basis. Sego v.Commissioner, 114 T.C. 604">114 T.C. 604, 610 (2000). Where, as here, there is no disputeconcerning the underlying tax liability, the Court reviews the Commissioner'sadministrative determination to proceed with collection for abuse of discretion.4Id. Abuse of discretion exists when a determination is arbitrary, capricious, orwithout sound basis in fact or law. See Murphy v. Commissioner, 125 T.C. 301">125 T.C. 301,320 (2005), aff'd, 469 F.3d 27">469 F.3d 27 (1st Cir. 2006).II. Collection Due ProcessIn deciding whether the SO abused her discretion in sustaining the proposedcollection action, the Court considers whether she: (1) properly verified that therequirements of any applicable law or administrative procedure have been met;(2) considered any relevant issues petitioner raised; and (3) determined whether"any proposed collection action balances the need for the efficient collection of4Regardless of whether petitioner could have contested its underlying liability at the CDP hearing, this Court may consider a challenge to such a liability only if the taxpayer properly raised it before the SO, Giamelli v. Commissioner, 129 T.C. 107">129 T.C. 107, 115 (2007), and again in its petition to this Court, seeRule 331(b)(4) ("Any issue not raised in the assignments of error shall be deemed to be conceded."). Petitioner did not raise this issue with SO Alcorte or in its petition. The Court accordingly deems it conceded.- 8 -[8] taxes with the legitimate concern of * * * [petitioner] that any collectionaction be no more intrusive than necessary." Seesec. 6330(c)(3).Review of the record reveals that SO Alcorte conducted a thorough reviewof petitioner's account, determined that the taxes had been properly assessed, andverified that other requirements of applicable law and administrative procedurewere followed.Petitioner's primary contention is that section 301.6343-1(b)(4)(i), Proced.& Admin. Regs. (defining economic hardship only with respect to individual taxpayers), is invalid and that SO Alcorte abused her discretion in failing to consider its request for relief under the economic hardship provision of section 6343(a)(1)(D). This contention is incorrect. This Court recently released its Opinion in Lindsay Manor Nursing Home, Inc. v. Commissioner (Lindsay ManorI), 148 T.C. __ (Mar. 23, 2017), finding that section 301.6343-1(b)(4)(i), Proced.& Admin. Regs., is valid and that the economic hardship relief provided by section 6343(a)(1)(D) is available only to individual taxpayers. And in a companion Memorandum Opinion, Lindsay Manor Nursing Home, Inc. v. Commissioner, T.C. Memo. 2017-50, the Court concluded that the SO did not abuse her discretion in failing to consider a request for economic hardship relief made by a corporate taxpayer. SO Alcorte did not abuse her discretion in declining this request either.- 9 -[9] Petitioner argues alternatively that SO Alcorte abused her discretion inrejecting its installment agreement request and in failing to adequately consider its"economic hardship" in the balancing analysis required by section 6330(c)(3).5Finally, petitioner suggests that SO Alcorte was not impartial as required bysection 6330(b)(3).A. Petitioner's Installment Agreement RequestIn its discretion, the IRS may enter into an installment agreement if itdetermines that doing so will facilitate full or partial collection of a tax liability.Seesec. 6159(a). The IRS also has discretion to reject a proposed installmentagreement (subject to certain restrictions not applicable here). See Thompson v.Commissioner, 140 T.C. 173">140 T.C. 173, 179 (2013); sec. 301.6159-1(a), (c)(1)(i), Proced. &Admin. Regs. Consequently, in reviewing this determination, the Court does notsubstitute its judgment for that of Appeals and decide whether in its opinionpetitioner's installment agreement should have been accepted. See Woodral v.Commissioner, 112 T.C. 19">112 T.C. 19, 23 (1999); Keller v. Commissioner, T.C. Memo.5In Lindsay Manor I, this Court found that sec. 301.6343-1(b)(4)(i), Proced. & Admin. Regs., is valid; accordingly, the economic hardship exception applies only to individuals. To the extent that petitioner's other arguments attempt to rehash this issue, they are summarily disregarded. The Court will, however, address petitioner's economic position with respect to SO Alcorte's sec. 6330(c)(3)(C) balancing analysis.- 10 -[10] 2006-166,aff'd in part, 568 F.3d 710 (9th Cir. 2009). Instead, the Courtreviews this determination for abuse of discretion.Petitioner argues that it was an abuse of discretion for SO Alcorte to rejectits proposed installment agreement. The record, however, demonstrates that SOAlcorte's rejection of petitioner's installment agreement was proper for either ofher reasons: (1) the value of petitioner's assets exceeded the underlying liabilityand (2) petitioner was not in compliance with its Federal employment tax depositobligations.61. Petitioner's AssetsSO Alcorte rejected petitioner's proposed installment agreement afterdetermining that it could fully or partially satisfy its tax liability--$63,683.30--byliquidating or borrowing against its assets--$123,212.42 in accounts receivablealone. SeeInternal Revenue Manual (IRM) pt. 5.14.1.4(5) and (6) (June 1, 2010)("Taxpayers do not qualify for installment agreements if balance due accounts canbe fully or partially satisfied by liquidating assets[.]"); see also Boulware v.Commissioner, T.C. Memo. 2014-80 (finding that settlement officer's reliance on6The Court finds disingenuous petitioner's argument that SO Alcorte's case activity report notes constituted a predetermination. The notes indicate her preparation for petitioner's CDP hearing and reflect a thorough review of the late-submitted Form 433-B and its attachments. This is not an abuse of discretion.- 11 -[11] this IRM provision was not an abuse of discretion), aff'd, 816 F.3d 133">816 F.3d 133(D.C. Cir. 2016). And other than its argument for economic hardship relief,petitioner does not suggest that any exception to the general rule applies. Therecord does not show any abuse of discretion by SO Alcorte in rejecting this offer.2. Compliance With Federal Tax ObligationsIn rejecting petitioner's proposed installment agreement, SO Alcorte alsonoted that petitioner was not in compliance with its current Federal employmenttax deposit obligations. Established IRS policy requires taxpayers to be incompliance with current filing and estimated tax payment requirements to beeligible for collection alternatives. See Reed v. Commissioner, 141 T.C. 248">141 T.C. 248, 256-257 (2013). Generally, current compliance with tax laws is a prerequisite to beingeligible for collection alternatives. See Cox v. Commissioner, 126 T.C. 237">126 T.C. 237, 257(2006), rev'd on other grounds, 514 F.3d 1119 (10th Cir. 2008). And despitepetitioner's contention, SO Alcorte was well within her discretion to requirecompliance with current tax obligations. See Giamelli v. Commissioner, 129 T.C.107, 111-112 (2007); cf. Christopher Cross, Inc. v. United States, 461 F.3d 610">461 F.3d 610,613 (5th Cir. 2006) (finding no abuse of discretion when settlement officerrejected collection alternative because taxpayer was not in compliance with its taxpayment obligations); Reed v. Commissioner, 141 T.C. at 257 (same).- 12 -[12] Petitioner argues that SO Alcorte abused her discretion because--eventhough it was not in compliance--she failed to consider that its inability to remaincurrent with its Federal tax deposits was a result of its nonreceipt of Medicare andMedicaid funding from the Federal and State Governments. For support,petitioner cites Alessio Azzari, Inc. v. Commissioner, 136 T.C. 178">136 T.C. 178 (2011).In Alessio Azzari, Inc., a lender stopped lending money to the taxpayer afterthe Commissioner's settlement officer erroneously determined that theCommissioner did not need to subordinate his lien on the taxpayer's accounts tothe lender's lien on the same accounts. Id. at 181-183. As a result, the taxpayerwas unable to stay current with its employment tax deposits after being incompliance for six consecutive quarters. Id. at 183. The Commissioner denied thetaxpayer's installment agreement request because the taxpayer was no longer incompliance. Id. at 183-184. The Court held that it was an abuse of discretion forthe Commissioner to deny the taxpayer's request for an installment agreement onthe basis of the taxpayer's failure to stay current on its tax deposits because thesettlement officer's erroneous interpretation of law led to the lender's decision tostop lending money to the taxpayer, which led to the taxpayer's not being incompliance. Id. at 194.- 13 -[13] Unlike the taxpayer in Alessio Azzari, Inc., petitioner was indisputably notin compliance when it requested an installment agreement. And because section301.6343-1(b)(4)(i), Proced. & Admin. Regs., is valid, SO Alcorte's interpretationwas not erroneous. See Lindsay Manor I. Accordingly, SO Alcorte did not abuseher discretion in rejecting petitioner's installment agreement request on thegrounds that petitioner was not in compliance.B. SO Alcorte's Balancing AnalysisPetitioner next argues that SO Alcorte either did not conduct the requiredstatutory balancing test or did not explain her reason for concluding that itsrequirements were met. Petitioner suggests that it "proposed a viable collectionalternative that it could afford to pay on a monthly basis while staying current onits federal tax deposit payments that was less intrusive than enforced levy action".This Court also found in Lindsay Manor I that the section 6330(c)(3)(C)balancing test properly takes into account a taxpayer's specific economic realitiesand the consequences of a proposed collection action. On the basis of the Court'sthorough analysis of the record in this case, the Court concludes that there is nomaterial issue of fact regarding whether SO Alcorte properly balanced "the needfor the efficient collection of taxes" with the legitimate concern of petitioner that"any collection action be no more intrusive than necessary." Seesec. 6330(c)(3).- 14 -[14] At the time petitioner requested this installment agreement, its monthlyexpenses substantially exceeded its monthly income. Although there was anongoing dialogue between petitioner's counsel and SO Alcorte, petitioner gave noindication of how it would make the proposed installment payments with negativemonthly revenue of $20,873.27. SO Alcorte noted petitioner's accountsreceivable, which were together sufficient to pay the outstanding liabilities in full.These accounts included delayed payments from Medicare and Medicaid, butpetitioner did not suggest that they would be unpaid.Although petitioner complains of the possibility of being forced to close itsdoors to its patients and employees, this Court finds that SO Alcorte gave dueweight to petitioner's specific circumstances. The Government's interest inefficiently collecting the amounts petitioner owed simply tipped the scale the otherway.Furthermore, it is well established that rejecting a collection alternativebecause of noncompliance with estimated tax payment requirements does notviolate the proper balancing requirement. See, e.g., Orum v. Commissioner, 123T.C. 1 (2004), aff'd, 412 F.3d 819">412 F.3d 819 (7th Cir. 2005); Friedman v. Commissioner,T.C. Memo. 2015-196; Schwartz v. Commissioner, T.C. Memo. 2007-155. Inpreparation for the CDP hearing SO Alcorte discovered that petitioner was not in- 15 -[15] compliance with its current employment tax deposit obligations for thetaxable period ending June 30, 2014, and that it did not provide proof of makingits required September 30, 2014, deposit. Upon consideration of petitioner'sfailing financial position and its failure to remain in compliance with itsemployment tax requirements, SO Alcorte determined that there was no alternativeto sustaining the notice of intent to levy; she explained the reasoning behind herdecision in the notice of determination. Accordingly, the undisputed material factsestablish that SO Alcorte did not abuse her discretion in conducting the section6330(c)(3)(C) balancing test.C. SO Alcorte's ImpartialityNext, petitioner argues that SO Alcorte's review of the documents itprovided before the CDP hearing violates its section 6330(b)(3) right to a CDPhearing by an Appeals officer who had no prior involvement with respect to theunpaid tax.Section 6330(b)(3) requires a CDP hearing to be "conducted by an officer oremployee who has had no prior involvement with respect to the unpaid tax * before the first hearing". Prior involvement exists only when (1) the taxpayer, thetax, and the tax period at issue in the CDP hearing also were at issue in a priornon-CDP matter and (2) the Appeals officer or employee actually participated- 16 -[16] in the prior matter. Sec. 301.6330-1(d)(2), Q&A-D4, Proced. & Admin.Regs.Petitioner does not argue that SO Alcorte had prior involvement in anearlier, non-CDP matter; rather, it argues that, because she had reviewedpetitioner's documents before the CDP hearing, SO Alcorte was not impartial.Petitioner is incorrect. The regulations clearly state that prior involvement meansthat an Appeals officer actually participated in an earlier, non-CDP matter. Id.Because petitioner does not assert that SO Alcorte participated in a prior non-CDPmatter, its argument must fail.SO Alcorte verified that she had not had any prior involvement with respectto the specific tax periods at issue. Because SO Alcorte did not participate in aprior non-CDP matter concerning the same tax, taxpayer, and tax period at issue,she was an eligible Appeals officer to conduct the CDP hearing. Accordingly, theundisputed material facts establish that SO Alcorte did not abuse her discretion byreviewing the information petitioner had provided before its CDP hearing.III. ConclusionFinally, petitioner argues that the Court should remand this case foradditional consideration. The Court is not convinced that a remand is necessary orwould be productive. See Lunsford v. Commissioner, 117 T.C. 183">117 T.C. 183, 189 (2001);- 17 -[17]Kakeh v. Commissioner, T.C. Memo. 2015-103, at 13. The purpose of aremand is not to afford a "do over" for a taxpayer whose missteps during the CDPprocess resulted in its collection alternative's being rejected. See Kakeh v.Commissioner, at *13. It appears to the Court that petitioner is seeking a "doover" here.Finding no abuse of discretion in any respect, the Court will grantrespondent's motion for summary judgment and deny petitioner's. The Court hasconsidered all of the arguments made by the parties, and to the extent they are notaddressed herein, they are considered unnecessary, moot, irrelevant, or withoutmerit.To reflect the foregoing,An appropriate order and decisionwill be entered.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622776/	Robert O. Fowler, Jr., and Paula E. Fowler, Petitioners v. Commissioner of Internal Revenue, RespondentFowler v. CommissionerDocket No. 6760-90United States Tax Court98 T.C. 503; 1992 U.S. Tax Ct. LEXIS 37; 98 T.C. No. 34; 15 Employee Benefits Cas. (BNA) 1659; April 22, 1992, Filed Decision will be entered under Rule 155. Petitioner husband received lump-sum distributions from his employer's profit-sharing and incentive savings plans in 1986 on account of his separation from service. Both plans were qualified under sec. 401(a), I.R.C. P elected to roll over the total taxable amount of the incentive savings distribution pursuant to sec. 402(a)(5), I.R.C., and elected 10-year averaging under sec. 402(e)(1), I.R.C., with respect to the profit-sharing distribution. Held, 10-year averaging as provided by sec. 402(e)(1), I.R.C., is available only to taxpayers electing such treatment for all lump-sum distributions received in a single taxable year. Held, further, P is not entitled to utilize 10-year averaging with respect to his profit-sharing distribution. William H. Schmidt and Gary P. Brady, for petitioners.Louise R. Forbes, for respondent. Tannenwald, Judge. TANNENWALD504 OPINIONTannenwald, Judge:Respondent determined a deficiency in petitioners' Federal income tax for 1986 of $ 110,364 and an addition to tax under section 6661(a) 1 of $ 27,591. Respondent having38 conceded the addition to tax, the issue for decision is whether petitioners may elect 10-year averaging of a lump-sum distribution received in 1986 without making such election for another lump-sum distribution received and rolled over in that year.This case was submitted fully stipulated pursuant to Rule 122(a). All the facts are stipulated and are so found. The stipulation of facts and attached exhibits are incorporated by reference.Petitioners, husband and wife, were residents of Lexington, Massachusetts, at the time their petition was filed. They filed a joint Federal income tax return on the cash basis for 1986 with the Internal Revenue Service Center, Andover, Massachusetts. Petitioners filed an amended return for 1986 with the Internal Revenue Service Center, Andover, Massachusetts, on January 24, 1989.On November 30, 1985, Robert O. Fowler, Jr. 39 (Fowler), terminated his employment with Leslie E. Robertson Associates (Robertson Associates). At that time, Fowler had participated in Robertson Associates' profit-sharing plan since January 1, 1969, and in its incentive savings plan since January 1, 1981. Both plans were qualified under section 401(a).505 During 1986, Fowler received a total distribution from the profit-sharing plan of $ 175,782.81 and a total distribution from the incentive savings plan of $ 112,190.19. 2 Pursuant to section 402(a)(5), see infra note 3, Fowler rolled over $ 77,906.38 of the incentive savings plan distribution into an individual retirement account with Chubb Securities Corp. representing the total taxable amount received from that account. No portion of the distribution from the profit-sharing plan was rolled over.40 Petitioners did not report either of the distributions on their 1986 Federal income tax return.On their 1986 amended return, petitioners reported the two distributions and the rollover of $ 77,906.38. They elected the 10-year averaging method provided by section 401(e) for reporting the profit-sharing distribution.Respondent determined that the $ 125,318.85 of ordinary income Fowler received from the profit-sharing plan did not qualify for 10-year averaging under section 402(e)(1) and was therefore taxable in full to petitioners in 1986.Under section 401(a), amounts distributed from a qualified pension or profit-sharing plan are generally taxable to the recipient under section 72 in the year of distribution. However, section 402(e)(1) provides a preferential 10-year averaging 3 method for purposes of computing the tax on lump-sum distributions. The parties agree that amounts received by petitioner in 1986 constitute lump-sum distributions under section 402(e)(4)(A). If a taxpayer elects 10-year averaging, the ordinary income portion of the lump-sum distributions received in the taxable year are treated as though they were the only income and were received evenly over a 10-year41 506 period. Section 402(e)(2) provides a look-back 6-year calculation of lump-sum distributions in order to determine the rate of tax to be applied to each year of the 10-year spread. The 10-year method enables a taxpayer to avoid the higher marginal tax rate that often results from the bunching of income in the year of distribution.Another option available to taxpayers receiving lump-sum distributions is provided by section 402(a)(5). Under that section, 4 if a taxpayer transfers all or part of a lump-sum distribution "paid to him" to an "eligible retirement plan", such amount is excluded from the taxpayer's gross income for the taxable year in which paid.42 Petitioners seek to obtain the benefits of section 402(e)(1) with respect to the amount received from the profit-sharing plan, and, at the same time, take advantage of the rollover permitted by section 402(a)(5) with respect to amounts received from the incentive savings plan, both distributions having been received in 1986. Respondent contends that 10-year averaging is available only to taxpayers electing to report all lump-sum distributions received in the taxable year and that because petitioner rolled over the incentive savings distribution, 10-year averaging is not available with respect to the profit-sharing distribution. 5The arguments of the parties focus on the impact of two statutory provisions. The first provision, section 402(e)(2), provides in 43 pertinent part:(2) Multiple distributions and distributions of annuity contracts. -- In the case of any recipient of a lump sum distribution for the taxable year with respect to whom during the 6-taxable-year period ending on the last day of the taxable year there has been one or more other lump 507 sum distributions after December 31, 1973, or if the distribution (or any part thereof) is an annuity contract, in computing the tax imposed by paragraph (1)(A), the total taxable amounts of all such distributions during such 6-taxable-year period shall be aggregated * * * [Emphasis added.]The second provision, section 402(e)(4)(B), provides in pertinent part:(B) Election of lump sum treatment. -- For purposes of this section and section 403, no amount which is not an annuity contract may be treated as a lump sum distribution under subparagraph (A) unless the taxpayer elects for the taxable year to have all such amounts received during such year so treated at the time and in the manner provided under the regulations prescribed by the Secretary. 6 * * * [Emphasis added.]44 Petitioners maintain that a proper interpretation of the phrase "all such amounts" in section 402(e)(4)(B) should be construed to mean "all such taxable amounts" of the distributions consistent with the phrase "total taxable amounts of all such distributions" in section 402(e)(2). They assert that a literal interpretation of the statutory language is contrary to the legislative history and undermines the objectives which Congress sought to achieve in providing for the 10-year averaging method. Respondent argues that paragraphs (2) and (4)(b) of section 402(e) deal with differing aspects of the tax treatment of lump-sum distributions and that we should adhere to the plain meaning of section 402(e)(4)(B). For the reasons hereinafter set forth, we agree with respondent.We again look to the most recent Supreme Court guidelines for statutory construction. See Guilzon v. Commissioner,97 T.C. 237">97 T.C. 237, 239 (1991), on appeal (5th Cir., Mar. 2, 1992). In United States v. Ron Pair Enterprises, Inc.,489 U.S. 235">489 U.S. 235, 241-242 (1989), the Court stated:The task of resolving the dispute over the meaning of [the statute] begins where 45 all such inquiries must begin: with the language of the statute itself. * * ** * The plain meaning of legislation should be conclusive, except in the "rare cases [in which] the literal application of a statute will produce a result 508 demonstrably at odds with the intentions of its drafters." * * * [Citations omitted.]See also Demarest v. Manspeaker,498 U.S. 184">498 U.S. 184, 111 S. Ct. 599">111 S. Ct. 599, 604 (1991).Petitioners argue that section 402(e)(4)(B), interpreted in light of its legislative history, applies only to taxable lump-sum distributions received in a single year. That being the case, petitioners contend that only the profit-sharing distribution is subject to section 402(e)(4)(B) because the incentive savings distribution, rolled over into an eligible retirement account under section 402(a)(5), is nontaxable. In support of their argument, petitioners assert that section 402(e)(4)(B) is merely an extension of the interyear aggregation rule of section 402(e)(2), which applies to "the total taxable amounts of all such distributions". We disagree.Petitioners' conclusion that section 402(e)(4)(B) is merely an "extension" 46 of section 402(e)(2) is mistaken. Section 402(e)(2) was designed to prevent tax avoidance possibilities. See H. Rept. 93-807 (1974), 1974-3 C.B. (Supp.) 236, 387. It embodies a rule covering both interyear and intrayear distributions, including the taxable year. Such being the case, there was no need for an additional intrayear provision, i.e., section 402(e)(4)(B), to prevent tax avoidance. While the underlying purpose of section 402(e)(4)(B) is not similarly articulated and the legislative history in respect of that section is sparse, there is a revealing sentence in the conference report:The House bill requires that a taxpayer who wishes to use the special averaging and capital gains treatment described above for one lump-sum distribution must use that treatment for the aggregate of the lump-sum distributions he receives in the same taxable year. The Senate amendment and existing law contain no comparable provision. The conference substitute accepts the House rule. [H. Conf. Rept. 93-1280 (1974), 3 C.B. 415">1974-3 C.B. 415, 510; emphasis added.] Moreover, in H. Rept. 93-807, supra, the House Ways and Means Committee 47 stated:A recipient of a distribution could not use this special ten-year-averaging method unless he combines all amounts received in any taxable year that might be eligible for this special averaging system into a single lump-sum distribution. * * * [1974-3 C.B. (Supp.) at 388; emphasis added.]Such statements more than counteract petitioners' reliance on the fact that both paragraph (2) and paragraph (4)(B) of 509 section 402(e) are discussed in close proximity in the legislative history and their assertion that this implies that both paragraphs serve the same tax avoidance purpose. Had Congress intended that section 402(e)(4)(B) apply only to taxable distributions, it could have easily inserted the word "taxable" in the pertinent language of that section.Moreover, petitioners misconstrue the meaning of the phrase "total taxable amounts of all such distributions" contained in section 402(e)(2). That phrase is not the same as "total amounts of gross income", which is the interpretation petitioners ask us to adopt. This lack of sameness is clearly reflected in the manner in which Congress constructed the definition of "total taxable amount" 48 in section 402(e)(4)(D). Thus, clause (i) of that section provides that the amounts of contributions by the employee which are usually to be subtracted from the amount of the distribution to determine the amount includable in gross income should be reduced, before such subtraction, by amounts previously "distributed to him which were not includible in gross income". Thus, the "total taxable amount" is different from the "gross income" amount.A further reflection of this lack of sameness is contained in section 402(e)(2) itself which provides that the taxable amount of a distribution, solely for the purpose of aggregation under that section to determine the applicable tax bracket, includes the "actuarial value" of an annuity contract, a value which is not usually included in gross income. See H. Rept. 93-807, supra, 1974-3 C.B. (Supp.) at 388; S. Rept. 93-383 (1974), 1974-3 C.B. (Supp.) 80, 220; H. Conf. Rept. 93-1280, supra,1974-3 C.B. at 510.Finally, we read the provision of section 402(a)(5), see supra note 3, as providing for a condition subsequent to payment, and therefore receipt, 49 of the rolled-over distribution. Absent an election to roll over (which can occur any time within 60 days of receipt) the distribution, if otherwise qualified, would be treated as a lump-sum distribution and required to be included in the 10-year averaging computation.Petitioners argue that a literal reading of section 402(e)(4)(B), so as to deprive a taxpayer who elects to roll over a lump-sum distribution under section 402(a)(5), imposes a substantial hidden cost on the exercise of a statutory right and that such a hidden cost was not intended by Congress. We are not 510 convinced that such a result was not intended. An election to use the 10-year averaging method requires a conscious choice on the part of the taxpayer, and there are a variety of considerations which should be taken into account in deciding whether the election should be made. See Satterfield, "Federal Income Taxation of a Lump Sum Distribution from a Qualified Employee Benefit Plan", 35 Baylor L. Rev. 413">35 Baylor L. Rev. 413, 460-461 (1983). The so-called "hidden cost" is an element of that choice which, when made, may not necessarily involve such a cost.Petitioners also contend that section50 402(e)(4)(B) does not address any perceived tax abuse. Section 402(e)(4)(B), as previously stated, was not designed to prevent tax avoidance but was included in section 402 to impose a condition of election (election must be made with respect to all lump-sum distributions received in a single taxable year) on taxpayers wishing to report lump-sum distributions under the 10-year averaging method provided in section 402(e)(1). Petitioners have not convinced us otherwise.Finally, petitioners argue that a literal reading of section 402(e)(4)(B) leads to absurd results. In support of their argument, petitioners provide several examples of the disparate treatment among taxpayers that emanates from a literal application of section 402(e)(4)(B). Granted that a literal reading may, under certain circumstances, produce results that were not anticipated by Congress at the time the statute was originally drafted, but this consequence is not sufficient, in and of itself, to warrant a departure from the plain meaning of the statute. Should a literal interpretation of section 402(e)(4)(B) result in a gap in the statute imposing a claimed hardship or inequity on taxpayers, it is up to Congress, 51 and not the courts, to deal with the inadequacies. Hanover Bank v. Commissioner,369 U.S. 672">369 U.S. 672, 687 (1962); Chronicle Publishing Co. v. Commissioner,97 T.C. 445">97 T.C. 445, 452 (1991); Guilzon v. Commissioner,97 T.C. 237">97 T.C. 237, 240 (1991) (quoting Badaracco v. Commissioner,464 U.S. 386">464 U.S. 386, 398 (1984)); Metzger Trust v. Commissioner,76 T.C. 42">76 T.C. 42, 60 (1981), affd. 693 F.2d 459">693 F.2d 459 (5th Cir. 1982). In applying the principles of statutory construction articulated in this opinion, we have also been cognizant of Giardino v. Commissioner,776 F.2d 406">776 F.2d 406 (2d Cir. 1985), which dealt with a question involving the interpretation of section 402(e)(4) for the purposes of the statutory exclusion of lump-sum distributions 511 from the gross estate under section 2039(c). In that case, the positions of the parties were reversed with the taxpayer arguing for a literal reading of the statute and the Government urging a more flexible interpretation. The Court of Appeals rejected the Government's position 52 and concluded that the explicit statutory language should control, despite the Government's contention that such a result would produce an "absurd" result. See Giardino v. Commissioner, supra at 409 n.9; see also Estate of Rosenberg v. Commissioner,86 T.C. 980">86 T.C. 980, 990 (1986), affd. per curiam 812 F.2d 1401">812 F.2d 1401 (4th Cir. 1987).We conclude that the failure of petitioners to include the rolled-over distribution from the incentive savings plan invalidates their election to use the 10-year averaging method as to the profit-sharing distribution.In order to take into account respondent's concession,Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code in effect for 1986, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The parties have stipulated as follows:8. During 1986, the petitioner, due to his termination of employment * * * received a total distribution from his employer's Incentive Savings Plan in the amount $ 112,190.19, which represented $ 34,283.81 in employee contributions, $ 69,906.38 in ordinary income, and an $ 8,000.00 IRA contribution.* * 11. During 1986, the petitioner, due to his termination of employment * * received a total distribution from his employer's Profit Sharing Plan in the amount of $ 175,782.81, which represented $ 125,318.85 in ordinary income and $ 50,463.96 in capital gain.↩3. The Tax Reform Act of 1986, Pub. L. 99-514, sec. 1122 (a)(2), 100 Stat. 2085, 2466, replaced the 10-year period with a 5-year period.↩4. Sec. 402(a)(5) provides in pertinent part as follows:(5) Rollover amounts. --(A) General rule. -- If --(i) any portion of the balance to the credit of an employee in a qualified trust is paid to him,(ii) the employee transfers any portion of the property he receives in such distribution to an eligible retirement plan, and(iii) in the case of a distribution of property other than money, the amount so transferred consists of the property distributed,↩then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid.5. In Priv. Ltr. Rul. 7928017 (Apr. 10, 1979), respondent took the same position. We note that a private letter ruling has no precedential value. Sec. 6110(j)(3); Estate of Jalkut v. Commissioner,96 T.C. 675">96 T.C. 675, 684↩ (1991).6. This section was substantially revised by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1122 (a)(1), 100 Stat 2085, 2466.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622778/	APPEALS OF WILLISON-DENNISON CO. AND HOME REALTY CO.Willison-Dennison Co. v. CommissionerDocket Nos. 4317, 4318.United States Board of Tax Appeals2 B.T.A. 1114; 1925 BTA LEXIS 2153; October 30, 1925, Decided Submitted September 17, 1925. 2153 Howard L. Robinson, Esq., for the taxpayers. J. Arthur Adams, Esq., for the Commissioner. 1114 Before GRAUPNER and TRAMMELL. The taxpayers appeal from determinations of deficiencies in income and profits taxes for the year 1919 as follows: Willison-Dennison Co$2,874.34Home Realty Co924.18Total deficiencies3,798.52The Commissioner computed tax for 1919 under section 302 of the Revenue Act of 1918 and the taxpayers contend that the tax should be computed under section 303 of that Act. By stipulation of counsel, this is the only issue involved. FINDINGS OF FACT. The taxpayers are affiliated West Virginia corporations, each having its principal place of business at Clarksburg. The capital stock of the taxpayers was owned in 1919 as follows: Willison-Dennison Co.Home Realty Co.SharesSharesR. B. Willison4824A. F. Dennison4923T. B. Willison11F. C. Deem11W. P. Willison1J. M. Dennison1Total shares10050The Willison-Dennison Co. is engaged in the business of selling real estate on a brokerage basis, renting property for others and operating an insurance2154 agency. The Home Realty Co. was organized for the purpose of securing for the Willison-Dennison Co. a return of expenses incurred at the 1115 sale of properties for which a clear title could not be given except by first passing title from the owner to another party, and to hold title to properties in its own name. The consolidated net income of the taxpayers for 1919 was $16,209.01, of which $5,658.99 was derived from the employment of capital and $10,550.02 was personal-service income. The consolidated invested capital was $7,338.90, of which $6,764.37 is ascribed to that part of the business employing capital and $574.53 to the personal-service part. The excess-profits tax computed under section 302 of the Revenue Act of 1918 amounts to $2,641.80, which is less than 20 per cent of the net income of the taxpayers, and section 303 of the Act is, accordingly, not applicable. DECISION. The determination of the Commissioner is approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622780/	REINALDO MOURIZ AND MARIA E. MOURIZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMouriz v. CommissionerDocket No. 32259-83.United States Tax CourtT.C. Memo 1986-43; 1986 Tax Ct. Memo LEXIS 569; 51 T.C.M. (CCH) 392; T.C.M. (RIA) 86043; January 29, 1986. 569 Over a period of 6 months in 1979 and 1980, petitioner-husband engaged in six currency transactions in which he received an aggregate of $439,988 in small-denomination bills. None of this money was reported on petitioners' joint tax returns. Also, other income was omitted for 1980. Held: (1) Respondent has proven fraud by clear and convincing evidence as to petitioner-husband for 1979 and 1980, and as to petitioner-wife for 1980. Additions to tax imposed. Sec. 6653(b), I.R.C. 1954. (2) Respondent has failed to carry his fraud burden of proof as to petitioner-wife for 1979. (3) Petitioners have failed to carry their burden of proof as to the deficiencies for 1979 and 1980. Luis Medina, for the petitioners. John F. Hernandez, for the respondent. CHABOTMEMORANDUM FINDINGS OF FACT AND OPINION CHABOT, Judge: Respondent determined deficiencies in Federal individual income taxes and additions to tax under section 6653(b)1570 (fraud) as follows: YearDeficiency 2Addition to Tax--Sec. 6653(b)1979$91,102.70$47,646.851980131,520.2565,760.13 After concessions by both sides, the issues for decision are as follows: (1) Whether each of the petitioners is liable for an addition to tax under section 6653(b) for each of the years in issue; and (2) How much, if any, of the $229,997 and $209,991 that petitioner-husband received from certain banks in 1979 and 1980, respectively, is includible in petitioners' income for these years. FINDINGS OF FACT Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference. When the petition was filed in the instant case, petitioners Reinaldo Mouriz (hereinafter sometimes referred to as "Reinaldo") and Maria E. Mouriz (hereinafter sometimes referred to as "Maria"), husband and wife, resided in Miami, Florida. 1979 Tax ReturnPetitioners filed their 1979 tax return on October 15, 1980. To the tax return there was attached a Form 4868, Application for Automatic Extension of time to File U.S. Individual Income Tax Return. On the Form 4868, dated April 14, 1980, petitioners 571 stated that they expected not to owe any income tax for 1979. The purpose of the Form 4868 was to secure for petitioners a 2-month extension of time, until June 15, 1980, to file the 1979 tax return. To the tax return there also was attached a Form 2688, Application for Extension of Time to File. On the Form 2688, dated June 10, 1980, petitioners asked for an extension of time until August 15, 1980, to file the 1979 tax return, and stated that "Additional time is necessary as the accountant has not completed analyzing all distributions the taxpayer received from domestic and foreign entities." On their 1979 tax return, petitioners reported income in the amounts and from the sources indicated in table 1. Table 1 AmountSource$ 9,710Wages--Maria--Roche Clinical Labs, Inc.10,200Wages--Reinaldo--Diaz Marble Co., Inc. 3187Interest1,878Rent, royalty income5,200"Miscellaneous" 4572 $27,175On their 1979 tax return, petitioners reported a chapter 1 income tax liability of $3,770 (determined by use of income averaging), a chapter 2 self-employment tax liability of $421, a total liability of $4,191, a withholding credit of $2,325, and a balance due of $1,866. Petitioners' 1979 tax return was prepared by Wilfred Braceras (hereinafter sometimes referred to as "Braceras"), who enquired into both petitioners' sources and amounts of income and included on the tax return all such information provided by petitioners. Any information included or excluded from the tax return was so treated by Braceras with petitioners' express knowledge and consent. 1980 Tax ReturnPetitioners filed their 1980 tax return on October 15, 1981. To the tax return there was attached a Form 4868. On the Form 4868, dated April 10, 1981, petitioners stated that they expected not to owe any income tax for 1980. The purpose of the Form 4868 was to secure for petitioners a 2-month extension of time, until June 15, 1981, to file the 1980 tax return. To the tax return there also were attached two Forms 2688. On the first Form 2688, dated June 15, 1981, petitioners 573 asked for an extension of time until August 15, 1981, to file the 1980 tax return and stated that "Additional information is being forwarded to the return preparer so that a proper and complete return may be filed." On the second Form 2688, dated August 13, 1981, petitioners asked for an extension of time until October 15, 1981, to file their 1980 tax return and stated that "Additional information is still being accumulated and researched by the taxpayer to be forwarded to the return preparer to enable the return preparer to file a proper and complete return." On their 1980 tax return, petitioners reported income in the amounts and from the sources indicated in table 2. Table 2 AmountSource$16,218 Wages--Reinaldo144 Interest(22)Rent, royalty income5,200 "Miscellaneous" (see n.4, supra)$21,540On their 1980 tax return, petitioners reported a chapter 1 income tax liability of $2,583, a chapter 2 self-employment tax liability of $421, a total liability of $3,004, a withholding credit of $1,882, and a balance due of $1,122. 5574 Petitioners' 1980 tax return was prepared by Edward Guttenmacher (hereinafter sometimes referred to as "Guttenmacher"), who enquired into both petitioners' sources and amounts of income and included on the tax return all such information provided by petitioners. Any information included on or excluded from the tax return was so treated by Guttenmacher with petitioners' express knowledge and consent. Currency TransactionsReinaldo engaged in the currency transactions described in table 3. Table 3 Date of check/Amount oftransactionDrawer of checkcheckSep. 12/13, 1979Banco Immobilario, S.A.$100,000Sep. 27/27, 1979Banco Immobilario, S.A.100,000Dec. 6/18, 1979The Bank of Miami29,9971979 Total$229,997Jan. 4/4, 1980The Bank of Miami34,997Feb. 28/29, 1980The Bank of Miami99,997Mar. 6/10, 1980The Bank of Miami74,9971980 Total$209,991In each instance, Reinaldo was notified by someone at a branch of the Bank of Miami that a check made out to him was at the bank; Reinaldo drove alone to the bank and parked in a nearby parking lot; he walked from there to the bank; he identified himself; he endorsed the check; he received the money in small-denomination 575 bills; 6 he put the money in a briefcase; he went back to his car; and he placed the briefcase in the trunk of his car. Other IncomeIn 1980, Maria was employed by Roche Clinical Labs, Inc.; she was paid $11,018 for her services. From this amount, $1,231.70 was withheld as Federal income tax and $665.12 was withheld as F.I.C.A. (Social Security) tax. Petitioners' 1980 tax return does not include these amounts. In 1980, petitioners received $201 in interest income from Dade Federal Savings and Loan Association, and $143 in interest income from First National Bank. Petitioners' 1980 tax return includes only $144 in interest income. * * For each of the years 1979 and 1980, petitioners had an underpayment of income taxes required to be shown on their tax return; some part of each such underpayment was due to fraud on the part of Reinaldo; some part of the 1980 underpayment was due to fraud on the part of Maria. OPINION Respondent contends that the entire amounts 576 involved in the currency transactions (see table 3, supra) constitute income to petitioners for 1979 ($229,997) and 1980 ($209,991), and that the omission of these amounts from petitioners' tax returns for these years (and the omission from petitioners' 1980 tax return of $11,018 in Maria's wages and $200 in interest) "was engaged in willfully and fraudulently with intent to evade or defeat tax." Petitioners contend that none of the amounts involved in the currency transactions belonged to petitioners but that Reinaldo was acting on behalf of South Caicos Pride Fisheries, and that there was no deceit by petitioners. We agree with respondent, except that we agree with petitioners as to fraud on the part of Maria for 1979. I. FraudWhen respondent seeks to impose the addition to tax under section 6653(b), 7577 he bears the burden of proving by clear and convincing evidence that petitioner has an underpayment, and that some part of this underpayment is due to fraud. Section 7454(a); 8 Rule 142(b); 9 e.g., Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 220 (1971); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105 (1969). The issue of fraud poses a factual question which is to be decided on an examination of all the evidence in the record. Plunkett v. Commissioner,465 F.2d 299">465 F.2d 299, 303 (CA7 1972), affg. a Memorandum Opinion of this Court; 10Mensik v. Commissioner,328 F.2d 147">328 F.2d 147 (CA7 1964), 578 affg. 37 T.C. 703">37 T.C. 703 (1962); Stone v. Commissioner,56 T.C. at 224; Stratton v. Commissioner,54 T.C. 255">54 T.C. 255, 284 (1970). Fraud is an actual intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing. E.g., Webb v. Commissioner,394 F.2d 366">394 F.2d 366, 377 (CA5 1968), affg. a Memorandum Opinion of this Court; 11Powell v. Granquist,252 F.2d 56">252 F.2d 56, 60 (CA9 1958); Estate of Pittard v. Commissioner,69 T.C. 391">69 T.C. 391, 400 (1977); McGee v. Commissioner,61 T.C. 249">61 T.C. 249, 256-257 (1973), affd. 519 F.2d 1121">519 F.2d 1121 (CA5 1975). This intent may be inferred from circumstantial evidence (Powell v. Granguist, 252 at 61; Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 200 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (CA8 1978); Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92-93 (1970)), including the implausibility of the taxpayer's explanations. Boyett v. Commissioner,204 F.2d 205">204 F.2d 205, 208 (CA5 1953), affg. a Memorandum Opinion of this Court. 12Respondent need not prove the precise amount of underpayment resulting from fraud, but only that there is some underpayment and that some part of it is attributable to fraud. E.g., 579 Lee v. United States,466 F.2d 11">466 F.2d 11, 16-17 (CA5 1972); Plunkett v. Commissioner,465 F.2d at 303; Kreps v. Commissioner,351 F.2d 1">351 F.2d 1, 6 (CA2 1965), affg. 42 T.C. 660">42 T.C. 660 (1964). In carrying his burden, respondent may not rely on petitioners' failure to meet their burden of proving error in respondent's determinations as to the deficiencies (e.g., Habersham-Bey v. Commissioner,78 T.C. 304">78 T.C. 304, 312 (1982), and cases there cited). Petitioners concede that Reinaldo received the $439,988 in the Bank of Miami currency transactions. They claim, essentially, that the money was not Reinaldo's. (See discussions of conduit and other theories in, e.g., Schuster v. Commissioner,84 T.C. 764">84 T.C. 764 (1985), on appeal (CA7, July 23, 1985); Diamond v. Commissioner,56 T.C. 530">56 T.C. 530 (1971), affd. 492 F.2d 286">492 F.2d 286 (CA7 1974).) In his testimony, Reinaldo described the situation essentially as follows: At some time around 1975, Mavis Harvey Shelley (hereinafter sometimes referred to as "Shelley") came to Diaz Marble Company, Inc.'s place of business (see n.3, supra), to look for a piece of marble.In the next few years, Shelley returned to Diaz Marble Company, Inc., several times to look for marble items. On one occasion, Reinaldo580 sold a small marble table to her. A friendship developed between the two of them. In late 1978 or early 1979, Shelley told Reinaldo that she wanted to build a plant on South Caicos Island (an island in the Caribbean nation of Turks and Caicos Islands) for South Caicos Pride Fisheries (hereinafter sometimes referred to as "Fisheries"), a company which Shelley owned. The plant was to enable Fisheries to process lobsters, fish, and conch. She asked Reinaldo to buy materials, building equipment, and machinery in the Miami area and ship it to South Caicos, so that she could use it to build the plant. Reinaldo visited South Caicos Island for the first time in 1979. He saw the site of Fisheries' plant, but no construction work had yet begun. Shelley and others who were involved in the construction told Reinaldo what building and other materials (e.g., blocks, cement, plywood, nails) were needed. When Reinaldo returned to Miami, he went price-shopping, and then reported his results to Shelley. Shelley told Reinaldo to order specific items, but not to pay for them until she sent him money. Shelley transferred money to the Bank of Miami for Reinaldo. Reinaldo received the money in small-denomination 581 bills. Reinaldo paid cash for everything that he bought for Fisheries. The sellers delivered the items to shipping companies. Reinaldo paid cash for the services of the shipping companies. All of the money Reinaldo spent for Fisheries (purchases and shipping) was in cash and all of it was from the small-denomination bills that Reinaldo received at the Bank of Miami (see table 3, supra). Reinaldo never paid for any Fisheries item out of his own funds. Reinaldo never advanced funds to pay for any Fisheries' item in anticipation of later reimbursement. Reinaldo never received money for any Fisheries item other than the money received in the course of the six currency transactions described in the Findings of Fact, supra.Shelley never compensated Reinaldo for his services, although she had promised to do so. The only money that he received was the $439,988 in the Bank of Miami currency transactions, plus reimbursement of his expenses, such as his expenses on visits to South Caicos in connection with his purchasing and shipping activities. All of the $439,988 was spent by Reinaldo in the foregoing activities on behalf of Fisheries and under Shelley's authorizations. Shelley largely 582 corroborated Reinaldo's testimony, although there were a number of discrepancies. We do not believe Reinaldo's story, even where it was corroborated by Shelley. Firstly, both Reinaldo and Shelley testified that all of Reinaldo's expenditures for Fisheries (purchases and shipping) were made in cash out of the funds received by him in the Bank of Miami currency transactions. Reinaldo testified that he never used his own funds for those purposes. Both Reinaldo and Shelley testified that every item appearing in certain invoices, customs forms, and shipping bills received into evidence was paid for by Reinaldo in this manner. In their testimony, both Reinaldo and Shelley "tracked" several items through customs forms and shipping bills to show when and how the steps occurred in securing, transporting, and paying for the items. (a) At least seven of the invoices, totalling about $2,800, were paid before the first of the currency transactions. (b) At least five of the customs forms (Shipper's Export Declaration) for items (apparently not reflected in the invoices), totalling about $21,000, were for items exported before the first of the currency transactions. (c) At least nine of the shipping 583 bills, totalling about $12,000, were paid before the first of the currency transactions. Thus, Reinaldo and Shelley would have us believe that Reinaldo paid at least $36,000 in cash before receiving any money from the currency transactions and they would also have us believe that Reinaldo did not pay anything before he received any money from the currency transactions. We must emphasize that this is not merely a conflict between Reinaldo's testimony on the one hand and Shelley's testimony on the other hand. Rather, the conflict appears within the testimony of Reinaldo and also within the testimony of Shelley. The magnitude of the discrepancy--some $36,000 in 21 payments--convinces us that this was not merely a matter of a failure to remember some small item in testimony given 6 years after the event. The $36,000 discrepancy is substantially more than the total adjusted gross income that petitioners acknowledge for either of the years in issue. 13584 Secondly, Reinaldo testified that he was not compensated at all for his extensive activities on behalf of Fisheries. Shelley testified that she compensated Reinaldo in the amount of $800 or $1,000 per month (depending on the extent of Reinaldo's activities during the month) from November 1979 to September or October 1980. Then Shelley testified that all of this was merely to reimburse Reinaldo for his expenses. Then Shelley testified that she paid Reinaldo about $100 or $200 as compensation for his services, 585 in addition to reimbursing him for his expenses.We do not believe that Reinaldo would have continued the extensive work involved in pricing, ordering, paying for, and shipping the various items, not to mention the dangers involved in travelling around Miami with large amounts of small-denomination bills, without being compensated for his labors. Thirdly, Reinaldo testified that he spent the entire $439,988 for Fisheries in about 12 months without keeping any records of what he spent. We observed Reinaldo on the stand. We do not believe that if he had really been engaged in the apparently above-board activities he described he would have been so unconcerned about being able to show that he had faithfully discharged his trust and not kept some of the funds. Fourthly, the project for which the $439,988 allegedly was spent was the construction of Fisheries' plant on South Caicos. Shelley testified that the plant cost only $85,000, including labor. We do not believe that Reinaldo spent $439,988--or any amount approaching that sum--on the purchasing and shipping of items for Fisheries. We are convinced that Reinaldo either kept all or part of the $439,988, or was compensated for his services 586 in connection with the currency transactions. None of these funds are reported on petitioners' tax returns. We are convinced that petitioners' explanation of what happened is untrue. See Boyett v. Commissioner,supra.Petitioners do not suggest another explanation. Petitioners concede 1980 tax return omissions totalling $11,218 and do not suggest any explanation for these omissions. Petitioners do not suggest that the $5,200 "miscellaneous" income item reported on their tax returns (see n.4, supra) is related to the currency transactions or any other omissions from income. Petitioners concede that their tax return preparers enquired of both of them as to petitioners' sources and amounts of income and that petitioners' tax returns correctly show all the information they provided to their tax return preparers. On the basis of the record as a whole, (1) we conclude that respondent has shown that petitioners omitted income from both their 1979 and 1980 tax returns; (2) we conclude that, since there do not appear to be any offsetting deductions or credits, these omissions of income result in an underpayment of tax required to be shown on their tax return for each of the years in issue; 587 14 (3) we conclude, and we have found, that some part of the 1979 underpayment is due to fraud on the part of Reinaldo; and (4) we conclude, and we have found, that some part of the 1980 underpayment is due to fraud on the part of each petitioner. The foregoing has been proven by clear and convincing evidence. As to 1979, we note that the entire overpayment results from the 1979 currency transactions. Respondent has failed to persuade us by clear and convincing evidence that Maria knew that petitioners' 1979 joint tax return should have included income on account of these transactions. We hold for respondent as to Reinaldo for 1979 and 1980. We hold for respondent as to Maria for 1980. We hold for petitioners 588 as to Maria for 1979. II. DeficienciesPetitioners have the burden of proving that respondent erred in his determinations in the notice of deficiency (other than his determinations as to fraud, discussed supra). Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Except insofar as respondent has conceded that the $439,988 is to be treated as personal service income within the meaning of section 1348 ("maxitax"), 15 petitioners have failed to carry their burden of proof. (Respondent's concession as to petitioners' entitlement to credit against tax for income tax withheld from Maria's wages in 1980 does not affect the amount of the deficiency for 1980, although it does, of course, reduce the amount petitioners have to pay.) We hold for respondent on this issue. Decision will be entered under Rule 155.Footnotes1. Unless indicated otherwise, all section and chapter references are to sections and chapters of the Internal Revenue Code of 1954 as in effect for the years in issue. 2. Of these amounts, self-employment taxes under chapter 2 are $607.70 for 1979 and $363.25 for 1980; the remaining amounts are chapter 1 income tax.↩3. Reinaldo was a one-third owner of Diaz Marble Co., Inc., where he was employed as an appraiser or job estimater. Diaz Marble Co., Inc., went out of existence in 1981. ↩4. The $5,200 "miscellaneous" item is not further described on petitioners' 1979 tax return, except that it also appears on Schedule SE as net earnings from nonfarm self-employment of Reinaldo.5. To their 1980 tax return, petitioners attached a Form 2210, Underpayment of Estimated Tax by Individuals, showing a "penalty" (evidently, this is an addition to tax under section 6654(a), and not a penalty) of $42.6. Each of the Bank of Miami's currency transaction reports stated that none of the money was in denominations of $100 or greater. Reinaldo testified that he thought he received the money in denominations from $5 through $100.↩7. SEC. 6653. FAILURE TO PAY TAX. * * (b) Fraud.--If any part of any underpayment (as defined in subsection (c)) of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. * * * In the case of a joint return under section 6013, this subsection shall not apply with respect to the tax of a spouse unless some part of the underpayment is due to the fraud of such spouse. [The subsequent amendment of this provision by section 325(a) of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324, 616, does not affect the instant case.] ↩8. SEC. 7454. BURDEN OF PROOF IN FRAUD, FOUNDATION MANAGER, AND TRANSFEREE CASES. (a) Fraud.--In any proceeding involving the issue whether the petitioner has been guilty of fraud with intent to evade tax, the burden of proof in respect to such issue shall be upon the Secretary. ↩9. Unless indicated otherwise, all rule references are to the Tax Court Rules of Practice & Procedure.↩10. T.C. Memo. 1970-274↩.11. T.C. Memo. 1966-81↩. 12. Dated March 14, 1951.↩13. "That's the way it's done," the Queen said with great decision: "nobody can do two things at once, you know. Let's consider your age to begin with--how old are you?" "I'm seven and a half, exactly." "You needn't say 'exactly,'" the Queen remarked. "I can believe it without that. Now I'll give you something to believe. I'm just one hundred and one, five months and a day." "I ca'n't believe that!" said Alice. "Ca'n't you?" the Queen said in a pitying tone. "Try again: draw a long breath, and shut your eyes." Alice laughed. "There's no use trying," she said: "one ca'n't believe impossible things." "I daresay you haven't had much practice," said the Queen. "When I was your age, I always did it for half-anhour a day. Why, sometimes I've believed as many as six impossible things before breakfast." Dodgson, C.L., "The Complete Works of Lewis Carroll" (Through the Looking-Glass), p. 200 (Modern Library ed.).↩14. Petitioners' reported taxable income for 1980 placed them at the marginal tax rate of 24 percent. (Sec. 1(a).) The conceded 1980 omitted income of $11,218 would have produced more additional tax liability than the additional withholding credit of $1,231.70. Thus, although petitioners are entitled to an additional credit for 1980, there is already an unexplained but conceded underpayment for this year even without regard to the $209,991 in the currency transactions for this year.↩15. The repeal of this provision by section 101(c)(1) of the Economic Recovery Tax Act of 1981 (Pub. L. 97-34, 95 Stat. 172, 183) does not affect the instant case.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622783/	T. O. CREMIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cremin v. CommissionerDocket No. 9198.United States Board of Tax Appeals5 B.T.A. 1169; 1927 BTA LEXIS 3664; January 25, 1927, Promulgated 3664 R. L. Slaughter, Esq., for the petitioner. R. A. Littleton, Esq., for the respondent. MARQUETTE 1169 This proceeding is for the redetermination of a deficiency in income tax for the year 1920 in the amount of $1,447.06, and an overassessment of $1,570.89 for the year 1919. FINDINGS OF FACT. The petitioner is an individual, residing at Tulsa, Okla.During the years 1919 and 1920 the petitioner was a stockholder of the Eastern Torpedo Co., a corporation, and was also an officer of the company, at a salary of $10,000 per year. He was not, however, actually paid any salary for the year 1919 until January 1, 1920, at which time he was paid the entire amount of $10,000. The corporation, during the year 1919, had earned sufficient money to pay the petitioner's salary and the full amount thereof was available for that purpose in that year. The corporation, in its income and profits-tax return for the year 1919, claimed no deduction on account of salaries paid or accrued to its officers, and in fact did not actually pay or accrue any such salaries in that year. In the year 1919 the corporation paid the petitioner $4,500, which was due him as salary3665 for the year 1918. In adjusting the tax liability of the corporation for the years 1916 to 1919, inclusive, the Commissioner, in the year 1925, permitted the corporation to rewrite its books upon what is known as the accrual basis, to file amended returns, and to accrue upon its books and to deduct from gross income for the year 1919 1170 the amount of $10,000 paid to the petitioner on January 1, 1920, as salary for the year 1919. In the year 1920 the Eastern Torpedo Co. was dissolved and its assets were distributed to its stockholders, of which the petitioner was one, as liquidating dividends. The corporation did not set up a reserve to take care of additional income and profits taxes that were subsequently, in the year 1925, found to be due for the years 1916 to 1919, inclusive, in the amount of $12,972.86. On the liquidation of the corporation, the petitioner received his pro rata share of the assets, and in the year 1925 he paid, on behalf of the dissolved corporation, his pro rata share, of $3,154.05, of the additional taxes for the years 1916 to 1919, inclusive. In his income-tax return for 1920 he included in his gross income the entire amount received by him3666 as a liquidating dividend from the corporation. The petitioner kept his books and filed his income-tax returns for the years 1919 and 1920 on the cash receipts and disbursements basis. Upon audit of the returns for these years, the Commissioner included as income for the year 1919 the amount of $4,500 paid to the petitioner in that year by the Eastern Torpedo Co., as salary for the year 1918, and included in income for the year 1920 the amount of $10,000 paid to the petitioner in that year by the Eastern Torpedo Co. as salary for the year 1919. OPINION. MARQUETTE: The facts in this proceeding are identical with those in , decided this day, except in that proceeding there was also involved the question of the amounts of deductions for depreciation of oil-well drilling equipment that should be allowed to certain partnerships of which E. F. Cremin was a member. Upon the authority of our decision in E. F. Cremin v. Commissioner, we hold (1) that we have no jurisdiction of this proceeding in so far as it relates to the petitioner's tax liability for the year 1919; (2) that the amount of $10,000 paid to the3667 petitioner on January 1, 1920, by the Eastern Torpedo Co., as salary for the year 1919, was income to him for the year 1920: and (3) that the amount included in the petitioner's income for the year 1920, as liquidating dividends received from the Eastern Torpedo Co., should be reduced by the amount of income and profits taxes that were subsequently paid by him for the company. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622784/	Arthur H. DuGrenier, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentArthur H. Du Grenier, Inc. v. CommissionerDocket No. 502-70United States Tax Court58 T.C. 931; 1972 U.S. Tax Ct. LEXIS 63; August 29, 1972, Filed 63 Decision will be entered for the respondent. Petitioner made payment to the estate of a former shareholder in settlement of a cause of action wherein the estate asserted that it received less than fair market value on petitioner's redemption of its stock. Held, through application of the origin-of-the-claim test, as originally stated in United States v. Gilmore, 372 U.S. 39">372 U.S. 39 (1963), the settlement payment is not an ordinary and necessary business expense, but rather, a nondeductible capital expenditure. Held, further, the same result is obtained through the application of the principle as stated in Arrowsmith v. Commissioner, 344 U.S. 6">344 U.S. 6 (1952). Herbert P. Phillips, for the petitioner.Alan I. Weinberg, for the respondent. Sterrett, Judge. STERRETT931 Respondent determined a deficiency in petitioner's Federal income tax of $ 859.25 for the taxable year ended December 31, 1967.The sole65 issue presented for adjudication is whether petitioner, Arthur H. DuGrenier, Inc., is entitled to deduct as an ordinary and necessary business expense under the provisions of section 162, I.R.C. 932 1954, 1 the payment of $ 190,000 in settlement of a suit instituted by the estate of a former shareholder. 266 FINDINGS OF FACTSome of the facts have been stipulated. The stipulation, together with the exhibits attached thereto, are incorporated herein by this reference.Arthur H. DuGrenier, Inc. (hereinafter referred to as petitioner), is a corporation duly organized under the laws of the Commonwealth of Massachusetts. At all times material hereto its principal office was in Haverhill, Mass. Petitioner filed U.S. corporate income tax returns for the taxable years 1963 through 1967 with the district director of internal revenue at Boston, Mass.From its inception in 1948 to January 23, 1964, petitioner's principal business activity was the manufacture of vending machines. For several years prior to the sale of its assets in January of 1964, petitioner's sales declined substantially due to the cigarette cancer scare. Petitioner sustained losses in 1962 and 1963 of $ 90,501 and $ 101,936, respectively. Petitioner's book value as of December 31, 1963, was $ 304,394.Prior to May 11, 1962, petitioner's only two shareholders were Francis C. DuGrenier (hereinafter referred to as DuGrenier, Sr.) and Blanche E. Bouchard (hereinafter referred to as Bouchard). Each owned 50 percent of petitioner's67 outstanding stock. On May 11, 1962, Bouchard died. C. Earl Russell (hereinafter referred to as Russell) and Beatrice Cavan (hereinafter referred to as Cavan) were duly appointed executors of the decedent's estate. Russell was also the accountant for petitioner and had prepared its financial statements.Shortly after Bouchard's death, negotiations were begun for the redemption by petitioner of the stock then owned by the estate and 933 the payment of certain outstanding debts. The estate was represented by the coexecutors and a law firm and petitioner was represented by DuGrenier, Sr., his son, Francis G. DuGrenier (hereinafter referred to as DuGrenier, Jr.), and another law firm.On December 4, 1963, the negotiations culminated with the execution of an agreement between petitioner and the estate. Such agreement provided for the payment of $ 160,000 in cash to the estate which represented:Stock$ 70,612.66Notes payable due Bouchard102,500.00Account payable due Bouchard15,576.32Subtotal188,688.98Less accounts receivable owed by Bouchard to three relatedcorporations28,688.98Total160,000.00At the time of sale Russell felt the estate68 received full value for the stock.By letter dated December 13, 1963, the Seeburg Corp. (hereinafter referred to as Seeburg) expressed a willingness to buy, and petitioner expressed a willingness to sell, the assets of petitioner, including patents, 369 applications for patents, and inventions, for $ 1,100,000. On December 23, 1963, a purchase agreement was executed wherein petitioner and Seeburg agreed to the sale of petitioner's assets for $ 1,100,000. 4 On January 23, 1964, the sale was completed with the execution of a "General Bill of Sale and Assignment," an "Assignment," an "Assignment of Patents, Applications for Patents, and Rights to Pending Inventions," a "Clerk's Certification," a "Certificate," a covenant not to compete, an "Agreement Re Use of Name," and a "Waiver Pursuant to Purchase Agreement."In April of 1963, prior to the sale of petitioner's assets to Seeburg, both DuGreniers, Sr. and Jr., met with Delbert W. Coleman (hereinafter referred to as Coleman), president and chairman of the board 934 of Seeburg. The purpose of such meeting is unclear. On April 16, 1963, DuGrenier, Sr., forwarded to Coleman petitioner's financial statements for 1961.From January 24, 1964, through sometime in 1966, petitioner was an inactive corporation not engaged in business activities which generated sales. During this period it investigated the possibility of acquiring other companies. Petitioner was never liquidated but rather has remained a legal entity up to the present.As a result of the sale of petitioner's assets to Seeburg the estate filed a complaint in the U.S. District Court, for the District of Massachusetts, against DuGrenier, Sr., individually. Subsequently, it amended its cause of action and included petitioner as a codefendant. The70 complaint states in pertinent part as follows:3. After their appointment as executors, the plaintiffs, on or about September 1, 1962 entered into negotiations with defendant relative to a complete disposition of decedent's interest with respect to DuGrenier, Inc.In addition to Seven Hundred and Forty-Nine shares of the common stock of DuGrenier, Inc. and the joint interest in said patents, decedent held demand notes in the amount of $ 102,500 on account of loans made to the corporation, and was also owed $ 15,576.12 by the corporation for interest, royalties and salary.4. In the course of the negotiations to dispose of decedent's interest, the plaintiffs with the knowledge and cooperation of the defendant examined corporate financial statements and data which indicated and which defendant represented as indicating that a liquidation or forced sale of the assets of DuGrenier, Inc. and the patents would realize less for decedent's interest than the $ 160,000 which he subsequently offered. The defendant represented that a sale of the assets could only be accomplished by such a forced liquidation, and that such forced liquidation was the only alternative to his offer.5. Relying71 upon these representations, as defendant intended them to rely, the plaintiffs on December 16, 1963 disposed of decedent's interest by transferring the decedent's shares and delivering her demand notes to DuGrenier, Inc. in return for $ 160,000 and an exchange of mutual releases. The defendant was thus left as sole stockholder in DuGreiner, Inc. with a right to sole ownership of the aforesaid patents.6. Subsequent to such disposition of decedent's interest and payment therefor, the plaintiffs learned that the foregoing representations were false and known by the defendant to be false, and that defendant had thereby intended to and did deceive and defraud the plaintiffs and had violated his duty under the circumstances to make a full and complete disclosure to the plaintiffs of all material facts affecting the value of decedent's interest.7. In truth and in fact, and in breach of such duty, the defendant wilfully and fraudulently concealed from the plaintiffs and failed to disclose that he was negotiating for a sale of the assets of DuGrenier, Inc. and of said patents to Seeburg Corporation and that such negotiations had so far progressed that defendant knew or had reason to believe72 that it was probable that such sale to Seeburg Corporation would be consummated and for a price far in excess of the liquidation basis upon which the plaintiffs had relied for a disposition of decedent's 935 interest as a result of the foregoing fraudulent representation and such nondisclosure.8. Within a few weeks after the decedent's interest was thus obtained from the plaintiffs for $ 160,000 as aforesaid, the defendant, as sole stockholder and owner of the patents, consummated the sale of the assets of DuGrenier, Inc. and of said patents to Seeburg Corporation for such excess price in accordance with his prior undisclosed negotiations with Seeburg Corporation.9. Except for the foregoing false and fraudulent representations and the defendant's failure to disclose that he was negotiating for a sale of the assets of DuGrenier, Inc. and of said patents to Seeburg Corporation and that such negotiations had so far progressed that defendant knew or had reason to believe that it was probable that such sale to Seeburg Corporation would be consummated and for such excess price, plaintiffs would not have agreed to the transfer and disposition of decedent's interest for $ 160,000, 73 but would have retained said interest in order to participate in and receive decedent's pro rata share of the price paid by Seeburg for the assets of DuGrenier, Inc. and for said patents. The fair value of decedent's interest was thus at least $ 400,000 more than the price received by plaintiffs.10. By reason of the facts set forth above, the plaintiffs have been damaged by the defendant to the amount of $ 400,000.Wherefore, plaintiffs demand judgment against the defendant in the sum of $ 400,000 with interest and costs. 5DuGrenier, Sr., and petitioner herein denied all allegations raised by the executors' complaint.A trial was never held on the merits of the estate's complaint. On January 17, 1966, a "Stipulation for Entry of Judgment" was filed by the estate and defendants, DuGrenier, Sr., and petitioner. It provided for the dismissal of DuGrenier, 74 Sr., as a defendant and the recovery of the estate of $ 190,000. On January 19, 1966, a judgment was entered dismissing the action and awarding the estate $ 190,000. During this period a release was executed by the executors which discharged the defendants from any further liability on account of:(1) any matter relating to the sale by C. Earl Russell and Beatrice Cavan, as Executors of the will of Blanche E. Bouchard, late of Haverhill, Massachusetts, to Arthur H. DuGrenier, Inc. of seven hundred and forty nine (749) shares of the common stock of Arthur H. DuGrenier, Inc., pursuant to the "Agreement" between the said Executors and the said corporation dated as of December 4, 1963, including, but not limited to, the said sale itself; (2) any matter relating to the sale by Arthur H. DuGrenier, Inc. of certain of its assets to The Seeburg Corporation, a Delaware corporation, pursuant to the "Purchase Agreement" between the said two parties, dated as of December 23, 1963; * * In addition to the cause of action brought by the executors, four other suits were filed against petitioner between 1964 and 1966. The damages sought in these cases totaled over $ 110,000, 6 bringing the total75 936 damages from all suits pending against petitioner to over $ 510,000. Petitioner's book value for the years ended 1964 and 1965 was $ 460,045 and $ 456,743, respectively.On its 1966 U.S. corporate income tax return petitioner deducted the payment of the $ 190,000 as an ordinary and necessary business expense. Petitioner's 1966 return reflected a net operating loss which was carried back to 1964 and forward to 1967.OPINIONPrior to May 11, 1962, petitioner's sole shareholders were DuGrenier, Sr., and Bouchard. On May 11, 1962, Bouchard died. Shortly thereafter negotiations were begun for the redemption by petitioner of the stock then owned by the estate and the payment of certain outstanding debts. On December 4, 1963, the negotiations culminated with the execution of an agreement which provided for the payment by petitioner of $ 160,000 to the estate. Approximately $ 70,000 of76 this amount represented the value of the stock held by the estate in petitioner. Shortly thereafter, on December 13, 1963, Seeburg expressed a willingness to buy the assets of petitioner for $ 1,100,000. On December 23, 1963, a purchase agreement was executed for the purchase and sale of petitioner's assets at the above-noted price. As a result of this sale the Bouchard estate filed a complaint in the U.S. District Court against DuGrenier, Sr., and petitioner alleging the fraudulent concealment of certain facts relevant to the value of petitioner's stock held by the estate. The estate asserted that the stock redeemed by petitioner was worth an additional $ 400,000. Prior to trial the parties entered into a settlement wherein petitioner paid $ 190,000 to the estate in return for the execution by the estate of a release barring any further action by the estate with regard to the redemption of the stock. The sole issue presented for determination relates to whether the payment by petitioner to the Bouchard estate in settlement of the suit is deductible as an ordinary and necessary business expense under the provisions of section 162, which states in part:SEC. 162. TRADE OR BUSINESS77 EXPENSES.(a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * . 7937 or is a nondeductible capital expenditure within the purview of section 263, which provides, in part:SEC. 263. CAPITAL EXPENDITURES.(a) General Rule. -- No deduction shall be allowed for -- (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. 878 In recent years the courts in distinguishing between certain ordinary and necessary business expenses and capital expenditures have applied what is commonly referred to as the origin-of-the-claim test as first enunciated in United States v. Gilmore, 372 U.S. 39">372 U.S. 39 (1963). See Woodward v. Commissioner, 397 U.S. 572 (1970); United States v. Hilton Hotels Corp., 397 U.S. 580">397 U.S. 580 (1970); Ransburg v. United States, 440 F. 2d 1140 (C.A. 10, 1971); Anchor Coupling Co. v. United States, 427 F. 2d 429 (C.A. 7, 1970); Stass Reed, 55 T.C. 32">55 T.C. 32 (1970).In Gilmore, the Supreme Court, in attempting to distinguish between business and personal expenses indicated that it was not the "primary purpose" which determined the nature of an expense, but rather the origin and character of such expense. The Court stated:For these reasons, we resolve the conflict * * in favor of the view that the origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences79 upon the fortunes of the taxpayer, is the controlling basic test of whether the expense was "business" or "personal" and hence whether it is deductible or not. * * [372 U.S. at 49.]Several years later in Woodward, the Supreme Court applied this same origin-of-the-claim test in ascertaining whether appraisal litigation expenses were capital expenditures incurred with respect to the acquisition or disposition of a capital asset. The Court therein noted:In our view * * * litigation expenses involves the simpler inquiry whether the origin of the claim litigated is in the process of acquisition itself. [397 U.S. at 577.]Shortly thereafter in Anchor Coupling Co., the Court of Appeals for the Seventh Circuit, analyzing the Gilmore and Woodward decisions in an attempt to determine the character of a settlement payment made to protect a party's interest in property, stated:However, the Court did not intimate the extent to which the primary purpose test, as applied to costs incurred in protecting ownership, has been rejected by the adoption of an objective standard of deductibility in Gilmore and Woodward80 . We are convinced that the considerations which prompted the Court to announce 938 such a test in these cases also impel us to fashion a similar test for determining whether the settlement payment in this case is a business expense or a capital expenditure.In so doing we rely particularly on Gilmore. Taxpayer argues that Gilmore is inapplicable because we are asked here to determine whether a settlement constitutes an ordinary and necessary business expense or a capital outlay and not whether a payment is a deductible business expense or a nondeductible personal expense. We disagree. Although the two questions are admittedly different, substantially the same problems arise in each determination. Thus in both cases the court must determine the tax consequences of monetary outlays made in connection with contesting a claim on the taxpayer's assets. Consideration of the taxpayer's motive and the consequences of his failure to make a payment or to incur an expense create the same problems in both cases. [427 F. 2d at 432-433.]It is apparent from the above-cited cases that the origin-of-the-claim test will characterize an expense as a capital81 expenditure if such expense is incidental to either the purchase or sale of an asset or is made to protect one's interest in an asset, regardless of the taxpayer's motives in making such payment. Such doctrine is clearly applicable to the present factual situation and it necessitates the characterization of the payment presently in issue as a capital expenditure. The origin of the Bouchard estate's claim was founded on the sale of stock. Though the catalyst for this action may have been the subsequent sale by petitioner to Seeburg, this does not alter the basic fact that the estate was attempting to obtain what it deemed to be the full value for the stock transferred. The settlement payment made by petitioner was therefore nothing more than an additional portion of the purchase price which simultaneously clarified and validated its title to the stock and underlying assets. We find little substantive difference between this situation and that presented in the cases noted above.Further, in Stass Reed, this Court faced with the question of the character of legal expenses incurred by a party in bringing suit noted: "Without considering the potential consequences of the lawsuit, 82 the suit itself had its roots in the acquisition process * * * [55 T.C. at 42]." We find such language equally applicable to the defendant in such action who attempts to extricate himself from the suit by making payment in settlement of the cause of action.Furthermore, in addition to the origin-of-the-claim test applied above we find the theory as expounded in Arrowsmith v. Commissioner, 344 U.S. 6">344 U.S. 6 (1952), to be equally applicable. There the Supreme Court in characterizing payments made incidental to, but several years after, the initial transaction noted:It is contended, however, that this payment which would have been a capital transaction in 1940 was transformed into an ordinary business transaction in 1944 because of the well-established principle that each taxable year is a separate unit for tax accounting purposes. United States v. Lewis, 340 U.S. 590">340 U.S. 590; 939 North American Oil v. Burnet, 286 U.S. 417">286 U.S. 417. But this principle is not breached by considering all the 1937-1944 liquidation transaction events in order properly to classify the nature83 of the 1944 loss for tax purposes. Such an examination is not an attempt to reopen and readjust the 1937 to 1940 tax returns, an action that would be inconsistent with the annual tax accounting principle.It is manifest to this Court that, since the settlement payment was nothing more than an additional portion of the purchase price paid several years later, the Arrowsmith decision permits us to look back to the sale year and characterize such payment as a capital expenditure. Rees Blow Pipe Manufacturing Co., 41 T.C. 598">41 T.C. 598, affirmed per curiam 342 F. 2d 990 (C.A. 9, 1965); Estate of James M. Shannonhouse, 21 T.C. 422 (1953). 984 This fact, that the payment was in reality attributable to a redetermined purchase price and integrally related thereto, serves to distinguish the case from William L. Mitchell, 52 T.C. 170">52 T.C. 170 (1969), revd. 428 F. 2d 259 (C.A. 6, 1970), and James E. Anderson, 56 T.C. 1370">56 T.C. 1370 (1971), on appeal (C.A. 7, Dec. 23, 1971), wherein the payments in issue were deemed to have been paid out of the taxpayers' concern for their reputation as businessmen.Petitioner asserts however that an allocation should be made. That is, it requests the Court to find that a portion of the settlement was in fact a business expense.We are prevented from doing so. In E. I. duPont de Nemours & Co. v. United States, 432 F. 2d 1052, 1059 (C.A. 3, 1970), the court noted that "In the present case, however, the taxpayer made no attempt at such a breakdown. With respect to the entire expenditure, therefore, we hold that the taxpayer failed to meet its burden of proving deductibility under section 162(a)." See Clark Oil & Refining Corp. v. United States, 326 F. Supp. 145">326 F. Supp. 145, 150 (E.D. Wis. 1971);85 Stass Reed, supra at 41. Compare DeMink v. United States, 448 F. 2d 867 (C.A. 9, 1971).Upon an examination of the entire record we conclude that the petitioner's settlement payment is a capital expenditure and therefore not deductible.Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Petitioner made payment in settlement of the suit in 1966 and deducted a like amount as a business expense in that year. Its expenditures for such year, irrespective of the settlement payment, exceeded its income. Therefore, as permitted by sec. 6411, petitioner carried the entire resultant loss back to 1964, filing a request for refund from carryback of net operating loss for 1964, Form 1139. Respondent in compliance with sec. 6411(b) refunded the amount requested to petitioner. Subsequently respondent disallowed the 1966 deduction. However since petitioner carried over the unused net operating loss for 1966 to 1967 as a deduction, respondent issued a notice of deficiency for 1967.With regard to 1964 though a deficiency was in fact determined and noted in the "explanation of adjustments" section of the notice of deficiency, because of the net operating loss refund allowed by respondent, respondent has not included such amount in his total deficiency determination. The reason for such exclusion is apparently respondent's reliance on sec. 6213(b)(2), wherein such amounts are treated as mathematical errors, if in fact such carryback is determined to be invalid, and therefore do not require the issuance of a notice of deficiency. We find respondent's procedural actions to be in complete compliance with the statute, but would only request that he make such actions more clearly known to the Court.↩3. Bouchard, DuGrenier, Sr., and petitioner entered into agreements in April 1951, January 1955, and September 1958, wherein Bouchard and DuGrenier, Sr., agreed to lease to petitioner certain patents owned jointly by Bouchard and DuGrenier, Sr. On June 27, 1957, Bouchard and DuGrenier, Sr., entered into an agreement wherein if either party disposed of his stock interest in petitioner the remaining shareholder would purchase such patent interest for $ 1.Petitioner contends that the sale of its assets to Seeburg for $ 1,100,000 included an allocation of approximately $ 243,000 which represented the value of the patents. It further contends that such amount was immediately thereafter passed through to DuGrenier, Sr.If such be the true nature of the events we find it somewhat peculiar that Seeburg did not require DuGrenier, Sr., to personally transfer title since he was in fact the true owner of the patents.↩4. The final purchase price paid was $ 1,072,000. The discrepancy was due to certain adjustments which were required by agreement of the parties.↩5. In addition to the above-quoted language the executors alleged three additional causes of action. They also motioned for equitable attachment, which was granted.↩6. One of the suits noted above involved a deficiency in income tax. Such case was settled prior to trial in the Tax Court.↩7. Sec. 1.162-1. Business expenses.(a) In general↩. Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business * * . No such item shall be included in business expenses, however, to the extent that it is used by the taxpayer in computing the cost of property included in its inventory or used in determining the gain or loss basis of its plant, equipment, or other property.8. Sec. 1.263(a)-2. Examples of capital expenditures. * * (a) The cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year. * * *(c) The cost of defending or perfecting title to property.↩9. In Arrowsmith, Rees Blow Pipe, and Shannonhouse, the courts disallowed a business expense under sec. 162 and an ordinary loss under sec. 165, but they granted the taxpayer a capital loss because the year of the transaction was closed and the additional expense could not be added to basis. To have prohibited any loss would in effect have caused the taxpayer to be subject to a double tax, i.e., the payment of additional funds without a commensurate increase in basis.In the instant case we have classified the additional purchase payment as a capital expenditure though the year of the redemption is closed. The reason is that we are not here concerned with a sale, but rather, the redemption by a corporation of its own stock. Therefore, there is no question of a double tax since a corporation recognizes no gain in dealing in its own stock.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622785/	STOKELY USA, INC., FORMERLY OCONOMOWOC CANNING COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentStokely USA, Inc. v. CommissionerDocket No. 4385-91United States Tax Court100 T.C. 439; 1993 U.S. Tax Ct. LEXIS 29; 100 T.C. No. 29; May 24, 1993, Filed 29 Decision will be entered under Rule 155. Sec. 1253, I.R.C., allows a transferee of a trademark to amortize its cost if the transferor retains any significant power, right, or continuing interest in the subject matter of the trademark. P purchased trademarks from F for a lump-sum payment of $ 1,584,500. Pursuant to the trademark transfer agreement, F retained the right to disapprove any assignment of the trademarks by P for a 5-year period, and P agreed that it would not use the trademarks in connection with certain products for 20 years. Held: The 5-year right retained by F to disapprove assignment of the trademarks is not a right contained within the nonexclusive list of "significant" rights in sec. 1253(b)(2), I.R.C., nor has it been proven to be an otherwise "significant" right in the context of the particular facts in this case. Held further: In the context of this case, the 20-year restriction upon P's ability to use the trademarks in connection with certain products is a significant power, right, or continuing interest with respect to the subject matter of the trademarks that was retained by the transferor. Sec. 1253(a), I.R.C. Therefore, P is entitled to amortize30 the cost of the trademarks. For petitioner: Robert A. Schnur and Joseph A. Pickart. For respondent: James M. Klein and Nelson E. Shafer. RUWERUWE440 OPINION RUWE, Judge: Respondent determined deficiencies in petitioner's corporate income tax as follows: Tax Year EndedDeficiencyMar. 31, 1983$ 62,931Mar. 31, 198475,201Mar. 31, 198574,037Mar. 31, 198611,106Total223,275The only issue we must decide to resolve this case is whether a lump sum that petitioner paid to purchase certain trademarks may be amortized pursuant to section 1253(d)(2)(A). 1This case was submitted fully stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner was incorporated in 1920 under the name Oconomowoc Canning Co. When it filed the petition in this case, 31 petitioner was a Wisconsin corporation with its principal office in Oconomowoc, Wisconsin. Petitioner is in the business of processing, canning, and marketing canned and frozen vegetables, fruits, tomato products, and juices. Its principal products are canned corn, beans, peas, and beets. Petitioner's net sales during 1983 through 1989 were as follows: Fiscal YearNet Sales1983$ 43,900,0001984105,200,0001985131,400,0001986139,700,0001987159,800,0001988188,800,0001989214,600,000441 During the years in issue, roughly half of petitioner's net sales (and 26 percent of total sales) were made under the trademarks and trade names Stokely's or Stokely's Finest. Products sold by petitioner under the Stokely trademarks and trade names carry a higher price than those sold under its other labels and generate a higher unit profit margin for petitioner. Petitioner initially obtained the right to use the Stokely's Finest trademarks and trade names in a 1983 license agreement with Stokely-Van Camp, Inc. (SVC), 2 an unrelated Indiana corporation that also owned the rights to other trademarks and trade names, including Stokely's, Stokely-Van Camp's Finest, and Van32 Camp's. In 1983, petitioner also purchased production facilities related to the Stokely's Finest trademarks that it licensed from SVC. All SVC's trademarks, trade names, and registrations included rights of use for a variety of canned and frozen food products, including pork and beans. Petitioner was also interested in obtaining SVC's pork and beans product lines and related trademarks; however, SVC specifically retained its Stokely-Van Camp's and Van Camp's trademarks and trade names and prohibited petitioner from using the Stokely's Finest trademarks on pork and beans products. At no time prior to its negotiations with SVC did petitioner produce pork and beans products. As of June 1983, SVC's share of the market for canned pork and beans in the United States was about 33 percent, totaling about $ 150,000,000 annually in sales. 33 In September 1983, the Quaker Oats Co. (Quaker Oats) acquired all the assets of SVC. Petitioner's management expressed to Quaker Oats its interest in acquiring additional rights in the Stokely's Finest trademarks 3 and rights to the Stokely's 4 and Stokely-Van Camp's Finest 5 trademarks. Quaker Oats' management informed petitioner of the company's interest in such a transaction, but stated that it would not transfer any trademark containing the name Van Camp's; nor would it transfer its pork and beans product lines. Quaker Oats' management further informed petitioner442 that Quaker Oats desired to protect the Van Camp's trademark as used for pork and beans and that any agreement regarding the Stokely trademarks must include a restriction on the use of those trademarks for pork and beans products because of the close connection in the public mind between the Van Camp's and Stokely's names. Quaker Oats' management34 believed that the Van Camp's trademark would be seriously diluted, and Quaker Oats' pork and beans sales would have been materially and adversely affected if petitioner were allowed to use the Stokely trademarks for pork and beans products. The current label used by Quaker Oats on pork and beans products includes the Van Camp's name and, in small type, the name "Stokely". On November 16, 1983, petitioner made an offer of $ 1,250,000 for the right to acquire ownership of the Stokely's Finest trademarks, a trademark called "Shellie", and the Stokely-Van Camp's Finest trademark. Quaker Oats refused to consider transferring rights in any trademarks that included the name Van Camp's. Petitioner and Quaker Oats eventually agreed to the transfer of certain trademarks owned by Quaker Oats. On November 5, 1984, Quaker Oats transferred to the Quaker Oats Foundation (the Foundation), a private foundation controlled by Quaker Oats, the trademarks that it intended to transfer to petitioner. On November 15, 1984, the Foundation and petitioner entered into a trademark transfer agreement pursuant to which, for a lump-sum payment of $ 1,584,500, the Foundation: [transferred], [sold] and35 [assigned] to * * * [petitioner] * * * THE FOUNDATION'S right, title and interest, both statutory and at common law, in The Trademarks and the registrations thereof, subject to * * * [certain restrictions] * * * including the right to sue for and collect damages for any past infringement * * .The trademarks referred to in the agreement were Stokely's, Shellie, Bavarian Style, and the two Stokely's Finest trademarks (the Stokely trademarks). Also under the agreement, petitioner's royalty obligations to SVC for the latter two trademarks were canceled. 6 The restrictions mentioned in the agreement were as follows: (1) Because of prior agreements with SVC, petitioner's rights were subject to the rights of two443 other companies in various Stokely trademarks; (2) United Foods, Inc., held the exclusive right to use the Stokely's and Stokely's Finest trademarks on frozen foods sold in the United States during 1983, 1984, and 1985; (3) Stokely-Van Camp of Canada, Inc., held the exclusive right and license to use in Canada, and the nonexclusive right and license to use in certain specified European countries, the trademarks Stokely's, Stokely's Finest, Stokely-Van Camp's, and Van Camp's; 36 and (4) The agreement also contained the following restrictions: 2.1 * * [Petitioner] shall not use The Trademarks on * * * [pork and beans, and products containing beans and wieners (such wieners being composed of either beef, pork, chicken or poultry or a combination thereof) for] * * * [20 years]. * * * 2.2 * * * [Petitioner], and its successors and assigns shall never use the trademark "VAN CAMP" on any products either as part of or apart from The Trademarks. * * * 2.4 The FOUNDATION shall have the right to disapprove any assignment of (Petitioner's] right, title and interest in the Trademarks for a period of five years.The payment amount was negotiated by the parties on the basis of the present value of the estimated future royalty payments that petitioner would have had to make to Quaker Oats under the SVC license agreement. Petitioner delivered to the Foundation its certified37 check for $ 1,584,500 on November 15, 1984. The agreement remained in effect for all years relevant to this proceeding. 7In January 1985, petitioner changed its name to Stokely USA, Inc. On December 24, 1986, petitioner acquired from the American National Co. a number of processing plants, including one used for pork and beans, as well as an inventory of pork and beans. Petitioner proceeded to sell this inventory under a variety of labels, not including the Stokely trademarks or trade names. Petitioner also continued production of pork and beans products at the acquired plants for several months under other trade names and trademarks and had acquired another plant that it could38 have converted to the444 production of consumer-size pork and beans products. However, petitioner was soon forced to discontinue production of pork and beans due to the lack of a major brand name and consequent low profitability for those products. Had petitioner been able to use the Stokely trademarks on pork and beans products, or obtain rights to the Van Camp's trademarks, petitioner would have continued pork and beans production and converted the other plant for such production. Quaker Oats continued selling pork and beans under the Van Camp's label. During the years after the agreement between petitioner and the Foundation, Van Camp's pork and beans products accounted for approximately 28 percent of the United States market for such products. The dollar amounts of the sales comprising this share in 1986 through 1989 were as follows: Fiscal YearSales1986$ 123,000,0001987126,000,0001988134,000,0001989132,000,000Petitioner took deductions beginning in the taxable year ended March 31, 1985, for amortization of the lump-sum payment paid to the Foundation. 840 On December 27, 1990, respondent issued a notice of deficiency covering petitioner's taxable years39 ended March 31, 1983 through 1986, in which these deductions were disallowed. This determination also led respondent to disallow petitioner's amortization deduction for the taxable year ended March 31, 1987. While that year is not before the Court, the 1987 disallowance caused respondent to reduce a claimed net operating loss carryback from that year to the taxable year ended March 31, 1984. This led to an increased deficiency for 1984. Respondent's determination also led to the reduction of a claimed investment credit carryback from the taxable year ended March 31, 1986, to petitioner's taxable year ended March 31, 1983. Petitioner445 timely filed a petition with this Court seeking a redetermination of the deficiencies determined for its taxable years ended March 31, 1983, through March 31, 1986. 9The only issue is whether petitioner is entitled41 to amortize the $ 1,584,500 payment it made for the purchase of the Stokely trademarks. Section 1253(d)(2)(A) provides for amortization of the cost of a trademark over a 10-year period if, pursuant to section 1253(a), the transfer of the trademark is not treated as a sale or exchange of a capital asset. 1042 Section 1253(a) states: A transfer of a franchise, trademark, or trade name shall not be treated as a sale or exchange of a capital asset if the transferor retains any significant power, right, or continuing interest with respect to the subject matter of the franchise, trademark, or trade name.There is no question that the Stokely trademarks were transferred to petitioner. Therefore, whether the transfer of the Stokely trademarks is to be treated as the sale or exchange of a capital asset under section 1253(a) depends upon (1) whether the Foundation retained any "power, right, or continuing interest with respect to the subject matter" of the Stokely trademarks and, if so, (2) whether one or more of these rights was "significant". 11446 1. Did the Transferor Retain Any Power, Right, or Continuing Interest in the Subject Matter of the Trademarks?Petitioner contends that the Foundation's 5-year right to disapprove any assignment of petitioner's right, title, and interest in the trademarks and the 20-year prohibition on petitioner's use of the trademarks with respect to pork and beans (the pork and beans restriction), represent powers, rights, or continuing interests retained by the Foundation. 12 We agree with petitioner that the Foundation's right to disapprove transfer of the trademarks by petitioner during the first 5 years after the transfer constitutes a retained power, right, or continuing interest with respect to the subject matter of the trademarks. Respondent does43 not dispute this. Respondent's only argument with respect to this retained power, right, or interest is that it is not "significant" within the meaning of section 1253(a). Respondent argues, however, that the pork and beans restriction does not constitute a retained power, right, or continuing interest, but rather, merely defines the assets that petitioner purchased. In essence, respondent contends that petitioner simply did not purchase the right to use the Stokely trademarks for pork and beans. According to respondent, petitioner purchased44 the right to use the Stokely trademarks on everything except pork and beans, and the Foundation retained no right to use the Stokely trademarks. Respondent, therefore, concludes that the pork and beans restriction did not give the Foundation a retained power, right, or continuing interest over what petitioner purchased. Respondent's analysis begs the question. It is clear that petitioner did not "purchase" the right to use the Stokely trademarks on pork and beans (for 20 years). It is equally clear that the Foundation retained no right to continue to use the specific trademarks that were transferred to petitioner. However, the relevant statutory language of section 1253 refers to neither of these factors. Rather, section 1253(a) refers to a "transfer of a * * trademark". This reference to447 the transfer of a trademark contemplates all transfers, including those with substantial restrictions and limited durations. 1345 Section 1253(a) states that such "transfer" "shall not be treated as a sale or exchange of a capital asset if the transferor retains any significant power, right, or continuing interest with respect to the subject matter of the * * * trademark". (Emphasis added.) The subject matter of the Stokely trademarks included the ability to use them in the marketing of food products. Trademarks and trade names represent goodwill. Philip Morris, Inc. v. Commissioner, 96 T.C. 606">96 T.C. 606, 634 (1991), affd. without published opinion 970 F.2d 897">970 F.2d 897 (2d Cir. 1992). Goodwill is characterized as "the expectancy of continued patronage, for whatever reason." Boe v. Commissioner, 307 F.2d 339">307 F.2d 339, 343 (9th Cir. 1962), affg. 35 T.C. 720">35 T.C. 720 (1961); see Canterbury v. Commissioner, 99 T.C. 223">99 T.C. 223, 247 (1992); Philip Morris, Inc. v. Commissioner, supra at 634. Petitioner purchased the Stokely trademarks with the expectation that potential customers would be more likely to purchase petitioner's products if they were identified by the Stokely46 trademarks. Stokely trademarks could have been used to market pork and beans. Registration number 277,037 (one of the Stokely's Finest trademarks) expressly includes pork and beans within the products for which the trademark is to be used. The other two transferred trademarks have less detailed usage descriptions, but both could be used for pork and beans products. While petitioner acquired less than the full use of the Stokely trademarks, this was the direct result of the pork and beans restriction, through which the Foundation was able to prevent petitioner from using the trademarks on pork and beans products. The statute contains examples that show the error of respondent's reliance on the fact that petitioner did not purchase the right to use the trademarks on pork and beans. Section 1253(b)(2) lists several significant retained powers, rights, or continuing interests. One of these is the right of the transferor to disapprove any transfer. Sec. 1253(b)(2)(A). The purchaser of a trademark encumbered by this type of restriction clearly does not "purchase" the unencumbered448 right to transfer the trademark. Nevertheless, it is clear that this type of restriction was to qualify47 as a retained power within the meaning of section 1253. Another example is the "right to prescribe the standards of quality of products used or sold". Sec. 1253(b)(2)(C). A transferee subject to such a right clearly does not purchase the right to use a trademark with respect to any product that it wishes. Yet, in this situation, the statute states that the transferor retains a significant power, right, or continuing interest. Sec. 1253(b)(2)(C). Respondent argues that the pork and beans restriction is not a power, right, or continuing interest retained by the "transferor", since the Foundation itself did not market pork and beans products. In the trademark transfer agreement, petitioner specifically acknowledged that its use of the trademarks for pork and beans products during the 20-year period would result in irreparable injury to the Foundation and that injunctive relief for the Foundation would be appropriate if petitioner violated this restriction. The Foundation is a private entity controlled by Quaker Oats. Quaker Oats' control over the Foundation also indicates that the restriction on petitioner's use of the Stokely trademarks on pork and beans products was a genuine48 restriction designed to protect Quaker Oats and the Foundation. Based on the foregoing factors, we find that the pork and beans restriction was a retained power, right, or continuing interest with respect to the subject matter of the Stokely trademarks. 2. Were the Retained Powers, Rights, or Continuing Interests "Significant"?Petitioner's primary argument is that the Foundation's right to disapprove assignment of the Stokely trademarks for 5 years is, as a matter of law, "significant". Section 1253(b)(2) states: The term "significant power, right, or continuing interest" includes, but is not limited to, the following rights with respect to the interest transferred: (A) A right to disapprove any assignment of such interest, or any part thereof. (B) A right to terminate at will. (C) A right to prescribe the standards of quality of products used or sold, or of services furnished, and of the equipment and facilities used to promote such products or services. 449 (D) A right to require that the transferee sell or advertise only products or services of the transferor. (E) A right to require that the transferee purchase substantially all of his supplies and equipment49 from the transferor. (F) A right to payments contingent on the productivity, use, or disposition of the subject matter of the interest transferred, if such payments constitute a substantial element under the transfer agreement.The powers, rights, or continuing interests specified in section 1253(b)(2) are deemed significant by the terms of the statute. If a retained power, right, or continuing interest falls within the rights listed in section 1253(b)(2), no further inquiry is necessary. This list, however, is nonexclusive and does not preclude the possibility that other retained powers, rights, or continuing interests may be "significant". Petitioner contends that the Foundation's right to disapprove assignment of the Stokely trademarks for 5 years is "A right to disapprove any assignment of such interest, or any part thereof" within the meaning of subparagraph (A) of section 1253(b)(2). Respondent counters by pointing out that the Foundation's right to disapprove assignments was limited to the 5-year period following the transfer, whereas petitioner's rights in the transferred trademarks were for an unlimited duration. Respondent therefore argues that the Foundation's50 disapproval rights did not extend to "any assignment" within the meaning of the statute. In essence, the parties ask us to decide whether the words "any assignment" in the statute mean all assignments (suggested by respondent), or some assignments (suggested by petitioner). 14Respondent argues that "any assignment" means "all assignments" because any other interpretation would mean that every transitory right to disapprove an assignment would be deemed significant regardless of how short (or insignificant) the period during which the disapproval right could be exercised. In response, petitioner contends that if the period during which a transferor retains the right to disapprove an assignment is so short as to be meaningless, the courts could treat such a right as a sham and disregard it. The parties' arguments present us with a conundrum. Subparagraph (A) refers51 to "any assignment of such interest, or any part thereof." (Emphasis added.) The second "any" in450 subparagraph (A) can only mean "some". It would be arguably inconsistent to interpret the first "any" in a single sentence to mean "all" and the second "any" to mean "some". Yet, if the first "any" means "some", the interpretative problems noted by respondent arise. The better course, and the one we adopt, is to interpret subparagraph (A) in light of the statute as a whole. Section 1253(b)(2) contains a list of retained rights upon which Congress conferred significance as a matter of law. Once a right falls within one of the specifically enumerated rights in subsection (b)(2), Congress intended that there should be no further inquiry into its significance. 15 However, unless the retained rights listed in subsection (b)(2) are coextensive in duration with the interest transferred, it can readily be seen that any one of them could be objectively insignificant if the time period during which the transferor could exercise such right was restricted. Courts would then be faced with the dilemma of either interpreting the statute in a way that would produce absurd results or making52 a case-by-case determination of the actual significance of whatever temporal limits had been placed on the retained right. Neither approach is satisfactory or in keeping with the legislative objective of subsection (b)(2). We believe, therefore, that the retained rights enumerated in subsection (b)(2) must be exercisable for a period of time that is coextensive with the duration of the interest that was transferred. This interpretation is consistent with the language in section 1253, the legislative history, and the objective of the statute. The language of section 1253 makes a literal distinction between the object of a significant retained right referred to in subsection (a) 1654 and the object of the specifically described rights in subsection (b)(2). 17Section 1253(a) refers to retained rights "with respect to the subject matter of the franchise, trademark, or trade name." (Emphasis added.) 451 While 53 a transferred interest in a franchise, trademark, or trade name may itself have a specifically limited duration, the "subject matter" of these intangibles, including the goodwill associated with them, would not likely have an ascertainable limit. In contrast, section 1253(b)(2), which lists specifically defined rights, refers to rights retained "with respect to the interest transferred". (Emphasis added.) The "interest transferred" can encompass less than the subject matter of a franchise, trademark, or trade name. The "interest transferred" can be, and often is, for a limited period. 18 See S. Rept. 91-552 (1969), 3 C.B. 423">1969-3 C.B. 423, 557 ("For purposes of this provision, a transfer is to include a transfer of any interest (i.e., a part) in a franchise, trademark or trade name."). (Emphasis added.) Thus, the duration of a retained right takes on added importance "with respect to the interest transferred" under subsection (b)(2). Our interpretation of the statute recognizes that importance. The legislative history of section 1253 also emphasizes the importance of duration in regard to the retained rights enumerated in subsection (b)(2). It states: If the transfer agreement includes significant conditions or restrictions which are subject to the transferor's55 approval on a continuing basis, this power to exercise continuing, active, operational control over the transferee's business activities is to be considered as a retention by the transferor of a significant power, right, or continuing interest. * * * [S. Rept. 91-552, supra, 1969-3 C.B. at 556; emphasis added.]The legislative history then lists six retained rights (found in section 1253(b)(2)) that, in the view of Congress, meet the above standards without question. Id. The focus of the legislative history on continuing control supports our interpretation that retained rights listed in subsection (b)(2) must be coextensive with the duration of the interest transferred. One of the objectives of Congress in enacting section 1253 was to provide a simple, uniform method for determining whether the transfer of a trademark, franchise, or trade name should receive capital gains treatment. Id. Courts had452 previously conducted detailed factual analyses of such transfers to determine the significance of rights retained by the transferor. These factual analyses led to divisions of authority among courts about the significance 56 of many retained rights. Id. Subsection (b)(2) was intended to end this diversity. Id. If, as suggested by petitioner, the duration of the retained rights listed in subsection (b)(2) need not be coextensive with the duration of the interest transferred, two potential interpretative scenarios follow. Under the first scenario, a retained right listed in subsection (b)(2) would be deemed significant regardless of its duration. If we were to adopt this approach, a 1-month or 1-week right to disapprove the assignment of a 20-year franchise would, as a matter of law, be considered significant for purposes of section 1253(b)(2). The same problem exists with respect to the other six rights enumerated in section 1253(b)(2). For example, restaurant franchises are typically granted for a limited period. See Canterbury v. Commissioner, 99 T.C. at 243. If such a franchise gave the transferor a right to terminate at will that could only be exercised in the first month of a 20-year franchise, such a right would probably be objectively insignificant but would nonetheless automatically qualify as significant if we adopted petitioner's approach. 19 This57 is clearly not what Congress intended, S. Rept. 91-552, supra, 1969-3 C.B. at 555-556, and could easily lead to absurd results. See EEOC v. Commercial Office Products Co., 486 U.S. 107">486 U.S. 107, 120 (1991) (interpretation of statutory language should not lead to "'absurd or futile'" results "'plainly at variance with the policy of the legislation as a whole'" (quoting United States v. American Trucking Associations, 310 U.S. 534">310 U.S. 534, 543 (1940))). Under the second scenario, a retained right listed in subsection58 (b)(2) might or might not have significance, depending upon an analysis of the facts and circumstances in order to determine whether its duration was adequate. This type of analysis leads directly back to the problems and resulting uncertainty that existed prior to the enactment of section453 1253, and therefore, subverts the intent of Congress. See S. Rept. 91-552, supra, 1969-3 C.B. at 555. Based on the foregoing analysis, we hold that those powers, rights, or continuing interests retained by a transferor that are enumerated in subsection (b)(2) must be coextensive with the duration of the interest transferred. It follows that the Foundation's 5-year transfer disapproval right is not a significant right within the meaning of section 1253(b)(2). This does not mean that the Foundation's disapproval right is not significant for purposes of section 1253(a). The list in subsection (b)(2) is nonexclusive, and therefore, retained rights not included in subsection (b)(2) may still qualify under subsection (a) so as to entitle petitioner to amortize its payment. Whether a retained right not specifically enumerated in section 1253(b)(2) is "significant" 59 for purposes of section 1253(a) must be determined in light of all the facts and circumstances at the time of the transfer. There is very little evidence regarding the impact on petitioner as a result of the 5-year disapproval right. The parties presented no evidence regarding the circumstances that supplied the motivation for including the 5-year disapproval right in the transfer agreement. Absent such evidence, we are unprepared to find that this disapproval right, on its own, should be characterized as a significant power, right, or continuing interest for purposes of section 1253(a). Petitioner next argues that the 20-year restriction on using the Stokely trademarks on pork and beans products is itself a "significant" retained power, right, or continuing interest. Respondent contends that this restriction is not significant for two reasons. First, respondent asserts that the name "Stokely" is barely visible on Quaker Oats' well-known line of Van Camp's pork and beans products. This, according to respondent, belies the claim that the Stokely trademarks could have been used by petitioner to successfully market pork and beans products. Second, respondent notes that petitioner60 was not in the business of producing pork and beans products at the time it entered the transaction to acquire the trademarks. From this, respondent argues that the restriction had no significance for petitioner's business or its use of the Stokely trademarks. We disagree. The restriction clearly had significance for Quaker Oats. The specific reason for its inclusion in the contract was to454 protect the company's Van Camp's line. Because of the close connection in the public mind between the Van Camp's and Stokely names, Quaker Oats' management believed that the Van Camp's mark would be "seriously diluted", and Quaker Oats' sales of pork and beans products materially and adversely affected, if petitioner were allowed to use the Stokely trademarks for these products. On brief, respondent agrees that the Stokely and Van Camp's names have been associated with one another in the minds of the public. Thus, it is probable that the use of the Stokely trademarks on pork and beans products would have had considerable importance in any effort by petitioner to market such products. Moreover, petitioner wanted to enter into the market for pork and beans. Petitioner initially approached61 Quaker Oats regarding the purchase of the Stokely-Van Camp's trademark, but was rejected. Petitioner wanted to use the Stokely trademarks on pork and beans products and would have done so but for the restriction. Despite the restriction, petitioner attempted to sell pork and beans for a short period under another label. Petitioner was forced to abandon its plans for that market due to the lack of a strong brand name. Stokely could have been that name. As of June 1983, SVC, using the Van Camp's label, had a 33-percent share of the canned pork and beans market in the United States totaling about $ 150,000,000 annually in sales. During the years after the trademark transfer agreement between the Foundation and petitioner, Quaker Oats' share of the U.S. market for pork and beans was 28 percent. The dollar amounts of this share in recent years were as follows: Fiscal YearSales1986$ 123,000,0001987126,000,0001988134,000,0001989132,000,000In 1983, petitioner's net sales for all its products, including those on which the Stokely trademarks were used, was455 $ 43,900,000. In recent years, petitioner's net sales were as follows: Fiscal YearNet Sales1986$ 139,700,0001987159,800,0001988188,800,0001989214,600,00062 In light of these facts, the pork and beans restriction carried undoubted significance for the Foundation, Quaker Oats, and petitioner. The trademark transfer agreement states this clearly: [Petitioner] recognizes and acknowledges that such use of The Trademarks before expiration of the applicable time period would result in immediate and irreparable injury to the FOUNDATION, which could not be adequately compensated by payment of money damages, and hence injunctive relief would be appropriate in favor of the FOUNDATION or its designees to prevent use of The Trademarks in such manner. 20Respondent contends that section 1.1253-2(d)(9), Proposed Income Tax Regs., 36 Fed. Reg. 1315963 (July 15, 1971), requires a different conclusion. Proposed regulations constitute a body of informed judgment on which courts may draw for guidance, but do not carry the weight of a final regulation. Bolton v. Commissioner, 694 F.2d 556">694 F.2d 556, 561 n.10 (9th Cir. 1982), affg. 77 T.C. 104">77 T.C. 104 (1981). They are considered to be nothing more than respondent's position for purposes of litigation. F.W. Woolworth Co. v. Commissioner, 54 T.C. 1233">54 T.C. 1233, 1265-1266 (1970). Section 1.1253-2(d), Proposed Income Tax Regs., supra, lists nine rights that are considered to be "significant". Six of the rights listed in the proposed regulations are identical to those listed in section 1253(b)(2). The right listed in section 1.1253-2(d)(9), Proposed Income Tax Regs., supra, is: "Any other right which permits the transferor to exercise continuing, active, and operational control over the transferee's trade or business activities." Respondent argues that active, operational control is the sine qua non of significance. We observe, however, that the proposed regulation itself456 belies respondent's conclusion. It introduces64 its list with the caveat that "The term 'significant power, right, or continuing interest' includes, but is not limited to, the following rights". See sec. 1.1253-2(d), Proposed Income Tax Regs., supra. (Emphasis added.) Respondent points to the Senate Finance Committee report and its reference to powers, rights, or interests allowing the transferor "active, operational control" and argues that, in contrast to this language, the pork and beans restriction does not grant such control to the Foundation. However, the Senate Finance Committee report also indicates that "any general control of the transferee's activities and operations by the transferor", S. Rept. 91-552, supra, 1969-3 C.B. at 555, can be significant. We believe the pork and beans restriction allows the Foundation control of the transferee's activities and operations in that it prevents petitioner from using its trademarks for a significant market that petitioner could have and would have otherwise entered. 21 This constitutes a "significant [condition] or [restriction]". See id., 1969-3 C.B. at 556. 65 We recognize that the pork and beans restriction is not coextensive with the duration of petitioner's rights in the trademarks. The restriction lasts for 20 years, whereas petitioner acquired its right, title, and interest in the trademarks in perpetuity. 2266 Section 1253(a) provides that a transfer "not be treated as a sale or exchange of a capital asset if the transferor retains any significant power, right, or continuing interest with respect to the subject matter of the franchise, trademark, or trade name." (Emphasis added.) As previously noted, the subject matter of a trademark may be broader than the "interest transferred" referred to in section 1253(b)(2). Section 1253(a) is therefore distinguishable from section 1253(b)(2). 23 Unlike section 1253(b)(2), section457 1253(a) contains no specifically enumerated criteria for determining the significance of a retained right. While the duration of a restriction may be an important factor, the ultimate determination of whether a retained right is "significant" for purposes of section 1253(a) must be based on all the facts and circumstances. In the context of petitioner's business, 20 years is a significant period. We have examined all the facts and circumstances regarding the Stokely trademarks and the pork and beans restriction and conclude that the pork and beans restriction qualifies as a "significant power, right, or continuing interest with respect to the subject matter of the * * [trademarks]" within the meaning of section 1253(a). As a result, petitioner is entitled to deductions that it claimed under section 1253(d)(2). Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. There were two trademarks using the name Stokely's Finest with registration numbers 999,795 and 277,037, respectively. Petitioner did not obtain the rights to use the trademark Stokely's, registration number 994,422, in this license agreement.↩3. U.S. Reg. Nos. 999,795 and 277,037.↩4. U.S. Reg. No. 994,422.↩5. U.S. Reg. No. 999,794.↩6. The Stokely-Van Camp's and Van Camp's trademarks and trade names were not transferred and remained in use by Quaker Oats.↩7. Petitioner remains unable to use the Stokely trademarks in Canada and has only a nonexclusive right to use them in England, Scotland, Sweden, Denmark, Norway, Finland, France, Belgium, Germany, Switzerland, and Holland. Petitioner subsequently registered the Stokely trademarks in Mexico and has begun to make sales into that country.↩8. On brief and in the notice of deficiency, respondent states that petitioner took a deduction of $ 160,950 in 1985 and in 1986. On its return, however, petitioner lists deductions for "Trademark Amortization" in the amounts of $ 148,504 and $ 158,450, respectively. Neither the petition, nor petitioner's brief suggests an amount for the deductions at issue. We note, however, that sec. 1253(d)(2)↩ mandates a 10-year ratable amortization schedule, with which a deduction of $ 158,450 would comport in the case of a single cash payment of $ 1,584,500, as was made here. This discrepancy is unexplained.9. Pursuant to the pleadings and briefs, the only issue we are asked to decide is the deductibility of the payment made to the Foundation on Nov. 15, 1984, and its effect on the aforementioned carrybacks. Despite this, respondent makes reference on brief and in the notice of deficiency to a deduction of $ 2,500 for amortization taken in petitioner's taxable year ended Mar. 31, 1984. Given that the only transaction at issue occurred well after the end of that taxable year, it is unlikely that the $ 2,500 deduction stems from that transaction. Moreover, no such deduction appears on petitioner's 1984 corporate income tax return. While petitioner did deduct $ 6,448 for "Amortization" on its corporate income tax return for that year, on its corporate income tax returns for subsequent years, petitioner labeled the deductions for the transaction at issue as "Trademark↩ Amortization". (Emphasis added.) Thus, we are confused as to the source of the $ 2,500 deduction disallowed by respondent. Petitioner, however, has failed to contest that determination.10. In some cases, the amortization period may be shorter. Sec. 1253(d)(2)(A) provides: (A) in the case of a single payment made in discharge of such principal sum, ratably over the taxable years in the period beginning with the taxable year in which the payment is made and ending with the ninth succeeding taxable year or ending with the last taxable year beginning in the period of the transfer agreement, whichever period is shorter;See Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7622(b) and (c), 103 Stat. 2377-2378 (amending sec. 1253(d)↩ to provide for capitalization and 25-year amortization of all payments over $ 100,000 in the case of transfers after Oct. 2, 1989).11. While both parties rely, to some degree, on case law decided prior to the enactment of sec. 1253, we look primarily to the provisions of the statute since sec. 1253 was enacted in large part to resolve the confusion engendered by prior case law. Tomerlin Trust, Transferee v. Commissioner, 87 T.C. 876">87 T.C. 876, 883↩ (1986).12. Petitioner also argues that the exclusive right to use the Stokely trademarks on frozen foods held by United Foods, Inc., during 1984 and 1985, and the failure of petitioner to obtain exclusive rights in Europe or any rights in Canada were significant retained powers, rights, or continuing interests. Because of our findings with respect to the 5-year right to disapprove assignments and the pork and beans restriction, we need not consider petitioner's additional arguments.↩13. That temporal limitations were contemplated in such transfers is clear from the language of sec. 1253(d)(2)(A) and (B), which refers to "the period of the transfer agreement", and sec. 1253(b)(3)↩, which describes a "renewal of a franchise, trademark, or trade name" as a "transfer".14. Webster's Third New International Dictionary (1986) defines "any" in several ways. It can mean "one or some". It can also mean "all".↩15. See Jefferson-Pilot Corp. v. Commissioner, 98 T.C. 435">98 T.C. 435, 447-450↩ (1992).16. Sec. 1253(a) provides: (a) General Rule. -- A transfer of a franchise, trademark, or trade name shall not be treated as a sale or exchange of a capital asset if the transferor retains any significant power, right, or continuing interest with respect to the subject matter↩ of the franchise, trademark, or trade name. [Emphasis added.]17. Sec. 1253(b)(2) provides in part: Significant power, right, or continuing interest. -- The term "significant power, right, or continuing interest" includes, but is not limited to, the following rights with respect to the interest transferred↩: [Emphasis added.]18. For example, a typical restaurant franchise, which encompasses trademarks and trade names, is generally granted for a specified period of years. See Canterbury v. Commissioner, 99 T.C. 223">99 T.C. 223, 243 (1992). As previously noted, sec. 1253(b)(3) defines "transfer" to include "the renewal of a franchise, trademark, or trade name" (emphasis added), and subsec. (d)(2)(A) allows for an amortization period of less than 10 years if the interest transferred was for a period of less than 10 years. See supra↩ note 13.19. A franchisor (transferor) also typically retains rights to prescribe standards of quality and service. See, e.g., Canterbury v. Commissioner, supra at 236. This is the type of power referred to in sec. 1253(b)(2)(C)↩. If, however, the franchisor retained such a right for just the first month of a 20-year franchise, it would probably be absurd to label such a right or power as "significant".20. Respondent argues that the pork and beans restriction has no significance with regard to the Foundation because the Foundation has no competitive or economic interest in the pork and beans market. As previously explained, the Foundation is a private entity controlled by Quaker Oats, which did market pork and beans.↩21. A transferor's retained right to disapprove any assignment of a trademark is clearly a retained power, right, or continuing interest pursuant to sec. 1253(b)(2)(A), even though such a right may not allow control over the details of a transferee's actual everyday business functions. The pork and beans restriction confers control over petitioner's business that is analogous to the control conferred by a right to disapprove assignment of an interest in a trademark. Sec. 1253(b)(2)(A)↩.22. Trademark rights are property under principles of the common law. Trade-Mark Cases, 100 U.S. 82">100 U.S. 82, 92 (1879). Federal registration of a trademark remains in force for 10 years (20 years during the years here at issue), 15 U.S.C. sec. 1058(a), but can be renewed. 15 U.S.C. sec. 1059↩. Respondent makes no argument that the 20-year life of the restriction renders it insignificant.23. We have previously held that the retained powers, rights, or continuing interests specifically enumerated in sec. 1253(b)(2)↩ must be coextensive in duration with the "interest transferred". The subject matter of a franchise, trademark, or trade name has no temporal limitation per se. Thus, whether a retained right in the subject matter of a trademark is significant is not necessarily determined by its duration.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622788/	VICTOR A. LAMBERT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lambert v. CommissionerDocket No. 37974.United States Board of Tax Appeals20 B.T.A. 443; 1930 BTA LEXIS 2124; July 31, 1930, Promulgated 2124 Certain payments made by one stockholder (petitioner) to another stockholder of the same corporation held not to be deductible in determining the income taxable to the petitioner. Joseph R. Little, Esq., for the petitioner. John D. Kiley, Esq., for the respondent. SEAWELL443 This proceeding involves a deficiency in income tax as determined by the Commissioner for 1923 in the amount of $860.85. Two errors were assigned in the petition, but at the hearing the error with respect to certain entertainment expenses was abandoned. This leaves as the only issue before us the question of whether a certain amount received by the petitioner from the corporation of which he was a stockholder and paid over by him to another stockholder of the same corporation is taxable to the petitioner. FINDINGS OF FACT. The petitioner is an individual with his place of residence in New York City, and is an officer and stockholder in Lambert Brothers, Jewelers, Inc.444 Prior to the formation of the aforementioned corporation, the business now carried on by it was conducted by a partnership under the name of Lambert Brothers. The names of the2125 partners and their interests in the partnership were as follows: Per centAugust V. Lambert51Robert Lissauer29Harry Lissauer20In 1920, or prior thereto, negotiations and plans were started looking to the formation of a corporation as a continuation of the business then being carried on by the partnership, but which would have Victor A. Lambert, petitioner herein, and son of August V. Lambert mentioned above, as a stockholder in addition to the then members of the partnership. After extended negotiations a contract was entered into on July 30, 1920, to which the partners and petitioner were parties and under which the corporation, Lambert Brothers, Jewelers, Inc., was formed on or about February 1, 1921. With certain limitations not here material it was agreed, under the foregoing contract, that the entire good will, trade names, and leases of the partnership should become the exclusive property of August V. Lambert, with the right on his part to dispose of the same to any member of his immediate family for such consideration as he might desire. The agreement recited that of $1,000,000 in capital stock which was to be issued by the corporation payment2126 therefor would be made as follows: One-half or $500,000 (5,000 shares) to members of the partnership on the basis of their then existing interests in the partnership in consideration for their transfer and assignment to the corporation of their respective interests in the partnership as follows: Per centSharesAugust V. Lambert512,550Robert Lissauer291,450Harry Lissauer201,000Total5,000One-fourth or $250,000 (2,500 shares) to Victor A. Lambert (petitioner) in consideration for his transfer and assignment to the corporation of the good will, trade name and leases of the partnership. And one-fourth or $250,000 (2,500 shares) to be paid for in cash as follows: SharesAugust V. Lambert1,000Robert Lissauer500Harry Lissauer500Victor A. Lambert500445 It was then provided that, after the issuance of the stock in the manner provided above, Victor A. Lambert (petitioner) would transfer, assign and set over stock to the members of the partnership as follows: SharesAugust V. Lambert450Robert Lissauer50Harry Lissauer500The foregoing agreements were carried out and the2127 stockholdings were accordingly as follows: Per centSharesAugust V. Lambert404,000Robert Lissauer202,000Harry Lissauer202,000Victor A. Lambert202,000Total10,000The contract contained a further provision to the effect that a voting trust should be established for a period of five years, to which the stockholders would transfer their stock and receive therefrom voting trust certificates. This provision was likewise carried out. The contract also provided that: The party of the fourth part [Victor A. Lambert] agrees that he will pay over and unto the party of the second part [Robert Lissauer] on or before April 1st in each year, beginning April 1st, 1922 and ending April 1st, 1926, an amount equal to the net earnings of four hundred and fifty (450) shares of the capital stock of said corporation in the preceding fiscal year, said net earnings to be computed before declaration of and payment of dividends and the payment of taxes; provided, however, that the total amount of officers' salaries to be deducted for the purpose of arriving at net earnings under the provisions of this paragraph shall be the sum of Forty thousand2128 ($40,000) Dollars per annum. A further agreement was entered into between Robert Lissauer and petitioner on October 4, 1920, to the effect that in the event of the death of Robert Lissauer prior to the expiration of the five-year period referred to above the provisions of the agreement of July 30, 1920, with respect to payments by petitioner to Robert Lissauer should become null, void and of no effect nine months after the death of the said Robert Lissauer. Of the amount received by petitioner in 1923 on account of the voting trust certificates then held by him, petitioner paid to Robert Lissauer $7,257.63 under the agreement of July 30, 1920, referred to above. In preparing his return for 1923 petitioner reported the entire amount received under the voting trust certificates as dividends 446 and then claimed a deduction on account of the amount paid to Robert Lissauer, which deduction was disallowed by the Commissioner. OPINION. SEAWELL: In effect what the petitioner here contends is that when amounts were received by him under his voting trust certificates, such amount thereof as he was required to pay over to Robert Lissauer under the contract referred to in2129 our findings was not taxable to him, but was taxable to Robert Lissauer. On a consideration of the entire record, including the evidence offered in explanation of the inducements leading up to the contract, we are unable to sustain the petitioner's contention. What, in effect, occurred was that a contract was entered into and carried out through which the petitioner (son of the partner who had a controlling interest in the partnership) was permitted to become a stockholder in a corporation which was organized to succeed the partnership. After the corporation was organized and the stock issued, we find that one partner had the same interest in the corporation that he had in the partnership, but that the interests of the petitioner's father and the other partner were decreased 11 per cent and 9 per cent, respectively, and that the petitioner then had an interest of 20 per cent. A provision in the contract under which the petitioner came into the corporation was that for a period of five years the petitioner would pay to the partner whose interest was decreased 9 per cent an amount equal to 4 1/2 per cent of the net earnings of the corporation, such net earnings to be computed before2130 the declaration and payment of dividends and the payment of taxes. The record is silent as to any relationship, by blood or otherwise, between the partner to whom the payments were to be made and the petitioner. While the contract states that stock was to be issued to the petitioner on account of a paying in on his part of the good will of the partnership, little significance can be attached to this feature, for the reason that the petitioner was not a member of the partnership and was unable to state how he came to own such good will. A reasonable interpretation of the entire situation would seem to be that the partner whose interest in the business was decreased required that some payment be made to him on account of this reduction and that what the petitioner was doing through the payments in question was nothing more than making payments on account of his becoming a stockholder in the corporation. That the payments were not made to the corporation would not seem to be material. The corporation was not a party to the contract in question and, as far as the corporation was concerned, whatever 447 dividends were declared by the corporation on the stock issued to petitioner2131 were payable to him. There is nothing in the record to show that the total amounts received by the petitioner from the corporation and reported by him on his return were other than dividends declared and paid in the usual manner. What the petitioner asks is that a deduction be allowed from these amounts because petitioner was required under a contract to make certain payments to another stockholder. We fail to see justification either for excluding any amount from the dividends as received, or for allowing a deduction on account of the payments made. In fact, under the contract, it would seem that the declaration and payment of dividends by the corporation to the petitioner are not necessary before an obligation arises on the part of the petitioner to make the payments in question. What the petitioner was required to pay each year was an amount equal to the net earnings on 450 shares of stock, computed before the declaration and payment of dividends and before the payment of taxes. Ordinarily, such an amount would certainly not be the same as annual dividend payments. If payments should be made in excess of dividends or when no dividends were paid, it would hardly be contended2132 that the amount paid when not received as a dividend constitutes an allowable deduction, and we think the same reasoning requires the disallowance of a deduction on account of any amount thus paid. The case of , on which petitioner relies, involves an entirely different situation, the decision as to which we do not consider decisive of the issue here presented. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622789/	FAITOUTE IRON & STEEL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Faitoute Iron & Steel Co. v. CommissionerDocket No. 10547.United States Board of Tax Appeals11 B.T.A. 818; 1928 BTA LEXIS 3712; April 25, 1928, Promulgated 3712 1. In 1919 petitioner purchased certain stock which it sold in 1920. Under the circumstances, it is held that petitioner suffered a deductible loss of $17,550. 2. The Commissioner's action in disallowing as a deduction from gross income for the year 1920 the amount of $8,050 as a business expense is reversed. John A. Conlin, Esq., for the petitioner. W. H. Lawder, Esq., for the respondent. LOVE 818 This proceeding is for the redetermination of a deficiency in income and profits taxes for the calendar year 1920 in the amount of $10,214.19. The petitioner alleges that, in determining the deficiency, the Commissioner erred (1) in disallowing as a deduction a loss sustained from the sale of stock in Bloomingdale Farms, Inc., and (2) in disallowing as a deduction the amount of $8,050 representing traveling expenses of the petitioner's president. FINDINGS OF FACT. The petitioner is a New Jersey corporation with its principal office and place of business as 182 Frelinghuysen Avenue, Newark. It is and was during the year 1920 and prior thereto engaged in business as a jobber and dealer of iron and steel. On May 3, 1919, petitioner3713 acquired a one-half interest in the Bloomingdale Farms, Inc., a corporation which owned and operated a live stock farm on which were bred and raised the finest Holstein-Friesian cattle. The one-half interest in Bloomingdale Farms, Inc., was represented by 325 shares of stock for which the petitioner paid $32,500. Hamilton Kean owned the remaining 325 shares for which he had paid the amount of $32,500. Subsequent to the acquisition of the stock of the Bloomingdale Farms, Inc., and during the year 1919, the petitioner and Kean each 819 invested, as additional contributions of capital, various sums in equal and like proportion for the purpose of acquiring new live stock, installing an electric-light plant, and other improvements of a capital nature. The amount contributed by the petitioner and Kean was $35,100, the share of each being $17,550. The petitioner's investment in the Bloomingdale Farms, Inc., was, therefore, $50,050. However, no additional shares of stock were issued as additional investments were made for the reason that the owners of the stock did not deem such action necessary. About September, 1919, it was discovered that the production records of the3714 Holstein-Friesian Association had been dishonestly made. This discovery resulted in the immediate depreciation of the market value of the live stock owned by Bloomingdale Farms, Inc. In view of the serious decline in the market value of the live stock and as the business of the farm did not measure up to the expectations, the petitioner in September, 1920, sold the 325 shares of stock of the Bloomingdale Farms, Inc., to Moses Faitoute, its president, for $32,500, which was a fair and reasonable price for the stock at that time. Faitoute, petitioner's president, gave his individual note to petitioner for $32,500. He was then, and at all times has been, financially able to make full payment thereof at any time demand for payment was made upon him. The note for the purchase price of the stock has always been carried by the petitioner as an asset in accounts receivable. Upon the execution of the note in the amount stated, the petitioner, by proper endorsement, transferred the stock of the Bloomingdale Farms, Inc., to Faitoute. In its return for 1920, petitioner claimed as a loss the amount of $17,500 resulting from the sale of the stock of the Bloomingdale Farms, Inc. The Commissioner, 3715 however, disallowed the amount as a deduction. During the year 1920, petitioner exported to South America through brokers, considerable iron and steel. With a view of saving brokerage charges, petitioner sent its president, Faitoute, to South America in order that he might survey trade conditions and ascertain the feasibility of dealing with South American merchants on credit. Faitoute, accompanied by his wife, visited South America and there studied trade conditions. As a result of his observations, petitioner withdrew from the export business. In making the trip Faitoute incurred expenses in the amount of $8,050 and he was some time in 1920 reimbursed in that amount by petitioner. In its return for the year 1920, petitioner claimed as a deduction for business expense the amount of $8,050 paid to Faitoute to reimburse 820 him for expenses incurred on his South American trip. Upon audit of the return, the Commissioner disallowed the deduction. OPINION. LOVE: With respect to the first contention advanced by the petitioner, the evidence shows that during the year 1919 the petitioner invested in the Bloomingdale Farms, Inc., the amount of $50,050 and that in3716 September, 1920, the 325 shares of stock representing the investment theretofore made were sold for $32,500 to Faitoute, its president. However, in view of all of the facts, it is evident that the sale was bona fide and we see no reason why the petitioner should not deduct the loss sustained. Accordingly, the Commissioner's action in disallowing as a deduction from gross income for 1920 the amount of $17,500 representing the loss sustained by reason of the sale of the stock in question is reversed. Petitioner's second contention is that it is entitled to deduct the amount of $8,050 as a business expense incurred and paid in 1920 The Commissioner takes the position, however, that so much of the expense as was incurred by Mrs. Faitoute is not deductible. It is clear that Faitoute went to South America on a mission connected with petitioner's business. It is true that his wife accompanied him. Upon his return, he was reimbursed by petitioner in the amount of $8,050 for expenses incurred on the trip. Obviously, the amount paid by petitioner was a business expense to it and as such properly deductible from gross income. Of course, the amount of $8,050 constituted gross*3717 income to Faitoute and his wife's expenses on the trip are not deductible therefrom in computing his net income. However, petitioner's right to deduct the amount in question is not altered or affected thereby. The amount in question is none the less a business expnse merely because Faitoute's wife accompanied him. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622790/	Hemenway-Johnson Furniture Co., Inc. v. Commissioner.Hemenway-Johnson Furniture Co. v. CommissionerDocket No. 13648.United States Tax Court1948 Tax Ct. Memo LEXIS 158; 7 T.C.M. (CCH) 380; T.C.M. (RIA) 48113; June 23, 1948Laurence F. Casey, Esq., 31 Nassau St., New York, N. Y., for the petitioner. Francis S. Gettle, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion The Commissioner determined deficiencies for the fiscal years ended March 31st, as follows: Declared ValueExcess Profits TaxExcess-YearIncome TaxProfits TaxDeficiencyPenalty1941$10,042.73$5,060.36$ 1,119.08$279.7719428,928.622,236.0911,293.8619431,772.351,369.3438,825.57The petitioner paid the excess profits tax deficiency and the addition to the tax for 1941159 on May 15, 1946, and claims an overpayment thereof. The respondent claims, in his amended answer, increased deficiencies for 1943 of $2,971.51 in income tax, $657.42 in declared value excess-profits tax, and $1,687.26 in excess profits tax. The issues for decision are whether the Commissioner erred in disallowing deductions claimed for 1941, 1942 and 1943 as interest on so-called debenture bonds and notes, and also, parts of deductions claimed for 1942 and 1943 as reasonable compensation paid to an officer. The addition to the tax for 1941 was imposed for failure to file an excess profits tax return, as to which the sole issue is whether the petitioner was required to file such return. At the hearing the petitioner accepted the respondent's determination that expenditures made for a gallery and removable partitions, which were claimed as deductions for 1941, were a capital outlay. On brief the respondent concedes that the cost thereof should be depreciated over the remaining life of the petitioner's lease (eight years and three months.) Findings of Fact The parties have filed a stipulation of facts which is incorporated herein by reference. Some of the stipulated facts are160 also recited hereinafter, together with our findings of fact based upon the testimony adduced at the hearing of this proceeding. The petitioner, a corporation, was originally named Hemenway, Inc. It was organized in 1931 under the laws of Louisiana for the purpose of engaging in the business of wholesaling and retailing furniture and household appliances. The petitioner now operates nine retail furniture stores and a wholesale appliance business. There is also a subsidiary finance company. The petitioner's accounts are kept on an accrual basis. All of its tax returns for the fiscal years here involved were filed with the collector of internal revenue at New Orleans, except that no excess profits tax return was filed for the year ended March 31, 1941. Frank Hemenway, Jr., has been president of the petitioner throughout its existence. He organized the petitioner to take over certain inventory and other assets of the Hemenway Furniture Co., Ltd., in which his father had been the principal stockholder. The petitioner began business at a store in Alexandria, Louisiana, and during its first year its sales were approximately $150,000. In September 1932 it opened a small store on Milam161 Street in Shreveport. The annual sales of this store were nearly $200,000 when it was moved in 1935 to a better location on Texas Street. During the first year at this location the petitioner's Shreveport business was approximately doubled. Thereafter it was the principal competitor of Shreveport's leading furniture store which was then operated by the Johnson Furniture Co. In 1937 Hemenway moved his residence from Alexandria to Shreveport. In the meanwhile the petitioner opened several branch stores. In 1938 the petitioner and the Johnson Co. engaged in extravagant promotional activities and waged a price war which resulted in a reduction of net earnings. At about the same time the petitioner was notified that it would have to pay an increase of about 400 per cent in rent for the renewal of its lease. It could not find another location in Shreveport. At this point it occurred to Hemenway that he could solve the dual problem of competition and location if he could buy out the Johnson Co. In January 1939 Hemenway approached J. R. C. Moseley, who was the vice-president, general manager and majority stockholder of the Johnson Co., to find out whether the business of that company was162 for sale. Both Moseley and F. M. Johnson, the other principal stockholder, wanted to retire from the business of the Johnson Co. After numerous preliminary discussions Moseley reported that his company would sell its accounts receivable, inventories and certain other fixed assets at face value, for cash, and that the company would lease its building to the petitioner. On that basis the petitioner would have had to pay about $584,000 in cash which it did not have and could not raise. It was agreed later that the petitioner would be given time to pay $250,000 of the total price. Even on those terms Hemenway was advised by the president of his bank in Alexandria that the petitioner's credit was too far extended to enable it to sell enough debentures to raise the required amount of cash from the public. The bank agreed, however, that it would make a demand loan of over $300,000 if the Johnson Co. would agree to take $250,000 of the purchase price in preferred stock and if the petitioner could sell an additional $100,000 worth of preferred stock. The bank refused to make the loan if the petitioner issued debentures. Moseley objected to this proposal but finally agreed to take preferred163 stock when Hemenway assured him that the deal could not be financed in any other way, and further assured him that the petitioner would give the Johnson Co. some notes to replace the preferred stock or refinance the transaction in some other satisfactory way if, as and when possible. Moseley and Johnson wanted either cash or notes, rather than preferred stock, but Hemenway's assurances had weight in closing the agreement. In the meanwhile, Hemenway prevailed upon P. H. Corbett, who held petitioner's note for $50,000, to agree that he would surrender this note and pay another $50,000 in cash for $100,000 of petitioner's preferred stock, provided that he would also receive 1,500 shares of its common stock which then had a value of $15,000. On or about June 3, 1939, the petitioner purchased all of the assets of the Johnson Co., except its real property, at a total cost of $584,115.76. On that date the petitioner adopted its present name and its charter was also amended to provide for an authorized capital 1 of 4,200 shares of 8 per cent cumulative preferred stock, each having a par value of $100 per share, as well as 50,000 shares of voting common stock and 30,000 shares of nonvoting164 common stock, both without par value. There were 684 shares of preferred stock then outstanding. On June 5, 1939, the petitioner borrowed $334,115.76 from its bank, with the understanding that not less than $200,000 would be repaid by the liquidation of inventories and accounts receivable before January 1, 1940. The petitioner then paid over the proceeds of this loan and issued 2,500 shares of its preferred stock to the Johnson Co. It also issued 1,000 shares of its preferred stock to Corbett. Moseley asked for, and received, the privilege of having the preferred stockholders elect three out of the petitioner's seven directors, and in case of default in dividend payments, the right to elect four of the directors. The record does not show the manner in which this privilege was given. He wanted a voice in the management solely in order to protect the interest of the Johnson Co., in keeping the petitioner's assets from being dissipated in dividends or salaries or bonuses. Shortly after the sale, Moseley, Johnson and Corbett became directors of the petitioner. Moseley and Corbett regularly attended the meetings of, and voted on all questions before, the board of directors; but otherwise165 the operation of the business was left in the hands of Hemenway. Moseley remained a director until 1945. The bank loan of $334,115.76 was reduced by the petitioner at various times until it was fully paid on January 5, 1940, with interest at the rate of 7 per cent. Other loans with the same bank were then repaid with the proceeds of a loan of $150,000 which the petitioner secured from Corbett. Because of his feeling of obligation to Moseley and Johnson by reason of the assurances he had given them, and because he wished, for tax purposes, to replace the preferred stock with true interest-paying obligations, Hemenway wanted to issue debentures in exchange for the petitioner's outstanding preferred stock, but did not want to do so while the bank was in a position to object. When all of the bank loans were paid off Hemenway proposed a plan for the issuance of debentures. Hemenway wished the due date to be 1970, while Moseley and Johnson wished the debentures166 to be for a shorter term. Finally, Moseley and Johnson agreed to the term proposed by Hemenway, provided that they would not lose any rights which they already had under the preferred stock. As of March 27, 1940, the petitioner's preferred stock was held as follows: August W. Berdon100 sharesF. S. Hemenway, Sr.350 sharesLouise J. Hemenway52 sharesMurdock McIntosh40 sharesAlfred Wettermark142 sharesJohnson Furniture Co.2,500 sharesP. H. Corbett1,000 sharesTotal4,184 shares Louise J. Hemenway, McIntosh, Wettermark and Corbett were among 15 persons who held voting common stock of the petitioner during the taxable years. On March 27, 1940, the petitioner's charter was amended to authorize its board of directors to issue debentures, not to exceed the sum of $420,000, in multiples of $100. The amendment provided that the debentures were to be issued on April 1, 1940, to be due and payable thirty years thereafter unless sooner called and paid, with interest at the rate of 8 per cent which was cumulative and payable before any dividend, liquidating or otherwise, could be paid on the common stock. The debentures were subordinated to the petitioner's167 other debts. If the petitioner called and paid less than the full face amount of all of the debentures, then it had to call and pay the same proportionate amount of all debentures. The amendment further provided that all general voting power would be held by the voting common stockholders, except that three of the petitioner's seven directors were to be elected by the holders of the debentures. If the petitioner failed to pay two semiannual interest payments on the debentures a cause of action should arise to collect such pastdue interest, and also, in that event, all voting power was to pass to the holders of the debentures, except that three of the seven directors then were to be elected by the voting common stockholders until the petitioner had sufficient earnings to pay all interest in default, any deficit which might have existed and two other consecutive semiannual interest payments on the debentures. Upon thirty days' notice a majority of the holders of the debentures could require the petitioner to exchange their debentures for voting common stock at book value, but the petitioner was required to issue only so many shares in exchange for debentures that, after the exchange168 was completed, the proportion of the newly issued shares was not greater than 45 per cent of the total number of shares of voting common stock. The number of shares which could be exchanged for debentures was to be fixed as of the time of the first election; the remaining debentures could, however, be exchanged later for nonvoting common stock at book value, or for one-year notes with interest at 4 per cent as determined by the petitioner. It was further provided that until such time as the debentures were called, and paid, exchanged or otherwise retired, the dividends declared and paid on common stock in any one year could not exceed 5 per cent of the book value thereof nor 25 per cent of the petitioner's net earnings for that year, but in computing net earnings the interest on debentures was to be included as expense. This restriction was not to be defeated by the payment of unreasonable salaries or bonuses but it could be waived by unanimous vote of the directors. However, a common stockholder who had exchanged his debentures for less than 25 per cent of the voting common stock could prevent such action on the part of the directors, but if he persisted the petitioner had the right169 to call and pay for his stock at book value. The board of directors was authorized to issue additional debentures upon the affirmation vote of two-thirds of the voting common stock, and two-thirds of the holders of the outstanding debentures. On or about March 31, 1940, pursuant to the amendments hereinbefore described, the petitioner issued debentures in exchange for its outstanding preferred stock. On April 1, 1940, additional debentures were issued for cash to F. S. Hemenway, Sr. ( $600), and Louise J. Hemenway ($1,000). During the fiscal years ended March 31, the debentures were held as follows: 194319411942(up to 12-31-42)August W. Berdon$ 10,000$ 10,000$ 10,000Perry H. Corbett100,000100,000109,700Louise J. Hemenway6,2006,2006,200Est. of Frank Hemenway Sr., Frank Hemenway Jr., Trustee35,60035,60035,600Johnson Furn. Co.250,000250,000250,000Murdock McIntosh4,0004,0004,000Alfred Wettermark14,200Frank Hemenway, Jr.5,200Paul Hemenway4,500Eliz. Hemenway Foote4,5004,500 On August 29, 1942, Frank Hemenway, Jr., and Paul Hemenway sold to Perry H. Corbett the debentures held by170 them as of the close of the fiscal year ended March 31, 1942. The petitioner's debentures were issued in the following form: "No. 43 $100.00 "United States of AmericaState of Louisiana Parish of Rapides "For Value Received, Hemenway-Johnson Furniture Co., Inc., hereinafter called Company, promises to pay to the recorded holder hereof, on or before the 1st day of April, 1970, the sum of ONE HUNDRED DOLLARS ($100.00), together with interest thereon at the rate of 8% per annum, payable semi-annually on the first days of October and April of each calendar year, beginning with October 1, 1940. "The Company Reserves the right to pay this indebtedness at any time upon giving five (5) days' written notice to the recorded holder hereof, its right to call this debenture being in accordance with the terms of the Company's charter. "This is one of a series of debentures of like tenor of which the aggregate amount outstanding does not exceed the sum of $420,000.00. This debenture and the others of said series are deferred in rank to the other debts of the Company and the holders of said debentures shall not be entitled to payment unless there are sufficient assets on hand to pay171 the other debts of the Company. In the event of a liquidation of the Company's affairs the holders of these debentures shall not be paid until all other creditors shall have been paid in full. "This Debenture shall be recorded in the name of the holder on the books of the Company and shall be transferred on the order of the recorded owner. All payments of principal or interest shall be made to the person in whose name this debenture is recorded on the books of the Company. "This Debenture is issued subject to the provisions of the Company's charter, all of which, by reference, are made a part of this debenture. "In Witness Whereof, Hemenway-Johnson Furniture Co., Inc., has signed these presents and has affixed its corporate seal on this the day of , A.D. 19 . "Hemenway-Johnson Furniture Co. Inc."By President "ATTEST: Secretary." The petitioner accrued on its books and paid in cash to the holders of its debentures, the sum of $33,600 during each of the fiscal years 1941 and 1942, and $26,143.33 during 1943. Those amounts were deducted as interest in the petitioner's tax returns for the respective years involved. By December 28, 1942, the petitioner had accumulated172 substantial amounts of cash because it was unable to secure merchandise in the usual quantities, its collections had increased and its cash sales had also increased in proportion to instalment sales. It had enough cash to redeem the debentures held by the Johnson Co. but it did not have enough cash to redeem all of its outstanding debentures. On or about December 31, 1942, the petitioner borrowed $200,000 from Corbett for which it gave a promissory note due April 1, 1970, with interest at 8 per cent. On the same date it redeemed $369,700 of its outstanding debentures and on January 10, 1943, it redeemed the balance of $50,300. On the latter date the petitioner borrowed $49,100 for which it gave promissory notes due April 1, 1970, with interest at 8 per cent, to Frank Hemenway, Jr., Trustee ($35,600), Elizabeth Hemenway Foote ($4,500), Louise J. Hemenway ($5,000), and Murdock McIntosh ($4,000). By the redemption of its debentures and the issuance of its promissory notes the petitioner's deferred liabilities were reduced from $420,000 to $249,100, or a reduction of $170,900. The notes, including the note given to Corbett, were in the following form: No. $ "UNITED STATES OF AMERICA173 STATE OF LOUISIANA PARISH OF RAPIDES"For Value Received, HEMENWAY JOHNSON FURNITURE CO., INC. hereinafter called Company, promises to pay or the recorded holder hereof, on or before the 1st day of April, 1970, the sum of Dollars, together with interest thereon at the rate of % per annum, payable semi-annually on the first days of October and April of each calendar year, beginning with the date hereof. "The Company reserves the right to pay this indebtedness or any portion thereof, at any time upon giving five (5) days written notice to the recorded holder hereof. "This note is deferred in rank to the other debts of the Company and the holder of this note shall not be entitled to payment unless there are sufficient assets on hand to pay the other debts of the Company. In the event of a liquidation of the Company's affairs the holder of this note shall not be paid until all other creditors shall have been paid in full. "This note shall be recorded in the name of the holder on the books of the Company and shall be transferred on the order of the recorded owner. All payments of principal or interest shall be made to the person in whose name this note is recorded on the books of174 the Company. "IN WITNESS WHEREOF, Hemenway-Johnson Furniture Co., Inc., has signed these presents and has affixed its corporate seal on this the day of 19 . "HEMENWAY JOHNSON FURNITURE CO., INC."By "ATTEST: Secretary" During the period January 10, 1943, to March 31, 1943, the petitioner paid $9,960.92 to the noteholders named hereinbefore. It deducted that amount as interest in its tax return for the fiscal year. The petitioner's net sales for the fiscal years 1937 through 1943, ended March 31, of each year, were as follows: Net Sales1937$ 715,183.171938692,354.351939611,271.3719401,443,616.4019411,756,826.3119421,997,517.3819431,385,092.23The petitioner paid dividends on its preferred stock during the fiscal years 1937 through 1940, and on its common stock during the fiscal years 1937 and 1939 through 1943. During those years officers' salaries and bonuses were paid by the petitioner and deducted on its tax returns as follows: Frank Hemenway, Jr.,Paul Hemenway,PresidentVice-PresidentOthersYearSalaryBonusSalaryBonusSalaryBonus1937$ 7,500$10,000$ 5,000$ 2,400.00$10,00019387,5006,000$ 3,202.002,0003,000.006,00019397,5004,0003,901.003,000.002,000194011,37510,0004,500.008,000.00194112,0005,625.008,250.00194211,30015,0007,708.325,00011,499.921,00019433,60015,00011,699.8515,00010,199.942,000175 From 1934 until about February 19, 1942, Frank Hemenway, Jr., had the entire responsibility for the management and financing of the petitioner's business. He set up systems of accounting and bookkeeping, inventory controls and collection methods. He personally attended all markets, did the larger part of the buying and wrote all of the advertising prior to June 1939. He negotiated all leases and contracts, and arranged for all loans and financing. He worked long hours, frequently in the evening and often on Sundays. He had the reputation of being a highly capable furniture executive. He had the task of closing out the old store in Shreveport, liquidating inventories, bringing together the personnel of the two businesses and reorganizing the petitioner's new store. During the year ended March 31, 1941, Hemenway was not paid any bonus because the petitioner had no cash available, its credit was extended and it had trouble meeting its obligations. However, the board of directors adopted the following resolution on February 14, 1941: "On motion made by J. R. C. Moseley and seconded by F. M. Johnson, a resolution was unanimously adopted declaring that it was the sense of the Board176 of Directors that the management of the corporation had done an unusually good job during the current fiscal year and that under normal circumstances, based on the profits earned, the management should be given extra remuneration in the form of an annual bonus, but that since the business is in an expanding condition necessitating the use of large amounts of borrowed money, it was deemed unwise at this time to withdraw cash for this purpose, or set up additional obligations. It was, however, resolved that this Board of Directors, or its successors, should feel and assume a moral obligation to consider the interest of the management and its work and success during the current fiscal year at a future date when, in its judgment, the bonus could be paid without jeopardizing the interest of the stockholders and/or bond holders." On February 19, 1942, Frank Hemenway, Jr., was commissioned as an officer in the U.S. Navy. He was ordered to active duty within a few days thereafter and was stationed at New Orleans until May or June 1942. He kept in close touch with the petitioner's business. He visited Alexandria and Shreveport once or twice and his brother, the petitioner's vice-president, 177 visited him at New Orleans. They telephoned and corresponded with each other regularly. When Frank was later transferred to Chicago his brother visited him there. In October 1942 he was ordered to the U.S.S. Card, a small carrier, then fitting out at Tacoma, Washington. He was aboard the Card when it departed for the East Coast via the Panama Canal about January 1, 1943. The Card did not enter into North Atlantic service until after March 31, 1943. Hemenway received detailed monthly reports and corresponded with the petitioner's officers throughout his naval service. He was released from active duty in October or November 1945, and thereupon resumed his duties with the petitioner. Before Hemenway entered the Navy he discussed his salary with the petitioner's board of directors. They knew of the issuance of an Income Tax Unit Ruling (I.T. 3417) which provided that salaries paid to employees who were absent in military or naval service but who intended to return to their employment at the conclusion of the emergency constituted allowable deductions from gross income for Federal income and excess profits tax purposes. They decided, however, to reduce Hemenway's basic salary to $3,600178 because they did not know what the petitioner would be able to pay. On December 15, 1942, the payment of a bonus was discussed by the directors. They took into consideration the services Hemenway had actually rendered in the past, for which he had not been compensated, as well as those rendered during the fiscal year 1943 to the extent hereinabove described. They authorized the payment of a bonus of $15,000. On March 8, 1945, the Bureau of Internal Revenue published a special ruling which held, in substance, as follows: "Salaries to employees absent in armed forces or in government service during present emergency. - The Bureau has reconsidered its position taken in a letter dated November 29, 1944, 443 CCH paragraph 6688, 454 CCH paragraph 6057. Upon reconsideration of the letter, and in view of the rule stated in I.T. 3417, 1940-2 CB 64, it is now held by the Bureau that salary payments to employees who are absent in the armed forces, or who are serving the government in other ways at a nominal compensation, are deductible expenses if the payments are reasonable in amount, even though the employer has not adopted the policy of making such payments to its employees179 generally. It is stated that it was not intended that I.T. 3417 should preclude inquiry into the facts in each particular case, and in any case where the payments seem to be unreasonable, or are motivated by the employee's proprietary interest in the business or by his family relationship, the deductions will be disallowed." Frank Hemenway, Jr., owned 21.86 per cent of the petitioner's outstanding voting common stock during the fiscal year 1941 and 25.89 per cent of such stock during each of the fiscal years 1942 and 1943. He did not own any of the petitioner's preferred stock. He held $5,200 of its debentures for a short time as shown hereinbefore. Reasonable compensation for the services actually rendered by Frank Hemenway, Jr., is not less than the amounts paid by the petitioner and deducted on its tax returns for the fiscal years 1942 and 1943. Opinion KERN, Judge: The first question presented for decision is whether the payments made by the petitioner on its debentures during each of the taxable years are deductible as interest under section 23 (b) of the Internal Revenue Code. The statute provides for the deduction of "interest paid or accrued within180 the taxable year on indebtedness." The question therefore, depends upon whether an indebtedness of petitioner actually existed which was evidenced by the debentures issued by it on April 1, 1940. The debentures in question were issued in exchange for the petitioner's preferred stock. The debentures contained a promise to pay a certain annual amount as "interest" regardless of the amount of the corporation's earnings; they were assignable without restriction; and they had a definite maturity date in the reasonable future. In short, although subordinated to other debts, they had most of the principal characteristics of an indebtedness. See John Kelley Co., 326 U.S. 521">326 U.S. 521; Commissioner v. H. P. Hood & Sons, Inc., 141 Fed (2d) 467. But for one clause contained in the debentures, the present controversy probably would not have arisen. That clause provided that the petitioner's charter was made a part of the debentures, by reference; and the charter gave the holders of the debentures, in addition to new rights under the debentures, certain of the rights which they had had previously held as preferred stockholders. These included the cumulative right to the annual181 payments and priority over the petitioner's common stock; and these rights were reinforced by certain limited voting privileges. The debenture holders could elect three directors out of seven, and in case of default in the annual payments of "interest" they could elect four of the directors. They had the additional right to exchange the debentures for common stock under certain conditions and within certain limits. However, the fact that these were convertible debentures is not greatly stressed in argument, and, in our opinion, is immaterial. The respondent contends that due to these charter provisions the debentures represented proprierity rights rather than an indebtedness. He also relies upon the circumstances underlying the issuance of the debentures. The real problem in this proceeding is to determine from all the facts and circumstances whether the parties intended the transaction to give rise to an indebtedness or to constitute the debenture holders proprietors of the business and assets of the corporation subject to the risks of the business. While the debentures were issued in exchange for preferred stock, most of that stock was issued as part payment for assets which182 the petitioner acquired from its principal competitor, the Johnson Co. That company did not want to be paid in preferred stock but finally agreed to accept the stock upon being assured by the petitioner's president that the deal could not be financed in any other way, and that the stock would be redeemed or exchanged, if, as and when possible. The petitioner's president wanted to secure the tax advantage of interest deductions, according to his testimony, but that advantage was not the main purpose served by the issuance of the petitioner's debentures. He also wanted to fulfill his obligation to the officers and stockholders of the Johnson Co. The entire transaction was at arm's length with both parties negotiating for their own advantage. The evidence has satisfied us that the Johnson Co. did not want to become an investor and that it accepted preferred stock in 1939 only because of the assurance hereinbefore mentioned. It wanted the purchase price of the assets to be paid by petitioner either in cash or in definite obligations of petitioner. On the other hand, the evidence is that, by force of the circumstances related in our findings, the Johnson Co. consented to become a temporary183 investor with the assurance and reasonable expectation that the stock would be redeemed in cash, or exchanged for some definite obligation of petitioner within the near future. There was, at least, a moral obligation on the part of the petitioner to redeem the stock or to issue the debentures in question. The petitioner recognized that obligation by issuing the debentures within 9 months, and by redeeming them within 3 1/2 years, after the original transaction. Cf. Palmer, Stacy-Merrill, Inc., 37 B.T.A. 530">37 B.T.A. 530, aff'd on reconsideration, 39 B.T.A. 636">39 B.T.A. 636, aff'd 111 Fed. (2d) 809, in which the sellers of certain assets accepted stock only on condition that the stock would be redeemed in cash and the dividends paid on dates certain. The difference between that case and the present one is slight. The Johnson Co. secured certain voting rights when it received the petitioner's preferred stock. The record does not show how this privilege was obtained. This privilege, however, was plainly intended to give the Johnson Co. an advantage in collecting the full face amount of the preferred stock. The primary purpose of obtaining this right was not to establish184 a proprietary interest as such, but to serve as additional security. The Johnson Co. originally had wanted to be paid in cash; later it agreed to extend credit for part of the payment; finally, it accepted preferred stock with the reservation that it would have a voice in the management for the sole purpose of protecting and securing its right to the payment of the balance of the purchase price of its assets represented by the amount of the preferred stock which it received. When the debentures were issued by the petitioner, however, the Johnson Co. was permitted to keep certain of its voting rights in return for its consent that the debentures should be for a longer term than it had thought desirable. In the light of all the circumstances underlying the issuance of the debentures, we have concluded that the voting, or the proprietary rights were not intended to be the primary characteristics of the transaction, but rather were in the nature of additional security, and they did not so detract from the other characteristics of the debentures as an indebtedness as to cause us to conclude that the debenture holders were proprietors rather than creditors of petitioner. Cf. Richmond, Fredericksburg & Potomac Railroad Co., 33 B.T.A. 895">33 B.T.A. 895, 898,185 aff'd 90 Fed. (2d) 971. See Industrial Addition Assn., 1 T.C. 378">1 T.C. 378, 385. Upon all of the facts and circumstances presented by the record, we conclude that the parties to the transaction intended to create, and actually created, an indebtedness of petitioner on April 1, 1940. It follows that the Commissioner erred in disallowing as interest the payments made on the debentures during each of the taxable years. The next question is whether the payments made by the petitioner on its promissory notes are deductible under section 23 (b). These notes did not incorporate any of the charter provisions hereinbefore mentioned, but they carried the same maturity date as the debentures. They, too, created an indebtedness of the petitioner. Accordingly, we hold that the Commissioner erred in disallowing an interest the payments made on the notes during 1943. In reaching our conclusion upon these two issues, we have not ignored the cases cited by respondent in his brief. It is a truism that each case involving the question here presented must be decided on its peculiar facts. We consider that the facts of the instant case distinguish it from those cited by respondent. 186 The next question is whether the Commissioner erred in disallowing parts of the deductions taken by the petitioner for payments of salary to its president during the taxable years 1942 and 1943. The Commissioner determined that reasonable compensation for the petitioner's president and largest stockholder, who entered the Navy on February 19, 1942, is not in excess of $24,108.33 for the fiscal year ended March 31, 1942, and not in excess of $3,600 for the fiscal year 1943. The effect of that determination is to disallow 1/12th of the compensation paid during the fiscal year 1942 and all of the bonus paid during the fiscal year 1943. The evidence is that the petitioner's president had rendered valuable services in the past for which he was not fully compensated; that his basic salary was greatly reduced when he entered the Navy; and that the compensation paid to him during the fiscal years 1942 and 1943 was in recognition of past services as well as those actually rendered during the taxable years. Hemenway, the president, was the largest stockholder but he did not own a controlling interest in the petitioner. Moreover, the Johnson Co. was in a position to keep the salaries paid187 by the petitioner at a reasonable level. And finally, the petitioner had an employer's interest in retaining Hemenway's services as an experienced and highly competent furniture executive upon his release from the Navy. Cf. Berkshire Oil Co., 9 T.C. 903">9 T.C. 903. On all the evidence we think the petitioner has demonstrated that the amounts paid to its president during the years in question were reasonable in amount. We hold that the Commissioner erred in his determinations for both years. The final question is whether the addition to the excess profits tax for the fiscal year 1941 was properly imposed under section 291 of the Internal Revenue Code. That section provides relief from delinquency penalties where the failure to file a required return is "due to reasonable cause and not due to willful neglect." The petitioner has not offered any evidence to show that its failure to file an excess profits tax return for 1941 was due to reasonable cause. Whether it was required to file such return, however, will depend upon the results of the computation under Rule 50 in accordance with the stipulation of the parties and our opinion herein. If any excess profits188 tax was due in accordance therewith, an addition to such tax would be properly imposed. Decision will be entered under Rule 50. Footnotes1. Petitioner began business in 1931 with paidin capital of $120,000 represented by 1,000 shares of 8 per cent cumulative preferred stock, each having a par value of $100 per share, and 2,000 shares of no par value common stock.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622791/	CHARLES PETTIT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BERTIE PETTIT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pettit v. CommissionerDocket Nos. 94292, 94293, 94799, 94800.United States Board of Tax Appeals41 B.T.A. 264; 1940 BTA LEXIS 1206; February 6, 1940, Promulgated 1206 Petitioners prior to the taxable years in question acquired by investment certain oil payment contracts which by assignments and conveyances contained in such contracts entitled them to certain fractional interests in the the first oil if, as, and when produced and saved from certain leases until either a certain number of barrels of oil or a certain number of dollars had been received. It was estimated that it would take from three to thirty years to realize all the oil or dollars to which petitioners were so entitled. During the taxable years in question, petitioners by virtue of their contracts and the production of oil on the leases in which they owned an interest, received certain sums of money which the respondent in his determinations has treated as gross income from the properties offset by deductions for depletion based upon cost or percentage depletion, whichever was greater. Held, that the respondent's treatment of the matter was proper, and that petitioners are not entitled to the benefit of the capital gains provisions of the applicable statutes since they did not sell or exchange any of the oil interests which they held during the taxable years involved. 1207 W. B. Harrell, Esq., Russell Allen, Esq., and Albert G. Moss, C.P.A., for the petitioners. James H. Yeatman, Esq., M. L. R. Wade, Esq., and James L. Backstrom, Esq., for the respondent. BLACK 265 The respondent has determined deficiencies in income tax against petitioners for the years 1934, 1935, and 1936, as follows: PetitionerDocket No.YearDeficiencyCharles Pettit942921934$4,552.98Do9429219352,316.07Do9479919365,523.44Bertie Pettit9429319344,552.98Do9429319352,316.07Do9480019365,523.44During the taxable years in question petitioners received certain sums of money from 31 oil payment contracts, against which sums the respondent has allowed deductions for depletion and has determined that the balance is taxable as ordinary income. Petitioners accept and claim the depletion allowances but assign as error the failure of the respondent to apply section 117 of the Revenue Acts of 1934 and 1936, respectively, relating to capital gains and losses, which application petitioners allege will result in refunds instead of deficiencies, as follows: PetitionerDocket No.YearAlleged RefundCharles Pettit942921934$1,445.18Do942921935545.37Do947991936473.54Bertie Pettit9429319341,445.18Do942931935545.37Do948001936473.541208 The respondent contends that if the Board should hold that the proceeds received by petitioners under the various oil payment contracts represent gains from the sale or exchange of capital assets, then in that event only a proportionate part of the cost of the contracts may be deducted from the amounts received in arriving at the net 266 income subject to tax, and that petitioners are not entitled to deduct depletion. Petitioners assigned another error, (h), in Docket Nos. 94292 and 94293, which the parties have stipulated "may be disregarded by the Board." On motion, the proceedings were consolidated. FINDINGS OF FACT. During the years involved petitioners were husband and wife, domiciled at Dallas in the State of Texas, and filed separate income tax returns with the collector for the second district of Texas. They kept their books and rendered their returns on the basis of cash receipts and disbursements, and all of their income and all of their allowable deductions for the years in controversy are community income and deductions, respectively. Petitioners have at divers times entered into written agreements or contracts with various persons involving oil1209 and gas leases. Copies of the contracts involved have been filed as exhibits 1 to 31, inclusive. Some of these contracts are sometimes referred to as "barrel" contracts and others as "dollar" contracts. Under the socalled barrel contracts (exhibits 1 to 9, inclusive), the sellers in exhibits 1 to 8, inclusive, granted, conveyed, and sold to petitioners, and agreed to deliver to them if, as, and when produced, a definite number of barrels of merchantable pipeline crude oil from a fractional part of the total production from the particular leased premises. Exhibit 9 was a sale by petitioners in 1931 of their interests in an oil lease for $5,000 and a reservation of 210,000 barrels of oil in place. Under the so-called dollar contracts, nine (exhibits 16, 23, 24, and 26 to 31, inclusive) were acquired direct from the owners of the working interests in the leases, and by them the sellers conveyed and sold to petitioners the proceeds of the sale of certain fractional parts of all the oil and gas in and under, and that which might be produced, saved, and sold from the wells on the leases, until petitioners had received a certain fixed sum of money from the sale of the oil. In eleven1210 of the so-called dollar contracts (exhibits 11 to 15, inclusive, 17, 19 to 22, inclusive, and 25), petitioners purchased or otherwise acquired from others their interests, or a portion of their interests, in and to various and sundry oil payments. In two of the dollar contracts (exhibits 10 and 18), petitioners had been the owners or part owners of the leases and they had assigned them to other parties, retaining the right to receive a certain sum of money payable out of a fraction of the oil produced and saved from the leases. All of the contracts are alike in that there is no personal obligation on the part of the assignors to pay petitioners the specified number of barrels of oil 267 or amounts of money out of oil, and petitioners must look to the oil, and to the oil only, for the return of their capital investment. If there were no production, no right to any payment would arise. If there were production, the right to payment would be limited to the fraction of the oil out of which the barrels of oil or sums of money were to be delivered or paid. Petitioners' exhibit No. 1 is an agreement made and entered into by and between Inland Oil Co., of Dallas, Texas, and Charles1211 Pettit of Dallas, Texas, whereby Inland Oil Co. "For and in consideration of the sum of ten dollars ($10.00) and other good and valuable consideration * * granted, sold, conveyed and hereby agrees to deliver unto Buyer, if, as and when produced and saved from the aforesaid tracts of land two hundred twenty thousand (220,000) barrels of merchantable pipe line crude oil, of forty-two (42) gallons each, out of seven-sixteenths (7/16) of the total production of oil from said lands." Said written agreement and contract contained the following paragraph: This conveyance is intended to have all of the effect of a deed to the said oil hereby conveyed to the buyer out of seven-sixteenths (7/16) of all of the oil produced and saved from the aforesaid leases herein provided, and any pipe line company or other purchasers of oil from said tract shall so treat this agreement, and it shall not be necessary for the Seller to execute to the buyer any further conveyances or other instruments to enable the Buyer to receive full performance hereof. A similar clause of conveyance is contained in the other 30 oil payment contracts, hereinbefore referred to, whether "barrel" contracts or "dollar" 1212 contracts, though not stated in all contracts, in the identical language above quoted. Neither party contends that there are any differences in substance in this respect, in the several contracts and conveyances involved in these proceedings. It is, therefore, deemed unnecessary to further set forth the language of the several contracts. There is included in the record as a part of a stipulation of facts a tabulation, which is incorporated herein by reference, listing the 31 contracts, the date of their acquisition by petitioners, the name of the lease upon which the contracts are respectively applicable, the number of barrels to be received under the barrel contracts and the amount in dollars to be received under the dollar contracts, the original cost of each contract, the amount of cost unrecovered at December 31, 1933, the proceeds received by petitioners from the sale of oil under each contract for the years 1934, 1935, and 1936, the amount of cost or percentage depletion allowed by the respondent in determining the deficiencies, the net income as determined by the respondent, and the amounts of the net income which petitioners contend is taxable under section 117 of the1213 Revenue Acts of 1934 and 1936. in some instances the tabulation varies from the contracts in 268 the matter of the number of barrels purchased or dollars to be recovered. The variances came about because, in certain instances, Charles Pettit took title in his own name to the whole amount of the barrels or dollars shown on the face of the contract, when in fact other persons were interested with him. He immediately assigned such persons their interests, and the amounts shown in the tabulation to belong to petitioners are, in fact, the amounts which petitioners acquired. A condensed summary of the tabulation is as follows: ContractsTotal collectionsDeduction for cost or percentage depletion (whichever greater)Net income as determined by respondent9 Barrel$84,457.58$23,225.83$61,231.7522 Dollar72,460.1925,427.7047,032.49Total 31156,917.7748,653.53108,264.249 Barrel$71,694.58$19,716.01$51,978.5722 Dollar27,279.3910,863.4816,415.91Total 3198,973.9730,579.4968,394.489 Barrel$80,166.28$24,970.07$55,196.2122 Dollar35,155.3214,910.1220,245.20Total 31115,321.6039,880.1975,441.411214 Prior to the acquisition of the contracts, except the contracts evidenced by exhibits 9, 10, and 18, petitioners had no interest either in the properties to which the contracts were applicable or in the oil and gas leases on the properties. The leasehold estates to which the contracts were applicable were developed by the lessees or persons other than petitioners, without cost to petitioners, and petitioners had nothing whatever to do with, and paid no part of, the cost of the drilling of the wells on the leasehold estates or the production of oil therefrom. The operators of the leasehold estates to which the contracts were applicable arranged with pipeline companies to purchase and run the oil produced from the wells thereon, and in each instance petitioners executed what is known in the oil industry as a "division order" to the oil company purchasing and running the oil from the wells. There is inserted in the record as a part of a stipulation of facts, as exhibit B, a copy of a division order executed to the Magnolia Petroleum Co. on the Pinkston lease, and this division order is typical 269 of the division orders executed by petitioners in the case of the other1215 leases with respect to which they held contracts. In their returns for the years in controversy, petitioners treated the proceeds from the sales of oil under the contracts as proceeds from the sale or exchange of capital assets. For the years 1934 and 1935 petitioners deducted from the amounts received from the sales of oil a proportionate part of the cost of each contract and reported a percentage of the balance, the percentage depending on the length of time the contract had been in force. For the year 1936 petitioners deducted from the amounts received in each instance a proportionate part of the cost of the contract or percentage depletion, whichever was greater, and reported a percentage of the balance in gross income, the percentage depending on the length of time the contracts had been held. The respondent has included in income the entire amount received under the various contracts and has allowed as deductions against such amount cost or percentage depletion, whichever is greater. The parties have stipulated in part that: If the Board should hold that the proceeds aforesaid received by Petitioners under the various "dollar" and "barrel" contracts represent gains1216 from the sale or exchange of capital assets, Respondent contends that only a proportionate part of the cost of the contracts may be deducted from the amounts received in arriving at the net income subject to tax, and that Petitioners are not entitled to deduct cost or percentage depletion, whichever is higher. There is attached hereto and made a part hereof as Exhibit "C" a tabulation showing the amount of cost which will be deductible from the amounts received in the cases of each contract for each year if the Board decides that said proceeds received under the contracts represent gain from the sale or exchange of capital assets and that the Petitioners are entitled to deduct only a proportionate part of the cost of the contracts from the amounts received in arriving at net income, as contended by the Respondent. We deem it unnecessary to incorporate this exhibit as a part of these findings of fact. It is incorporated herein by reference. Under present restrictions, it will require from three to thirty years for petitioners to receive the number of barrels of oil or the number of dollars payable out of or under their contracts. The wells out of which petitioners' oil is produced1217 are permitted to produce oil five days a week, with a maximum production of twenty-two and a fraction barrels a day. The oil that is produced from the wells is accumulated on the leases in storage tanks. At irregular intervals, depending upon the amount of storge, the oil is run from the storage tanks into the pipelines belonging to the companies that purchase it. Pettit has nothing to do with the running of this oil. The pipeline companies purchasing the oil pay him once a month for the amount he is entitled to receive under the contracts. 270 The petitions in Docket Nos. 94292 and 94293 were filed on June 9, 1938, wherein each petitioner prayed for a refund of $1,445.18 for the year 1934 and for a refund of $545.37 for the year 1935. A claim for refund for the year 1934 was filed by petitioners on February 28, 1938. Amendments to the petitions in Docket Nos. 94799 and 94800 were filed on January 30, 1939, wherein each petitioner prayed for a refund of $473.54 for the year 1936. There have been previously assessed against and paid in quarterly installments by each of the petitioners the following taxes as shown by Joint Exhibit A-1: YearAssessedPaid1934$7,451.19$7,451.1919352,913.122,913.12193610,500.1510,500.151218 OPINION. BLACK: The material provisions of section 117 of the Revenue Acts of 1934 and 1936 are identical and are set out in the margin. 1 Petitioners contend that the rights and estates held by them by virtue of the 31 oil payment contracts are "capital assets" as that term is defined in section 117(b); that the profits resulting from the sales of oil in connection with these contracts should be taken into account in computing net income at the percentages mentioned in section 117(a), depending upon the length of time the contracts have been held; and that in computing the profits resulting from the sales of oil, petitioners are entitled to have the gross proceeds received by them reduced by cost or percentage depletion, whichever is greater. The respondent, in determining the deficiencies, has reduced the gross proceeds received by petitioners by cost or percentage depletion, whichever is greater. He contends that petitioners have not sold or exchanged capital assets and are not, therefore, entitled to the benefits of section 117, and that his determinations of 271 the deficiencies are correct. He further contends as an alternative, that if the Board should hold1219 that petitioners are entitled to the benefits of section 117, then the gross proceeds received should only be reduced by a proportionate part of the cost of the contracts, and that the deductions for depletion which he has allowed should be disallowed. The parties are in agreement as to the amount of taxable net income from the sales of oil in connection with the 31 oil paymemt contracts for each of the taxable years involved under either the petitioners' contention or the respondent's alternative contention, which taxable net income, compared with the respondent's determination, is as follows: YearRespondent's determinationPetitioners' contentionRespondent's alternative1934$108,264.24$69,778.06$80,883.79193568,394.4842,998.9251,547.89193675,441.4144,349.5852,766.571220 The term "capital assets" is defined by section 117(b) to mean "property held by the taxpayer" exclusive of three classifications of property, namely, (1) stock in trade, (2) property of a kind which would properly be included in the inventory, and (3) property held primarily for sale to customers in the ordinary course of the taxpayer's trade or business. The respondent does not seriously contend that the "property held by the taxpayer" falls within any of the three classifications specifically excluded, and, under the view which we take, it will not become necessary to decide whether the "property held by the taxpayer" does or does not fall within any of the three classifications specifically excluded from the term capital assets. The respondent contends that the "property held by the taxpayer" consisted of the 31 oil payment contracts, vesting in petitioners an economic interest in a certain amount of oil in the ground, and that no part of this property, as such, was either sold or exchanged by petitioners during the taxable years in question. If any "property" were sold, the property sold was the oil itself, rather than the economic interest in the oil, and although some of1221 the oil was run into storage tanks prior to its sale, it is not petitioners' contention that any of the oil sold had been held in the storage tanks for more than one year prior to its sale. But as will be explained later in this opinion, we think the proceeds received by petitioners should be classed as "income * * * growing out of the ownership or use of or interest in * * * property" rather than "gains" from the sales of property. (Words within quotation marks are taken from section 22(a), Revenue Acts of 1934 and 1936.) 272 The respondent says in his brief, "If petitioners had sold their contracts outright, we would then agree that they were entitled to the benefit of the capital gain provisions * ." Such a situation would be controlled by , reversing . But petitioners did not sell their economic interests in the oil in place. They retained those interests, diminished, of course, from time to time by depletion, and merely enjoyed the income which those interests produced. This, we think, is the deciding factor in the case. We do not think there is any difference in substance1222 between the proceeds which petitioners received by virtue of their ownership of the several economic interests, and the bonus payments which Harmel received in . In that case Harmel was the owner in fee of Texas oil lands. He executed oil and gas leases of the lands for a stated period in return for bonus payments, aggregating $57,000 in cash, and stipulated royalties, measured by the production of oil and gas by the lessee. The question there was whether under the Revenue Act of 1924, the bonus payments of $57,000 were "gain from the sale or exchange of capital assets." The Supreme Court was of the opinion that the payments (both bonus and royalties) by the lessee to the lessor were not a conversion of capital, as upon a sale of capital assets, but were income to the lessor, like payments of rent. It did not think that the treatment of the payments as income produced the kind of hardship aimed at by the capital gains provision of the taxing act, as the abstraction of the oil from the soil was a time-consuming operation and the payments made to the lessor did not normally become payable as the result of a single transaction within1223 the taxable year, as in the case of a sale of property. It said that the statute speaks of a "sale" and that the leases there in question would not generally be described as a "sale" of the mineral content of the soil, using the term in its technical sense or as it is commonly understood. Finally, the Supreme Court noted that the court below thought that the bonus payments, as distinguished from the royalties, should be treated as capital gain, apparently because it assumed that the statute authorized a depletion allowance upon the royalties alone, an assumption which later proved to be incorrect. Cf. . It said it could see no basis for such a distinction, and that: Bonus and royalties are both consideration for the lease, and are income of the lessor. We cannot say that such payments by the lessee to the lessor, to be retained by him regardless of the production of any oil or gas, are any more to be taxed as capital gains than royalties which are measured by the actual production. Although the Harmel case was decided under the Revenue Act of 1924, there are no provisions in the Revenue Acts of 1934 and 1936 273 1224 which would require any different holding on the same set of facts as were there involved. In the instant proceedings, the proceeds received and to be received by petitioners are as much of a time-consuming operation as was the receipt of income by Harmel from his leases. Pettit testified that it would take from three to thirty years to realize all that he hoped to realize from his contracts. Furthermore, there can be no question as to petitioners' rights to depletion deductions against the gross proceeds received by them. By virtue of their 31 oil payment contracts, they acquired for a capital outlay such an economic interest in the oil as under , and , entitles them to the statutory depletion allowance. The respondent in his determinations has granted them this allowance and in his brief states, "if income is subject to depletion it cannot be classed as capital gain." There is merit in this statement, we think. Cf. . In his determination of the deficiencies in these proceedings, respondent has included the entire amount received1225 under the various contracts in gross income and has allowed, as deductions against such gross income, cost or percentage depletion, whichever is the greater. This is the same method that we directed should be used as to receipts from the Fox lease oil payment contract involved in Depletion is a deduction from gross income. The latter term includes "gains" from the sales of property and also "income * * * growing out of the ownership or use of or interest in * * * property." See sections 22(a) and 23(m) of the Revenue Acts of 1934 and 1936. The amount of the "gain" from the sale of property is determined under section 111(a) of the Revenue Acts of 1934 and 1936 and "shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) * * ." Congress certainly did not intend to reduce the "amount realized" on a sale by the "adjusted basis" and then, on top of that, allow the taxpayer a deduction for depletion. Cf. . So, if it is clearly established, as it has been in these proceedings, that petitioners are entitled to deductions for depletion, then it1226 is our opinion that the proceeds received by petitioners must be classed as "income * * * growing out of the ownership or use of or interest in * * * property" rather than "gains" from the sales of property. The Circuit Court of Appeals for the Fifth Circuit, in the case of , affirming , held that an oil well driller who was paid for his services by an assignment of an interest in the oil in place, until he received the amounts of the payments in the contracts, obtains an economic interest in the oil in place and can not deduct the costs of drilling from the payments received by him under his 274 drilling contracts, but he must recover his costs through depletion deductions. The court said the production of oil under the contract is not a sale of the partnership interest in the oil in place, but is an enjoyment of that interest. Its interest in the oil reserve, like the fee owner's, is not thereby sold, but only depleted. Neither of them can deduct cost in dealing with the income so received, but each may reduce his income by depletion. The statute, of1227 course, provides that a taxpayer who is entitled to deduct depletion may either deduct percentage depletion or depletion based on cost, whichever is the greater. Counsel for petitioners cite , and , and in their briefs say, "We think it unquestionable that under the rulings in these cases, the money received by the Pettits under their contracts is taxable under the capital gains provisions of the Revenue Acts of 1934 and 1936." The Carroll case held that, where a partnership engaged in the manufacture and sale of lumber at wholesale was the owner of extensive tracts of standing timber and sold a part of the timber to another company under an agreement that the purchaser cut and pay for the same as cut, such timber, having been held by the taxpayer for more than two years prior to sale, was a capital asset and the gain thereon was a capital gain, under the capital gains provisions of the applicable statutes. We do not think this case throws any particular light on the questions involved in the instant proceedings, as the law relating to timber is quite different from*1228 that relating to oil and gas. The Boeing case is also a timber case and was reversed by the Circuit Court of Appeals for the Ninth Circuit at 106 Fed.(2d) 305; certiorari denied, December 11, 1939. It is our opinion that the instant proceedings are controlled by , as we can not say that the proceeds received by petitioners are any more to be taxed as capital gains than were the bonus payments which were involved in that case. The respondent's determination on this issue is sustained. Decisions will be entered under Rule 50.Footnotes1. SEC. 117. CAPITAL GAINS AND LOSSES. (a) GENERAL RULE. - In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income: 100 per centum if the capital asset has been held for not more than 1 year; 80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years; 60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years; 40 percentum if the capital asset has been held for more than 5 years but not for more than 10 years; 30 per centum if the capital asset has been held for more than 10 years. (b) DEFINITION OF CAPITAL ASSETS. - For the purposes of this title, "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include 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. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622792/	HAROLD E. GRAHAM, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; MARY JO GRAHAM, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGraham v. CommissionerDocket Nos. 12159-79, 17530-80.United States Tax CourtT.C. Memo 1981-692; 1981 Tax Ct. Memo LEXIS 52; 43 T.C.M. (CCH) 15; T.C.M. (RIA) 81692; December 3, 1981. Richard Z. Kabaker, for the petitioner in docket No. 12159-79. Daniel T. Hardy, for the petitioner in docket No. 17530-80. Make D. Petersen, for the respondent. EKMANMEMORANDUM53 OPINION EKMAN, Judge: Respondent determined a deficiency of $ 996.00 in petitioner Harold E. Graham's Federal income tax for 1976. Respondent also determined a deficiency of $ 2,397.00 in petitioner Mary Jo Graham's Federal income tax for 1976. The cases were consolidated for trial. Due to concessions by the parties, the sole issues remaining for decision are: (1) whether $ 500 monthly payments made by petitioner Harold E. Graham to petitioner Mary Jo Graham are in the nature of support or alimony deductible to Harold and taxable to Mary Jo within the meaning of sections 71 and 215, I.R.C. 1954; (2) whether, in computing Harold's gain from the sale of his residence, his basis in a one-half interest in property transferred to him from Mary Jo by quitclaim deed was equal to the fair market value of that one-half interest at the time Mary Jo made the transfer; and (3) whether Mary Jo was liable for a note on which the property was pledged as collateral, and thus realized income when Harold assumed sole liability for the note. All of the facts have been stipulated and are so found. The stipulation and exhibits attached thereto are incorporated herein by this reference. The54 pertinent facts are summarized below. Petitioner Harold E. Graham (Harold) was a resident of Charlotte, North Carolina at the time his petition herein was filed. For the taxable year 1976, Harold timely filed Form 1040 as an unmarried head of household. Petitioner Mary Jo Graham (Mary Jo) was a resident of Wilmington, Delaware at the time her petition herein was filed. For the taxable year 1976, Mary Jo timely filed her individual Form 1040. Harold and Mary Jo were divorced April 26, 1976 by judicial decree. The court incorporated into its judgment a divorce settlement stipulation submitted to it by Harold and Mary Jo. They had agreed upon the stipulation after engaging in protracted negotiations by letter. Pursuant to the stipulation, Harold paid to Mary Jo $ 15,000 cash and assumed liability for all amounts owed on their Wisconsin residence. In return, Mary Jo transferred to Harold by quitclaim deed her joint tenancy interest in the home. The stipulation also provided that Harold would monthly pay to Mary Jo $ 600 as alimony, and $ 500 as part of a "full, complete and final division of the estate." In 1979, Harold made a motion to the Dane County Circuit Court for55 an order to have the $ 500 monthly payments termed "maintenance." The Court denied his motion. 1. Alimony or Property Settlement. Section 71(a) includes in a wife's gross income periodic payments received in discharge of a legal obligation which, because of the marital or family relationship, is imposed on the husband by a divorce decree. Section 215 generally allows a husband to deduct payments made to his wife which are includible in the wife's gross income under section 71. Both respondent and Mary Jo agree that the $ 1,100 payments she received monthly from Harold are periodic and are imposed or incurred under a divorce decree or written instrument incident to the divorce within the meaning of section 71. However, they contend that $ 500 of the $ 1,100 payments is part of a property settlement, and thus is the equivalent of a return of capital to Mary Jo which is neither includible in her gross income nor deductible from Harold's gross income. Thompson v. Commissioner, 522">50 T.C. 522 (1968). Harold disagrees. He argues that the payments are in the nature of support or alimony, imposed "because of the family or marital relationship" and are thus deductible56 by him pursuant to section 71. See section 1.71-1(b)(4), Income Tax Regs.; Warnack v. Commissioner, 71 T.C. 541 (1979). The character of the $ 500 payments is a question to be resolved in light of the surrounding facts and circumstances. Wright v. Commissioner, 62 T.C. 377">62 T.C. 377 (1974), affd. 543 F.2d 593">543 F.2d 593 (7th Cir. 1976); Phinney v. Mauk, 411 F.2d 1196 (5th Cir. 1969); Ryker v. Commissioner, 33 T.C. 924">33 T.C. 924 (1960). An important factor to be considered is the intent of the parties. Porter v. Commissioner, 388 F.2d 670">388 F.2d 670 (6th Cir. 1968), affg. per curiam a Memorandum Opinion of this Court. However, it should be noted that the label given to the payments by the parties, the decree, or the State law does not govern their characterization for tax purposes. Joslin v. Commissioner, 52 T.C. 231">52 T.C. 231, 236 (1969), affd. 424 F.2d 1223">424 F.2d 1223 (7th Cir. 1970); Taylor v. Campbell, 335 F.2d 841 (5th Cir. 1964). The form of the payments at issue and the respective property interests of the parties are also significant factors. Schottenstein v. Commissioner, 75 T.C. 451">75 T.C. 451 (1980).57 See also Wright v. Commissioner, supra; Weiner v. Commissioner, 61 T.C. 155">61 T.C. 155 (1973); Hesses v. Commissioner, 60 T.C. 685">60 T.C. 685 (1973), affd. without published opinion 511 F.2d 1393">511 F.2d 1393 (3d Cir. 1975), cert. denied 423 U.S. 834">423 U.S. 834 (1975). In this case, the intent of the parties and the form of the $ 500 payments give us little guidance as to how the payments should be characterized. While petitioners appear to have intended the payments to be in the nature of support, 1 the record is ambiguous and any conclusion which might be reached from this evidence would be entirely inferential. Moreover, the form of the payments looks as much like alimony as it does like a property settlement. 2 Therefore, we must examine carefully the respective property interests of petitioners at the time of the divorce to resolve the character of the $ 500 monthly payments. 58 For the payments in issue to be a property settlement, Mary Jo must have had rights in property which she relinquished in exchange for the payments. Schottenstein v. Commissioner, supra; Hesse v. Commissioner, supra. The stipulation and divorce decree imply that Mary Jo had such property rights. They state the she was to receive the $ 500 payments as part of the "division of the estate" and for "property settlement." Moreover, the divorce court refused to relabel the so-called property settlement payments as "maintenance payments" on Harold's motion because the language of those documents was plain, whether or not Mary Jo and Harold actually intended the payments to be for support. Howver, these documents and the denial of Harold's motion did not interpret Wisconsin law, but merely labelled the payments as property settlement; the labels given to the payments by the parties or the decree do not govern their characterization for tax purposes. Joslin v. Commissioner, supra; Taylor v. Campbell, supra.Thus, we must look to Wisconsin law to find what rights are involved in a divorce "property settlement.59 " Mary Jo asserts that the property settlement nature of the payments she received was established by Wis. Stat. sec. 247.26 (1976). We disagree. Under that section, a division of the estate and a transfer between the parties of title to separately owned properties is within the discretion of the divorce court. When divisions of property are discretionary, they are based upon equitable considerations, not pursuant to claims of right or entitlement.Cf. Wright v. Commissioner, supra at 391. Moreover, the section explicitly permits the divorce court to consider factors such as the parties' ages, health, abilities to support themselves, and liabilities for debt and for support of minor children in making its division. Such factors define the parties' respective needs for support, not their rights in the marital estate. The section seems to recognize implicitly that a "division of the estate" is tantamount to alimony by stating that the property award made by the court may be in lieu of, or in addition to, alimony. Wis. Stat. sec. 247.26 (1976). Furthermore, in Tonjes v. Tonjes, 24 Wis. 2d 120">24 Wis.2d 120, 125, 128 N.W.2d 446">128 N.W.2d 446 (1964), the Wisconsin Supreme60 Court stated "both alimony payments and a division of the estate [pursuant to section 247.26] are means whereby a husband meets the obligation to support his wife in the status to which she was accustomed." See also Anderson v. Anderson, 72 Wis. 2d 631">72 Wis.2d 631, 242 N.W.2d 165">242 N.W.2d 165 (1976); Lacey v. Lacey, 45 Wis. 2d 378">45 Wis.2d 378, 173 N.W.2d 142">173 N.W.2d 142 (1970). Section 71(a) covers payments which are "in the nature of or in lieu of alimony or [are] an allowance for support." Section 1.71-1(a), Income Tax Regs.In Wright v. Commissioner, supra at 392, we reviewed Wis. Stat. sec. 247.26 (1967) generally and concluded that the section "contemplates that both alimony payments and division of the estate of the husband are means of discharging the obligation of the husband * * * to support his wife." We relied in part, on United States v. Davis, 370 U.S. 65">370 U.S. 65, 70 (1962), where the Supreme Court, upon reviewing a substantively similar statutory provision, stated that: [T]he inchoate rights granted a wife in her husband's property * * * do not even remotely reach the dignity of co-ownership. * * * Her rights are not descendable, and she must survive61 him to share in his intestate estate. Upon dissolution of the marriage she shares in the property only to such extent as the court deems "reasonable." * * This is not to say it would be completely illogical to consider the shearing off of the wife's rights in her husband's property as a division of that property, but we believe the contrary to be the more reasonable construction. Regardless of the tags, Delaware seems only to place a burden on the husband's property rather than to make the wife a part owner thereof. In the present context the rights of succession and reasonable share do not differ significantly from the husband's obligations of support and alimony. Although Wright interpreted Wis. Stat. sec. 247.26 as it existed in 1967, amendments made to the statute between 1967 and 1976 did not change the substance of the section. Respondent agrees that the changes, which merely incorporate a list of specific factors the divorce court should consider in making a division, should not affect our decision, and petitioners do not argue otherwise. The conclusion in Wright, as supported by United States v. Davis, supra, controls our interpretation62 of Wis. Stat. sec. 247.26 (1976). Finally, we observe that Wisconsin is a common law jurisdiction. Property acquired during a marriage is not mutually owned, as it would be in a community property state. In the stipulation and divorce decree, Mary Jo retained her separate property acquired before and during the marriage. She had property rights in nothing else. While Mary Jo may have contributed substantially as a housewife to the maintenance of the family during the course of the marriage, she has adduced no evidence indicating the value of her contributions or relating them to the monthly $ 500 payments made to her under the decree. See Schottenstein v. Commissioner, supra at 463-464; Blate v. Commissioner, 34 T.C. 121">34 T.C. 121, 129 (1960). Faced with the foregoing evidence and decisions, we cannot help but conclude that Mary Jo had not basis for receiving $ 500 monthly, in addition to the $ 600 agreed to be alimony, other than her claim for support, nor did she relinquish rights of significant value, other than her claim for support, in order to receive the $ 500 payments. See also Schottenstein v. Commissioner, supra; 63 Hesse v. Commissioner, supra at 692. Therefore, we find that the $ 500 monthly payments were made "because of the marital or family relationship", and thus constitute support within the meaning of section 71. Therefore they are includible in Mary Jo's income pursuant to section 71; and are deductible by Harold pursuant to section 215. 2. Harold's Basis in the House. Shortly after the divorce, Harold sold the Wisconsin residence which he and Mary Jo had jointly owned. For purposes of determining his gain on the sale, he argues that his basis in the one-half interest that Marry Jo quitclaimed to him was equal to one-half the fair market value of the entire property. Respondent maintains that Harold's basis in Mary Jo's former interest was equal to the cash paid plus liabilities assumed. Harold disagrees, and asserts that he relinquished his marital claims against Mary Jo in exchange for her transfer of the property to him and thus, under United States v. Davis, supra, the value of the rights he gave up is to be presumed equal to the fair market value of the property he received. While Davis does stand for the general proposition64 Harold asserts, he has introduced no evidence to show that he had marital claims against Mary Jo or that he gave up such claims in exchange for the quitclaim deed. The divorce decree and correspondence during the divorce negotiations make clear that Harold paid Mary Jo for her interest in the house with cash and the assumption of her liabilities, not with marital rights. Thus, his basis in the property acquired is equal to what he paid for it, not its fair market value at the time of exchange. Section 1012. See also Rule 142(a), Tax Court Rules of Practice and Procedure.3.Mary Jo's Relief from Indebtedness. As mentioned above, Mary Jo quitclaimed her joint interest in the Wisconsin home to Harold. In return, he paid her $ 15,000 cash and assumed her portion of liabilities connected with the house. Mary Jo concedes that the amount she realized on the exchange equals cash received plus liabilities assumed; however, she disputes respondent's determination that she was liable on a promissory note secured by the house, and thus that she was relieved of indebtedness when Harold assumed this note. Mary Jo bears the burden of disproving respondent's determination. Rule 142(a), 65 Tax Court Rules of Practice and Procedure. She has come forth with no evidence to do so, and such evidence as is in the record supports his contentions. Because Mary Jo has not discharged her burden of proof, respondent's determination on this issue will be sustained. See Welch v. Helvering, 290 U.S. 111 (1933). Decisions will be entered under Rule 155. Footnotes1. First, the divorce negotiation correspondence evinces Mary Jo's concern that she receive at least $ 1,000 monthly so that she could maintain her lifestyle. Such maintenance payments are in the nature of support or alimony. Second, testimony given by Harold and the parties' attorneys at the Dane County Circuit Court hearing indicates that the payments in issue were stipulated as an element of the "division of the estate" merely so that they would not terminate, as would alimony, upon Mary Jo's remarriage. See Wis. Stat. Ann. sec. 247.38 (West 1957) as revised and renumbered in Wis. Stat. Ann. sec. 767.38↩ (West 1981). 2. Probative evidence of a property settlement is the payment of a fixed principal sum, which is not subject to decrease in the event of contingencies, which is secured, and the amount of which is significantly greater than support paid during divorce negotiations. Hesse v. Commissioner, 685">60 T.C. 685 (1973), affd. without published opinion 511 F.2d 1393">511 F.2d 1393 (3d Cir. 1975), cert. denied 423 U.S. 834">423 U.S. 834↩ (1975). Mary Jo was to receive a fixed principal sum which was not subject to contingencies. However, her receipt of the money was not secured. Furthermore, during the course of divorce negotiations, she demanded minimum monthly support of $ 1,000, which nearly equals the $ 1,100 payments she received pursuant to the divorce decree.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622794/	PARKERSBURG CHAIR CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Parkersburg Chair Co. v. CommissionerDocket No. 19237.United States Board of Tax Appeals13 B.T.A. 1251; 1928 BTA LEXIS 3081; October, 26, 1928, Promulgated 3081 Special assessment disallowed for lack of evidence showing inability of the Commissioner to determine invested capital. Charles F. Rhodes, Esq., for the petitioner. Byron M. Coon, Esq., for the respondent. ARUNDELL1251 ARUNDELL: Petitioner, a West Virginia corporation engaged in the manufacture and sale of chairs, brings this proceeding for the redetermination of a deficiency of $3,158.47 in income and profits taxes for the year 1920, assigning as error respondent's refusal to compute petitioner's taxes under the provisions of section 328 of the Revenue Act of 1918. The only evidence offered by petitioner was the deficiency letter and a communication addressed to it by the respondent under date of November 1, 1923, relative to its 1917 taxes, which letter contains the following statement: In accordance with the recommendation of the Committee on Appeals and Review, your invested capital as at January 1, 1917, has been decreased by a composite accrual of 25% of the book value of the depreciable assets as at that date, on account of insufficient depreciation written off in prior years, resulting in a deduction of $24,201.36 from your invested3082 capital instead of $54,651.29, as previously deducted by this office. It is petitioner's contention that the adjustment of its invested capital as of January 1, 1917, in the manner set forth in the foregoing letter, demonstrates respondent's inability to determine invested capital for 1917, and since this arbitrary adjustment is reflected in invested capital for all years thereafter, it follows that special assessment 1252 should be allowable for the taxable year 1920 under the provisions of subdivision (a) of section 327 of the Revenue Act of 1918. The evidence offered is entirely insufficient to warrant us reaching the conclusion petitioner asks. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622795/	APPEAL OF THOMAS THORKILDSEN.Thorkildsen v. CommissionerDocket No. 385.United States Board of Tax Appeals2 B.T.A. 570; 1925 BTA LEXIS 2338; September 9, 1925, Decided Submitted July 20, 1925. 2338 A loss sustained on shares of stock which became worthless during 1919 was properly deducted in that year. Theodore Martin and Lloyd W. Moultrie, Esqs., for the taxpayer. A. Calder Mackay, Esq., for the Commissioner. GRAUPNER 570 Before GRAUPNER, TRAMMELL, and PHILLIPS. This appeal involves a deficiency in income tax for the year 1919 in the amount of $37,018.22. No hearings were had in the Bureau of Internal Revenue and the contentions herein made by the taxpayer were never brought before the Commissioner for his consideration. FINDINGS OF FACT. 1. The taxpayer is a resident of the City of Los Angeles, State of California, and for more than 25 years has been engaged in the business of mining. 2. During the latter part of 1917, Franklin K. Lane, then Secretary of the Department of the Interior of the United States, requested the taxpayer to undertake the production of manganese which was then greatly needed by the Government and fabricators of steel for the manufacture of manganese steel for war uses. This request contemplated the taxpayer's engaging in the production of manganese ore at his own expense and taking such2339 profit or loss 571 as might result from the undertaking. The taxpayer assented to the request of the Secretary of the Interior and undertook the production of manganese ore on properties located near Las Vegas, Nev., and at Aquila, Ariz. 3. On April 17, 1918, the taxpayer purchased the entire capital stock, or 500,000 shares, of the Manganese Association, Inc., a Nevada corporation, and paid therefor the sum of $88,500. This corporation held leases for a three-year term on four lode claims located in Clark County, Nev., and known as "Three Kids," "Las Vegas," "Las Vegas Extension No. 1," and "Las Vegas Extension No. 2," which contained a very high grade of manganese ore. These lode claims were mining locations and not patented property. In addition to the capital stock of the Manganese Association, the taxpayer acquired from the vendors thereof, by quitclaim deed and for the same consideration, the entire interest in other adjacent manganese mining claims, known as "Three Kids Annex," "Wedge," "Connor Fraction," "Manganese," "Manganese Annex," and "Manganese Extension," and also an undivided three-quarters interest in the "Annex No. 1" and "Annex" lode mining claims, 2340 and an undivided two-thirds interest in the "Big Lode Fraction" mining claim. None of these claims were patented. 4. On April 19, 1918, the taxpayer purchased three additional manganese lode mining claims, known as "Rabbit," "Sunny Jim," and "Uncle Sam," for the sum of $3,000. These claims were unpatented and were situated in Clark County, Nev., close to the mining claims described in the preceding paragraph. On the same day he acquired the outstanding undivided one-third interest in the "Big Lode Fraction" mining claim. 5. On April 29, 1918, the taxpayer purchased seven other lode manganese mining claims, known as the "Johnson No. 1," "Johnson No. 2," "Johnson No. 3," "Johnson No. 4," "Johnson No. 5," "Johnson No. 6," and "Johnson No. 7," for the sum of $1,200. These claims were unpatented and were situated in Clark County, Nev., near to the other mining claims which the taxpayer had previously acquired. 6. During the month of May, 1918, the taxpayer paid the sum of $30,000 to the owners of the four manganese lode claims, known as "Three Kids," "Las Vegas," "Las Vegas Extension No. 1," and "Las Vegas Extension No. 2," for an option to purchase and as a part of the2341 purchase price on said claims. These were the claims upon which leases had been made and assigned to the Manganese Association and which constituted the sole mining rights of that corporation when the taxpayer acquired all of the capital stock 572 thereof. This option was taken and paid for to avoid a controversy over methods of mining which threatened to result in the cancellation of the lease, and the terms of the option required a second payment in November of 1918. The second payment was not made. 7. Immediately following the purchase of the entire issue of the capital stock of the Manganese Association on April 17, 1918, the taxpayer began operations on the property leased by the corporation and all the properties purchased by him, and continued to mine and ship ore from the claims named above until the 15th of November, 1918, at which date the steel companies refused to purchase any more manganese ore. Between these dates the taxpayer mined and shipped 9,007.23 long tons of manganese ore. After the shipment of ore ceased the taxpayer continued to work 8 or 10 men on the properties in doing assessment work on some of the claims and dismantling and salvaging the2342 mining machinery and equipment. All work ceased and the properties were vacated by the latter part of February, 1919. 8. From the time that the taxpayer acquired all of the capital stock of the Manganese Association he disregarded the corporate entity and existence in all fiscal matters. Some ore was shipped in the name of the Association, but no meetings of directors were held, no corporate office was set up, and no corporate bank account was opened. The claims held by the Association under lease and on which the taxpayer had an option to purchase were worked in conjunction with the claims acquired in his individual name as his individual enterprise. All of the claims that were sufficiently high grade to work were operated at the same time; the ore therefrom was mingled; the costs of mining and shipping ore therefrom to the railroad were expended from the same general fund and not segregated to the separate claims or groups of claims when expended; the contracts for work, equipment, and supplies were made in the taxpayer's name, and the receipts from the sales of ore were placed in the taxpayer's personal bank account. Moneys for the operation of the properties were deposited2343 by the taxpayer in his own name in the First State Bank of Las Vegas, Nev., and drawn upon by his super-intendent by checks signed "Thomas Thorkildsen, by L. D. Osborne." Moneys received from the sale of ore were deposited to the taxpayer's personal account in his bank at Los Angeles, Calif. Where the checks were made payable to the Manganese Association they were endorsed by the taxpayer's secretary, who was not an officer or employee of the Association, and deposited to the taxpayer's personal bank account in Los Angeles. 9. The expenditures and receipts of the taxpayer from April 16, 1918, to May 25, 1919, when the last of the accounts of the Las Vegas venture was paid, were as follows: Expenditures:Cost of entire issue of capital stock of Manganese Associationand 20 mining claims$122,700.00Mine equipment$1,378.40Camp equipment1,130.49Administration1,073.05Mine supplies8,222.43Camp supplies15,058.96Expenses of administration5,961.35Hauling ore (trucking)49,181.28Pay roll52,854.17Sales commission6,107.37Royalties7,592.89Dismantling175.00Auditing310.00Interest186.38Attorney's fees677.18149,908.95Total272,608.95Receipts:Boarding house12,631.97Commissary1,625.83Refund on prospecting account20.00Refund on laboratory account7.44Sales of equipment and supplies2,802.85Equipment on hand834.2717,922.36Ore sales184,953.81Total receipts202,876.17Total expenditures272,608.95Total receipts202,876.17Net loss69,732.782344 573 The taxpayer claimed a loss of $70,857.20 and set up this amount as a deduction in his income-tax return for the year 1919. The whole amount was disallowed by the Commissioner. 10. With the signing of the Armistice on November 11, 1918, the intense manufacture of articles and materials for war purposes ceased and by February 1, 1919, it was apparent that the demand for, and opportunity for sale of, manganese ore had terminated. The taxpayer therefore determined to abandon the leases held by the Manganese Association and his rights under the option to purchase the four mining claims held by the Association under lease and, also, all of the claims purchased by him. In accord with this determination he made no further payments on account of his options to purchase the four mining claims leased to the Manganese Association, ordered all work to cease on all of the mining claims, and proceeded to remove and salvage all mining equipment installed by him on the premises. 574 11. On April 3, 1919, the owners and lessors of the mining claims known as "Three Kids," "Las Vegas," "Las Vegas Extention No. 1," and "Las Vegas Extension No. 2," served notice on the2345 lessees thereof, the Manganese Association, Inc., the assignee of the lessees, and the taxpayer that the lease was "declared forfeited for noncompliance with the terms of said lease" and that none of said parties had "any interest whatever in and to any of the said mining claims or any part thereof" and had "no right whatever therein or thereto." This notice resulted from the failure of the taxpayer to operate the mining claims in accordance with the terms and requirements of the lease. The taxpayer accepted said notice of forfeiture and made no contest thereof either on his own behalf or that of the Manganese Association. This left the Association without assets or funds. The corporation was formally dissolved in the year 1921. 12. On March 2, 1919, an act of Congress entitled "An act to provide relief in cases of contracts connected with the prosecution of the war, and for other purposes," 40 Stat. 1272, was approved by the President. Section 5 of this Act authorized the Secretary of the Interior to adjust, liquidate, and pay such net losses as had been suffered by any person, firm, or corporation, by reason of producing or preparing to produce manganese and other minerals2346 in compliance with the request of the Department of the Interior and other governmental agencies. The Act, as passed, did not include losses suffered from "acquiring property for producing," such provision having been stricken from the Act during its consideration in the Senate. Shortly after the approval of the above-mentioned Act of Congress, the taxpayer presented to the War Minerals Relief Commission of the Department of the Interior a claim for the losses sustained by him in producing manganese on the aforesaid mining claims near Las Vegas. This claim was formally disallowed by the Commission on March 29, 1920. 13. The properties operated near Aquila were distinct from those described above and consisted of two groups of claims - one known as the Flynn-Gallagher group and the other as the Armour-Pittsburg group, situated, respectively, in the Vulture mining district and the Ellsworth mining district, Maricopa County, Ariz. 14. About February 13, 1918, the taxpayer purchased a lease covering the Flynn-Gallagher group of six claims for a consideration not shown by the evidence and commenced mining operations thereon. About 94 tons of ore were produced from this property2347 and sold for $2,518.10. This property was not developed beyond the prospecting stage and did not contain ore in sufficient quantity to be of commercial importance. The taxpayer discontinued operations on this 575 property about May 1, 1918, and subleased it to two men who operated it for but a short time thereafter. From such evidence as is before us, apparently, the purchase price of the lease and cost of operations by the taxpayer totaled $3,740.92 and, after deducting the amount of $2,518.10 received from the sale of ore, he suffered a loss of $1,222.82 from his operation of this group of claims. 15. About May 25, 1918, the taxpayer paid $100 for a lease of the mining claims known as the Armour-Pittsburg group. These he had begun to operate about May 1, 1918, and continued to operate until about July 1, 1918, when he entered into an agreement with one B. F. Miller, Jr., whereby Miller was to take over the active supervision of operations, erect a mill and participate thereafter in certain profits of the enterprise. Under this agreement Miller took active control of the property, mined considerable manganese ore, and constructed a mill, which was finished about November 11, 1918, and2348 operated at a loss for two or three months thereafter. 16. From such evidence as we have before us, the following is a summary of expenditures and receipts on the operation of the Armour-Pittsburg group of claims from May 1, 1918, to about January, 1919: Expenditures: Thorkildsen's operations, May 1 to June 30, 1918, including purchaseprice of lease$3,159.75Miller's operating expense, July 11 to Nov. 12, 191818,148.82Miscellaneous expense725.33Machinery purchased5,933.08Total expenditures27,966.98Receipts: Ore sales$577.19Salvage2,373.332,950.4225,016.5617. Soon after the enactment of the Act of Congress mentioned in paragraph 12 hereof, the taxpayer and Miller presented a claim for compensation of losses to the War Minerals Relief Commission of the Department of the Interior. The proportion of the amount claimed by the taxpayer as his loss was $6,090.93, and he sought allowance thereof as a deduction in his income-tax return for the year 1919. The Commissioner disallowed this deduction. On or about May 5, 1921, the Secretary of the Interior allowed the claim of the taxpayer and Miller in the amount of2349 $19,951.88, and the taxpayer received therefrom as his share $5,485.45. This amount of $5,485.45 was reported by the taxpayer as income in his tax return for the year 1921. 576 DECISION. The deficiency should be computed in accordance with the following opinion. Final determination of the Board will be settled on consent or on 15 days' notice. OPINION. GRAUPNER: The taxpayer contends that the Commissioner committed error in refusing to allow as losses deductible from income (a) the sum of $70,857.20 which the taxpayer claimed as a loss resulting from mining operations near Las Vegas, Nev., and (b) the sum of $6,090.63 claimed as a loss sustained through mining operations near Aquila, Ariz. The Commissioner asserts that the losses claimed are not deductible items under the provisions of section 214(a) of the Revenue Act of 1918, because (a) the losses sustained on the Las Vegas operations were not those of the taxpayer but of the Manganese Association, Inc., and (b) that if the taxpayer sustained any losses on the two ventures they were not sustained during the year 1919. The two assigned errors involve such distinctly different conditions that2350 they must be separately discussed. At the time of the purchase of the 500,000 shares of stock and the mining claims, described in paragraph 3 of the findings of fact, on April 17, 1918, the corporation had no assets, except an assignment of a lease for a period of three years on four mining claims. The corporation owned no machinery or equipment for operating the mines, and it had no funds. The taxpayer disregarded the corporate entity and placed his personal funds directly in the operation of the mining claims. Because the operating funds were used indiscriminately for operating the claims leased to the corporation and the claims owned by the taxpayer without any segregation and because the ore mined from various claims was intermingled without segregation, there is no way in which we can allocate any share of the moneys advanced for operating expense or received from sale of ore to the corporation or to any particular claim. The taxpayer intended the whole project to be his and, because he owned all the corporation's stock, considered all rights of the Manganese Association merged into his individual venture. Whether the stock of the Manganese Association was worthless, when2351 it became worthless, and, if worthless, when the taxpayer was entitled to claim his loss, are the questions which must be decided by the Board. At no time after the acquisition of the stock by the taxpayer did the Manganese Association have any assets, except the leases to the four mining claims. When the taxpayer abandoned the lease and the lease was declared forfeited on April 3, 1919, the corporation ceased 577 to do business and to have any assets or claim to any assets. It had nothing with which to do business or to give the stock any worth, and there could be no market for its sale. Therefore, during 1919, the taxpayer was left with certificates representing 500,000 shares which had no value and no market. The stock became worthless during that year, and the taxpayer was entitled to deduct his loss thereon, unless there existed some claim upon which he could recover. . The taxpayer filed a claim with the War Minerals Relief Commission during 1919, in which he sought to recover from the Government the loss he had sustained on the Las Vegas property. As the receipt from sales of manganese ore greatly exceeded2352 the cost of mining and producing, his claim for a loss on this venture could only be predicated upon moneys expended for purchases of properties and mining rights. As a matter of fact, his profits from ore sales recompensed the taxpayer for all expenditures for purchasing mining claims and a portion of the cost of the stock of the Manganese Association. Therefore, the taxpayer's only claim for loss rested upon the unrecouped balance of $69,732.78 paid for the stock of the Manganese Association, and this stock was purchased for no other purpose than to use the mining rights of the corporation. His claim against the Government for such a loss was without merit, and there could be no chance of recovery thereon. Section 5 of the Act of March 2, 1919, authorized the Secretary of the Interior "to adjust, liquidate, and pay such net losses as have been suffered by any person, firm, or corporation, by reason of producing or preparing to produce, either manganese, chrome, pyrites, or tungsten in compliance with the request or demand of the Department of the Interior," etc. On its introduction in Congress, section 5 of the bill contained this further provision: "or acquiring property2353 for producing." This clause was stricken from the bill while it was under consideration in the Senate on January 28, 1919. Senator Smoot objected to the provision in the following language: I want to call the attention of the Senator from Nevada to the words "or acquiring property for producing." It seems to me that is going too far. I think that where a man has purchased a piece of property for producing these metals, we should not authorize the Secretary of the Treasury to go into the question as to what he paid and whether he lost upon the purchase price of that property because of the fact that the war closed sooner than he anticipated. I believe that is going altogether too far. I will ask the Senator if it would not be very much better to strike out the words "or acquiring property for producing"? The chairman of the Senate Committee on Mines and Mining in charge of the bill replied: "I will consent to that, Mr. President." Whereupon, the provision was stricken from the bill. 57 Cong. Rec., Pt. 3, p. 2213. 578 The taxpayer's claim did not rest upon a loss suffered "by reason of producing or preparing to produce," but upon a loss resulting from "acquiring property2354 for producing." He was without right under the law and therefore should not be prejudiced from deducting his loss when it was sustained in 1919 by the fact that he had filed a claim without merit. He should not be compelled to await a certain adverse decision before claiming his deduction. We are, therefore, of the opinion that the taxpayer is entitled to a deduction for his loss in the amount of $88,500 on the stock in 1919. What was the purchase price or market value of the nine mining claims named in paragraph 3 of the findings of fact and included in the $88,500 paid for the entire issue of the capital stock of the Association can not be determined from the evidence, but it, as well as the $3,000 paid for the three claims described in paragraph 4 of the findings, and the $1,200 paid for the seven claims described in paragraph 5 of the findings, became a loss immediately upon the execution of the taxpayer's intention to abandon those claims, which he did in February of 1919. A mining claim may be abandoned, as was said in , and adopted in 2355 , and : In determining whether one has abandoned his property or rights, the intention is the first and paramount object of inquiry; and there can be no strict abandonment of property without the intention to do so. * * Abandonment may be completed the very instant the miner leaves his claim, for time is not an essential element of abandonment; the moment the intention to abandon and the relinquishment of possession unite, the abandonment is complete. The $30,000 paid by the taxpayer in May of 1918 for an option to purchase the four claims under lease to the Association became a loss in 1919 when he abandoned operation of the mines under lease and permitted the lease to be forfeited without intention to purchase the claims. This was the final act of abandonment of his rights to purchase and use the property and the meeting of intention and fact on abandonment. 18 R.C.L. 1167. Thus the taxpayer's actual loss in 1919 was as follows: On stock and mining claims purchased as described in findings 3$88,500.00On mining claims purchased as described in finding 43,000.00On mining claims purchased as described in finding 51,200.00On option to purchase described in finding 630,000.00Total122,700.002356 Whether the taxpayer had any income from the operation of the mines during the month of January and the early part of February, 1919, we can not determine from the evidence at hand, there being no proof and no copy of the income-tax return before us. 579 Regarding the claim for losses on the Aquila properties, it would appear that those losses were sustained in 1921, at which time final settlement was made with the Government and the losses set at $1,828.30. ARUNDELL not participating.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622797/	IDA JOY SHERESH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSheresh v. CommissionerDocket No. 10155-81.United States Tax CourtT.C. Memo 1982-543; 1982 Tax Ct. Memo LEXIS 204; 44 T.C.M. (CCH) 1173; T.C.M. (RIA) 82543; September 21, 1982. Ida Joy Sheresh, pro se. William H. Quealy, Jr., for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined a deficiency in petitioner's income tax for the calendar year 1977 in the amount of $434. The issues for decision are (1) whether the deficiency determined by respondent is invalid because petitioner's return was selected for examination on an improper basis; and (2) whether petitioner was subjected to an unnecessary examination or an improper second inspection of her books and records and, if so, does this fact cause the deficiency as determined by respondent to be invalid. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner, who resided in Chula Vista, California, at the time her petition in this205 case was filed, filed a 1977 Federal income tax return Form 1040 with the Internal Revenue Service Center, Fresno, California, on or before April 14, 1978, reporting income and deductions for the year 1977 on the cash basis. On or about April 13, 1978, petitioner filed a document entitled "Corrected" 1977 Federal income tax return Form 1040 with the Internal Revenue Service. On her return as originally filed, petitioner showed "Cash contributions for which you have receipts, cancelled checks or other written evidence" of $180; two other amounts of cash contributions with donees listed, one of $60 and one of $61; with total cash contributions of $301. On this return, the date of petitioner's signature was shown as February 2, 1978. On the "Corrected" return filed by petitioner, the date of her signature was shown as March 26, 1978. On the corrected return, petitioner claimed contributions of $150 marked "See Original--1/2" and in addition claimed cash contributions of $1,770 with the explanation "Cash contribution of wife's separate property," making a total of cash contributions claimed of $1,920. Under date of March 27, 1978, respondent sent to petitioner a notice of "Correction206 to Arithmetic" regarding the computation on her return for the calendar year 1977. The copy of the notice sent to petitioner was returned by petitioner to the Internal Revenue Service Center on or about April 13, 1978, with a handwritten notation which stated: I made no error. You just can't Read!! Joy Sheresh. Send me a letter explaining why you did this and apologize. Under date of August 11, 1978, petitioner received a letter from the chief of the Service Center Audit Division which stated that-- Part of your refund for the year shown above has been delayed due to a review of your return. This review has been completed and if you owe no other taxes, we will mail the remainder of your refund as soon as possible within the next six weeks. The letter further stated that if petitioner wished to call, she could contact the number and the person shown above. Petitioner called the person whose name was shown as the person to contact on the letter and was referred to a Mr. Domer, who told petitioner that her return was being audited. Petitioner asked why no letter was sent to her and Mr. Domer stated that the letter she had received with respect to the review of her return207 was sufficient, and that she would be notified when the audit was completed. Petitioner called again on October 11, 1978, and was told that Mr. Domer was no longer with the Internal Revenue Service but that she would be getting her check. Petitioner did receive the check. Under date of March 12, 1980, petitioner received a letter from the Internal Revenue Service office in Riverside, California, which informed her that her Federal income tax return for the calendar year 1977 was being examined. This letter requested that she telephone the number given above within 10 days to set up an appointment at a time convenient with her. An explanation was made of the need to see petitioner's records and she was requested to bring records to substantiate the claimed contributions of "Cash Contribution of wife's Separate Property." Petitioner wrote a letter to the Internal Revenue Service, asking why she was being audited and why the letter sent to her with respect to the audit of her return was signed by the district director, and what criteria had been used to select her return, and for other information which she stated she wanted under the Freedom of Information Act. Thereafter, a208 number of other letters were exchanged between petitioner and representatives of the Internal Revenue Service. Under date of August 20, 1980, petitioner received a letter from the Internal Revenue agent who had previously been indicated as the agent to whom her return was assigned for audit stating that-- This will be the last attempt I will make to obtain the documents substantiating the contribution claimed per your individual income tax return. * * * The letter went on to say that if the writer had not heard from petitioner within 10 days the case would be forwarded as an unagreed case to Los Angeles. The letter further explained that the district director was not involved in the audit examination but that letters sent under his signature were merely form letters used by Revenue agents. The letter further pointed out that the writer believed the request of substantiation of the claimed charitable deduction was reasonable and that he had been attempting to obtain the information since March 12, 1980. On February 27, 1981, the statutory notice which forms the basis of the petition in this case was sent to petitioner. After the filing of the petition, petitioner was offered209 a conference by the Appeals Division of respondent's office. Petitioner did not produce any records, receipts or other evidence to any representative of the Internal Revenue Service to substantiate her claim for the charitable deduction of $1,770 for the year 1977. Petitioner produced no such substantiation at the trial of this case, relying exclusively on her claim of discrimination in selecting her return for audit and her claim of an unnecessary examination or that an improper second inspection was made of her records. Petitioner was not sent a "30 day" letter prior to the the issuance by respondent of the statutory notice of deficiency on February 27, 1981. The only adjustment made by respondent to petitioner's return as filed in the statutory notice of deficiency was a disallowance of $1,770 of her claimed charitable contributions, with the explanation that she had not established that she was entitled to any charitable contribution deductions in excess of $150. OPINION Petitioner, at the trial and in the brief she filed at the trial, argued that her return was improperly selected for examination because her husband was an employee of the Internal Revenue Service. Petitioner210 argued that there existed no other reason for selecting her return. It was her position that returns could be selected for examination only if selected based on a computer computation, a weighted score, or a random sample. She states that respondent has not proved to her that her return was selected in this manner. Without going into all of the details of petitioner's argument, there is simply no evidence whatsoever in this record that petitioner's return was improperly selected for audit. The Court so informed petitioner at the trial and suggested to her that if she had evidence to substantiate the claimed charitable deduction, she should produce it and substantiate the claimed deduction. Petitioner refused to do this because of her firm belief that her return was selected for examination only because her husband was an employee of the Internal Revenue Service. We therefore conclude that petitioner has totally failed to show any impropriety in the selection of her return for audit. Cf. Karme v. Commissioner,673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982). Petitioner does not state on what basis she contends that her return was improperly subjected to a further examination. 211 Apparently, from certain statements she made at the trial of this case and a statement in the brief she filed referring to "Internal Revenue Code 7605(B)," petitioner is relying on section 7605(b)1 in support of her contention. Section 7605(b) places restrictions with respect to unnecessary examinations and with respect to a second inspection of a taxpayer's books of account. Specifically, this section provides that-- No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer's books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary. It is not clear whether petitioner is stating that after she received her refund check any further examination of her return was unnecessary, or that a second inspection was made of her books of account. Clearly, no inspection at all was ever made of petitioner's212 books and records since in the audit to check the correctness of her return as filed prior to issuing the refund check, no request was made of her for any books and records. She was requested to produce substantiation for charitable deductions claimed when her return was later being examined, but refused to do so. See Grossman v. Commissioner,74 T.C. 1147">74 T.C. 1147, 1155-1156 (1980). If petitioner is contending that it was an unnecessary request on the part of respondent that she substantiate claimed cash deductions of $1,770, she has certainly failed to show why requiring substantiation of a relatively large claimed cash contribution of separate property of the wife was unnecessary. As we pointed out in Collins v. Commissioner,61 T.C. 693">61 T.C. 693, 699 (1974), it is clear from the legislative history of section 7605(b) that an investigation is not unnecessary if it may contribute to the accomplishment of any of the purposes for which respondent is authorized by statute to make inquiries. Requiring substantiation of claimed cash contributions is within the legitimate power of respondent's investigative authority. Finally, petitioner seems to contend that her213 rights were in some way violated since she was not issued a preliminary notice or given an opportunity to appear before the Appeals Division of respondent's office prior to the issuance of the statutory notice. From this record, it would appear that no useful purpose would have been served by any further notices to petitioner or by referring the examination of her return for consideration by the Appeals Division prior to issuing the deficiency notice. However, in any event, as we pointed out in Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 327-328 (1974), generally this Court will not look behind a deficiency notice to determine the propriety of respondent's motive or the administrative policy involved in making the determination. We then stated: Thus, we will not look into respondent's alleged failure to issue a 30-day letter to the petitioners or to afford them a conference before the Appellate Division. * * The underlying rationale for the foregoing is the fact that a trial before the Tax Court is a proceeding de novo; our determination as to a petitioner's tax liability must be based on the merits of the case and not any previous record developed214 at the administrative level. * * In the instant case petitioner was informed several times during the trial of her case that if she had substantiation for her claimed cash charitable contributions, she should bring it before the Court and let the Court rule on the merits of her case. Being fully informed that this would be necessary to show error in respondent's determination, petitioner chose to rely on her claims of discrimination, further examination and a second inspection of her records. Decision will be entered for the respondent.Footnotes1. 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.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622798/	Clarence N. Benson v. Commissioner. Dorothy A. Benson v. Commissioner.Benson v. CommissionerDocket Nos. 18752, 18753.United States Tax Court1950 Tax Ct. Memo LEXIS 288; 9 T.C.M. (CCH) 67; T.C.M. (RIA) 50021; January 27, 1950288 Amount of purchases for 1942 determined. The evidence failing to show that total receipts were not understated in the returns or that the amount of total receipts determined by the Commissioner was arbitrary and excessive, the amount of total receipts of restaurant business for 1943 and 1944, respectively, determined by the Commissioner, is approved. Joseph May, Esq., for the petitioners. Sheldon V. Ekman, Esq., for the respondent. VAN FOSSAN Memorandum Opinion VAN FOSSAN, Judge: The Commissioner determined deficiencies in income tax as follows: Docket No.YearAmount187521943$15,320.0719442,418.351875319442,415.31The questions involved are whether the Commissioner erred (1) by increasing business income for 1942 by $22,491.97 by reducing the amount of reported purchases in that amount, and (2) by increasing business income for 1943 and 1944 by the amounts of $26,744.99 and $14.934.63, respectively, by increasing reported sales in such amounts, the amount of sales in each year having been determined by the Commissioner by a 100 per cent and a 200 per cent mark-up of purchases of food and of purchases of beer and liquor, 289 respectively. [The Facts] The petitioners are husband and wife. Clarence N. Benson, hereinafter referred to as the petitioner, during 1942 and 1943 operated as sole proprietor a restaurant, called "The Dog Club", in Buffalo, New York. The Dog Club was opened in November, 1941. During the year 1944 the restaurant business was owned and operated by petitioner and his wife as a partnership. The petitioner's wife has been in the restaurant business for 12 years and was manager of The Dog Club. The returns for the years involved were filed with the collector for the 28th district of New York. The 1942 and 1943 returns were stated to have been made on the cash basis. After an examination of petitioner's income tax return for 1942 and an investigation of his books and records by a revenue agent, no changes were made by the Commissioner in any of the figures shown in petitioner's 1942 return, except that the amount of purchases of $59,088.30 reported in "Schedule H - Profit (or Loss) from Business or Profession" was reduced by the amount of $22,491.97, based upon the revenue agent's report that petitioner's records disclosed purchases only in the amount of $36,596.33, as follows: 290 By CheckBy CashTotalLiquor and Beer$17,868.95$ 1,770.50$19,639.45Food5,507.319,856.9415,364.25Misc. - Soft drinks, tobacco, etc.217.131,375.501,592.63Total$23,593.39$13,002.94$36,596.33 This adjustment resulted in an increase in reported net profit derived from the restaurant business of $3,370.23 to $25,862.20 and an increase in net income from $3,285.23 to $25,777.20. Petitioner's financial records for 1942 consisted of several so-called daybooks, which contained entries of daily cash expenditures, business and personal, and also some entries in memo form of checks issued in 1942; cancelled checks; bills; invoices; cash reconciliation sheets on which were recorded total income for the day, amounts paid out, and a net figure to balance cash at the end of the day; and the worksheet of an accountant employed by petitioner to prepare his 1942 income tax return as the bookkeeper theretofore employed by petitioner fied in the latter part of December, 1942. The accounant's worksheet contained a detailed summary of checks issued and of cash expenditures shown in the daybooks in various classifications of expenses and merchandise291 purchases. An examination of the financial records of petitioner by another accountant employed by him in 1946 disclosed that during 1942 checks were issued by petitioner for purchases of food, liquor, wine, beer, soft drinks, tobacco and other merchandise in the aggregate amount of $27,409.87 and that the daybooks disclosed additional purchases in cash during 1942 in the aggregate amount of $17,347.11, of which the amount of $11,241.76 was substantiated by bills or invoices, and the amount of $6,105.35 by penciled memo notations thereof on daily cash reconciliation sheets disclosing either the vendor's name or the type of merchandise purchased. These notations were made by petitioner's wife in the ordinary course of business at the time the purchases were made. [Opinion] It is argued by the respondent that the petitioner is not entitled to a deduction for purchases in excess of $40,412.81 consisting of the purchases paid for by check of $27,409.87 and the cash purchases of $13,002.94, originally allowed by him. In his brief he concedes the amount of $40,412.81 to be allowable as purchases. Although the petitioner concedes that his records for 1942 were improperly kept, 292 he contends that upon the evidence adduced the amount of $44,756.98, consisting of the purchases paid for by check and the cash purchases of $17,347.11 as recorded in the daybooks, is allowable. It is true that some of the cash purchases were not evidence by bills or invoices. However, those purchases were supported by notations thereof, showing either the vendor or the type of merchandise purchased, made in the daily cash reconciliation sheets in the ordinary course of business. The testimony of petitioner's wife that she often paid out money for purchases of food, liquor and other items and would "put it on my regular pay out slip that I had in the cash register every day" is undisputed. We find that the amount of purchases allowable is $44,756.98. It is also contended by petitioner that he is entitled to the deduction of $9,868.77, overhead expenses, and $3,616.50, amortization of leasehold improvements, which amounts had been erroneously included in the amount reported as purchases. The respondent argues that the amount of $9,868.77 is not deductible as overhead expense because the petitioner has failed to prove that such an amount was actually spent. The accountant employed293 by petitioner in 1946 testified in substance that his examination of petitioner's records disclosed that the accountant who had prepared petitioner's return for 1942 had included in reported purchases the amount of $9,868.77, representing cash expenditures entered in the daybooks properly classifiable and deductible as overhead expenses; that there was a considerable amount of money expended in cash for overhead which would appear ordinary and necessary in the normal course of the business; that the accountant who had prepared the 1942 return had included in purchases all overhead items in the daybooks and that other items of overhead paid by check were separately designated as overhead and deducted as overhead expenses in the return. In the 1942 return, in computing the net profits derived from the restaurant business, deductions covering overhead expenses of $5,753.57 and $241.09, or a total of $5,994.66, were claimed and allowed by the Commissioner. Thus the petitioner now claims a deduction for overhead expenses in the total amount of $15,763.43 for 1942. In the 1943 return the deduction for overhead expenses, other than "Leasehold Expense", aggregated $11,776.57, and in the294 1944 return $7,606.68. These deductions were allowed by the Commissioner. The burden of proof rested upon petitioner to show that he was entitled to the deduction of overhead expenses of $9,868.77 in addition to the amount of $5,994.66 claimed and allowed by the Commissioner. He has failed to discharge that burden. The testimony of the accountant that the amount of $9,868.77 represented allowable overhead items in addition to the amounts claimed is a conclusion unsupported by any evidence of facts upon which the conclusion was based. There is no evidence whatever as to the nature or character of the various items included in the amount. It is the duty of this Court to determine from the facts presented by the evidence whether or not the various items included in the amount claimed constituted allowable overhead expenses. This we are unable to do. It follows that the amount of $9,868.77 is not allowable as a deduction. As to the $3,616.50 item, the only evidence is the testimony of the accountant, who testified in substance that the accountant who prepared the 1942 return included this item in reported purchases, that he (the witness) considered this an error, but nevertheless an295 item of admissible overhead on a tax return as it was one-fifth of leasehold improvements totalling some $18,000, which were spread over a five year period based on a lease, which lease he had been told was a five year lease, and that no allowance had been made for the item by the respondent in computing the deficiency for 1942. No deduction in the amount of $3,616.50 was claimed in the 1943 return or in the 1944 returns. In the 1943 return a deduction of $3,215.83 designated as "Leasehold Expense" was claimed. In each of the 1944 returns a deduction was claimed designated as "Leasehold Expense" in the amount of $1,607.92, or a total of $3,215.84. There is no explanation of these items in the returns. These deductions were allowed by the Commissioner. The restaurant was opened in November, 1941. Presumably the so-called improvements were made prior to such opening. The accountant's testimony apparently was based on his examination of the records for 1942. There is no evidence showing that he examined the records for 1941 or that the so-called improvements were improvements in fact. The lease is not in evidence. As to this item also, the petitioner has not met his burden of proof. 296 The claimed deduction, therefore, may not be allowed. The total of the allowable purchases of $44,756.98, the claimed overhead of $9,868.77 and the claimed leasehold improvements of $3,616.50 is $58,242.25. This leaves $846.05 of the reported purchases of $59,088.30 unaccounted for. The petitioner in his brief admits additional income beyond that shown in his return to the extent of $846.05. During the years 1943 and 1944 the records of the restaurant business were kept more efficiently. In the 1943 return, total receipts reported were $92,600.64. The inventories and merchandise purchased were reported as follows: Inventory at beginning of year atcost$ 2,140.00Merchandise bought for sale52,657.3054,797.30Less inventory at end of year atcost900.00Total cost of merchandise sold$53,897.30Total receipts as reported were not accepted upon examination of the records of petitioner and the selling price for 1943 was determined by the revenue agent as follows: CostSellingItemPer BooksMark-upPriceFood$22,775.63100%$ 44,551.26Misc. (soft drinks, tobacco, etc.)7,425.32(cost)7,425.32Beer and Liquor: Invt. Jan. 1, 1943$ 2,140.00Purchases21,216.35Total23,356.35Less Invt. Dec. 31, 1943900.00Cost of beer and liquor sold22,456.35200%67,369.05$52,657.30Total sales119,345.63Sales per return92,600.64Increase in income$ 26,744.99297 This adjustment resulted in an increase in taxable income for 1943 from $4,278.57, as reported, to $31,023.56. The Commissioner's computation of selling price for 1944 is not in evidence. It appears. however, that a similar mark-up of cost to determine selling price was made by the Commissioner in 1944 resulting in an increase of selling price and income of the business for 1944 in the amount of $14,934.63, $7,467.32 thereof being included in the taxable income of each petitioner. During 1943 and 1944 the number of persons employed by the petitioner, or petitioner and his wife, in the operation of the restaurant varied from 12 to 14, but generally they had 12 employees. These employees were allowed two meals a day. The cost of the food consumed by the employees was about $1.50 a day for each employee, or approximately $6,000 a year on a basis of $10 a week for 12 employees over a period of 50 weeks. Petitioner's wife ate at the restaurant and petitioner ate there occasionally. It was the custom in the conduct of the business to give free drinks to certain customers and also to give bottles of liquor as gifts to certain customers, particularly during the Christmas holidays. 298 The cost of the liquor in bottles given to customers as gifts was about $900 a year. The petitioners contend that the determination of selling price or gross receipts by the Commissioner by a 100 per cent mark-up of the cost of food and a 200 per cent mark-up of the cost of liquor was arbitrary since he entirely disregarded the fact that employees ate two meals a day at the restaurant, and the common practice of courtesy drinks and gifts of liquor, thus including in selling price or gross receipts at least $12,000 for food and $2,700 for liquor for which there were no cash receipts whatever. The respondent seeks to justify the mark-up of costs to determine selling price on the ground that loans in excess of reported taxable income were paid by petitioners indicating that sales were understated and that prices charged for meals and drinks were high. Loans in the aggregate amount of $5,172 were paid in 1943. There is no evidence that any loans were paid in 1944. The reported taxable income of petitioner for 1943 was $4,278.57 and the aggregate of the reported taxable income of petitioner and his wife in 1944 was $7,152.46. The fact that loans are paid in excess of taxable income299 by itself does not establish that sales are understated. Some deductions allowable in computing taxable income, such as depreciation and amortization of leasehold improvements, do not represent cash expenditures and the amounts of such deductions are available to the taxpayer for payment of loans or other items. Furthermore, although petitioner's wife testified that she and her husband lived on their income, there is no evidence that all of the income was required for their living expenses. The record leaves much to be desired and is very unsatisfactory. This may be due in part to the destruction of petitioners' records by fire, it appearing from a statement of respondent's counsel at the hearing that the Dog Club was destroyed by fire a few weeks prior to the hearing. However, no evidence to that effect was adduced by petitioners. The petitioners did not attempt to show the correct amount of sales or gross receipts of the restaurant business other than to suggest a stipulation to counsel for respondent at the hearing that the gross receipts reported in the 1943 and 1944 returns were the totals of the cash register tapes, which counsel for respondent refused to do for lack of knowledge. 300 The report of the revenue agent discloses cash register tapes were presented at the time of the investigation of the 1943 return but that it was impossible for the examiners to accept them due to conflicting statements made by the taxpayer's wife, his accountant and bartender. The revenue agent who made the examination for 1942, 1943 and 1944 testified that there were large envelopes which contained all the tapes, receipted bills for the particular day and guest checks. The petitioner's wife testified that a Dixie chicken dinner, which sold for $1.25, cost around 80 cents. This shows a profit on that dinner of 45 cents or 36 per cent. She testified further that the cost of a complete chicken dinner, which sold for $1.75, cost from $1 to $1.10. Taking the latter cost, the profit was 65 cents or about 37 per cent. The menu used, beginning in April, 1943, contained complete dinners ranging in price from $1.50 to $3.50 for a live whole broiled lobster dinner. The price of a sirloin steak dinner was $3 and of a special steak dinner $5. The special steak dinner was the same as the regular steak dinner except that it included a double steak. There was also a la carte service. The petitioner's301 wife testified also that the profits of the business varied from 25 to 33 1/3 per cent, but that the latter was a very high per cent and she would have considered herself fortunate in the last couple of years to have made such a profit. In the 1943 return the total receipts reported were $92,600.64 which the Commissioner increased to $119,345.63. The reported amount of net cost of goods sold was $81,266.58 and other business deductions reported totalled $7,055.49. Using the total receipts as determined by the Commissioner the net profit is $31,023.56, or 25.994 per cent. In the 1944 returns the aggregate total receipts reported were $105,070.22, which were increased by the Commissioner by $14,934.63, to $120,004.85. The aggregate amount of net cost of goods sold reported was $68,301.63 and the aggregate of other business deductions reported was $29,616.13. Using the total receipts as determined by the Commissioner, the net profit is $22,087.09, or 18.405 per cent. Although it appears that some food and liquor were consumed and disposed of, but not sold, and there were no receipts therefor, it has not been shown that the total receipts or net profits as determined by the Commissioner*302 were excessive or arbitrary. The net profit resulting from the determination of the Commissioner in 1943 was 25.994 per cent and in 1944, 18.405 per cent. This is not an unreasonable or excessive profit in view of the testimony of petitioner's wife that the profit varied from 25 to 33 1/3 per cent. There is no evidence showing that the Commissioner was unreasonable or arbitrary in rejecting the cash register tapes. The evidence does not show that the petitioners could not have realized, at the prices charged for food, liquor and other items, the total receipts or profits as determined by the Commissioner or that his determination that sales were understated was without rational foundation or that the amount of sales determined by him was excessive. Cf. . The evidence is to the contrary. Under the circumstances, the determination of the Commissioner of the deficiencies in income tax of petitioner for 1943 and 1944 and of the deficiency in income tax of petitioner's wife for 1944 must be approved. Decision in Docket No. 18752 will be entered under Rule 50. Decision in Docket No. 18753 will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622799/	ROBERT M. MODEER AND JANICE L. MODEER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentModeer v. CommissionerDocket No. 12638-79.United States Tax CourtT.C. Memo 1982-127; 1982 Tax Ct. Memo LEXIS 619; 43 T.C.M. (CCH) 782; T.C.M. (RIA) 82127; March 16, 1982. Robert M. Modeer, pro se. Dale P. Kensinger, for the respondent. GOFFEMEMORANDUM OPINION GOFFE, Judge: The Commissioner determined the following deficiencies in the petitioners' Federal income tax: Taxable YearEndedDeficiency12/31/74$ 1,252.5112/31/752,601.30Due to concessions, the only issue is whether business interest620 in the amount of $ 12,310 was deductible by petitioners or by a corporation. The resolution of this main issue turns upon the determination of three sub-issues: (1) whether or not the corporation is to be recognized as a separate taxable entity for purposes of the Federal income tax, (2) is so, whether the corporation was an "agent" of the petitioners in incurring the interest expense and related indebtedness, and (3) whether interest which is withheld from loan proceeds by the lender is "paid" by a cash basis taxpayer. The petitioners timely filed a joint Federal income tax return for their taxable year 1975. At the time they filed their petition herein, they resided in Kansas City, Missouri. Urban Land Projects, Inc. ("ULP, Inc." herein), was incorporated as a Missouri corporation on March 4, 1970. The certificate of incorporation granted ULP, Inc., all of the rights and privileges granted corporations organized under the General Business Corporation Law of Missouri and provided that its period of existence was to be perpetual. Since its incorporation, ULP, Inc., has continued to exist as a valid corporation under Missouri law except for a brief period in 1972. Because621 ULP, Inc., failed to file an annual registration statement and antitrust affidavit for 1971, its charter was revoked as of January 1, 1972. Raymond A. Sisson, acting in his capacity as the last president of ULP, Inc., filed on or about January 26, 1972, with the secretary of state of Missouri an "Application for Rescinding Forfeitures" along with (1) the annual registration fee and antitrust affidavit the failure to file which resulted in the forfeiture of ULP, Inc.'s rights and privileges, (2) all fees, charges, and penalties resulting from such failure to file, (3) all franchise taxes owed by ULP, Inc., (4) a fee of $ 50 and (5) an affidavit in which Raymond A. Sisson stated that he was the last president of ULP, Inc., that ULP, Inc., had not attempted to evade (nor had evaded) the process of any Missouri court, or attempted to conceal from the general public the location of its principal place of business in Missouri nor the address of its president or secretary, thereby preventing ordinary process of law to be served upon it. The document was signed by Raymond A. Sisson as the "last President" of ULP, Inc. On March 31, 1972, the secretary of state issued to ULP, Inc., a "Certificate622 of Rescission of Forfeiture" providing that the forfeiture of ULP, Inc.'s charter was rescinded as of that date and that the corporation was restored to good standing. The Articles of Incorporation of ULP, Inc., provided that the purposes and functions of the corporation were: to own, hold, build, construct and erect buildings and structures of all types, and to buy, sell, lease, own, manage, operate, maintain, repair, restore and rebuild the same; to buy or otherwise acquire, own, hold, lease, sell or otherwise dispose of, and mortgage or otherwise incumber, real property and personal property of all kinds, and to operate, manage and maintain the same; to borrow money and for such purpose to execute notes, bonds, debentures, or any form of indebtedness, and to secure the payment of the same by mortgage, deed of trust or other form of incumbrance, pledge or other forms of hypothecation; to execute deeds, mortgages, deeds of trust, contracts and other types of written instruments; to represent as agent, broker, and attorney-in-fact, insurance companies of all kinds; and to do all things incident to the conduct of a general insurance agency. The articles provided that the duration623 of ULP, Inc., was to be perpetual. There was no language in the articles of incorporation specifically authorizing ULP, Inc., to act as an agent for any person other than an insurance company. Under its by-laws, ULP, Inc., had as its officers a president, vice president, secretary, treasurer and such assistant secretaries and assistant treasurers as the board of directors was to prescribe. The by-laws also provided for their election, term of office, duties, and compensation, and permitted the board of directors to require them to post bond in order to assure the faithful and honest performance of their duties. The by-laws established the corporation's principal office as St. Joseph, Missouri, provided and prescribed detailed rules for shareholders' meetings, established a board of directors and specified the number and term of the directors, procedures for their meetings, and compensation for their attendance there. The by-laws further created an executive committee of the board and authorized the board to appoint other committees. The form and mode of transfer of ULP, Inc.'s, stock certificates and procedures regarding the stock transfer books were detailed in the by-laws,624 as was the form of the corporate seal. Article X, section 2, provided that no loans were to be contracted on behalf of ULP, Inc., and no evidences of indebtedness were to be issued in its name unless authorized by a resolution of the board. Except for 1971, ULP, Inc., has annually paid the corporation franchise tax and filed the related registration statement. The corporation also filed annually, except for the year 1971, the registration and fee required by Mo.Ann.Stat. sections 351.120 and 351.126 (Vernon 1966). ULP, Inc.'s corporate minute book contains minutes of annual meetings for the years 1973 to 1976, inclusive. During 1973, 1974, and 1975, Mr. Raymond A. Sisson was the president of ULP, Inc. Mr. Lawrence Douglas was its vice president and petitioner Robert Modeer (hereinafter sometimes referred to as "petitioner") was its assistant secretary. Petitioner was not a director of ULP, Inc. Its shareholders were Mr. Sisson and Mr. Douglas, each of whom owned 50 percent of the common stock. In 1972, Messrs. Sisson, Douglas, and Modeer (hereinafter sometimes referred to as "the investors") made an oral agreement to acquire a 104-acre tract of land in Platte County, 625 Missouri. They intended to develop it for residential housing by grading it, installing sewers and water lines, and subdividing the property into lots. They planned to then sell the lots to purchasers for the purpose of constructing residential houses thereon. Under this oral agreement the profits from the venture were to be divided equally among the investors. When Messrs. Sisson, Douglas, and Modeer investigated the possibility of financing the residential development in Platte County (hereinafter the "project"), they found that prospective lenders were unable to lend funds to individuals due to interest rate ceilings on individual loans imposed by Missouri usury laws. In order to meet the requirements of lenders, the three decided that title to the real property to be used in the project would be transferred to, and that the financing agreements and related evidences of indebtedness would be executed by, ULP, Inc. The maximum permissible rate of interest in Missouri on secured loans made to individuals prior to January 9, 1975, was 8 percent per annum. During 1972, ULP, Inc., acquired approximately 104 acres of land in Platte County for use in the project. In September626 1972, a contract for the purchase of 80 acres of land in Platte County was entered into between certain individuals by the name of Anderson as "Sellers" and "Urban Land Projects, Inc., a Missouri corporation, or assigns" as "Buyer." ULP, Inc., is referred to as "Buyer" throughout the contract, which makes no mention of ULP, Inc., acting in the capacity of agent for another party. The contract was signed by Raymond A. Sisson as the president of ULP, Inc. The contract required a down payment of $ 5,000 which was made by Messrs. Sisson, Douglas, and Modeer, each contributing equal amounts. In October 1972, a contract for the purchase of 23.65 acres of land in Platte County was entered into between certain individuals by the name of Miller as "Sellers" and "Urban Land Projects, Inc., a Missouri corporation, or assigns" as "Buyers." ULP, Inc., is referred to as "Buyer" throughout the contract, which makes no mention of ULP, Inc., acting in the capacity of agent for another party. The contract was signed by Raymond A. Sisson as president of ULP, Inc. A down payment of $ 10,000 was required under the contract and was made by Messrs. Sisson, Douglas, and Modeer, each contributing equal627 amounts. At a meeting of ULP, Inc.'s board of directors held October 17, 1972, the board resolved that the following corporate officers, to wit: Raymond A. Sisson, President Lawrence A. Douglas, Vice President Betty C. Jones, Secretary-Treasurer, as well as those holding such offices in the future, were authorized to effect loans from, and deliver promissory notes and hypothecate corporate property to, the Commerce Bank of St. Joseph, Missouri, on behalf of ULP, Inc. At a meeting of ULP, Inc.'s board of directors held on November 9, 1972, it was resolved that one of the following officers of ULP, Inc., to wit: Raymond A. Sisson, President Lawrence A. Douglas, Vice President Betty C. Jones, Secretary-Treasurer would be authorized to sign checks drawn on ULP, Inc.'s corporate account at the First National Bank of St. Joseph, Missouri, borrow money from an execute promissory notes to the bank on behalf of ULP, Inc., and pledge corporate property as security therefor. On May 23, 1973, the board of directors of ULP, Inc., resolved that the Commerce Bank of St. Joseph was designated as a depository of ULP, Inc., and that any funds standing to the credit of the corporation628 with the bank could be withdrawn by a check signed by one of the following corporate officers, to wit: Raymond A. Sisson, President Lawrence A. Douglas, Vice President Betty C. Jones, Secretary-Treasurer Robert M. Modeer, Assistant Secretary. On March 1, 1973, ULP, Inc., executed a real estate note payable to IDS Mortgage Corporation (hereinafter referred to as "IDS"), and a deed of trust securing same. These documents were subscribed as follows: URBAN LAND PROJECTS, INC.By: /s/ Raymond A. Sisson Raymond A. Sisson, President. IDS cancelled these instruments on March 13, 1973. On March 12, 1973, ULP, Inc., made, in its own name, an acquisition and development loan application with IDS, which IDS approved. On the same date, ULP, Inc., issued to IDS a real estate note in the amount of $ 1,250,000 and a deed of trust securing same. The deed of trust covered the real property which ULP, Inc., had acquired for use in the project, and was made between "Urban Land Projects, Inc., a Missouri corporation," as the grantor, Donald B. Steele, as the trustee, and IDS, as the beneficiary. Both the note and related deed of trust were subscribed as follows: URBAN LAND629 PROJECTS, INC.By: /s/ Raymond A. Sisson Raymond A. Sisson, President. In the March 12, 1973, deed of trust, ULP, Inc., covenanted that it had good title in fee simple to the hypothecated real estate free and clear of all liens and encumbrances except those created by the deed of trust. The corporation agreed to pay all taxes and assessments levied or assessed upon the property and to promptly deliver the official receipts therefor to IDS. ULP, Inc., further agreed to keep all buildings then or thereafter erected or placed upon the project real estate insured against loss by fire or other casualty to the extent required by IDS and to promptly pay the insurance premiums. The deed of trust also incorporated by reference an acquisition and development loan agreement between ULP, Inc., as borrower and IDS as lender. Under the latter agreement, ULP, Inc., agreed that, prior to any advance under the loan from IDS, it would furnish to IDS, Interalia, (a) a mortgagee's title insurance policy, (b) such evidence of the corporation's authority to enter into the loan agreement as IDS might require and approve, (c) surveys and plats of the premises with detailed drawings of630 the land grading, building lot lines, roads, streets, and public utility and other easements located or to be located or constructed thereon, and (d) evidence satisfactory to IDS that the plat has been duly recorded, aproved and accepted by the supervising government authorities and by the FHA. ULP, Inc., agreed upon fulfillment of these requirements, and no later than 30 days from the date of the loan agreement, to commence and vigorously expedite the development of the project. The agreement further provided that ULP, Inc., would request monthly loan disbursements in order to pay for work on the development which had already been performed and that each request would be signed by a representative of ULP, Inc., and appropriately verified. Also on March 12, 1973, Messrs. Sisson, Douglas, and Modeer and their respective wives executed a document entitled "Guaranty," which provided as follows: WHEREAS, URBAN LAND PROJECTS, INC. hereinafter called Borrower, may from time to time become indebted to IDS MORTGAGE CORPORATION, * * NOW THEREFORE, for a valuable consideration, receipt of which is hereby acknowledged the undersigned, hereinafter, whether one or more, called Guarantors,631 jointly and severally, hereby guarantee to IDSMC the prompt payment at maturity of the Guaranteed Indebtedness, as that term is herein defined, * * 1. "Guaranteed Indebtedness", as that term is used herein, means all indebtedness of every kind and character, whether now existing or hereafter arising, or Borrower to IDSMC, regardless of whether evidenced by notes, drafts, or otherwise, and without limit as to amount. Thus, these six individuals personally guaranteed the indebtedness of ULP, Inc., to IDS on the $ 1,250,000 project loan and related note. On March 31, 1973, ULP, Inc., by its president Raymond A. Sisson, executed the following document: DECLARATION OF TRUSTWHEREAS, on the 31st day of March, 1973, Robert M. Modeer, Raymond A. Sisson, and Lawrence L. Douglas, caused to be conveyed to the undersigned URBAN LAND PROJECTS, INC., a Missouri corporation, the real estate and property, situated in the County of Platte, State of Missouri, described in Exhibit "A" attached hereto; and WHEREAS, in the transaction in which the aforementioned conveyance was made, the undersigned was acting for and on behalf of Robert M. Modeer, Raymond A. Sisson, and Lawrence L. 632 Douglas, and the consideration for such conveyance was furnished, arranged and guaranteed by said aforementioned persons or parties. NOW THEREFORE KNOW ALL MEN BY THESE PRESENTS, that the actual and equitable ownership of said real estate property is in said Robert M. Modeer, Raymond A. Sisson, and Lawrence L. Douglas; that the undersigned, URBAN LAND PROJECTS, INC., does hereby declare that it stands seized of the title thereto and holds the same entirely in trust for the use of said aforementioned persons or parties; that it will upon demand of aforementioned persons or parties convey said real estate to such person or persons or corporations as said aforementioned persons or parties may direct, and will generally do and perform any and all acts and things in respect to the same as it may be directed to do and perform by said aforementioned persons or parties. IN WITNESS WHEREOF, the undersigned has executed this declaration of trust the 31st day of March, 1973. URBAN LAND PROJECTS, INC. By /s/ Raymond A. SissonThe real estate mentioned in the foregoing document was the project real estate acquired by ULP, Inc. ULP, Inc., obtained a comprehensive general liability633 insurance policy (No. CG18-33-13) covering the project premises from Aetna Insurance Company. The policy period was from March 7, 1973, to March 7, 1976. ULP, Inc., was also the named insured on three fire insurance policies collectively covering the same period. The property insured, however, was not the project real estate but was instead a roof frame building occupied by tenants located at 4700 N.W. 64th Street, Kansas City, Missouri. ULP, Inc., and IDS agreed that interest on the loan funds advanced under the note would be deducted from the undisbursed loan funds on the first business day of each month that the construction loan was outstanding. Pursuant to this agreement, IDS each month reduced the funds available under the loan by the amount of interest which accrued during the preceding months on funds which had been previously disbursed under the loan. IDS followed this procedure beginning with March 1973 and continuing through March 1975. A memorandum dated July 13, 1973, provides as follows: TO: IDS Mortgage CorporationRE: Construction Loan Number * * , Loan Amount: $ 1,250,000.00, Borrower: Urban Land Projects, Inc. * * [T]he * * * undersigned authorizes634 Lender to deduct accrued interest due pursuant to the terms of [the] note * * out of the undisbursed loan funds on the first business day of each month that said loan is outstanding * * . DATED July 13, 1973/s/ Raymond A. Sisson Borrower /s/ Lawrence L. Douglas Neither ULP, Inc., nor any of Messrs. Sisson, Douglas, or Modeer at any time made any payments of interest to IDS on the note. After securing financing for the project, contracts were made to grade the land and install sewers. Mr. Douglas, who was in charge of the construction phase of the project, would certify to IDS the percentage of completion under each contract. IDS would then transmit to ULP, Inc., the amounts necessary to pay contractors. ULP, Inc., would deposit these funds in its bank accounts and pay the contractors with checks drawn thereon. Messrs. Sisson and Modeer were also active in the project. Mr. Sisson negotiated for the purchase of the property and planned to sell the residential lots when the development was completed. Mr. Modeer negotiated the financing arrangements for the property. A contract for the sale of a portion of the project real estate was made between "Urban635 Land Projects, Inc., a Missouri Corporation, Sellers, and Bob McLaughlin Construction Company, * * * Buyer." There was no mention in the contract that ULP, Inc., was acting in an agency capacity for another person. The project was unsuccessful and was not completed because both the interest rates under the loan from IDS and actual construction costs were higher than anticipated. Since IDS reduced the funds available to ULP, Inc., by the amount of prior interest accrued, the amount available for actual construction was significantly less than expected. After the project failed and payments to IDS required under the loan agreement were not timely made, IDS, on March 10, 1975, through its corporate counsel in Kansas City, issued to ULP, Inc., a letter addressed as follows: URBAN LAND PROJECTS, INC., c/o RAYMOND A. SISSON COMPANY, 200 SOUTH 8TH STREET, ST. JOSEPH, MISSOURI 64501 Re: IDS Mortgage Corporation, Urban Land Projects, Inc., IDS Loan No. 010-305-0343 The letter notified ULP, Inc., that due to its failure to pay upon demand $ 99,842.67 interest due under the note for the months of July 1974 through February 1975, the note and related deed of trust were in default. 636 The letter further stated that IDS had discovered that state and county real property taxes on the project premises for 1974 were unpaid. The letter demanded that, prior to March 21, 1975, ULP, Inc., pay the past-due interest and furnish IDS copies of receipted tax bills showing that 1974 state and county taxes on the project property had been paid. Otherwise, IDS would declare the entire indebtedness under the note immediately due and payable and foreclose the loan pursuant to the deed of trust. Also on March 10, 1975, IDS issued through its counsel in Kansas City a letter to Messrs. Raymond A Sisson, Robert M. Modeer, Lawrence L. Douglas, and their respective wives. The letter recited that IDS was the holder of the Guaranty executed by the above parties whereby they guaranteed to IDS the repayment of the loan "by and between ULP, Inc., a Missouri Corporation, as borrower, and [IDS], as lender * ." The letter demanded that they pay as guarantors the $ 99,842.67 past-due interest and deliver to IDS the receipted tax bills, described in the letter to ULP, Inc., on or before March 21, 1975, and notified them of the steps IDS planned to take if its demands were not met. 637 On March 24, 1975, IDS through its counsel issued a letter to ULP, Inc., addressed as was the March 10, 1975, letter. The letter notified the corporation that due to its failure to cure the deficiencies outlined in the prior letter, IDS had accelerated the maturity of the note and that the entire unpaid balance of principal, together with the interest accrued thereon, was due and payable. IDS threatened to foreclose the deed of trust and pursue other legal remedies unless all amounts due were paid in full before March 31, 1975. Also on March 24, 1975, IDS, through its counsel, issued to each of the guarantors of the note a letter advising them of the acceleration of the principal and interest due from ULP, Inc., and demanding that they perform their obligation of guaranteeing the payments to IDS under the note. Subsequent to the issuance of the foregoing letters, IDS filed a petition against each and every guarantor of the note in the Circuit Court of Clay County, Missouri. The petition described the making of the loan from IDS to ULP, Inc., and the issuance of the note and deed of trust. The petition then stated that the "defendants, on or about March 12, 1973, gave their638 written, personal guarantees to IDS * * that Urban Land Projects, Inc., would complete construction * * , would pay all expenses incurred thereby, and would repay the loan in accordance with the terms of the Loan Agreement." The petition then mentioned the letters (above described) of March 10, 1975 (described supra), and represented that "Urban Land Projects, Inc., and the defendants, as guarantors, failed to pay IDS the * * accrued interest due under the * * * note * * * or to furnish IDS with copies of receipted tax bills" for 1974 state and county taxes. The petition then noted IDS' acceleration of the entire balance owing and set forth IDS' foreclosure of the deed of trust. As of April 29, 1975, $ 1,165,783.51 was due under the note. On that date, IDS purchased the project real estate from the trustee under the deed of trust for $ 615,000, leaving a deficiency of $ 550,783.51 "due and owing IDS on behalf of Urban Land Projects, Inc.," which "has failed to * * * repay the construction loan in accordance with the terms of the loan document." The petition then represented that "[d]efendants, as guarantors, have refused and do refuse to tender to IDS the deficiency * 639 * which Urban Land Projects, Inc. owes IDS * * * which these defendants have jointly and severally guaranteed to IDS" and prayed that judgment be entered against each and every defendant, jointly and severally, for the amount of the deficiency. ULP, Inc., intervened in this action and counterclaimed against IDS for breach of the acquisition and development loan agreement in that IDS did not mitigate damages as required by the agreement. The action and counterclaim were eventually dismissed without prejudice. Petitioners have not paid IDS any amount arising out of the guarantee of the note. No lots were sold in connection with the project and consequently the project generated no income. Messrs. Sisson, Douglas, and Modeer did not agree to pay and did not pay ULP, Inc., any amounts for holding title to the project real estate, executing the notes and deeds of trust, obtaining insurance, and maintaining bank accounts from which funds were disbursed to contractors. These three made no agreement interse respecting any accounting method to be used in connection with the project. ULP, Inc., did not maintain any formal set of books and records with respect to the640 project. The checking accounts from which payments were made to the contractors are the only such records maintained. ULP, Inc., did not execute any notes, deeds of trust, or financing agreements during 1972 to 1975 other than those connected with the project. As of March 12, 1973, ULP, Inc., held no significant assets other than title to the project real property. Mr. Sisson did not claim on any of his individual income tax returns any interest deduction with respect to the project. Mr. Modeer did not take any such deductions on his original 1973 and 1974 income tax returns. They were first claimed in claims for refund filed April 19, 1976. He did deduct such interest in the amount of $ 12,310 on his 1975 return. The Commissioner disallowed the 1975 deduction with the following explanation: The deduction of $ 12,310.00 * * as interest expense is not allowable because it has not been established that the interest accrued on an indebtedness of yours rather than * * * of Urban Land Projects, Inc. Furthermore, since the interest was not paid during the taxable year, no deduction is allowable to a cash basis taxpayer. Petitioners unfortunately have not submitted a brief641 setting forth factual and legal arguments. Given the theories contained in the statutory notice and further explicated in respondent's brief, we surmise that petitioners would argue as follows: (1) ULP, Inc., is not a viable corporation and should not be recognized for tax purposes as a separate entity. Rather, the Court should "look through" this corporate shell and determine that its assets were actually owned, and its indebtedness was actually owed, by the investors and that, therefore, the interest expense on the note was actually incurred by them and not by ULP, Inc.; (2) in the event that we determine ULP, Inc., to be a viable corporate entity, it was in reality an "agent" of these individuals in purchasing the 104 acres, securing the financing from IDS, and in incurring the development and interest expenses. Issue 1. ULP, Inc., As a Separate Taxable EntityULP, Inc., was formed in 1970 and has existed as a valid corporation under Missouri law ever since, except for a brief period in 1972 when its charter was revoked for failure to file a registration statement and pay certain fees. The situation was quickly corrected, however, and ULP, Inc., was soon restored to good642 standing. ULP, Inc., had articles of incorporation spelling out the corporate purposes and functions. By-laws established the corporate officers and principal office, provided for shareholder meetings (including detailed rules about such matters as voting proxies), established and set out rules regarding a board of directors, specified the form and manner of transfer of the corporation's stock certificates, and provided that no debt was to be created in ULP, Inc.'s name unless authorized by a resolution of the board. Annual shareholder meetings were held from 1973 to 1976, inclusive. The board of directors met and adopted resolutions authorizing ULP, Inc., to maintain corporate checking accounts and to take out loans from certain banks in St. Joseph, Missouri. ULP, Inc., transacted business in its own name. In the fall of 1972, it entered into contracts to purchase the 104 acres in Platte County (to be used in the project) from the Millers and Andersons. These were signed by Mr. Sisson as president of ULP, Inc. On March 12, 1973, ULP, Inc., entered into a financing arrangement evidenced by a note, a deed of trust, and an acquisition loan and development agreement. These643 all refer to ULP, Inc., as the borrower and are all signed by Mr. Sisson as president. By executing these documents, ULP, Inc., undertook significant duties (outside of the obligation to repay funds advanced from IDS with interest) such as insuring the premises against fire and other hazards, paying all taxes, and expediting development. ULP, Inc., also covenanted that it had good, fee simple title to the project premises and would furnish to IDS upon request evidence of its authority to enter into the loan agreement. The loan agreement contemplated that ULP, Inc., would request, on the first working day of each month, sufficient funds from IDS to pay contractors for work performed to that date. The request was to be signed by a representative of ULP, Inc., and verified in such manner as IDS required. Messrs. Sisson, Douglas, and Modeer, together with their wives, executed a document entitled "Guaranty" in which they were referred to as "Guarantors." The document stated that ULP, Inc., "may from time to time become indebted to IDS * " and that the guarantors "guarantee[d] to IDS the prompt payment at maturity of any such indebtedness." The declaration of trust of March 31, 1973, referred644 to ULP, Inc., as a separate entity, as did the memorandum of July 13, 1973, referring to ULP, Inc., as the "Borrower." ULP, Inc., entered into a contract with Bob McLaughlin Construction Company in its own name. After interest payments under the note became delinquent, IDS addressed separate letters on March 10, 1975, to ULP, Inc., and to the six individual guarantors. The first letter demanded that ULP, Inc., pay the past-due interest which it owed to IDS on the note. The second letter advised the guarantors of their duties and obligations under the guaranty and demanded that they pay the past-due interest to IDS as guarantors. On March 24, 1975, IDS issued two more letters, addressed as above. The one issued to ULP, Inc., advised it that IDS had accelerated the note's maturity and that the entire unpaid balance of principal, plus accrued interest, was then due from ULP, Inc., on the note. The second letter advised the six guarantors of the acceleration and demanded that they perform their obligation under the guaranty and pay to IDS the full amount which ULP, Inc., owed. IDS subsequently foreclosed the deed of trust, sold the project real estate and applied the proceeds645 against the amounts due from ULP, Inc., on the note. IDS sued the six guarantors for the deficiency. The petition was based upon their liabilities as guarantors of ULP, Inc.'s debt to IDS. ULP, Inc., intervened and counterclaimed against IDS. The project property and the indebtedness to IDS were acquired and incurred by ULP, Inc., rather than by the six individual guarantors, in order to circumvent Missouri usury law. The foregoing facts make clear that ULP, Inc., cannot be disregarded as a mere shell having no separate entity status. It was treated and respected by all parties concerned as an independent corporate entity. Corporate formalities were observed. Detailed articles of incorporation and by-laws were drawn up for it; there were annual shareholder meetings for at least 1973 through 1976. Except for 1971, ULP, Inc., filed its annual statement and paid its annual fee and thus continued as a viable Missouri corporation. For a brief period in 1972 its charter was forfeited but especial pains were quickly taken to rectify the situation. The board of directors met and authorized the opening of checking and loan accounts with St. Joseph banks. In connection with the646 project, the Andersons, Millers, and IDS dealt with ULP, Inc., as a separate corporate entity. It is true that Messrs. Sisson, Douglas, and Modeer guaranteed the note; yet, this was wholly consistent with ULP, Inc.'s separate status as the primary obligor. ULP, Inc., as an entity, intervened in a suit to which the investors were already party. ULP, Inc., also conducted substantial business activity as a corporation. It acquired the 104 acres of land used in the project, entered into the financing arrangement with IDS, and disbursed funds to contractors from its corporate accounts. Messrs. Sisson, Douglas, and Modeer availed of ULP, Inc., to avoid the restrictions of Missouri usury law. A corporate entity will be recognized for tax purposes if it was organized for valid business purposes, has a special function from its inception, and carries on unambiguous business activities subsequent to its formation. Moline Properties v. Commissioner,319 U.S. 436">319 U.S. 436, 440 (1943). Avoidance of state usury laws is a valid business purpose. Strong v. Commissioner,66 T.C. 12">66 T.C. 12 (1976),647 affd. without opinion 553 F.2d 94">553 F.2d 94 (2d Cir. 1977). Under this test, it is clear that during the years in issue ULP, Inc., was a separate taxable entity and not a mere "sham" or "shell." A taxpayer will normally be held, for tax purposes, to the form in which he has voluntarily chosen to conduct his business. Issue 2. Corporate AgencyIt is likely that petitioners' main argument would be that ULP, Inc., while to be recognized as a separate taxable entity, was in reality an "agent" of Messrs. Sisson, Douglas, and Modeer in acquiring the property, securing the financing, and incurring interest expense. Petitioners would no doubt point to the declaration of trust, executed by ULP, Inc., on March 31, 1973, as creating such an agency relationship. In the recent case of Roccaforts v. Commissioner,77 T.C. 263">77 T.C. 263 (1981), we recognized that under certain circumstances a true corporate agency could exist, and set forth the analysis to be applied in resolving this issue. We adopted the criteria specified by the Supreme Court in National Carbide Corp. v. Commissioner,336 U.S. 422">336 U.S. 422, 436 (1949), and we are thus compelled to so analyze this648 case. As a preliminary matter, however, we would like to comment upon the effect of the corporation's declaration of trust. The existence of an agency agreement 1 might tend to indicate that a substantive agency relationship was actually created, but it is certainly not dispositive of the issue. Jones v. Commissioner,640 F.2d 745">640 F.2d 745, 753 (5th Cir. 1981), cert. denied U.S. (Nov. 2, 1981), affg. a Memorandum Opinion of this Court; Roccaforte v. Commissioner,supra at 283, 285. Nor is the fact that equitable title may be in the alleged principal. Jones,supra at 753. We also note that petitioners have the burden of proving that a true corporate agency exists. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). 649 We turn now to the analysis mandated by Roccaforte,supra. The first factor is whether the corporation operated in the name and for the account of the principal. The record clearly shows that this was not the case. In none of the documents discussed above was ULP, Inc., ever referred to as any sort of agent for any other person. Petitioner has not shown that those who dealt with ULP, Inc., were aware that it was acting for Messrs. Sisson, Douglas, and Modeer. Interestingly, the articles of incorporation specifically authorized ULP, Inc., to represent insurance companies, yet did not provide for it to act as agent for other persons. Petitioners have not shown that it was disclosed clearly to relevant third parties that the corporation operated for the account of the investors or for that of an undisclosed principal. The second element is whether the principals are bound by the alleged corporate agents' actions. We conclude that petitioners have failed to prove this element.First, as stated above, there is no evidence that third parties dealing with ULP, Inc., were aware that it was acting as agent for Sisson, Douglas, and Modeer. In fact, ULP, Inc., was treated as650 the primary obligor on the note by IDS. The individual investors guaranteed the note, of course, but in a true agency relationship their liability would not have been secondary, as guarantors, but primary, as principals bound by the act of the agent. In other words, this mere guarantee of the debt was not sufficient in itself to apprise IDS (or others) of an agency relationship. Further, it is not at all clear that the declaration of trust of March 31, 1973, binds any of the investors to anything. ULP, Inc., merely declared that it was holding the property in trust for the investors. There is no indication that the investors intended or agreed to be bound by the corporation's acts and/or representations; in fact, they did not even sign the document. It would be quite difficult for a third party to use the declaration without other evidence to prove that they were liable as principals for the acts and obligations of the corporation. Compare our facts with those in Roccaforte,supra, where the agency relationship was common knowledge among relevant third parties and the principals executed an agency agreement in which they committed themselves to indemnify the651 corporate agent for its acts and debts and agreed that they, and not the corporation, should be liable for the mortgage which the corporation had entered into. The third and fourth factors are not relevant here because no income was generated. The fifth factor is whether the corporate agent's relationship was dependent upon the fact that it was owned and controlled by the investors. The inquiry is whether the corporation would have entered into the agency relationship absent such ownership and control, i.e., whether the agreement was arm's length. In our case, Messrs. Sisson and Douglas owned 100 percent of ULP, Inc.'s stock. The investors did not agree to pay and did not pay ULP, Inc., any compensation for performing its alleged agency services. There is no evidence that ULP, Inc., would ever have received any such compensation. No profit-oriented economic entity would, at arm's length, enter into such an arrangement. We thus conclude that petitioners have failed to show that ULP, Inc.'s, relationship with the investors was independent of their control of its stock. The final factor is whether the corporation's activities were consistent with the normal duties of an652 agent. In our discussion of this factor in Roccaforte,supra, we observed that the taxpayers therein had "put forth sufficient evidence to convince us that the acts of the corporation were consistent with the claims of agency. They were careful to endow the corporation with specific indicia of an agency relationship." As examples, we pointed to the facts that the investors represented to creditors that they, and not the corporation, were the true obligors on the note, and that the corporation held only mere legal title to the property. In Jones,supra at 754, the court stated: Taxpayers have introduced no evidence in this regard. In particular, taxpayers have introduced no evidence to prove that corporate general partners commonly take title to real estate without disclosure of any fiduciary capacity. We are mindful of the fact that the National Carbide test contains, as one of its factors, an inquiry into whether the agency was disclosed. There is no indication in this record that it is more common common for a corporate general partner to act in an undisclosed capacity than for an agent to do so. * * * [640 F.2d at 754; footnote653 omitted.] In the instant case, there is no evidence that ULP, Inc., ever disclosed its agency capacity to any third parties. Although it executed the March 31, 1973, declaration of trust, there is likewise no evidence that this trust relationship was disclosed. Indeed, in the March 12, 1973, deed of trust, ULP, Inc., covenanted that it had good, fee simple title to the project property. There was also no evidence that a corporate agent would omit to disclose its capacity.On balance, we conclude that petitioners have not shown that ULP, Inc., functioned in a manner consistent with the normal duties of an agent. It is our view that, on the basis of the foregoing analysis, ULP, Inc., was not a true agent of the investors. Hence, all interest deductions are properly attributable to it as a separate entity, and not to the investors. Issue 3. Interest "Paid"Having found that ULP, Inc., was a taxable entity separate and apart from the individual investors, and was not an agent of same in incurring the indebtedness to IDS and related interest expense, it, of course, follows that any such expense, if deductible by any taxpayer, is deductible only by ULP, Inc. Assuming654 arguendo, however, that ULP, Inc., was an agent of the investors, they would nevertheless not be entitled to an interest deduction for the simple reason that they never "paid" any interest. A cash basis taxpayer who satisfies an interest obligation merely by incurring a new obligation does not "pay" the interest within the meaning of section 163(a).Similarly, where a taxpayer on the cash basis who is indebted on a note for past-due interest borrows from his creditor an amount in excess of the past-due interest on a second note, and the creditor advances to the taxpayer the principal amount of the second note less the past-due interest, no cash payment is made warranting a deduction. Cleaver v. Commissioner,6 T.C. 452">6 T.C. 452, 454 (1946), affd. 158 F.2d 342">158 F.2d 342 (7th Cir. 1946), cert. denied 330 U.S. 849">330 U.S. 849 (1947); Franklin v. Commissioner,77 T.C. 173">77 T.C. 173, 183 (1981). The facts of the instant case fall squarely within the letter situation. IDS merely withheld past-due interest upon earlier advances of development funds from later ones, *655 thus reducing the amount of funds advanced. Under this method, no interest was ever "paid"; the unpaid balance of principal and interest merely continued to accumulate, and was the subject of IDS' subsequent collection efforts. Thus, under no theory may petitioner deduct any part of the interest accured on the note during 1975. To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. It is not clear, however, that the declaration even qualifies as an "agency agreement." It was not so denominated, and it was not signed by any of the investors. Compare this document with the agency agreement in Roccaforte v. Commissioner,77 T.C. 263">77 T.C. 263 (1981), which clearly purported on its face to create an agency relationship and was signed by the investors as principals. The declaration is thus even less probative of an agency relationship than would be a Roccaforte↩-type agreement.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622800/	NORTH AMERICAN REASSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.North American Reassurance Co. v. CommissionerDocket Nos. 52674, 60678.United States Board of Tax Appeals31 B.T.A. 92; 1934 BTA LEXIS 1165; August 14, 1934, Promulgated 1165 1. DEDUCTIONS - DEPRECIATION. - Petitioner held not to be entitled to a reasonable allowance for depreciation upon furniture and fixtures used in the underwriting department of its business. Rockford Life Ins. Co. v. Commissioner,292 U.S. 382">292 U.S. 382, followed. 2. Id. - RESERVES. - The valuation or "separate liability" required by section 85 of the insurance statute of the State of New Yorkheld not to be a reserve required by law within contemplation of section 245(a)(2) of the Revenue Act of 1926 and section 203(a)(2) of the Revenue Act of 1928 and consequently not includable by petitioner in the total reserve upon which its deduction is computed under those sections. William H. Hotchkiss, Esq., for the petitioner. I. Graff, Esq., for the respondent. LEECH92 OPINION. LEECH: On January 5, 1934, the Board promulgated its opinion in these consolidated proceedings, reported at , but the final decision has not been entered, due to the granting of a motion to withhold its entry pending the decision of the Supreme Court in the case of 1166 . Respondent has now filed a motion for reconsideration and revision of the Board's opinion with respect to its holding that petitioner was entitled to a deduction for depreciation upon furniture and fixtures used in the underwriting, as well as the investment department, of its business. The hearing in the proceeding occurred January 16, 1933. On August 18, 1932, upon motion granted by this Board, respondent filed an amended answer herein, praying a specific increase in the deficiencies. Cf. . Respondent now also moves that the Board grant that prayer. Such motion is well founded and, therefore, is hereby granted. Under the cited decision of the Supreme Court in , petitioner herein is not entitled to a deduction for depreciation on its furniture and fixtures used in the underwriting department of its business. Accordingly, our opinion heretofore promulgated is now modified to so hold. The stipulation of facts in these proceedings, set out in our prior opinion, discloses that in1167 determining the deficiencies in controversy, the respondent allowed for the years 1926 to 1928, inclusive, depreciation at the rate of 10 percent on the stipulated cost of all furniture and fixtures used in the business, and, further, that for *93 the year 1929, respondent allowed depreciation at the rate of 10 percent on the cost of furniture and fixtures used only in the investment department. The cost of the furniture and fixtures used only in the investment department for each of the years in controversy is stipulated. We now conclude that, in determining the deficiencies for the years 1926 to 1928, inclusive, respondent erred in allowing depreciation on furniture and fixtures used in petitioner's underwriting department, and that his prayer for an increase in the deficiencies for those years should be granted. Our prior opinion is, therefore, further modified to so hold. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622801/	ESTATE OF OMAR L. ASH (DECEASED), STEPHEN V. ASH, ADMINISTRATOR C.T.A. AND SANDRA C. ASH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Ash v. CommissionerDocket No. 9573-76United States Tax CourtT.C. Memo 1981-575; 1981 Tax Ct. Memo LEXIS 177; 42 T.C.M. (CCH) 1310; T.C.M. (RIA) 81575; September 30, 1981. 177 1. On Jan. 7, 1969, Omar Ash and other directors of SCC improvidently granted an option to Reed to acquire 75,000 shares of SCC stock from SCC for less than 1 percent of its fair market value. Reed exercised the option the same day. Upon being advised by their accountants and attorneys that the option would be considered compensatory and excessive the directors entered into an agreement with Reed in October 1969 whereby Reed would reconvey half of his shares of stock to SCC for the amount he paid for them and the directors would transfer an equal number of shares to SCC from their personal holdings for the price Reed paid for the stock, thus making SCC whole. Ash's shares of stock were delivered to the SCC's stock transfer agent on December 24, 1969, and were cancelled on December 26, 1969, but the check in payment therefor was not issued to Ash until Jan. 8, 1970. Held: Any gain, loss or expense incurred by Ash as a result of transferring his stock to SCC must be recognized and accounted for in 1969, not 1970 as claimed by petitioners. 2. Ash owned all the stock of Sandomar, a corporation formed April 23, 1970, to engage in the business of buying and selling cattle. In the 178 latter part of December 1970 Ash went to Wichita, Kansas, to arrange for buying cattle and feed in Sandomar's name. A bank account was opened in Sandomar's name but not in Ash's name. The bank approved a loan to Sandomar on Dec. 30, 1970, for the purpose of buying cattle and feed. However, a check in the amount of this loan was issued to Ash and he and his wife signed the loan agreement. On Dec. 30, 1970, Ash endorsed the check to Sandomar and deposited it in Sandomar's bank account. Checks were immediately drawn on this account to make a prepayment for feed, a prepayment of interest to the bank, and to pay for 1,143 head of cattle. However, the bank treated the loan as a loan to Ash and the bill of sale for the cattle and feed was issued in Ash's name, until Ash formally transferred them to Sandomar on April 15, 1971. Held: Sandomar either bought the cattle and feed or Ash obtained the bank loan and used it to buy the feed and cattle for and in behalf of Sandomar. Petitioners may not deduct the prepayments for feed and interest on their return for 1970. 3. Held: Petitioners, Omar and Sandra Ash, filed a joint income tax return for 1970 and Sandra is jointly and serverally liable 179 for the deficiencies in tax for that year. Sandra is not relieved of liability under the innocent spouse provisions of section 6013(e), I.R.C. 1954. Section 6013(e) is not unconstitutional. John B. Huffaker and Reginald A. Krasney, for Stephen v. Ash. Norman Perlberger, for Sandra C. Ash. Stephen J. Sokolic, for respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: Respondent determined a deficiency in petitioners' income tax for the calendar year 1970 in the amount of $ 376,940. The issues presented for our decision are: (1) Whether a transfer of a corporation's own stock to it by Omar L. Ash gave rise to a long-term capital gain and a section 162, 1 business expense deduction; (2) Whether petitioners are entitled to deductions under section 162 and 163, respectively, of $ 476,093.85 for the prepayment of cattle feed and $ 20,245.43 for the prepayment of interest on a bank loan; and (3) Whether petitioner Sandra C. Ash is not liable for any deficiency in tax determined for 1970 because she is entitled to protection under the "innocent 180 spouse" provisions of section 6013(e), or because her signature on the joint return for 1970 was "involuntary." 2181 FINDINGS OF FACT Omar L. Ash (hereinafter Ash) and petitioner Sandra C. Ash (hereinafter Sandra) were husband-wife and they resided in Gladwyne, Pennsylvania, when they filed their petition herein. Ash and Sandra timely filed a joint Federal income tax return, using the cash basis method of accounting, for the taxable year 1970 with the Office of the Internal Revenue Service at Philadelphia, Pa.Ash died on October 17, 1980. On April 13, 1981, petitioner Estate of Omar L. Ash (deceased), Stephen V. Ash, Administrator c.t.a., was substituted for Ash as a party in this proceeding. General FactsAsh married Sandra in November 1970. (Sometimes hereinafter Ash and Sandra will be referred to collectively as petitioners.) The joint return for 1970 filed by petitioners was prepared solely by Ash. He presented it to Sandra for her signature on April 14, 1971, and she signed the return on that date without examining it or being told of the information contained therein. Petitioners 182 also timely filed a joint Federal income tax return for the taxable year 1971. Ash filed a single income tax return for the taxable year 1969. These returns were also filed using the cash basis method of accounting. Stock TransactionSystems Capital Corporation (hereinafter SCC) was organized under the laws of the State of Delaware and was engaged in the business of leasing computers, aircraft and plant machinery. During the years 1968 and 1969, the principal shareholders of SCC were Ash, Donald Benscoter (hereinafter Benscoter), John Liecty (hereinafter liecty), Ronald Baldwin (hereinafter Baldwin) and Rex Staley (hereinafter Staley). During the years 1968, 1969, and up to December 10, 1970, Ash was the chairman of the board of directors of SCC and a member of the board's executive committee. Ash did not receive compensation directly from SCC for these activities. He did, however, receive a salary of $ 30,000 in 1969 and $ 48,205 in 1970 from Investment Leasing Services, Inc., a subsidiary corporation of SCC. The stock of SCC was traded on the over-the-counter market, the corporation having gone "public" in March 1968. At that time, SCC initiated a public offering of 150,000 183 shares of its common stock, which offering was completed in April 1968. This public offering amounted to less than 10 percent of the total SCC stock outstanding during this period. Also in 1968 SCC made a public offering of debentures convertible into common stock, which debentures were converted into 83,000 shares of SCC common stock during 1968. These two offerings were the only public offerings of SCC stock during 1968, 1969 and 1970. On January 7, 1969, the board of directors of SCC unanimously approved the granting of an option by SCC to one Travis E. Reed, Jr. (hereinafter Reed), to acquire 75,000 shares of SCC stock at $ 0.067 per share, or $ 0.10 per share if the option were exercised in full at one time. Any shares acquired pursuant to the option were subject to certain restrictions on transferability. Ash, Benscoter, Baldwin and Staley were present at the board of directors meeting and voted to grant the stock option to Reed. Also present and voting in favor of granting the option was a Mr. McCowen. The only board member absent was Liecty. The minutes of the board of directors meeting provided in pertinent part: RESOLVED, That in consideration of the acceptance by 184 Travis E. Reed, Jr. of employment as Vice President of Systems Capital Corporation, and in consideration of his remaining in office as Executive Vice President of Systems Capital Aircraft, Inc., a subsidiary of this Corporation, and in further consideration of Mr. Reed's agreement not to engage in the leasing of commercial aircraft except on behalf of this Company, Systems Capital Corporation hereby grants to Travis E. Reed, Jr., an option to acquire 75,000 shares of the Corporation's Common Stock under the following terms and conditions: The stock option shall be exercisable from the date of grant for a period not to exceed five (5) years. The purchase price of the shares subject to this option shall be $ .067 per share, or if the option is exercised in full at one time, $ 7,500.00 BE IT FURTHER RESOLVED, That the extension of Option herein made Mr.Reed rescinds the action of the Board in granting a Stock Option to Mr. Reed, as of the meeting of the Board held on August 28, 1968. On January 7, 1969, Reed exercised the stock option in full for the entire 75,000 shares at a total cost of $ 7,500. On that date the average of the bid and asked prices for SCC stock on the over-the-counter 185 market was $ 47 per share. In February 1969 and SCC stock was split two-for-one, thereby increasing Reed's stock-holding to 150,000 shares. Following the February 1969 stock-split, Ash owned 900,000 shares of SCC stock, which amount represented approximately 25 percent of the outstanding SCC stock during that year. On February 26, 1969, representatives of SCC, including Ash, were informed by SCC's certified public accountants, Price Waterhouse & Co., that it was the latter's belief that the stock option granted to and exercised by Reed was compensatory in nature and, consequently, that, unless the option was substantially revised, the approximately $ 2.5 to $ 3 million difference between the market value of the stock received by Reed pursuant to the option and the option price paid by him would have to be charged to income over the period 1969-1973 (the length of Reed's employment agreement). In March 1969 SCC received a letter from its legal counsel concerning the stock option granted to Reed, in which letter was discussed both the potential charge to income and the potential for a stockholder derivative suit against the board of directors based on the claim that the grant of the 186 stock option was a waste of corporate assets. Legal counsel was of the opinion that, assuming the difference between market value of the stock and the option price was approximately $ 3 million, "The grant of compensatory options of this value would be held to be a waste of corporate assets." The letter further stated that the stock "transaction in the form set forth in the present [January 7, 1969] contract is not defensible and we believe that any stockholder bringing a derivative suit would be successful in obtaining" relief. Possible relief included recovery "from the Directors [of] such sums as the court found to be either excessive compensation or an excessive price paid to Mr. Reed…" 3187 or "revision of the entire transaction on the grounds that the transaction was fraudulent as to the Company and Mr. Reed was chargeable, as an officer of the Company, with knowledge that it was fraudulent." Subsequent to the receipt of this letter, SCC began to consider alternative courses of action, including recision of the stock-option transaction, to rectify any problems that arose because of the granting of the option to Reed. Negotiations commenced between SCC and Reed concerning the possibility of Reed retransferring the stock to SCC in exchange for the amount he had paid for it. By agreement dated May 21, 1969, Ash, Baldwin, Benscoter, Liecty and Staley, as shareholders and directors, agreed with SCC that: If it is ultimately determined, either in a suit or proceeding or by agreement between Reed and SCC, that Reed is entitled to retain any of the shares of SCC capital stock issued to him pursuant to the exercise of the said [January 7, 1969, stock] option, Shareholders agree to sell to SCC from their personal holdings of SCC capital stock, pro rata ccording to their holdings of SCC stock on March 29, 1968, at a price of $ 0.05 per share, 4 that number of shares which it is determined, as above stated, that Reed is entitled to retain, 188 provided, however, that in no event shall Shareholders be required under this Agreement to sell in the aggregate more than 20,000 shares of SCC capital stock to SCC. Also by agreement dated May 21, 1969, Ash and Benscoter, 5 as shareholders and directors, agreed with SCC that: 1. If and at such time as it is ultimately determined, either in a suit or proceeding or by agreement between Reed and SCC, that Reed may retain more than 20,000 shares of SCC capital stock issued to him pursuant to the exercise of the said [January 7, 1969, stock] options, Shareholders agree to sell to SCC from their personal holdings of SCC capital stock, at a price of $ .05 per share, that number of shares in excess of 20,000 which Reed retains according to the following proportions: Omar L. Ash51.54%Don L. Benscoter48.46%2. If either Shareholder is unable to promptly sell to SCC any shares required by paragraph 1 above, those additional shares shall be sold to SCC by the other Shareholder; provided, that such other Shareholder 189 shall have the right to purchase after a reasonable time those number of additional shares at $ .05 a share from the Shareholder unable to comply in the first instance. The foregoing two agreements were executed before any agreement was reached between SCC and Reed concerning the latter's retransfer of any stock to SCC. The purpose for executing the agreements as of May 21, 1969, was to enable Price Waterhouse & Co. to certify SCC's financial statement for 1968 without the inclusion of any adverse information concerning the stock option granted to Reed. 6190 McCowen, the only board member who did not sign either of the foregoing two agreements, did not individually reach any agreement with SCC concerning the transfer of personally owned shares to the company as a result of his involvement in the decision to grant the stock option to Reed. SCC's annual report for 1968, which was certified by Price Waterhouse & Co. as of May 23, 1969, contains the following footnote to the balance sheet: Note 11 - Events subsequent to balance sheet date On January 7, 1969, the Company issued 150,000 shares of capital stock, after giving effect to the two-for-one stock split described above, to Mr. Travis E. Reed, Jr., Vice President of the Company, for an aggregate consideration of $ 7,500 pursuant to an option granted that day. The mean between the bid and asked prices of the Company's stock at the close of business on January 7, 1969, after giving effect to the two-for-one stock split, was $ 23 per share. 130,000 of such shares are subject to certain restrictions and are repurchasable by the Company for the price paid by Mr. Reed upon the occurrence of certain conditions. The Company is of the opinion that this transaction should be rescinded entirely and is currently negotiating with Mr. Reed for the return of the 150,000 shares. It is not possible to determine at this time to what extent the Company will be able to rescing this transaction in whole or in part or 191 be able to repurchase the 130,000 shares of capital stock for the price paid by Mr. Reed. Certain directors and shareholders of the Company have agreed to transfer to the Company up to 150,000 shares from their holdings of the Company's capital stock at the price paid by Mr. Reed for the purpose of replacing shares not so acquired from Mr. Reed and putting the Company in the position in which it would have been if the transaction had been rescinded. In October 1969 and agreement was reached between SCC and Reed whereby, interalia, Reed agreed to return to SCC 75,000 shares (one-half of the number of shares held after the February 1969 stock split) in exchange for $ 3,750 (one-half of the total consideration paid of $ 7,500). Under this agreement Reed was to retain the remaining 75,000 shares. On November 11, 1969, the executive committee of SCC's board of directors approved the agreement reached with Reed, subject to the conditions that (1) Price Waterhouse and Co. confirm that, upon return of the 75,000 shares by Reed and the transfer by the shareholder-directors of 75,000 shares to SCC pursuant to the May 1969 agreements, no charge against income would be required in SCC's financial 192 statements; and (2) certain controlling shareholders, including Ash, agree to assume all of SCC's obligations under the agreement with Reed. On November 12, 1969, Price-Waterhouse advised that there would be no charge to income for 1969 from the Reed transaction provided counsel would render an opinion that the Reed transaction had been rescinded. By letter of November 17, 1969, legal counsel for SCC rendered an opinion that if all the provisions of the settlement agreement were carried out the Reed transaction "has been rescinded and the Company will be in the same position (financially) as if the transaction had never occurred." Counsel also wrote to the 5 stockholders on the same date advising that he had confirmed with Price-Waterhouse that the sale of the 75,000 shares to the company must be completed by December 31, 1969. The above-mentioned conditions were satisfied and the agreement between SCC and Reed was consummated. Under the terms of the May 1969 shareholder agreements, Ash was obligated to transfer 36,888 shares to SCC. To satisfy this obligation, and to satisfy shareholder-director Baldwin's obligation to transfer 2,140 shares which Baldwin was then unable to transfer, 193 Ash mailed stock certificates encompassing 39,035 shares (7 shares in excess of 36,288 - 2,140) to SCC's attorney on December 23, 1969, for forwarding to SCC's transfer agent. 7 These certificates were delivered to SCC's transfer agent on December 24, 1969, by legal counsel accompanied by a letter in which it was stated, "Please note that the shares must be transferred and cancelled by December 31, 1969, the end of the corporation's fiscal year." The 75,000 shares were cancelled by the transfer agent on December 26, 1969. On January 2, 1970, a new stock certificate for 7 shares was sent by SCC's transfer agent to SCC's attorney for forwarding to Ash. On January 8, 1970, SCC issued a check to Ash in the amount of $ 1,951.40, which amount equalled $ 0.05 per share for the 39,028 shares received from Ash and cancelled. Ash received this check on January 9, 1970. In its annual report for 1969, SCC reported net income of $ 1,070,609. Had SCC been required to charge against 194 its earnings a ratable portion of the difference between the fair market value of the stock (approximately $ 2.5-$ 3.0 million) acquired by Reed and the option price ($ 7,500), there would have been a substantial adverse impact on the market value of the SCC stock. Note 10 to this report, which was dated March 10, 1970, but was as of December 31, 1969, referred to the Travis Reed option and reported that the 150,000 shares issued to him had been returned to the company for $ 7,500, thereby placing the company in the position it would have been in had the transaction not occurred. For purposes of determining the amount of compensation to the deducted by SCC and reported by Reed with respect to the sale of 75,000 shares of SCC stock to Reed on January 7, 1969, SCC requested the brokerage house of Hayden Stone, Inc. to value those shares, which shares were subject to certain restrictions under the Securities Act of 1933. Because the stock option granted to Reed in January 1969 and the October 1969 agreement between Reed and SCC contained certain restrictions on Reed's ability to transfer the 75,000 shares which Reed ultimately retained under the October 1969 agreement, Hayden Stone195 was requested to value the 75,000 shares in the follwoing manner: a 10,000-share block as of January 7, 1969; a 10,000-share block as of October 10, 1969; and a 55,000-share block as of January 2, 1970. Hayden Stone was of the opinion that the securities law restrictions on the stock and the "thin-market" for SCC stock required a 60 percent discount from the average of the bid and asked prices for the stock on January 7, 1969, and a 65 percent discount for October 10, 1969, and January 2, 1970. Accordingly, Hayden Stone valued the stock on a per-share basis as follows: 8196 DateAverage Market PriceValueJan. 7,1969$ 47.00$ 18.80Oct. 10, 19695.501.93Jan. 2,19705.501.93According to Smith, Barney and Co., a Chicago brokerage firm, the bid and asked prices for SCC stock were $ 6.50 and $ 7.25 per share, respectively, on January 8, 1970, and $ 7.25 and $ 8.00 per share, respectively, on January 9, 1970. Respondent's stock-valuation expert witness, Fredrick Tebbon, was of the opinion that, on any particular day during the December 1969-January 1970 period, the per share value of the stock which Ash transferred to SCC equalled 50 percent of the mean of the bid and asked prices for the stock on that day. The 39,028 shares of stock which Ash transferred to SCC were not registered pursuant to the Securities Act of 1933. Further, at least 33,647 of those shares were subject to restrictions as contained in various shareholder agreements. Ash's basis in the 39,028 shares of stock transferred to SCC was $ 8,988, or $ 197 0.23 per share. On the joint return filed for 1970, Ash's reporting of the transfer had two components: (1) A miscellaneous business expense deduction in the amount of $ 202,946 was taken, which amount was calculated as the difference between a fair market value for the stock of $ 5.25 per share, and the $ 0.05 per share received from SCC; and (2) a long-term capital gain of $ 195,909 was included in income, which amount was calculated as the difference between a fair market value for the stock of $ 5.25 per share and Ash's $ 0.23 per-share basis therein. In the statutory notice of deficiency, respondent determined that neither the miscellaneous deduction nor the capital gain income were properly reported and, accordingly, he disallowed the deduction and excluded the capital gains from income in determining the deficiency. Cattle Feed TransactionsSandomar Corporation (hereinafter Sandomar) is a Pennsylvania corporation having been incorporated on April 23, 1970. From that date through March 31, 1972, Ash owned 100 percent of the stock of Sandomar and he was the corporation's president and sole shareholder. Sandomar filed its first tax return utilizing an April 23, 1970-March 31, 198 1971 fiscal year. Its next return was filed on an April 1, 1971-March 31, 1972, fiscal year. A valid election to be taxed as a small business corporation under Subchapter S, I.R.C., was filed for Sandomar's taxable year beginning April 1, 1971. No earlier election was made for Sandomar's first taxable year. Sandomar's principal business activity during its first fiscal year ended March 31, 1971, was the purchase and sale of livestock. In December 1970 Sandomar purchased 7,000,000 pounds of feed for $ 155,400 and 1,954 head of cattle in Amarillo, Texas. 9Ash and his accountant-tax adviser travelled to Wichita, Kansas, on December 17, 1970, to gather information about cattle feeding operations with a view toward entering the cattle feeding business. Upon arriving in Kansas, Ash met and discussed with various individuals the prospects for the purchasing and feeding of cattle. Ash intended that any cattle and feed to be acquired would be 199 acquired by Sandomar. During the period involved Ash received information that grain prices were rising and that if a cattle feeding operation was undertaken, it would be beneficial to purchase feed at a fixed price. On December 17, 1970, Ash negotiated with and orally agreed to purchase 5,000 head of cattle from or through a Mr. Les Cooper, a cattle dealer associated with the livestock brokerage firm of Young & Cooper, Inc. On the same date Ash negotiated with a representative of Old Santa Fe Feeders, Inc. (hereinafter Old Santa Fe), a feedlot operator, for the purchase of feed for the cattle to be acquired. Ash orally agreed at that time to purchase feed from, and to feed his cattle on the feed lot of, Old Santa Fe. By letter dated December 18, 1970, Old Santa Fe informed Ash that, based on the understanding that 5,000 head of cattle would be acquired between December 21, 1970, and June 15, 1971, and they would be fed to finished grade (requiring an average feeding period of 160 days) prior to December 31, 1971, Old Santa Fe would sell to Ash the grain necessary, in the following quantities, to feed the cattle for the entire period: TonsIngredientCost Per TonTotal Cost94.4 Alfalfa Hay$ 39.40$ 27,359.361,075.2 Corn Silage14.8615,977.475,443.2 Corn42.60231,880.32593.6 Molasses38.9723,132.591,814.4 Wheat51.7393,858.911,187.20Sugar Beet Pulp44.9053,305.28392.0 Premix78.0130,579.92$ 476,093.85200 This price reflected both a quantity and cash discount. Old Santa Fe also agreed to give a cash discount of $ 0.02 per hundred weight of feed consumed. (See agreement between Old Santa Fe and Ash infra.) Old Santa Fe estimated that by buying in bulk in December Ash would pay approximately $ 28,000 less for grain than the normal feed costs would be during early spring and summer of 1971. In December 1970 Ash borrowed $ 210,000 from the Girard Trust Bank of Philadelphia, Pennsylvania. This money was ultimately used to purchase 1,143 head of cattle. On December 22, 1970, Ash wrote a letter to Cooper in which he set forth his understanding of the terms pursuant to which 5,000 head of cattle were to be acquired. Cooper acknowledged that the terms set forth also corresponded to his understanding. In pertinent part, the letter provided: I have completed tentative financial arrangements with the Fourth National Bank and Trust, Wichita, to acquire 5000 head of cattle and feed costing approximately $ 500,000 * * * * Please proceed at once with the acquisition of the 5000 head of cattle which are to be fed at the Old Santa Fe Feeders, Inc., feedlots in Sublette, Kansas. I understand that 201 you have 1,143 head of cattle on hand for immediate delivery. By document dated December 23, 1970, Ash, as sole director of Sandomar, consented to the adoption of the following resolution: RESOLVED, That the President of the Corporation is hereby authorized to purchase up to 7,500 head of beef cattle on or after December 23, 1970. FURTHER RESOLVED, That the President is hereby authorized to purchase feed for the feeding of said beef cattle on or after December 23, 1970. FURTHER RESOLVED, That the President is hereby authorized to borrow, on behalf of the Corporation, up to $ 2,000,000 at an interest rate of up to 8 1/2% from The Fourth National Bank and Trust Company of Wichita, Kansas in connection with the purchase of such cattle and feed with respect thereto. FURTHER RESOLVED, That the President is hereby authorized to borrow, on behalf of the Corporation, up to $ 600,000 at an interest rate of up to 9 1/2% from The First National Bank of Amarillo, Amarillo, Texas, in connection with the purchase of such cattle and feed with respect thereto. FURTHER RESOLVED, That the Presidentis [sic] hereby authorized to execute all documents which he deems necessary in order to purchase 202 such cattle and feed and finance the purchase thereof, his authority to be conclusively presumed by his execution of such documents. In correspondence between Ash and the Fourth National Bank and Trust Co., Wichita (hereinafter bank), dated December 21-24, 1969, concerning the financial arrangements for the purchase of the cattle and feed, it was understood that the loans were to be made to Sandomar, provided the Ashes would personally guarantee them and they were approved by the loan committee of the bank. To facilitate the granting of loans to Sandomar, Ash was prepared to contribute $ 700,000 to the corporation. Ash so advised his attorneys in Wichita. On December 29, 1970, a checking account was opened at the bank in the name of Sandomar Corporation. Ash did not open an individual account at the bank. Records of the bank contain the following with regard to loans for the purchase of cattle: Sandomar Corp. 12-28-70 (Loan Committee Meeting) $ 685,000 approved, rate 8 1/2%, secured by feed, cattle, and stock * * * * 12-30-70 (SPECIAL EXECUTIVE COMMITTEE MEETING) Approval was given to loan this corporation $ 685,000 to purchase $ 476,000 in feed and $ 210,000 worth of cattle, 203 for a period of six months, rate 8 1/2%, with interest paid in advance. Supported by 10% bank balances on a time open deposit account. Also, $ 300,000 worth of stock will be pledged which will be held in our collateral files. This corporation is a corporation of Omar Ash and his wife and will operate under Subchapter S. At some point in time, however, the bank decided not to make a loan to Sandomar because it did not have a certificate of authority to do business in Kansas and because it could not establish clear and identifiable ownership and title to the collateral to be pledged for the loan. Instead, the loan was to be made to Ash and Sandra. A cashiers check dated December 30, 1980, in the amount of $ 686,363.12 was drawn by the bank payable to Omar L. Ash and Sandra C. Ash. This check was endorsed by the Ashes, "Pay to the order of Sandomar Corporation," and was deposited in Sandomar's bank account on December 30, 1970. In addition, $ 50,000 had also been deposited in this account. 10 On December 30, 1970, Ash and Sandra 204 executed a security agreement note pursuant to which the bank made a loan of $ 476,363.12. As security for this loan, Ash and Sandra also executed a security agreement giving the bank a security interest in 1,143 head of cattle; 1,075.2 tons of corn silage; 1,500 tons of wheat; and 9,122.5 tons of ground corn. By checks drawn on Sandomar's account and dated December 29, 1970; (1) Young & Cooper, Inc. was paid $ 210,269.27 for 1,143 head of cattle; (2) Old Santa Fe was paid $ 476,093.85 for feed; and (3) the bank was paid $ 20,245.43 as interest on the $ 476,363.12 loan. The $ 20,245.43 amount represents interest at 8.5 percent on the principal amount of $ 476,363.12 for a period of 180 days (December 31, 1970, through June 28, 1971). After these checks were debited to the account, approximately $ 29,000 remained therein. On December 30, 1970, Cooper executed a bill of sale granting, selling and conveying to Ash 1,143 head of cattle then located at Old Santa Fe feed yards. On December 30, 1970, Ash and Old Santa Fe executed an agreement, the import of which was that Old Santa Fe agreed to undertake the care of the cattle purchased and to feed such cattle the grain obtained from 205 Old Santa Fe. No mention was made of Sandomar in the agreement. This agreement provided in relevant part: WITNESSETH: That, WHEREAS, Old Santa Fe is engaged in the business of custom feeding of cattle for customers and enjoys a reputation for providing a highly skilled program of feeding which is designed to obtain maximum advantageous weight growth at the minimum of cost therefor, and, WHEREAS, ASH is the owner of 1,143 head of mixed breed yearling steers and is in the processof [sic] acquiring additional cattle with the intention of owning approximately 5,000 head in the near future, and, WHEREAS, Ash owns 1075.2 Tons of corn silage, 1500 Tons of wheat and 9122.5 Tons of ground corn which he purchased to feed cattle owned by him, and which feed is presently located and stored at Old Santa Fe's Sublette, Kansas, feedlots and which is hereafter referred to as "Ash Feed", and, WHEREAS, Old Santa Fe is desirous of caring for and feeding Ash's cattle. NOW THEREFORE, it is agreed by and between the parties hereto that for and in consideration of the mutual promises, covenants and performances between them, the parties do respectively agreed as follows: FIRST: Old Santa Fe agrees to undertake 206 the care and feeding of the 1,143 head of mixed breed yearling steers owned by Ash and such additional Ash cattle (to a maximum of 5,000 head) which are delivered to its Sublette, Kansas, feedlots by June 15, 1971. SECOND: Old Santa Fe will determine the types of diets and rations and the procedures for the care of Ash's cattle, it being understood that such diets, rations and procedures will be calculated to provide the maximum growth of the cattle in the interests of sound economy. THIRD: In feeding Ash's cattle and preparing rations therefor, Ash authorizes and Old Santa Fe agrees to utilize and include Ash Feed, and Old Santa Fe agrees to store and maintain the same without charge for storage therefor. FOURTH: Ash agrees to pay Old Santa Fe for his cattle fed by Old Santa Fe at a yardage rate of five cents (5") per head per day and agrees to pay, in addition, Old Santa Fe's charges for ingredients other than Ash Feed which is fed Ash's cattle as follows: Alfalfa Hay$ 39.40 Per TonMolasses38.97 Per TonSugar Beet Pulp44.90 Per TonPremix78.01 Per TonIn addition, Ash agrees to Pay Old Santa Fe actual cost for veterinary services and medicines furnished Ash's cattle. Old Santa Fe 207 will invoice Ash bi-monthly for yardage, other ingredients, medicines and veterinary fees furnished, and Ash agrees to promptly pay such invoices as received. SEVENTH: On the completion of the feeding of Ash's cattle now located at Old Santa Fe's Sublette, Kansas, feedlots, or placed thereat by June 15, 1971, Old Santa Fe agrees to pay Ash a sum equal to two cents (2") per hundred weight (cwt) of all feed fed to such Ash cattle, including all corn silage, wheat, ground corn, alfalfa hay, molasses, sugar beet pulp and Premix. Such payment will be due and payable within fifteen (15) days following the completion of all such feeding. By letter dated January 15, 1971, from Sandomar Corporation to Old Santa Fe, it was agreed that too much corn sileage, corn and wheat had been purchased and that the excess feed would be traded (on a dollar-for-dollar basis) for the alfalfa hay, molasses, sugar beet pulp and premix to be fed to the cattle. In a handwritten letter dated December 31, 1970, from Ash to his attorney in Philadelphia, in a paragraph designated "Assignments," Ash stated: 1. Because of some technicalities in Kansas, the approx. $ 686,000 loan at 4th Nat'l Bank & Trust was made 208 by Mr. & Mrs. Omar L. Ash, and the cattle and feed were purchased in our names. However, we immediately assigned everything to Sandomar, subject to the loan, and let Sandomar assume the loan (the attorney has prepared these papers--the bank's records will not reflect such.) In Amarillo everything was clean - all purchases, loans, interest, accounts, etc. were in Sandomar's name. In order to close the Wichita deal, it was necessary for me (personally) to borrow $ 210,000 from Girard Trust Bank (unsecured). I immediately deposited the funds into the Sandomar account at 4th National Bank in Wichita. At the moment I am inclined to treat this as a capital contribution rather than a loan, & have the securities (which were put in Sandomar's name), treated as a loan. I hate to see Sandomar's statement appear "THIN", and, anyway, it has been necessary for me to personally guarantee Sandomar's obligations. On January 20, 1971, and April 5, 1971, petitioners signed Collateral Pledge Notes in the respective amounts of $ 800,000 and $ 210,000. By executing these notes, petitioners established lines of credit against which bank drafts were drawn for the purchase of additional head of cattle. 209 Drafts were drawn against these lines of credit for cattle and freight charges on the following dates: DateNumber of HeadJan. 269629125Feb. 2 1383 2365 110Mar. 2 1178 5415141161211922523120261312634029200308630223027931173Apr. 123083022During the March-April 1971 period, Ash and Sandra also obtained other monies from the bank for the purchase of cattle.On April 15, 1971, Ash, as sole director of Sandomar, consented to the adoption of a resolution which provided in pertinent part: RESOLVED, That the President of the corporation is hereby authorized to purchase a cattle inventory of 4,975 head, at price of $ 1,256,187, the purchase price to be paid by the corporation's assumption of the indebtedness against such cattle inventory owed to the Fourth National Bank and Trust Company, Wichita. FURTHER RESOLVED, That the President of the corporation is hereby authorized to enter into an agreement for and in behalf of the corporation reflecting the purchase of the cattle inventory and as a part thereof, assume the indebtedness against the same. FURTHER RESOLVED, That the President of the corporation is hereby authorized on behalf of the corporation to borrow up to $ 2,000,000 at an interest 210 rate of up to 8-1/2 per cent from The Fourth National Bank and Trust Company, Wichita, in connection with the assumption of the indebtedness owed against the cattle and any feed inventories and in connection with the purchase by the corporation of additional cattle and feed. On or about April 15, 1971, Ash transferred to Sandomar the cattle and feed previously purchased. On or about April 15, 1971, Sandomar borrowed $ 1,750,000 from the bank. On or about the same data, the Bank's liability ledger for Ash and Sandra reflected an outstanding balance on the various loans of $ 1,664,839.73. Sandomar used the $ 1,750,000 loan to pay off this outstanding balance, plus accrued interest of $ 10,242.43, resulting in a total payment of $ 1,675,082.16. The bank's records contain the following entries: SANDOMAR CORPORATION4-2-71 (Loan Committee Meeting) Approval was given to transfer the borrowings of Omar Ash to the Sandomar Corp. Loans will continue to be secured by the existing collateral and in addition, the personal guarantee of Mr. & Mrs. Omar Ash. * * * 4-14-71 (Executive Committee Meeting) Approval was given to increase this company's approved line up to $ 1,750,000 secured by stock, 211 feed, and cattle. In April 1971, approximately $ 350,000 worth of feed remained. By September 1971 approximately $ 19,000 remained. On Ash's and Sandra's joint Federal income tax return for 1971, $ 1,256,187 of the payment made by Sandomar was allocated to cattle. From this amount a basis of $ 1,114,995 was subtracted and gain of $ 141,192 was reported. On petitioners' joint return for 1970, a $ 476,094 deduction for "feed purchased" was reported on the Schedule F (Farm Income and Expenses). No other items being reported on the schedule, this deduction gave rise to a net farm loss of equal amount, which in turn was included in the adjusted gross income computation. As a Schedule A itemized deduction on the same return, the $ 20,245 paid to the Fourth National Bank was deducted as an interest expense. Petitioners also reported the following on the return: IncomeWages$ 50,311 Interest3,568 Other: Business Loss$ (176,073)Sales or Exchangesof Property11212 1,001,149 Pensions857 Farm Loss(476,094)349,839 Adjusted Gross Income403,718 Itemized Deductions 12(266,094)(266,108)Exemptions( 2,500)( 2,500)Taxable Income134,907 Ash reported adjusted gross income of $ 41,847 in 1969 and petitioners' reported $ 133,775 in 1971. In the statutory notice of deficiency, respondent disallowed both the $ 476,094 deduction for feed and the $ 20,245 deduction for interest. OPINIONStock TransactionThe first issue for decision involves the tax treatment to be accorded Ash's transfer of 39,028 shares of SCC stock to SCC in connection with the "reversal" of the stock option granted to and exercised by Reed. This transfer was accounted for in the joint return filed by Ash and Sandra by: (1) The deduction of a miscellaneous business expense in the amount of $ 202,946, which amount represented the difference between the alleged $ 5.25 per-share fair market value of the stock and $ 0.05 per-share received by Ash from the SCC in consideration for the transfer, and (2) the inclusion in income of a long-term capital gain in the amount of $ 195,909, which amount 213 represented the difference between the alleged $ 5.25 per-share fair market value of the stock and Ash's $ 0.23 per-share basis therein. In the statutory notice of deficiency, respondent determined a deficiency by disallowing the deduction and not including the capital gain in income. Petitioners contend that the claimed deduction falls within the ambit of section 162 as a deduction for an ordinary and necessary expense paid during the taxable year in carrying on a trade or business. The gist of petitioners' contention is that the stock transfer was an expenditure paid during 1970 by Ash in carrying on his trade or business of being a corporate director of SCC. Petitioners argue that the transfer was made because its purpose was to reverse the effects on SCC of the exercise by Reed of the stock option and, thereby, remove any grounds for a possible shareholder-derivative suit against Ash as a corporate director for waste of corporate assets. Petitioners, of course, have the burden of proving their entitlement to the deduction. 13214 Rule 142(a), Tax Court Rules of Practice and Procedure; New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934). Respondent disputes each of the necessary elements of petitioners' section 162 argument, specifically: (1) That Ash was not in the trade or business of being a corporate director for purposes of section 162; (2) even if ash was in such trade or business, that the stock transfer was not made in the "carrying on" of this trade or business, 215 but rather was in the nature of a capital contribution by Ash as a shareholder (for which no deduction is allowable) for the purpose of protecting his investment in SCC; and (3) in any event, even if a deduction is otherwise allowable under section 162, the proper tax year for such deduction is 1969, when the stock was transferred to SCC, rather than 1970, the year at issue. Finally, respondent also disputes the amount of the deduction claimed by petitioners, contending that the fair market value of the transferred stock was considerably less than the value used in calculating the deduction claimed. We agree with respondent that this was a 1969 transaction for tax purposes, although not necessarily with his reasoning, and because only the year 1970 is before us we do not have to decide the other issues raised by the parties relative to the stock transaction. There can be no question from the evidence that all parties concerned intended the recision of the Reed option to be completed before the end of 1969. Since the option was granted and exercised in January of 1969, recision by the end of 1969 was the only way from an accounting standpoint that reflection of the transaction in 216 the financial statements for the year 1969 could be avoided. In fact, the stockholder-directors entered into the agreement with SCC to make it whole in May of 1969, long before the final settlement with Reed, to permit the accountants to defuse the option transaction in their audit report for 1968. The attorneys for SCC emphasized to all involved that all steps in the plan to rescind had to be carried out on or before December 31, 1969. The stockholder-directors were aware of this and they did everything they were required to do under the agreement before the end of 1969; Ash even agreed to sell additional shares of his own stock to make up for the shares that Baldwin was supposed to sell but could not produce at the time. The stock certificates were delivered to the stock transfer agent on December 24 and were cancelled on the corporate records on December 26, 1969. The financial records of the company as of December 31, 1969, were the same as though the option transaction had never taken place and in note 10 to the annual report for 1969 it was reported that the 150,000 shares issued to Reed had been returned to the company for $ 7,500, thereby placing the company in the position 217 it would have been in had the transaction not occurred. This necessarily meant that the entire $ 7,500 the company paid for the return of the stock, including the $ 1,951.40 paid to Ash, had been accounted for by December 31, 1969. Petitioners claim that because the certificate representing the 7 excess shares delivered by Ash was not issued to Ash until January 2, 1970, and because the check in the amount of $ 1,951.40 issued to Ash in Payment for his shares was not received by Ash until January 9, 1970, the capital transaction was not completed until 1970 and since the capital transaction was an integral part of the loss or expense incurred by Ash, both the capital gain and the expense must be recognized for tax purposes in 1970. Respondent agrees that the capital gain transaction (assuming that a gain was in fact realized) would be properly reportable in 1970, the year in which the payment for the stock was actually received, relying on Rev. Rul. 72-381, 2 C.B. 233">1972-2 C.B. 233. But he claims that the capital gain and the loss are divisible transactions and that since all events had occurred in 1969 to fix the amount of the loss, it must be taken in that year. Initially, we confess 218 difficulty in understanding how there were two parts to the transaction or how Ash suffered a recognizable loss therefrom in anywhere near the amount claimed. The only actual transaction that took place was that Ash sold 39,028 shares of his stock to SCC for $ 1,951.40. Since his basis in those shares was $ 8,988, he suffered a loss of $ 7,036.60. The parties seem to expand this transaction into a multi-faceted transaction based on the theory, we assume, that if property that has appreciated in value is used to pay off an obligation gain is realized and recognized in the amount of the difference between the basis in the property and this amount of the obligation; if the amount of the obligation is not fixed, it is determined by the fair market value of the property transferred in satisfaction thereof. See United States v. Davis, 370 U.S. 65">370 U.S. 65 (1962). Thus the obligor acquires a basis for claiming a loss, or expense, in the amount of the difference between the fair market value of the property transferred and the amount received therefor, if any. The recipient, we assume, would have to account for the same difference. United States v. Davis, supra.But here no deductible expense 219 had been incurred by Ash, the satisfaction of which would entitle him to a loss deduction. All Ash did was transfer stock, which had an untaxed appreciation in value, to the issuer for a nominal consideration. He had no fixed obligation to SCC which was satisfied; or if he had an obligation to make SCC whole, that obligation was worth only 5" a share to SCC. SCC had no gain on the transaction and Ash suffered a loss measured by the difference in his basis in the stock and the amount he received therefor. The way petitioner reported it gave Ash a fictitious long-term capital gain and a fictitious loss based on the appreciation in value of the stock which had never been taxed to him. But even if the transaction gave rise to a loss for Ash, as was reported by petitioners, we think it was attributable to 1969. If the loss was separable from the asserted capital gain transaction, which we don't believe it was, such loss was sustained in 1969 because the transaction was closed and completed in 1969 when his obligation to SCC was satisfied by transfer of stock. See Income Tax Regs. 1.165-1(b). Or if the timing of the loss must be tied to the timing of the capital transaction, we believe 220 the capital transaction was closed in 1969. It is true that Ash was a cash basis taxpayer and gain is not recognized to such a taxpayer until the year in which he actually or constructively receives it. Income Tax Regs. 1.451-1(a). A taxpayer is considered to be in constructive receipt of such gain for the taxable year during which "it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given." Income Tax Regs. 1.451-2(a). (Emphasis added). In the corporate context "made available" has been interpreted to mean that the seller has both the right and the power to receive payment in the preceding year. Hyland v. Commissioner, 175 F.2d 422">175 F.2d 422 (2d Cir. 1949); affg. a Memorandum Opinion of this Court. Here Ash had transferred the stock to the company and it had been cancelled before the end of 1969. There was no provision in the agreement that payment for the stock would be deferred until 1970; in fact it was understood by everyone concerned that the entire transaction would be completed by December 31, 1969. Thus 221 Ash had the right to receive payment in 1969. He also had the power to obtain it.He was president, a director, and the largest stockholder of SCC. He could have demanded and received payment for the stock on or before December 31, 1969. There would have been no justification for withholding it. In fact, we imagine that the failure to issue the check until January 8, 1970, was due to oversight in light of the fact that the financial records of the company reflected complete rescission of the Reed option transaction by December 31, 1969. There was adequate time to issue the check after the stock was transferred and before December 31, 1969. This is a different situation than that described in Rev. Rul. 1972-381, supra, where stock was sold on the stock market on the last day of the year and payment was not received until the next year. Constructive receipt was not applicable there but it is here.The fact that the certificate for 7 excess shares was not issued until 1970 is irrelevant, Young, Exr. v. Commissioner, 6 B.T.A. 472">6 B.T.A. 472 (1927). We conclude that any gain realized on the sale of the stock and any loss suffered by Ash in this transaction was realized and should be recognized 222 in 1969. 14223 224 225 See Cooney v. Commissioner, 18 T.C. 883">18 T.C. 883 (1952); Huntington National Bank v. Commissioner, 90 F.2d 876">90 F.2d 876 (6th Cir. 1937). Cattle Feed TransactionsThe issues for decision center around the purchase in late December 1970 of cattle and the deductibility of: (1) A payment of $ 476,363.12 for feed for those cattle and others to be acquired; and (2) a payment of $ 20,245.43 as interest on a loan obtained in order to purchase the feed. Payments for both the feed and interest were also made in late December 1970. On their joint Federal return for 1970, petitioners deducted both the $ 476,363.12 and the $ 20,245.43 amounts. In the statutory notice of deficiency, respondent disallowed both deductions.In litigating the question of the deductibility of the payments for feed and interest, the first question on which 226 the parties have focused is whether the payments for feed and interest were made by Ash for his own account or by him as agent or nominee for the benefit of Sandomar. 15Respondent contends that Ash intended to acquire the cattle and feed in the name of Sandomar when he travelled to Wichita; that he acted at al times on behalf of Sandomar; and that Sandomar, not Ash, purchased the feed and paid the interest and was the real debtor with respect to the loan at the bank. Accordingly, respondent argues, Sandomar, not Ash, is entitled to whatever deductions may be allowable. In circumstances such as this involving an individual and his solely-owned corporation with which the individual apparently was not always careful in preserving the distinction between his business activities and those of the corporation, it is difficult to pinpoint where his activities end and those of the corporation begin. Moreover, recitation of the general proposition that the substance of a transaction rather than its form controls 227 for tax purposes is of no particular benefit in this case because the "substance" of the cattle-feeding transaction would not be much changed regardless of whether Ash or Sandomar entered into it. The bank, Young and Cooper, and Old Santa Fe were entering into the various components of the overall transaction based on the underlying financial worthiness of Ash. We agree with respondent that Sandomar was a viable corporation and that Ash travelled to Wichita and conducted preliminary negotiations with the intention of structuring any cattle and feed purchases engaged in in the name of Sandomar. To effect this intention, Ash indicated a willingness to contribute sufficient capital to Sandomar. However, at the 11th-hour the bank would not loan the money to Sandomar because the corporation did not have a certificate of authority to do business in Kansas and because it could not establish clear and identifiable ownership and title for the collateral to be pledged for the loan. 16 Accordingly, Ash and Sandra individually signed the note for the loan and Ash individually was listed on the bill of sale for the cattle and entered the agreement with Old Santa Fe for the care and feeding 228 of the cattle. Nevertheless, according to Ash's letter of December 31, 1970, to his attorney, he immediately deposited the money in Sandomar's bank account and assigned everything to Sandomar, subject to the loan. Sandomar's bank account records bear this out because a cashiers check from the bank made payable to the Ashes was endorsed to Sandomar and deposited into its account. Checks were then drawn on Sandomar's bank account to pay for the feed and the interest that are in question. By letter dated January 15, 1971, a letter was written to Old Santa Fe in behalf of Sandomar in which reference was made to the feed and cattle "owned by this corporation." However, subsequent to 1970 both the bank and Old Santa Fe dealt with Ash as the owner of the feed and cattle and as the obligor on the loans until April 15, 1971, when a formal transfer of the cattle and the loans was made by the Ashes to Sandomar. The evidence is quite clear that Ash intended that the cattle business be conducted by Sandomar. The Amarillo cattle and feed transaction was carried 229 out in the name of Sandomar; and it is not questioned that after April 15, 1971, the Wichita cattle business was conducted by Sandomar. The question is whether the bank's last minute change in attitude which caused the Ashes to substitute temporarily for Sandomar made the Ashes the actual owners of the business for 3 1/2 months and entitles them to deductions for 1970 for prepaid feed and interest. We think not. 17 Unfortunately, there is very little evidence that the bank actually insisted that the transaction be structured in Ash's name rather than Sandomar, and if so, why. The loan to Sandomar was approved by the 230 loan committee and the executive committee of the bank on December 28 and December 30, 1970, respectively. No evidence in the form of minutes was offered to prove that the committees changed their minds or that they approved a loan to Ash personally. The Ashes would have been required to secure a loan to Sandomar anyway so there seems to be little reason for changing the transaction at the last minute. The only explanation we have of why this was done is the rather vague testimony of Mr. Lesher, who was handling the matter for the bank but who later became an officer of Sandomar, that Sandomar was not qualified to do business in Kansas and could not produce clear title to the securities that were to be used as collateral for the loan. We have no explanation of why Sandomar could not have been qualified to do business in Kansas and why there was an impediment in the title to the securities which Ash later told his attorney he had transferred to Sandomar. Furthermore, the use of Sandomar's bank account, for "convenience," does not ring true. In our opinion even if the bank insisted at the last minute that the loan be made in Ash's name, Ash intended it to be a Sandomar transaction 231 and took steps to carry out that purpose until he subsequently discovered that it was in his interest for tax purposes that the business be in his name for a while at least. 18 There is also evidence that the books and records of Sandomar were altered by erasing entries made at the end of the year which reflected that Sandomar received $ 686,363.12 as a loan from Ash and used 232 these funds to pay for the cattle and the feed and to pay interest. We recognize that the erasures could have been made to correct a mistake but that is not the usual way to correct a bookkeeping mistake. The facts that the bank treated the loans as being those of Ash until Sandomar formally took them over in April of 1971 and that the management of Old Santa Fe dealt with the cattle and feed as being the property of Ash until April of 1971 certainly support petitioners' version of the status of the business. Of course, the banker and the managers of the feed lot had dealt with Ash personally and basically were looking to Ash's assets as security for the transactions. There would be no reason for them to change unless instructed to do so by Ash. We think Ash must have realized soon after the beginning of 1971 that it was in his best interests to have the business in his own name for a while and consequently made no effort to straighten matters out until after Sandomar elected Subchapter S status. Based on all the evidence, we are convinced that Sandomar either bought the cattle and feed in its own right and assumed the obligations to the bank before the end of 1970 or that Ash 233 bought the cattle and feed and made the loans for and in behalf of Sandomar as its agent. Sandomar was a viable corporation formed by Ash to carry on legitimate business activities, and did carry on such activities, and its corporate existence cannot be ignored. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943). Moreover, where a stockholder incurs an expense on behalf of a corporation, the expenditure is not deductible by him personally but is treated as a loan or a contribution of capital to the corporation. Deputy v. Dupont, 308 U.S. 488">308 U.S. 488 (1940). Consequently, we conclude that petitioners are not entitled to a deduction for the feed purchased in December of 1970 or the interest paid to the bank in December of 1970. 19234 Liability of Petitioner Sandra AshThe final issue for decision concerns the liability of Sandra Ash for any deficiency in petitioners' income tax determined herein. Petitioners filed a joint return for 1970 and their liability with respect to the tax therein is joint and several.Section 6013(d)(3). Sandra, however, makes two arguments in support of a contention that she should not be liable for any deficiency in tax for 1970. Sandra's first argument pertains to section 6013 and is framed as follows: Whether IRC § 6013 is unconstitutional on due process and equal protection grounds in that it arbitrarily provides relief for certain spouses but not to others who have been equally wronged.Section 6013(e)(1) provides: (e) Spouse Relieved of Liability in Certain Cases.-- (1) In General. Under 235 regulations prescribed by the Secretary, if-- (A) a joint return has been made under this section for a taxable year and on such return there was omitted from gross income an amount properly includable therein which is attributable to one spouse and which is in excess of 25 percent of the amount of gross income stated in the return, (B) the other spouse establishes that in signing the return he or she did not know of, and had no reason to know of, such omission, and (C) taking into account whether or not the other spouse significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such omission, then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent that such liability is attributable to such omission from gross income.On brief Sandra discusses the legislative history of section 6013(e) and the reasons which led Congress to adopt the provision. She admits that she fails to qualify under section 6013(e)236 because the deficiency herein arises from unallowable deductions, not a 25-percent omission of gross income.Section 6013(e)(1)(A). She states, however: A perusal of this record should make evident that, as applied, § 6013 is unconstitutional as there is no rational basis in precluding a spouse from establishing her innocent status in the case of fraudulent or improper deductions as with the relief provisions of § 6013(e) as to omitted gross income. Although she never specifically states the relief sought in the event this Court finds section 6013(e) unconstitutional "as applied," we can only conclude from the foregoing quotation that Sandra is seeking to have the Court apply section 6013(e) without reference to subparagraph (A). This conclusion comports with Sandra's statements on brief that she had no knowledge of (see subparagraph (B)) and received no benefit from (see subparagraph (C)) the unallowable deductions and, accordingly, that holding her liable would be inequitable. Although we recognize the financial straits in which she finds hereself, Sandra's constitutional argument is both without merit and self-defeating. The validity of the "25-percent-omission" requirement of 237 subparagraph (A) has been upheld. See Quinn v. Commissioner, 524 F.2d 617">524 F.2d 617 (7th Cir. 1975), affg. 62 T.C. 223">62 T.C. 223 (1974); Estate of Klein v. Commissioner, 63 T.C. 585">63 T.C. 585 (1975), affd. 537 F.2d 701">537 F.2d 701 (2d Cir. 1976), cert. denied 429 U.S. 980">429 U.S. 980 (1976); Resnick v. Commissioner, 63 T.C. 524">63 T.C. 524 (1975). While the exact arguments advanced herein by Sandra may not have been advanced in these cases, we do not read the cases as narrowly as she does. Moreover, even if we were to conclude that section 6013(e)(1)(A) is unconstitutional, such a conclusion would not enable us to apply section 6013(e)(1) without regard to subparagraph (A) or to otherwise rewrite the statute. Rather, the entire provision would be invalidated and Sandra would be liable for the deficiency in tax as a result of the joint and several liability undr section 6013(d)(3). Quinn v. Commissioner, supra at 626. As we understand it, Sandra also argues that since there is no rational basis in precluding a spouse from establishing her innocent status in the case of fraudulent or improper deductions as do the relief provisions of section 6013(e) with respect to omitted gross income, the entire section 6013 is unconstitutional, because the 238 arbitrariness of the relief remedies is a fundamental denial of due process. Sandra cites no case in support of this argument and we have found none. We do find that a legislative classification will not be set aside if any state of facts rationally justifying it is demonstrated or perceived by the courts. United States v. Maryland Savings-Share Insurance Corp., 400 U.S. 4">400 U.S. 4, 6 (1975). The legislative history of the innocent spouse provisions indicate that Congress was concerned with situations involving illegal income such as embezzled funds and thus directed its attention toward the omission of gross income. We find that Congress had a rational basis for differentiating between cases involving omissions of income and those involving improper deductions. Section 6013(e) is a mitigation provision and not every taxpayer is entitled to relief. Estate of Klein v. Commissioner, 63 T.C. 585">63 T.C. 585 (1975), affd. 537 F.2d 701">537 F.2d 701 (2d Cir. 1976), cert. den. 429 U.S. 980">429 U.S. 980; Resnick v. Commissioner, 63 T.C. 524">63 T.C. 524 (1975). In Quinn v. Commissioner, 62 T.C. 223">62 T.C. 223 (1974), affd. 524 F.2d 617">524 F.2d 617 (7th Cir. 1975), this Court considered a due process and equal protection challenge to section 6013(e) and concluded 239 that the statute did not invidiously discriminate. It found that the relief provision was not unconstitutional where it related to a privilege whose election was voluntarily made. 62 T.C. at p. 231. Furthermore, we do not believe that even if the relief provisions of section 6013(e) were found to be unconstitutional this would pull the mantle of unconstitutionality over the voluntary and elective provisions of section 6013(a), which permits the filing of joint returns. In addition to the foregoing, Sandra has also failed to prove that she otherwise qualifies as an innocent spouse undr subparagraphs (B) and (C) of section 6013(e)(1).Sandra has the burden of proving that she is entitled to the protection of section 6013(e). Sonnenborn v. Commissioner, 57 T.C. 373">57 T.C. 373 (1971). Section 6013(e)(1)(B) requires an "innocent spouse" to establish "that in signing the return he or she did not know of, and had no reason to know of" the omission from income. In the context of this case, that would require that Sandra have no knowledge or no reason to know of the deductions at issue herein. Since the amount of the deductions are clearly set forth on the returns which she signed, we fail to see 240 how it could be said that she had no reason to know of them. Her failure to examine the return does not absolve her. 20Moreover, the knowledge requirement of subparagraph (B) is not knowledge of the tax consequences of a particular transaction but knowledge of the transaction itself. McCoy v. Commissioner, 57 T.C. 732">57 T.C. 732 (1972).Sandra was with Ash in Wichita when the cattle feed transaction was consummated and she signed the note for the loan to purchase the feed. She obviously knew of this transaction. That she may have been unfamiliar with the tax consequences thereof is of no consequence.Sandra has also not established, as required by section 6013(e)(1)(C), that she did not significantly benefit as a result of the erroneously claimed deductions. The fact that the deductions may have "sheltered" Ash's income and not Sandra's rather minimal income during the year in issue does not show that Sandra did not "benefit" from whatever tax savings may have been attributable to the claimed deductions. Based on the scant evidence of record, it appears that Ash and Sandra lived rather well and we cannot say that Sandra did not benefit. In summary, 241 we conclude that Sandra has failed to prove that she satifies the requirements of section 6013(e)(1)(B) and (C) and, consequently, that regardless of her constitutional argument concerning section 6013(e)(1)(A), she does not merit relief from liability as an innocent spouse under section 6013(e). Sandra's second argument in support of her contention that she should not be liable for a deficiency in ax for 1970 is that the return filed by petitioners should not be considered a joint return. As was the case with Sandra's first argument, this argument is an equitable one pursuant to which she asks that the Court consider her signature on the joint return to be either "involuntary" or "of no legal consequence," resulting in the further conclusion of no "joint" return. Her reasons for the foregoing request include: Although not tricked or coerced into signing the return, she relied on the confidential relationship between her husband and herself without suspecting the existence of improper deductions; and, having little or no income for the year, she did not benefit from the filing of a joint return. Again, while Sandra may paint an equitable picture, there is no question that the return 242 filed was a joint one, and that petitioners' liability with regard thereto is joint and several. Section 6013(d)(3). Sandra admits that she was not coerced or tricked into signing the return. The fact that she was unaware of the potential tax liability or relied on her husband to file the return is of no import. Douglas v. Commissioner, 27 T.C. 306 (1956). The question is whether Sandra intended that the return be joint. Estate of Campbell v. Commissioner, 56 T.C. 1">56 T.C. 1 (1971). The only evidence of record is that she did.Accordingly, we conclude that the return filed for 1970 was a joint return and that Sandra's liability with regard thereto is joint and several. Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year in issue.↩2. In support of evidentiary objections made and not ruled on at trial, the parties on brief argued numerous objections to various documents and testimony. For the most part, these objections were made by petitioners on the grounds that the evidence in question was "irrelevant and immaterial." Rule 401, Federal Rules of Evidence, which rules are applicable in this Court under Rule 143(a), Tax Court Rules of Practice and Procedure, provides: "Relevant evidence" means evidence having any tendency to make the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence. The evidence in question to which petitioner objected was "relevant" to respondent's theories concerning the issues presented. Although we may not have agreed with respondent's analysis, he has the right to introduce evidence which supports his analysis and such evidence is not irrelevant and immaterial. Accordingly, petitioners' objections are overruled. With few exceptions, no further reference will be made to evidence in question. This is not to say, however, that factual findings in connection with the objected to evidence were made in each instance requested. We have made those findings which we considered necessary.3. The letter's statement concerning "excessive price" refers to the possibility that the January 1969 stock option granted to Reed could be viewed as having been given in exchange for the release of an earlier-granted stock option, which earlier option was worth so much less than the January 1969 option that the granting of the January 1969 option would be found to be an "excessive price" for obtaining the return of the earlier option.4. The $ 0.05 per share price reflects the 2-for-1 stock split in February 1969 after Reed had purchased shares in January 1969 for $ .10 per share.↩5. Benscoter was president of SCC.↩6. At trial respondent introduced both documentary and testimonial evidence, subject to petitioners' objection, to show that both of the agreements dated May 21, 1969, were in fact signed at a later time. Since the purpose for the timing of the agreements is undisputed, it is of no particular import when the agreements were actually signed and we have made no factual findings as to when the documents were signed.7. A mistake was made initially in calculating the number of shares Ash was to sell under the agreement. The certificate Ash mailed to the attorney on December 23, 1969, covered the additional shares he was selling.↩8. Petitioners objected to the introduction of this evidence on the grounds it was irrelevant and immaterial in that the dates and stock-amounts involved were not useful in valuing the stock which Ash transferred to SCC. Although the stock valuations of January and October 1969 are of little value, the valuation as of January 1970 is both near in time and stock amount to the time and amount which petitioners claim are critical. Moreover, we believe the manner in which the stock was valued is useful for our purposes. Although the question of the stock's value is not essential to the resolution of this issue presented, since we have held against petitioners on a question which prevented consideration of the valuation question, we have nonetheless included facts concerning valuation of the stock because they aid in providing a general understanding of this case.9. The cost of the feed purchased at Amarillo was not claimed as a deduction on petitioners' 1970 return and has no direct bearing on the issues in this case. Sandomar deducted $ 155,400 for feed on its return for fiscal year ended March 31, 1971.↩10. It is not explained why the bank drew a cashiers check in the amount of $ 686,363.12 if $ 210,000 of this amount was borrowed from Girard Trust Bank.↩11. Included within this amount were long-term capital gains of $ 2,007,055 from sales of stock. 12. The principal component of the itemized deductions was the $ 202,946 deducted in connection with Ash's stock transfer to SCC. The $ 20,245 deducted as prepaid interest was included in a total of $ 37,898 deducted as interest expenses.↩13. Petitioners defend the method used to account for the stock transfer (i.e. a business deduction and long-term capital gain inclusion) as proper under United States v. Davis, 370 U.S. 65">370 U.S. 65 (1962). In Davis the Supreme Court held that taxpayer-husband's transfer of appreciated assets to his wife pursuant to a property settlement agreement was a taxable event upon which taxpayer-husband realized and recognized gain. Respondent does not challenge the correctness of petitioners' reporting both a deduction and a capital gain if petitioners are in fact entitled to a deduction at all. See Estate of Nickel v. Commissioner, T.C. Memo. 1962-55; cf. United States v. General Shoe Corp., 282 F.2d 9">282 F.2d 9 (6th Cir. 1960), cert. denied 365 U.S. 843">365 U.S. 843 (1961); International Freighting Corp. v. Commissioner, 135 F.2d 310">135 F.2d 310 (2d Cir. 1943), affg. 45 B.T.A. 716">45 B.T.A. 716 (1941); Tilford v. Commissioner, 75 T.C. 134">75 T.C. 134, 147↩ (1980).14. As noted above, having concluded that any gain or loss realized by petitioner must be accounted for in 1969, we need not decide whether a recognizable loss was actually incurred in the transaction. However, the parties presented voluminous evidence on that issue, have argued it on brief and our Findings of Fact contain all that is relevant to the inquiry. It is possible that if a loss was allowable for 1969, this might affect Ash's tax liability for 1970. In light of the circumstances we will very briefly summarize our thoughts on the issue. Because of the issuance of the improvident option to Reed the directors were open to a real charge of wasting corporate assets. Also Reed's exercise of the option made it compensatory and it would be chargeable to income, with a very unfavorable affect on the market value of the company stock. Both to protect themselves from a possible stockholders suit and to protect their investment in SCC stock, and we doubt that either reason could be considered the primary reason, the directors took steps to nullify or rescind the option transaction. Under the plan agreed upon by the directors and the company Reed transferred 1/2 of his shares back to the company for the price he paid for it and the directors transferred an equal number of shares to the company for the same price Reed paid for it.The number of shares each director transferred was pro rata to the number of shares he owned compared to the shares owned by the other four. The plan was carried out. As a result, Ash transferred over 39,000 shares of stock to SCC and received 5" a share therefor. This was a sale and Ash realized a capital loss in the amount of the difference between his basis in the stock and the amount received. Ash had no fixed obligation in any specified amount to SCC and we see no reason that a fictitious gain should be charged to him, measured by the difference between his basis in the stock and the fair market value thereof. Nor do we find that Ash suffered a loss or incurred an expense on the transaction, business or otherwise. All he did was to make SCC whole and nullify the effect on it of the Reed option. That affect was to dilute its capital among a larger number of shares. By returning those shares to SCC Ash simply increased the pro rata share of each of the other stockholders in the capital of the company. In doing so he suffered no actual loss except the difference in his basis and the amount received for the stock, which we have accounted for. Ash had never realized or recognized for tax purposes the difference between the fair market value of the stock and the price he received for it and we see no reason why he should be allowed a loss deduction, ordinary or capital, on this paper loss. He in effect contributed that difference to SCC, which satisfied the only obligation he might have had to the company. We add that we have doubts that Ash's activities as an officer and director of SCC would be recognized as being a business under the criteria established by Whipple v. Commissionr, 373 U.S. 193">373 U.S. 193 (1963). Ash was not paid a salary by SCC and any expense he incurred could not be said to be for protection of his salary. Also, it could be questioned whether any loss or expense he incurred relative to the Reed transaction was an ordinary and necessary expense of his business of being a director of SCC. While any liability he might have incurred arose out of his job as a director his expenses were for his personal benefit. See Ditmars v. Commissioner, 302 F.2d 481">302 F.2d 481 (2d Cir. 1962), revg. and remanding in part a Memorandum Opinion of this Court. And, finally, if the stock transfers are considered to be contributions to the corporation rather than sales, we think they would be considered to be pro rata. See Tilford v. Commissioner, 75 T.C. 134">75 T.C. 134↩ (1980), for a discussion of the significance of a pro rata as opposed to a non-pro rata surrender of stock to the issuing corporation.15. Although the purchase of the cattle is intertwined with the payments for the feed and interest, no issue is pending concerning the tax treatment of any payment for the cattle.↩16. Although never specifically identified, apparently the collateral in question was stock which Ash had agreed to provide as security.↩17. An issue we will not have to decide in light of our conclusion above is whether, if Ash were found to be the owner of the business and the payor of the obligations, he would qualify as a "farmer" entitled to elect to deduct instead of capitalize the cost of the feed under section 471, I.R.C. 1954, and Regs. 1.471-1. We think that to characterize him as a "farmer" in 1970, which he might have been for one day at the most in 1970 and formally transferred the business to Sandomar 3 1/2 months later, would stretch too far the purpose of Congress in enacting sec. 471↩.18. The bank apparently thought Sandomar was a Subchapter S corporation and perhaps Ash thought so too. When it was discovered that Sandomar was not qualified and thus its deductions could not be passed through to Ash, Ash may have decided to restructure the cattle business and make it his own until Sandomar could make an election to become a Subchapter S corporation at the beginning of its next taxable year, starting April 1, 1971. This, however, was not accomplished. The courts have repeatedly held that while a taxpayer is free to organize his affairs as he chooses, nevertheless, having done so, he must accept the tax consequences of his choice, whether contemplated or not. Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134 (1974); Blanco v. United States, 602 F.2d 324">602 F.2d 324↩ (Ct. Cl. 1979).19. Here again our conclusion on this issue makes it unnecessary for us to decide other related issues argued by the parties and concerning which evidence was produced. We mention them briefly for the benefit of the parties. We have already referred to the question of whether Ash could qualify as a farmer under section 471 in footnote 17. We think the evidence supports the conclusion that the payment for the feed in December of 1970 was a prepayment, made for sound business reasons, and was not simply a deposit. We also find no reason why the interest prepaid for the approximately 6-month term of the loan in December 1970 should not be deductible by the obligor thereof in 1970. If there were sound business reasons for these prepayments, covering such short periods of time, which we think there was, there would be no distortion of income.20. James v. Commissioner, T.C. Memo. 1980-99↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622802/	ARTHUR J. MORRIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Morris v. CommissionerDocket No. 64246.United States Board of Tax Appeals33 B.T.A. 241; 1935 BTA LEXIS 779; October 22, 1935, Promulgated 779 1. TRUSTS - INCOME FOR BENEFIT OF GRANTOR. - Where the taxpayer created certain trusts, making himself one of the two trustees, and such part of the income of each trust as the trustees, in the exercise of their discretion, might decide upon, was payable thereunder to the primary beneficiaries, and the corpus of the trust in each case was to be reconveyed to the taxpayer upon termination of the trust period, it is held that income arising from sales of the trust corpus, and constituting under state law an addition to such corpus, not distributable to the beneficiaries, is income in respect to which the taxpayer as trustee had no discretion, within the purview of section 167 of the Revenue Act of 1928, to hold or accumulate for future distribution to himself and, consequently, such income is not taxable to him under the provisions of that section. Preston R. Bassett,33 B.T.A. 182">33 B.T.A. 182, followed. 2. Id. - The current income of the trusts aforementioned, derived from the investment of the trust assets and provided by the trust instruments to be subject, in the discretion of the taxpayer and his cotrustee, to distribution to the primary beneficiaries, or accumulation780 for future distribution to himself, held taxable to him under section 167 of the Revenue Act of 1928. James A. Vaughan, Esq., for the petitioner. John H. Pigg, Esq., for the respondent. LEECH241 OPINION. LEECH: This proceeding seeks redetermination of a deficiency of $34,769.61 for the calendar year 1929. The error assigned is the action of respondent in including in petitioner's income for the year in question the income of five trusts created by him in favor of his wife and four daughters. The facts are stipulated and only a brief statement of such as are necessary for an understanding of the issues will be made here. 242 Petitioner, at the time of the occurrence here involved, was, and is now, a resident of the State of New York. On July 1, 1926, he executed five trust instruments by which he conveyed to himself and his secretary, as trustees, five separate lots of securities. The trust instrument in each instance was substantially the same, except as to the beneficiary. The trust in each case was created for the term of five years, at the end of which time the property was to be reconveyed to the grantor. In each781 instance the property was transferred to the trustees to hold "IN TRUST to receive all the income thereof and after paying therefrom all lawful charges and expenses including compensation of the Trustees as hereinafter provided, to pay or apply the net income or such part thereof as the Trustees may determine upon, from such trust estate arising each year in substantially equal monthly instalments, or in such other instalments as may be deemed advisable by the Trustees" to or for the beneficiary. The trust in each case was executed in, and the trust estates were at all times located in, the State of New York. In the case of each trust it is not disputed that gains arising from the sale of securities would not be subject to distribution but would, under the law of New York, be accumulated as part of the corpus and only the income from investments be subject to distribution to the beneficiaries. It was provided, however, in each trust, with respect to the distributable income, that "nothing herein shall prevent the said Trustees from paying out to the beneficiaries herein contemplated only part of said income and accumulating the balance for the purpose of increasing the principal782 of said trust fund in such manner and in such amounts as to the Trustees may seem proper." No power of revocation was reserved. Upon the expiration of five years or upon the death of the beneficiary, whichever should first occur, the trustees were, under each trust, "to pay over the principal of said trust estate as it shall then exist with all gains and increase of capital, if any, in fee simple to the Donor if he is living." Returns were filed for each of the five trusts for the calendar year here involved, reporting the net income received by each. The parties hereto are agreed as to the amount of the income received, the portion in each case represented by profit from sale of the trust corpus and the part representing the current investment income of the trust. The disputed deficiency here arises from respondent's action in including the total income of each trust for the year in question, in petitioner's income as taxable to him. Respondent contends that the income in question, whether that represented by gains on disposition of capital assets of the trusts or the investment income realized by the trust estates, was taxable 243 to petitioner under section 167783 of the Revenue Act of 1928, 1 for the reason that petitioner was vested with discretion to hold or accumulate such income for future distribution to himself. Petitioner's position is that, as to the income represented by gains upon the sales of capital assets, the trustees had no such discretion but were required by law to accumulate such income, and, consequently, section 167 of the Revenue Act of 1928 is not applicable. As to the investment income of each trust, petitioner argues that, notwithstanding the authority reserved to the trustees to accumulate such income as an addition to the corpus, the beneficiary in each case obtained a vested right to such income under New York law and could have enforced its distribution to her had petitioner attempted to withhold it. As to this income it is insisted that the trustees, in fact, had no authority, in the exercise of their discretion, to accumulate it for later distribution to petitioner. Actually, all of the income of this character was distributed by the trustees in each year to the several beneficiaries. 784 In reference to the income consisting of gains upon sales of assets included in the corpus of the several trusts, section 167 of the Revenue Act of 1928 is not applicable. . With respect to the investment income of these five trusts which was distributed to the several beneficiaries, we have given careful consideration to the argument of petitioner's counsel, that the specific reservation in the trust instrument of the power in the trustees to accumulate this income for the purpose of increasing the corpus distributable to the grantor, was without effect under the laws of New York. Examination has been made of the authorities submitted by counsel and we are unwilling to conclude that under the decisions of the courts of that state, petitioner's wife and daughters would be held to have a vested interest in this income and be entitled to enforce its distribution to them if accumulation were attempted by the trustees. The intent of the grantor of these trusts appears to be clear that these beneficiaries are to receive only such amounts as the trustees, in the exercise of their discretion, distributed to them. The record does not785 disclose whether the beneficiaries were of age nor is it indicated that the trust was, in any instance, for the purpose of maintenance of the beneficiary. We recognize the rule in New York State that, where the trust is created for the purpose of maintenance and the intent is clear that the income 244 is to be used for that purpose, an attempt to limit the right of the beneficiary to receive that income, embodied in provisions granting discretion of the trustees to withhold, is, under some conditions disregarded where the result reached by such construction does not violate the intent of the grantor that the beneficiary shall receive the entire income. ; ; ; ; ; ; ; ; ; 786 . The cases cited by counsel for petitioner fall within this general class, but it does not appear to us that the instant case is controlled by them. Each trust instrument here discloses that the intent of the grantor was not to give a vested interest to these several beneficiaries in the income as realized by the trustees, but only in such part of that income as the trustees, in their discretion, might distribute. It is apparent from a consideration of all of the trust provisions, that the purpose of the grantor was to retain control of the trust income to the extent of applying it for his own benefit, if he so desired. These five trusts are the creation of this petitioner. In them he has sought to reserve povers, to himself, with respect to the trust income which, if effective, make such income taxable to him under the applicable revenue act. He now asks that we determine that, had the question of his powers as trustee under these various trusts been submitted to a New York court, its decision would have denied him the right to exercise the powers reserved. It is quite true that if these trust instruments had been submitted to the state court and787 reformed by the dlimination fo those sections granting discretionary power to the trustees, such decision would be binding on us. . The trusts, however, have not been construed by the New York courts. It does appear that the provisions in the trust instruments reserving the right in the trustees to accumulate investment income for future distribution to petitioner violate section 16 of the New York Personal Property law. 2 This fact, however, in our opinion, does not mean that a judicial construction of 245 the instruments would hold the primary beneficiaries entitled to trust income withheld by the trustees. 788 This result would follow, only, if the court's decision voided, not only the provisions authorizing the accumulation, but also the discretionary power of the trustees to determine the amount distributable to the primary beneficiaries. But the intent of the grantor here is so clear that the trustees should have this power, that no legal reformation of this present instrument would ignore it. The result, then, would be merely to accelerate the next eventual estate, the vested remainder, and hold the remaindermen entitled now to distribution of that portion of the income unlawfully accumulated by the trustees. ; ; ; ; . As petitioner holds that vested remainder interest under each of the trusts, the result to him, in liability for tax upon this income, would be the same. He would have the right, as trustee, to withhold the income from distribution to the primary beneficiaries, in which event it would be distributable and thus taxable to him. Upon the789 present record we hold that the disputed income derived from the investment of the trust assets is taxable to petitioner. Judgment will be entered under Rule 50.Footnotes1. SEC. 167. Income for benefit of grantor.↩ - Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called "charitable contribution" deduction), such part of the income of the trust shall be included in computing the net income of the grantor. 2. 16. Validity of directions for accumulation of income. An accumulation of the income of personal property, directed by any instrument sufficient in law to pass such property is valid: 1. If directed to commence from the date of the instrument, or the death of the person excuting the same, and to be made for the benefit of one or more minors, then in being, or in being at such death, and to terminate at or before the expiration of their minority. * * * 3. All other directions for the accumulation of the income of personal property, not authorized by statute, are void. In either case mentioned in subdivisions one and two of this section a direction for any such accmulation for a longer term than the minority of the persons intended to be benefited thereby, has the same effect as if limited to the minority of such persons, and is void as respects the time beyond such minority. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622803/	ERIC F. AND MARY E. WEISS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWeiss v. CommissionerDocket No. 24389-84.United States Tax CourtT.C. Memo 1988-586; 1988 Tax Ct. Memo LEXIS 615; 56 T.C.M. (CCH) 948; T.C.M. (RIA) 88586; December 27, 1988; As amended January 3, 1989 Walter Tribbey, for the petitioners. Joseph E. Mudd, for the respondent. GERBERMEMORANDUM OPINION GERBER, Judge: Respondent, in a statutory notice of deficiency dated April 13, 1984, determined deficiencies in income tax and additions to tax for petitioners' 1976, 1977 and 1978 taxable years, as follows: Addition to TaxTaxable YearIncome TaxSection 6653(b) 11976$ 10,876.31$ 5,438.1519777,602.603,801.30197815,936.757,968.38Petitioners, in anticipation of a November 30, 1987, trial date, filed a Motion To Suppress Evidence on October 19, 1987. 616 The parties have stipulated specific amounts of deficiencies in income tax and additions to tax that would result if we granted or denied petitioners' motion. Accordingly, this opinion will be dispositive of all issues raised by the pleadings and the petitioners' motion is being treated as a summary judgment motion under Rule 121. No trial was held and the parties have orally stipulated that the facts and holdings of the United States District Court are to be accepted for purposes of this case. Petitioners' motion is premised upon the holding of the United States District Court for the Central District of California dismissing with prejudice the related criminal tax indictment because of "institutional bad faith" on the part of the Internal Revenue Service. United States v. Weiss,566 F. Supp. 1452">566 F. Supp. 1452 (C.D. Cal. 1983), affd. without published opinion 730 F.2d 772">730 F.2d 772 (9th Cir. 1984) (Weiss I). The "institutional bad faith" consisted of variances from the Internal Revenue Manual (IRM) in the process of criminal referral of the case from the Examination Division (Exam) to the Criminal Investigation Division (CID) of the Internal Revenue Service. Specifically, 617 CID advised Exam of the acceptance of the case for criminal investigation 26 days after referral, instead of 15 days as required by the IRM. Additionally, the wrong form was used by CID to request the assistance of a cooperating revenue agent from Exam. During the 11-day hiatus between the 15-day IRM standard and the 26-day actual time, the District Court in Weiss I assumed that "Civil Summonses" issued under section 7602 may have been used to gather evidence in violation of the holding in United States v. LaSalle National Bank,437 U.S. 298">437 U.S. 298, 316-317 n. 18 (1978). The question presented for our consideration is whether such "institutional bad faith" in the context of this civil proceeding precludes respondent's use of any such evidence and/or calls for sanctions to be employed against respondent. See United States v. Janis,428 U.S. 433">428 U.S. 433 (1976). The facts as presented by the parties, consist of the District Court's "Minute Order" in Weiss I, as follows: Hauk, District Judge: This matter came on for Jury Trial on Wednesday, June 29, 1983, before the undersigned Judge A. Andrew Hauk upon transfer under Central District of CaliforniaLocal618 Rules, Rule 2, from the Honorable A. Wallace Tashima of this above-entitled Court due to his crowded Court calendar, and continued at jury trial before the undersigned Judge thereafter from day to day, June 29, June 30, July 1, July 5, and July 6, 1983. In the course of the trial, evidence was introduced and analyzed by the Court which strongly indicated and suggested to the Court that Plaintiff U.S.A., by and through its Internal Revenue Service (IRS) of the Department Of The Treasury by reason of possible acts of misconduct by the IRS agents and employees, had engaged in what the Court considered might well constitute "governmental misconduct" and "institutional bad faith", in the improper and intermingled initiation and execution of civil and criminal investigations in this case. For which reasons, the Court entertained a motion by Defendant for Dismissal of the Indictment and Judgement of Acquittal, against Plaintiff U. S. A. and in favor of Defendant, and set a deadline date of noon, July 6, 1983, for the Government to produce documents and other evidence showing or tending to show that there was no governmental misconduct or institutional bad faith in the course of the investigation619 and prosecution of this case and ordered briefings on law and fact by both sides of this issue. When the Government was unable and failed to produce such documents and evidence, the Court initiated the hearing on July 6, 1983, which it had previously indicated it would, immediately after the deadline of noon. After full hearing of the arguments, and consideration of the briefings on facts and law, the Court now finds and concludes as follows: Findings of Fact and Conclusions of Law 1. The Government and the Internal Revenue Service (IRS) of the Treasury Department in this case are guilty of governmental misconduct and institutional bad faith in failing to follow the strictures and regulations of the Internal Revenue Manual (IRM). 12. They did not follow the Manual and its Regulations in conducting the civil investigation and the criminal investigation in this case. 3. While the Civil Audit Division referred the investigation to the Criminal Intelligence Division (CID) for criminal investigation on May 15, 1979, utilizing Form620 2797 as required by Section 4565.22(1) of the IRM, the CID did not return the referral report within the fifteen (15) work-day limitation contained in Section 4565.22(2) of the IRM, failing to notify the Audit Division of the acceptance of the referral for criminal investigation until June 21, 1979, after the passing of twenty-six (26) work days. 4. Although the Internal Revenue Manual requires that such notification of acceptance of the investigation by CID must be made on either Form 2797 or Form 3212 (IRM, Section 9322.2(1)), upon which the CID must also note whether a cooperating civil officer should be assigned, and although the CID utilized Form 2797 in accepting the referral, it did not fill in the box on this form to request the assistance of a cooperating Civil Revenue Agent, all in violation of IRM, Section 9322.2(1); nor was any extension of time requested as permitted in Section 9322.2(2) of said IRM. 2621 5. The request for assignment of a Cooperating Civil Officer was made by the CID on Form 1937 and Form 1937-A (carbon copy), which is not permitted by the IRM. 36. In any event the request was not made until October 9, 1979 by the Criminal Intelligence Division and was not acted upon by the Civil (Audit) Division until October 10, 1979 when Civil Revenue Agent Krietz was finally designated to be assigned to the CID as a Cooperating Officer. 47. In the meantime, however, the CID initiated its criminal investigation622 and utilized as early as October 1, 1979, Revenue Agent Floyd Krietz to assist as a Cooperating Officer although at that time he had not yet been so assigned or designated. The CID Special Agent Thompson and the Civil Revenue Agent Krietz interviewed the taxpayer twice, on October 1, 1979 and October 4, 1979, interrogating the defendant taxpayer and demanding records as part of the Criminal Investigation conducted by Thompson with the assistance of Krietz, who was not assigned or designated for such assistance until six days after the second interrogation and demand for production of documents. 58. Despite repeated requests by the Court, the Assistant United States Attorney in charge of the case for the Government failed and refused to give the Court copies of the Civil Summonses issued under Section 7602 of the Internal Revenue Code, 26 U.S.C. 7602, by the Special Agent of the Criminal Investigation Division (CID) or by the Revenue Agent of the Civil Audit Division, so the Court could determine whether or not the CID or CAD issued and served623 any such Civil Summonses before the assignment and designation of the Civil Revenue Agent on October 10, 1979. The Court was informed that copies of these Civil Summonses could not be found despite diligent searches throughout the files and records of the U.S. Attorney's Office, and of the Internal Revenue Service, both Civil Audit Division and Criminal Intelligence Division. In the absence of copies of these Civil Summonses, and failing to receive even the dates of issuance or service of any such Civil Summonses, although the witness Thompson, the CID Special Agent, testified there were at least fifteen (15) such Civil Summonses issued and served, the Court cannot assume anything except that it was possible, if not probable, that at least some of these Civil Summonses were utilized by the Criminal Special Agent or the Civil Revenue Agent in support of an investigation wholly criminal in nature, in the ten-day period between the first questioning of the defendant taxpayer and the assignment and designation of the Civil Revenue Agent Krietz to assist and cooperate in the criminal investigation. 9. Any such criminal use of Civil Summonses is not to be condoned or tolerated by624 the Judiciary. United States v. LaSalle National Bank,437 U.S. 298">437 U.S. 298, 316-317 n.18 (1978), United States v. Genser,595 F.2d 146">595 F.2d 146, 151 (3rd Cr. 1979), cert. denied,444 U.S. 928">444 U.S. 928 (1979), United States v. Dahlstrum,493 F. Supp. 966">493 F. Supp. 966, 971-973 (C.D. Cal. 1980), appeal dismissed,655 F.2d 971">655 F.2d 971 (9th Cir. 1981), cert. denied,455 U.S. 928">455 U.S. 928, 102 S. Ct. 1293">102 S.Ct. 1293, 71 L.Ed 2d 472 (1982). 10. As this Court aptly stated in Dahlstrum, supra,"While dismissal is a strong remedy to apply, it serves as the only effective deterrent when a case reaches the criminal trial phase. This Court understands and respects the difficulties faced by the IRS in the performance of its assigned tasks. However, in view of the circumstances of this case, this Court feels compelled to dismiss the indictment with prejudice in order to preserve the interests of a taxpayer defendant subjected to this type of governmental misconduct, even though fueled only by 'institutional bad faith' and not any personal bad faith." 493 F. Supp. 966">493 F. Supp. 966 at 975. The Dahlstrum factual situation is virtually625 identical to the facts found here, which compels the Court to conclude that the present case is legally undistinguishable from Dahlstrum.The foregoing shall constitute the Court's Findings of Fact and Conclusions of Law in addition to the Findings and Conclusions made in its oral decision rendered in open Court on July 6, 1983, all of which are being transcribed and which the Court will in due course sign and date. 6LET JUDGMENT BE ENTERED ACCORDINGLY Judgment The Court having thus made and entered its Decision and Order containing its Findings of Fact and Conclusions of Law herein, and good cause appearing, IT IS HEREBY, ADJUDGED AND DECREED AS FOLLOWS: 1. The Indictment herein, and each and every count thereof, is dismissed with prejudice. 2. Defendant is acquitted of and from any and all counts and charges626 contained in said indictment. 3. The Jury, and each and every member thereof, is discharged and ordered to report to the Jury Clerk for further assignment. 4. Defendant's appearance bond and its obligors are exonerated and defendant and his bail are released. 5. At the request of the Government, this Minute Order, (Findings of Fact, Conclusions of Law and Judgment Dismissing Case Against Plaintiff, U.S.A. and Granting Acquittal to Defendant) is stayed, except for discharge and release of Defendant and exoneration of bail, for a period of ten (10) days to enable the Government to determine and act upon any appeal or other proceeding if so advised. 6. The Clerk shall forthwith serve copies of this Minute Order on all counsel of record herein. Our task is to analyze whether the "institutional bad faith" described in Judge Hauk's Minute Order should have any effect on this subsequent civil tax proceeding involving the same taxable year(s) and/or event(s). Petitioners argue that certain evidence should be suppressed 2 because of respondent's "institutional bad faith" as found by Judge Hauk. Respondent, in general, argues that "evidence in a civil case should only be suppressed627 when constitutional rights have been violated." Respondent further contends that the failure to follow the IRM provisions in question did not violate petitioners' rights so as to require the suppression of evidence. We agree with respondent. Petitioners suggest we begin our analysis with consideration of United States v. Janis,428 U.S. 433">428 U.S. 433 (1976). In that case the Supreme Court analyzed the exclusionary rule, from its inception in628 Weeks v. United States,232 U.S. 383">232 U.S. 383 (1914), and concluded "that the judicially created exclusionary rule should not be extended to forbid the use in the civil proceeding of one sovereign of evidence seized by a criminal law enforcement agent of another sovereign." United States v. Janis, supra at 460-461. Because the exclusionary rule was intended to work as a "deterrence effected by the denial of use of the evidence," the Supreme Court reasoned that evidence illegally seized by one sovereign "falls outside the offending officer's zone of primary interest" and accordingly would not effectively serve as a deterrent. Here, however, petitioners ask us to suppress evidence, not necessarily because it was illegally seized, but because it was obtained under conditions of "institutional bad faith" and possibly in violation of the principles set down in United States v. LaSalle National Bank,437 U.S. 298">437 U.S. 298 (1978). Not all violations of an agency's internal procedures rise to the level of a violation of constitutional rights or statutory requirements. United States v. Caceres,440 U.S. 741">440 U.S. 741, 755-756 (1979) (Caceres);629 Vallone v. Commissioner,88 T.C. 794">88 T.C. 794, 807 (1987) (Vallone);Riland v. Commissioner,79 T.C. 185">79 T.C. 185, 201 (1982). Furthermore, there is no contention here that respondent's agents were acting in bad faith or that their actions were fraudulent or deceitful. See, for example, United States v. Nuth,605 F.2d 229">605 F.2d 229, 234 (6th Cir. 1979); United States v. Tweel,550 F.2d 297">550 F.2d 297, 299 (5th Cir. 1977). In Caceres the Supreme Court was confronted with a situation where Internal Revenue Service agents had made tape recordings of conversations which were offered in evidence in support of a criminal prosecution for bribery of a Government agent. The tape recordings, although made in violation of the IRM, did not amount to violations of constitutional or statutory law. The lower courts had suppressed the tape recordings under the principles of the exclusionary rule and the Supreme Court reversed. A balancing between the deterrent effect of the exclusionary rule and the benefit of self-imposed rules utilized by law enforcement agencies was employed by the Supreme Court in its analysis. Unlike the circumstances in United States v. Janis, supra,630 Caceres presents a situation where a "sovereign" seeks to utilize evidence that its own agents obtained in violation of some internal requirement. The Supreme Court in Caceres established, what has been called, a "good-faith exception" to the exclusionary rule. The "good-faith exception" permits a trial court to use its discretion to decide whether to exclude (suppress) evidence obtained in violation of internal regulations, but not in violation of constitutional rights or statutory requirements, where the "agency action, while later found to be in violation of the regulations, nonetheless reflected a reasonable, good-faith attempt to comply * ." United States v. Caceres, supra, at 758. Recently, in Vallone v. Commissioner, supra at 806-815, we applied the principles set forth in Caceres.Vallone involved respondent's agent's contacts with the taxpayer "after finding firm indications of fraud" which was in violation of IRM. The type of contact involved concerned the executions of consents to extend the period within which respondent was able to assess and collect the tax. The contact occurred within a few weeks of the finding631 of firm indications of fraud and one week after the referral for criminal investigation. Thereafter respondent's agent obtained certain checks which the taxpayer sought to suppress on constitutional grounds. Vallone is similar to this case, including a United States District Court finding against the Government based upon respondent's agent's failure to comply with the IRM. In Vallonethe District Court refused to enforce respondent's summons because they were apparently based upon information obtained by the Government following the obtaining of a consent, which occurred after referral for criminal consideration. "[T]he District Court concluded that the denial of the summonses was warranted because enforcement would otherwise constitute an abuse of the Court's process." Vallone v. Commissioner, supra, at 801. In the civil tax case we did not find the IRM violations to be a "serious affirmative misrepresentation" or a violation of the taxpayers' constitutional rights or a statutory requirement and the questioned evidence was not suppressed. Vallone v. Commissioner, supra at 811-816. In this case the District Court analyzed evidence632 "which strongly indicated and suggested" that respondent "by reason of possible acts of misconduct * * engaged in what the Court considered might well constitute 'governmental misconduct.'" Similarly, the "misconduct" involved the transition from the civil tax examination to the criminal tax investigation. In this case, however, the Government was unable to provide the summonses used to obtain information after the "governmental misconduct." In view of the Government's failure to provide the summonses, the District Court dismissed the criminal indictment based upon its inability to "assume anything except that it was possible, if not probable, that at least some of these * * * Summonses were utilized by the Criminal Special Agent in support of an investigation wholly criminal in nature, in the ten-day period between the first questioning * * * and designation of the [civil examining agent]." The District Court was conditional in its findings of "governmental misconduct" or "institutional bad faith" and did not actually find any such conduct. The criminal tax indictment was dismissed on the assumption that a constitutional right could have been violated and the Court was unable633 to determine whether such violation actually occurred. There was no finding that respondent's agents intentionally or knowingly acted in bad faith. The essence of Judge Hauk's holding is that there was potential for violation of the principles set down in United States v. LaSalle National Bank,437 U.S. 298">437 U.S. 298 (1978). That case, in the broadest sense, prohibits the use of a civil summons to develop the criminal case. Assuming that civil summonses were issued or outstanding during the 11 days that respondent's agents failed to use the proper form, check the appropriate box or notify of the acceptance of a criminal case, we conclude that the District Court's dismissal of the indictment brought against petitioners is sufficient to fulfill the purpose of the exclusionary rule. For purposes of this civil tax matter, we are not aware that petitioners' constitutional rights have been violated or that respondent has otherwise violated a law or statute. Although the District Court found it necessary to sanction respondent in the setting of that case, we are not compelled to sanction respondent here. This is especially true here, where the District Court did not find specific634 violations of constitutional rights or statutes as a result of the "governmental misconduct" and said "misconduct" does not itself rise to that level. Moreover, the District Court did not identify any specific evidence that may have been obtained during the period that respondent was in a state of "governmental misconduct." In view of the foregoing, we see no need to sanction respondent by means of the suppression of evidence, or otherwise. To reflect the foregoing, Decision will be entered in accord with the parties' stipulation.Footnotes1. 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 this Court's Rules of Practice and Procedure.↩1. The Internal Revenue Manual in effect during the relevant period of 1979 is found and cited in "Internal Revenue Manual" (C.C.H. 1979).↩2. Interesting enough to arouse the Court's skeptical curiosity is the fact that the same IRS Criminal Group Manager, Thomas W. Sullivan, made the same kind of referral acceptance on behalf of the Criminal Intelligence Division to the Civil Audit Division in Dahlstrum, as Group Manager of Criminal Special Agent Marc Schreiber on the same Form (IRS Form 2797) which he used here as Group Manager of Criminal Special Agent Ralph R. Thompson, and significantly also here failed to fill out the box "[] Please assign Cooperating Officer" (Exhibit 1 to GOVERNMENT'S RESPONSE TO COURT'S QUESTIONS RE IRS INVESTIGATION), just as he failed to do in Dahlstrum,493 F. Supp. 966">493 F. Supp. 966 at 969, f.n. 5). See U.S. v. Dahlstrum,493 F. Supp. 966">493 F. Supp. 966 (C.D. Cal. 1980), appeal dismissed,655 F.2d 971">655 F.2d 971 (9th Cir. 1981), cert. denied, 455 U.S. 928">455 U.S. 928, 102 S. Ct. 1293">102 S.Ct. 1293, 71 L.Ed 2d 472↩ (1982).3. See Exhibit 5 to Government's Response to Court's Questions re IRS Investigation.↩4. Id., f.n. 3 supra,↩ Exhibit 5 to Government's Response. Thomas W. Sullivan, CID's Group Manager of CID Special Agent Thompson, used the original of Exhibit 5 to request on October 9, 1979, the Civil Examination (Audit) Division to assign a Civil Revenue Agent to cooperate with CID's Criminal Investigation; and Marty G. Laffer, the Civil Examination Division Group Manager of Civil Revenue Agent Charles Siemer, used the carbon copy of Exhibit 5 to designate on October 10, 1979 another civil Revenue Agent, Floyd Krietz for assignment as the civil Cooperating Officer.5. That is, not until October 10, 1979. See f.n. 3, supra,↩ Exhibit 5, carbon copy.6. As a matter of fact the Court has taken pains to sign, file and enter the transcript of the Court's oral Findings of Fact and Conclusions of Law and Decision rendered in open Court on July 6, 1983, as additional support for the within Minute Order, and on the same day it is signing, filing and entering the Minute Order, to wit, today, July 12, 1983.↩2. The parties have not specifically delineated the nature or type of evidence to be suppressed, but have provided the Court with two sets of agreed deficiencies for entry of dicision depending upon whether or not we decide to suppress evidence. Although the parties have not expressly so stated, we surmise that the evidence to be suppressed was obtained during the 11-day period within which Judge Hauk found respondent to have been in a state of "institutional bad faith." Petitioners also argued that res judicata would require the same findings as Judge Hauk. Becauuse the parties agreed that Judge Hauk↩'s findings of fact and conclusions of law are to be accepted as correct, we see no need to address the concept of res judicata.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622804/	SOCIETY OF COSTA RICA COLLECTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSociety of Costa Rica Collectors v. CommissionerDocket No. 8531-83X.United States Tax CourtT.C. Memo 1984-648; 1984 Tax Ct. Memo LEXIS 28; 49 T.C.M. (CCH) 304; T.C.M. (RIA) 84648; December 13, 1984. Charles G. Trenckmann, for the petitioner, David A. Hampel and Mark L. Puryear, for the respondent. GUSSIS MEMORANDUM OPINION GUSSIS, Special Trial Judge: This is an action for declaratory judgment 1 under section 7428 of the Code. 2 It has been decided pursuant to assignment under the provisions of section 7456(d)(1) and Rule 218(a). Pursuant to Court Order this case was submitted on the basis of the administrative record filed September 28, 1983. The issue is whether petitioner qualifies for exemption from Federal income tax under section 501(c)(3). 30 The Society of Costa Rica Collectors (hereinafter referred to as petitioner or SOCORICO) was incorporated on December 5, 1978 pursuant to the provisions of the Texas Non-Profit Corporation Act. At the time the petition in this case was filed, SOCORICO's principal office was in Naples, Florida. Petitioner's Certificate of Incorporation states that the general purposes of SOCORICO are "educational and scientific" and the "[t]he primary and specific purposes are the study and promotion of the philately and related history of the Central American Republics with emphasis on the Republic of Costa Rica." Since its incorporation in 1978, SOCORICO has included some 200 members from both the United States and abroad. 3 Applicants for membership are required to be at least 18 years old and interested in promoting the purposes of SOCORICO and in participating in its various activities. The activities carried on by SOCORICO include: The quarterly publication of a magazine called The Oxcart which is published four times a year; publication of The Catalogue of the Stamps of Costa Rica (hereinafter the Catalogue) and The Index to Costa Rican Philatelic Literature (hereinafter the Index); 31 an expertization service for members for the authentication of the stamps of Costa Rica; a philatelic library; and, distribution of educational program materials to collectors clubs. The Oxcart serves as an informational newsletter and is distributed free of charge to SOCORICO's members and to its library. The Oxcart provides members with the opportunity to both buy and advertise for sale Costa Rican and Central American stamps. The Oxcart is not sold to the public. The operation of this intermember stamp exchange is as follows: When a member possesses excess stamps or postal histories, he sends them to SOCORICO's sales administrator who serves without compensation. The sales administrator decides to present the material either as single stamp items or as sets. The material is also given an estimated value by the sales administrator. All offerings of sale are then described and listed for bids in The Oxcart. Bids can only be made by other SOCORICO members entered by a date certain. 4 The sales administrator selects the highest bid and collects the32 money from the buyer member. The sales administrator retains 10% for SOCORICO and the balance is sent to the seller. 5 sale offerings of stamps and postal histories by SOCORICO's members are not advertised publicly but only through The Oxcart. Individuals may join SOCORICO as regular, supporting, patron or life members. Dues vary depending on the type of membership. SOCORICO does not engage in membership solicitation. Seventy-five percent of annual dues is directed toward the publication and distribution of The Oxcart. All work performed by SOCORICO's members is voluntary. Officers and directors of SOCORICO serve without compensation, but they may be reimbursed for expenses incurred in attending regular or special Board meetings. SOCORICO usually meets once or twice a year for the conduct of official business and in connection with major philatelic exhibitions. In its application for exemption petitioner listed as its principal sources33 of financial support the commissions made on the mail bid sales, membership dues, sales of its two other publications (the Catalogue and the Index) and interest from savings accounts. SOCORICO operates a philatelic library for the use of its members which provides specialized bibliographies on all phases of Costa Rica collecting. Although use of the library is free, members are required to pay for the cost of all photostatic copies of reference literature. Petitioner's financial status as of the end of 1979 was as follows: REVENUE: Gross dues and assessments of members$1,930.80Gross amounts derived from activitiesrelated to organization's exempt purpose(less cost of goods sold)4,022.14Interest, dividends, rents and royalties607.23Total Revenue6,560.17EXPENSES: Oxcart publication and distribution$2,431.25Expenses of officers, postage, phone585.59supplies, printingTotal Expenses$3,016.84Excess of revenue over expenses$3,543.33 Petitioner's estimated financial status as of the end of 1980 was as follows: REVENUE: Gross dues and assessments of members$2,200.00Gross amounts derived from activitiesrelated to organization's exempt purpose(less cost of goods sold)$2,445.00Interest, dividends, rents and royalties$1,370.00Total Revenue$6,015.00EXPENSES: Oxcart publication and distribution$3,100.00Expenses of officers, postage, phone,supplies and printing655.00Total expenses$3,755.00Excess of revenue over expenses$2,260.0034 As of December 31, 1980 the assets and liabilities of SOCORICO were as follows: ASSETS: Cash: interest bearing accounts$15,375.36Other250.00Inventories2,950.00Depreciable assets65.70Total assets$18,641.06LIABILITIES:noneTotal net worth$18,641.06 On March 30, 1980, petitioner filed Form 1023, Application for Recognition of Exemption, with the Internal Revenue Service in Austin, Texas. On January 19, 1983, respondent issued its final adverse ruling letter which denied petitioner tax exempt status. This determination was based on the grounds that petitioner was not organized or operated exclusively for exempt purposes pursuant to section 501(c)(3); that a substantial part of petitioner's activities are commercial in nature and therefore not in furtherance of an exempt purpose; that petitioner does not operate for a public purpose; and, that its net earnings inure to the benefit of SOCORICO's members. The burden of proof is on petitioner to overcome the grounds enumerated in respondent's notice of determination. Hancock Academy of Savannah, Inc. v. Commissioner,69 T.C. 488">69 T.C. 488, 492 (1977);35 Rule 217(c)(2)(i). This Court's determination is based on the facts contained in the administrative record and any inferences that may fairly be drawn therefrom. Dumaine Farms v. Commissioner,73 T.C. 650">73 T.C. 650, 664-665 (1980). We find that petitioner has failed to meet its burden. An organization may qualify for exemption from income taxation under section 501(c)(3) only it it is organized and operated exclusively for one or more of the exempt purposes specified in section 501(c)(3). Section 1.501(c)(3)-1(a)(1), Cincome Tax Regs. To meet this two-part test, petitioner must show (1) that its "articles of organization" limit it to one or more exempt purposes and (2) petitioner must not engage, except in insubstantial part, in activities which do not further an exempt purpose, i.e. an "organizational" test and an "operational" test. Section 1.501(c)(3)-1(b) and 1(c), Income Tax Regs. The presence of a single nonexempt purpose, if substantial in nature, will destroy the exemption regardless of the number of truly exempt purposes. Better Business Bureau v. United States,326 U.S. 279">326 U.S. 279 (1945);36 Copyright Clearance Center v. Commissioner,79 T.C. 793">79 T.C. 793 (1982). We find that petitioner fails the operational test of section 501(c)(3). 637 Here, the record establishes that publication and distribution of The Oxcart was a substantial activity engaged in by petitioner and that a substantial portion of Tex Oxcart was utilized to carry on a mail bid sales service operation for its members. Buyers and sellers of stamps were brought together and sales were made through the offices of SOCORICO's sales administrator who decided on the appropriate marketing format, provided estimates, made sales to the highest bidder and, after retaining a commission, remitted the balance of the sales proceeds to the seller. The procedures followed in these transactions are indistinguishable from commercial public sales, with the exception that SOCORICO's sales commission was 10 percent instead of the usual 20 percent. Only members could obtain expertization service for the authentication of stamps and educational programs provided by SOCORICO were only available to its members. This substantial mail bid sales activity clearly served a private and hence nonexempt purpose. See Baltimore Health and Welfare Fund v. Commissioner,69 T.C. 554">69 T.C. 554 (1978); see also section 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs.38 The educational activities of petitioner are minimal in nature and are simply incidental to the philatelic sales service operations conducted by SOCORICO. Petitioner's other publications the Index and the Catalogue, deal with stamps of Costa Rica and philatelic literature of Costa Rica. Initially, the Catalogue was distributed free to petitioner's members. A second edition of the Catalogue is available to both members and nonmembers for a fee. Even if the purpose of such activities qualifies as educational within the meaning of the statute, the presence of the substantial nonexempt activity of mail bid sales negates petitioner's claimed exemption under section 501(c)(3). On this record, we must affirm the determination of the respondent that petitioner is not exempt from taxation under the provisions of section 501(c)(3). Decision will be entered for the respondent.Footnotes1. The statutory prerequisites for declaratory judgment have been satisfied: Petitioner is the organization whose qualification is at issue, sec. 7428(b)(1); petitioner exhausted all its administrative remedies, sec. 7428(b)(2); petitioner timely filed its petition with this Court, sec. 7428(b)(3)↩. 2. All statutory references are to the Interal Revenue Code of 1954, as amended, unless otherwise indicated. Rule references are to the Tax Court Rules of Practice and Procedure.↩3. In its application for exemption, petitioner listed seven individuals who headed SOCORICO's governing body.↩4. According to the December 1979 issue of The Oxcart, some 35% SOCORICO's members have participated in the mail bid sales. ↩5. The proceeds of one such mail bid sale totaled about $9,700, 10% of which was retained by SOCORICO.↩6. In Syrang Aero Club, Inc. v. Commissioner,73 T.C. 717">73 T.C. 717, 720-721 (1980) we explained the operational test as follows: The operational test requires an organization's activities be primarily those which accomplish one or more exempt purposes as specified in section 501(c)(3) and not, except to an insubstantial part, those which do not further an exempt purpose. Sec. 1.501(c)(3)-1(c)(1), Income Tax Regs. Included among the exempt purposes are "educational" and "charitable" purposes. Sec. 1-501(c)(3)-1(d)(1)(i)(b) and (f), Income Tax Regs. * * An organization is not organized and operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. Sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs. See Baltimore Health and Welfare Fund v. Commissioner,69 T.C. 554">69 T.C. 554 (1978); Callaway Family Association v. Commissioner,71 T.C. 340">71 T.C. 340↩ (1978).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4622806/	Estate of H. H. Weinert, Deceased, Jane W. Blumberg, Executrix, and Hilda B. Weinert, Petitioners, v. Commissioner of Internal Revenue, RespondentWeinert v. CommissionerDocket No. 56328United States Tax Court31 T.C. 918; 1959 U.S. Tax Ct. LEXIS 246; 9 Oil & Gas Rep. 1220; January 30, 1959, Filed 246 Decision will be entered for the respondent. Petitioner sold a one-half undivided interest in certain unitized oil and gas leases and a $ 50,000 production payment, payable out of the income from petitioner's retained one-half interest in the leases, to Lehman and Maracaibo for $ 100,000 cash in 1947. At the same time Lehman and Maracaibo agreed to loan and advance up to $ 150,000 to pay petitioner's pro rata share of drilling and recycling plant costs under the unitization agreements. Petitioner assigned his retained one-half interest in the lease and the proceeds attributable thereto under the unitization agreements to a trustee, the trustee to apply income received, first, to payment of interest at 2 per cent on the amounts loaned and advanced by Lehman and Maracaibo, next to payment of the amounts loaned and advanced, and then to payment of the $ 50,000 production payment, after payment of all of which the interest in the leases was to be reassigned to petitioner. The loan agreement executed in connection therewith provided that the loans and advances should be repaid only out of the net profits arising from petitioner's retained one-half interest in the leases included247 in the unit and out of the net profits arising from petitioner's interest in the recycling plant accruing by virtue of the retained one-half interest in these leases. Held, the revenues received by the trustee and paid to Lehman and Maracaibo as payment of interest on, and repayment of, the loans and advances were taxable income of the petitioner in the year received by the trustee. Held, further, the fact alone that Lehman and Maracaibo agreed to look only to the net profits from petitioner's one-half interest in the leases and recycling plant, which were assigned to the trustee for repayment of the loans and advances made to or on behalf of petitioner, does not convert what was clearly intended to be a loan into either an assignment of an economic interest in the minerals in place or an assignment for a valuable consideration of the right to future income, so as to make the revenues received by the trustee and paid over to the lender in repayment of such loans and advances taxable to the lender rather than the borrower. Leon O. Lewis, Jr., Esq., and Edgar Engelke, Esq., for the petitioners.Harold A. Chamberlain, Esq., and Robert L. Liken, Esq., for the248 respondent. Drennen, Judge. Train, J., concurring. Mulroney and Forrester, JJ., agree with this concurring opinion. DRENNEN919 OPINION.Respondent determined deficiencies in petitioners' income tax of $ 817.31 and $ 4,193.86, for the calendar years 1949 and 1950, respectively. In their petition, petitioners seek a determination that there have been overassessments of $ 1,399.06 and $ 7,987.30 for the years 1949 and 1950, although the basis for the claimed overassessments is not clear.The sole issue raised by the pleadings is whether petitioners were taxable on revenues from their interest in certain oil and gas leases and a recycling plant, received by a trustee under an assignment thereof, in the years 1949 and 1950.The case was submitted on a stipulation of facts which consisted of certain facts and a number of documents attached thereto or filed at the hearing as exhibits. The facts so stipulated are found as stipulated and the stipulation, together with the exhibits, is incorporated herein by reference.There is no disagreement between the parties as to the basic facts in this case, but only as to the ultimate tax effect of the various transactions involved. 249 Petitioners are the Executrix of the Estate of H. H. Weinert, Deceased, and Hilda B. Weinert, widow of the deceased. H. H. Weinert, deceased, and petitioner Hilda B. Weinert were husband and wife, living together at all times pertinent to this proceeding up to the time of his death.H. H. Weinert, deceased, and petitioner Hilda B. Weinert filed joint income tax returns with the former collector of internal revenue for the first collection district, Austin, Texas, for each of the calendar years 1949 and 1950.Petitioners kept their books and filed their income tax returns on the cash basis of accounting. All of the business operations of H. H. Weinert, deceased, and petitioner Hilda B. Weinert were conducted for their community estate by the husband, H. H. Weinert.For many years prior to and during the years involved in this proceeding, H. H. Weinert was engaged in the operation, development, and production of oil and gas properties.Prior to April 15, 1947, H. H. Weinert and others (hereinafter referred to collectively as petitioner) owned certain oil and gas leases 920 covering lands in the North Pettus Field, in Goliad and Karnes Counties, Texas.On or about April 15, 1947, 250 petitioner entered into an agreement (hereinafter referred to as sales agreement) with the Lehman Corporation and Maracaibo Oil Exploration Corporation (hereinafter collectively referred to as Lehman), wherein petitioner agreed to sell and Lehman agreed to buy an undivided one-half interest in the above-mentioned leases insofar as they covered minerals produced from horizons below the base of the Cockfield Zone. The sales agreement also provided that petitioner agreed to sell and Lehman agreed to purchase a $ 50,000 production payment, payable out of the proceeds from petitioner's retained one-half interest in the oil, gas, and other minerals in and under and that may be produced from the leases above mentioned, and also from the petitioner's interest in the proceeds and revenues from the operation of a recycling plant to be built under the terms of a unitization agreement, hereinafter mentioned. The consideration for the sale of the undivided one-half interest in the oil and gas leases mentioned above and the $ 50,000 production payment was $ 100,000 cash, to be paid upon execution of certain other documents referred to therein.The sales agreement also provided that simultaneously251 with the execution and delivery of the assignment of the one-half interest in the oil and gas leases and payment of the purchase price therefor, the parties to the sales agreement would enter into a certain "Loan Agreement," and that petitioner would also execute and deliver an "Assignment of Runs and Production Payment" from his remaining one-half interest in said leases.The sales agreement also specifically stated that it was anticipated that petitioner would enter into certain agreements relating to a proposed plan to pool and unitize said oil and gas leases with certain other oil and gas leases covering lands in the North Pettus Field, and that conveyance from petitioner to Lehman would be subject to any such agreements which may have been executed prior to the date of such assignment.Prior to the assignment of the one-half interest in said oil and gas leases to Lehman, petitioner entered into six separate agreements affecting said leasehold interests, referred to collectively as the North Pettus operating and unitization agreements, as contemplated in the sales agreement.The effect of the North Pettus operating and unitization agreements was that petitioner pooled the deep252 rights in the subject oil and gas leases with other oil and gas leases in the area so that all unitized substances within the unit area and all leases and lands comprising such area, to the extent of unitized substances therein and thereunder, were pooled and unitized as if the said substances and lands had been 921 included in a single lease. The percentage of participation of each participant in the unit was determined on the basis of acre-feet of effective sand each participant put into the unit.The parties in the North Pettus unit and the parties in another unit, known as the Burnell unit, joined in an agreement to construct and operate a plant to process unitized substances produced and saved from the two units, the percentage of undivided ownership of each of the parties in the plant to be determined by the ratio of the acre-feet of effective sand contributed by each to the acre-feet of effective sand contributed by all the parties. Unit operators for the two fields and a plant operator for the processing plant were designated.Under the terms of the several unitization and processing agreements affecting the subject leasehold interests, each party became personally253 obligated to pay his pro rata part of all costs and expenses incurred in the development and operation of the unit area to the unit operator, as well as his pro rata part of all costs and expenses incurred in the construction and operation of the processing plant to the plant operator.Each of the parties owning an interest in the recycling and processing plant owned the same interest in the hydrocarbons extracted and saved at the plant as he owned in the plant. However, the agreements contemplated the possible processing of production from leases other than those covered by the unitization agreements in this plant.On or about October 30, 1947, pursuant to the sales agreement mentioned above, petitioner and others executed three agreements, as follows: (a) An Assignment; (b) a Loan Agreement; and (c) an Assignment of Runs and Production Payment.The Assignment conveyed to Gas Properties, Inc., a wholly owned subsidiary and nominee of the Lehman Corporation, and Maracaibo an undivided one-half interest in the deep rights in the oil and gas leases mentioned above, subject to the six unitization agreements affecting these leases. Insofar as petitioner is concerned this Assignment, 254 considered in connection with the unitization agreements, conveyed an undivided one-half of his interest in the unitized leases and one-half of petitioner's rights to participate in the ownership of the processing and recycling plant. The Assignment did not mention the $ 50,000 production payment and the stated consideration was $ 10 and other valuable considerations.The Loan Agreement provided that Lehman and Maracaibo would loan and advance to petitioner his pro rata part of the drilling costs and costs of the processing plant and other equipment, provided that the sum of the loans and advances would not exceed $ 150,000.The Loan Agreement provided further:922 3. The loans and advances referred to above shall be made as and when Weinert, et al, are required to pay their share of the cost of the wells and of the cost of the recycling and processing plant and other equipment, and shall be paid to Weinert, et al, on submission of evidence by them that they have paid the equivalent amount to the Unit Operator of the North Pettus Unit or to the Plant Operator of the processing and recycling plant or, in lieu thereof, at the option of Weinert, et al, and upon written instructions255 from them to Lehman and Maracaibo, said advancement shall be made by payment of funds directly to said Unit Operator and to said Plant Operator as and when required.The said Loan Agreement provided further:4. All of such loans and advances so made by Lehman and Maracaibo to Weinert, et al, shall bear interest at the rate of 2% per annum from the date of the respective loans and advances to the date of payment thereof, and the principal of such loans and advances, together with interest thereon, shall be repaid only out of the net profits arising from Weinert, et al's, interest in the above described leases included in said unit, and out of the net profits arising from the interest of Weinert, et al, in said recycling and processing plant accruing to them or their heirs, legal representatives, or assigns by virtue of their interest in said plant arising from their ownership of the 50% interest in the leases hereinabove described in which Gas Properties and Maracaibo also own a 50% interest.Petitioner did not at any time sign any notes, obligations, or other evidence of indebtedness whereby he became personally liable to pay or repay any sums of money to Lehman and Maracaibo.The256 Assignment of Runs and Production Payment provided that petitioners, for good and valuable consideration, do hereby:Bargain, Sell, Transfer, Assign and Convey unto Marquis Eaton, Trustee, of San Antonio, Texas, all of their right, title and interest in all oil, gas and other minerals which may be produced and saved from their 50% interest in the above described oil and gas leases in so far as they cover the tracts of land specifically described or referred to hereinabove and in so far as such oil, gas, and other minerals may be produced from sands or reservoirs located below the base of the Yegua (Cockfield) Zone * This agreement also provided that all of the oil, gas, and other minerals, and proceeds thereof and revenues of every kind therefrom to which the assignors may be entitled under the unitization agreements by virtue of their ownership of the undivided one-half interest in the oil and gas leases were also transferred and assigned to the trustee and should be paid and delivered to him.The Assignment of Runs and Production Payment provided further:This assignment and conveyance to Marquis Eaton, Trustee, is made for the purpose of securing repayment to The Lehman257 Corporation and Maracaibo Oil Exploration Corporation of all amounts loaned and advanced, or hereafter loaned or advanced, by them or either of them to the undersigned Assignors, their heirs and assigns, under that certain Loan Agreement this day entered into between said Assignors and the Lehman Corporation and Maracaibo Oil Exploration Corporation, and also for the purpose of conveying to the said 923 Marquis Eaton, Trustee, for and on behalf of The Lehman Corporation and Maracaibo Oil Exploration Corporation, that certain Production Payment in the amount of $ 50,000.00 due and payable to them out of the revenues and interests hereby transferred and assigned, after all amounts due under said Loan Agreement have been fully paid * This instrument also provided that it would remain in full force and effect until all such amounts were fully paid.The Loan Agreement provided that upon receipt of any revenues from interests conveyed by petitioner to him, Marquis Eaton, trustee, should first use such funds to reimburse petitioner for any operating costs, as therein defined, paid by him and applicable to his interest in the leases and properties covered by the agreement, and258 any excess of revenues over such operating costs should be paid to Lehman and applied first to interest on the advances and loans made by Lehman, and the remaining balance applied on the repayment of the principal of such loans and advances. The operating costs referred to above were to include:(1) All production taxes and property or ad valorem taxes;(2) All operation and maintenance charges made by the Unit Operator of the North Pettus Unit and the Plant Operator of the recycling and processing plant;(3) All royalties payable by Weinert, et al, under their 50% interest in the leases above described; and(4) All well and plant costs in excess of the limit of $ 150,000 set forth above, for the advancements and loans to be made by Lehman and Maracaibo to Weinert, et al, hereunder.The Loan Agreement provided further that upon completion of the repayment of the loans and advances, any further revenue in excess of operating costs should be paid to Lehman and applied to liquidation of the $ 50,000 production payment purchased by Lehman from petitioner. Upon the full payment of said production payment of $ 50,000, the trustee should distribute all further revenues to petitioner and259 the trustee and Lehman would execute and deliver to petitioner an instrument reassigning all rights and interests conveyed to said trustee under the Assignment of Runs and Production Payment mentioned above. This agreement also provided that petitioner at his option, and at any time, could repay the balance then due on the principal of the advancements and loans, together with interest thereon, and also pay in full said production payment, out of funds other than the revenues from their interest in the property covered by these agreements.Pursuant to the terms of the Loan Agreement, Lehman paid out for petitioner's pro rata part of the construction and operating costs the following amounts in the years indicated, and made such payments directly to the unit operator or to the plant operator: 924 Calendar year 1947:Plant equipment$ 124.39 Plant operating expense8.00 Lease operating expense16.65 $ 149.04Calendar year 1948:Plant equipment25,697.79 Lease equipment7,508.04 Lease operating expense1,087.44 Intangible drilling costs15,186.94 49,480.21Calendar year 1949:Plant equipment29,370.51 Lease equipment(502.01)Lease operating expense1,564.23 Plant operating expense2,809.05 Intangible drilling costs(1,245.11)31,996.67Calendar year 1950:Plant equipment469.59 Lease operating expense1,087.14 Plant operating expense9,986.42 11,543.15Calendar year 1951:Lease operating expense1,520.49 Plant operating expense8,503.80 10,024.29Total103,193.36260 Pursuant to the provisions of the Loan Agreement and Assignment of Runs and Production Payment, Marquis Eaton, trustee, received the following revenues from the interests conveyed to him by petitioner:Calendar yearLeasesPlantTotal1947(1) (1) (1) 1948$ 4,826.50(1) $ 4,826.5019494,094.47$ 8,909.0213,003.4919501,009.3639,810.6440,820.0019511,660.7743,862.1145,522.88Total11,591.1092,581.77104,172.87Marquis Eaton, trustee, credited the interest conveyed to him by petitioner with the revenues received as shown above, as follows:Calendar yearRevenuesLess interestNet creditreceived1948$ 4,826.50$ 334.54$ 4,491.97194913,003.491,274.9211,728.56195040,820.001,070.0339,749.97195145,522.88402.4545,120.43Total104,172.873,081.94101,090.93925 On June 19, 1952, the said Marquis Eaton, trustee, joined by Lehman and Maracaibo, reconveyed petitioner's 50 per cent interest to him, the instrument reciting that Lehman and Maracaibo had been reimbursed in full for all sums expended by them in behalf of said 50 per cent interest and had received261 in full a certain production payment in the amount of $ 50,000.In the preparation of their income tax returns, petitioners reported no income or deductions in any year from the transactions involved in this proceeding except for their share of the $ 100,000 cash consideration, which they reported in 1947.Respondent examined petitioners' returns for 1947 and 1948 and made no changes with respect to the reporting of the income and deductions attributable to the transactions involved in this proceeding. The revenue agent's report for these years includes a report of the engineer revenue agent, which contained the following statement:One transaction appearing in the return for 1947 as sale of leases in Karnes and Goliad Counties should be commented upon. The taxpayer and associates sold to Lehman Corp. and Maracaibo Oil Co. a 1/2 interest in a block of leases plus an oil payment out of the retained 1/2 interest in the face amount of $ 50,000.00, the cash consideration being $ 100,000.00 to the group, but coupled with a so-called loan agreement by virtue of which Maracaibo & Lehman agreed to advance to Weinert and others up to $ 150,000.00 of the cost to them, under a cycling and 262 operating contract, of the erection of a cycling plant and the drilling of whatever deep wells were necessary for distillate recovery, this money to be recouped by Maracaibo & Lehman out of, and only out of, an other oil payment for $ 150,000.00 payable out of Weinert et als retained 1/2 interest. In actual operation, no such advances were made to Weinert, et al, but their obligations under the cycling and operating agreements were met by Maracaibo & Lehman. This $ 150,000.00 oil payment was to be senior to the $ 50,000.00 oil payment first above mentioned, and both are payable out of 100% of Weinert et al's retained 1/2 interest in the leases.It is believed that this arrangement is one entered into for the development of the property, and that beyond accounting for the cash consideration, which has been done, no gain or loss results from the various oil payments and advances involved.In his determination of the deficiencies for the years here involved, the respondent has included in petitioners' gross income for 1949 and 1950 the revenues from production paid to Marquis Eaton, trustee, in those years as shown above, being $ 13,003.49 and $ 40,820, respectively, and has allowed263 certain deductions therefrom, including the interest shown to be credited by the trustee and depletion on the stipulated market value of the unitized substances prior to processing in the plant. This market value was less in each year than the gross income from the sale of the gas and hydrocarbons produced, which income was included by respondent in petitioners' gross income as above mentioned.926 The recycling and processing plant was designed to process the unitized substances and casinghead gas produced and saved from the unitized area and to return residue gas into the formation from which produced, less such residue gas as might be sold to others at the plant.The question for decision is whether the amounts received by the trustee in 1949 and 1950 from taxpayer's retained 50 per cent interest in the oil and gas leases and the processing plant mentioned in the facts recited above and paid over by the trustee to Lehman and Maracaibo, under the terms of the various agreements mentioned, were taxable to petitioner in the years 1949 and 1950.Respondent determined that the amounts received by the trustee in 1949 and 1950 were constructively received by petitioner and constituted264 taxable income to him, on the theory that petitioner's retained one-half interest in the oil and gas leases and the revenues therefrom were assigned to the trustee as security for repayment of loans. Alternatively, respondent claims that the assignment at most was an assignment of anticipatory income and therefore the income was taxable to petitioner.Petitioner claims that the amounts received by the trustee were applied to a production payment previously sold by petitioner and were therefore not taxable income to petitioner, or were receipts of income previously assigned by him to Lehman for a valuable consideration, and hence were taxable to Lehman and not to petitioner. Alternatively, petitioner claims that if any income from this source was taxable to petitioner, only those amounts advanced by Lehman or Maracaibo in the years 1949 and 1950 are taxable in those years, on the theory that those were the only amounts received in the taxable years by this cash basis taxpayer for the assignment of the oil payment.Neither party argues that there is any distinction between the amounts received by the trustee and applied to repayment of the loans and advances plus interest, and the265 amounts applied to payment of the $ 50,000 production payment. Possibly this is because, as hereinafter pointed out, it would appear from the stipulated facts that all amounts received by the trustee during the years here involved, being less than the total amounts advanced by Lehman prior to the end of the year 1950, must have been applied to repayment of the advances and interest thereon under the terms of the Loan Agreement.What we are concerned with here is whether petitioner is subject to tax on the income received by the trustee, not whether he is taxable on the amounts advanced by Lehman during these years, for reasons hereinafter mentioned.927 The essence of the transaction agreed upon and of what was accomplished by the numerous legal documents placed in evidence was that petitioner assigned an interest in property, consisting of his interest in all minerals and revenues produced from the pertinent oil and gas leases and from the recycling plant, to a trustee (1) to secure repayment of loans or advances made by Lehman for petitioner's benefit and (2) to pay Lehman the $ 50,000 production payment Lehman purchased, or received as a bonus, along with a one-half undivided266 interest in the leases and plant, for a consideration of $ 100,000 paid to petitioner in 1947. Thereafter the interest in property reverted to petitioner. The essence of a transaction is determined not by subtleties of draftsmanship but by its total effect. , rehearing denied .We do not think there can be any doubt from the language used in the various agreements between petitioner and Lehman that the parties understood and intended that the amounts advanced by Lehman in payment of costs chargeable to petitioner's retained one-half interest in the oil and gas leases were loans. Nor do we find anything in the actions of the parties or elsewhere in these transactions, as shown in the record, to indicate otherwise. The only question is whether the fact alone that Lehman agreed to look only to the proceeds from the unitization agreement for repayment of his loan changed what was otherwise clearly a loan into a production payment. We do not believe it did.The original agreement was that Lehman would buy one-half of petitioner's interest in the oil and gas leases267 to be unitized and a $ 50,000 production payment from petitioner's retained one-half interest for $ 100,000 cash. Lehman also agreed to loan petitioner all moneys necessary up to $ 150,000, to meet petitioner's obligations with respect to the retained interest under the unitization agreement, such advances to be repaid out of the revenues from the retained interest before anything was paid on the production payment.All of the instruments drawn to carry out this agreement refer to the advances as loans, and to the "Loan Agreement." The precise amount advanced was to be repaid before any amounts were to be paid on the $ 50,000 production payment, and interest at 2 per cent per annum was to be paid on the net amounts advanced. Petitioner had control of whether these amounts were to be paid to him or to the unit operator. There is nothing to indicate that Lehman assumed liability for any of petitioner's obligations for which these moneys were advanced or that petitioner was relieved of liability therefor, and the amounts paid were used to pay petitioner's share of these costs for which he remained liable. The amount that Lehman was to advance was indefinite, except that it was limited268 to $ 150,000. 928 Lehman actually advanced less than $ 150,000 and was repaid only the amount advanced, plus interest.The Assignment of Runs and Production Payment, being the instrument whereby petitioner's retained one-half interest was assigned to the trustee, recites two separate and distinct purposes for which the assignment is made, one being for the purpose of securing repayment to Lehman of all amounts loaned and advanced by them to the assignors, their heirs, and assigns, under the loan agreement, and the second being for the purpose of conveying to the trustee for Lehman the $ 50,000 production payment.And the instrument by which the one-half interest was reassigned to petitioner by the trustee, with Lehman joining, recites that Lehman had been reimbursed in full for all sums expended by them in behalf of the 50 per cent interest and has received in full the $ 50,000 production payment.From the above and other language in the various documents, it seems abundantly clear that Lehman was not buying anything with the funds advanced under the loan agreement but was simply lending the money which was to be repaid before anything else. In fact it 269 appears that most of the funds advanced by Lehman were paid for plant equipment and we do not believe there is any claim that Lehman acquired petitioner's interest in that plant equipment.The only language in any of the agreements which casts any doubt on the conclusion is the statement contained in the Loan Agreement, that --the principal of such loans and advances, together with interest thereon, shall be repaid only out of the net profits arising from Weinert, et al's, interest in the above described leases included in said Unit, and out of the net profits arising from the interest of Weinert, et al, in said recycling and processing plant * * We find nothing in the agreements which states specifically that petitioner was to have no personal liability for repayment of the loans, although it is stipulated that petitioner did not sign any note or other evidence of indebtedness whereby he became personally liable to pay any sums of money to Lehman.We do not believe the fact alone that the parties agreed that the moneys advanced should be repaid only out of the net profits from petitioner's one-half interest in these leases and the recycling plant is sufficient to convert what270 was clearly a loan, from the unambiguous language of the written agreements, into a conveyance of an equitable interest in the oil and gas in place, or into an unfettered assignment of the right to future income for a consideration. We do not believe the cases cited by petitioner so hold or require.In , this Court simply held that, under the rather complicated set of facts there involved, the 929 effect of the transactions under the controlling instruments was that the assignees acquired an economic interest in oil and minerals in place as a result of which the royalties received by them constituted their taxable income and not taxpayers, and taxpayers could not deduct interest on the so-called notes evidencing the amount of the assignee's economic interest. It is true that the Court relied on the fact that, under the terms of the so-called notes, taxpayer was released from all obligation to pay the amounts specified therein and the assignees were required to look for recovery solely out of the oil royalties if, as, and when produced from the property. But the facts in that case were that, at the time the new271 agreement was made, taxpayer was already indebted to the assignees, which indebtedness was secured by liens on the property involved, that in order to get someone to operate the property the assignees had to subordinate their lien to the rights conveyed to the operator, and that the assignees accepted assignment of the royalty interest in exchange for releasing taxpayer from personal obligation on the preexisting indebtedness. On those facts, this Court found that the real intent of the parties was to convey to assignees an economic interest in the oil in place and the so-called note was simply evidence of the amount of that interest. As pointed out above, we think the facts here present require a different conclusion as to the intent of the parties and the effect of the documents and the mere fact that Lehman agreed that the loans should be repaid only out of the revenues from the unitization agreement does not change the situation.Here, the trust form of transaction appears to have been used deliberately to preserve the distinction between the advances or loans and the production payment. Nothing was conveyed or assigned directly to Lehman. Legal title was placed in the trustee272 and the income was received by him in behalf of the beneficial owner thereof as determinded from the Loan Agreement. The revenues received by the trustee were first to be applied to repayment of funds which petitioner requested Lehman to advance for him to pay his pro rata share of the costs of drilling and building the processing plant. The object of the transaction was for Lehman to advance cash for petitioner's use and benefit until such time as the revenues from petitioner's interest made such cash available to petitioner. The evidence indicates that at the time this was done there was little, if any, question that those revenues would be sufficient in a relatively short time to repay Lehman in full, plus interest. The first revenues received by the trustee were received for petitioner's use and benefit and the agreements simply specified how they were to be applied.In , also relied upon by petitioner, this Court held that under agreements whereby fractional working interests in oil and gas leases were temporarily assigned to taxpayer to 930 reimburse it for its expenditures in drilling and developing the property, 273 the income received by taxpayer from such source was taxable to it. There was nothing to indicate that taxpayer was simply loaning or advancing funds for the assignor.Petitioner also relies on (C.A. 5), affirming . There, the owner of the working interest in a lease formed taxpayer corporation, in which he owned all but 2 qualifying shares, and transferred the lease to it for a $ 7,000 note of taxpayer and his agreement to advance the funds for drilling wells, for the return of which he agreed to look only to the proceeds of oil, if, as, and when produced. Taxpayer executed an assignment to the stockholder of all the proceeds of the working interest in the wells, after deducting actual operating expenses, until the proceeds repaid stockholder the specific amount he had paid out for drilling wells, plus interest. Both the Board of Tax Appeals and the Court of Appeals for the Fifth Circuit held that the assignment gave stockholder an economic interest in the oil in place until his outlay was returned to him because he stood to be reimbursed only if oil274 was produced. But, as stated by the Board of Tax Appeals in its opinion, page 713:In reality, petitioner retained no interest in the oil in place, but had only a reversionary interest to come back to it when and after Caldwell's right was exhausted. * * * Under the facts it appears that petitioner was no more than an agent of Caldwell, its chief stockholder, to operate the lease. * * In this case there is no suggestion that petitioner was acting in behalf of Lehman and it is clear that petitioner intended to retain his full 50 per cent interest in the project, subject only to the $ 50,000 production payment carved out of it. Use of the revenues from it to repay the advances made by Lehman for his account was simply a charge on that income of petitioner's if he did not repay the advances with other funds. And in the Caldwell case, the corporation made an outright assignment of the proceeds of its working interest in the lease direct to Caldwell, Caldwell became directly responsible to the drilling contractors for the costs incurred, and, as pointed out in the Board of Tax Appeals' opinion, Caldwell was not limited to the corporation's "net profits" for recovery of his275 payment; while in this case petitioner's interest was assigned to a trustee, for the purpose of securing repayment of a loan. Lehman assumed no obligation to anyone except to loan money to or advance money for petitioner, and the loans were to be repaid out of the "net profits" from petitioner's interest in the leases and recycling plant.Petitioner also relies on . There the taxpayer corporation bought some of its stock from two of its stockholders. In payment therefor taxpayer assigned a certain percentage 931 of its interest in the net proceeds of a certain oil and gas lease for a period of 20 years. While the agreements did state that the assignments were to be made as "security" for payment of the sums specified therein they also provided that assignee would lose if the percentages did not equal the specified sums in the 20-year period but would also take any excess over those sums produced in that period. This Court held that under the facts the assignee received an economic interest in the oil and gas in place and the income from the percentage assigned was not taxable to the assignor. The Court emphasized276 that the assignees were entitled to the "net proceeds" of the oil and gas produced, rather than "net profits" and that the amount assigned was not a stated amount but all the revenues over a 20-year period. We do not think that case is similar to the security assignment here under consideration where the property interest was assigned to a trustee to repay from net profits in a relatively short time a specified amount loaned to petitioner. We have been cited no case wherein we find the factual situation to be sufficiently similar to the facts here to be controlling.In our opinion, under the facts in this case, Lehman did not acquire the equitable interest in the oil and gas in place by virtue of these advances. The funds advanced were used to meet petitioner's obligation for his pro rata share of the drilling and recycling plant costs. They were not used to pay any part of Lehman's pro rata share of these costs. Lehman did not acquire any interest in the product of these expenditures and they were not made for Lehman's direct benefit. The funds advanced were used to provide a direct economic benefit to petitioner, being used to pay his obligations under the unitization agreements. 277 Lehman acquired nothing for these advances except the right to be repaid, first, with interest, from the proceeds of petitioner's retained interest in the leases. The equitable interest in the proceeds assigned, insofar as they were used to repay these advances and interest, remained in petitioner. He assigned these proceeds, in trust, as security for the repayment of the loans. Even though petitioner may have had no personal obligation to repay the loans, the income from the pledged property having been received and used by the trustee to repay the loans and thus release the property and future income therefrom to petitioner, the income was received for the economic benefit of petitioner and was taxable to him. ; ; (C.A. 7, 1956), reversing .The facts in this case distinguish it from , on appeal (C.A. 5, 1958), wherein the petitioner had no obligation to pay any of the drilling278 and development expenses for the reimbursement 932 of which the oil payment was reserved and wherein there was no semblance of a loan to petitioner. Nor is this case inconsistent with the result reached by this Court in the recent case of , although a statement in that opinion might suggest a different conclusion where the creditor must look solely to the oil production for recovery of his advances. That statement was not necessary to the conclusion in that case, and we will not apply it to the facts here involved.We do not agree with petitioner's alternative contention that only so much of the income as equaled advancements actually made by Lehman and Maracaibo during 1949 and 1950 should be taxable to petitioner in those years. These payments did not represent the purchase price of an assignment of an oil and gas interest. They represented loans to or advances for petitioner. It is the income received by the trustee and the purpose for which it is received with which we are concerned.Under the above conclusions, until such time as the entire amount of the advances and interest thereon was paid to Lehman, the 279 trustee was receiving the income from petitioner's retained one-half interest in the leases for or for the use of petitioner, and such income was taxable to petitioner. From the accounting made as part of the stipulation of facts filed herein, it appears that all of the receipts of the trustee during the years 1949 and 1950 would have had to be applied, under the agreements, to payment of interest on the loans and repayment of principal thereof. By the end of 1950 the advances made by Lehman totaled about $ 93,000 while the total revenues received by the trustee up to the end of 1950 totaled only a little less than $ 59,000, and the trustee credited the interest conveyed to him by petitioner with a net amount of about $ 56,000. This being the case, we are not concerned in the years here involved with income received by the trustee and applied to payment of the $ 50,000 production payment. Consequently we hold that all income received by the trustee during 1949 and 1950 is taxable as ordinary income to petitioner, subject, of course, to depletion and other expense properly chargeable thereto. Petitioner having raised no questions with reference to respondent's allowance of depletion280 and other expenses, decision will be entered for respondent.Decision will be entered for the respondent. TRAIN Train, J., concurring: I agree with the result reached in the majority opinion because, under the terms of the agreement involved in this case, the petitioner clearly retained the economic interest in the oil and gas.933 It is true that Weinert did not assume personal liability for the loan in question. However, the terms of the loan agreement provided that Lehman was to look for the recovery of the loan to the net profits arising from oil and gas production and to the net profits from the recycling and processing plant. In my opinion, such a right of recovery is not limited to and is substantially broader than a right of recovery only out of mineral production. Therefore, since Lehman's right of recovery did not depend solely on the oil and gas production, Lehman did not possess the economic interest in the minerals in place. .The majority opinion refers to our recent decision in , with the comment "that a 281 statement in that opinion might suggest a different conclusion" than that reached in the instant case "where the creditor must look solely to the oil production for recovery of his advances." The majority opinion then continues: "That statement was not necessary to the conclusion of that case, and we will not apply to the facts here." The statement in , referred to by the majority is apparently the following:If the right of recovery had extended solely to the oil production, the Withers estate would have held the economic interest in the 45 per cent interest of the community estate, and would receive ordinary income from that interest as long as the receipts were applied to its advances. .Granting that the above statement may not have been essential to our decision of the Wood case, I am disturbed by the clear inference in the instant opinion that the quoted language may be an incorrect statement of the law and, thus, is not to be followed here. I would have thought it well settled that, where an individual's right of recovery extends only to the 282 mineral production, he is the owner of an economic interest in the minerals in place and is taxable on the income allocable to that interest and is likewise entitled to an allowance for percentage depletion.I understand the allowance for percentage depletion to be a provision, arbitrary in measure, for the recovery of capital where the capital is at the risk of mineral production. See and . It is upon this fundamental principle that the rule stated above is based, namely, that, if the advancer of moneys can look only to mineral production for his recovery of those moneys then his capital is at the risk of that mineral production and he is entitled to percentage depletion. Moreover, while it is true that the "economic interest" question arises with regard to the allocation of the right to percentage depletion rather than to the allocation of income proper, certainly 934 the two issues are inseparable in the field of oil and gas taxation and the one must follow the other.The majority's difficulty with the language quoted from the 283 Wood case is due apparently to its conclusion that Lehman's right of recovery was limited solely to oil production. If that conclusion were correct under the facts of this case, then the rule stated in the earlier case, if accepted as valid, would require a different result than that reached here. However, as I have pointed out, I believe that that conclusion is erroneous and that Lehman's right of recovery was not so limited. This being the case, the petitioner cannot shift to Lehman the income involved. This approach reaches the identical result as does the majority opinion and does so without casting doubt on a fundamental principle of long standing. Footnotes1. None.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/265570/	337 F.2d 56 SWITZERLAND COMPANY, a corporation, and Joseph H. Walker, Appellants,v.Stewart L. UDALL, Conrad Wirth, and Sam P. Weems, Appellees. No. 9385. United States Court of Appeals Fourth Circuit. Argued June 12, 1964. Decided September 30, 1964. Guy T. Carswell and James F. Justice, Charlotte, N. C., (Francis O. Clarkson, Jr., Carswell & Justice, and Craighill, Rendleman & Clarkson, Charlotte, N. C., on brief), for appellants. Richard N. Countiss, Atty., Dept. of Justice, and William Medford, U. S. Atty. (Ramsey Clark, Asst. Atty. Gen., and Roger P. Marquis, Atty., Dept. of Justice, on brief) for appellees. Before SOBELOFF, Chief Judge, HAYNSWORTH, Circuit Judge, and HEMPHILL, District Judge. HAYNSWORTH, Circuit Judge. 1 Concluding that this was an action against the United States to which it had not consented, the District Court dismissed this action brought nominally against three individuals who occupy the offices, respectively, of the Secretary of the Interior, the Director of the National Park Service and the Superintendent of the Blue Ridge Parkway. The relief sought by the plaintiffs is a compulsory removal of obstructions, deliberately erected by employees of the National Park Service, of a road, and the continuing maintenance of access over that road, to the Blue Ridge Parkway. We agree with the District Judge that this action for injunctive relief is not maintainable. 2 In 1909, the plaintiff, Switzerland Company, acquired a tract of some 1200 acres lying along the crest of the Blue Ridge Mountains, portions of which it proceeded to subdivide and develop as sites for summer residences. Some roads were laid out, and sometime later a stone tower, known as Kilmichael Tower, was constructed to provide residents and visitors with an unobstructed 360° view of the mountain scenery of the area. A road, ten feet in width, was constructed, running between Kilmichael Tower and other portions of Switzerland's lands, and this road came to be known as "The Kilmichael Tower-Wohlford Road." It is this road and access over it to the subsequently constructed Blue Ridge Parkway, which is the subject of controversy. 3 In 1937, at the request of the United States, the State of North Carolina by condemnation took a fee simple title to a strip of land, 200 feet in width, running through lands of the Switzerland Company. It also took certain related scenic easements. The land and the easements North Carolina thus acquired it conveyed to the United States in 1938. The deed recited that it was a transfer of the grantor's proprietary estate and was not a surrender of state sovereignty. North Carolina expressly reserved the right to maintain "existing public roads" within the area, subject to location changes that might be effected by supplementary agreement. This grant, of course, was for the purpose of construction by the United States of the Blue Ridge Parkway, which was planned ultimately to connect the Shenandoah National Park in Virginia with the Great Smoky Mountains National Park in North Carolina-Tennessee. 4 Thereafter, the United States proceeded with the construction of a section of the Blue Ridge Parkway within the 200-foot wide strip acquired by it from North Carolina and running through lands of the Switzerland Company and others. As laid out, the Parkway crossed the Kilmichael Tower-Wohlford Road and other roads in the community known as Little Switzerland. When the trial of Switzerland's right to just compensation was held in 1939, this section of the Parkway and certain connections with existing roads were actually under construction. These included connections with the Kilmichael Tower-Wohlford Road on either side of the Parkway. 5 There was physical access to the Blue Ridge Parkway to and from Kilmichael Tower-Wohlford Road in either direction until 1960. For the latter portion of the period, however, there were in existence license agreements between the Park Service and the Switzerland Company, authorizing the connection as if for a private rather than a public road. In 1960, Switzerland insisted that it was not a gratuitous licensee, that it had an absolute right of access to the Parkway over the road, and it refused to accept a renewal license agreement. The Park Service then erected physical barricades which prevented access to the Parkway from either direction from the Kilmichael Tower-Wohlford Road. This action effectively shut off access to the Tower and to certain lands, in the vicinity of the Tower, owned by the Switzerland Company and the individual plaintiff, Walker. We infer that it is important to the plaintiffs to establish a right of access to the Parkway rather than permissive access to the Parkway in order to develop their lands in that area for residential or commercial use. On the other hand, the National Park Service is intent upon the avoidance of acquisition of rights by prescription when there are no pre-existing rights of access. Thus, this controversy ensued. 6 The plaintiffs claim that the National Park Service had no right to obstruct the Kilmichael Tower-Wohlford Road because it was a public road at the time of condemnation, reserved by North Carolina in its deed to the United States. The District Court concluded that it was not a public road within the meaning of the deed, and this conclusion is not without support. Its preliminary finding that the road originally was laid out for "public use" is not a contradiction, and it does not require a contrary conclusion. Undoubtedly the Switzerland Company wished to make its Kilmichael Tower accessible to the public, but, during some of this period, at least, it charged admission fees to the Tower. During one winter when the tower was being damaged by vandals, the Switzerland Company, itself, closed the road to avoid further depredation. In a deed to the predecessor in title to the plaintiff, Walker, the Switzerland Company included a reservation of control of the road, and the same reservation for Switzerland's benefit was included in the subsequent deed to Walker. 7 Whether the public may have acquired some interest in the road, however, is not determinative of the plaintiffs' factual contention. Though it may have been laid out for use by the public and though it may have been used by the public, the question is whether or not it was a public road as that term was used in the reservation in the deed from North Carolina to the United States. That question is not answered by a finding that the public had used the road or that its constructor had intended that the public use it. 8 The intention of the parties to the deed from North Carolina to the United States is persuasively indicated by a supplemental agreement executed some three months after delivery of the deed. This agreement purports to provide for the location and construction of every crossing of every public road with the Blue Ridge Parkway in the area. It specifically provides for four such crossings in the Little Switzerland community, one of which was to be by a grade separation structure without interchange of traffic, while the other three were to have access roads or were to be crossings at grade. The Kilmichael Tower-Wohlford Road was not mentioned in any way in the supplemental agreement purporting to cover all public roads within the reservation clause of North Carolina's deed. North Carolina never has maintained this road, and, if it had intended to reserve the right of maintenance, the reasonable inference is that the road would have been mentioned in the agreement which purports to be all inclusive of the roads to which the reservation was intended to apply.1 9 We have set forth the underlying facts and the substantive contentions of the parties, not for the purpose of reviewing the merits of the ultimate conclusion of the District Judge that the road in question was not a public road within the meaning of the reservation in North Carolina's deed,2 but for the purpose of putting the controversy in its context. It is apparent that the plaintiffs are contending, as bounding owners on a public road, that they are entitled to continued access to the Parkway because the United States, in acquiring the fee simple title to the strip of land, acquired no right from North Carolina to close the public roads. On the other hand, it has been the position of the National Park Service that it has a right to close this road, a private road in its view, and, indeed, that under the authorizing statute it has no power to grant more than a terminable, permissive right to use this road within the boundaries of the land the United States owns in fee. If the plaintiffs are granted the relief they seek, of course, the employees of the National Park Service, under the direction of the individual defendants, will be required to remove the obstructions and barricades and provide continued access from the Kilmichael Tower-Wohlford Road to the Blue Ridge Parkway. 10 It is under these circumstances that we face the preliminary question as to whether or not this action is maintainable against the three individual defendants, or whether it was properly dismissed as, in substance, a suit against the United States for injunctive relief to which the United States has not consented. 11 In United States v. Lee, 106 U.S. 196, 1 S. Ct. 240, 27 L. Ed. 171, it was held that an individual might maintain an action for the possession of land against individuals wrongfully withholding possession from him, though the individuals were employees or officials of the United States and acting for it. The Court thus rectified the wrongful seizure by the United States of the George Washington Parke Custis estate, known as Arlington, upon which Arlington National Cemetery is now located. 12 The general principle that the sovereign's wrongs may be rectified by ejecting its servants has not survived without substantial qualification, however. 13 It is difficult to find complete consistency in application of the rule of the Lee case prior to 1949. Though long after passage of the Tucker Act, however, it exhibited substantial vitality in 1947 when the Supreme Court decided Land v. Dollar, 330 U.S. 731, 67 S. Ct. 1009, 91 L. Ed. 1209, as it had earlier when Colorado v. Toll, 268 U.S. 228, 45 S. Ct. 505, 69 L. Ed. 927, and Goltra v. Weeks, 271 U.S. 536, 46 S. Ct. 613, 70 L. Ed. 1074, were decided. The tide set definitely in the other direction, however, with Larson v. Domestic & Foreign Commerce Corp., 337 U.S. 682, 69 S. Ct. 1457, 93 L. Ed. 1628. 14 In Larson, it was held that an action for equitable relief may be maintained against a governmental agent, without the necessity of joining the sovereign, only if the statute which purportedly authorized his conduct was unconstitutional in its application or the agent's act was beyond his delegated authority. And the bounds of his delegated authority, the Court held, were determinable as in the common law of agency. The delegated authority encompasses not only decisions of the agent which are right, but those which are wrong and harmful to the claimant. The Court, thus, specifically rejected the notion that when a governmental agent's conduct is tortious, as where he wrongfully interferes with the plaintiff's possessory rights to property, he may not shield himself behind the doctrine of sovereign immunity.3 The Courts' explanation of Lee demonstrates Lee's inapplicability to this case in view of the existence of a provision for payment of compensation. 15 This is manifest in the subsequent decision of Malone v. Bowdoin, 369 U.S. 643, 82 S. Ct. 980, 8 L. Ed. 2d 168. That was an action of ejectment against a Forest Service officer to try title to land. It was conceded that the defendant acted within his delegated authority, since the Forest Service claimed the land under a deed. On that account, despite the fact that the plaintiffs might have been able to prove theirs the superior title and an exclusive right of possession, it was held that the action could not be maintained. 16 The only difference between Lee and Malone is the existence now of means for the recovery of damages for the wrongful taking. That difference was held in Malone to be critical, and the availability of damages is now held to foreclose equitable remedies. 17 The effect of the erection of the doctrine of sovereign immunity to foreclose equitable actions is to prohibit equitable remedies without consideration of the adequacy of the legal remedy or, indeed, of the interest of the United States. The result is that every claim advanced by an overly zealous agent of the sovereign and by those multitudes of governmental agents who feel unauthorized to relinquish a governmental claim, however baseless it may appear, effects an informal seizure as if by condemnation. It is done, however, without consideration of the appropriateness of condemnation or a comparison of the potential advantage to the United States with the cost of payment of just compensation.4 18 Dugan v. Rank, 372 U.S. 609, 83 S. Ct. 999, 10 L. Ed. 2d 15, and Hawaii v. Gordon, 373 U.S. 57, 83 S. Ct. 1052, 10 L. Ed. 2d 191, are not so relevant here as Larson and Malone. They do illustrate the renewed and abounding vigor of the doctrine of sovereign immunity as now applied by the Supreme Court. They, the most recent pronouncements on the subject indicate no disposition to consider a retreat from Malone. And Dugan v. Rank clearly instructs us that equitable relief against governmental officers cannot be allowed when the requested relief would affect the administration of a governmental project and require congressionally unauthorized expenditures by the United States, notwithstanding that payment of just compensation, the open alternative, might be a greater burden upon the public treasury. 19 We take our cue, of course, from the decisions of the Supreme Court. If some of us, appraising the policy considerations, were inclined to assign a more restricted role to the doctrine of sovereign immunity in this area, we could not follow our inclination when the Supreme Court, clearly and currently, is leading us in the other direction. 20 Applying the doctrine as recently developed by the Supreme Court, the plaintiffs cannot prevail. There is no suggestion of constitutional invalidity of any statute under which the defendants and their subordinates have acted. Construing the plaintiffs' rights of access to a federally owned parkway over federally owned land to be permissive only, they clearly acted within the scope of their authority in declining to acquiesce in the plaintiffs' assertions of greater rights. Whether their determination of the plaintiffs' rights was correct or erroneous and their acts lawful or tortious, they did not depart from their delegated authority as Larson clearly holds. 21 The United States owns in fee the land where the obstructions to the road are maintained. The statute, 16 U.S.C.A. § 460a-2 authorizes these defendants to administer those lands. All of this the plaintiffs conceded. If, in 1938, the road now closed was a public one within the meaning of the reservation in North Carolina's deed, if, regardless of the status of the road, the plaintiffs have an access easement because Switzerland's right of access to the now isolated lands was not effectively condemned in 1938, the defendants and their subordinates have wrongfully exercised their delegated authority, but they have not exceeded it. The scope of the delegated authority to administer the lands of the United States is not restricted by possible or actual encumbrances upon the Government's title. If the defendants have committed a wrong in the exercise of their delegated authority, if their administration of the land has deprived others of the enjoyment of their legal rights, a departure from the delegated authority is not shown. This is the plain holding of Larson. 22 The plaintiffs cannot bring themselves within either of the two exceptions to the rule of immunity which are now recognizable. 23 That this is, in substance, an action against the United States is also illustrated by the nature of the relief sought and the relation of the individual defendants to the alleged wrong. 24 The plaintiffs seek the return of no specific res. They seek a judgment declarative of their rights as against the United States. This is apparent in their joinder as defendants of individuals, occupying high governmental offices, who could have had no personal involvement in the little incidents giving rise to this controversy. The subordinates who erected the barricades are not the defendants, but their ultimate superiors, who obviously are made so only because of their offices.5 25 We conclude that this action cannot be maintained because of the sovereign immunity of the United States. In substance, it is an action against the United States. Since the United States, an essential party, has not consented to be sued, the action must be dismissed. 26 This leaves the plaintiffs to the pursuit of such remedies as they may have for the collection of just compensation for taking their access to their properties. 27 The defendants here contend that the taking occurred in 1937 and that compensation was paid for it as a result of the condemnation proceeding in 1939. This contention is an outgrowth of the defendants' basic contention that the road was a private one and thus not excluded from the deed of North Carolina. It is buttressed by Switzerland's insistence in the 1939 condemnation trial that it had no assurance of access. It is greatly weakened, however, by North Carolina's insistence in the condemnation trial that access would be preserved, and that position was dramatically supported by employees of the United States who testified that the physical connections between the Parkway and this road were actually under construction at the time of trial. The jury might well have thought that Switzerland was not being deprived of what government employees were busily engaged in providing for it and assuring to it. Regardless of the ultimate resolution of the question of the status of this road in 1938, therefore, there is a substantial question whether the United States may now contend that Switzerland's right of access over it was condemned in 1937 and compensation paid for it in 1939. If not, there may have been no appropriation of Switzerland's rights of access to its lands in the vicinity of the tower until the barricades were erected and the road physically closed, at which time a claim for just compensation would have arisen. 28 Those are questions for another day, however. They are not cognizable in this action for equitable relief only 29 Affirmed. Notes: 1 Plaintiffs urgently argue that the supplemental agreement should be construed as applying only to public roads which were to be relocated. We are not persuaded that narrow construction is correct. The reservation in the deed does contemplate a subsequent agreement on location changes, but the agreement actually executed deals with the public roads in the area which were not to be relocated as well as those which were. Moreover, the Kilmichael Tower-Wohlford Road, though unmentioned in the supplemental agreement, was actually relocated. As reconstructed, one traveling from one end of that road to the other would travel for a short distance on the Parkway 2 Our statement that the District Court's finding of ultimate fact is not unsupported, is not intended as an indication that the fact-finder in some subsequent proceeding might not find the facts differently 3 Even under the rejected notion, of course, equitable relief could be granted only if the force of the decree would be expended upon the errant agent and without imposing burdens upon funds or property unquestionably belonging to the sovereign. See the dissenting opinion of Mr. Justice Frankfurter in Larson p. 712, 69 S.Ct. p. 1472 4 The present case is illustrative. The Park Service has no objection to maintenance of access to the Parkway here if only the plaintiffs would agree with it that their use is permissive. The United States has no independent interest in, or advantage to be gained from, a continuing closure of these roads. If it should ultimately be determined, however, that Park Service officers were mistaken in their interpretation of the plaintiffs' rights, then their conscientious assertion of the protective, but erroneous, claim has occasioned a taking of rights of access to large tracts of land. Just compensation for that taking would probably be extremely disproportionate to the value, if any and none is apparent, to the United States of the physical closure of this road at its connections with the Parkway 5 See the dissenting opinion of Mr. Justice Frankfurter in Larson v. Domestic & Foreign Corp., 337 U.S. 682, 712, 69 S. Ct. 1457	01-04-2023	08-23-2011
https://www.courtlistener.com/api/rest/v3/opinions/4562808/	[Cite as Norman v. Kellie Auto Sales, Inc., 2020-Ohio-4311.] IN THE COURT OF APPEALS OF OHIO TENTH APPELLATE DISTRICT Justin Norman, : Plaintiff-Appellee, : No. 18AP-32 v. : (C.P.C. No. 17CV-5681) Kellie Auto Sales, Inc., : (REGULAR CALENDAR) Defendant-Appellant. : D E C I S I O N Rendered on September 3, 2020 On brief: Coffman Legal, LLC, and Matthew J.P. Coffman; Bryant Legal, LLC, and Daniel I. Bryant, for appellee. On brief: Law Offices of Thomas Tootle Co., LPA, and Thomas Tootle, for appellant. ON APPLICATION FOR RECONSIDERATION DORRIAN, J. {¶ 1} Plaintiff-appellee, Justin Norman, has filed an application for reconsideration, pursuant to App.R. 26(A)(1), of this court's decision in Norman v. Kellie Auto Sales, Inc., 10th Dist. No. 18AP-32, 2019-Ohio-360 ("Norman" or "original decision") filed February 5, 2019. For the reasons that follow, we grant Norman's application for reconsideration, vacate the original decision, and affirm the November 30, December 11, 2017, and January 9, 2018 judgments of the Franklin County Court of Common Pleas. I. Facts and Procedural History {¶ 2} The procedural history and facts of this case were summarized in the original decision. {¶ 3} Norman purchased a vehicle from defendant-appellant, Kellie Auto Sales, Inc. ("Kellie Auto"). Neither party disputes that Kelli Auto did not inform Norman the No. 18AP-32 2 vehicle was a rebuilt salvage. The retail installment contract was executed between the parties for the purchase and financing of the vehicle. As part of the sale, the parties also executed an arbitration agreement authorizing either party to "choose to have any dispute between [the parties] decided by arbitration and not in court of [sic] by jury trial." (Emphasis omitted.) Norman at ¶ 3. The agreement also set forth the process for arbitration. Once Norman became aware the vehicle was rebuilt salvage, the parties attempted to negotiate a resolution. Negotiations were not successful and, ultimately, Kellie Auto informed Norman it was invoking the arbitration agreement. A demand for arbitration was completed and submitted. Id. at ¶ 7. {¶ 4} Arbitration was conducted before an arbitrator from the American Arbitration Association. As summarized in the original decision, the arbitrator rendered an award as follows: On June 5, 2017, the arbitrator rendered an award in favor of Norman, having found that Kellie Auto had knowingly committed an unfair or deceptive act under the CSPA. Having heard and considered the parties' evidence, the arbitrator awarded $53,911.75 to Norman, a sum that included: (1) Economic damages – the unrebutted testimony was that [Norman] incurred economic damages in the amount of $7,430. (Down payment, tag fee and loan payments) (2) Non-economic damages – while [Norman] testified he suffered non-economic damages of aggravation, frustration and humiliation, this testimony was not credible. Long after [Norman] found out about the salvage title he continued to drive the car. Early on, [Kellie Auto] offered to rescind the transaction which [Norman] refused. It appears to the Arbitrator that [Norman] held on to his remedy options for an extended period of time for the sole purpose of increasing his recovery. Non-economic damages will not be awarded; (3) Attorney's fees and costs – [Norman] is entitled to his reasonable attorney's fees and costs for this knowing violation of the CSPA. [Norman] has submitted the affidavits of his attorneys (Ex. 23 and 24) along with the affidavit of Attorney DeRose (Ex. 25) attesting to the reasonableness of the rates submitted. The Arbitrator finds that applying the lodestar approach set forth by the Ohio Supreme Court in Bittner v. Tri- County Toyota (1991), 58 Ohio St. 3d 143 an attorney's fees award of $31,494.50 (an extra $1,000 is awarded for post- No. 18AP-32 3 hearing work) is appropriate. In addition, hearing fees of $127.25 will be imposed; (4) The economic damage award shall be trebled to ($7,420 x 3) $22,290 pursuant to Rev. Code 1345.09. (See Pep Boys v. Vaughn, 2006-Ohio-698 (C.A. 10th 2006). While the Arbitrator may believe that treble damages are not factually justified he cannot apply his personal belief on an appropriate remedy that is not statutorily authorized. Treble damages are to be awarded. Bierlein v. Alex's Continental Inn, (1984) 16 Ohio App. 3d 301) (Sic passim and emphasis added.) (Ex. A at 5-6, attached to Application.) The arbitrator also ordered Kellie Auto to pay $2,400 for the association's administrative fees and $1,500 for the arbitrator's compensation. The arbitrator's award constituted a full, final disposition of all claims submitted. (Emphasis sic.) Norman at ¶ 9. {¶ 5} After the arbitration, Norman requested and, according to Norman, Kellie Auto's counsel agreed to provide payment to Norman pursuant to the arbitrator's award. However, Kellie Auto retained new counsel and refused to provide payment. Norman then filed an application for judgment and to confirm the arbitration award pursuant to R.C. 2711.09. Kellie Auto was served with Norman's application on June 30, 2017. {¶ 6} Construing Norman's application, pursuant to R.C. 2711.09, as an "action" under the Ohio's Consumer Sales Practices Act ("CSPA"), and R.C. 1345.092(B), on July 10, 2017 Kellie Auto filed a notice of cure offer with the court and an application to modify the arbitration award pursuant to R.C. 2711.11. Kellie Auto requested the trial court: "[I]ssue an order modifying and correcting the arbitration award at issue in this action," reducing the award to $9,930 (economic damages of $7,430 and attorney fees of $2,500), plus court costs or, alternatively, "remand this matter to the Arbitrator with instructions that he include an analysis of attorney's fees as required under Bittner v. Tri-County Toyota, 58 Ohio St.3d 143 (1991)." (Aug. 4, 2017 Mot. To Modify at 1, 10.) Norman at ¶ 13. {¶ 7} The trial court denied Kellie Auto's request to modify the arbitration award and granted Norman's application to confirm the award. Kellie Auto filed a motion for relief from judgment. The trial court denied the same. Kellie Auto appealed. No. 18AP-32 4 {¶ 8} On appeal, Kellie Auto raised as its first assignment of error that the trial court erred "when it refused to recognize the Defendant-Appellant's timely exercise of a 'right to cure' pursuant to R.C. 1345.092." Id. at ¶ 18. Norman sustained the assignment of error and concluded: R.C. 1345.092(A) is clear—a statutory cure offer can be made only after the consumer has commenced an action against an act or practice that violates R.C. Chapter 1345. R.C. 1345.092(A). But this statute does not prevent a supplier such as Kellie Auto from attempting to cure the problem with one or more offers to make the buyer whole before any such action, or even arbitration, occurs. That the first and only lawsuit filed by Norman was the action seeking to enforce the arbitration award premised on a CSPA claim does not change the operation of the statutory language of R.C. 1345.092(A) enabling Kellie Auto to make a statutory cure offer. *** We find Kellie Auto's arguments well-taken. In harmonizing the CSPA with Ohio's arbitration statutes, a reviewing court may vacate or modify an arbitration award only as provided for in R.C. 2711.10 or 2711.11, respectively. In its brief, Kellie Auto states no error with the arbitrator's finding of liability, only with the damages awarded: [Kellie Auto] asserts that the award of damages exceeds the amount allowable following a valid cure offer. R.C. § 2711.11 provides: "In any of the following cases, the court of common pleas * * * shall make an order modifying or correcting the award upon the application of any party to the arbitration if: (A) There was an evident material miscalculation of figures or an evident material mistake in the description of any person, thing, or property referred to in the award..." * * * A material miscalculation of figures and an evident material mistake exists. Norman's award must be limited to only that permitted following a timely exercise of the right to cure. Based upon the foregoing, Kellie [Auto] asks this Court to remand this matter to the trial court to order a modification of the award to $9,930 plus court costs. This represents actual damages (as determined by the arbitrator) of $7,430 and attorney fees of $2,500 – the maximum permitted by statute. No. 18AP-32 5 (Kellie Auto's Brief at 20-21.) We find Kellie Auto's request for remand for modification appropriate. Based on the foregoing, we find as a matter of law that the provisions of R.C. 1345.092 were triggered in this matter when Kellie Auto timely filed a cure offer under R.C. 1345.092(A). Accordingly, the common pleas court erred when it refused to recognize as timely Kellie Auto's exercise of a right to cure pursuant to R.C. 1345.092 and to reduce the arbitrator's award in accordance with R.C. 1345.092(G). We remand this matter to the common pleas court to allow Kellie Auto to present to the court its cure offer and to modify the arbitrator's award consistent with this decision. Kellie Auto's first assignment of error is sustained. Id. at ¶ 27, 34-35. {¶ 9} Norman asks this court to reconsider the court's original decision to the extent it sustained the first assignment of error and reversed the trial court's decision on the same grounds. II. Applicable Law for Reconsideration {¶ 10} The test applied to an application for reconsideration is whether the motion calls to the attention of the court an obvious error in our prior determination or raises an issue that was not properly considered by the court in the first instance. Matthews v. Matthews, 5 Ohio App.3d 140 (10th Dist.1981). We believe the grounds for reconsideration have been met. III. Reconsideration and Overruling of the First Assignment of Error {¶ 11} Norman makes several arguments in support of his objection to the court's original decision sustaining the first assignment of error. As relevant here, he argues the original decision "created what is tantamount to an appeal right for Appellant when it would otherwise not have any appealable rights under its own legally-binding arbitration agreement which prohibits either party from appealing the arbitrator's decision unless one of three specific events are triggered [and the parties' exclusive remedies] do not include modification of the Arbitrator's award under these circumstances." (Norman's App. for Reconsideration at 10-11.) In Norman's merit brief on appeal, he argued Kellie Auto did not seek vacation, modification, or correction through any of the means outlined in R.C. No. 18AP-32 6 2711.10 or 2711.11.1 Norman argued this court "should summarily reject Appellant's radical position and affirm the trial court[,] [and] [t]his Court should not adopt Appellant's alternative, unsubstantiated interpretation to R.C. [2711.10 and 2711.11] by adding language from R.C. 1345.092." (Norman's Brief at 18.) {¶ 12} We agree with Norman. Although Kellie Auto did not specifically request that the trial court vacate the arbitrator's award, we note that R.C. 2711.10 authorizes a trial court to vacate an award only if: (A) The award was procured by corruption, fraud, or undue means. (B) There was evident partiality or corruption on the part of the arbitrators, or any of them. (C) The arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced. (D) The arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made. {¶ 13} Kellie Auto did not meet any of the grounds in R.C. 2711.10 for vacating an arbitrator's award. {¶ 14} Kellie Auto did request the trial court modify the arbitrator's award. R.C. 2711.11 authorizes a trial court to modify an award only if: (A) There was an evident material miscalculation of figures or an evident material mistake in the description of any person, thing, or property referred to in the award; (B) The arbitrators have awarded upon a matter not submitted to them, unless it is a matter not affecting the merits of the decision upon the matters submitted; 1 We note the arbitration agreement states that "[a]ny arbitration under this Arbitration Agreement shall be governed by the Federal Arbitration Act (9 U.S.C. sec. 1 et seq.) and not by any state law concerning arbitration." (Arbitration Agreement.) It also reads that "[t]he arbitrator shall apply governing substantive law in making an award." Notwithstanding, both Norman and Kellie Auto support their arguments in their original merit briefs and their briefs regarding reconsideration with references to Ohio law only, not federal law. No. 18AP-32 7 (C) The award is imperfect in matter of form not affecting the merits of the controversy. {¶ 15} In Norman, this court found Kellie Auto's request for remand for modification appropriate; however, none of the grounds for modification outlined in R.C. 2711.11 were met. Kellie Auto's claim that modification was required for application of the CSPA cure provisions was not based on any flaw in the arbitrator's decision. Rather, the modification was based on something that happened after the arbitrator issued his decision and award and after Norman applied for confirmation. The Supreme Court of Ohio has stated: R.C. Chapter 2711 does not confer authority on an arbitration panel to reconsider its awards. Instead, R.C. Chapter 2711 confers jurisdiction only on the trial court, pursuant to R.C. 2711.10 and 2711.11, to vacate, modify or correct arbitration awards. Furthermore, "when the submitted issues are decided, the arbitrators' powers expire. Thus, a second award on a single, circumscribed submission is a nullity." Lockhart v. Am. Res. Ins. Co. (1981), 2 Ohio App. 3d 99, 102, citing Bayne v. Morris (1863), 68 U.S. 97, 99. Lockhart also relied on Citizens Bldg. of W. Palm Beach, Inc. v. W. Union Tel. Co. (C.A.5, 1941), 120 F.2d 982, 984, which held, "Arbitrators are appointees with but a single duty and * * * performance of that duty terminates their authority. When an arbitral board renders a final award, its powers and duties under the submission are terminated. Its authority is not a continuing one, and, after its final decision is announced, it is powerless to modify or revoke it or to make a new award upon the same issues." We find this analysis to be well crafted. Accordingly, the arbitration panel, once it entered the award, had no authority to reconsider its decision. (Emphasis sic.) Miller v. Gunckle, 96 Ohio St.3d 359, 2002-Ohio-4932, ¶ 23. {¶ 16} Further, in BIGResearch, L.L.C., [Prosper Business Dev. Co. Intervenor- appellant] v. PENN, L.L.C., 10th Dist. No. 11AP-855, 2012-Ohio-2992, ¶ 37 ("Prosper Business"), we noted that "an arbitrator may not make factual findings with respect to events that occurred after the conclusion of arbitration." Id., citing Accu-Med Servs., Ltd. v. Omnicare, Inc., 1st Dist. No. C-020789, 2004-Ohio-655, ¶ 24. {¶ 17} Here, no cure offer was made as arbitration proceeded and the arbitrator did not err—requiring vacation or modification—by failing to consider the cure provisions because no cure offer was made for him to assess. The cure offer was made after the No. 18AP-32 8 arbitrator's powers expired and he was powerless to modify or revoke his award at the time Kellie Auto made the cure offer. Kellie Auto did not meet any of the grounds for vacation or modification in R.C. 2711.10 or 2711.11. Therefore, we agree with Norman that reconsideration is warranted as application of the CSPA cure provisions in this instance did not meet the grounds for vacation or modification pursuant to R.C. 2711.10 or 2711.11.2 {¶ 18} Because we have determined that grounds for modification or vacation were not met, it is not necessary for us to address the merits of the question whether the CSPA cure provisions apply here. {¶ 19} Accordingly, we grant Norman's application for reconsideration and vacate our decision in Norman to sustain the first assignment of error and reverse and remand the trial court decision on those grounds. We now overrule the first assignment of error. IV. Affirmation of Original Determination to Overrule the Third Assignment of Error {¶ 20} In Norman, we also addressed Kellie Auto's third assignment of error and determined the trial court did not err when it did not conduct a hearing on Kellie Auto's application to modify the arbitrator's award. We stated: Kellie Auto argues a mistake occurred when, on November 30, 2017, the trial court ruled on both Norman's July 11, 2017 application for judgment confirming the arbitration award and Kellie Auto's August 4, 2017 motion to modify the award without first conducting any hearing. Consequently, on December 15, 2017, Kellie Auto filed a motion for relief from judgment pursuant to Civ.R. 60(B) and a motion to stay the execution of judgment pursuant to Civ.R. 62(A). On January 9, 2018, the trial court issued a decision and entry denying Kellie Auto's Civ.R. 60(B)(1) motion filed 2 Kellie Auto also did not meet the grounds for vacation or modification pursuant to federal law. 9 U.S.C. 10 states an arbitration award may be vacated upon application of any party: "(a)(1) where the award was procured by corruption, fraud, or undue means; (2) where there was evident partiality or corruption in the arbitrators, or either of them; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made." 9 U.S.C. 11 states that an arbitration award may be modified upon the application of any party: "(a) Where there was an evident material miscalculation of figures or an evident material mistake in the description of any person, thing, or property referred to in the award. (b) Where the arbitrators have awarded upon a matter not submitted to them, unless it is a matter not affecting the merits of the decision upon the matter submitted. (c) Where the award is imperfect in matter of form not affecting the merits of the controversy." As noted above, Kellie Auto did not argue that any of these grounds were met and we would also determine that none of these grounds were met. No. 18AP-32 9 December 15, 2017, and a decision entry and order denying Kellie Auto's motion to stay filed December 15, 2017. The trial court noted that "Civ.R. 60(B) is a remedial rule to be liberally construed so that the ends of justice may be served." Kay v. Marc Glassman, Inc., 76 Ohio St.3d 18, 20 (1996), citing Colley v. Bazell, 64 Ohio St.2d 243, 249 (1980). The trial court continued: To prevail on a Civ.R. 60(B) motion, "the movant must demonstrate that: (1) the party has a meritorious defense or claim to present if relief is granted; (2) the party is entitled to relief under one of the grounds stated in Civ.R. 60(B)(1) through (5); and (3) the motion is made within a reasonable time, and, where the grounds of relief are Civ.R. 60(B)(1), (2), or (3), not more than one year after the judgment, order or proceeding was entered or taken." GTE Automatic Elec., Inc., v. ARC Industries, Inc. (1976), 47 Ohio St.2d 146, 351 N.E. 2d 113, paragraph two of the syllabus. Furthermore, "Civ.R. 60(B) relief is improper if any one of the foregoing requirements is not satisfied." Boston v. Parks-Boston, 10th Dist. Franklin No. 02AP-1031, 2003-Ohio-4263, ¶ 12-13. Only the first two elements are at issue here. (Jan. 9, 2018 Decision & Entry at 2.) The trial court disagreed with Kellie Auto's argument that the language of R.C. 2711.09 and the holding of Zingarelli v. Lord, 10th Dist. No. 94APE05-699 (Nov. 17, 1994) required the trial court to hold a hearing on Kellie Auto's Civ.R. 60(B) motion. As we noted in the Facts and Procedural Background portion of this decision, the trial court determined that this Court's decision in [Victoria's Secret Stores, Inc. v. Epstein Contracting, Inc., 10th Dist. No. 00AP-209 (Mar. 8, 2001)] was controlling, and that it obviated the need to conduct a hearing on the motion because Kellie Auto had not requested a hearing. The trial court found Epstein to be controlling because Epstein considered the hearing requirement on motions to amend and/or modify pursuant to R.C. 2711.09 through 2711.11, while concurrently examining the provisions of R.C. 2711.05, Civ.R. 7(B)(2), and Loc.R. 21.01 of the Franklin County Court of Common Pleas, General Division. The trial court continued: Having determined that Epstein controls, the Court notes that [Kellie Auto] did not request a hearing. See White v. Fitch, 2015-Ohio-4387, 2015 Ohio App. LEXIS 4332 (Ohio Ct. App., No. 18AP-32 10 Cuyahoga County 2015) (holding trial court was within its authority to deny the home owners' motion to modify or vacate the arbitration award without a hearing and noting the owner never requested a hearing, and could have made such a request in her initial motion to modify or vacate the arbitration award or in her reply brief). And, this Court did conduct a status conference and a non-oral hearing "utilizing the various memoranda filed in support and opposition to appellees' application to confirm the arbitration award and appellant's motion to vacate or modify the award." Epstein, 2001 Ohio App. LEXIS 827, at * 14. Accordingly, the Court holds under Epstein and Fitch that [Kellie Auto] fails to demonstrate both that [Kellie Auto] has a meritorious defense or claim to present if relief is granted and that [Kellie Auto] is entitled to relief under Civ.R. 60(B)(1). [Kellie Auto's] Motion to Vacate is therefore DENIED under Boston. (Emphasis sic.) (Jan. 9, 2018 Decision & Entry at 4-5.) We find the common pleas court's reasoning to be sound. Accordingly, the common pleas court did not err by not conducting a hearing on the Kellie Auto's motion to modify the arbitrator's award before denying the motion, especially when Kellie Auto did not specifically request a hearing on its Civ.R. 60(B) motion. Kellie Auto's third assignment of error is overruled. Id. at ¶ 39-43. {¶ 21} We again adopt these points from Norman with respect to Kellie Auto's third assignment of error. {¶ 22} Accordingly, we overrule Kellie Auto's third assignment of error. V. Overruling of the Second Assignment of Error {¶ 23} Finally, in Norman we declined to address Kellie Auto's second assignment of error, determining it to be moot based on our original sustaining of the first assignment of error and reversal of the trial court on these grounds. Now that we have reconsidered and vacated our original decision, it is necessary for us to address Kellie Auto's second assignment of error. {¶ 24} In its second assignment of error, Kellie Auto avers "[t]he lower Court erred when it affirmed [sic] the Arbitrator's award of attorney fees absent a discussion of the No. 18AP-32 11 required factors enumerated in Bittner v. Tri-County Toyota, Inc. 58 Ohio St.3d 143, 145, 569 N.E.2d 464 (1991)."3 {¶ 25} Specifically regarding attorney fees, Norman stated: On June 5, 2017, the arbitrator rendered an award in favor of Norman, having found that Kellie Auto had knowingly committed an unfair or deceptive act under the CSPA. Having heard and considered the parties' evidence, the arbitrator awarded $53,911.75 to Norman, a sum that included: * (3) Attorney's fees and costs – [Norman] is entitled to his reasonable attorney's fees and costs for this knowing violation of the CSPA. [Norman] has submitted the affidavits of his attorneys (Ex. 23 and 24) along with the affidavit of Attorney DeRose (Ex. 25) attesting to the reasonableness of the rates submitted. The Arbitrator finds that applying the lodestar approach set forth by the Ohio Supreme Court in Bittner v. Tri-County Toyota (1991), 58 Ohio St. 3d 143 an attorney's fees award of $31,494.50 (an extra $1,000 is awarded for post-hearing work) is appropriate. In addition, hearing fees of $127.25 will be imposed; * (Sic passim and emphasis added.) (Ex. A at 5-6, attached to Application.) Id. at ¶ 9. 3 Bittner, at 145-46, stated: "When awarding reasonable attorney fees pursuant to R.C. 1345.09(F)(2), the trial court should first calculate the number of hours reasonably expended on the case times an hourly fee, and then may modify that calculation by application of the factors listed in DR 2-106(B). These factors are: the time and labor involved in maintaining the litigation; the novelty and difficulty of the questions involved; the professional skill required to perform the necessary legal services; the attorney's inability to accept other cases; the fee customarily charged; the amount involved and the results obtained; any necessary time limitations; the nature and length of the attorney/client relationship; the experience, reputation, and ability of the attorney; and whether the fee is fixed or contingent. All factors may not be applicable in all cases and the trial court has the discretion to determine which factors to apply, and in what manner that application will affect the initial calculation. Moreover, the trial court determination should not be reversed absent a showing that the court abused its discretion. 'It is well settled that where a court is empowered to award attorney fees by statute, the amount of such fees is within the sound discretion of the trial court. Unless the amount of fees determined is so high or so low as to shock the conscience, an appellate court will not interfere. The trial judge which participated not only in the trial but also in many of the preliminary proceedings leading up to the trial has an infinitely better opportunity to determine the value of services rendered by lawyers who have tried a case before him than does an appellate court.' Brooks v. Hurst Buick-Pontiac-Olds-GMC, Inc. (1985), 23 Ohio App. 3d 85, 91, 23 OBR 150, 155, 491 N.E. 2d 345, 351-352." No. 18AP-32 12 {¶ 26} When Kellie Auto filed its application to modify the arbitration award, pursuant to R.C. 2711.11, he requested the trial court "issue an order modifying and correcting the arbitration award at issue in this action" by applying the CSPA cure provisions or, alternatively, "remand this matter to the Arbitrator with instructions that he include an analysis of attorney's fees as required under Bittner v. Tri-County Toyota, 58 Ohio St.3d 143 (1991)." Norman at ¶ 13. The trial court denied Kellie Auto's motion to modify on November 30, 2017, issuing a final appealable order on December 11, 2017. Regarding attorney fees, the trial court stated: The Award specifically states that the 'Arbitrator finds that applying the lodestar approach set forth by the Ohio Supreme Court in Bittner * * * an attorney's fee award of $31,494.50 (an extra $1,000 is awarded for post-hearing work) is appropriate.' (Award at 6.) Clearly, then, the Arbitrator considered and utilized the Bittner factors. This alternative ground is unavailing and Kellie has fallen short of its burden of proving 'the arbitrator committed an error so patent and grave as would have required him to change his award.' [Warner v. CTL Eng., Inc.], 9 Ohio App.3d 52, 55, 458 N.E.2d 399 (10th Dist. 1983). As such the Court DENIES Kellie's Motion to Modify. (Emphasis sic.) (Nov. 30, 2017 Decision at 4.) {¶ 27} Kellie Auto argues the trial court erred in not discussing the factors outlined in Bittner and, therefore, it is not possible to determine what factors the arbitrator considered or the weight, if any, it placed on those factors. Kellie Auto argues "[w]ithout such a statement, an appellate court cannot conduct a meaningful review * * * [and] '[a] court must give adequate reasoning as to how it arrived at the specific amount of the award.' " (Emphasis added.) (Kellie Auto's Brief at 23, citing Pack v. Hilock Auto Sales, 10th Dist. No. 12AP-48, 2012-Ohio-4076, ¶ 16, and quoting Ridenour v. Dunn, 10th Dist. No. 03AP-611, 2004-Ohio-3375, ¶ 10.) Kellie Auto further argues " 'in cases where the amount recovered is small compared to the attorney fees assessed, the court must give adequate reasoning as to how it arrived at the specific amount of the award.' " (Emphasis added.) (Kellie Auto's Brief at 23-24, quoting Whitestone Co. v. Stittsworth, 10th Dist. No. 06AP-371, 2007-Ohio-233, ¶ 60.) {¶ 28} We overrule Kellie Auto's second assignment of error for several reasons. No. 18AP-32 13 {¶ 29} First, in the application to modify and reply brief to Norman's memorandum contra to the application, as well as in the brief before this court, Kellie Auto did not assert any grounds pursuant to R.C. 2711.10 or 2711.11 for a court to vacate or modify an arbitrator's award on the grounds asserted in the second assignment of error. Kellie Auto claims the error by the trial court was failure to discuss Bittner factors and failure to include an analysis of the factors required. Kellie Auto does not allege the fee amount was incorrect but, rather, that the procedure used to assess the fees was not proper. Nowhere does Kellie Auto assert: (1) there was an evident material miscalculation of figures or an evident material mistake;4 (2) the award was upon a matter not submitted to the arbitrator; or (3) the award is imperfect in matter of form not affecting the merits of the controversy. It was not the job of the trial court, nor is it the job of this court, to discern the grounds for modification, if any. See also Classic Bar & Billiards, Inc. v. Samaan, 10th Dist. No. 08AP- 210, 2008-Ohio-5759, ¶ 17 ("It is the duty of the appellant, not the appellate court, to construct the legal arguments necessary to support the appellant's assignments of error."). {¶ 30} Second, as revealed in its argument in support of the second assignment of error quoted above, Kellie Auto ignores that the role of an arbitrator, trial court, and appellate court when parties pursue arbitration differs from the role of a trial court and an appellate court when parties pursue litigation.5 {¶ 31} In Prosper Business, we noted that "in agreeing to arbitration, the parties trade the procedures and opportunity for review of the courtroom for the simplicity, informality, and expedition of arbitration." Id.6 at ¶ 52, citing DePalmo v. Schumacher 4 In the application to modify, Kellie Auto argued evident miscalculation of figures and evident material mistake as grounds for modification that the arbitrator's award must be limited to only that permitted following a timely exercise of the right to cure. However, in the next section of the application, Kellie Auto asserted no particular grounds, pursuant to R.C. 2711.11 or 2711.10, as the reason for modifying the award for failure to properly assess attorney fees. 5 Indeed, the Arbitration Agreement drafted by Kellie Auto states "either you or we may choose to have any dispute between us decided by arbitration and not in court or by jury trial." (Emphasis omitted.) (Arbitration Agreement.) It further states "rights to appeal in arbitration are generally more limited than in a lawsuit, and other rights that you and we would have in court may not be available in arbitration." (Emphasis omitted.) (Arbitration Agreement.) 6 Also relevant here, in Prosper Business, at ¶ 52, we recognized, referring to Bittner, that "in a civil action in an Ohio court of law, an award of attorney fees is dependent upon the completion of prescribed procedures and analyses, e.g., a lodestar analysis. [But the appellant] has not, however, cited any precedent extending those procedures to arbitrations." Likewise here, Kellie Auto did not cite any precedent extending those procedures to arbitrations. No. 18AP-32 14 Homes, Inc., 5th Dist. No. 2001CA272, 2002-Ohio-770, citing Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614, 628 (1985). The trial court's role on reviewing an arbitrator's award is limited. Arbitration awards are presumed valid, and a reviewing court may not merely substitute its judgment for that of the arbitrator. Id. {¶ 32} " 'Once an arbitration is completed, a court has no jurisdiction except to confirm and enter judgment (R.C. 2711.09 and 2711.12), vacate (R.C. 2711.10 and 2711.13), modify (R.C. 2711.11 and 2711.13), correct (R.C. 2711.11 and 2711.13), or enforce the judgment (R.C. 2711.14).' " Champion Chrysler v. Dimension Serv. Corp., 10th Dist. No. 17AP-860, 2018-Ohio-5248, ¶ 10, quoting State ex rel. R.W. Sidley, Inc. v. Crawford, 100 Ohio St.3d 113, 2003-Ohio-5101, ¶ 22. " 'A trial court may not evaluate the actual merits of an award and must limit its review to determining whether the appealing party has established that the award is defective within the confines of R.C. Chapter 2711.' " Id., quoting Telle v. Estate of William Soroka, 10th Dist. No. 08AP-272, 2008-Ohio-4902, ¶ 9. Because R.C. Chapter 2711 is the method to challenge an arbitration award, "[t]he jurisdiction of the courts to review arbitration awards is thus statutorily restricted; it is narrow and it is limited." Warren Edn. Assn. v. Warren City Bd. of Edn., 18 Ohio St.3d 170, 173 (1985). {¶ 33} An appellate court's role when reviewing a trial court's determination regarding arbitration is even more limited. "An appeal may be taken from an order confirming, modifying, correcting, or vacating an award made in an arbitration proceeding or from judgment entered upon an award." R.C. 2711.15. However, because "[a] trial court is precluded from evaluating the actual merits of an award and must confine itself to determining whether the appealing party has established that the award is defective in a manner recognized by R.C. Chapter 2711," on appeal, "the standard of review is further restricted." MBNA Am. Bank, N.A. v. Jones, 10th Dist. No. 05AP-665, 2005-Ohio-6760, ¶ 10-11. {¶ 34} "[W]hen a court of appeals reviews a trial court's judgment concerning an arbitration award, the appellate court must confine its review to evaluating the order issued by the trial court pursuant to R.C. Chapter 2711." State v. Ohio Civ. Serv. Emps. Assn., Local 11 AFSCME AFL-CIO, 10th Dist. No. 14AP-906, 2016-Ohio-5899, ¶ 13. Thus, when "an appeal is taken from an order confirming, modifying, correcting, or vacating an arbitration award, the review is confined to the order and the original arbitration No. 18AP-32 15 proceedings are not reviewable." Robert W. Setterlin & Sons v. N. Mkt. Dev. Auth., Inc., 10th Dist. No. 99AP-141 (Dec. 30, 1999), citing Lockhart v. Am. Reserve Ins. Co., 2 Ohio App.3d 99, 101 (8th Dist.1981). "[W]hen reviewing a decision of a common pleas court confirming, modifying, vacating, or correcting an arbitration award, an appellate court should accept findings of fact that are not clearly erroneous but decide questions of law de novo." Portage Cty. Bd. of Dev. Disabilities v. Portage Cty. Educators' Assn. for Dev. Disabilities, 153 Ohio St.3d 219, 2018-Ohio-1590, ¶ 26. {¶ 35} The arbitration agreement here states that an "arbitrator shall apply governing substantive law in making an award." It further states that "[e]ach party shall be responsible for its own attorney, expert and other fees, unless awarded by the arbitrator under applicable law." (Arbitration Agreement.) The trial court points out, the arbitrator cited Bittner—the Ohio applicable law—and considered and utilized the Bittner factors. We agree the arbitrator applied governing Ohio law in making the award of attorney fees. {¶ 36} Third, notwithstanding that it was not the trial court's role to evaluate the merits of the arbitrator's award, and the original arbitration proceedings are not reviewable by the appellate court, we do note that Kellie Auto did not address the award of attorney fees in its post-hearing brief before the arbitrator when he had the opportunity to argue the merits of the arbitrator's award of attorney fees. {¶ 37} Attached to Norman's memorandum contra to Kellie Auto's application to modify were Exhibits C and D. Exhibit C contained Norman's post-arbitration brief submitted to the arbitrator. Pages 27-32 of Norman's post-arbitration brief address his request for attorney fees and specifically addresses the Bittner factors.7 Attached to 7 In addition to the affidavits and time sheets, Norman also referred the arbitrator to an analysis of the reasonableness of fees. Norman stated in his brief, and we have confirmed in reviewing the record: "In addition to the time records and affidavits Plaintiff's attorneys submitted with the post-arbitration brief, Plaintiff extensively briefed his entitlement to attorneys' fees. (See Exhibit C at 27-32.) Plaintiff outlined the ten (10) factors used by courts (following Bittner) to analyze the reasonableness of attorney fees. Id. Additionally, Plaintiff's counsel submitted its well-documented and contemporaneous time reports detailing the amount of time as well as affidavits regarding the number of hours worked and their hourly rates of recompense and argued that, pursuant to Bittner, they constitute sufficient evidence of reasonableness to determine the basis of attorneys' fees. See Bittner, 58 Ohio St.3d at 145. Further support of Plaintiff's attorneys' rates was submitted using Judge Rubin's 1983 committee's determination of reasonable attorney fee rates that is still currently used by the Southern District of Ohio. Under Judge Rubin's rubric, the rates requested are comparable and Plaintiff included a chart to compare Plaintiff's attorneys' fee rates compared to Judge Rubin's rubric using 1983 rates calculated for 2016 rates and applied a 4% annual cost-of-living allowance to measure the reasonableness of the fees requested. Applying the Rubin Rate as of 2016, the rates for attorney Coffman was $352 per hour and the rate for attorney Bryant is $263 per hour." (Emphasis sic.) (Norman's Memo. Contra Mot. to Modify at 12-13.) No. 18AP-32 16 Norman's post-arbitration brief were exhibits 23, 24, and 25—affidavits and detailed time sheets of Norman's attorneys Coffman and Bryant, as well as the affidavit of Attorney DeRose opining on reasonableness of Coffman and Bryant's fees and quality of work; as well as detailed description and breakdown by hours spent of Norman's counsels' work on his behalf. Exhibit D contained Kellie Auto's post-arbitration brief. Kellie Auto's post- arbitration brief states simply that Norman is not entitled to attorney fees, but does not address the reasonableness of Norman's counsels' fees or work or any of the Bittner factors. Nor does it complain that the arbitrator did not analyze the request for attorney fees award pursuant to Bittner. {¶ 38} In Bittner, the Supreme Court observed that " '[i]t is well settled that where a court is empowered to award attorney fees by statute, the amount of such fees is within the sound discretion of the trial court. Unless the amount of fees determined is so high or so low as to shock the conscience, an appellate court will not interfere. The trial judge which participated not only in the trial but also in many of the preliminary proceedings leading up to the trial has an infinitely better opportunity to determine the value of services rendered by lawyers who have tried a case before him than does an appellate court.' " Id. at 146, quoting Brooks v. Hurst Buick-Pontiac-Olds-GMC, Inc., 23 Ohio App.3d 85, 91 (12th Dist.1985). The same reasoning applies here to the arbitrator. The arbitrator, who participated in the arbitration and preliminary proceedings leading up to the arbitration, had an infinitely better opportunity to determine the value of services rendered by the lawyers who arbitrated before him than the trial court asked to modify the award and more so than the appellate court asked to review the trial court's confirming of the award and denial of the motion to modify the award. {¶ 39} Taking all these factors into consideration, including the trial court's limited role in considering applications to confirm and modify an arbitrator's award, as well as our own limited role in reviewing the trial court's decisions, we cannot say the trial court clearly erred or abused its discretion in confirming the arbitrator's award and amount of attorney fees and denying Kellie Auto's application to modify the same. {¶ 40} Accordingly, we overrule Kellie Auto's second assignment of error. {¶ 41} Finally, we note that on December 12, 2018, Norman filed a motion for post- arbitration attorney fees and costs with the trial court. Norman requested the trial court provide an opportunity to request additional attorney fees and costs incurred as part of No. 18AP-32 17 post-judgment collection efforts given Kellie Auto's continued refusal to pay the amounts recovered in this dispute. On January 9, 2019, the trial court denied Kellie Auto's motion to vacate judgment, pursuant to Civ.R. 60, and motion to stay. Although the trial court did not expressly rule on Norman's motion in the January 9, 2019 entry, we construe the trial court's silence as a denial of the same. See State ex rel. The V Cos. v. Marshall, 81 Ohio St.3d 467, 469 (1998) (holding that an appellate court ordinarily presumes that a trial court denied a motion when the trial court fails to explicitly rule on the motion). In his original merit brief, Norman requested the order remand to the trial court solely to determine the additional attorney fees and costs incurred resulting from Kellie Auto's unnecessary and avoidable conduct following its refusal to pay the award. Norman did not, however, raise this as an assignment of error.8 Furthermore, the trial court did affirm the arbitrator's award of an extra $1,000 for post-arbitration work. Therefore, we decline to remand this case to the trial court to consider any additional post-arbitration attorney fees. VI. Conclusion {¶ 42} For the foregoing reasons, we grant Norman's application for reconsideration and vacate the original decision. We overrule the first assignment of error. Consistent with the original decision, we overrule the third assignment of error. Further, we overrule the second assignment of error. Norman's motion to supplement the record is moot. The judgments of the Franklin County Court of Common Pleas are affirmed. Reconsideration granted; original decision vacated; judgments affirmed. NELSON, J., concurs. BRUNNER, J., dissents. NELSON, J., concurring. {¶ 43} I concur fully in the decision of the court. {¶ 44} Reconsideration is warranted particularly because the original panel decision, it seems to me, altered two important Ohio statutes: the Arbitration Act (by ruling that a court can and must modify an arbitrator's decision based on conduct a party undertakes after the arbitration award has issued) and the CSPA (by permitting what the 8Pursuant to App.R. 16, "[the court] do[es] not determine appeals based on mere arguments and may dismiss any arguments not specifically included in an assignment of error." Curry v. Columbia Gas of Ohio, Inc., 10th Dist. No. 19AP-618, 2020-Ohio-2693, ¶ 14. No. 18AP-32 18 decision itself called "potential abuses" whereby a supplier can circumvent the result of its own arbitration contract and escape the treble damages and attorney fees the Act provides when no cure has been offered before final determination, compare Norman, 2019-Ohio- 360, at ¶ 33). We should avoid starting down either path. {¶ 45} As we now affirm, a common pleas court "shall grant" a timely application for confirmation of an arbitration award "unless the award is vacated, modified, or corrected as prescribed in" R.C. 2711.10 and 2711.11. R.C. 2711.09. The court can vacate the arbitration award only if it was procured by fraud, or the arbitrator displayed "evident partiality or corruption" or was guilty of procedural misconduct or exceeded his or her powers "or so imperfectly executed them that a mutual, final, and definite award" was not made. R.C. 2711.10. And a court may modify an arbitration award only if "[t]here was an evident material miscalculation of figures or an evident material mistake" in a description in the award, or the award was on a matter not submitted to arbitration or the award was "imperfect in matter of form not affecting the merits of the controversy." R.C. 2711.11. {¶ 46} Here, our earlier decision found "Kellie Auto's request for remand for modification appropriate," 2019-Ohio-360, at ¶ 34, but not on the basis of any of the exclusive grounds for modification specified in R.C. 2711.11. Indeed, the basis for the ordered modification does not relate to any claimed flaw at all in the arbitrator's decision; the arbitrator apparently made no miscalculation of figures or mistake in describing the award, which was not imperfect in form, and the matter had been submitted to him. The modification was ordered on the strength of something that happened well after the award issued and after Mr. Norman had applied for confirmation. But the structure and text of Ohio's arbitration statutes do not countenance such after the fact tinkering. "For a dispute resolution procedure to be classified as 'arbitration,' the decision rendered must be final, binding and without any qualification or condition as to the finality of an award whether or not agreed to by the parties. The decision may only be questioned pursuant to the procedure set forth in R.C. 2711.13 [regarding a motion to vacate, modify, or correct an award] on grounds enumerated in R.C. 2711.10 and 2711.11." Schaefer v. Allstate Ins. Co., 63 Ohio St.3d 708, 711 (1992). {¶ 47} Contrary to the suggestion of our earlier decision here, I do not think that we "harmoniz[e]" the arbitration statutes with the CSPA by ignoring or interpreting away the plain text of R.C. 2711.11 regarding the limited grounds for modifying an arbitration award. No. 18AP-32 19 Compare 2019-Ohio-360, at ¶ 34 (further positing that arbitrator made a "material miscalculation" in arbitration award by not prognosticating post-award cure offer). And observing the terms of the arbitration statutes as written does not strip suppliers of the protections provided by the "cure" provisions of the CSPA. For starters, arbitration in this context is available and binding only if both parties agree to it—just as Kellie Auto did here, through contract language it drafted and then agreed to and then invoked providing that " 'any claim * * * which arises out of or relates to * * * [the] purchase or condition of this vehicle * * * shall, at your or our election, be resolved by * * * binding arbitration and not by court action.' " See 2019-Ohio-360, at ¶ 3, quoting arbitration agreement. Kellie Auto acknowledges that it "was the first to raise the existence of an arbitration clause. The purpose of doing so was to remind the Plaintiff that this matter would ultimately be decided by arbitration. It was." Answer in Opposition to Motion for Reconsideration at 8. Just so. {¶ 48} Moreover, there can be no argument here that the arbitrator ignored the law in failing to consider CSPA cure provisions, because Kellie Auto made no cure offer for him to assess. The parties proceeded through arbitration, an award was issued, and Mr. Norman had applied for confirmation before Kellie Auto advanced its offer. Compare 2019-Ohio-360, at ¶ 23 (quoting Kellie Auto on the "historical backdrop" of the CSPA as designed to provide " 'opportunity to cure violations before protracted litigation' "). Therefore, and as noted in the decision above, we need not reach and we decline to catalogue what hypothetical procedural permutations could permit a valid CSPA cure offer in the arbitration context; it would be for arbitrators in appropriate cases, and not for an advisory opinion of this court, to decide in the first instance whether a particular cure offer would have effect in a particular circumstance being arbitrated by agreement. In any event, the language of the CSPA indicates that any operative cure offer must precede any final award in binding arbitration. The notice that must accompany a cure offer for it to have effect, for example, is to recite in part that "[r]ejection of this cure offer could impact your ability to collect court costs and legal fees. If * * * [an] arbitrator finds in your favor, but does not award you an amount more than the value of the supplier's remedy, the supplier will not be responsible for treble damages, attorney's fees, [etc.]"; the statute also specifies that "[i]f * * * [an] arbitrator awards actual economic damages * * * that are not greater than the value of a supplier's remedy included in a cure offer made pursuant to this section, the consumer shall not be entitled to * * * [a]n award of treble damages * * ." R.C. No. 18AP-32 20 1345.092(D)(2) and (G)(1) (emphasis added). Both the word "if" and the references to an "award" (with all its attendant confirmation provisions) signal in this context that the arbitrator's ruling is envisioned prospectively, not retrospectively. To the same effect, I myself do not read the statutory predicate for a right to cure (requiring an "action seeking a private remedy pursuant to section 1345.09 of the Revised Code," see R.C. 1345.092(A) (emphasis added)) to encompass an application made pursuant to R.C. 2711.09 to confirm an arbitration award (an application that the court "shall grant" absent specified circumstances for vacating, modifying, or correcting it, see R.C. 2711.09). {¶ 49} A proper understanding of both the Arbitration Act and of the CSPA, it seems to me, or of either one, avoids the "potential abuses" conceded by our initial decision that would come with judicially rewriting an arbitration award for "a supplier [who] could insist on arbitration, refuse to pay, force a court action, and [then] make a cure offer * * that is the same as or just higher than the economic damage amount awarded by an arbitrator * * *." 2019-Ohio-360, at ¶ 33. The initial decision concluded that such rewriting "appears to be how the legislature intended for the CSPA to work," id., but I find nothing in the legislative language to suggest that the General Assembly intended to reward such gamesmanship on the part of CSPA violators by amending the arbitration statutes. And while Kellie Auto hints that it considers selling rebuilt salvage to an unsuspecting buyer without notice to be "a merely technical violation of the CSPA," see Answer in Opposition to Motion for Reconsideration at 7, I do not believe that anything here turns on that questionable characterization. {¶ 50} I entirely concur in granting reconsideration, in vacating our original decision, in overruling Kellie Auto's assignments of error, and in affirming the judgments of the Franklin County Court of Common Pleas. BRUNNER, J., dissenting. {¶ 51} I respectfully dissent from the majority decision and concurring decision on reconsideration of Norman v. Kellie Auto Sales, Inc., 10th Dist. No. 18AP-32, 2019-Ohio- 360 ("Norman" or "original decision"). The majority in its two decisions has not specifically pointed out under the standard for reconsideration of a prior appellate decision either that which is an obvious error under the law, or an issue that was not properly considered at all No. 18AP-32 21 by the court in the first instance. Instead, the majority states in only the majority decision, "[w]e believe the grounds for reconsideration have been met." (Majority decision at ¶ 10.) {¶ 52} The majority decision contains a cite to the 1981 case of Matthews v. Matthews, 5 Ohio App.3d 140 (10th Dist.1981), as authority for the standard of review on reconsideration. However, a more recent statement of that standard is: An application for reconsideration is not intended for cases in which a party simply disagrees with the reasoning and conclusions of the appellate court. Drs. Kristal & Forche, D.D.S., Inc. v. Erkis, 10th Dist. No. 09AP-06, 2009-Ohio-6478, ¶ 2, citing State v. Owens, 112 Ohio App.3d 334, 336, 678 N.E.2d 956 (11th Dist.1996). An application for reconsideration will be denied where the moving party "simply seeks to 'rehash the arguments' " presented in the initial appeal. Appenzeller v. Ohio Dept. of Rehab & Corr., 10th Dist. No. 17AP-747, 2018- Ohio-1698, ¶ 4, quoting Garfield Hts. City School Dist. v. State Bd. of Edn., 85 Ohio App.3d 117, 127, 619 N.E.2d 429 (10th Dist.1992). Thus, if an application for reconsideration does not raise an issue that either was not considered at all or was not fully considered, nor demonstrates the court made an obvious error or rendered a decision unsupportable under the law, it should not be disturbed. [State v.] Harris, [10th Dist. No. 13AP-1014, 2014-Ohio-672,] ¶ 8. (Emphasis added.) Hal v. State Dept. of Edn., 10th Dist. No. 18AP-301, 2020-Ohio-204, ¶ 2. My point here is that the majority decision should educate the reader (1) under what standard is it essentially reversing itself on reconsideration, especially with a new panel of judges, and (2) how it is applying such a standard, demonstrating that the previous decision was unsupportable under the law or that a particular issue was not at all considered in the earlier decision. I do not believe it has done that here, and thus, procedurally, reconsideration is not warranted. {¶ 53} Second, in the interest of brevity and finality for the parties, I reiterate and incorporate the substantive holding in Norman as the substantive basis for my dissent, as that decision reviews an application, to the facts of this case, of the statutes in question— the Ohio Consumer Sales Practices Act and the state's statutes on arbitration. Our prior review of the application of those two statutes to the facts at hand in this case is one that is supportable under the law and thus not subject to reconsideration, according to Hal, whether or not it reaches a desirable result. No. 18AP-32 22 {¶ 54} In my view, the statement of the law in our original decision, is as the legislature intended for amendments to the Consumer Sales Practices Act to apply in conjunction with its arbitration statutes. If the result should be better, it is up to the legislature to repair its language. It is not for us to construe or re-construe it in an effort to improve it. To strain our analysis to reach a different conclusion on reconsideration knee caps predictability of case precedent in our district and takes us outside our jurisdiction as set forth in Ohio Constitution, Article IV, Section 3(B)(2), which provides that our jurisdiction is "as [is] provided by law." {¶ 55} When interpreting statutes, we must first apply their plain meaning: Unambiguous statutes are to be applied according to the plain meaning of the words used, Roxane Laboratories, Inc. v. Tracy (1996), 75 Ohio St. 3d 125, 127, 661 N.E.2d 1011, 1012, and courts are not free to delete or insert other words, State ex rel. Cassels v. Dayton City School Dist. Bd. of Edn. (1994), 69 Ohio St. 3d 217, 220, 631 N.E.2d 150, 153. State ex rel. Burrows v. Indus. Comm., 78 Ohio St.3d 78, 81 (1997). Moreover, a court must read all statutes relating to the same general subject matter together to give proper force and effect to each one. In re Duke Energy Ohio, Inc., 150 Ohio St.3d 437, 2017-Ohio-5536, ¶ 27. {¶ 56} I believe the first decision in this matter in Norman, based on the plain meaning of the Consumer Sales Practices Act and the state's arbitration statutes, gives effect to both. If the legislature did not intend such an outcome, it is incumbent on the legislature to modify its statutes and not on us to modify our decision on reconsideration, especially when the decision in the matter does not bear obvious error and is supportable under the law. {¶ 57} Finally, I respectfully point out that both the majority and concurring decisions vacate this Court's prior decision in Norman via reconsideration. But such action is neither authorized nor supported under App.R. 26, because nowhere in the Rules of Appellate Procedure are we authorized to vacate our own decisions. Perhaps interlocutory, non-final orders may be vacated, but no such authorization appears in the appellate rules for applications for reconsideration. No. 18AP-32 23 {¶ 58} I submit that this Court has no authority under the Rules of Appellate Procedure to vacate its own decisions and judgments on reconsideration.9 And in the past, as noted in footnote 1, we have reconsidered decisions without having vacated them. In civil cases, only language in the appellate rules relating to en banc consideration discusses the vacating of an earlier decision and that language is somewhat moot, since App.R. 26(B) does not now require a decision to be vacated "in the event of a sua sponte decision to consider a case en banc." App.R. 26, Staff Note (July 1, 2012 Amendment). This Court should have simply reconsidered its decision and not vacated the earlier decision, and to do this is error. {¶ 59} It is for these reasons that I respectfully dissent from the majority decision and concurring decision, constituting a majority of the panel on reconsideration. 9 App.R. 26(A)(1) is silent about what an appellate court should do in the event it reconsiders a prior decision, and this district has been inconsistent in what it does. See State v. Wade, 10th Dist. No. 06AP-644, 2008- Ohio-1797, wherein we reconsidered our decision without vacating it, and Grothaus v. Warner, 10th Dist. No. 08AP-115, 2008-Ohio-6683, wherein we reversed part of an earlier decision without vacating it. See also State v. Morris, 10th Dist. No. 10AP-512, 2011-Ohio-5484, ¶ 8, wherein we stated, "[w]e find that reconsideration is proper because we admittedly relied, in part, upon a concession that was withdrawn. Accordingly, we grant appellee's application. This decision shall therefore replace the decision rendered in [State v. Morris, 10th Dist. No. 10AP-512, 2011-Ohio-2226]." But compare Spitznagel v. State Bd. of Edn., 10th Dist. No. 07AP- 757, 2008-Ohio-6080, ¶ 11, where we vacated an earlier decision that was no longer supportable by law because of a Supreme Court of Ohio decision that was decided the same day as the decision that was reconsidered.	01-04-2023	09-03-2020

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