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https://www.courtlistener.com/api/rest/v3/opinions/4475877/ | OPINION. Black, Judge: There are two questions for our decision-in this proceeding : (1) Whether respondent erred in determining that the voting trust certificate representing 4,000 shares of Graybar stock which decedent held at the time of his death is includible in the gross estate at a value of $60 per share or a total of $240,000; and (2) whether respondent erred in including in decedent’s gross estate the amount of $40,000 which decedent’s widow received from Graybar (decedent’s former employer) as a “Regular Death Benefit.” The special death benefits aggregating $80,400 paid to Mrs. Salt over a period of 5 years described in our findings of fact are not in issue. Issue 1. As to the value of the voting trust certificate representing 4,000 shares of Graybar stock which decedent held at the time of his death respondent has determined the value to be $60 per share or a total of $240,000 for inclusion in decedent’s gross estate. Petitioner reported the value of these shares in the estate tax return at $20 per share or $80,000 which was the amount received by the estate from Graybar on September 30, 1946, when Graybar exercised its option to purchase at $20 per share. Not only was the estate required to offer the stock to Graybar after decedent’s death for $20 per share but also, if during decedent’s lifetime he had desired to dispose of the stock, he was required to offer it to Graybar at $20 per share. The stock being subject to this restrictive agreement, which in practice had always been adhered to by Graybar, we conclude that the value of the stock for estate tax purposes was $20 per share. Lomb v. Sugden, 82 F. 2d 166; Wilson v. Bowers, 57 F. 2d 682. Cf. May et al., Exrs. v. McGowan, 97 F. Supp. 326. In that case the court said in deciding an issue similar to the one we have here: The first inquiry should he whether the stock was subject at the time oí decedent’s death to. an enforceable option to buy at a specific price. If so the fair market value could not exceed the option price. * * * That was the fair market value of the decedent’s stock at his death for estate tax purposes. Wilson v. Bowers, 57 F. 2d 682; Lomb v. Sugden, 82 F. 2d 166. It would require far more temerity than I possess to hold with the Government’s contention that the Wilson and Lomb cases (both decisions of the Court of Appeals for the Second Circuit) are plainly outmoded and have no remaining vitality. If those cases are to be discarded it would seem to be the more prudent course to await the unequivocal word of that Court, or a higher one. In determining the value of the stock to be $60 per share respondent has laid great stress on the fact that over the period from 1946 through 1950, after decedent’s death, decedent’s widow received from Graybar as a “Special Death Benefit” pursuant to the Plan for pension and other benefits, an amount equivalent to what the dividend on 4,000 shares would have been during this period. Although the widow received sums which were measured by the stockholdings of decedent at the time of his death the provisions of the Plan under which the payment of this money was made were subject to termination by the board of directors of Graybar at any time either before or after the death of decedent. The amount actually received by decedent’s widow as a special death benefit was $80,400 extending over a period of 5 years; however, it was not something in which decedent had any interest whatever at the time of his death. These payments were made to Mrs. Salt as special death benefits under the Plan and not as a stockholder of Graybar. All stock that decedent owned in Graybar at the time of his death had been sold by his executors to Graybar who owned the enforceable option to acquire it at $20 per share. These 4,000 shares had been sold and transferred to Graybar prior to the time that any of the special death benefits were paid to Mrs. Salt. She never at any time owned any interest in these shares which were sold to Graybar under its option. For reasons already stated we sustain petitioner’s valuation of $20 per share; they could not have been sold for more and were not sold for more. Issue 8. At the time of decedent’s death Graybar’s Plan for pensions and other benefits provided that in the discretion of the committee administering the Plan, the committee could authorize the payment of a specified amount to certain persons related to a deceased pensioner. This payment came under the provisions of the Plan entitled' “Regular Death Benefits.” Decedent was one of Graybar’s pensioners and pursuant to this provision by order of the committee administering the Plan decedent’s widow received $40,000 from Graybar.' Respondent has determined that this $40,000 is includible in decedent’s gross estate and relies on section 811 (a) of the Internal Revenue Code.1 Petitioners did not include the $40,000 in the estate tax return filed by them and they contend that respondent has erred in his determination. At the time of his death decedent had no vested interest in the $40,000 nor did his widow have an enforceable right to the $40,000. Whether she would receive it was entirely within the discretion of the committee administering the Plan. Since the decedent’s “interest” in the $40,000 was a mere expectancy that his widow would receive the payment, it is not includible as a part of his gross estate under section 811 (a) of the Code. See Dimock. v. Corwin, 19 F. Supp. 56, affirmed on other issues 99 F. 2d 799, 306 U. S. 363. In the Dimock case it was held that where an employer adopted an annuity and insurance plan subject to withdrawal or modification providing for payment of a death benefit to a designated beneficiary, but for no payment if no beneficiary had been designated or if designated beneficiary died before employer and another had not been designated, such death benefit was no part of decedent employee’s estate subject to tax, as employee’s right to render it possible for beneficiary to receive the benefit was not property. The court in so holding said, among other things: It is concluded as to the first question, that there pertained to Mr. Folger, during his life, only the right to render it possible for Mrs. Folger to receive a grant from the Standard Oil Company, and that this did not constitute property of his under section 302 of the law, or subdivision (a), and that the act of naming her as the recipient of the death benefit was not a transfer of property by him to her, so as to fall within subdivisions (c) or (d), 44 Stat. 70, 71, * * *. It should be noted that the Dimock case, supra, held that decedent did not have an interest in property includible in gross estate under a section of the Revenue Act of 1926 comparable to section 811 (a) of the Code even though in that case: (1) decedent could designate the beneficiary of the death benefit (decedent Salt could not do so), and (2) the Standard Oil Company was obliged upon decedent’s death to pay the benefit to a named beneficiary who survived the decedent in accordance with the plan as in effect at the date of death. (Graybar had no such obligation, but reserved the right to withhold payment although a qualified beneficiary survived.) Of course, entirely apart from the discretion imposed with the Gray-bar committee, under the Graybar Plan the death benefit might never have been paid if a qualified beneficiary failed to survive, a significant factor noted by the court in the Dimock case, supra. We hold that the Commissioner erred in including the $40,000 death benefit in decedent’s gross estate under section 811 (a). Cf. Estate of William S. Miller, 14 T. C. 657, dismissed and affirmed by the Seventh Circuit September 15,1950; Estate of Emil A. Stake, 11 T. C. 817. Because of other adjustments of the respondent which petitioners have not contested and because the parties have stipulated that petitioners will incur and pay additional administrative expense, attorneys’ fees, and expenses of litigation, and the determination and allowance of the allowable deductions for such expenses will be made under the rules of this Court, Decision will be entered under Rule 50. SEC. 811. GROSS ESTATE. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside of the united States— (a) Decedent's Interest. — To the extent of the interest therein of the decedent at the time of his death: | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/1219792/ | 547 P.2d 827 (1976)
In the Matter of L.A.M., Appellant,
v.
STATE of Alaska, Appellee.
No. 2221.
Supreme Court of Alaska.
March 15, 1976.
*828 Herbert D. Soll, Public Defender, Phillip P. Weidner, Asst. Public Defender, and R. Collin Middleton Anchorage, Alaska, for appellant.
Avrum M. Gross, Atty. Gen., Juneau and Larry R. Weeks, Asst. Atty. Gen., Anchorage, for appellee.
Before RABINOWITZ, Chief Justice, and CONNOR, ERWIN, BOOCHEVER and BURKE, Justices.
*829 OPINION
ERWIN, Justice.
L.A.M. seeks review of the superior court's order dated July 26, 1973, declaring her a delinquent[1] child for violation of AS 09.50.010,[2] i.e., willful failure to comply with certain court orders made after a prior adjudication that she was a child in need of supervision.[3]
In order to understand L.A.M.'s arguments and place her situation in context, it will be necessary to set out her history at some length.
L.A.M. was born in Canada in 1958 and was adopted by the M's shortly thereafter. The M.'s soon were divorced and Mrs. M. moved with L.A.M. to Alaska. In 1971 Mrs. M. married Mr. C. and retired from work, intending to spend more time with L.A.M. Difficulties arose almost immediately with L.A.M. neglecting to return home after staying with friends.
L.A.M. began a consistent pattern of running away in the Spring and Summer of 1972. During this period two petitions were filed seeking to have her declared a child in need of supervision, but in both cases the petitions were dismissed on stipulation and the matter handled informally.[4] On November 2, 1972, a new petition was filed. At the hearing L.A.M. admitted the allegations of the petition and was declared a child in need of supervision. She was ordered detained at the McLaughlin Youth Center pending adjudication.
On December 12, 1972, the disposition hearing was continued and L.A.M. was released to her parents. One week later the court was informed that she had run away. A pick-up order was issued and the minor was brought back to court on December 27, 1972, at which time she was detained pending disposition. The disposition hearing was finally held on January 11, 1973. Upon listening to testimony, the Master for the Family Court filed his recommendation that the minor be "released to her parents." A superior court judge adopted the finding and executed a release.
On March 19, 1973, L.A.M. was brought back to court by an intake officer who informed *830 the court that she had "been a runaway almost constantly since the time the court released her." The intake officer then filed a petition with the court alleging that the minor was a "child in need of supervision" by virtue of having been truant from school in violation of AS 47.10.010(a)(3) and AS 14.30.010 (truancy).[5] At the hearing the court was informed that Mrs. C. had obtained a child psychiatrist who had met with the child and her mother, and together they had worked out some program of counseling. The parties agreed that L.A.M. would be placed in a foster home during a period of counseling and the judge accepted a stipulation to that effect. Having previously explained to L.A.M. that if she violated a court order she could be held in contempt of court and incarcerated, the judge informed the child that she was not to leave the foster home without contacting her psychiatrist, her social worker, or her mother. She agreed. The minor was released from McLaughlin on March 31, 1973, and placed in a foster home. She ran away on April 2, without notification, and was not apprehended until May 4.
A hearing was held on May 14, 1973, at which time L.A.M. was charged with contempt of court by the intake officer. Because of the uncertainty in this area, the trial court appointed the public defender to represent her. On May 17, 1973, the hearing resumed. The state argued that a child in need of supervision could not thereby be held in contempt of court and incarcerated, but that a child guilty of "criminal contempt" could on that basis be adjudicated a "delinquent child" and thereafter institutionalized. The State, therefore, moved to dismiss the petitions, alleging contempt of court and substituting a petition of alleged delinquency. The court denied the motion but permitted the State to file an amended petition alleging as a separate count an act of delinquency predicated upon "criminal contempt."
A petition alleging delinquency was filed on May 23, 1973, at which time a hearing was held. In responding to the petition L.A.M. denied the allegations and requested a trial. Pending trial, she was placed at the Alaska Children's Services receiving home. A written order was entered on June 8, 1973, specifically setting out the conditions under which L.A.M. would reside at the receiving home pending her adjudication hearing. Specifically, it provided that "[T]he child is not to remain away from the Anchorage Children's Christian Home overnight without the permission of the appropriate adult authorities of the home."
On July 26, 1973, an intake officer filed a petition for revocation of conditions of release pending L.A.M.'s adjudication hearing. In part, the petition stated that she had left the receiving home without permission on July 3, 1973, and remained away until July 24, 1973. A detention hearing was held on July 26th, and at the hearing L.A.M., through her counsel, admitted the allegations of the petition of alleged delinquency based on violation of a court order filed on May 23, 1973. L.A.M.'s counsel made it clear that the minor was only admitting the facts and reserving the right to litigate the legal consequences of those facts.
The court then proceeded to a consideration of the petition for revocation of conditions of release pending adjudication hearing filed on July 26, 1973. Upon admitting the allegations of this petition as well L.A.M. requested through her attorney that a disposition hearing be scheduled within thirty days.
*831 At the disposition hearing held on August 28, 1973, and on August 31, 1973, two experts testified on behalf of the minor and two testified on behalf of the State. The expert testimony pointed up the substantial differences of opinion both as to principle and policy that exists regarding runaways and their treatment. After considering all of the evidence, the court accepted the recommendation of the Division of Corrections and ordered the minor institutionalized, but deferred execution of the order for a period of sixty days to give L.A.M. one more opportunity to establish that she could be rehabilitated within the community. During the deferred period L.A.M. was assigned to Sheila Lankford of the Division of Corrections Probation Department.
On November 2, 1973, the superior court, on the request of Ms. Lankford, vacated the deferred order of institutionalization and placed the child on regular probation, having been advised that L.A.M. was functioning effectively within the community while living at home. On November 5, 1973, the minor ran away but returned of her own accord on November 7. Two days later she ran away again and remained away until December 5, 1973, when she was apprehended by the police. On December 6, 1973, Ms. Lankford petitioned to revoke the minor's probation. At the hearing on this matter held on December 18, the superior court granted the petition to revoke probation but reinstated it on new conditions in light of a request by Ms. Lankford that the minor not be institutionalized. It was agreed that the child would reside in the Alaska Children's Services Receiving Home.
On March 18, 1974, Ms. Lankford filed a further petition seeking revocation of probation. In it she alleged that on February 20, 1974, the minor ran away from the receiving home and remained away until March 16, 1974, when she was apprehended by the police. At the hearing on the petition, held on March 22, 1974, the court found the minor had violated the conditions of her probation and had run away from the receiving home. The court considered the minor's objections presented by her attorney and, after considering the evidence and the argument of the parties, directed that the minor be institutionalized.
L.A.M. seeks to have her adjudication of delinquency set aside on two grounds. She contends that both as a matter of statutory interpretation and constitutional law, a child in need of supervision may not be prosecuted for criminal contempt; or, in the alternative, if such a prosecution is allowable, such prosecution cannot result in incarceration. Upon discussing the nature of contempt in this case, each of these grounds will be dealt with in order.
Before a party may be held in criminal or civil contempt for failure to abide by a court order, certain elements must be established: (1) the existence of a valid order directing the alleged contemnor to do or refrain from doing something and the court's jurisdiction to enter that order; (2) the contemnor's notice of the order within sufficient time to comply with it; and in most cases, (3) the contemnor's ability to comply with the order; and (4) the contemnor's willful failure to comply with the order.
The distinction between criminal and civil contempt is generally phrased in terms of whether the character and purpose of the contempt is "remedial" or "punitive."
In Johansen v. State[6] we used a balancing test in determining that the failure to pay child support was criminal rather than civil contempt. We did so because incarceration was imposed for a fixed period under AS 09.50.020[7] to punish a completed act rather than to coerce future conduct *832 pursuant to AS 09.50.050.[8] Specifically, the court held that where the contempt power was invoked to punish the alleged contemnor for "past, willful, flouting of the court's authority" pursuant to AS 09.50.010(5) (cf. AS 09.50.020), contempt was criminal, but where the contempt proceeding was instituted to "coerce future conduct" pursuant to AS 09.50.050, the contempt is civil.
Applying that distinction here, the contempt order issued by the court would obviously be classified as "criminal." Were L.A.M. an adult, her failure to abide by court orders would be characterized as a "crime" under AS 09.50.010(5). Hence, L.A.M. could properly be declared a delinquent under AS 47.10.010(a)(1) after a proceeding in the Children's Court.
L.A.M. grounds her constitutional argument in Breese v. Smith,[9] where this court ruled that the right to liberty set out in Art. I, Sec. 1, of the Alaska State Constitution[10] guarantees every Alaskan regardless of age "... total personal immunity from governmental control: the right to be let alone ...," which L.A.M. contends the supreme court qualified only to the extent that it "... must yield when [it] intrudes upon the freedom of others... ." Therefore, she continues, a citizen's right to liberty as enunciated in Breese, supra, (bolstered by the more recently enacted "right to privacy")[11] cannot be infringed by preventing her from doing anything that does not injure a specific definable victim. Consequently, L.A.M. concludes since her conduct, i.e. running away from home and foster home placement, did not injure anyone (except perhaps herself, which she contends has not been proved), it necessarily follows that it cannot constitutionally be interfered with by the State because there is no compelling state interest to justify such an interference.
L.A.M. assumes that the only interest to be protected by legislation in this area is that of the children. This is simply not the case. The parents' interest as well as the State's must be considered.[12]
Proceedings against children alleged to be in need of supervision are in substance and effect custody disputes where the contestants are parent and child, and the parent appeals to the court to vindicate and enforce his custody rights in the child against that child.[13] Viewed in *833 this light, the statutes creating the status "child in need of supervision" provide a judicial remedy and discourage resort to self-help and the attendant risk of violence.[14]
Thus, before L.A.M. can sustain her case that the child in need of supervision procedure, including the invocation of the court's contempt power to enforce orders made pursuant to it, is an unconstitutional invasion of her liberty and privacy, she must first establish that her mother has no legally enforceable right to her custody and the State thus has no right to enforce such an order. We note at the outset, however, that there is more to the parent-child relationship than simple custody. It is love and trust and a responsibility toward each other which cannot be defined legally. It is impossible to discuss severing this relationship without considering the heartache and anguish of the parents who must ultimately live with themselves and the decision after the child reaches adulthood. Further, the consideration of such an issue must accept the limitations of the State to be a parent; good intentions are not adequate substitutes for the day-to-day relationship which we have come to accept as necessary to the growth of children into responsible adults. True, like all legal rights, a parent's right to the custody of his child is not absolute and may be lost through divorce,[15] by conduct depriving the child of the necessities of life,[16] by abandonment,[17] by the child's emancipation,[18] or, subject to constitutional limitations, where the welfare of the child requires a limitation or termination of parental rights.[19]
*834 L.A.M. was given an opportunity to show any of the foregoing as a defense to a finding that she was a "child in need of supervision" or, subsequent thereto, to a finding that she had committed criminal contempt of court and was therefore delinquent by violating orders regarding her placement; but she failed to do so.
Runaway children of L.A.M.'s age are generally incapable of providing for or protecting themselves. As a result, police spend a substantial amount of time protecting these youths from those who would prey upon them, as well as protecting the community from those who are ultimately driven to criminal activity to provide themselves with the necessities of life.
Various other social agencies also expend considerable efforts attempting to protect and shelter runaways in an effort to provide both an alternative to criminal activities and counseling in lieu of that they received from their parents. Without question these children's matters are of broad public interest and concern. They go to all aspects of the physical and mental well being of such children.[20]
The family, school, social agency and police resources allocated to aid the runaway are enormous. In this case, the child had continuing aid and support of (1) her mother and step-father, (2) a private psychiatrist hired by her mother, (3) counseling with social workers in Division of Family and Children's Services, (4) probation officers in Division of Corrections, (5) school counselors, (6) psychologists and psychiatrists from Langdon Clinic, (7) Alaska Youth Advocates, (8) group home counselors, (9) her court-appointed attorney, and (10) the court. To assert that the State has no interest in this child is to deny that the function of government is to protect its citizens. All of this presupposes the heartache and anguish of the parents, who in the first instance have been unable to deal with this problem but who must also live with the solution.
This court has previously found that there is sufficient State interest to justify restrictive measures on much less substantial grounds.[21] Further, this court has noted that distinct government interests with reference to children may justify legislation that could not properly be applied to adults.[22]
The State has a legitimate interest in protecting children from venereal disease, from exposure to the use of dangerous and illicit drugs, from attempted rape, and from physical injury, all of which occurred in this case. Doubtless the State will never be entirely successful in its efforts. It does, however, have the right and obligation to try to protect its young people from such conditions.[23] The test set out by this court in Ravin v. State,[24] is whether the means chosen by the State are closely and substantially related to an appropriate government interest. Clearly they are here.
While it may be argued that the necessary "supervision" contemplated by the statute is simply the furnishing of food, clothing, shelter and schooling in lieu of that which would otherwise have been provided by a parent, this argument begs the question, for the purpose of the supervision or treatment contemplated by the creation of the child in need of supervision and its predecessor non-criminal delinquency was reintegration of the child into her family and resumption of parental custody including parental control (cf. AS 47.10.280). *835 Thus, the State's efforts regarding the child are not directed solely at providing an alternate living situation (as they are in a true case of dependency) but at putting the child back in her own home. The reestablishment of her mother's custody and supervision over her and any foster placement is merely a means to that end, not an end in itself. Thus, by rejecting these efforts L.A.M. defeats, or at least slows, this reintegration process and thereby prejudices her mother's right to her custody and control, subjecting herself to the more severe sanction contemplated by AS 09.50.020.
We note that L.A.M.'s primary argument in this case is that as a child in need of supervision whose conduct from the inception of the case to the present has not changed, she may not be placed in a closed setting, i.e. one where the doors may be locked. However, the cases upon which L.A.M. relies proceed to a different point, namely that the child should not be placed in a state training school. In Colorado, California, Illinois and New York,[25] children in need of supervision can at the first instance be placed in juvenile halls or youth centers, i.e. places with locked doors, but cannot be placed at the state training school, i.e. maximum security institutions. The McLaughlin Youth Center in Anchorage is more the equivalent of a juvenile hall than it is a state training school. It should be noted that Alaska has contracts with Colorado and California to place Alaska delinquents who are too sophisticated for McLaughlin in the state institutions in those states. Thus L.A.M. is not to be placed at either the California or Colorado training schools; she is threatened with placement at the McLaughlin Youth Center.
Substantial evidence was introduced during the many hearings of this case regarding the population at the McLaughlin Youth Center. Based upon that evidence, it is clear that the kind of children who are extremely agressive, and extremely hardened in delinquency, are not treated at McLaughlin Youth Center but are sent outside for placement at schools in Colorado and California under contract with the State of Alaska. While the population at McLaughlin is made up at the present time exclusively of "delinquents," the evidence introduced at trial convinces us that while delinquency in some form is a prerequisite to gaining admission to McLaughlin, it is not the real reason that the child is at McLaughlin. The overwhelming majority of delinquents with strong family ties are treated in the community. Those delinquents who end up at McLaughlin are by and large there for the same reason that L.A.M. may be there, namely an unwillingness to remain at home or a home substitute and heed parental or a custodian's regulations. Based upon the evidence, it appears that L.A.M. and other chronic runaways would not be distinguishable in sophistication, exposure to criminal activity, etc., from the average child in the population at McLaughlin and that therefore the reasoning of the cases cited by L.A.M. should not apply to Alaska.
Whether we characterize L.A.M. as a delinquent child, a child in need of supervision, a dependent child, or merely a child whose custody is disputed in a domestic relations proceeding, the court has authority, upon extending all procedural safeguards, to make orders affecting her custody. It is argued, however, that this is a situation where the court has no power to enforce its order, and thus the court must release L.A.M. This view is contrary to the inherent power of the court to enforce its orders or decrees.[26] While the court *836 may have limitations on its power to act, there are only due process limitations on its authority to compel enforcement of its orders. Hence, we reject the argument that the superior court lacked the authority to enforce specific orders against L.A.M. in this case.
The lower court determined that L.A.M. would not abide by any orders it entered regarding her supervision under AS 47.10.080(j). This behavior constitutes willful criminal contempt of the court's authority; were she an adult, her actions would be characterized as a "crime" under Alaska statutes. She was, therefore, properly declared a delinquent and subject to those sanctions available for the correction of a delinquent minor's behavior. Certainly, conciliation should precede coercion; and if coercion is necessary, mild sanctions should first be tried before more severe sanctions are imposed. However, where mild sanctions fail, the court's orders must be enforced and severe sanctions should be imposed if necessary. In the instant case, all available sanctions, save institutionalization, were tried and found unsuccessful. Thus, the lower court determined that it had no choice but to order L.A.M. institutionalized.
In affirming this decision, we note that the trial judge was most innovative in fashioning a necessary remedy for a situation not covered by statute.[27] The very nature of the problem, however, calls for legislative overhaul of the statutes in this area, for the trial court's remedy is not easily modified to cover other situations where there is no statutory guidance.
BOOCHEVER, Justice, with whom RABINOWITZ, Chief Justice, joins, concurring.
I concur in the court's opinion based on the last three paragraphs thereof. I would not reach the other issues discussed in the opinion. Protection of parental rights to care, custody and supervision do not seem to me to be an appropriate rationale for placing a child in an institution. In my opinion, the court's efforts were devoted primarily to furthering the welfare of the child, a subject in which the state does have an interest.[1] There was ample testimony to indicate that L.A.M.'s conduct was harmful to her.[2]
*837 On the basis of the record, I do not believe that we can conclude that police spend countless hours protecting the community from anti-social conduct of runaway children. Recent studies indicate that status offenders (such as runaways) are not a source of general harm to others as contrasted with children who have committed offenses which, if perpetrated by adults, would be crimes.[3] I concur in the opinion since I believe that the state has an interest in the welfare of children justifying the entry of appropriate orders. In cases involving status offenders, only after all else fails, should placement in a closed setting be justified. But under the facts of this case, the trial judge had no alternative.
RABINOWITZ, Justice (concurring).
Although I am in agreement with the court's disposition of this appeal, I think it appropriate to answer appellant's contention that our prior decisions precluded the superior court from institutionalizing L.A.M. This contention is grounded upon In re E.M.D., 490 P.2d 658 (Alaska 1971), where we rejected the argument that under Alaska's statutes a minor who has been adjudicated a child in need of supervision may be institutionalized by the state. Upon analysis of the relevant statutes, we concluded that "... the legislature has authorized institutionalization only when the child is found to be a delinquent minor."[1] Thus, if the superior court in the case at bar had institutionalized L.A.M. because she had been adjudicated a child in need of supervision, such action would have been erroneous under E.M.D.
But here L.A.M.'s status was not merely that of a child in need of supervision; the scope of her future conduct had been limited by the superior court's order. By virtue of this order L.A.M. was, as the state argues, essentially on probation.[2] The majority notes that the superior court found that L.A.M. had violated the conditions of her probation by running away. The majority then observes that
Were L.A.M. an adult, her failure to abide by court orders would be characterized as a `crime' under AS 09.50.010(5). Hence, L.A.M. could properly be declared a delinquent under AS 47.10.010(1) after a proceeding in the Children's Court.
I thus conclude that what essentially transpired below was that the trial court found a violation of the conditions of probation which it imposed pursuant to its determination that L.A.M. was a child in need of supervision, and ordered L.A.M. incarcerated.[3] In my view, E.M.D. did not prohibit the superior court from ordering the institutionalization of L.A.M. in the circumstances of this case.
NOTES
[1] AS 47.10.010(a)(1) provides in relevant part:
(a) Proceedings relating to a minor under 18 years of age residing or found in the state are governed by this chapter, except as otherwise provided in this chapter, when the minor (1) violates a law of the state, or an ordinance or regulation of a political subdivision of the state... .
[2] AS 09.50.010 provides in relevant part:
Acts or omissions constituting contempt.
The following acts or omissions in respect to a court of justice or court proceedings are contempts of the authority of the court:
.....
(5) disobedience of a lawful judgment, order, or process of the court... .
[3] AS 47.10.290 provides in relevant part:
In this chapter, unless the context otherwise requires,
.....
(7) "child in need of supervision" is a minor whom the court determines is within the provisions of (AS 47.10.010(a)(2), (3), (4), and (6)). [Matter in parentheses supplied.]
AS 47.10.010(a)(2), (3) and (6) respectively provide:
[B]y reason of being wayward or habitually disobedient is uncontrolled by his parent, guardian or custodian;
[I]s habitually truant from school or home, or habitually so conducts himself as to injure or endanger the morals or health of himself or others;
.....
[A]ssociates with vagrant, vicious or immoral people, or engages in an occupation or is in a situation dangerous to life or limb or injurious to the health, morals, or welfare of himself or others... .
[4] Children's Rule 4(d) provides:
Informal Disposition. If the intake officer, after investigation, believes that in the best interest of the child the matter should be handled on an informal basis, he may thereafter refrain from filing a petition and shall thereafter on behalf of the court, counsel with the child and parents, guardian or custodian, and with their consent and cooperation establish such informal supervision or disposition of the child matter as the circumstances may require.
[5] AS 14.30.010 provides in relevant part:
When attendance compulsory. (a) Every child between seven and 16 years of age shall attend school at the public school in the district in which the child resides during each school term. Every parent, guardian or other person having the responsibility for or control of a child between seven and 16 years of age shall insure that the child is not absent from attendance.
[6] 491 P.2d 759 (Alaska 1971).
[7] See n. 2, supra.
[8] AS 09.50.050 states in relevant part:
When the contempt consists of the omission or refusal to perform an act which is yet in the power of the defendant to perform, he may be imprisoned until he has performed it.
[9] 501 P.2d 159, 168-170 (Alaska 1972).
[10] Art. I of the declaration of rights of the Alaska Constitution, § 1, provides:
Inherent Rights. This constitution is dedicated to the principles that all persons have a natural right to life, liberty, the pursuit of happiness, and the enjoyment of the rewards of their own industry; that all persons are equal and entitled to equal rights, opportunities, and protection under the law; and that all persons have corresponding obligations to the people and to the State.
[11] Alaska Constitution, Art. I, § 22, provides:
Right of Privacy. The right of the people to privacy is recognized and shall not be infringed. The legislature shall implement this section.
[12] The U.S. Supreme Court has on a number of occasions held that a parent's "right" to the custody and control of his child was constitutionally protected. See Roe v. Wade, 410 U.S. 113, 93 S.Ct. 705, 35 L.Ed.2d 147 (1973); Wisconsin v. Yoder, 406 U.S. 205, 92 S.Ct. 1526, 32 L.Ed.2d 15 (1972); Stanley v. Illinois, 405 U.S. 645, 92 S.Ct. 1208, 31 L.Ed.2d 551 (1972); Armstrong v. Manzo, 380 U.S. 545, 85 S.Ct. 1187, 14 L.Ed.2d 62 (1965); May v. Anderson, 345 U.S. 528, 73 S.Ct. 840, 97 L.Ed. 1221 (1953); Pierce v. Society of Sisters, 268 U.S. 510, 45 S.Ct. 571, 69 L.Ed. 1070 (1925); Meyer v. Nebraska, 262 U.S. 390, 43 S.Ct. 625, 67 L.Ed. 1042 (1932).
[13] While there is much discussion of parental rights in reported cases, few cases attempt to define those rights making discussion difficult. A careful review of the literature, including case law, treatise and law review, indicates that the following have been listed as "parental rights" protected to varying degrees by the Constitution:
(1) Physical possession of the child which, in the case of a custodial parent includes the day-to-day care and companionship of the child. In the case of a non-custodial parent, possession is tantamount to the right to visitation.
(2) The right to discipline the child, which includes the right to inculcate in the child the parent's moral and ethical standards.
(3) The right to control and manage a minor child's earnings.
(4) The right to control and manage a minor child's property.
(5) The right to be supported by an adult child.
(6) The right to have the child bear the parent's name.
(7) The right to prevent an adoption of the child without the parents' consent.
Of these so called residual parental rights, those that remain after custody is placed in another include the right to consent to an adoption and to withhold consent to prevent an adoption, the right to visitation and the right to have the child bear the parents' name. See the discussion in Burt, Forcing Protection on Children and Their Parents, 69 Michigan 1259 (1971); Dobson, The Juvenile Court and Parental Rights, 4 Family Law Quarterly 393 (1970); Young, The Problem of Neglect: The Legal Aspects, 43 Journal of Family Law 29 (1964); Note, Child Neglect: Due Process for the Parent, 70 Col.L.Rev. 465 (1970).
[14] By withdrawing court assistance (and police assistance) from embattled parents, the state is not inducing compromise but may encourage violence, since parents have the right under Alaska law to physically control their children. See AS 11.15.110(1) as interpreted in State v. England, 220 Or. 395, 349 P.2d 668 (1960), and compare the civil liability of parents for disciplining their children which is discussed in Hebel v. Hebel, 435 P.2d 8, 14-15 (Alaska 1967).
[15] AS 09.55.205 gives a court in a divorce action the right to provide for the custody of the children.
[16] See AS 47.10.010(a)(5) which, when read in conjunction with AS 47.10.080(c) and AS 47.10.290(3), permits the state to take custody of a child who "lacks proper parental care by reason of the faults, habit or neglect of his parent, guardian or custodian."
[17] See AS 47.10.010(a)(4), which authorizes the state to take custody of a child who has been abandoned.
[18] A child is emancipated as a matter of law when he or she reaches the age of majority which in Alaska is 19 years of age; AS 25.20.010. See R.L.R. v. State, 487 P.2d 27 (Alaska 1971).
[19] Turner v. Pannick, 540 P.2d 1051, (Op. No. 1189, 1975); In the Matter of the Adoption of K.S., 543 P.2d 1191, (Op.No. 1219, 1975).
[20] In Re G.M.B., 483 P.2d 1006 (Alaska 1971); Wagstaff v. Superior Court, 535 P.2d 1220 (Alaska 1975).
[21] Kingery v. Chapple, 504 P.2d 831 (Alaska 1972).
[22] Ravin v. State, 537 P.2d 494 (Alaska 1975).
[23] In the analogous equal protection argument concerning "... economics and social welfare, a State does not violate the Equal Protection Clause merely because the classification made by its laws are imperfect." Dandridge v. Williams, 397 U.S. 471, 90 S.Ct. 1153, 25 L.Ed.2d 491.
[24] 537 P.2d 494 (Alaska 1975).
[25] In re Presley, 47 Ill.2d 50, 264 N.E.2d 177 (1970); Matter of Tomasita N., 30 N.Y.2d 927, 335 N.Y.S.2d 683, 287 N.E.2d 377 (1972); C. v. Redlich, 32 N.Y.2d 588, 300 N.E.2d 424 (1973); Cal.Welf. and Inst. Code, §§ 601, 730, 777 (West 1972).
[26] Alaska Const. Art. IV, § 1, provides in part:
The judicial power of the State is vested in a supreme court, a superior court, and the courts established by the legislature.
See also Ex Parte Robinson, 86 U.S. (19 Wall) 505, 510, 22 L.Ed. 205, 207 (1874); In re Shortridge, 99 Cal. 526, 528, 34 P. 227, 229 (1893); Frankfurter and Landis, Power of Congress over Procedure in Criminal Contempts in "Inferior" Federal Courts A Study in Separation of Powers, 37 Harv. L.Rev. 1010, 1017-1022 (1924); Goldfarb, The Contempt Power, 37-40 (Columbia University Press 1963).
[27] The trial judge was a model of patience and fairness in this extremely difficult case. Further, we are indebted to him for his scholarly memorandum opinion which aided in the preparation of this opinion.
[1] The state's power to act in support of the welfare of children is exemplified by such statutory enactments as compulsory education (AS 14.30.010 et seq.); financial assistance for dependent children (AS 47.25.310 et seq.); protective laws as to the employment of children (AS 23.10.325 et seq.); minimum age of consent for marriage (AS 25.05.171); prohibition of the use of alcohol and tobacco by minors and of the sale of either substance to minors (AS 04.15.050 et seq. and AS 11.60.080); punishment for statutory rape (AS 11.15.120); contributing to the delinquency of a minor (AS 11.40.130); and for lewd or lascivious acts toward children (AS 11.15.134).
In Anderson v. State, 384 P.2d 669, 671 (Alaska 1963), this court stated that the purpose of the statute punishing acts which contribute to the delinquency of a minor is "to protect all children under the age of 18". In Hanby v. State, 479 P.2d 486, 498 (Alaska 1970), the court held that the state can enact statutes to protect the juveniles to prevent as well as punish delinquency. In Hanby, the court found that material which was not so obscene as to be proscribed for the general population could be forbidden to minors. Children who were judged to be in a harmful environment were removed from their home in In re P.N., 533 P.2d 13 (Alaska 1975). The court determines child custody in divorce proceedings according to the welfare and best interest of the child. Horton v. Horton, 519 P.2d 1131, 1132 (Alaska 1974); Nichols v. Nichols, 516 P.2d 732, 734 (Alaska 1973); Carle v. Carle, 503 P.2d 1050, 1052 (Alaska 1972).
[2] While a runaway, L.A.M. was truant from school; was allegedly the victim of a rape as reported in a call to the police; contracted gonorrhea; suffered an injured jaw and broken teeth from a fall, which injuries had not received medical attention.
[3] Clarke, Stevens H., "Some Implications for North Carolina of Recent Research in Juvenile Delinquency," Journal of Research in Crime and Delinquency, January 1975.
[1] In re E.M.D., 490 P.2d 658, 659 (Alaska 1971). In E.M.D., after finding the minor to be a child in need of supervision, the trial court committed E.M.D. to the custody of the Department of Health and Welfare and directed the Department to place her in a correctional or detention facility.
[2] AS 47.10.080(j) provides in part:
If the court finds the minor is a child in need of supervision it shall make any of the following orders of disposition for his supervision, care and rehabilitation:
.....
(2) order the minor placed on probation under those conditions and limitations that the court may prescribe.
[3] See AS 47.10.080(b)(1). | 01-04-2023 | 10-30-2013 |
https://www.courtlistener.com/api/rest/v3/opinions/4622992/ | WALTER E. PARCHUTZ, SR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentParchutz v. CommissionerDocket No. 27093-86.United States Tax CourtT.C. Memo 1988-327; 1988 Tax Ct. Memo LEXIS 355; 55 T.C.M. 1357; T.C.M. (RIA) 88327; July 27, 1988. Walter E. Parchutz, Sr., pro se. Marjory A. Gerdes, for the respondent. RUWEMEMORANDUM FINDINGS OF FACT AND OPINION RUWE, Judge: Respondent, in a statutory notice dated April 8, 1986, determined deficiencies in petitioner's Federal income taxes for 1982 and 1983 and additions to tax as follows: Additions to TaxYearDeficiencySec. 6661 1Sec. 6651(a)(1)1982$ 13,832.00$ 1,383.20--19833,152.00--$ 33.15The issues for decisions are: (1) whether petitioner's 1982 and 1983 gambling losses should be disallowed; (2) whether petitioner is liable for an addition to tax under section 6661 for a substantial understatement of his 1982 income tax liability; and (3) whether petitioner is liable for an addition to tax under section 6651(a)(1) for failure to file timely his 1983 return. FINDINGS OF FACT Some of the facts1988 Tax Ct. Memo LEXIS 355">*357 have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Chicago, Illinois at the time he filed the petition in this case. Petitioner goes to racetracks frequently 2 and during the years in issue regularly placed bets at Arlington Park Thoroughbred Race Trace and Chicago Downs Associations, Inc., among other tracks located in the Chicago, Illinois area. On April 15, 1983, petitioner timely filed his Federal income tax return for the tax year 1982. On this return, petitioner reported $ 40,767.00 as "Race Track Winnings" and deducted $ 40,767.00 as "Gambling Losses." Petitioner's 1982 return reflected gross income from non-gambling sources in the amount of $ 8,021.93. Petitioner's 1982 winnings as reflected on Forms W-2G (Statements for Certain Gambling Winnings) 3 totalled $ 39,390.00. Petitioner had substantial 1982 winnings, in amounts less than what was required to be reported on Forms W-2G, that were not reported on his 1982 return. The total amount of bets reflected on losing 1982 wagering tickets which1988 Tax Ct. Memo LEXIS 355">*358 petitioner produced at trial was $ 41,214.00. On May 1, 1984, petitioner filed a Federal income tax return for the tax year 1983. The return was signed by petitioner on April 27, 1984. It has been prepared by a H & R Block employee, whose signature on the return bears the date January 28, 1984. The top of the first page of the return bore the handwritten notation "(Duplicate) Original was filed 2/11/88." 1988 Tax Ct. Memo LEXIS 355">*359 On this return, petitioner reported $ 19,056.00 as "Race Trace Winnings" and $ 19,056.00 as "Gambling Losses." Petitioner's 1983 return reflected gross income from non-gambling sources in the amount of $ 1,175.04. Petitioner's 1983 winnings reflected on forms W-2G totalled $ 19,005.37. Petitioner had substantial 1983 winnings, in amounts less than what was required to be reported on For W-2G, that were not reported on his 1983 return. The total amount of bets reflected on losing 1983 wagering tickets which petitioner produced at trial was $ 6,181.00. In 1982 and 1983, petitioner did not receive any substantial gifts, loans, social security payments, or any type of public aid. Petitioner did not have any pre-existing large cash hoards available to purchase wagering tickets during the years involved. His sources of funds were those shown on his tax returns plus unknown amounts of unreported wagering winnings. Petitioner's monthly winnings as reported on Forms W-2G, and amounts shown on losing tickets produced by petitioner and dated the same month, are as follows: 1982WinningsLosing TicketsJanuary$ 1,200.00$ 7,022.00February -- 6,408.00March7,456.506,730.00April2,278.308,307.00May1,623.805,159.00June2,287.101,113.00July-- 51.00August10,703.90121.00September905.10638.00October6,799.701,808.00November-- 3,007.00December6,135.60850.00Total:4 $ 39,390.00$ 41,214.001988 Tax Ct. Memo LEXIS 355">*360 1983January-- $ 38.00February-- 184.00March-- 158.00April$ 2,891.20537.00May723.70282.00June4,727.60395.00July3,843.2730.00August635.30174.00September-- 850.00October-- 134.00November3,018.802,517.00December3,165.50882.00Total:5 $ 19,005.37$ 6,181.00Petitioner did not keep any books, records, or diaries of his 1982 and 1983 winnings or losses except the Forms W-2G and certain losing tickets. Some of the losing tickets reflected purchase dates during a two-week period within the first two months of 1982 when petitioner was confined to a hospital due to a herniated disc. OPINION Gambling losses are deductible1988 Tax Ct. Memo LEXIS 355">*361 only to the extent of a taxpayer's gambling winnings during the same taxable year. Secs. 165(d); 1.165-10, Income Tax Regs.; Gajewski v. Commissioner,84 T.C. 980">84 T.C. 980, 84 T.C. 980">982 (1985). Respondent determined that petitioner failed to substantiate his 1982 and 1983 gambling losses. Petitioner bears the burden of proving error in respondent's determination. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Petitioner has the burden of proving that his alleged losses were in fact sustained. Mack v. Commissioner,429 F.2d 182">429 F.2d 182 (6th Cir. 1970), affg. a Memorandum Opinion of this Court. The issue is a factual one to be decided on the basis of all the evidence. Fogel v. Commissioner,237 F.2d 917">237 F.2d 917 (6th Cir. 1956), affg. per curiam a Memorandum Opinion of this Court; Green v. Commissioner,66 T.C. 538">66 T.C. 538, 66 T.C. 538">544 (1976). If there is sufficient evidence in the record to show that petitioner in fact incurred some loss, we may apply the rule laid down in Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d Cir. 1930), to permit deductions by estimating those losses using our best judgment on the record. Drews v. Commissioner,25 T.C. 1354">25 T.C. 1354 (1956);1988 Tax Ct. Memo LEXIS 355">*362 Stein v. Commissioner,322 F.2d 78">322 F.2d 78, 322 F.2d 78">83 (5th Cir. 1963), affg. a Memorandum Opinion of this Court. See DelGozzo v. Commissioner,T.C. Memo. 1983-613. Petitioner did not keep any books, records, or diaries of his 1982 and 1983 winnings and losses except (1) Forms W-2G that each racetrack was required to end to respondent pursuant to section 1.6011-3, Income Tax Regs., and (2) a shopping bag of losing tickets which petitioner testified he had purchased. The 1982 and 1983 losing tickets were separated into packets with a segment of adding tape attached to each packet. Petitioner introduced two sheets of paper with handwritten numbers which had been prepared by his sister as a summary of his 1982 and 1983 losing tickets. However, the computations include the cost of losing tickets which were purchased subsequent to the years at issue, and we do not view them as records prepared contemporaneously with gambling activity. Gambling loss tickets are of slight, if any, evidentiary weight where no corroboration is offered of petitioner's1988 Tax Ct. Memo LEXIS 355">*363 own testimony that each losing ticket was purchased by him. See Donovon v. Commissioner359 F.2d 64">359 F.2d 64 (1st Cir. 1966), affg. per curiam a Memorandum Opinion of this Court; Schooler v. Commissioner,68 T.C. 867">68 T.C. 867 (1977); Scoccimarro v. Commissioner,T.C. Memo. 1979-455. In the instant case, petitioner offered only his own uncorroborated testimony that the losing tickets were his. We have no way of knowing whether petitioner purchased these tickets or received them from acquaintances at the track or acquired them by resorting to stooping down and picking up the discarded stubs of other bettors. See Scoccimarro v. Commissioner, supra.Moreover, the credibility of petitioner's testimony that he purchased each of the losing tickets has been undermined since some of the losing tickets were purchased during a two-week period within the first two moths of 1982, when he was confined to a hospital and unable to go to the track. Petitioner reported only a small amount of winnings other than those reported on Forms W-2G; yet, he testified that his unreported winnings could have been triple the amount of the reported wagering1988 Tax Ct. Memo LEXIS 355">*364 income shown on his tax returns. 6 Having little income from sources other than gambling, and few assets, petitioner admittedly would have had to rely on unreported gambling winnings to fund the losing wagers he claims. As noted in the table setting forth petitioner's gambling winnings and losses, during January 1982, petitioner's winnings as reported on Forms W-2G were $ 1,200, and he presented losing tickets which costs $ 7,022; during February 1982, no winnings were reported on Forms W-2G, and he presented losing tickets which cost $ 6,408; during November 1982, no winnings were reported on Forms W-2G, and he presented losing tickets which cost $ 3,007. 1988 Tax Ct. Memo LEXIS 355">*365 Where, as in this case, a taxpayer admits receiving unreported winnings, he must establish that his annual losses exceed his annual unreported winnings in order to be entitled to deduct any losses. 359 F.2d 64">Donovan v. Commissioner, supra;68 T.C. 867">Schooler v. Commissioner, supra.Although we believe that petitioner must have sustained some losses, petitioner's lack of accurate documentation or other credible corroborating evidence concerning the amount of his losses and unreported winnings affords us no basis to conclude that his losses exceeded his unreported earnings for the years in issue. 359 F.2d 64">Donovan v. Commissioner, supra;68 T.C. 867">Schooler v. Commissioner, supra.We recognize that this court has applied the role of 39 F.2d 540">Cohan v. Commissioner, supra, and permitted deductions based on estimates where it was convinced that net losses were in fact sustained; however, the record in the case before us provides no satisfactory basis for estimating the amount of petitioner's winnings or losses. Accordingly, we must hold that petitioner has failed1988 Tax Ct. Memo LEXIS 355">*366 to carry his burden of proof and his claimed gambling losses are not allowed. The second issue for decision is whether petitioner is liable for the addition to tax for the substantial understatement of his 1982 income tax under section 6661. 7The addition to tax is applicable where the amount of understatement exceeds the greater of (1) 10 percent of the tax required to be shown on the return, or (2) $ 5,000. Sec. 6661(b). Petitioner bears the burden of proof concerning his liability for the addition to tax. Rule 142. There is no question here that petitioner's understatement of his income tax constitutes a substantial understatement, unless it can be reduced by application of section 6661(b)(2)(B). 81988 Tax Ct. Memo LEXIS 355">*367 Section 6661(b)(2)(B) provides for the reduction of an understatement "by that portion of the understatement which is attributable to": (i) the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment, or (ii) any item with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return. Petitioner in this case has not called our attention to any authority for his contested 1982 gambling loss deductions on the facts of this case. He is therefore not entitled to reduce the amount of his substantial understatement on this ground. The amount of understatement of income tax may also be reduced for items where the relevant facts affecting the item's tax treatment are "adequately disclosed" in the return. 9 The relevant facts are adequately disclosed by providing on the return sufficient information to enable respondent to identify the potential controversy involved. 1988 Tax Ct. Memo LEXIS 355">*368 S. Rept. No. 97-494 at 274 (1982); Schirmer v. Commissioner,89 T.C. 277">89 T.C. 277, 89 T.C. 277">285-286 (1987). Whether there is adequate disclosure on the return, and which items on the return will be considered in making this determination, depends on the facts and circumstances of the particular case. In this case we think that full disclosure of the relevant facts regarding the tax treatment of the gambling loss deduction would have required a accurate description of both the nature and amount of the deduction an the nature and amount of the related gambling income. Petitioner admitted having substantial amounts of unreported wagering income. He admitted this in the context of explaining the source of funds for his claimed wagering losses when he tried to rebut respondent's evidence that he had insufficient funds to sustain the claimed losses during certain moths. Under the circumstances we find that, for respondent to be fully apprised of the nature of the controversy, he would need accurate information regarding both winnings and losses. Accurate1988 Tax Ct. Memo LEXIS 355">*369 reporting of the amount of wagering income does affect the allowance of the loss deductions under the facts in this case. We have already held that the acknowledged underreporting of wagering income makes it improper to allow the claimed losses unless petitioner establishes that those losses exceed unreported income. 359 F.2d 64">Donovon v. Commissioner, supra;68 T.C. 867">Schooler v. Commissioner, supra.Petitioner understated his wagering income for 1982 by substantial amounts. Since we have found that wagering income was a relevant fact, we find that petitioner failed to disclose and, indeed, misstated relevant facts affecting the disallowed losses. Petitioner is liable for the addition to tax under section 6661 for 1982. The final issue for decision is whether petitioner is liable for the addition to tax under section 6651(a)(1) for failure to file timely his 1983 return. Petitioner bears the burden of proof concerning his liability for the addition to tax. Rule 142. See Foy v. Commissioner,84 T.C. 50">84 T.C. 50 (1985); Abramo v. Commissioner,78 T.C. 154">78 T.C. 154, 78 T.C. 154">163 (1982).1988 Tax Ct. Memo LEXIS 355">*370 Petitioner's 1983 tax return was due to be filed April 15, 1984. The only 1983 return in evidence is date-stamped received by respondent May 1, 1984. The return was signed and dated by petitioner on April 27, 1984. Petitioner testified that the return in evidence was actually a "duplicate" of two 1983 returns which he had filed previously. Petitioner introduced no evidence to corroborate the alleged timely filing and based on the entire record, we find that petitioner has failed to meet his burden of proving that his 1983 return was timely filed. See Marvin v. Commissioner,T.C. Memo. 1983-126. Due to concessions, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner at trial described himself as a compulsive gambler. ↩3. Pursuant to section 6041, racetracks making a payment of $ 600 on a winning ticket (exclusive of the amount of the bet) are required to file an information return (Form W-2G) with the Internal Revenue Service indicating, among other items, the name, address, social security number of the winner, and the date and amount of payment. For purposes of identification, the person receiving payment must furnish to the track two types of identification verifying his name, address, and social security number. Sec. 7.6041-1(c), Temp. Income Tax Regs., 42 Fed. Reg. 1471 (Jan. 7, 1977); Wagoner v. Commissioner,T.C. Memo. 1987-614↩. 4. Petitioner's 1982 winnings as reported on Forms W-2G, $ 39,390, are slightly less than the racetrack winnings reported on his 1982 return, $ 40,767. ↩5. Petitioner's 1983 winnings as reported on Forms W-2G, $ 19,005.37, are slightly less than the racetrack winnings which he reported on his 1983 return, $ 19,056.00. ↩6. Petitioner appeared to take the position at trial that any winnings below the amounts required to be reported on Form W-G2 were not reported because he did not think they were includable in income. He further testified that he had more losses than he was claiming, but that he only saved enough losing tickets to offset reported income. His explanation for the fact that the 1983 losing tickets presented at trial represent only one-third of the losses claimed for 1983 is that the remainder of the losing tickets were destroyed in a basement flood. ↩7. The notice of deficiency in which respondent determined the section 6661(a) additions to tax against petitioner was issued on April 8, 1986. As of that date, the section 6661(a) addition to tax was equal to 10 percent of the underpayment attributable to a substantial understatement. Section 6661(a) has twice been amended since then. The section 6661(a) addition to tax is now 25 percent of the underpayment attributable to a substantial understatement for additions to tax assessed after Oct. 21, 1986. See Pallottini v. Commissioner,90 T.C. 498">90 T.C. 498 (1988). Respondent has neither amended his answer to seek nor sought at trial an increase to the section 6661(a)↩ addition to tax over the amount determined in the notice of deficiency. 8. Petitioner's understatement of Federal income tax for 1982 was $ 13,832. This exceeds $ 5,000 which is greater than 10 percent of the tax required to be shown on the return. ↩9. Petitioner has not attached a statement to his return; therefore, we need only consider what was shown on the return. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622993/ | ESTATE OF SIDNEY F. TYLER, DECEASED, FIDELITY-PHILADELPHIA TRUST COMPANY AND ROBERT L. MONTGOMERY, EXECUTORS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Tyler v. CommissionerDocket No. 95672.United States Board of Tax Appeals40 B.T.A. 330; 1939 BTA LEXIS 863; July 27, 1939, Promulgated 1939 BTA LEXIS 863">*863 The settlor of a trust reserved power to alter or absolutely revoke and annul and to declare other uses. By a later instrument he released the right of revocation, with a proviso that no other rights should be affected. Held, the power to alter was retained and the corpus of the trust was within the gross estate. Sec. 401, Revenue Act of 1934. W. W. Montgomery, Jr., Esq., for the petitioner. Eugene G. Smith, Esq., for the respondent. STERNHAGEN 40 B.T.A. 330">*330 OPINION. STERNHAGEN: The Commissioner determined a deficiency of $121,936 in estate tax, by including in gross estate the value of the corpus of a trust. Tyler died June 3, 1935. On April 22, 1885, he transferred personal property in trust, the trustee to hold, sell and invest, collect the income, and, after payment of taxes and expenses, to pay over the remaining income in equal shares to or for the benefit of Tyler's children for life, and upon the death of one of the children, to the deceased child's issue. Upon the death of the survivor of the children the trustee was to make distribution of the trust property among their issue in equal shares per stirpes, or, if either left1939 BTA LEXIS 863">*864 no issue, in a specified manner not here materia. It was further provided that: * * * Sidney F. Tyler may at any time or times before said period of distribution of said trust property shall arrive, by any deed or deeds or other instruments in writing either alter or absolutely revoke and annul all or any of the uses, trusts and estates, hereinbefore limited and declared, and by the same or any other deed or instrument limit and declare such other uses, trusts and estates, of or concerning all or any part of the said trust property hereinbefore transferred and conveyed and the investments representing the same as he shall think fit, anything hereinbefore to the contrary notwithstanding. On February 25, 1888, Tyler executed an instrument whereby he: * * * releases and annuls the right of revocation so in the said Indenture of the twenty-second day of April A.D. 1885 was reserved and provided. [Sic.] Provided, nevertheless, that nothing herein contained shall be deemed to affect or limit any other of the terms and conditions of said Indenture, or divest, affect or disturb any estate, right, title or interest of the said Sidney F. Tyler in the said estate, other than1939 BTA LEXIS 863">*865 the said right of revocation. In an estate tax return filed with the collector at Philadelphia, the gross estate did not include the value of the trust property. 40 B.T.A. 330">*331 In determining the deficiency the Commissioner included $277,708.41, and the petitioner does not assail the figure of valuation if, contrary to its contention, the property is held to be within the statutory gross estate. The essence of petitioner's contention is that the instrument of 1888 ended the settlor's power to alter, and that therefore the Revenue Act of 1934, section 401, 1 does not touch the estate. If this is so, it must be by virtue of a necessary construction of the 1888 instrument, for it would be plainly at variance with the decedent's express language. An unsophisticated reading of the 1885 instrument shows a retention by the settlor of two separately conceived powers described disjunctively. He might either (1) alter or (2) absolutely revoke and annul; might also limit and declare such other uses, etc., of all or part of the trust property. In the 1888 document with equal care and precision he annulled but one of these, the right of revocation. Without more, this would leave unaffected1939 BTA LEXIS 863">*866 the other retained rights, and any alteration or any declaration of new uses would be unassailable. But the settlor was not content that such retained rights should be left in any doubt; the expressio unius maxim was not enough. By the proviso he assured himself that the annulment of the right of revocation should not affect or limit any other terms or affect or disturb any right other than the right of revocation. Thus the settlor did about all that a forthright person could to show an intention to keep the right to alter and to forego the right to revoke. He used discriminating language, with a fine sense of draftsmanship, to express that intention. The petitioner now urges, however, that such an understanding of the two instruments1939 BTA LEXIS 863">*867 is indeed unsophisticated and that the juristic conception is otherwise. This is a refined argument (no less respected on that account) which must be supported not alone by logic, but by compelling authority. Petitioner's logic is that any alteration, especially to change benefits, would be pro tanto a revocation and hence inhibited by the 1888 instrument. This is so inconsistent with the unmistakable intention to retain the rights described in the proviso that it would stultify the instrument in one of its important objects. Clearly it was no more designed to annul the power of revocation than it was to leave unimpaired the described power of alteration. It might have been possible to read the renunciation of the power to revoke as preventing an alteration if there were ambiguity of language or if there 40 B.T.A. 330">*332 had been an emergence of unforeseen circumstances. But there is no such ambiguity and no unforeseeable situation arose. Petitioner suggests that the settlor clearly had no right after the renunciation of 1888 to vary the quantities by assigning to one beneficiary a part of what had theretofore been assigned to another, because as to the latter this would be to1939 BTA LEXIS 863">*868 some extent a revocation. But it would be more aptly described as a declaration of another use, trust, or estate "of any part of the said trust property hereinbefore transferred", and this was separately retained in the 1885 instrument, covered by the proviso of 1888, and hence not relinquished under the cancellation of the power of revocation. The petitioner cites Restatement of the Law of Trusts, ch. 10, sec. 331 comment h. This, we think, gives petitioner no support. The black letter states that the power to modify exists if reserved, and the comment and the cases cited in the explanatory notes of tentative draft No. 5 (sec. 321) indicate that a reserved power to modify may be interpreted in the light of all the circumstances as subject to restriction, and that if not restricted it includes the power to revoke. This is far from saying that the relinquishment of a reserved power to revoke destroys a separately expressed power to alter, despite an express proviso containing the reservation of the latter. ; 1939 BTA LEXIS 863">*869 , indicates that the power to amend may dominate an express restriction on the power to revoke so thoroughly as to support a complete termination of the interest of a cobeneficiary. Even the doubt as to the Faulkner decision which Judge Hand expressed in , would not affect the present case, for it relates only to an alteration which defeats the original beneficiaries to the profit of the settlor. Apparently a modification to redistribute the original interests would be free from doubt even though the power of revocation were restricted. The petitioner cites an unreported decision of the Orphans' Court of Philadelphia County in Grossman's Estate (May 25, 1938), confirming a trustee's account. The terms of that trust and the later documents are materially different, and the circumstances much more complex. It can not be regarded as analogous. Chance's Estate, 29 D. & C. (Penna.) 586, is more like our case (although still not close enough to be controlling), and there the reserved power to amend by will was held not to include the power to revoke by will when there1939 BTA LEXIS 863">*870 was expressly reserved a power to revoke by deed. From this it may be inferred that the restriction on the power of revocation did not reach the reserved power of amendment. But perhaps as to both these Orphans' Court cases, Judge Van Dusen's language could be aptly quoted: "This case is not at all helpful because the language used in the instant case is not at all similar to that used in the case 40 B.T.A. 330">*333 cited." There is really nothing we can find and nothing cited by petitioner which demonstrates that Pennsylvania would say that the decedent at the time of his death had no power to alter the trust, even though we are not so sure that any or every alteration which he might have attempted would have been successful. Conceivably some attempts would have been held to impinge upon the relinquishment of the power to revoke. But if there were any alterations which conceivably the decedent might validly have made, the revenue act imposes a tax upon the property thus under his control. . It is not for us to say that a power to alter so deliberately reserved and later so carefully preserved in the proviso was after all without1939 BTA LEXIS 863">*871 force and substance because it was inadvertently destroyed with the annulment of the right of revocation. The revenue act includes in the gross estate the trust property which was subject at the time of decedent's death to a power to alter or a power to revoke the trust. Petitioner would say that although in terms the decedent retained a power to alter, in fact such power to alter was absorbed in the relinquishment of the power to revoke. Since the two were separate, we conclude for the foregoing reasons that petitioner retained the power to alter and that the corpus of the trust was squarely within the statutory language including it within the gross estate. The determination is sustained. Decision will be entered under Rule 50.Footnotes1. SEC. 401. REVOCABLE TRUSTS. Section 302(d) of the Revenue Act of 1926 is amended to read as follows: "(d) (1) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, * * *." ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622994/ | CHESTER N. WEAVER COMPANY, A CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CHESTER N. WEAVER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ELSIE S. WEAVER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Chester N. Weaver Co. v. CommissionerDocket Nos. 82865, 82870, 82871.United States Board of Tax Appeals35 B.T.A. 514; 1937 BTA LEXIS 866; February 17, 1937, Promulgated 1937 BTA LEXIS 866">*866 The petitioners sustained losses during the taxable year upon liquidation of a corporation in which they owned all of the preferred stock. They had owned the stock for a period of less than two years. No claim is made that they realized gains during the taxable year from the sale of stocks or bonds which were not capital assets. Held, that the deduction of the loss sustained by each of the petitioners is barred by section 23(r)(1) of the Revenue Act of 1932. A. E. Graupner, Esq., for the petitioners. O. W. Swecker, Esq., for the respondent. TURNER 35 B.T.A. 514">*514 These proceedings, which were consolidated for hearing, involve deficiencies in income tax for the year 1933 as follows: PetitionerDocket No.DeficiencyChester N. Weaver Co828654,323.48Chester N. Weaver828708,832.43Elsie S. Weaver828712,447.84The only question for our determination is whether petitioners, in determining their net income, may deduct the losses sustained by them upon the liquidation of the Jeff R. Townsend Co., in which they held all of the preferred stock. The losses in question were disallowed by the respondent under section1937 BTA LEXIS 866">*867 23(r) of the Revenue Act of 1932. Other allegations of error are set forth in the petitions, but since no evidence has been offered to sustain them, it will be deemed that they have been waived. The respondent's claim for an increased deficiency in Docket No. 82871 will also be deemed to have been waived by reason of his failure to offer evidence to support it. FINDINGS OF FACT. The Chester N. Weaver Co., hereinafter referred to as the Weaver Co., is a California corporation. Chester N. Weaver and Elsie S. Weaver are husband and wife and reside in San Francisco, California. 35 B.T.A. 514">*515 On December 2, 1931, Chester N. Weaver and Elsie S. Weaver purchased 500 shares each of the 6 percent cumulative preferred stock of the Jeff R. Townsend Co., hereinafter referred to as the Townsend Co., paying therefor $100 per share. On August 9, 1932, the Weaver Co. acquired from the same corporation 1,000 shares of its preferred stock at the same price. The 2,000 shares of preferred stock so purchased constituted all of the preferred stock of the Townsend Co. The common stock belonged to other interests. The articles of incorporation provided that in the event of liquidation the holders1937 BTA LEXIS 866">*868 of preferred stock should be entitled to receive therefor a sum equal to 105 percent of the par value thereof before any amount should be distributed to the holders of the common stock. Early in 1933 the Townsend Co. became financially involved and unable to continue business. Its stockholders took the necessary steps to effect its dissolution and liquidation. On or about September 17, 1933, it sold all of its assets to the Weaver Co. for $26,280.50. On September 18, 1933, the petitioners in these proceedings, holders of all of the preferred stock of the Townsend Co., surrendered their stock certificates for cancellation and for the purpose of completing liquidation and effecting dissolution of that company. The $26,280.50 received for its assets was distributed in liquidation to the preferred stockholders pro rata. The Weaver Co. received $13,140.25; Chester N. Weaver, $6,570.13, and Elsie S. Weaver, $6,570.12. In their income tax returns for 1933 each of the petitioners deducted as a loss the difference between the amount paid for the preferred stock so surrendered and the amount received in liquidation, and, in determining the deficiencies herein, the respondent has disallowed1937 BTA LEXIS 866">*869 the deductions so claimed. OPINION. TURNER: The only question for determination is whether or not section 23(r)(1) 1 of the Revenue Act of 1932 bars the deduction of the losses sustained by the petitioners on liquidation of the Townsend Co. There is no claim by the petitioners that the gross income reported, and against which the deduction is sought, includes gains from the sale of stocks or bonds which were not capital assets. 35 B.T.A. 514">*516 It is the contention of the petitioners that the provisions of sections 22(d), 115(c), 111, and 112(a) 2 of the act provide for the deduction in full of losses sustained as the result of a distribution in complete liquidation of a corporation, and that the provisions of section 23, relating to deductions from gross income, are not applicable. 1937 BTA LEXIS 866">*870 The petitioners' argument that the losses in question are deductible without regard to section 23 starts with section 22(d), which provides that "distributions by corporations shall be taxable to shareholders as provided in section 115." Referring next to subsection (c) of section 115, they point out that although "amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock" the "gain or loss to a distributee resulting from such exchange" is determined under section 111, and "recognized" to the extent provided in section 112. Our attention is then called to the fact that by the terms of section 112(a), the entire amount of gain or loss "upon the sale or exchange" of property "shall be recognized" except as thereafter provided in that section. It is then concluded that since the remaining provisions of section 112 contain no limitation or prohibition of the recognition of a loss resulting from complete liquidation of a corporation, the entire amount of the loss is recognized, and being recognized in full, its deduction is in no way dependent upon or limited by the provisions of section 23. The fallacies in this argument1937 BTA LEXIS 866">*871 are elementary and obvious, and are at once arrarent upon examination of the structure and plan of the income tax statute. The tax is imposed on net income and, according to section 21, net income is "gross income computed under 35 B.T.A. 514">*517 section 22, less the deductions allowed by section 23." Section 22 provides generally that gross income "includes gains, profits, and income * * * of whatever kind and in whatever form paid, or from * * * any source whatever." It also enumerates certain specific items that are to be included in gross income and others that are to be excluded. Section 23 enumerates and describes the allowable deductions referred to in section 21. It is argued in this connection that sections 112 to 120, inclusive, are relief or distinctive provisions, and to rule that their application is to be made with reference to section 23 would amount to their repeal or nullification. We find nothing in any of these sections to indicate that the so-called relief or distinctive provisions are to be applied wothout reference to section 22 if they involve items of gain or profit, or without references to section 23 if they involve losses or other charges allowable against1937 BTA LEXIS 866">*872 gross income. On the other hand, Congress has particularly and specifically brought the application of these so-called relief sections within the provisions of sections 22 and 23. Illustrations are numerous. Subsection (b)(7) of section 22 provides for the exclusion from gross income of the items of gain set forth in section 116, while subsections (g), (h), (i), (l), (m), and (n) of section 23 specifically give effect to the provisions of sections 113, 118, 117, 114(b)(3), and (4), 114, and 120, respectively. It is thus apparent from the general plan of the statute that, in the absence of specific language to the contrary, deductions from gross income are allowable by and through the provisions of section 23 only. No other method of determining net income is provided. The petitioners seek to vary the general plan of the statute by arguing that losses resulting the stockholders from corporate liquidations are to be given effect through section 22(d). That argument is, in short, a claim that a loss deduction may be taken in the form of a minus or negative item of gross income, under the gross income provisions of the statute and without regard to the provisions of section 23. 1937 BTA LEXIS 866">*873 Obviously the provision in section 22(d), to the effect that "distributions by corporations shall be taxable to shareholders as provided in section 115", is not susceptible of such strained construction. The argument made here would also permit the deduction of a loss from the sale of stocks or securities on the market, without regard to section 23, since section 112(a) provides that such a loss is to be recognized in full, there being no subsequent provision in that section providing otherwise. Such reasoning would completely nullify the provisions of section 23(e), (f), and (r)(1). The recognition or nonrecognition of gain or loss under section 112 is in no sense a determination that the gain is to be included in gross income or that the loss is to be deducted therefrom. It is merely a determination as 35 B.T.A. 514">*518 to whether or not the gain or loss is to be given such tax significance as the statute provides in the year in which the transaction giving rise to the gain or loss occurred, or is to be postponed until the happening of a further transaction in a subsequent year. Even though recognized, the tax effect of the gain or loss in computing net income is to be determined1937 BTA LEXIS 866">*874 through the application of the gross income and deduction provisions of the statute. The result here being a recognized loss, the extent to which that loss is deductible is determined by the provisions of section 23. In their reply brief the petitioners make the further contention that the limitation prescribed by section 23(r)(1), on loss deductions, is not applicable here on the ground that a loss sustained in the disposition of stock in a corporate liquidation is not a loss from the sale or exchange of stock within the meaning of the statute. The reasoning advanced is that Congress, through sections 22(d) and 115(c), on the one hand, and sections 22(e) and 111(a) and (b) on the other, has carefully drawn a distinction between the disposition of stock in liquidation and an ordinary sale or exchange of stock on the market, and that the disallowance or limitation under section 23(r)(1), of a loss sustained in the disposition of stock in liquidation requires the distortion or disregard of other pertinent provisions of the statute. It is also claimed that section 23(r)(1) is applicable only to losses sustained in a sale or exchange of stocks and bonds on the market, because the1937 BTA LEXIS 866">*875 Congressional Committees, in stating reasons for the insertion of section 23(r)(1) in the statute, made specific reference to sales or exchanges on the market and no reference to the disposition of stock in a corporate liquidation. It is well established that the reports of Congressional Committees may be resorted to as an aid to construction when the terms of the statute are contradictory or ambiguous, or the meaning of the words used is doubtful. ; . But it is equally well established that the intent of the lawmaker must be sought in the language of the statute, and where that language is clear and unambiguous, it must be enforced according to its terms and may not be varied or limited by reference to committee reports. The plain language of the statute may not be cast aside for other language thought by some one to have been in the mind of the legislative body. Congress must be presumed to have meant what it has said. 1937 BTA LEXIS 866">*876 ; ; ; . From a consideration of the cases before us and the provisions of the statute involved, it does not appear here that the aid of the Committee reports is invoked because the language 35 B.T.A. 514">*519 of section 23(r)(1) is ambiguous, but because the petitioners desire to limit and restrict the application of that language to the situations covered by specific illustrations in those reports. Clearly the cases cited do not permit reference to legislative history for such purposes, and where there is no ambiguity the language of the statute is controlling. In support of their claim for a narrow and restricted application of section 23(r)(1), the petitioners have cited numerous court decisions which deal with the interpretation and construction of statutes. It is our opinion that the cases cited generally support the respondent rather than the petitioners. In 1937 BTA LEXIS 866">*877 , the Supreme Court stated that the intention of Congress, with reference to a particular provision of a taxing statute, is to be determined not by viewing the provision apart and separate from its setting in the act, but by considering it in connection with the context, general purpose of the statute in which it is found, and the occasion and circumstances of its use. In section 115(c), on which petitioners base their claim for distinction, it is provided that amounts distributed in complete liquidation of a corporation are to be treated "as in full payment in exchange for the stock." It is then provided that the amount of gain or loss is to be "determined under section 111" and recognized "to the extent provided in section 112." These sections deal generally with the "sale or exchange" or "the sale or other disposition" of property. It thus appears by direct reference to other sections of the statute, that the disposition of corporate stock in liquidation is to be treated, for income tax purposes, as a "sale or exchange" and the distinction claimed by the petitioners is refuted by the plain words of the statute. 1937 BTA LEXIS 866">*878 Furthermore, it is interesting to note that if any doubt did exist and there were any basis for a claim of ambiguity, the report of the Committee on Ways and Means of the House of Representatives submitted with the bill which became the Revenue Act of 1924, in which report the language used in section 115(c) was inserted, definitely indicates that the disposition of stock in a corporate liquidation is, for income tax purposes, a sale. The Committee there said: "The proposed bill, as did the 1918 Act, treats a liquidating dividend as a sale of the stock to the corporation and recognizes the true effect of such a distribution." The deduction of recognized losses in the case of an individual is governed by the provisions of subsection (e) of section 23, and of a corporation by the provisions of subsection (f). In both of these subsections it is provided that the deductions so allowed are subject to the limitation provided in subsection (r), paragraph (1) of which has been quoted above. The language of that limitation is plain and 35 B.T.A. 514">*520 the deduction of any loss resulting from the sale or exchange of stocks or bonds, not capital assets, is limited in amount to gains derived1937 BTA LEXIS 866">*879 from the sale or exchange of similar assets. In the cases before us the preferred stock of the Townsend Co. was disposed of in liquidation of that company. The stock did not constitute capital assets in the hands of the petitioners and they make no claim that they realized any gains from the sale of similar assets. This disposition of the stock, under the provisions of the statute considered above, was a sale or exchange and the deduction of the losses sustained is barred by the provisions of section 23(r)(1) of the statute. Reviewed by the Board. Decision will be entered under Rule 50.SMITH SMITH, dissenting: It is a cardinal principle of statutory construction that taxing statutes should be interpreted according to the intent of the legislative body enacting them. Thus, in Smythe v. Fiske,23 Wall. 374, the Supreme Court said: A thing may be within the letter of a statute and not within its meaning, and within its meaning, though not within its letter. ; 1937 BTA LEXIS 866">*880 Atkins v. The Fibre Disintegrating Co., 18 Wallace, 301; Bacon's Abridgment, title Statutes, 1, 2, 3, 5. The intention of the lawmaker is the law. In , the Supreme Court said: The rule that, where the statute contains no ambiguity, it must be taten literally and given effect according to its language, it a sound one not to be put aside to avoid hardships that may sometimes result from giving effect to the legislative purpose. ; . But the expounding of a statutory provision strictly according to the letter without regard to other parts of the act and legislative history would often defeat the object intended to be accomplished. Speaking through Chief Justice Taney in , this court said: "It is well settled that, in interpreting a statute, the court will not look merely to a particular clause in which general words may1937 BTA LEXIS 866">*881 be used, but will take in connection with it the whole statute (or statutes on the same subject) and the objects and policy of the law, as indicated by its various provisions, and give to it such a construction as will carry into execution the will of the Legislature, as thus ascertained, according to its true intent and meaning." Quite recently in , we said: "It is the duty of this Court to give effect to the intent of Congress. Primarily this intent is ascertained by giving the words their natural significance, but if this leads to an unreasonable result plainly at variance with the policy of the legislation as a whole, we must examine the matter further. We may then look to the reason of the enactment and inquire into its antecedent history and give it effect in accordance with its design 35 B.T.A. 514">*521 and purpose, sacrificing, if necessary, the literal meaning in order that the purpose may not fail." And in , we applied the rule laid down in 1937 BTA LEXIS 866">*882 , that "a thing which is within the intention of the makers of a statute is as much within the statute as if it were within the letter, and a thing which is within the letter of a statute, is not within the statute, unless it is within the intention of the makers." Did the Congress by section 23(r) intend to prevent corporate stockholders sustaining losses upon the liquidation of corporations from deducting those losses from gross income except to the extent of gains realized from sales or exchanges of stocks and bonds? I think not. The legislative history of section 23(r) of the Revenue Act of 1932 shows that that provision was designed to prevent corporate stockholders from deducting from gross income losses created through sales or exchanges "in the stock and bond markets." The Ways and Means Committee Report 708 on H.R. 10236, which later became the Revenue Act of 1932, comments upon five proposed additions to section 23 of the Revenue Act of 1928, i.e., subsections (r), (s), (t), (u), and (v). These proposed subsections emerged in amended form as subsections (r), (s), and (t) of the Revenue1937 BTA LEXIS 866">*883 Act of 1932. In presenting the five proposed additions to the House the Ways and Means Committee Report stated, p. 12: Many taxpayers have been completely eliminating from tax their income from salaries, dividends, rents, etc., by deducting therefrom losses sustained in the stock and bond markets, with serious effect upon the revenue. Your committee is of the opinion that some limitation ought to be placed on the allowance of such losses. After referring to the exclusion of "dealers in securities", as provided in subsection 23(r)(3), the Committee report stated: Traders or other taxpayers who buy and sell securities for investment or speculation, whether or not in their own account, and irrespective of whether such buying or selling constitutes the carrying on of a trade or business, are not regarded as dealers in securities within the meaning of this rule. The Finance Committee Report of the Senate on this same bill (Report 665, p. 12) contains the following: The House Bill adopted very severe limitations upon the allowance of losses from the sale of securities, as a deduction in computing net income. The provision is based upon a twofold policy: (1) Protecting the1937 BTA LEXIS 866">*884 revenues from the growing practice of reducing tax liabilities by the sale of securities on which losses had accrued, and (2) preventing speculative losses from wiping out ordinary income, which represents real tax-paying ability. There is nothing in the Committee reports which tends in the slightest to show that section 23(r) had in contemplation losses sustained through the liquidation of corporations. 35 B.T.A. 514">*522 Section 22(d) of the Revenue Act of 1928 provides that "Distributions by corporations shall be taxable to the shareholders as provided in section 115", and section 115(c) provides in part: Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. * * * The Revenue Act of 1928 contained no provision corresponding to section 23(r) of the Revenue Act of 1932. Section 22(d) and section 115(c) of the Revenue Act of 1928 were incorporated and made a part, without change, of the Revenue Act of 1932. Where corporations are liquidated, stockholders receiving liquidation1937 BTA LEXIS 866">*885 distributions may or may not turn in their shares of stock. It is a common thing for them to do so. See . Whether they do so or not, however, they are treated as exchanges under both the Revenue Act of 1928 and that of 1932 for the purpose of giving corporate stockholders the benefits of sections 111 and 112. The word "exchange" in its ordinary meaning carries with it the idea of mutual agreement - a transfer of property for property in a transaction freely arrived at between two parties. See . These elements are lacking where in distributions in liquidation a stockholder has no alternative but to surrender his shares of stock and receive his proportion of the assets of the corporation distributable to him. Section 115(c) does not provide that distributions in liquidation shall constitute "exchanges." It simply provides that they shall be treated as in full or part payment "in exchange" for the stock. In section 23(r) of the Revenue Act of 1932 the word "exchange" is coupled with the word "sales." Under the doctrine of ejusdem generis the word "exchanges" 1937 BTA LEXIS 866">*886 must be interpreted in the light of the word with which it is associated. Losses sustained upon sales of stocks and bonds are subject to the limitation of section 23(r)(1). If the word "exchanges" had not been used in this provision the very evil at which section 23(r) was aimed might have been perpetuated by corporate stockholders exchanging their stocks and bonds for other securities or other property. Such circumvention of the statute was forestalled by the language used by the draftsmen of the act. In the light of the legislative history of section 23(r) I can not believe that Congress had any intention of limiting the deduction from gross income of losses sustained by taxpayers in the liquidation of corporations. BLACK, TYSON, HILL, and HARRON agree with this dissent. Footnotes1. SEC. 23. (r) LIMITATION ON STOCK LOSSES. - (1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not capital assets (as defined in section 101) shall be allowed only to the extent of the gains from such sales or exchanges (including gains which may be derived by a taxpayer from the retirement of his own obligations). ↩2. SEC. 22. (d) DISTRIBUTIONS BY CORPORATIONS. - Distributions shall be taxable to the shareholders as provided in section 115. SEC. 115. (c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of section 112(h) of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital accounts shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporations. SEC. 111. (a) COMPUTATION OF GAIN OR LOSS. - Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b), and the loss shall be the excess of such basis over the amount realized. * * * (c) RECOGNITION OF GAIN OR LOSS. - In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this title, shall be determined under the provisions of section 112. SEC. 112. (a) GENERAL RULE. - Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622995/ | KIESAU PETROLEUM CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kiesau Petroleum Corp. v. CommissionerDocket No. 95760.United States Board of Tax Appeals42 B.T.A. 69; 1940 BTA LEXIS 1057; June 13, 1940, Promulgated 1940 BTA LEXIS 1057">*1057 Petitioner entered into contracts with lessees of oil producing land whereby in return for furnishing equipment needed in exploiting such land petitioner became entitled to a certain precentage of the oil produced. Held, that petitioner's income realized pursuant to such contracts was not "derived from royalties" within the meaning of section 351(b)(1) of the Revenue Acts of 1934 and 1936, and petitioner was not "a personal holding company" within the meaning of those acts; held, further, that petitioner is entitled to depletion calculated upon such income. Jonah Jones, Jr., Esq., for the petitioner. John H. Pigg, Esq., for the respondent. KERN 42 B.T.A. 69">*70 In this proceeding respondent determined a deficiency in the sum of $1,169.09 against petitioner for the years 1935 and 1936 because of petitioner's alleged liability for surtax as a personal holding company for those years. Respondent also imposed a delinquency penalty of $292.27. This deficiency and penalty arise by reason of respondent's determination that petitioner during the taxable years derived more than 80 percent of its gross income from royalties within the meaning of section1940 BTA LEXIS 1057">*1058 351(b)(1) of the Revenue Acts of 1934 and 1936, and was, therefore, a personal holding company. At the time of the hearing respondent filed an amended answer alleging that in event the Board should find that the income derived by petitioner pursuant to a certain contract does not constitute income from royalties within the meaning of section 351(b)(1), then respondent erred in allowing petitioner depletion deductions for the taxable years, and in that event there would be deficiencies in petitioner's income tax and excess profits tax liability for the taxable years in the sums of $1,747.60 and $832.17, respectively. FINDINGS OF FACT. Petitioner was incorporated on April 17, 1930, under the laws of the State of California, and its principal place of business is at Long Beach, California. More than 64 percent of its capital stock was owned at all times here material by three members of the Kiesau family. Its income for 1935 and 1936 was derived entirely from the operation of nine separate oil wells, only one of which, known as the Paige well, was drilled upon land owned by petitioner. The income from the other eight of said wells, which constituted over 80 percent of1940 BTA LEXIS 1057">*1059 its gross income, was derived from contracts similar to exhibits No. 1 and No. 2, the pertinent parts of which are set out as follows: AGREEMENT THIS AGREEMENT, made and entered into this 28th day of August, 1933, by and between EQUITABLE OIL COMPANY, a corporation, First Party, and KIESAU PETROLEUM CORPORATION, a corporation, Second Party, both of the County of Los Angeles, State of California; WITNESSETH: That First Party is the owner of and in possession of a recorded oil and gas lease covering the following described real property. [Description omitted.] WHEREAS, First Party is desirous of Second Party's furnishing certain equipment to be used in the drilling and completion of an oil well on the above described property, known as Fowler Number One. NOW, THEREFORE, it is agreed, in consideration of the mutual promises and benefits to be derived by both parties hereto, that Second Party will furnish to 42 B.T.A. 69">*71 First Party, to be used in the drilling and completion of the said oil and/or gas well, the following property: To furnish water string casing, shoe and guide to the value of $5,000.00 and if the same does not total $5,000.00 to furnish tubing or other1940 BTA LEXIS 1057">*1060 equipment as agreed upon so that the total shall equal $5,000.00. All of the above equipment shall be of the value of $5,000.00 which First Party agrees to take and use in the drilling of said oil well, and in payment thereof agrees to and does hereby give the Second Party 15% of 100% of the received from the sale of all oil, gas and/or other hydrocarbon substances produced and saved from the well situated upon the above described real property, until such time as Second Party has been reimbursed from the income of said 15% for the actual cost to it of the above listed equipment. After said Second Party has been reimbursed as aforesaid, its interest shall be a permanent 7 1/2% of 100% of the said production from said well. The royalty interests herein provided for shall not be subject to any drilling cost, but are to bear an operating charge due and payable only from production of oil and gas produced, saved and sold from the above mentioned property, at the rate of $5.00 per each one per cent. per month. * * * In no event shall the additional 7 1/2% royalty interest herein assigned to repay the cost of equipment furnished by the Second Party be chargeable with any operating1940 BTA LEXIS 1057">*1061 expense whatsoever, and it shall only be liable for its pro-rata share of mineral rights taxes assessed against production from the above referred to well. * * * It is further agreed that if for any reason, First Party abandon the drilling of same before said well is completed, Second Party, at its option, may complete the said well, in which event said Second Party shall reimburse itself for said completion out of the available royalty owned by both parties, after which it shall reimburse First Party for its actual expense. The First Party warrants that the consent of the landowner to permit a completion of said well by Second Party shall have been obtained in writing prior to the execution of this agreement. It is further agreed that in the event of the bankruptcy or insolvency of First Party, or in the event that a receiver in equity be appointed, or a receiver be appointed otherwise, or in the event of attachment or levy of execution, that in such event, Second Party may complete said well and reimburse itself therefor out of the available royalty owned by both parties, and it is further warranted that the consent of the landowner to this proviso shall have been obtained1940 BTA LEXIS 1057">*1062 in writing prior to the execution of this agreement. In the event of the bankruptcy, insolvency, appointment of a receiver in equity, or the appointment of a receiver otherwise, the title to the equipment aforementioned shall be deemed to have been retained by the Second Party. * * * It is further agreed that in case of production being obtained on said property, First Party shall have the right to contract for the sale of the Second Party's oil, at a price per barrel posted and freely offered by the Standard Oil Company, Shell, Union and General Petroleum Corporation. In case a different price is posted by these companies, then the average of these prices shall be the price for which First Party shall settle with Second Party, and settlement for same to be made in money not later than the 25th day of the following month in which any oil shall have been sold. First Party agrees 42 B.T.A. 69">*72 to order the payment of oil to be made direct by purchasing company to Second Party. * * * It is further agreed that in no event is it the intention of the parties hereto to enter into a partnership agreement of any kind or nature whatsoever. * * * It is understood that it is proposed1940 BTA LEXIS 1057">*1063 to drill said Fowler Well No. 1 to the Ashton Zone, found at a depth of less than 5,000 feet in the Huntington Beach Oil Field. Should First Party hereafter drill additional wells to the Ashton Zone, Second Party is to have the option of purchasing a like interest for the same price and upon the same terms as hereinbefore set forth. A thirty day notice to be given to Second Party prior to commencing additional wells, and Second Party, within fifteen days after receipt of such notice, to exercise or reject such option. Should a well be drilled to a zone deeper than the Ashton Zone in an attempt to obtain production from such deeper zone, then and in that event, Second Party shall have the option of purchasing 7 1/2% participating interest in such well by paying therefor the proportionate part of such costs of such deeper well. Such part of the costs to be in the proportion that 7 1/2 bears to 81. * * * IN WITNESS WHEREOF, the parties hereto have set their hands and seals the day and year in this agreement first above written. KIESAU PETROLEUM CORPORATION, By A. H. KIESAU By R. M. KiesauEQUITABLE OIL COMPANY, By H. S. KOHLBUSH, PresidentBy D. M. WAITE, 1940 BTA LEXIS 1057">*1064 SecretaryAGREEMENT THIS AGREEMENT, made and entered into this 24th day of August, 1931, by and between WEST AMERICAN OIL COMPANY, a Calif corp., FIRST PARTY, and KIESAU PETROLEUM CORPORATION, a corp., SECOND PARTY, both of the City of Long Beach, County of Los Angeles, State of California. WITNESSETH: That FIRST PARTY is the owner of, and in possession of a recorded oil and gas lease covering the following described real property; [Description omitted.] Whereas, FIRST PARTY is desirous of SECOND PARTY's furnishing certain equipment to be used in the drilling and completion of an oil well on the above described property: NOW, THEREFORE, it is agreed, in consideration of the mutual promises and benefits to be derived by both parties, hereto, that SECOND PARTY, will furnish FIRST PARTY, to be used in the drilling and completion of the said oil and/or gas well, the following property: [Description omitted.] 42 B.T.A. 69">*73 All of the approximate value of Seven Thousand Six hundred Dollars ($7,600.00), which FIRST PARTY agrees to take and use in the drilling of said oil well, and in payment thereof, agrees to, and hereby does, give the SECOND PARTY, twenty-five1940 BTA LEXIS 1057">*1065 per cent (25%) per cent of one hundred per cent (100%) of the oil, gas and other hydro-carbon substances produced from the said premises previously described, until such time as said SECOND PARTY has been reimbursed from the income of said twenty-five per cent (25%) for the actual cost to them of the above listed equipment. After said SECOND PARTY has been so reimbursed, its interest shall be ten per cent (10%) of one hundred per cent (100%) of the said production from the said well. The twenty-five per cent (25%) and the ten per cent (10%) referred to is not to be subject to any drilling cost, but is to bear an operating charge, due and payable only from production of oil and gas produced, saved, and sold from the above mentioned property, as follows: * * * In no event shall the fifteen per cent (15%) additional royalty assigned to repay the cost of equipment furnished by the SECOND PARTY, be chargeable with any operating expense whatsoever, and shall only be liable for its pro rata share of mineral rights, taxes assessed against production from above referred to well. In the event the amount spent by said SECOND PARTY for the above referred to equipment is more than Seven1940 BTA LEXIS 1057">*1066 Thousand Six Hundred Dollars ($7,600.00), or in the event that the cost thereof shall be less than that sum, the difference will be adjusted in cash between the parties in question at the earliest possible time, following completion of said well. It is further agreed that if for any reason FIRST PARTY abandon the drilling of same before said well is completed, that second party, at its option, may complete the said well, in which event, said SECOND PARTY shall reimburse itself for said completion out of the available royalty owned by both parties, after which it shall reimburse FIRST PARTY for its actual expense. The FIRST PARTY warrants that the consent of the landowner to permit a completion of said well by SECOND PARTY shall have been obtained in writing prior to the execution of this agreement. It is further agreed that in the event of the bankruptcy, insolvency of FIRST PARTY or in the event that a receiver in equity be appointed, or a receiver be appointed otherwise, or in the event of attachement or levy of execution, that in such event SECOND PARTY may complete said well and reimburse itself therefor out of the available royalty owned by both parties, and it is further1940 BTA LEXIS 1057">*1067 warranted that the consent of the landowner to this proviso shall have been obtained in writing prior to the execution of this agreement. It is further agreed that in case of production being obtained on said property, that FIRST PARTY shall have the right to contract for the sale of the SECOND PARTY'S oil, at a price per barrel posted and freely offered by the Standard Oil Company, Shell, Union and General Petroleum Corporation. In case a different price is posted by these Companies, then the average of these prices shall be the price for which FIRST PARTY shall settle with SECOND PARTY, and settlement for same to be made in money not later than the 25th day of the following month in which any oil shall have been sold. FIRST PARTY agrees to order the payment of oil to be made direct by purchasing company to SECOND PARTY. FIRST PARTY shall also have the right to contract for the sale of gas and other hydro-carbon substances, produced, saved, or sold from the above described premises, and to remit in money to said SECOND PARTY for its share, as provided above. 42 B.T.A. 69">*74 It is further agreed that in no event is it the intention of the parties to enter into a partnership agreement1940 BTA LEXIS 1057">*1068 of any kind or nature whatsoever. It is further agreed that FIRST PARTY will, at all times, carry ample and complete workmen's compensation insurance. IN WITNESS WHEREOF, the parties hereto have set their hands and seals the day and year in this agreement first above written. WEST AMERICAN OIL COMPANY, By H. S. KOHLBUSH, PresidentBy H. S. GIMBAL, Secretary First PartyKIESAU PETROLEUM CORPORATION By A. H. KIESAU, PresidentBy R. M. KIESAU, SecretarySecond Party.Petitioner during the taxable years had an economic interest in oil in place by virtue of said contracts and was entitled to deduct depletion calculated on the income therefrom. The income derived by petitioner during the taxable years from the eight wells pursuant to the contracts above described was not income derived from royalties within the meaning of section 351 of the Revenue Acts of 1934 and 1936. Petitioner was not a personal holding company during said years. Petitioner failed and refused to file a return for either of the years 1935 or 1936 on Form 1120-H. Petitioner is not liable for the 25 percent penalty for failure to file said returns. OPINION. 1940 BTA LEXIS 1057">*1069 KERN: The primary question before us is whether 80 per centum of petitioner's gross income for the taxable years was derived from "royalties" as the word is used in section 351(b)(1) of the Revenue Acts of 1934 and 1936, set out in the margin. 1 If it was so derived, then petitioner must be considered as a personal holding company within the meaning of those acts. Petitioner concedes that the income derived from the oil well which it owns "is derived from royalties", but contends that its interests in the other eight oil wells were merely participating interests1940 BTA LEXIS 1057">*1070 and the income which petitioner derived from them pursuant to the contracts described in our findings, and constituting more than 80 per centum of its gross income, can not be considered as being derived from royalties. 42 B.T.A. 69">*75 These contracts were executed between petitioner and the owners of various oil leases, and provided that, in consideration of certain equipment furnished by petitioner, the owner of the lease would give petitioner a certain percentage of the proceeds received from the sale of oil produced from the well situated on the property. Is the interest in the oil thus acquired by petitioner a "royalty" within the meaning of the revenue acts? In construing the words contained in a statute our first resort should be to the natural, ordinary, and familiar meaning of the words used, unless Congress has definitely indicated an intention that the words should be construed otherwise. We, therefore, turn to the definitions of the word "royalty" as found in the following dictionaries: Webster's New International Dictionary defines the word "royalty" as "(a) A share of the product or profit (as of a mine, forest, etc.) reserved by the owner for permitting another to1940 BTA LEXIS 1057">*1071 use the property. (b) A duty or compensation paid to the owner of a patent or a copy-right for the use of it or the right to act under it, usually at a certain rate for each article manufactured, used, sold, or the like; also, a percentage, as an output, paid to the owner of an article, especially a machine, by one who hires the use of it." In Black's Law Dictionary, 3d ed., the word "royalty" is defined as "A payment reserved by the grantor of a patent, lease of a mine, or similar right, and payable proportionately to the use made of the right by the grantee." Ballentine's Law Dictionary defines the word "royalty" as "Rent based upon the amount of mineral or oil taken from the ground; * * * As applied to oil and gas leases the term signifies the compensation provided in such a lease for the privilege of drilling on the premises for oil and gas, and consists of a share in the oil and gas produced under the lease. The royalty interest does not consist of a perpetual interest in the oil or gas as they lie in the ground, but, on the expiration of the lease, the right of the owner of the royalty expires." It is apparent from these definitions that the word "royalty" refers to an1940 BTA LEXIS 1057">*1072 interest reserved by the owner in return for permission to use the property owned. To take examples from the oil industry, the interest reserved by the owner of the fee to be paid by the lessee out of oil produced would be a royalty, as would also be the interest reserved by the owner of the leasehold to be paid by a sublessee from the oil produced. In , we referred to "royalty" in the following language: * * * The word "royalty" as used in a gas lease generally refers to "a share of the product or profit reserved by the owner for permitting another to use the property." ; . It is compensation for the privilege of drilling and producing oil and gas and consists of a share in the product. . In the instant case the petitioner, by the contracts referred to, did not reserve an interest in the oil producing properties; it acquired such an interest for the first time. It acquired a percentage of the interest of the lessees and was to share with them in the1940 BTA LEXIS 1057">*1073 oil produced from the leased properties. Certainly the interests of the lessees in the oil produced from the properties held by them on lease could not be considered royalties. We conclude that the ordinary meaning of the word "royalties" does not embrace the interest held by petitioner under the various contracts with lessees of oil producing properties. Does the word "royalties" have a technical meaning peculiar to the oil industry which would embrace petitioner's interests? If it does, it may be that Congress was using the word in this special sense. The record in this case contains uncontradicted testimony to the effect that according to the terms used in the oil industry, petitioner's interest was known as a "participating interest" and not as a "royalty," and that the word "royalty" was only used to describe the interest of the owner of the fee of oil producing land reserved upon lease ("a landowner's royalty") and the interest of a lessee in cases of sublease ("an overriding royalty"). Therefore, we must conclude that the word "royalties" has no technical or commercial meaning different from its ordinary and normal meaning. Nor is there anything in the revenue acts1940 BTA LEXIS 1057">*1074 which would indicate that Congress intended this word to have any meaning other than ordinary and normal. Petitioner here acquired by contract for a consideration an interest in the natural resources of oil producing property. This was not a royalty. Respondent lays great stress on the fact that the contracts refer to petitioner's interest as a "royalty interest." However, if petitioner's interest was not in fact a "royalty" in the sense that that term was used by Congress, it matters not what label is given it by a contract between individuals. We are concerned with the rights created by the contract, and with the labels used only to the extent that they may be helpful in a construction of the contract. Here the contract is unambiguous, and, therefore, the label attached by the scrivener to petitioner's interest is immaterial. For the reasons above stated, we conclude that 80 per centum of petitioner's income was not derived from royalties within the meaning of section 351(b)(1), and petitioner is not a personal holding company. 42 B.T.A. 69">*77 Respondent argues in the alternative that no depletion is allowable to petitioner in the event that we conclude, as we have concluded, 1940 BTA LEXIS 1057">*1075 that petitioner's income is not derived from royalties. He says in his brief: "To place the income received by petitioner beyond the bounds of royalty income must of necessity remove it from its classification of income subject to depletion." For this proposition of law he cites no authority. With it we can not agree. The right of a lessee of oil producing property to a depletion deduction can not be based upon any concept of royalty. The right to depletion depends upon an economic interest in oil in place acquired as a capital investment. See ; ; ; . From an examination of the contracts introduced in evidence in this proceeding we are of the opinion that petitioner had such an interest and is entitled to depletion. Certain provisions present in the contracts persuade us to this result. Among them are the following: "After said Second Party [petitioner] has been reimbursed as aforesaid, its interest shall be a permanent 7 1/2% of 100% of the said production1940 BTA LEXIS 1057">*1076 from said well"; "* * * First Party shall have the right to contract for the sale of the Second Party's oil * * *"; "* * * First Party * * * hereby does give the Second Party twenty-five percent (25%) of one hundred percent (100%) of the oil * * * produced from the said premises * * *"; and "After said Second Party has been so reimbursed, its interest shall be ten percent (10%) of one hundred percent (100%) of the said production of the said well." These provisions indicating the acquisition by petitioner of oil in place as a capital investment being present in the contracts before us, the decision of , is not applicable to the facts of the instant proceeding. Since we have concluded that petitioner is not a personal holding company, it follows of course that it was not obliged to file a return as such, and is not liable for the payment of any penalty for failure to do so. Reviewed by the Board. Decision of no deficiency will be entered.MELLOTT and ARNOLD dissent. MURDOCK MURDOCK, dissenting: I dissent from the holding of the majority that the petitioner is not a personal holding company. Footnotes1. SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES. * * * (b) Definitions. - As used in this title - (1) The term "personal holding company" means any corporation * * * if - (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals, * * * ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622996/ | Edward I. Weinroth & Eva Weinroth, Petitioners, v. Commissioner of Internal Revenue, RespondentWeinroth v. CommissionerDocket No. 67104United States Tax Court33 T.C. 58; 1959 U.S. Tax Ct. LEXIS 63; October 19, 1959, Filed 1959 U.S. Tax Ct. LEXIS 63">*63 Decision will be entered under Rule 50. Held, petitioner, a high school teacher, is not entitled to a "sick pay" exclusion under section 105(d) of the Internal Revenue Code of 1954 for wages paid him while he was incapacitated during his summer vacation. Zachary S. Zimmerman, Esq., for the petitioners.Norman L. Rapkin, Esq., for the respondent. Mulroney, Judge. MULRONEY 33 T.C. 58">*58 OPINION.Respondent determined a deficiency of $ 233.84 in petitioners' income tax for the year 1955. The1959 U.S. Tax Ct. LEXIS 63">*64 sole question for decision is whether petitioners are entitled to a "sick pay" exclusion under section 105(d) of the Internal Revenue Code of 1954. 1All facts have been stipulated and they are found accordingly.Edward I. Weinroth (hereinafter called petitioner) and his wife, Eva, filed a joint income tax return for the year 1955 with the district director of internal revenue, Brooklyn, New York.During the calendar year 1955 petitioner was employed as a teacher by the Board of Education of the City of New York. Under such employment petitioner was subject to the New York State Education Law and the bylaws of the board of education. Article I, section 2, 33 T.C. 58">*59 paragraph 15, of the New York State Education Law is and was during the period here involved as follows:15. School year. The term "school year" means the period commencing on the first day of July in each year and ending on the thirtieth day of June next following.Article X, section1959 U.S. Tax Ct. LEXIS 63">*65 90, paragraph 37, of the bylaws of the board of education is and was during the period here involved as follows:37. The vacations and holidays allowed in the public schools shall be as follows: Every Saturday throughout the year; the 12th day of October; Election Day; the eleventh day of November; Thanksgiving Day and the day following; the 25th day of December to the 1st day of January and the intervening days; the 12th day of February; and the 22nd day of February; the day commonly known as Good Friday and the week following; the 30th day of May; the next day following any day above specified when such day shall be Sunday; in the Borough of Brooklyn, Anniversary Day; in the Borough of The Bronx, Borough Day; and the interval between the 30th day of June and the second Monday in September.During the calendar year 1955 petitioner was assigned by the board of education to Abraham Lincoln High School, in Brooklyn, New York.In June 1955, Gabriel R. Mason, then principal of Abraham Lincoln High School, requested petitioner to perform the following tasks:(a) Revision of the lesson planning in General Science to conform with the projected new syllabus in that subject, and(b) To review1959 U.S. Tax Ct. LEXIS 63">*66 a number of text books in General Science for the purpose of selecting a book for use at Lincoln High School.It was anticipated by Gabriel R. Mason and petitioner that such tasks would be performed and completed during July and August 1955. Gabriel R. Mason did not directly order petitioner to perform and complete such tasks during July and August 1955, but rather, petitioner agreed to comply with Gabriel R. Mason's request.Gabriel R. Mason had no authority from the board of education or from the superintendent of schools to require a teacher to work during the months of July and August 1955, nor to assign a task or tasks during this period which, if performed, would deprive the teacher of his summer vacation. Likewise, the superintendent of schools had no authority from the board of education to require such work or to make such assignment during the calendar year 1955. Nothing contained in the New York State Educational Law or the bylaws of the board of education precluded petitioner from voluntarily complying with Gabriel R. Mason's request.On July 1, 1955, petitioner began to perform the tasks requested but terminated such efforts on July 3, 1955, because of a painful 1959 U.S. Tax Ct. LEXIS 63">*67 back condition. Petitioner was hospitalized for this painful back condition from July 5 to July 19, 1955, and he remained incapacitated during 33 T.C. 58">*60 July and August 1955. He did not recover until September 9, 1955. Classes for the 1955-1956 school year began at Abraham Lincoln High School, as at all other New York City schools, on September 12, 1955, at which time petitioner reported for duty as a teacher.The bylaws of the board of education provided that a teacher will be entitled to 10 days of sick leave with pay per year. Such unused sick leave may be accumulated up to a maximum of 200 days.Pursuant to article IV, section 106(3) of the bylaws of the board of education a teacher would be charged with sick leave when absent from work during a school day, Monday through Friday. A teacher would not be charged with sick leave when sick on a Saturday, Sunday, legal holiday and/or Christmas, spring, or summer vacations.Petitioner was not charged with any sick leave, either annual or accumulated, because of any sickness or injury sustained by petitioner during the period July 1 through September 9, 1955.In his income tax return for 1955 petitioner excluded $ 914.28 from his 1959 U.S. Tax Ct. LEXIS 63">*68 gross income as "sick pay," because of his sickness during the period July 3 to September 9, 1955, and respondent, in the 90-day letter, disallowed this exclusion explaining "the amount of $ 914.28 has been disallowed as not deductible within the meaning of section 105(d) of the Internal Revenue Code of 1954."Section 105(d)2 allows an employee to exclude from gross income certain amounts which "constitute wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injuries or sickness." Petitioner reported receiving wages from the Board of Education of New York City in the total sum of $ 7,175.45 for the year 1955. His teaching contract is not in evidence and it is not specifically stipulated that petitioner received one-twelfth of his annual salary each month. However, petitioner pleaded that he was paid one-twelfth of his annual salary each month and, though respondent denied this in his answer, he now concedes on brief that petitioner was, pursuant to his employment 33 T.C. 58">*61 contract, paid one-twelfth of his annual salary each month. We will assume petitioner received regular monthly salary payments during the period1959 U.S. Tax Ct. LEXIS 63">*69 of his illness which it is stipulated extended from July 3 to September 9, 1955. The only question is whether he was "absent from work" during said period. It appears from the stipulation that the illness period was wholly within petitioner's normal vacation period: i.e., between the 30th day of June and the second Monday in September. The question comes down to whether petitioner was "absent from work" within the meaning of the statute when the period of the alleged absence on account of illness falls entirely within his vacation period.1959 U.S. Tax Ct. LEXIS 63">*70 The Commissioner, in his Income Tax Regulations, section 1.105-4(a)(3)(i), et seq., issued under the 1954 Code, has stated:(i) Section 105(d) applies only to amounts attributable to periods during which the employee would be at work were it not for a personal injury or sickness. Thus, an employee is not absent from work if he is not expected to work * * *(ii) Similarly, an employee who incurs a personal injury or sickness during his paid vacation is not allowed to exclude under section 105(d) any of the vacation pay which he receives, since he is not absent from work on account of the personal injury or sickness. Likewise, a teacher who becomes sick during the summer or other vacation period when he is not expected to teach, is not entitled to any exclusion under section 105(d) for the summer or vacation period. However, if an employee who would otherwise be at work during a particular period is absent from work and his absence is in fact due to a personal injury or sickness, a payment which he receives for such period under a wage continuation plan is subject to section 105(d).(4) * * * the exclusion provided under section 105(d) is applicable only to * * * payments attributable1959 U.S. Tax Ct. LEXIS 63">*71 to a period when the employee would have been at work but for such personal injury or sickness.Petitioner does not attack these regulations as an unreasonable or arbitrary interpretation of section 105(d), but rather urges that they have no application to the present case because petitioner was "at work." We cannot agree.Petitioner was paid at a yearly rate by the board of education to teach school. His employer specifically provided in its bylaws that its teachers were to receive a summer vacation extending at least from June 30 to the second Monday in September. Petitioner was hired to, expected to, and required to teach school about 10 months out of the year. If he had done nothing during the months of July and August he would still have been entitled to the entire amount of his salary. The board of education did not expect or require that he work for it during his vacation. At the request of his principal he volunteered to undertake several projects directly connected with his job. The projects he undertook and the amount of time which it was expected he would spend on them in no way affected his annual salary or the periodic payment of it to him.33 T.C. 58">*62 While the Commissioner, 1959 U.S. Tax Ct. LEXIS 63">*72 in his regulations, has stated that all circumstances must be taken into account 3 in determining whether the employee was absent from work and has ruled 4 that the manner in which the employee's absence is reflected on the employer's records is not determinative of the rights of the employee to the exclusion, yet we think it significant that the board of education did not charge petitioner with sick leave and thus evidently did not consider him at work for the period in question.Petitioner was a volunteer doing "work" which he was not required to do, without extra compensation, during the time normally set aside for his vacation. Although we have no doubt that the projects he had undertaken may well have entailed both mental and physical effort, we must hold, on the record before us, that he cannot qualify for an exclusion under section 105(d) because he cannot be "absent from work" in a period1959 U.S. Tax Ct. LEXIS 63">*73 which is not a working period for him. 5We sustain respondent upon the issue presented. Certain adjustments were not contested and certain adjustments were conceded by respondent. Accordingly,Decision will be entered under Rule 50. Footnotes1. All section references are to the Internal Revenue Code of 1954.↩2. SEC. 105. AMOUNTS RECEIVED UNDER ACCIDENT AND HEALTH PLANS.(a) Amounts Attributable to Employer Contributions. -- Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer.* * * *(d) Wage Continuation Plans. -- Gross income does not include amounts referred to in subsection (a) if such amounts constitute wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injuries or sickness; but this subsection shall not apply to the extent that such amounts exceed a weekly rate of $ 100. In the case of a period during which the employee is absent from work on account of sickness, the preceding sentence shall not apply to amounts attributable to the first 7 calendar days in such period unless the employee is hospitalized on account of sickness for at least one day during such period. If such amounts are not paid on the basis of a weekly pay period, the Secretary or his delegate shall by regulations prescribe the method of determining the weekly rate at which such amounts are paid.↩3. Income Tax Regs., sec. 1.105-4(a)(5)↩.4. Rev. Rul. 55-85, 1955-1 C.B. 15↩.5. See Income Tax Regs., sec. 1.105-4(b)↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622997/ | Estate of Helen Thompson, Deceased, Girard Trust Corn Exchange Bank, Executor v. Commissioner.Estate of ThompsonDocket No. 61834.United States Tax CourtT.C. Memo 1958-100; 1958 Tax Ct. Memo LEXIS 126; 17 T.C.M. 510; T.C.M. (RIA) 58100; May 29, 1958Clarence E. Hall, Esq., 1710 Locust Street, Philadelphia, Pa., for the petitioner. Stephen P. Cadden, Esq., for the respondent. WITHEYMemorandum Findings of Fact and Opinion WITHEY, Judge: A deficiency in estate tax in the amount of $7,494.90 has been determined by the Commissioner against the petitioner. The issue presented for our decision is whether certain bequests by decedent of remainders to charities are deductible as charitable gifts under section 812(d) of the Internal Revenue Code of 1939. Findings of Fact Facts which have been stipulated are so found. Helen Thompson, a resident of Philadelphia, Pennsylvania, was born December 22, 1864, lived all her life in that city and died a spinster on January 5, 1954, testate. 1958 Tax Ct. Memo LEXIS 126">*127 Her last will and testament executed May 16, 1951, and two codicils thereto were duly probated in Philadelphia County, Pennsylvania, having been filed for probate on January 19, 1954. Girard Trust Corn Exchange Bank and Thomas B. Lewars were appointed and qualified as executors. The latter died April 19, 1956. Prior to his death the executors filed their estate tax return April 4, 1955, with the district director of internal revenue at Philadelphia. The return disclosed a gross estate of $828,639.74 and a net estate for basic tax of $699,338.35. The executors, in computing the net estate for basic tax, deducted from the gross estate the amount of $22,405.75 as being their estimate of the total present worth of decedent's bequests of remainder interests to 4 conceded charities following a life estate to her friend, Katharine Martin, also a spinster, of New York City. Decedent's will, insofar as here pertinent, provided as follows: "NINTH: I give and bequeath to my Trustees hereinafter named the sum of Twenty-five Thousand Dollars ($25,000.00) IN TRUST, nevertheless, to, and for and upon the following uses, intents and purposes: to invest, reinvest and keep the same invested and1958 Tax Ct. Memo LEXIS 126">*128 to receive all rents, interest, income and profits, and after deducting all necessary and lawful charges therefrom to pay the net income thereof to my friend, KATHARINE MARTIN, of New York, for her life. "Trustees may in their sole discretion apply the income of this Trust for the maintenance and support of the beneficiary, should she by reason of age, illness or any other cause, in the opinion of trustees, be incapable of disbursing it. "Trustees may further expend out of principal of this Trust such sums as trustees, in their sole discretion, may deem to be necessary for the best interests of the beneficiary, during illness or emergency of any kind. "TENTH: Upon the death of said KATHARINE MARTIN said Trust shall terminate and from said funds I give and bequeath the sum of Five Thousand Dollars ($5,000.00) each to the following charities: WOMEN'S PENNSYLVANIA SOCIETY FOR THE PREVENTION OF CRUELTY TO ANIMALS, CHILDREN'S HOSPITAL OF PHILADELPHIA, at 18th and Bainbridge Streets, Philadelphia, SEEING EYE, INC., of Morristown, New Jersey, and VISITING NURSE SOCIETY OF PHILADELPHIA." The codicil dated March 19, 1952, provided as follows: "TENTH A: If after the distribution made1958 Tax Ct. Memo LEXIS 126">*129 in accordance with Item Tenth there shall remain any balance or residue of the trust fund created in Item Ninth, I give and bequeath said balance or residue in equal shares to said charities: WOMEN'S PENNSYLVANIA SOCIETY FOR THE PREVENTION OF CRUELTY TO ANIMALS, CHILDREN'S HOSPITAL OF PHILADELPHIA. SEEING EYE, INC., and VISITING NURSE SOCIETY OF PHILADELPHIA, it being my intention that the entire balance or residue of said trust fund should be distributed to and among said charities." In addition, decedent bequeathed $1,000 to Katharine to be paid her "at once." In due course in accordance with decedent's bequests the above-named executors as co-trustees came into possession of $25,000 of decedent's estate which they proceeded to administer under the terms of those bequests. Decedent and Katharine Martin had been friends from their childhood. At her death and for many years prior thereto decedent had been a wealthy woman while Katharine had for many years lived without an income. She had been and at decedent's death still was subsisting solely on the amount of $125 each month which was given to her by decedent. She was aged at decedent's death, having been born July 16, 1865, but1958 Tax Ct. Memo LEXIS 126">*130 was in reasonable health and not under a doctor's care. She resided alone in an apartment in New York City for which she paid $85 monthly rental. On March 2, 1956, Katharine suffered accidental injuries from which she failed to recover and died March 19, 1956, leaving no estate. At no time during Katharine's life did the trust corpus produce income of $125 per month and the trustees shortly subsequent to decedent's death in their sole discretion began to supplement such income as it did produce with sufficient from the principal to provide her with that amount. At her death the total invasion of principal for Katharine's benefit amounted to $1,568.58 with an additional expenditure therefrom of $507.59 for her funeral expenses. In arriving at the least amount the charities would, in their estimation, ultimately receive at Katharine's death the executors deducted from the trust principal the sum of $2,594.25 as being their calculation of the probable total extent of the invasion of the principal for Katharine's benefit. In making their estimation they considered the beneficiary's life expectancy to be 1.66 years subsequent to the date of decedent's death. No reasonably accurate determination1958 Tax Ct. Memo LEXIS 126">*131 could be made as of the date of the death of decedent of the value of the remainder interests here involved which would at Katharine's death constitute gifts by the decedent to the 4 charities named in her will. Opinion The parties pose the issue with which we are faced in words characteristic of their respective theories of the case. As we view the issue it is whether by her will decedent with sufficient degree of certainty made a gift to charity of any of her estate so that the amount of such gift may be determined, thus allowing its deduction under section 812(d) of the 1939 Code. 1It is well settled that the discretionary right in trustees to invade the corpus of a trust for the benefit1958 Tax Ct. Memo LEXIS 126">*132 of a primary cestui que trust will not alone prevent the deduction for estate tax purposes of a remainder to charity. Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151; Commissioner v. Wells Fargo B. & U. Tr. Co., 145 Fed. (2d) 130, affirming a memorandum decision of this Court [2 TCM 113]. It is equally well settled however that the amount of such gifts must be accurately determinable on the basis of known facts existing at the date of death of the donor. Helvering v. Union Trust Co., 125 Fed. (2d) 401, reversing Estate of Carolyn G. Caughey, 44 B.T.A. 385">44 B.T.A. 385; De Castro's Estate v. Commissioner, 155 Fed. (2d) 254, affirming a memorandum decision of this Court [4 TCM 636], certiorari denied 329 U.S. 727">329 U.S. 727. See also Estate of Bartlett v. Smith, 153 Fed. Supp. 674. If the amount of the gift is accurately determinable, it logically follows that a gift in that amount has been made and if made to charities is deductible. If the amount is not accurately determinable at the donor's death, logically no completed gift has been made either in law or fact. Helen Thompson clearly1958 Tax Ct. Memo LEXIS 126">*133 in her will evidenced a desire and intent to provide sufficient income to be paid to or disbursed for the benefit of her lifelong friend in accordance with her standard of living established over the years by her expenditures for the friend's support, i.e., at the rate of $125 per month. However, this was equally clearly not her sole objective. She was aged herself and had known the circumstances of Katharine for many years. She knew of the infirmities attendant upon old age and that they are many and varied. She knew Katharine as her years advanced was apt to become a more ready victim to disease and accidental injury. She knew Katharine, in case she were felled by one or the other, being without other means of defraying the expenses incident to illness or injury, would be dependent for her welfare solely on decedent's largesse. It is true that she in all probability calculated the life expectancy of Katharine, but we cannot discover in her will or this record any indication that Katharine's life estate or the right of the trustees to invade the corpus of the trust was to be limited by that factor. It is clear that decedent anticipated all the exigencies of life and fully intended1958 Tax Ct. Memo LEXIS 126">*134 her trustees would invade the corpus of the trust estate to whatever extent the trustees deemed necessary to protect Katharine from the consequences of "illness or emergency of any kind." Had the purpose of decedent's bequest consisted only of providing a monthly stipend for Katharine of $125, petitioner's contention might be more sound, but the purpose being as above indicated we cannot agree that Helen Thompson ever intended to or did make a gift to charity with any reasonable certainty. It is only through the occurrence of events subsequent to her death that the charities became certain of benefiting from her bequest. It is only because such subsequent events may give clarity to and understanding of the intent and desires of a testator at the date of a will that such events may be considered with respect to this issue. Assuming the existence of an estate at the death of the testator, the crucial date with respect to the intent of a testator is nevertheless the date of the will. Decedent's primary and overriding purpose in creating the trust here involved was to defray the ordinary living and emergency expenses of Katharine. If there was a remainder, it was to be donated to charity. 1958 Tax Ct. Memo LEXIS 126">*135 To say with any degree of certainty at the date of decedent's death what emergencies and illnesses might arise relating to Katharine and what the expense incidental thereto would be is not reasonably possible. Indeed, it is not too difficult to imagine a single disease the cure or attempted cure of which might necessitate the complete exhaustion of the corpus of this trust. The same may be said of many injuries arising from accidents occasioned by infirmities of advanced age. Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151, is cited by petitioner in support of its position. We think the case before us is clearly distinguishable on its facts. In Ithaca a provision was made by the testator that his wife was to be supported in her accustomed manner by the income of a trust fund with a power in the trustees to invade the corpus in their discretion for that purpose. The income from the trust was ample in consideration of the ordinary exigencies of life to defray the widow's living expense. The occasion for invading the principal of the trust was remote at the date of the donor's death. Here it is clear that should the investment of the trust fund produce the amount of income1958 Tax Ct. Memo LEXIS 126">*136 obviously calculated by the testatrix, it would be no more than sufficient to furnish the beneficiary $125 per month, in other words, sufficient only to fulfill but one purpose of the donor. Under the best of circumstances, so far as return on the invested trust fund is concerned, it was clear at decedent's death that the beneficiary's expense of any illness, injuries arising from accident and emergencies of any kind must be borne by the trust corpus. We find the petitioner has failed to meet the test of deductibility of charitable remainders established by the Supreme Court in that case, i.e., at the date of vesting of the trust estate the likelihood of invasion of the trust corpus was so remote as to permit a conclusion that the charities would ultimately receive an amount which could at the date of vesting be ascertained. We have examined other decisions cited by petitioner and find them equally distinguishable in principle from the case at bar. Decision will be entered for the respondent. Footnotes1. SEC. 812. NET ESTATE. For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate - (d) Transfers for Public, Charitable, and Religious Uses. - The amount of all bequests, legacies, devises, or transfers * * * to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622998/ | COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brand v. CommissionerDocket Nos. 8432, 8553, 8572.United States Board of Tax Appeals5 B.T.A. 297; 1926 BTA LEXIS 2884; October 30, 1926, Decided 1926 BTA LEXIS 2884">*2884 VALUATION OF PROPERTY ACQUIRED BY DEVISE. - Evidence respecting the value of properties acquired by the petitioners by devise as of March 24, 1916, held to be too indefinite and uncertain to warrant us in overthrowing the values determined by the Commissioner. R. A. Gallagher, Esq., for the petitioners. J. W. Fisher, Esq., for the respondent. TRUSSELL 5 B.T.A. 297">*297 Each of the three above-named petitioners complained of deficiency letters dated September 4, 1925, asserting deficiencies in income taxes against each of the respective petitioners, as follows: 1920.1921.Philip R. Brand$279.90$654.41Hedwig B. Gottfried87.01299.64Alfred Brand529.921,296.285 B.T.A. 297">*298 The issue presented for our consideration is, What was the true value of certain properties acquired by the petitioners by bequest from their father on March 24, 1916, which must be used as a basis for ascertaining the question of gain or loss on the sale of such properties in the years 1919 and 1920? By agreement of all parties the three actions were consolidated for hearing and decision. FINDINGS OF FACT. The three petitioners are individuals1926 BTA LEXIS 2884">*2885 residing at Chicago, Ill.Each taxpayer acquired a one-third interest in certain property by bequest and devise from their father, Rudolph Brand, who died on March 24, 1916. To facilitate and equalize the distribution of this property to the heirs, a partnership, known as the Brand Heirs Trust, was formed on July 6, 1917, consisting of the three petitioners named herein. The sales of the assets of the partnership were to be effected at prices agreeable to the members thereof and distribution of the amount realized made in cash. Each partner was to share equally with the others in the profits and losses. Approximately 60 per cent of the assets of the partnership consisted of real estate, improved and unimproved, and the balance consisted of personal property. During the years 1920 and 1921 sales of real estate were made as follows: Petitioners' valuation as of Mar. 24, 1916.Special assessments paid between Mar. 24, 1916, and date of sale.Commissions and other selling expenses.Selling price.Commissioners' valuation as of Mar. 24, 1916.Properties sold during the year 1920.Group A - 4 lots in Rose Park subdivision$3,125.00$538.20$94.40$3,000.00$3,060.00Group B - 3 lots in Blue Island750.0057.72143.70750.00495.00Group C - Palos farm, 132.8 acres84,770.004,540.5072,490.0060,000.0088,645.00595.924,778.5076,240.0063,555.00Properties sold in 1921.Group D - 1 lot Hale subdivision500.0068.924.50650.00600.00Group E - 1 lot in Blue Island600.0011.67149.50700.00200.00Group F - 4 lots in Blue Island1,000.00178.97110.251,225.00620.00Group G - Murphy farm 155 1/4 acres41,771.25759.4440,000.0024,000.0043,871.25259.561,023.6942,575.0025,420.001926 BTA LEXIS 2884">*2886 In the foregoing tabulation, the figures of special assessments, selling expenses and selling price were established either by evidence or by agreement of the parties to these proceedings. The Commissioner's valuations as of March 24, 1916, as to all the properties except the Palos Farm, Group C, are the values stated in an appraisal made for the purposes of the Illinois state inheritance tax. The Commissioner's valuation as of March 24, 1916, for the 5 B.T.A. 297">*299 Palos Farm was $60,000, which amount is in excess of the valuation for state inheritance tax purposes. The valuations as of March 24, 1916, claimed by the petitioners are the result of an appraisal made in the year 1922 as of March 24, 1916, by an experienced real estate agent and dealer of Chicago. OPINION. TRUSSELL: At the trial of these actions the petitioners produced as a witness the same real estate dealer who made the appraisals upon which the petitioners rely and which they claim to be the true values as of March 24, 1916. This witness' testimony respecting the properties described in groups A, B, D, E and F does not convince us of the value claimed, and we must, therefore, conclude that the Commissioner's1926 BTA LEXIS 2884">*2887 valuations are representative of the true values on the date when the properties were acquired by the petitioners. As to the properties included in groups C and G, the witness' testimony shows that these properties are farms is the environs of the City of Chicago, and the witness testified that during the years 1915, 1916 and 1917, various farms somewhere in the near neighborhood had been acquired for the Chicago Forest Preserve and that such farms had been purchased at various prices ranging from $250 to $500 per acre. None of the farms so purchased for the forest preserve were identified, either as to location, character of land, or improvements, nor did the witness state how far any of such forest preserve property was from the properties here under consideration. The witness' valuation of the Palos Farm was, land $59,760, improvements $25,010, which is the equivalent to about $452 per acre, exclusive of the improvements, and his description of the farm indicated that he regarded it in the light of a gentleman's farm and that much of the cost of improvements was in landscaping and shrubberies, which might be of special value to the owner causing them to be made, but of little1926 BTA LEXIS 2884">*2888 value to a buyer, and would add little to the general market value of the property. This witness' valuation of Group G, the Murphy Farm, was, land $34,931.25, improvements $6,840. This value placed upon the land is the equivalent of approximately $225 per acre, exclusive of the improvements, and he described the farm as being poor farm land, very little tillable, and the buildings as being hardly worth talking about. There were also introduced in evidence certificates of appraisal made by the valuation committee of the Chicago Real Estate Board in 1924, as of March 24, 1916, of which valuation committee the 5 B.T.A. 297">*300 witness hereinabove described was a member. The aggregate of values shown by these certificates is slightly in excess of the values claimed by the petitioners. In view of all the testimony which we have here briefly summarized, we have arrived at the conclusion that it is not of such a character as will warrant us in overthrowing the values determined by the Commissioner, and we are of the opinion that the gain or loss upon the sale of each of the several groups of property herein under consideration must be computed on the valuations determined by the Commissioner1926 BTA LEXIS 2884">*2889 as of March 24, 1916, plus the special assessments paid by the petitioners between that date and the date when the properties were sold, and the selling price less selling expenses, as hereinabove shown. A redetermination of deficiencies in each case will be made upon 15 days' notice, pursuant to Rule 50, and judgment entered thereon in due course. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4622999/ | CONTINENTAL EQUITIES, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentContinental Equities, Inc. v. CommissionerDocket Nos. 7224-70, 6451-73.United States Tax CourtT.C. Memo 1974-189; 1974 Tax Ct. Memo LEXIS 129; 33 T.C.M. 812; T.C.M. (RIA) 74189; July 25, 1974, Filed. Robert A. Shupack and Eugene M. Short, Jr., for the petitioner. Joel Gerber, for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined the following deficiencies in petitioner's Federal income tax: Taxable year ended August 31 1Deficiency 1966$29,971.38196715,599.23196836,727.89196945,248.04197049,808.44Petitioner is a Florida corporation whose principal place of business was in Coral Gables, Florida, at the time of filing its petition herein. Petitioner filed its Federal income tax return for 1966 with the district director of internal revenue, Jacksonville, Florida, and its returns for 1967 through 1970 with the Director of the Southeast Service Center, Internal Revenue Service, Chamblee, Georgia. All of the facts herein have been stipulated. Petitioner concededly had net operating1974 Tax Ct. Memo LEXIS 129">*131 losses for its taxable years 1964 and 1965. The question before us is whether those losses, as respondent contends, should be held to be fully absorbed by petitioners' net long-term capital gain for the taxable year 1966, a year in which the alternative tax under section 1201 applies, 2 or whether, as petitioner contends, it is entitled to carry forward such losses to subsequent eligible years before us 3 in which the regular tax under section 11 applies. The parties agree that petitioner should prevail unless we decide to depart from our holding in , affirmed per curiam, (C.A. 1, 1970). Respondent urges us to reconsider the correctness of our holding1974 Tax Ct. Memo LEXIS 129">*132 in Chartier. This Court and others have considered and followed that holding on numerous occasions in the recent past. 4 Respondent's brief herein simply reiterates arguments, albeit with some refinement, which were fully considered and rejected either in Chartier or its progeny. We remain convinced of the soundness of Chartier and follow it in this case. 51974 Tax Ct. Memo LEXIS 129">*133 In order to reflect the concessions of the parties in regard to other issues, Decisions will be entered under Rule 155. Footnotes1. Petitioner's taxable years ending August 31 will hereinafter be denoted by the calendar years in which they end. ↩2. Statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue. ↩3. The last year before us in which the 1964 net operating loss can be used is the taxable year 1969 and the last year in which the 1965 net operating loss can be used is the taxable year 1970. See section 172(b) (1) (B).No claim that such losses should be carried back under section 172(b) (1) (A) (i) is involved herein. ↩4. Olympic Foundry Co. v. United States, an unreported case ( U.S.T.C. par. 9299), affirmed per curiam, (C.A. 9, 1974); Naegele v. United States, [*] F. Supp. [*] ( U.S.T.C. par. 9696); , on appeal (C.A. 6, Feb. 8, 1974); , on appeal (C.A. 4, Nov. 5, 1973). ↩5. We note that in each of the years 1966 through 1969, petitioner's deductions were in excess of its ordinary income but less than the sum of its ordinary income and net long-term capital gain. We have not been asked to decide whether, under such circumstances, petitioner has a net operating loss for any of those years - an issue which we expressly leave unanswered as we did in , on appeal (C.A. 3, April 23, 1974). ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623000/ | RICHLANDS MEDICAL ASSOCIATION, Petitioner v COMMISSIONER OF INTERNAL REVENUE, RespondentRichlands Medical Ass'n v. Comm'rDocket No. 16595-86United States Tax CourtT.C. Memo 1990-660; 1990 Tax Ct. Memo LEXIS 735; 60 T.C.M. 1572; T.C.M. (RIA) 90660; December 31, 1990, Filed Decisions will be entered under Rule 155. R. David Barbe and Joseph Anthony, for the petitioner. Scott Anderson, for the respondent. WELLS, Judge. WELLS*2232 Respondent determined deficiencies in petitioner's Federal income tax as follows: Taxable Year1 Additions to Tax Under Section EndedDeficiency6653(a)(1)6653(a)(2)10/31/82$ 637,376.44$ 31,868.82*10/31/83602,206.6130,110.33*The issues to be decided are: (1) whether petitioner is taxable as a corporation or as a partnership; (2) the amount of compensation to be allowed as a deduction to petitioner for payments to its owner-employees; and (3) whether petitioner is liable for additions to tax under sections 6653(a)(1) and (2). FINDINGS OF FACT General Background and Entity ClassificationSome of the facts are stipulated and are found accordingly. The stipulations and attached exhibits are incorporated herein 1990 Tax Ct. Memo LEXIS 735">*736 by reference. At the time the petition in the instant case was filed, Richlands Medical Association was a professional association under the laws of the State of Virginia with its principal place of business in Richlands, Virginia. In 1917, the Mattie Williams Hospital (the Hospital) began operations in Richlands, Virginia. The Hospital was owned by Dr. W. R. Williams until his death in 1961, at which time ownership passed to Dr. Williams' heirs (some or all of whom are referred to herein as "the Williams heirs"). The Hospital was a relatively small facility, containing 76 beds, and was located in a rural, mountainous area. The predominant business activity in the area of the Hospital was coal mining. The services provided by the Hospital included emergency room service, electrocardiography, sonography, radiology, obstetrics, surgery, intensive care, and pediatrics. During 1962, Richlands Medical Association (petitioner) was organized pursuant to the Professional Association Act of Virginia, section 54-873 et seq., Code of Virginia (the Virginia Act), 2 for purposes including the practice of medicine and the operation of a general hospital. In accordance with the Virginia Act, 1990 Tax Ct. Memo LEXIS 735">*737 articles of association were adopted for petitioner. Between 1962 and 1964, petitioner operated the Hospital without a written lease from the Williams heirs. Between 1964 and 1986, petitioner operated the Hospital pursuant to a series of written lease agreements and a financing agreement entered into with the Williams heirs. On October 26, 1981, petitioner's articles of association were amended. The amended articles of association (Articles) remained in effect throughout the years in issue, in addition to bylaws (Bylaws) governing the affairs of petitioner. The owners, or "members," of a professional association organized under the Virginia Act are referred to as its "associates," and each associate is entitled to a "certificate of ownership" evidencing the proportional part of the association owned by him. Virginia Act sections *2233 54-874(1), 54-888. The Virginia Act also provides that all associates of a professional association must be employees of the association and must be licensed to practice the profession for which the association is organized. Virginia Act sections 54-885, 54-888, 54-890. Petitioner's Articles listed 1990 Tax Ct. Memo LEXIS 735">*738 its associates as Doctors James H. McVey, William R. Strader, Ernest E. Moore, and Emile I. Khuri and listed those same individuals as petitioner's initial Board of Directors. Dr. Strader died during petitioner's taxable year ended October 31, 1982. Pursuant to the authority of section 54-889 of the Virginia Act, upon the death of one of petitioner's associates, the associate's certificate of ownership was to be returned to petitioner. Starting in mid-1982 and continuing for the remainder of the taxable years in issue, Doctors McVey, Moore, and Khuri were the sole associates of petitioner and were also the sole members of its Board of Directors. 31990 Tax Ct. Memo LEXIS 735">*739 On various occasions, they were required to guarantee or endorse loans (including a line of credit) obtained by petitioner. Under the Virginia Act, the board of directors of a professional association must be composed of at least three persons. Virginia Act section 54-882. The Bylaws provided that petitioner's Board of Directors could consist of between three and seven persons. 4 Vacancies in the Board of Directors were to be filled by the Board of Directors, and the person elected to fill a vacancy would hold office until the next annual meeting of the associates at which directors were to be selected. A majority of the Directors in office were necessary to constitute a quorum for the transaction of business, and any question before the Board was to be determined by majority vote. Moreover, 1990 Tax Ct. Memo LEXIS 735">*740 the Board could, by two-thirds vote, expel an associate. The Bylaws provided that petitioner's Board of Directors could hold its meetings at such times and places as it might designate, but was required to hold at least one meeting per quarter. During the taxable years in issue, petitioner's Board of Directors held at least 26 meetings, the minutes of which were recorded by petitioner's Executive Secretary pursuant to responsibilities outlined in the Bylaws. At those meetings, a variety of matters relating to the operation of the Hospital were discussed and voted upon, including: hiring decisions with respect to nonowner physicians, collections, pay raises and other personnel matters, purchases and leases of property, pension matters, litigation involving petitioner, and retention of accountants. The meetings sometimes were called on very short notice, depending on the urgency of the matters requiring attention. The Bylaws provided 1990 Tax Ct. Memo LEXIS 735">*741 for the employment of a Hospital administrator who was to act as the representative of the Board of Directors in the management of the Hospital. The hospital administrator, however, was required to obtain approval from the Board of Directors for all expenditures not necessary to the everyday operation of the Hospital in excess of $ 1,000. During the taxable years in issue, petitioner leased the Hospital from the Williams heirs under a seven year lease (the lease) commencing November 1, 1976, and ending October 31, 1983, for a monthly rental of $ 10,000. The lease provided that any fixtures, furniture, equipment or instruments purchased by petitioner, as well as any outstanding accounts receivable of petitioner, would become the property of the Williams heirs upon termination of the lease. The lease also provided that it would automatically terminate if, for any reason, petitioner had less than three members. The lease was signed by the President of petitioner solely on behalf of petitioner. On November 1, 1977, petitioner, its associates, and the Williams heirs entered into an amendment to the lease and a financing agreement. The financing agreement provided that petitioner would 1990 Tax Ct. Memo LEXIS 735">*742 be the maker of a note (the note), to be endorsed by petitioner's associates, evidencing a loan of up to $ 800,000, which amount was needed to finance construction necessary to maintain licensure and accreditation for the Hospital under standards prescribed by the Virginia State Health Department. Additionally, the Financing Agreement provided that the lease would be extended for a term coincident with the term of the note, and that a person mutually acceptable to the Williams heirs and to petitioner would serve as petitioner's Hospital administrator. On February 18, 1978, the note, in the amount of $ 800,000 payable in eight annual *2234 installments, was executed by petitioner and endorsed by its associates, who assumed joint and several liability on the note. Because the last installment of the note was due on October 15, 1986, the lease was extended until that date. No further extensions of the lease occurred subsequent to October 1986, and petitioner ceased operations in December 1986. Petitioner's Articles provided that "the duration of the association is to be perpetual." Petitioner consistently filed its Federal income tax returns as a corporation on Form 1120. Reasonable 1990 Tax Ct. Memo LEXIS 735">*743 CompensationDuring the years in issue, petitioner paid its associates the following amounts, and deducted such amounts as compensation of officers (Schedule E, Form 1120): 5Year EndedYear EndedAssociate10/31/8210/31/83Dr. James McVey$ 977,778$ 873,298Dr. Emile Khuri702,524672,871Dr. Ernest Moore566,552523,831Respondent, in his notice of deficiency, allowed as a compensation deduction with respect to each associate an amount equal to 100 percent of the "collections" recorded by petitioner as attributable to medical services performed directly for patients by such associate. The following chart illustrates the amount of such "collections" allowed by respondent, in addition to the amounts recorded by petitioner as "billed" for the medical services of each associate during the years in issue: 6Year Ended 10/31/82Year Ended 10/31/83AssociateBillingsCollectionsBillingsCollectionsDr. James McVey$ 622,260.36$ 397.556.12$ 592,470.60$ 324,759.38Dr. Emile Khuri363,641.51241,014.39426,434.13231,435.84Dr. Ernest Moore310,204.46191,713.62302,641.13162,467.941990 Tax Ct. Memo LEXIS 735">*744 A comparison of the compensation paid to each associate with "billings" and "collections" indicates that each associate was paid, during the years in issue, not only substantially more than the collections recorded for his services but also substantially more than the billings for his services. For example, Dr. McVey's pay for the year ended 10/31/82 was approximately 157 percent of his billings and 246 percent of his collections; Dr. Khuri's pay for such year was approximately 193 percent of billings and 291 percent of collections. Dr. McVey received his medical degree from the University of Virginia in 1957 an began his practice at the Hospital in 1958. His specialty was family medicine. On a daily basis, Monday through Friday, Dr. McVey saw an average of approximately 60 outpatients; on Saturdays, he saw an average 1990 Tax Ct. Memo LEXIS 735">*745 of 30-40 outpatients. Additionally, Dr. McVey saw approximately 40 inpatients on a daily basis. Dr. Khuri received his medical degree from the American University of Beruit in 1968. He began his practice in 1974 after completing four years of general surgery residency in Lebanon and two years of thoracic surgery residency at the University of California at Irvine. Dr. Khuri, who served as petitioner's President during the years in issue, worked at the Hospital about 55-60 hours per week in addition to hours "on call." He saw an average of approximately 25 outpatients and 7-8 inpatients per day at the Hospital. There were no employment contracts fixing the renumeration of petitioner's associates. The Bylaws, however, provided that: The Board of Directors at the end of the fiscal year shall divide the net profits in the following manner: 25.0% of the profits shall be divided equally among the associates, and the remaining 75.0% shall be divided according to each associate's productivity factor. The factor being his total net collections. The denominator being the total net collections of all associates.As among the three associates, Doctors McVey, Khuri, and Moore, relative compensation 1990 Tax Ct. Memo LEXIS 735">*746 during the years in issue was roughly proportional to relative collections, as illustrated in the following chart: *2235 Individual's Compen-sation as Individual's CollectionsPercentage of Total as Percentage of TotalAssociate of Associate *Associate CollectionsCompensation Year Ended 10/31/82Dr. McVey48%44%Dr. Khuri29%31%Dr. Moore23%25%Year Ended 10/31/83Dr. McVey45%42%Dr. Khuri32%33%Dr. Moore23%25%During the years in issue, petitioner employed other physicians, in addition to its associates, to work in the Hospital. There were eight of such nonowner physicians employed at the Hospital during the year ended 10/31/82, and ten of such physicians during the year ended 10/31/83. The nonowner physicians employed at the Hospital entered into written employment contracts with petitioner. The employment contracts submitted into evidence herein indicate that such physicians generally were paid on the basis of a fixed salary or a percentage of annual collections, whichever was greater, with such percentages ranging from 85 percent of 110 percent of collections. 1990 Tax Ct. Memo LEXIS 735">*747 Neither petitioner's associates nor the other physicians employed by petitioner paid rent for the use of Hospital facilities and equipment or paid the other expenses (such as nurses salaries) associated with private practices. When a patient was treated at the Hospital, the Hospital issued a single bill which included charges for physician's professional services (the physician component) and for other Hospital services and items (the Hospital component). Included within the Hospital component of the bill were charges for "ancillary services" such as anesthesia, operating room, recovery room, drugs, x rays, etc. In the event that a bill was not paid in full and the payor failed to designate whether his payment was to be applied to the physician or Hospital component (nondesignated partial payments), petitioner's practice was to treat the payment as attributable to the Hospital component up to the amount of such Hospital charges. Nondesignated partial payments sometimes occurred in the case of payments by certain private insurance companies. With respect to payments received from Blue Cross/Blue Shield, all amounts from Blue Shield were allocated to physician services, and all 1990 Tax Ct. Memo LEXIS 735">*748 amounts from Blue Cross were allocated to the Hospital component of a bill. Similarly, all payments from Medicaid, Medicare, and other Government insurance programs were designated as attributable to either physician or Hospital services. Petitioner's practice of allocating nondesignated partial payments to Hospital charges had the effect of reducing the "collections" recorded for its physicians. As noted above, petitioner's nonowner physicians were generally compensated based on a fixed salary or percentage of such "collections," whichever was greater. For the taxable year ended 10/31/82, petitioner's highest-paid nonowner physician received a salary of $ 146,574.00; for the taxable year ended 10/31/83, such salary was $ 214,011.90. Mr. James L. Davis, who previously had been a co-administrator of the Hospital, became the full-time Hospital administrator in February 1982. As administrator, Mr. Davis was paid $ 86,863 for the taxable year ended 10/31/82 and $ 95,536 for the taxable year ended 10/31/83. The Bylaws required the Hospital administrator to attend all meetings of petitioner's board of directors and outlined his duties, including (1) supervision of all business affairs 1990 Tax Ct. Memo LEXIS 735">*749 of the Hospital such as records of financial transaction, collection of accounts, and purchase and issuance of supplies and drugs, (2) submission of monthly reports to the board of directors showing the professional service and financial activities of the Hospital, (3) annual submission to the board of directors of a plan of organization of personnel and others concerned with Hospital operation, (4) serving as a liaison between petitioner's board of directors and the Hospital's medical staff, (5) enforcing all rules and regulations for the conduct of the Hospital made by and under the authority of the Board of Directors, and (6) responsibility for overseeing the physical condition and repair of Hospital properties. The compensation received by petitioner's associates during the years in issue substantially exceeded amounts received in prior years. While petitioner's gross income also increased over the same period, the increases in gross income were relatively small in comparison with the *2236 increases in compensation. The following chart illustrates the increases in petitioner's gross income during a six-year period ending with the years in issue. Petitioner'sYear EndedGross Income(Form 1120, line 11)10/31/78$4,642,842 10/31/795,323,68810/31/806,378,19110/31/817,378,71510/31/829,951,91610/31/8310,308,289The 1990 Tax Ct. Memo LEXIS 735">*750 chart below illustrates the increases in compensation and "collections" of Drs. McVey, Khuri and Moore during the same six-year period. As indicated in the chart, the increases in compensation which occurred starting with the years in issue were also high in relation to increases in "collections." 7Taxable Dr. McVeyDr. KhuriYear EndedCollectionsCompensationCollectionsCompensation10/31/78$ 249,254$ 378,000$ 101,600$ 95,00010/31/79281,084273,408159,223192,38310/31/80313,019345,870240,742285,82810/31/81308,121397,714181,838261,45010/31/82397,556977,778241,014702,52410/31/83324,759873,298231,436672,871Taxable Dr. MooreYear EndedCollectionsCompensation10/31/78$ 76,311$ 127,04210/31/7995,318124,27410/31/80150,218198,53010/31/81150,822228,24410/31/82191,714566,55210/31/83162,468523,831Thus, 1990 Tax Ct. Memo LEXIS 735">*751 between the years ended 10/31/78 and 10/31/81, Dr. McVey's compensation averaged approximately 121 percent of his collections. For the years in issue, however, Dr. McVey's compensation averaged approximately 256 percent of his collections. Similarly, Dr. Moore's compensation for the years ended 10/31/78 through 10/31/81 averaged approximately 143 percent of his collections while his compensation for the years in issue averaged approximately 308 percent of collections. During the years in issue, section 54-885 of the Virginia Act conveyed upon the board of directors of a professional association the right to fix the amount and method of compensation of association employees as well as the right "to set up reserves or distribute excess earnings to each of the associates in proportion to his ownership in the association." Petitioner's Bylaws provided for the distribution to its associates of all of petitioner's "net profits" each year. Petitioner treated all payments to its associates as compensation, and did not treat any of such payments as dividends. OPINION Classification of Petitioner - Corporation or Partnership?BackgroundIn its amended petition, petitioner claims that, notwithstanding 1990 Tax Ct. Memo LEXIS 735">*752 its consistent reporting of income and deductions as a corporation, it properly was taxable as a partnership because it lacked the corporate attributes of continuity of life, centralization of management, limited liability, and free transferability of interests. In considering petitioner's claim to partnership status, 8 a brief history of the classification of professional entities is useful to set the stage. The tax status of state-chartered professional associations and professional corporations is an issue which received widespread attention from courts as well as commentators during 1990 Tax Ct. Memo LEXIS 735">*753 the 1960's, at which time the Treasury's litigating posture was to argue against corporate status for such entities. See Bittker, "Professional Service Organizations: A Critique of the Literature," 23 Tax L. Rev. 429 (1968) (noting that the classification of professional groups "has been the subject of a vast polemical literature"); Eaton, "Professional Corporations and Associations in Perspective," 23 Tax L. Rev. 1 (1967); Bittker, "Professional Service Organizations: A Comment," 24 Tax L. Rev. 291 (1969); "Professional Service Organizations: A Reply," 24 Tax L. Rev. 300 (1969); B. Eaton, 17 Business Organizations, Professional Corporations and Associations, chs. 4-5 and 26-31 (1990) (hereinafter referred to as Eaton). The case often credited with igniting the controversy which occurred during the 1960's is United States v. Kintner, 216 F.2d z418 (9th *2237 Cir. 1954). In that case, the Ninth Circuit upheld the taxpayer's claim that a Montana medical group (which had adopted a pension plan) should be taxed as a corporation rather than as a partnership. Such claim was sustained by the court notwithstanding the fact that corporations could not practice medicine in Montana and that the 1990 Tax Ct. Memo LEXIS 735">*754 entity was "probably" a partnership under Montana's Uniform Partnership Act. 216 F.2d 421">216 F.2d 421, 216 F.2d 421">425-426. Presumably concerned over the increasing adoption of qualified plans by professionals, Treasury attempted to overturn the result in Kintner by adopting the "Kintner Regulations" in 1960. See Larson v. Commissioner, 66 T.C. 159">66 T.C. 159, 66 T.C. 159">187 (1976) (J. Dawson, concurring); Zuckman v. United States, 207 Ct. Cl. 712">207 Ct. Cl. 712, 524 F.2d 729">524 F.2d 729, 524 F.2d 729">733-734 (1975); Horsley, "The Virginia Professional Association Act: Relief for the Underprivileged?," 48 Va. L. Rev. 777">48 Va. L. Rev. 777, 48 Va. L. Rev. 777">786-7 (1962); Eaton, supra at 5-5 - 5-6. The Kintner Regulations, which provided that an entity had to possess "more" corporate than noncorporate characteristics to be taxed as a corporation, remained in effect, without substantial change, during the years in issue and form the crux of the parties' dispute herein. The Kintner Regulations contain the statement that: Although it is the Internal Revenue Code rather than local law which establishes the tests or standards which will be applied in determining the classification in which an organization belongs, local law governs in determining whether the legal relationships which have been established 1990 Tax Ct. Memo LEXIS 735">*755 in the formation of an organization are such that the standards are met. Thus, it is local law which must be applied in determining such matters as the legal relationships of the members of the organization among themselves and with the public at large, and the interests of the members of the organization in its assets. [Section 301.7701-1(c), Proced. and Admin. Regs.] Viewing the Treasury's focus on the role of local law as "an invitation," numerous states passed "enabling" acts during the early 1960's aimed at allowing professional groups to attain corporate status for Federal income tax purposes. See Eaton, supra at p. 5-11. The Act under which petitioner was organized was one of about 30 such statutes passed between 1960 and 1963. See Horsley, supra at 790-791; Eaton, supra at p. 5-11 ("by Labor Day 1969 the count had reached forty-seven"). In 1965, Treasury responded to the wave of state enabling acts by issuing amendments to the Kintner Regulations (referred to herein as "the 1965 Regulations") "designed to thwart the efficacy of state professional association acts to confer corporate status under the Kintner regulations." Kurzner v. United States, 413 F.2d 97">413 F.2d 97, 413 F.2d 97">109 (5th Cir. 1969). 1990 Tax Ct. Memo LEXIS 735">*756 The 1965 Regulations, which were contained primarily in former section 301.7701-2(h), Proced. and Admin. Regs. (entitled "classification of professional service organizations"), established criteria for classifying professional service organizations as corporations which clearly were different than the standards applied to all other entities and which effectively would deny corporate status to virtually all professional service entities. 91990 Tax Ct. Memo LEXIS 735">*757 The courts uniformly found that the 1965 Regulations were arbitrary, discriminatory, and an unauthorized attempt to legislate, and therefore held such regulations invalid. See, e.g., Kurzner v. United States, 413 F.2d 97">413 F.2d 97 (5th Cir. 1969); Holder v. United States, 289 F. Supp. 160">289 F. Supp. 160 (N.D. Ga. 1968), affd. per curiam 412 F.2d 1189">412 F.2d 1189 (5th Cir. 1969); O'Neill v. United States, 410 F.2d 888">410 F.2d 888 (6th Cir. 1969) (regulation held invalid only to extent it denied corporate status for Federal income tax purposes to an entity chartered as a corporation under state law); United States v. Empey, 406 F.2d 157">406 F.2d 157 (10th Cir. 1969). For a compilation of the cases invalidating the 1965 regulations, see Eaton, supra, Chapter 30. In Revenue Ruling 70-101, 1970-1 C.B. 278, the Internal Revenue Service announced that it would no longer seek to deny corporate status to professional entities organized under various state statutes. The ruling stated: In light of recent decisions of the Federal courts, the Service generally will treat organizations of doctors, lawyers and other professional people organized under state professional association acts as 1990 Tax Ct. Memo LEXIS 735">*758 corporations for tax purposes. 10Included in the list of state professional association acts contained in Revenue Ruling 70-101 was the Virginia Act under which petitioner was organized. The Virginia Act defines a "professional *2238 association" as an "unincorporated association, as distinguished from a partnership or a corporation," organized for the purpose of carrying on one of several designated professions, but provides that professional associations shall be taxable as corporations for income tax purposes. Sections 54-874(3), 54-897, Virginia Act. In addressing the classification issue herein, a number of cases holding the 1965 Regulations invalid are relevant in that those cases also held the organizations in question to be corporations under the Kintner Regulations. (As noted above, the Kintner Regulations remained in effect without any substantial change 1990 Tax Ct. Memo LEXIS 735">*759 during the taxable years in issue, the 1965 Regulations having been revoked by such time). 11 The instant case, therefore, is unique with respect to the posture in which the parties find themselves. The reversal of the traditional roles of the parties with respect to the issue, however, in no way requires us to apply different legal principles. Segel v. Commissioner, 89 T.C. 816">89 T.C. 816, 89 T.C. 816">826 (1987). Analysis of Classification FactorsThe parties are in agreement that the factors contained in the Kintner Regulations 12 (relevant portions of which are set forth in Appendix I to this opinion) are determinative of the classification issue presented in the instant case. As we stated in Larson v. Commissioner, 66 T.C. 159">66 T.C. 159, 66 T.C. 159">172 (1976), "our opinion and decision are consequently framed in that context; the validity of [the] regulations is not before us." 1990 Tax Ct. Memo LEXIS 735">*760 We therefore express no opinion as to the validity or invalidity of the regulations. The Kintner Regulations (hereinafter sometimes referred to as the regulations) set forth six characteristics ordinarily found in a corporation which distinguish it from other organizations. Those characteristics are (1) associates, (2) an objective to carry on business and divide the gains therefrom, (3) continuity of life, (4) centralization of management, (5) limited liability, and (6) free transferability of interests. The regulations go on to note that, in some cases, other factors may be found which may be significant in classifying an organization. In deciding whether an organization properly is classified as a partnership, as opposed to a corporation, the first two characteristics listed above -- associates and an objective to carry on business and divide the gains therefrom -- are ignored, since those characteristics are common to both entities. The relevant determination thus turns on the existence of continuity of life, centralization of management, limited liability, and free transferability of interests with respect to the entity. 1990 Tax Ct. Memo LEXIS 735">*761 Section 301.7701-2(a)(2), Proced. and Admin. Regs. Although the regulations cite the Supreme Court decision in Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344 (1935), for the proposition that corporate status will exist if an organization "more nearly resembles" a corporation than a partnership or trust, the regulations adopt a mechanical test for determination of corporate status. Under that test, each of the four characteristics "apparently bears equal weight in the final balancing," 66 T.C. 159">Larson v. Commissioner, supra at 172, and an entity will not be taxed as a corporation unless it possesses more corporate than noncorporate characteristics. Section 301.7701-2(a)(3), Proced. and Admin. Regs.; 66 T.C. 159">Larson v. Commissioner, supra at 185. 13 We now turn to a consideration of those characteristics.141990 Tax Ct. Memo LEXIS 735">*762 1. Continuity of LifePertinent provisions of section 301.7701-2(b), Proced. and Admin. Regs., concerning continuity of life, are set forth in the Appendix. Section 54-887 of the Virginia Act, under which petitioner was organized, 151990 Tax Ct. Memo LEXIS 735">*764 apparently is aimed at allowing professional associations to *2239 possess the characteristic of continuity of life. 16 The provision states: Duration of association. Unless the articles of association expressly provide otherwise, a professional association shall continue as a separate entity, independent of its associates, for all purposes and for such period of time as is provided in the articles of association, or until dissolved by a vote of two-thirds of the associates, and shall continue notwithstanding the death, insanity, incompetency, resignation, withdrawal, transfer of membership or of interest, retirement, or expulsion of any one or more of the associates, the admission of or transfer 1990 Tax Ct. Memo LEXIS 735">*763 of membership or interest to any new member or members, or the happening of any other event which under the laws of this State and under like circumstances, would cause a dissolution of a partnership, it being the purpose and intent of this section that such professional association shall have continuity of life independent of the life or status of its associates. No associate shall have the power to dissolve the association by his independent act of any kind. [Emphasis supplied.] Section 54-887 of the Virginia Act mirrors the regulations' requirements with respect to events that will not trigger dissolution of the organization. While section 54-887 of the Virginia Act, at first glance, does not 1990 Tax Ct. Memo LEXIS 735">*765 provide for continuity in the event of a member's bankruptcy specifically, such event is included within the clause which provides for continuity notwithstanding "any other event which under the laws of this State and under like circumstances, would cause a dissolution of a partnership." See Code of Virginia, section 50-31(5) (providing that partnership dissolution is caused by the bankruptcy of any partner). Moreover, although the Virginia Act allows a professional association's articles of association to provide "otherwise," petitioner's Articles expressly state that "The duration of the association is to be perpetual." Finally, the Virginia Act denies associates the independent power to dissolve the association, which power would, under the regulations, 17 defeat continuity of life. See also Virginia Act section 54-894 (dissolution of association requires two-thirds vote by associates). Notwithstanding the fact that the Virginia Act in conjunction with petitioner's Articles would cause petitioner to possess continuity of life, petitioner states on brief that continuity of life is "arguably" absent in the instant case because "the 1990 Tax Ct. Memo LEXIS 735">*766 primary purpose of [petitioner] was to operate a hospital; and, upon termination of the existing lease, the entity could not operate a hospital without a Certificate of Public Need." Such argument is without merit. As we stated in 66 T.C. 159">Larson v. Commissioner, supra at 175,the regulations are so clearly keyed to "dissolution" (a term encompassing * * * legal relationships * * *) rather than "termination of the business" (a phrase capable of more pragmatic interpretation encompassing the life of the business enterprise) * * * See section 301.7701-2(b)(2), Proced. and Admin. Regs. ("there may be a dissolution of the organization and no continuity of life although the business is continued by the remaining members"); Kurzner v. Commissioner, 413 F.2d 97">413 F.2d 97, 413 F.2d 97">103 (5th Cir. 1969) ("continuity of the enterprise is as much a characteristic of a partnership as of a corporation -- i.e., on the level of feasibility"); O'Neill v. United States, 410 F.2d 888">410 F.2d 888 (6th Cir. 1969). 181990 Tax Ct. Memo LEXIS 735">*767 Petitioner's argument also fails to take into account the fact that petitioner's Articles provided for business "purposes" broader than the operation of a hospital. The argument further assumes that an entity with a limited life automatically lacks continuity of life under the regulations. That is not the case; the regulations provide that if an organization is to continue for a stated period or until the completion of a stated transaction, the organization has continuity of life if the effect of the agreement establishing the organization 1990 Tax Ct. Memo LEXIS 735">*768 is that no member has the power to dissolve the organization in contravention of the agreement. Section *2240 301.7701-2(b)(3), Proced. and Admin. Regs; Outlaw v. United States, 204 Ct. Cl. 152">204 Ct. Cl. 152, 494 F.2d 1376">494 F.2d 1376, 494 F.2d 1376">1382 (1974); Hynes v. Commissioner, 74 T.C. 1266">74 T.C. 1266, 74 T.C. 1266">1282 (1980). Accordingly, we hold that petitioner possessed the characteristic of continuity of life. 2. Centralization of ManagementPertinent provisions of section 301.7701-2(c), Proced. and Admin. Regs., concerning centralization of management, are set forth in Appendix I. Virginia Act section 54-882 is an apparent effort to confer centralized management upon Virginia professional associations and provides in relevant part: Board of directors. A professional association organized pursuant to the provisions of this chapter shall be governed by a board of directors, which shall have the full management of the business and affairs of the association and continuing exclusive authority to make management decisions on its behalf, and no associate shall have the power to bind the association within the scope of its business or profession merely by virtue of his being an associate. * * * During the taxable years in issue, petitioner's 1990 Tax Ct. Memo LEXIS 735">*769 Bylaws likewise provided that "The affairs of this association shall be under the management of its Board of Directors and such officers and agents as said Board may elect to employ, and that Board of Directors acts as a Committee as a whole." At first blush, therefore, petitioner would appear to possess the characteristic of centralized management. Petitioner, however, argues on brief that: The entire scope of providing acute care hospital services by Petitioner was through its Owner-Physicians and include hiring, firing, promoting, suspending and discharging hospital employees as well as overseeing the other day-to-day operations at the hospital. Indeed, the Owner-Physicians did not delegate the authority to hire, fire, reprimand, suspend, or promote hospital employees or to borrow money on behalf of Petitioner. In making the various business decisions for Petitioner, the Owner-Physicians did so as a group and regarded those decisions as being made not only for Petitioner but for each Owner-Physician as well. [Citations to record omitted.] In its reply brief, petitioner also focuses on its check-signing authority arrangement, arguing that "all Owner-Physicians had to approve 1990 Tax Ct. Memo LEXIS 735">*770 any purchase in excess of $ 1,000 as well as endorsing any check of $ 1,000 or more." 19 The relevant testimony offered by petitioner's associates appears contradictory. More specifically, while Dr. McVey testified on direct examination that it was the "owner-members" (i.e., the associates) of petitioner who had the authority to hire, fire, discipline, and suspend employees, borrow money and approve 1990 Tax Ct. Memo LEXIS 735">*771 payments on behalf of petitioner, implement Hospital policies, procedures, or protocols, and approve nonowner physician contracts, Dr. Khuri (who was petitioner's President during the taxable years in issue) testified that it was petitioner's Board of Directors that "ran the Association" and had the authority to hire, fire, and discipline employees, approve payments of $ 1,000 or more, determine staffing patterns for the Hospital, and give final approval of policies and procedures for Hospital operations. 201990 Tax Ct. Memo LEXIS 735">*772 Dr. Khuri also testified that, to the extent that the Hospital administrator approved payments of less than $ 1,000, he did so under the authority delegated to him by the Board of Directors, and, to the extent that he took action with respect to hiring or firing employees, he did so at the Board's specific direction. See Ahola v. United States, 300 F. Supp. 1055">300 F. Supp. 1055, 300 F. Supp. 1055">1058 (D. Minn. 1969) (noting that clinic manager's authority was delegated to him by and derived from the authority of the Board of Trustees).The stipulations submitted by the parties in the instant case contain similar contradictions with respect to the management of petitioner. The parties stipulated that "Beginning with the initial lease in 1964 and thereafter overall operations of the petitioner were under the direct *2241 charge of the owner physicians of petitioner. Petitioner through its owner physicians also approved and hired other physicians." 211990 Tax Ct. Memo LEXIS 735">*773 Other stipulations, however, refer to exhibits containing descriptions of (1) "duties performed by the Board of Directors of the petitioner" (and shared at various times by its members), and (2) "minutes of the recorded Board of Directors meetings of petitioner during the years in issue." An examination of those exhibits and their descriptions indicates that petitioner's Board of Directors and the officers elected by the Board of Directors managed the affairs of petitioner. The confusion in the testimony and stipulations as to whether petitioner was managed directly by its associates or by its Board of Directors apparently is derived from the fact that petitioner's Board of Directors included, during the taxable years in issue, all three of its associates, or "owner-members." On brief, respondent acknowledges that all of petitioner's associates sat on the board, but argues that Although in the years at issue, all of the associates of [petitioner] were also officers and members of the Board of Directors of the association, the business of Richlands Medical Association was clearly conducted by a centralized management as that term is used in Treas. Reg. sec. 301.7701-2. We agree with respondent. Section 301.7701-2(c)(1), Proced. and Admin. Regs., states that "An organization has centralized management if any person (or any group of persons which does not include all the members) has continuing exclusive authority to make the management decisions." (Emphasis supplied.) In light of such language, several commentators 1990 Tax Ct. Memo LEXIS 735">*774 have expressed a concern that centralized management may be lacking where the board of directors of an organization includes all of its owners or members. For example, Eaton states at 4-3 that: In business corporations, except very small ones, the shareholders and directors are seldom identical. Usually less than all the shareholders are elected directors, and frequently less than all the directors are chosen as officers. In categorizing an unincorporated professional association for tax purposes, it is unclear whether this numerical funneling-down is the test or whether the attribute of centralized management theoretically exists solely by reason of the fact that the shareholders elect the directors, who elect the officers, even when the shareholders, directors and officers are all the same people. In a fairly large group, it may be desirable to play "safe" by having the board of directors consist of less than all the shareholders * * *. [Fn. ref. omitted.] In another chapter, Eaton states: While the Regulations under the 1939 Code and the cases emphasized the technical or formal representative capacity of those conducting the enterprise, the Kintner Regulations added the element 1990 Tax Ct. Memo LEXIS 735">*775 of numbers, indicating that the managers should consist of less than all the owners. The validity of this requirement is dubious at best. [Eaton at 27-25.] 22 For the following reasons, however, we hold that an identity between the owners and directors of an entity at a particular point in time does not preclude "centralized management" within the meaning of section 301.7701-2(c), Proced. and Admin. Regs., and that, notwithstanding such identity of owners and directors in the instant case, petitioner possessed the characteristic 1990 Tax Ct. Memo LEXIS 735">*776 of centralized management under the regulations. Section 301.7701-2(c)(2), Proced. and Admin. Regs., states that the persons who have management authority in a corporation "may, or may not, be members of the organization." While we recognize that respondent's rulings are not binding precedent in this Court, 23 respondent has interpreted the regulations to permit a finding of centralized management even where the board of directors includes all the members at a particular point in time. In Revenue Ruling 71-574, 1971-2 C.B. 432, two doctors comprised the membership of a professional association and also elected themselves as the sole members of the board of directors. The bylaws of the association provided that the board could be composed of between two and five persons. On the issue of centralized management, the Revenue Ruling states: In the instant case, even though all of the association's members happen to be members *2242 of its board of directors, i.e. the management group, at a particular time, this does not preclude the association from having centralized management, despite the parenthetical language of [section 301.7701-2(c)(1), Proced. 1990 Tax Ct. Memo LEXIS 735">*777 and Admin. Regs.] * * * since the authority to make management decisions is not vested in the entire membership as such, but in the board of directors. While the directors do have to be members of the association, all members do not have to be directors. (Cf. Guy T. Helvering v. Coleman-Gilbert Associates, 296 U.S. 369">296 U.S. 369 (1935), Ct. D. 1067, C.B. XV-1, 261 (1936). The approach taken in the Revenue Ruling is consistent with our interpretation of the provision in the instant case. In our view, the parenthetical language of section 301.7701-2(c)(1), Proced. and Admin. Regs., characterizing management as a "group of persons which does not include all the members," should be read to include situations in which the management group is not required, under an organization's governing documents, to include all the members. See Thies, "Professional Service Organizations: A Comment," 24 Tax L. Rev. 291, 294 (1969) (arguing that the regulation would be "in error" to the extent it could be construed otherwise). Our interpretation of section 301.7701-2(c), Proced. and Admin Regs., is consistent with several older cases following Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344 (1935), 24 and with our more 1990 Tax Ct. Memo LEXIS 735">*778 recent decision in Hynes v. Commissioner, 74 T.C. 1266">74 T.C. 1266 (1980). In Helvering v. Coleman-Gilbert Associates, 296 U.S. 369">296 U.S. 369 (1935), decided on the same day as and following Morrissey, the Supreme Court found centralized management in a business trust where all of the beneficiaries also were named as trustees. In so holding, the Supreme Court noted the lack of formalities in the trustees' activities and the fact that the trustees did not exercise all of the powers given to them in the trust instrument, but stated that "The parties are not at liberty to say that their purpose was other or narrower than that which they formally set forth in the instrument under which their activities were conducted." 296 U.S. 369">296 U.S. at 374. In Pelton v. Commissioner, 82 F.2d 473">82 F.2d 473 (7th Cir. 1936), affg. 32 B.T.A. 198">32 B.T.A. 198 (1935), centralized management was again found in a situation in which the trustees and beneficiaries of a trust were identical. Pelton involved three doctors who entered into an indenture whereby they transferred to themselves, as trustees, 1990 Tax Ct. Memo LEXIS 735">*779 various office furniture and medical equipment. The doctors were the sole beneficiaries and trustees of the trust. Finding Morrissey, Coleman-Gilbert, and two other Supreme Court decisions decided on the same day 25 dispositive of the issue, the Seventh Circuit held that the trust possessed all of the "substantial points of resemblance to a corporation" (including centralized management) specified in those decisions. Pelton v. Commissioner, 82 F.2d 473">82 F.2d at 476. In 74 T.C. 1266">Hynes v. Commissioner, supra, we held that centralized management existed where a single individual owned all of the beneficial interests in a trust and also served on its board of trustees. The taxpayer in Hynes, having taken the position that the trust was not taxable as a corporation (and having deducted the trust's losses on his own return), argued that centralization of management was lacking because the other trustees served as his agents and merely performed ministerial duties. In analyzing the question whether the trustees had the "continuing authority to manage the business in a manner resembling the management of a corporate 1990 Tax Ct. Memo LEXIS 735">*780 business by a board of directors," we focused on the provisions of the trust agreement, stating: These provisions of the trust agreement show that the trustees had broad powers to act on behalf of the trust, that their authority was not limited to purely ministerial acts, and that their actions did not require ratification by the beneficiary. It is immaterial whether, in reality, the petitioner could make the decisions for all the trustees; the significant fact is that the trustees had the power to act for the trust. See Helvering v. Coleman-Gilbert, 296 U.S. 369">296 U.S. at 374. Hence, we hold that the * * * trust had centralization of management. [74 T.C. 1266">74 T.C. 1283.] 26 Similarly, Bittker & Eustice, "Federal Income Taxation of Corporations and Shareholders," states: What is crucial 1990 Tax Ct. Memo LEXIS 735">*781 [with regard to centralized management] is the focus of authority in the *2243 hands of a particular group, in contrast to the mutual agency relationship of a partnership, in which each member can bind the organization by his acts; the corporate form "abhors anarchy of authority." (page 2-7) 27In the instant case, the Virginia Act prohibits individual associates from binding the association and confers management authority upon the board of directors. Petitioner's Bylaws mirror the Virginia Act in conferring management power on the Board of Directors, and petitioner has failed to convince us that it was not managed by such Board of Directors, acting as such in a representative capacity. Finally, there is no requirement in petitioner's governing instruments that petitioner's board of directors include all of petitioner's associates. Accordingly, we hold that petitioner possessed the characteristic of centralized management. 3. Limited LiabilityPertinent provisions of section 301.7701-2(d), Proced. and Admin. Regs., concerning 1990 Tax Ct. Memo LEXIS 735">*782 limited liability, are set forth in the Appendix. The provisions of the Virginia Act regarding the liability of associates are section 54-886 and section 54-892. Section 54-886 provides: 54-886. Professional relationships between persons not affected. -- The provisions of this chapter shall not be construed to alter or affect the professional relationship between a person furnishing professional services and a person receiving such service, either with respect to liability arising out of such professional service or the confidential relationship between the person rendering the professional service and the person receiving such professional service, if any, and all such confidential relationships enjoyed under the laws of this State, whether now in existence or hereafter enacted, shall remain inviolate. Provisions such as section 54-886, which speak of preserving the relationship between the professional and his client or patient, are referred to as "savings clauses." See Comment: "Limited Liability for Shareholders in Virginia Professional Corporations: Fact or Fiction?," 21 U. Rich. L. Rev. 571, 575 (1987). Section 54-892 of the Virginia Act, which deals more specifically with 1990 Tax Ct. Memo LEXIS 735">*783 liability, provides: 54-892. Personal liability of associates; liability of association for acts of associates, etc. -- Any associate of a professional association shall remain personally and fully liable and accountable for any negligent or wrongful acts, or misconduct committed by him, or by any person under his direct supervision and control, while rendering professional services on behalf of the association to the person for whom such professional services were being rendered. Such associate shall not, by reason of being an associate, be personally liable for any debts or claims against, or the acts or omission of the association or of another associate or employee of the association, but the association shall be liable for the acts or omissions of its associates, officers, agents, employees and servants to the same extent to which a corporation would be liable for the acts or omissions of its officers, agents, employees and servants while they are engaged in carrying on the corporate business. Petitioner argues in its reply brief that it lacked the characteristic of limited liability because: "While section 54-892 provides a degree of limitation on a member's liability, it also 1990 Tax Ct. Memo LEXIS 735">*784 prescribes that a member is still personally liable for the acts of one under his direction or control who renders services for the association." Petitioner also points to the fact that its associates personally were liable for most debts of petitioner due to the endorsement of the note by the associates and the guarantee of other obligations of petitioner by the associates. We reject petitioner's arguments regarding the effect of its associates' endorsement or guarantee of petitioner's obligations. Any personal liability of petitioner's associates in that regard arose as a matter of contract rather than under "local law," as contemplated by the regulations. 281990 Tax Ct. Memo LEXIS 735">*785 Shareholder guarantees of corporate obligations are not uncommon in the context of closely held corporations, Hynes v. Commissioner, 74 T.C. 1266">74 T.C. 1266, 74 T.C. 1266">1285 (1980), and the fact that such guarantees are needed to render the shareholders liable for corporate obligations underscores the fact that the shareholders are not otherwise liable under local law. Note: "Shareholder-Guarantor Fees: Deductible Business Expenses or Dividends?," 40 Tax. Lawyer 905 n.1 (1987). We also reject petitioner's argument that its associates lacked limited liability by reason of their personal liability for the negligence or misconduct of those under their direct supervision and control. Section 54-892 of the Virginia Act renders associates liable for the negligence or misconduct of persons under their direct supervision and control only "while rendering professional services" on behalf of the association. *2244 Section 54-885 of the Virginia Act provides that all associates of a professional association shall be employees of the association, and petitioner's associates were treated by petitioner as employees in connection with their performance of medical services. As discussed below, we find that the personal liability referred to in section 54-892 of the Virginia Act relates to an associate in his capacity as employee, or agent, of a professional association, and not in his capacity as owner of a professional association. 1990 Tax Ct. Memo LEXIS 735">*786 Section 301.7701-2(d), Proced. & Admin. Regs., by contrast, deals with the personal liability of an organization's "members," or owners. We therefore hold that petitioner possessed the characteristic of limited liability. In order to evaluate the impact of the Virginia Act with respect to an associate's liability, we first must consider the general rules regarding tort liability of corporate agents. Especially relevant is the common law rule that a corporation's agents (including employees) remain liable for their own negligence notwithstanding the fact that such negligence occurs while performing services on behalf of the corporation. See Fletcher Cyclopedia of the Law of Private Corporations, sec. 1135 (1986 rev.); American Law Institute, 2 Restatement of the Law of Agency 2d (referred to hereinafter as Restatement), secs. 343, 350 (1958); H. Henn & T. Alexander, Laws of Corporations, p. 608 (3d ed. 1983); F. Mechem, A Treatise on the Law of Agency, secs. 1460-1461 (2d ed. 1982). While suing a corporation for the negligent acts of its agents is often "more convenient or effective" than suing the agent, corporate liability under the doctrine of respondeat superior is derivative, 1990 Tax Ct. Memo LEXIS 735">*787 or secondary, in nature and in no way shields an agent from liability for his own negligence. Mechem, supra p. 1082. Viewing the Virginia Act in the context of such a well-established rule regarding agent's liability, and having found no contrary rule under Virginia law, the statement in section 54-892that associates "remain" liable for their own negligent and wrongful acts appears to be merely a codification or preservation of the common law rule applicable to corporate agents, rather than a means of expanding the liability of associates in their capacity as owners. Petitioners, however, focus their argument on the additional language in Virginia Act section 54-892 that associates may be held liable for the misconduct of persons under their "direct supervision and control" while rendering professional services, and argue that such additional liability precludes "limited liability" under section 301.7701-2(d), Proced. and Admin. Regs. We disagree. The notion that a corporation's agents may be held liable for the negligence of other agents under their direct supervision and control also finds precedent at common law. The Restatement indicates that an agent may be held liable for 1990 Tax Ct. Memo LEXIS 735">*788 the conduct of other agents if he is at fault in supervising or controlling them. See Restatement sections 358(1), 344, 351, 356, and the accompanying Comments. The Fletcher Cyclopedia of the Law of Private Corporations, supra, similarly states (at 278) that The superior or managing officer of a corporation cannot be held liable for the misconduct of a subordinate servant or employee unless the act is done with his consent or his order or direction, "and a representative of the master is not personally liable for the conduct of other agents or servants of the same master under him, unless he makes himself a participant therein in some way, either by actual participation, by directing their conduct, or otherwise. * * *" [Emphasis supplied; fn. refs. omitted.] See also Mechem, supra at 1098 ("superior agent" may be held liable for the negligent exercise of his power of control over other servants). Considering such common law notions, we find that the rule imposing liability for the misconduct of those under an associate's "direct supervision and control" in the rendering of professional services is merely an extension of the rule preserving liability for the associate's own negligence 1990 Tax Ct. Memo LEXIS 735">*789 and therefore relates to associates in their capacity as agents, rather than owners, of the association. Several cases holding the 1965 Regulations invalid provide support for our analysis of limited liability in the instant case. In Kurzner v. Commissioner, 413 F.2d 97">413 F.2d 97 (5th Cir. 1969), the Fifth Circuit considered the classification of an entity organized under the Florida Professional Service Corporation Act (the FloridaAct). With respect to the liability of "shareholder-professionals," the operative language of the FloridaAct virtually was identical to that contained in sections 54-886 and 54-892 of the Virginia Act. More specifically, the relevant provision of the FloridaAct, as in effect for the taxable years in issue in Kurzner, provided that: Nothing contained in this act shall be interpreted to abolish, repeal, modify, restrict or limit the law now in effect in this state applicable to the professional relationship and liabilities between the person furnishing the professional services and the person receiving such professional service and to the standards for professional conduct. Any officer, shareholder, agent, or employee of a corporation organized under this act 1990 Tax Ct. Memo LEXIS 735">*790 shall remain personally and fully liable and accountable for any negligent or wrongful acts or misconduct committed by him, or by any person under his direct supervision and control, while rendering *2245 professional service on behalf of the corporation to the person for whom such professional services were being rendered.291990 Tax Ct. Memo LEXIS 735">*791 Focusing its attention on the above provision, the Fifth Circuit found that the entity possessed the attribute of limited liability under the Kintner Regulations. In that regard, the court characterized the enactment of the provision as "a seeming excess of caution," in that the provision merely "made clear that the shareholder-professionals would not be immune from liability for their own conduct." 413 F.2d 97">413 F.2d at 107. The court went on to state that, in a Florida professional service corporation, personal liability is limited in a professional corporation to the same extent as in any other corporation. Although a shareholder-employee must necessarily be responsible for his misconduct, the corporate form nonetheless shields the shareholder from a considerable amount of contractual and tort liability. [Kurzner v. Commissioner, 413 F.2d 97">413 F.2d at 108.] 301990 Tax Ct. Memo LEXIS 735">*792 Finding that the entity would qualify as a corporation under the Kintner Regulations, the Fifth Circuit went on to invalidate the 1965 Regulations as arbitrary and discriminatory. 413 F.2d 97">413 F.2d at 111. 31 See also Holder v. United States, 289 F. Supp. 160">289 F. Supp. 160 (N.D. Ga. 1968), affd. per curiam 412 F.2d 1189">412 F.2d 1189 (5th Cir. 1969) (finding entity organized under Georgia Professional Association Act to be corporation; affirmed by the Fifth Circuit solely on basis of 413 F.2d 97">Kurzner v. United States, supra). In O'Neill v. United States, 410 F.2d 888">410 F.2d 888 (1969), the Sixth Circuit considered the classification of an entity organized under the Ohio Professional Association 1990 Tax Ct. Memo LEXIS 735">*793 law (the OhioAct). The Ohio Act incorporated by reference Ohio's general corporation law except as specifically provided in the OhioAct. With respect to liability, the OhioAct contained a savings clause similar to section 54-886 of the Virginia Act. 32 Focusing on that provision, the Sixth Circuit stated that: The statute however does not remove the limited liability of the shareholder; it merely preserves the personal liability of the professional man in his professional dealings with patients. Ohio Rev. Code. sec. 1785.04. This liability has nothing to do with his status as a shareholder. The shareholder in his capacity as a shareholder does enjoy limited liability. [O'Neill v. United States, 410 F.2d 888">410 F.2d at 898; emphasis supplied.] Thus, as we have done in the instant case, the Sixth Circuit in O'Neill viewed the shareholder-professionals 1990 Tax Ct. Memo LEXIS 735">*794 of a professional corporation as acting in a dual capacity, i.e., as shareholders and as employees, and evaluated their liability separately with respect to each capacity. 33Section 54-892 of the Virginia Act suggests that such separation of capacities is appropriate in stating that an associate shall not, "by reason of being an associate," be liable for claims against the association or its other associates or employees.Our holding that limited liability is present in the instant case is supported 1990 Tax Ct. Memo LEXIS 735">*795 further by recent *2246 state court decisions implementing provisions analogous to sections 54-886 and 54-892 of the Virginia Act. In We' re Associates Co. v. Cohen, Stracher & Bloom, 103 A.D.2d 130, 478 N.Y.S.2d 670 (2d Dept. 1984), affd. 65 N.Y.2d 148, 490 N.Y.S.2d 743 (1985), the shareholders of a New York professional service corporation were sued individually for rents due under a lease executed solely in the name of the corporation. The Appellate Division, in affirming the lower court's determination striking the shareholders' names as defendants, examined the effect of N.Y. Business Corporation Law sec. 1505(a) (McKinney 1986), which provides (similarly to section 54-892 of the Virginia Act) that Each shareholder, employee or agent of a professional service corporation shall be personally and fully liable and accountable for any negligent or wrongful act or misconduct committed by him or by any person under his direct supervision and control while rendering professional services on behalf of such corporation. Regarding the effect of such provision, the Appellate Division, citing a prior decision, stated that the liability imposed upon a shareholder of a professional corporation 1990 Tax Ct. Memo LEXIS 735">*796 by section 1505 of the Business Corporation Law is simply a reflection of the common law rule that a shareholder is liable for those torts of the corporation in which he is a participant * * *, or which are committed by those acting under his direct supervision and control. (Restatement, Agency, 2d, section 358, Comment a) [We' re Associates Co. v. Cohen, Stracher & Bloom, 478 N.Y.S.2d at 673-674; citation omitted; emphasis supplied.] The court went on to conclude that the members of New York professional corporations are to enjoy limited liability with respect to ordinary corporate business debts such as the rents in issue in that case. 341990 Tax Ct. Memo LEXIS 735">*797 In Birt v. St. Mary Mercy Hospital of Gary, Inc., 175 Ind. App. 32">175 Ind. App. 32, 370 N.E.2d 379 (1977), an emergency room patient named the physician who had treated him, as well as all the other physician-stockholders of such doctor's professional corporation, as defendants in a malpractice action. None of the nontreating physicians were present at the hospital or scheduled to be on duty when the plaintiff was treated, and none of the nontreating physicians advised the treating physician on the treatment or diagnosis or had the right to direct such treatment. With respect to liability, the savings clause of the Indiana Medical Professional Corporation Act provided that: This act does not modify any law applicable to the relationship between a person furnishing professional medical service and a person receiving such service, including liability arising out of such professional service. [Birt v. St. Mary Mercy Hospital of Gary, Inc., 370 N.E. 2d at 383, citing Ind. Code Ann. section 23-1-14-14 (Burns 1971).] Focusing on that provision, the court rejected the plaintiff's argument that the provision imports the vicarious liability of the Uniform Partnership 1990 Tax Ct. Memo LEXIS 735">*798 Act to apply to associating physicians. Birt v. St. Mary Mercy Hospital of Gary, Inc., 370 N.E. 2d at 383, 385. The court accordingly refused to hold the other shareholders of the professional corporation liable for the malpractice of the treating physician. See also Fure v. Sherman Hospital, 55 Ill. App. 3d 572, 371 N.E.2d 143 (1977); Annotation, "Professional Corporation Stockholders' Nonmalpractice Liability," 50 A.L.R. 4th 1276; Annotation, "What Constitutes Professional Services within Meaning of Statute Preserving Individual Liability of Professional Employees of Professional Corporation, Association, or Partnership," 31 A.L.R. 4th 898. While we are aware of one North Carolina case in which the court interpreted a savings clause to preserve joint and several liability among physician-shareholders for each other's negligence, 35 the opinion in that case contains virtually no reasoning on the issue of vicarious liability, and has been criticized. See Comment: "Limited Liability for Shareholders in Virginia Professional Corporations: Fact or Fiction?," 21 U. Rich. L. Rev. 571, 582 (1987). In the absence of any indication that a Virginia court would construe section 54-886 of 1990 Tax Ct. Memo LEXIS 735">*799 the Virginia Act to "import" vicarious liability, 361990 Tax Ct. Memo LEXIS 735">*800 the mere existence *2247 of such possibility is not dispositive. Rather, as the Fifth Circuit stated in Kurzner v. United States, 413 F.2d 97">413 F.2d 97, 413 F.2d 97">108 n.52 (5th Cir. 1969) (in response to the Government's contention that a Florida court might construe the provision involved therein to impose "virtually unlimited" liability): we have more than a little hesitation about determining corporateness by what some court might possibly do at sometime in the future; we think the more appropriate course is to accept the reasonable meaning of presently existing legal provisions. Accordingly, we hold that petitioner possessed the characteristic of limited liability. Because we have held that petitioner possessed three of the four characteristics distinguishing corporations from partnerships under section 301.7701-2, Proced. and Admin. Regs., we will not address the question of whether petitioner possessed the characteristic of free transferability of interests. Accordingly, we hold that petitioner was, during the years in issue, an association taxable as a corporation. Reasonable CompensationWe next address the issue of petitioner's deduction for compensation paid to its associates. Section 162(a)(1)allows as a deduction "a reasonable allowance for salaries or other compensation for personal services actually rendered," to the extent that such amounts are paid or incurred in carrying on a trade or business. Section 1.162-7, Income Tax Regs., 1990 Tax Ct. Memo LEXIS 735">*801 provides in relevant part that: The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services. * * * An ostensible salary paid by a corporation may be a distribution of a dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services and the excessive payments correspond or bear a close relationship to the stockholdings of the officers of employers, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. * * * The form or method of fixing compensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. * * * In any event the allowance for the compensation paid may not exceed what 1990 Tax Ct. Memo LEXIS 735">*802 is reasonable under all the circumstances. It is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under the like circumstances. As indicated by the above-quoted regulation, there is a two-prong test for deductibility under section 162(a)(1): the payment must be (1) reasonable in amount, and (2) solely for services. Elliotts, Inc. v. Commissioner, 716 F.2d 1241">716 F.2d 1241, 716 F.2d 1241">1243 (9th Cir. 1983), revg. on another matter and remanding a Memorandum Opinion of this Court. The two prongs, however, are "inextricably wed" to one another, Nor-Cal Adjusters v. Commissioner, T.C. Memo. 1971-200, 30 T.C.M. 837, 842, 40 P-H Memo T.C. par 71,200 at 800, affd. 503 F.2d 359">503 F.2d 359 (9th Cir. 1974), and the existence of a compensatory purpose can often be inferred to the extent that the amount is determined to be reasonable.37716 F.2d 1241">Elliotts, Inc. v. Commissioner, supra at 1243. "Where officer-shareholders, who are in control of a corporation, set their own compensation, careful scrutiny is required to determine whether the alleged compensation is in fact a distribution of profits." Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142">73 T.C. 1142, 73 T.C. 1142">1156 (1980). 1990 Tax Ct. Memo LEXIS 735">*803 In Mayson Mfg. Co. v. Commissioner, 178 F.2d 115">178 F.2d 115, 178 F.2d 115">119 (6th Cir. 1949), the Sixth Circuit provided a "rather comprehensive listing of pertinent factors for consideration" *2248 in reasonable compensation decisions. Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner, 61 T.C. 564">61 T.C. 564, 61 T.C. 564">567 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975). Those factors are: the employee's qualifications; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with the gross income and the net income; the prevailing general economic conditions; 1990 Tax Ct. Memo LEXIS 735">*804 comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years. The action of the Board of Directors of a corporation in voting salaries for any given period is entitled to the presumption that such salaries are reasonable and proper. * * * [Mayson Mfg. Co. v. Commissioner, 178 F.2d 115">178 F.2d at 119.] The Sixth Circuit also expressed the general rule that in reasonable compensation cases, no single factor is decisive; rather, "every case of this kind must stand on its own facts and circumstances." 178 F.2d 115">178 F.2d at 119. See also Miller Mfg. Co. v. Commissioner, 149 F.2d 421">149 F.2d 421, 149 F.2d 421">423 (4th Cir. 1945), affg. a Memorandum Opinion of this Court. In the instant case, respondent determined that the deductions claimed by petitioner for amounts paid to its associates exceeded a reasonable allowance for salaries or other compensation for personal services rendered. The following chart lists the amounts allowed and disallowed by 1990 Tax Ct. Memo LEXIS 735">*805 respondent with respect to each associate: Taxable Year EndedDeduction for Compensation10/31/82AllowedDisallowedDr. McVey$ 397,556.12$ 580,221.88Dr. Khuri* 241,041.39461,509.61Dr. Moore191,713.62374,838.3810/31/83Dr. McVey$ 324,759.38$ 548,538.61Dr. Khuri231,435.83441,435.17Dr. Moore162,467.94361,363.06Respondent's determination of the amount of compensation allowable as a deduction is presumed correct, and petitioner bears the burden of proving that a greater amount is appropriate. Rule 142(a); Botany Worsted Mills v. United States, 278 U.S. 282">278 U.S. 282 (1929); 149 F.2d 421">Miller Mfg. Co. v. Commissioner, supra.As we have found, the amounts allowed by respondent in his statutory notice of deficiency as compensation with respect to each associate equalled 100 percent of the "collections" attributed to the associate's direct patient services in petitioner's records. At the outset, we note that in view of the large increases in associate compensation during the years in issue, the magnitude of such increases as compared with the increases in petitioner's gross income, and the failure of petitioner to pay dividends, a number of the factors listed in 178 F.2d 115">Mayson Mfg. Co. v. Commissioner, supra, 1990 Tax Ct. Memo LEXIS 735">*806 appear to weigh against petitioner. No single factor is determinative, however, and the weight to be accorded each factor may vary with the circumstances. Pepsi Cola Bottling Co. of Salina, 61 T.C. 564">61 T.C. 567. We thus turn to a consideration of the parties' arguments. Both of the parties in the instant case submitted expert reports with respect to the reasonable compensation issue. 38 The expert reports are consistent to the extent that both calculate reasonable compensation for the associates' medical services for patients based on a percentage of the "collections" from patients for those services. As discussed below, petitioner's expert report adjusts the "collections" figure recorded by petitioner upward to reflect a "national norm," while respondent's report limits compensation for patient services to 85 percent of petitioner's recorded collections. The expert reports also are consistent to the extent that both allow additional amounts of compensation for the executive or administrative duties undertaken by petitioner's associates. Petitioner's expert report focuses in that regard on the associates' medically-related supervisory positions as heads *2249 of departments of the Hospital, 1990 Tax Ct. Memo LEXIS 735">*807 while respondent's report focuses on their services as petitioner's officers. The computations made in petitioner's expert report can be segmented into two categories. In one part of the report, petitioner's expert analyzes the amount reasonably payable to associates for patient services. In that regard, petitioner's expert uses collections from patients as a measure of reasonable compensation, but finds the "collections" figures actually recorded by petitioner to be artificially low and in need of adjustment. Petitioner's expert bases his conclusion that the "collections" figures recorded by petitioner were artificially low upon a comparison of such "collections" to the "billings" of petitioner's associates. His 1990 Tax Ct. Memo LEXIS 735">*808 report states that the ratio of collections to billings of petitioner's associates averaged 64.1 percent for the year ended October 31, 1982 and 54.4 percent for the year ended October 31, 1983. He then compares those ratios with a "national norm" of 92 percent. The report further concludes that the "startling difference" between the associates' collection ratios and the "national norm" was caused by petitioner's practice of allocating nondesignated partial payments to the Hospital component of a bill first, before crediting any portion of receipts to physician services. In that regard, the report states: "If the payments had been credited properly, the physician collection rates would have reflected the national norm of 92 percent of billings." Accordingly, petitioner's expert adjusts the "collections" of petitioner's associates upward, to 92 percent of their billings (i.e., the "national norm") and uses the resulting figures as reasonable compensation for patient services. We find the analysis of petitioner's expert to be not entirely persuasive for two reasons. First, the conclusion of petitioner's expert that associate collections should be adjusted to reflect a "national norm" 1990 Tax Ct. Memo LEXIS 735">*809 is based on the assumption that petitioner's method of allocating nondesignated partial payments triggered the divergence from such national norm. However, neither petitioner's expert report nor any other evidence offered by petitioner analyzes the effect of petitioner's receipt allocation practices in quantitative terms. While petitioner's expert report asserts that "numerous patient ledgers were reviewed" to verify its conclusion, the report presents neither any tabulation of the amount of nondesignated partial payments nor any information as to the frequency of occurrence of nondesignated partial payments. Moreover, petitioner's expert report states that "generally," third party payors would identify their payments as attributable to Hospital or physician charges, and we have found that the situation of nondesignated partial payments did not occur in the case of partial payments from Blue Cross, Blue Shield or other Government insurance programs. We therefore find little support for the apparently unsupported conclusion of petitioner's expert that petitioner's associate collection rate "would have equalled the national norm" had petitioner not followed the practice of allocating 1990 Tax Ct. Memo LEXIS 735">*810 nondesignated partial payments first to Hospital charges. Second, we are not convinced that the 92 percent collection rate used by petitioner's expert as a "national norm" actually represents an appropriate standard against which to measure petitioner's collections. Petitioner's expert admitted that the source of the 92 percent rate relied upon in his report was an article from "Medical Economics," entitled "Getting Paid is Getting Tougher," which specifically dealt with the collection ratios of office-based, as opposed to hospital -based physicians. The fact that such article specifically limits its discussion to "office-based M.D.'s" suggests that there is a difference in the data applicable to hospital-based physicians. We note that respondent's expert report lists as one of its sources a study specifically dealing with hospital-based physicians, and petitioner presented no evidence to refute the suggested difference. In light of the foregoing, we decline to calculate "reasonable compensation" for the services of petitioner's associates to patients by assuming, as petitioner's expert would have us do, that their collections were actually 92 percent of their billings and allowing 1990 Tax Ct. Memo LEXIS 735">*811 compensation equal to such assumed collections. Like petitioner's expert report, the report of respondent's expert determines reasonable compensation for the associates'services to patients as a percentage of collections. 391990 Tax Ct. Memo LEXIS 735">*812 Respondent's *2250 expert, however, uses the collections figures actually recorded by petitioner as a base, and calculates reasonable compensation for the associates' services to patients as 85 percent of such collections. Respondent's expert uses that 85 percent figure based on his conclusion that the Hospital's nonowner physicians were compensated at the rate of 85 percent of collections, and on his assumption that such "practice" was "accepted." We find, however, that such conclusions are not supported by the evidence in the instant case. Of the six employment contracts of nonowner physicians submitted into evidence in the instant case, only two provide for compensation equal 1990 Tax Ct. Memo LEXIS 735">*813 to 85 percent of collections (as an alternative to a fixed amount of compensation, with the physician receiving whichever is greater). Two of the contracts provide for fixed compensation or compensation based on 100 percent or 110 percent of collections, 40 and a third contract refers to the receipt of 100 percent of collections for certain months, less salary already received. The sixth contract submitted into evidence provides only for a fixed annual salary. Moreover, during the year ended October 31, 1982, four of petitioner's eight nonowner physicians actually received more than 85 percent of their collections as compensation; eight of its ten nonowner physicians received more than 85 percent of their collections during the subsequent year. 411990 Tax Ct. Memo LEXIS 735">*814 Having weighed all of the evidence before us, we conclude that the adjustments to "collections" proposed by neither expert are appropriate. 42 We hold that petitioner's associates were entitled to receive, as compensation for their services to patients, 100 percent of the collections recorded by petitioner as attributable such services. 431990 Tax Ct. Memo LEXIS 735">*815 We next consider the additional compensation warranted for other services performed by petitioner's associates. As noted above, petitioner's expert report assigned a separate value to the medically-oriented supervisory services of petitioner's associates. The report finds that the three associates collectively performed the functions of a director of intensive care, laboratory director, radiology director, stand-by and supervising emergency room physician, director of EKG, director of respiratory therapy, director of anesthesia, and chief of staff. The report then assigns an aggregate value to such services of $ 295,320 for the year ended October 31, 1982, and $ 310,860 for the year ended October 31, 1983, based on a review of salaries paid by Maryland hospitals having less than 200 beds." 44 For the year ended October 31, 1983, aggregate compensation is allocated among the various positions described in petitioner's 1990 Tax Ct. Memo LEXIS 735">*816 expert report as follows: Service ProvidedCompensation ReceivedChief of Staff$ 43,200Director of Intensive Care Unit8,820Emergency Room Department PhysicianSupervision and Stand by 77,400Director of Anesthesia57,780Laboratory Director60,300Radiology Director49,590Director of Respiratory Therapy4,770Director of EKG9,000$ 310,860For the year ended October 31, 1982, petitioner's expert applies a five percent discount to the above figures. At trial, Doctors McVey and Khuri testified that petitioner's associates did have a variety of *2251 medical responsibilities at the Hospital in addition to direct responsibility for patient care, none of which they separately were compensated for. Dr. McVey testified that, during the years in issue, he served as chairman of the 1990 Tax Ct. Memo LEXIS 735">*817 physiotherapy department, chairman of the intensive care unit, chairman of the obstetrics department, chief of staff (at various times), and co-chairman of the mortality-morbidity conferences. He also testified that he and Dr. Moore were in charge of the emergency room, and that Dr. Moore was in charge of radiology as well as being laboratory director for the Hospital. Dr. Khuri testified that during 1982 and 1983, he served as chief of the medical staff, chief of surgery, director of anesthesia, director of respiratory therapy, chairman of the tissue committee and infection control committee and co-chairman of the mortality and morbidity conference. While we believe that petitioner's associates were charged with medical responsibilities at the Hospital beyond ordinary patient care, we find the methodology used in petitioner's expert report to place a value on such responsibilities lacking in some respects. Notably, the report does not contain any information concerning the amount of time devoted to such responsibilities in either the Maryland hospitals surveyed or by petitioner's associates. Additionally, petitioner offered no significant information as to the hours spent by the 1990 Tax Ct. Memo LEXIS 735">*818 associates in their various capacities. The testimony of Dr. McVey on cross-examination also indicates that some of the medical "titles" held by petitioner's associates may have involved limited substantive responsibility, as such titles were unrelated to the associates' own medical specialties. In other cases, we have indicated that it is inappropriate to determine "reasonable compensation" for one individual performing multiple roles by aggregating the salaries of multiple persons each performing one of those roles on a full-time basis. 45Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner, 61 T.C. 564">61 T.C. 564, 61 T.C. 564">569 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975); Dockery v. Commissioner, T.C. Memo. 1982-509, 44 T.C.M. 1044, 1046, 51 P-H Memo T.C. par. 82,509 at 2317; Ken Miller Supply, Inc. v. Commissioner, T.C. Memo. 1978-228, 37 T.C.M. 974, 980, 47 P-H Memo T.C. par 78,228 at 973. Although petitioner's expert testified that in the Maryland hospitals surveyed, physicians holding the positions in question also would have patient care responsibilities, we are reluctant to adopt fully his conclusions in the absence of more definitive evidence of the comparability of those Maryland positions 1990 Tax Ct. Memo LEXIS 735">*819 with the functions of petitioner's associates. Applying our best judgment in light of all of the evidence bearing upon the additional medical responsibilities of petitioner's associates, we hold that petitioner is allowed an aggregate compensation deduction of $ 200,000 for such services for the year ended October 31, 1983, and $ 190,000 for the year ended October 31, 1982.Although petitioner's expert report arrives at specific compensation figures (for patient services and medical supervisory responsibilities) of $ 1,487,738 for the year ended 10/31/82 and $ 1,526,682 for the year ended 10/31/83, the report describes those amounts as "the minimum compensation that can be established for the three principals of [petitioner]." (Emphasis in original.) Those "minimum" figures represent significantly less than the $ 2,246,854 and $ 2,070,000 in compensation deductions claimed by petitioner in its returns for the respective years. In another section of his report, however, petitioner's expert purports to conclude that the entire1990 Tax Ct. Memo LEXIS 735">*820 amount claimed by petitioner as compensation to its associates must be reasonable because amounts received by petitioner for services provided to patients were judged reasonable by Medicare, Medicaid, and Blue Cross, who apply a reasonableness standard in determining permissible reimbursement. We find such analysis unconvincing in that petitioner has not shown that such payors separately evaluated the reasonableness of amounts paid to petitioner's associates for their services, as opposed to the reasonableness of gross charges made by petitioner to Medicaid or Medicare subscribers. In fact, on cross-examination, petitioner's expert admitted that, while Medicare required detailed reports concerning the "return on equity capital" of proprietary hospitals, it did not care whether hospital profits were distributed as compensation or as dividends. 461990 Tax Ct. Memo LEXIS 735">*821 Moreover, the conclusion of petitioner's expert that payments to petitioner's associates must have been reasonable compensation appears to be based on a misconception that the services of petitioner's associates generated all of the Hospital's profits. Perhaps in view of the disparity between the amount calculated in the report and the amount claimed as compensation deductions on petitioner's *2252 returns, petitioner's expert report states in conclusion that: In addition, further evaluation is being conducted to determine a reasonable compensation level for the following services: (1) Ancillary services rendered to private patients in the office practice. (2) Administrative duties performed by the three principals for RMA and the inpatient hospital facility. While petitioner's expert did not submit additional reports dealing with ancillary services or administrative duties, petitioner requests us to allow additional deductions for amounts attributable to such services and duties. At trial, petitioner's expert testified 1990 Tax Ct. Memo LEXIS 735">*822 that, in private practice, doctors bill their patients for ancillary services (such as laboratory work, anesthesia, drugs, x rays, etc.) provided by third parties, and "mark up" those charges beyond the amounts owed to such third parties. Because petitioner treated all ancillary charges as Hospital, rather than physician charges, petitioner argues that an amount should be added to associate collections or billings to reflect such profit, which would have been earned by physicians in a private practice setting. Petitioner also relies on the testimony of Ms. Jean Addison, petitioner's executive secretary and business office manager of the Hospital, that petitioner's associates "generated the majority of [ancillary revenues]" because they were "the major admitters" to the Hospital. We decline petitioner's invitation to allocate a portion of the Hospital's ancillary service charges to its associates. First, petitioner has submitted no quantitative analysis of the "profit" or "markup" which a private physician might expect to earn for ancillary services, or the equivalent amounts which might be attributed to its associates. Second, petitioner has not shown that its associates actually 1990 Tax Ct. Memo LEXIS 735">*823 performed any services related to generating ancillary revenues, or that any such services would not be encompassed within the duties for which appropriate compensation has already been allowed. Third, petitioner admits that its associates did not incur the expenses which are incurred by private practitioners and has not explained why its associates should be treated exactly like private practitioners with respect to compensation. Petitioner's submission of schedules documenting outpatient ancillary charges and total Hospital collections for ancillary services during the years in issue, together with petitioner's imprecise and unsupported arguments about such services, are insufficient to support any allocation of additional compensation for such services. As we stated in Jenkins v. Commissioner, T.C. Memo. 1988-292, 55 T.C.M. 1215, 1227, 57 P-H Memo T.C. par. 88,292 at 1485, "we refuse to guess in the absence of a single reliable guide and will not indulge in sheer 'unguided largesse.'" While petitioner's expert did not submit an additional report regarding "administrative" duties, respondent's expert assigned a value to the services of petitioner's associates as "president, vice 1990 Tax Ct. Memo LEXIS 735">*824 president and secretary-treasurer" of petitioner. Finding that the associates actually were "equal partners in a chief executive role," 471990 Tax Ct. Memo LEXIS 735">*825 respondent's expert report assigned a value of $ 90,750 to such services for each associate for the year ended October 31, 1982, and $ 97,500 for each associate for the year ended October 31, 1983. At trial, petitioner's expert appeared to agree that such amounts were reasonable and stated that they represented compensation for functions not considered in his report. On brief, petitioner states that the value of compensation for such executive functions is not in dispute. Accordingly, we will allow the additional amount found by respondent's expert as attributable to the associates' services as petitioner's officers. 48Finally, petitioner argues that additional amounts should be added to the amount found by its expert to reflect the value of services performed by the associates in prior years for which they were undercompensated. See Owensby & Kritikos, Inc. v. Commissioner, T.C. Memo. 1985-267, 50 T.C.M. 29, 41 n.10, 54 P-H Memo T.C. par. 85,267 at 1181 n.10, affd. 819 F.2d 1315">819 F.2d 1315 (5th Cir. 1987). In support of its argument, petitioner first points to the cost reimbursement requirements of Medicare, Medicaid, and Blue Cross, which it claims could delay payments for up to two years after the actual medical service had been rendered. At trial, petitioner attempted to introduce into evidence a letter from its expert 1990 Tax Ct. Memo LEXIS 735">*826 witness purporting to identify payments that related to services performed in prior years. That letter, however, was excluded from evidence on the grounds that it was not filed within the time *2253 provided by the Rules; respondent's objection to testimony by petitioner's expert that petitioner received money for past services during the years in issue also was sustained. In the absence of any reliable evidence demonstrating that the reimbursement requirements of various insurers produced financial distortions during the years in issue, and correlating such distortions with the compensation of petitioner's associates, we are unable to allow any additional compensation deductions based on petitioner's argument regarding reimbursement practices. 491990 Tax Ct. Memo LEXIS 735">*827 Petitioner also points to the fact that, in prior years, its associates consistently received compensation less than their "billings," arguing that such fact establishes that they were undercompensated in those years. Petitioner asserts that our decisions in Klamath Medical Service Bureau v. Commissioner, 29 T.C. 339">29 T.C. 339 (1957), affd. 261 F.2d 842">261 F.2d 842 (9th Cir. 1958), and McClung Hospital, Inc. v. Commissioner, T.C. Memo. 1960-86, establish a "billings standard" for physicians -- i.e., a rule of law that physicians are always entitled to compensation equal to 100 percent of their billings. Aside from the logical problems with such a rule (especially where, as here, the payor incurs all overhead and other expenses associated with the physicians' practices), we find that such rule is not prescribed by the cases cited by petitioner. In 29 T.C. 339">Klamath Medical Service Bureau v. Commissioner, supra, a corporation was engaged in providing medical services under contracts with subscribers. The corporation1990 Tax Ct. Memo LEXIS 735">*828 also entered into contracts with physicians (who were stockholders in the corporation) under which the physicians agreed to a schedule of fees for services to be performed for the corporation's subscribers. After performing such services, the physicians would "bill" the corporation in accordance with the agreed-upon fee schedule. Klamath Medical Service Bureau v. Commissioner, 261 F.2d at 844. While the scheduled fees in Klamath were unreasonably low when compared with amounts charged for like services by private practitioners, we characterized the arrangement as "not unrealistic" in view of the lessened administrative costs to doctors rendering services under the corporation's subscriber plans. Klamath Medical Service Bureau v. Commissioner, 29 T.C. 339">29 T.C. 348. Although the corporation in Klamath was not obligated to pay its stockholder-physicians, as compensation for their services, more than 100 percent of the scheduled fees "billed" by such physicians, it paid them over 100 percent of fees during the years in issue pursuant to a practice of dividing all net profits among the physicians. We held that amounts paid to the physicians in excess of 100 percent of their billings represented 1990 Tax Ct. Memo LEXIS 735">*829 distributions of the corporation's earnings rather than deductible compensation. In response to petitioner's argument that Klamath creates a rule entitling the physicians in the instant case to compensation of at least 100 percent of their "billings," respondent states on brief that: Petitioner does not understand the facts of Klamath. The billings which were involved in the Klamath case were bills submitted by the doctors to the Klamath Medical Services Bureau, not bills which Klamath sent to patients of the physicians employed by Klamath. There is no information in the Klamath opinion as to the hospital's success in collecting the amounts it billed patients. We agree with respondent. The fees "billed" to the corporation in Klamath, and the gross amounts directly billed to patients by doctors or hospitals, are apples and oranges. We therefore reject petitioner's argument that the Klamath decision requires a conclusion that its associates were undercompensated prior to the years in issue. Petitioner also directs our attention to McClung Hospital, Inc. v. Commissioner, T.C. Memo. 1960-86. In that case, we sustained the compensation deductions claimed with respect to two physicians 1990 Tax Ct. Memo LEXIS 735">*830 who were also brothers and majority shareholders in a hospital corporation. The compensation deductions were sustained in McClung notwithstanding the fact that (1) the aggregate compensation received by the brothers was equal to 100 percent of their billings to patients, without reduction for expenses or uncollectible amounts, (2) one of the brothers actually received more than his aggregate billings, and (3) the nonshareholder physicians employed by the hospital were compensated based on 60 percent of their billings to patients. In sustaining the compensation deduction claimed by the taxpayer in McClung, we noted that the brothers, who, as noted above, were also officers in the corporation, were in direct charge of the overall operation and administration of the hospital in addition to serving patients. We found that such "additional responsibilities" justified *2254 the more liberal payments made to the brothers than to junior physicians. Petitioner's argument concerning the effect of McClung appears to ignore the rule that reasonable compensation cases turn on their own peculiar facts and circumstances; thus, the fact that compensation in excess of patient billings was found reasonable 1990 Tax Ct. Memo LEXIS 735">*831 with respect to one of the physicians in McClung does not decide the amount reasonably payable to petitioner's associates. In the instant case, moreover, our opinion specifically allocates additional compensation amounts to the responsibilities, beyond direct patient care, undertaken by petitioner's associates. In that regard, our opinion herein is consistent with McClung, in which such additional responsibilities were found to justify the amount of compensation paid. We have considered all of petitioner's other arguments and find them without merit. In summary, we hold that petitioner was entitled to deduct the following amounts as reasonable compensation for the services of its associates: Taxable Year EndedTaxable Year Ended10/31/8210/31/83Amount Attributableto Direct Patient Services$ 830,294.13 $ 718,663.16 +Amount Attributableto Medical Depart-mental Responsibilities190,000 200,000 +Amount Attributableto Services asOfficers272,250 292,500 Total$ 1,292,544.13$ 1,211,163.16We note in conclusion that the testimony offered by petitioner's associates and by its expert, as well as petitioner's Bylaws, indicate that it was petitioner's practice to distribute all funds left 1990 Tax Ct. Memo LEXIS 735">*832 after the payment of Hospital expenses (and the setting aside of reserves) among the associates at year end. During the years in issue, petitioner chose to treat all of those distributed amounts as deductible compensation. On cross-examination, petitioner's expert, who was a C.P.A., was unable to explain how petitioner ever could have been expected to end up with a "profit" at the corporate level using such system of compensation, preferring to note that another expert would be testifying on the entity classification issue. In 29 T.C. 339">Klamath Medical Service Bureau v. Commissioner, supra, we found similar testimony by the taxpayer's president -- namely, that the corporation distributed all amounts in excess of expenses and reserves to the physicians -- indicative of an intent to distribute earnings under the guise of salary. In Klamath, we stated that: It seems clear from this testimony that under its contract with member physicians petitioner intended that all of its earnings in excess of amounts necessary for its operation, planned expansion, and reserves were to be distributed to its member-stockholder physicians. Viewed in that light the contract provides not only a method of computation 1990 Tax Ct. Memo LEXIS 735">*833 for services rendered but also a method for distribution of its profits to its stockholders. We are convinced from this record that petitioner, after attaining its objective of providing adequate medical, surgical, and hospital facilities for the people of Klamath County, fully intended its earnings and profits should be distributed to its stockholders and that the method of doing so was that with which we are here concerned. * * * [Klamath Medical Service Bureau v. Commissioner, 29 T.C. 339">29 T.C. 348-9] While the failure to pay dividends does not automatically trigger a finding that compensation paid to shareholders was unreasonable, Edwin's, Inc. v. United States, 501 F.2d 675">501 F.2d 675, 501 F.2d 675">677 n.5 (7th Cir. 1974), Laure v. Commissioner, 70 T.C. 1087">70 T.C. 1087, 70 T.C. 1087">1098, 70 T.C. 1087">1100 (1978), affd. in part and revd. in part on other issues 653 F.2d 253">653 F.2d 253 (6th Cir. 1981), the system employed in "compensating" petitioner's associates during the years in issue would seem to assure that there would never be funds available for the payment of dividends. Moreover, contrary to what petitioner would have us believe, petitioner's associates were far from the only generators of income for the Hospital; we are not dealing with a situation 1990 Tax Ct. Memo LEXIS 735">*834 in which all of an entity's income comes directly from services performed by its shareholders.501990 Tax Ct. Memo LEXIS 735">*835 As we stated in a *2255 similar vein in Dockery v. Commissioner, T.C. Memo. 1982-509, Petitioner, from his testimony, appears to have felt that he was worth whatever compensation he could withdraw from [his wholly-owned corporation]. While that approach is understandable, the Code establishes a different standard. * * * [44 T.C.M. 1044, 1047, 51 P-H Memo T.C. par. 82,509 at 2318. Fn. ref. omitted.] We have exercised our best judgment with the record before us to decide the "reasonalbe" value of the services performed by petitioner's associates. We note in conclusion that it is not our purpose to limit the ability of individuals to share in the profits of their enterprises: Nevertheless, we must, as a matter of law, decide to what extent the earnings from their businesses can properly be paid to them as compensation and to what extent such earnings must be treated as the profits of their business with the resulting tax consequences. Owensby & Kritokos, Inc. v. Commissioner, T.C. Memo. 1985-267, 50 T.C.M. 29, 48 54 P-H Memo T.C. par. 85,267 at 1187-1188, affd. 819 F.2d 1315">819 F.2d 1315 (5th Cir. 1987). NegligenceRespondent also determined additions to tax for negligence under section 6653(a) for the years in issue. 511990 Tax Ct. Memo LEXIS 735">*837 The addition to tax under section 6653(a)(1) applies if any part of the underpayment is due to negligence. Section 6653(a)(2), by contrast, applies only to that portion of the underpayment attributable to negligence or intentional disregard of rules and/or regulations. Petitioner bears the burden 1990 Tax Ct. Memo LEXIS 735">*836 of proving that respondent's determination is in error. Rule 142(a). Negligence is defined as a "lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985) (citing Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 380 F.2d 499">506 (5th Cir. 1967). While a showing of honesty, good faith, and disclosure by the taxpayer may preclude the existence of fraud, "good faith does not always negative negligence." Wesley Heat Treating Co. v. Commissioner, 30 T.C. 10">30 T.C. 10, 30 T.C. 10">26 (1958), affd. 267 F.2d 853">267 F.2d 853 (7th Cir. 1959). Rather, the taxpayer must show that he "acted reasonably and prudently and exercised due care." 85 T.C. 934">Neely v. Commissioner, supra.In the instant case, we find that at least a portion of petitioner's underpayment was due to negligence. The deductions claimed by petitioner herein were substantially in excess of the amounts which we have found to represent a reasonable allowance for services provided. See Summit Publishing Co. v. Commissioner, T.C. Memo. 1990-288, 59 T.C.M. 833, 839. Petitioner's Bylaws provided for the distribution of all of petitioner's net profits among the associates at year end, and the method 1990 Tax Ct. Memo LEXIS 735">*838 provided therein for dividing net profits -- 75 percent according to each associate's "productivity factor" and the other 25 percent equally -- suggests that the latter component was to be distributed based on ownership, i.e., as dividends. 52Petitioner's own expert, moreover, while making a "general" finding that the total amount paid to petitioner's associates was reasonable, actually computed "minimum" reasonable compensation as 66 percent and 74 percent of the amounts claimed by petitioner in its returns for the years ended October 31, 1982 and October 31, 1983, respectively. While petitioner's returns in the instant case were prepared by a C.P.A., that fact, without more, does not insulate petitioner from the negligence addition. Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 57 T.C. 781">802-803 (1972). Petitioner has failed to present evidence that its officers, who were well educated and highly-paid individuals, *2256 received any "advice" from such C.P.A. concerning allowable compensation deductions, United States v. Boyle, 469 U.S. 241">469 U.S. 241 (1985), and has failed to show that 1990 Tax Ct. Memo LEXIS 735">*839 any advice received was based on all the facts. Leonhart v. Commissioner, 414 F.2d 749">414 F.2d 749, 414 F.2d 749">750 (4th Cir. 1969), affg. a Memorandum Opinion of this Court. 53 In the absence of such evidence, we are unconvinced that petitioner's treatment of all distributions to its associates as compensation represented reasonable and prudent conduct. Accordingly, we hold that the five percent addition provided by section 6653(a) (1) is applicable. The addition provided by section 6653(a)(2) applies only to the portion of the underpayment attributable to negligence or intentional disregard of rules and/or regulations. While petitioner failed to establish that it acted reasonably in treating all distributions to its associates as deductible compensation, we do not believe that addition under section 6653(a)(2) is warranted with respect to the entire underpayment herein. The reasonable compensation issue in 1990 Tax Ct. Memo LEXIS 735">*840 the instant case was an intensely contested issue of mixed fact and law where reasonable minds can and often do differ. See United Title Insurance Co. v. Commissioner, T.C. Memo. 1988-38. While we did not accept the findings of either expert witness in their entirety, we found both experts highly qualified and adopted aspects of both expert reports in reaching our conclusions. As noted above, petitioner's expert report calculated "minimum" reasonable compensation for petitioner's associates as $ 1,487,738 and $ 1,526,682 for the years ended October 31, 1982, and October 31, 1983, respectively. To the extent that the compensation deductions claimed by petitioner exceeded such amounts, we hold that the underpayments attributable to such deductions were due to negligence for purposes of section 6653(a)(2). To reflect the foregoing,Decision will be entered under Rule 155. APPENDIX *2257 Section 301.7701-2(b), Proced. and Admin. Regs.(b) Continuity of life. (1) An organization has continuity of life if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will not cause a dissolution of the organization. On the other hand, if the death, insanity, bankruptcy, 1990 Tax Ct. Memo LEXIS 735">*841 retirement, resignation, or expulsion of any member will cause a dissolution of the organization, continuity of life does not exist. * * * (2) For purposes of this paragraph, dissolution of an organization means an alteration of the identity of an organization by reason of a change in the relationship between its members as determined under local law. For example, since the resignation of a partner from a general partnership destroys the mutual agency which exists between such partner and his copartners and thereby alters the personal relation between the partners which constitutes the identity of the partnership itself, the resignation of a partner dissolves the partnership. A corporation, however, has a continuing identity which is detached from the relationship between its stockholders. The death, insanity, or bankruptcy of a shareholder or the sale of a shareholder's interest has no effect upon the identity of the corporation and, therefore, does not work a dissolution of the organization. An agreement by which an organization is established may provide that the business will be continued by the remaining members in the event of the death or withdrawal of any member, but such 1990 Tax Ct. Memo LEXIS 735">*842 agreement does not establish continuity of life if under local law the death or withdrawal of any member causes a dissolution of the organization. Thus, there may be a dissolution of the organization and no continuity of life although the business is continued by the remaining members. (3) An agreement establishing an organization may provide that the organization is to continue for a stated period or until the completion of a stated undertaking or such agreement may provide for the termination of the organization at will or otherwise. In determining whether any member has the power of dissolution, it will be necessary to examine the agreement and to ascertain the effect of such agreement under local law. For example, if the agreement expressly provides that the organization can be terminated by the will of any member, it is clear that the organization lacks continuity of life. However, if the agreement provides that the organization is to continue for a stated period or until the completion of a stated transaction, the organization has continuity of life if the effect of the agreement is that no member has the power to dissolve the organization in contravention of the agreement. 1990 Tax Ct. Memo LEXIS 735">*843 Nevertheless, if, notwithstanding such agreement, any member has the power under local law to dissolve the organization, the organization lacks continuity of life. * * * Section 301.7701-2(c), Proced. and Admin. Regs.(c) Centralization of management. (1) An organization has centralized management if any person (or any group of persons which does not include all the members) has continuing exclusive authority to make the management decisions necessary to the conduct of the business for which the organization was formed. Thus, the persons who are vested with such management authority resemble in powers and functions the directors of a statutory corporation. The effective operation of a business organization composed of many members generally depends upon the centralization in the hands of a few of exclusive authority to make management decisions for the organization,and therefore, centralized management is more likely to be found in such an organization than in a smaller organization. (2) The persons who have such authority may, or may not, be members of the organization and may hold office as a result of a selection by the members from time to time, or may be self-perpetuating 1990 Tax Ct. Memo LEXIS 735">*844 in office. See Morrissey et al. v. Commissioner, (1935) 296 U.S. 344">296 U.S. 344. Centralized management can be accomplished by election to office, by proxy appointment, or by any other means which has the effect of concentrating in a management group continuing exclusive authority to make management decisions. (3) Centralized management means a concentration of continuing exclusive authority to make independent business decisions on behalf of the organization which do not require ratification by members of such organization. Thus, there is not centralized management when the centralized authority is merely to perform ministerial acts as an agent at the direction of a principal. (4) There is no centralization of continuing exclusive authority to make management decisions, unless the managers have sole authority to make such decisions. For example, in the case of a corporation or a trust, the concentration of management powers in a board of directors or trustees effectively prevents a stockholder or a trust beneficiary, simply because he is a stockholder or beneficiary, from binding the corporation or the trust by his acts. However, because of the mutual agency relationship between members 1990 Tax Ct. Memo LEXIS 735">*845 of a general partnership subject to a statute corresponding to the Uniform Partnership Act, such a general partnership cannot achieve effective concentration of management powers and, therefore, centralized management. Usually, the act of any partner within the scope of the partnership business binds all the partners; and even if the partners agree among themselves that the powers of management shall be exclusively in a selected few, this agreement will be ineffective as against an outsider who had no notice of it. In addition, limited partnerships subject to a statute corresponding to the Uniform Limited Partnership Act, generally do not have centralized management, but centralized management ordinarily does exist in such a limited partnership if substantially all the interests in the partnership are owned by the limited partners. Section 301.7701-2(d), Proced. and Admin. Regs. (d) Limited liability. -- (1) An organization has the corporate characteristic of limited liability if under local law there is no member who is personally liable for the debts of or claims against the organization. Personal liability means that a creditor of an organization may seek personal satisfaction 1990 Tax Ct. Memo LEXIS 735">*846 from a member of the organization to the extent that the assets of such organization are insufficient to satisfy the creditor's claim. A member of the organization who is personally liable for the obligations of the organization may make an agreement under which another person, whether or not a member of the organization, assumes such liability or agrees to indemnify such member for any such liability. However, if under local law the member remains liable to such creditors notwithstanding such agreement, there exists personal liability with respect to such member. * * * Footnotes1. Unless otherwise noted, 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.↩*. 50 percent of the interest payable on the portion of the underpayment due to negligence.↩2. The Virginia Act was repealed in 1988. See n. 36, infra.↩3. In their stipulation of facts, the parties agreed that Doctors McVey, Moore, and Khuri were the sole owners and directors of petitioner beginning in mid-1982 and "including all years in issue under the Notice of Deficiency." However, petitioner's tax return for the taxable year ended October 31, 1983, lists those three physicians as each owning only 25 percent of the "stock" in petitioner, for a total ownership of 75 percent. For purposes of our opinion, we follow the parties' stipulation as to ownership of the association. As noted above, interests in professional associations may be owned only by persons legally qualified to render the professional services for which the association is organized. While one exhibit in the record refers to the receipt of pension and other checks by Dr. Strader's widow, there is no indication in the record that she could have assumed Dr. Strader's status as an associate after his death.4. Although the Bylaws stated that the number of directors could be determined by the associates from time to time, section 54-882↩ of the Virginia Act requires that the number of directors be changed by amendment of the bylaws or articles of association.5. Petitioner also deducted $ 12,000 for its taxable year ended October 31, 1982, and $ 9,000 for its taxable year ended October 31, 1983, as directors' fees. Those amounts were allowed by respondent.↩6. The stipulated exhibit documenting the collections of petitioner's associates lists Dr. Khuri as having collections of $ 241,014.39 for the year ended October 31, 1982. The notice of deficiency apparently inverts two numbers, allowing $ 241,041.39 as a compensation deduction. We believe that the correct number is $ 241,014.39 and use that figure in our computations.↩*. Collections and compensation of Dr. Strader, who died during the year ended 10/31/82, have been ignored for purposes of these computations.↩7. Although Dr. Khuri testified that he became a "member" of petitioner in 1978, petitioner's returns for the years in issue indicate that Dr. Khuri did not become an officer of petitioner until the year ended October 31, 1982. Drs. McVey and Moore were apparently officers throughout the six-year period described in the chart. Petitioner's returns, however, indicate an increase in the "stock" ownership of Drs. McVey and Moore between the year ended October 31, 1979 and the year ended October 31, 1980.↩8. Respondent has not asserted that petitioner is barred, under the doctrine of equitable estoppel, from denying its corporate status, and we therefore do not consider the issue of estoppel. Cf. Sangers Home for Chronic Patients v. Commissioner, 72 T.C. 105">72 T.C. 105 (1979). Equitable estoppel and its various counterparts, such as quasi-estoppel (the "duty of consistency"), are affirmative defenses which must be pleaded and proved. Arkansas Best Corp. v. Commissioner, 83 T.C. 640">83 T.C. 640, 83 T.C. 640">660 n.8 (1984), affd. in part and revd. in part on other issues 800 F.2d 215">800 F.2d 215 (8th Cir. 1986), affd. 485 U.S. 212">485 U.S. 212↩ (1988); Rule 39.9. On the subject of centralized management, for example, former section 301.7701-2(h)(3), Proced. and Admin. Regs., provided a list of nine matters over which the managers of a professional service organization must have continuing exclusive authority and went on to state: Although a measure of central control may exist in a professional service organization, the managers of a professional service organization in which a member retains traditional professional responsibility cannot have the continuing exclusive authority to determine all of the matters described in the preceding sentence * * * Therefore, centralization of management does not exist in such a professional service organization. [Emphasis supplied.] For a detailed discussion of the 1965 Regulations and their effects, see Eaton, supra↩, Chapter 27.10. Revenue Ruling 70-101, 1970-1 C.B. 278, 280, also indicated that an organization could be classified as a corporation irrespective of whether it met the requirements of the 1965 Regulations, in essence conceding the invalidity of those regulations. The 1965 Regulations were officially revoked by T.D. 7515↩ (October 17, 1977).11. The only notable change in the relevant regulations as between 1960 and the years in issue was the deletion of Example (1) of section 301.7701-2(g)↩, Proced. and Admin. Regs., which dealt with classification of a medical clinic. The 1965 Regulations deleted that example, but Treasury failed to reissue it when the 1965 Regulations were revoked.12. Specifically, section 301.7701-2↩, Proced. and Admin. Regs.13. The regulations, however, recognize a "modified form" of free transferability of interests which is accorded less significance than such characteristic when present in unmodified form. Larson v. Commissioner, 66 T.C. 159">66 T.C. 159, 66 T.C. 159">185 (1976); sections 301.7701-2(e)(2) and 301.7701-2(g) Ex. (6)↩, Proced. and Admin. Regs.14. We recognize that petitioner submitted an "expert report" prepared by a C.P.A. on the issue of classification and that such report was admitted at trial without objection. As such report addresses an issue for the Court to decide as a matter of law, we have ignored it. The term "petitioner's expert report" as used hereinafter does not refer to such report.15. Petitioner, in its reply brief, argues that it failed to adhere to various procedural requirements of the Virginia Act, and that such statute, asserted by respondent to confer corporate status on petitioner, in reality reflects otherwise. Petitioner notes section 54-878 of the Virginia Act, which requires that articles of association be filed before a Virginia professional association is deemed formed, and section 54-879 of the Virginia Act, which requires that amendments to such articles also be filed, and asserts that it never filed its amended articles of association. Assuming arguendo that petitioner actually failed to file such amended articles, we refuse what appears to be a late attempt by petitioner to disavow its status as a professional association under Virginia law. In its petition, petitioner alleged that it was a professional association under the Virginia Act, and in their stipulation of facts, the parties agreed that petitioner "has always been a professional association as defined by Title 54 of the Code of Virginia." The parties also stipulated that petitioner's amended articles of association (referred to herein as the Articles) were "in effect" during the years in issue. We therefore have found that petitioner was governed by the provisions of the Virginia Act, as well as by the Articles, during the taxable years in issue.16. There are apparently no recorded legislative committee reports dealing with the Virginia Act. See Comment, "Limited Liability for Shareholders in Virginia Professional Corporations: Fact or Fiction?," 21 U. Richmond L. Rev. 571, 576 n.34 (1987)↩ (noting that the Virginia General Assembly does not record its legislative history).17. Section 301.7701-2(b)(3)↩, Proced. and Admin. Regs.18. In O'Neill v. United States, 410 F.2d 888">410 F.2d 888 (6th Cir. 1969), the Government argued that an entity organized under the Ohio Professional Association law lacked continuity of life because shares in such organization were required to be owned by persons licensed to practice the profession, and one of the shareholders might become disqualified at a time when the corporation could not redeem the shares and no one was willing to buy them. The Sixth Circuit rejected the Government's argument that the existence of such contingency would defeat continuity of life, stating: It is not clear under Ohio law what the result would be were such a situation to exist. However, the fact that there might be a condition which would require the forfeiture of corporate status does not change the legal situation: Ohio has granted to such corporations continuity of existence. 410 F.2d 888">410 F.2d at 899↩.19. Petitioner's argument on brief that "all" Owner-Physicians had to approve any purchase in excess of $ 1,000 as well as endorsing any check of $ 1,000 or more is not supported by the accompanying citation to the transcript. More specifically, the cited testimony (by Dr. Khuri) states that the Board of Directors had the authority to approve payments and that, for any payment above $ 1,000, two of petitioner's members would have to sign the checks. Dr. McVey testified consistently that the signatures of only two↩ associates were required for checks. The Bylaws provided that, generally, "all checks must be signed by the Executive Secretary, President, and Vice-President of the Governing Body." Petitioner's Executive Secretary was Mrs. Jean Addison, who was not an associate of petitioner.20. The following exchange took place on direct examination of Dr. Khuri: Q: All right. Let's focus a moment on the operation of the Association. Who ran the Association, that is, Richlands Medical? A: The board of directors. Q: Why do you state that? A: Because I've been a member of the board of directors. I've been the president of the Association. I know how it was run. [Emphasis supplied.]↩21. Petitioner's Medical Staff Bylaws, which provided rules governing the Hospital's medical staff, similarly defined the Hospital's "Governing Body" as "stockholders of the Richlands Medical Association T/A Mattie Williams Hospital."22. See also Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, p. 2-6 n.13 (5th Ed. 1987) (noting that "A one-owner organization * * * may encounter difficulties in establishing that it possesses such corporate characteristics as continuity of life and centralized management"); Horsley, "The Virginia Professional Association Act: Relief for the Underprivileged?" 48 Va. L. Rev. 777">48 Va. L. Rev. 777, 48 Va. L. Rev. 777">803-804↩ (1962) (suggesting that, under the original version of the Virginia Act, which required a three-person professional association to have only two directors, the death of one associate would cause such association to lose centralized management).23. Nico v. Commissioner, 67 T.C. 647">67 T.C. 647↩ (1977).24. We note that Morrissey is cited in section 301.7701-2(c)(2)↩, Proced. and Admin. Regs., which deals with the composition and selection of the management group.25. Swanson v. Commissioner, 296 U.S. 362">296 U.S. 362 (1935), and Helvering v. Combs, 296 U.S. 365">296 U.S. 365↩ (1935).26. While we did not focus in Hynes on the issue of whether centralization of management exists if the management group includes all the members of an association, an overly technical reading of the parenthetical language of section 301.7701-2(c)(1)↩, Proced. and Admin. Regs., in that case might have precluded the existence of centralized management because the board of trustees of the trust included the sole beneficiary.27. In the same paragraph, the Bittker & Eustice treatise notes the regulations' requirement that the managerial group be "composed of less than all the members."↩28. Section 301.7701-2(d)(1), Proced. and Admin. Regs., specifically notes that contractual agreements under which another person assumes a member's liability or agrees to indemnify the member for such liability are insufficient to create↩ limited liability if under local law the member remains liable to his creditor.29. See Kurzner v. United States, 286 F. Supp. 839">286 F. Supp. 839, 286 F. Supp. 839">842 (S.D. Fla. 1968). In 1967, the provision was amended by the addition of the following sentence: the personal liability of shareholders of a corporation organized under this act, in their capacity as shareholders of such corporation, shall be no greater in any aspect than that of a shareholder-employee of a corporation organized under [the general corporation laws]. [Kurzner v. Commissioner, 413 F.2d 97">413 F.2d 97, 413 F.2d 97">107 (5th Cir. 1969), citing Fla. Stat. section 621.07 (1967).] Such amendment was not retroactive, and the Government argued that a Florida court might construe the original provision at issue in Kurzner to impose virtually unlimited liability on shareholder-professionals. The Fifth Circuit, however, characterized the amendment as a "clarification" and declined what it referred to as the Government's "invitation to speculate." 413 F.2d 97">413 F.2d at 107-108↩ n. 52.30. The FloridaAct, unlike the Virginia Act, had a provision rendering Florida's general corporation laws applicable in all instances not covered specifically by the professional corporation law. The District Court (whose decision was affirmed by the Fifth Circuit) had cited such provision as "sharply limiting" the liability of the shareholder-professionals. Kurzner v. United States, 286 F. Supp. 839">286 F. Supp. 839, 286 F. Supp. 839">845 (S.D. Fla 1968). In the instant case, section 54-892 itself provides that associates shall not, by reason of being associates↩, be liable for claims against the association, other associates, or employees of the association.31. Because the professional corporation qualified as a corporation under the Kintner Regulations, the court found it unnecessary to decide the validity of such regulations. Kurzner v. Commissioner, 413 F.2d 97">413 F.2d 97, 413 F.2d 97">112↩ (5th Cir. 1969).32. The OhioAct's savings clause provided that: [The provisions of the OhioAct] do not modify any law applicable to the relationship between a person furnishing professional service and a person receiving such service, including liability arising out of such professional service. [O'Neill v. United States, 410 F.2d 888">410 F.2d 888, 410 F.2d 888">900↩ (6th Cir. 1969).]33. The portion of the O'Neill opinion discussed in the instant case may be regarded as dicta in that case, as the Sixth Circuit's holding in O'Neill was that a "corporation" under state law is to be treated as a corporation for Federal income tax purposes without regard to any test of corporate "resemblance." In that regard, the Court reasoned that section 7701(a)(3) does not define "corporation," but extends corporate status to organizations which otherwise would not fall within the meaning of the term. O'Neill v. United States, 410 F.2d 888">410 F.2d 888, 410 F.2d 888">895, 410 F.2d 888">899 (6th Cir. 1969). We need not address that issue in the instant case, as petitioner was an unincorporated↩ entity under the Virginia Act.34. While the Court of Appeals affirmed the Appellate Division decision quoted herein and did not explicitly disagree with any portion of the Appellate Division's analysis, the Court of Appeals in one portion of its opinion characterized section 1505 of New York's Business Corporation Law as warranting strict construction in that it "carves out a limited exception to a rule of broad and general application and imposes liability unknown at common law." 490 N.Y.S. 2d at 745. That language appears contrary to the quoted statement of the Appellate Divisionand to our analysis in the instant case.35. Nelson v. Patrick, 58 N.C. App. 546">58 N.C. App. 546, 326 S.E.2d 45, 50↩ (1985) (citing section 55B-9 of North Carolina Professional Corporation Act).36. In a Comment entitled "Limited Liability for Shareholders in Virginia Professional Corporations: Fact or Fiction?," 21 U. Rich. L. Rev. 571 (1987), the author proposes legislative change to the Virginia Professional Corporation Act (PC Act) to avoid the possibility of such judicial construction of the PC Act's savings clause. (The PC Act existed concurrently with the Virginia Act involved in the instant case between 1970 and 1988, at which time the Virginia Act was repealed). The Comment notes that the PC Act does not contain a provision similar to section 54-892 of the Virginia Act, and suggests that a construction of its savings clause as importing vicarious liability would be less likely if such a provision were added to the PC Act. 21 U. Rich. L. Rev. at 586-587↩.37. The Fifth Circuit has explained the "reasonableness" requirement of section 162(a)(1) as follows: Because the shareholders will receive the profits of the business one way or the other, all parties prefer to characterize payments to shareholders as compensation. For that reason, a corporation may deduct compensation only to the extent that it is reasonable. Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315">819 F.2d 1315, 819 F.2d 1315">1323 (5th Cir. 1987), affg. T.C. Memo. 1985-267. For a discussion of the legislative history of section 162(a)(1), see Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142">73 T.C. 1142, 73 T.C. 1142">1155↩ (1980).*. See footnote 6, supra↩.38. Petitioner's expert report was prepared by a partner specializing in health care consulting at a nationally known accounting firm. Respondent's expert report was prepared by an executive with a corporation engaged in the preparation of organizational studies including compensation studies. He also taught organizational evaluation in the Masters of Administration program at the University of Maryland and, in a book, wrote a chapter dealing with occupational issues.↩39. The majority of respondent's expert report consists of tabulations of data aimed at demonstrating that the compensation paid to petitioner's associates was unreasonable. While we found the data relating to changes in associate compensation, patient collections and various income measurements of petitioner useful, many of the charts comparing petitioner with other enterprises were misleading in that they apparently compared the total compensation received by petitioner's associates with amounts paid by other enterprises for executive services only. Useful information may be derived from these charts, however, by subtracting (from the amounts noted therein for petitioner) the amounts which we find to represent reasonable compensation for patient services and medical supervisory positions. See Anselmo v. Commissioner, 80 T.C. 872">80 T.C. 872, 80 T.C. 872">884-885 (1983), affd. 757 F.2d 1208">757 F.2d 1208 (11th Cir. 1985). Other charts prepared by respondent's expert are unconvincing in that they present data for enterprises too large or different in function to truly be comparable with petitioner. Petitioner heavily focuses on the fact that respondent's expert compared data relating to taxpayers on the accrual basis with data from petitioner, a cash basis taxpayer. As we have not relied on those comparisons (which primarily deal with compensation as a percentage of sales) in reaching our conclusions herein, we need not address petitioner's arguments about the effect of its accounting method on the data.↩40. We recognize that, in one of the contracts providing for "100%" of collections, a typed figure of 85 percent was crossed out and changed to 100 percent. We do not attach any significance to such fact, especially in view of the fact that in another contract, a typed figure of "100%" was changed in handwriting to 110 percent.↩41. We note that the data submitted into evidence with respect to nonowner physicians aggregates the "collections" of several emergency room physicians. We have used aggregate collections and compensation of such emergency room physicians in deriving the number of physicians receiving more than 85 percent of collections.42. While we may accept the opinion of an expert in its entirety, Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441">74 T.C. 441, 74 T.C. 441">452 (1980), we may be selective in the use of any portion of such an opinion. Parker v. Commissioner, 86 T.C. 547">86 T.C. 547, 86 T.C. 547">562↩ (1986).43. The amount which we hereby allow as compensation for services to patients is equal to the total amount allowed in respondent's notice of deficiency. Respondent argues on brief that the amounts allowed in his notice of deficiency were made up of two components -- namely, a "patient service" component equal to 85 percent of collections, and an "officer" component equal to 15 percent of collections. We, however, have found that the full amount allowed in the notice of deficiency constitutes reasonable compensation for services to patients. We note Dr. McVey's testimony that the hospital at which he practiced at the time of trial did not bill patients for his services.44. Petitioner's expert explained at trial why Maryland data was used even though the Hospital was located in Virginia. He stated that, because of the extensive state filing requirements imposed on Maryland hospitals, "every major health care researcher in the country uses Maryland data base for any type of comparisons." He also explained that there is no similar data base for Virginia and noted the proximity of the two states.↩45. We recognize that the compensation assigned by petitioner's expert to three of the positions in question is under $ 10,000 and suggestive of part-time work.↩46. Petitioner's expert testified that he did not review each line in petitioner's Medicare cost reports, which were each about 100 pages long, but relied upon "overall Medicare methodology" and net payments for his conclusion. He also testified that associates' compensation for direct patient care services would not be reflected in the Medicare cost reports. The Medicare cost report excerpt submitted in evidence in the instant case does not refer separately to the compensation paid to petitioner's associates.47. Although respondent's expert report listed Dr. Khuri as president, Dr. Moore as vice president, and Dr. McVey as secretary-treasurer, the record is unclear as to the offices held by Drs. McVey and Moore. Dr. McVey's testimony indicates that he was petitioner's vice president, and, in response to the question about who served as vice president, Dr. Khuri simply responded "One of the other two" (referring to Drs. McVey and Moore). The recorded minutes of petitioner's Board of Directors meetings list Dr. Khuri as president but do not list titles for Drs. McVey or Moore.48. We are reluctant to agree with the conclusion of respondent's expert that petitioner's associates participated equally↩ in a chief executive role; Dr. Khuri's testimony indicates otherwise. However, as we are determining only the total deduction allowable to petitioner, we find it unnecessary to allocate the compensation between the three associates.49. We note that petitioner admits on brief that the cost reimbursement methodology upon which it bases its argument also may result in situations where the health care providers must later repay amounts already collected as an interim settlement. Were we to adopt petitioner's argument that its associates should be given "credit" during the years in issue for services performed in prior years, we also would need to allow respondent to adduce evidence to address the logical extension of such argument, namely, that some of the services performed by petitioner's associates during the years in issue should not be compensated until later years.50. See Petro-Chem Marketing Co. v. United States, 221 Ct. Cl. 211">221 Ct. Cl. 211, 602 F.2d 959">602 F.2d 959, 602 F.2d 959">967 (1979) (referring to, but not deciding, the "novel issue" of whether a corporate enterprise whose income is earned solely from the personal services of its officers, should be permitted to pay out all of its income, less amounts retained for working capital, etc. to its officers in the form of compensation); Apolinsky, Tax Planning for Professionals, p. 3-83 (1986) ("Many commentators and practioners believe that a professional corporation should be insulated against unreasonable compensation issues because substantially all of the income generated by the corporation is derived from the efforts of the professionals.") Cf. Eduardo Catalano,Inc. Pension Trust v. Commissioner, T.C. Memo. 1979-183↩.51. Section 6653(a) provides: (a) NEGLIGENCE OR INTENTIONAL DISREGARD OF RULES AND REGULATIONS WITH RESPECT TO INCOME, GIFT, OR WINDFALL PROFIT TAXES. -- (1) IN GENERAL. -- If any part of any underpayment (as defined in subsection (c)(1)) of any tax imposed by subtitle A, by chapter 12 of subtitle B or by chapter 45 (relating to windfall profit tax) is due to negligence or intentional disregard of rules or regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment. (2) ADDITIONAL AMOUNT FOR PORTION ATTRIBUTABLE TO NEGLIGENCE, ETC. -- There shall be added to the tax (in addition to the amount determined under paragraph (1)) an amount equal to 50 percent of the interest payable under section 6601 -- (A) with respect to the portion of the underpayment described in paragraph (1) which is attributable to the negligence or intentional disregard referred to in paragraph (1), and (B) for the period beginning on the last date prescribed by law for payment of such underpayment (determined without regard to any extension) and ending on the date of the assessment of the tax (or, if earlier, the date of the payment of the tax).52. We note that at trial, petitioner's associates appeared to characterize the equal distributions as "draws" to meet living expenses.↩53. On cross-examination, Dr. Khuri stated that he had not kept copies of the information given to petitioner's accountants or bookkeepers on how to divide petitioner's profits. On cross-examination, Dr. McVey testified that he did not know whether petitioner filed corporate or partnership returns.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623003/ | John B. Paine, Petitioner, v. Commissioner of Internal Revenue, RespondentPaine v. CommissionerDocket No. 111499United States Tax Court2 T.C. 179; 1943 U.S. Tax Ct. LEXIS 129; June 22, 1943, Promulgated 1943 U.S. Tax Ct. LEXIS 129">*129 Decision will be entered under Rule 50. Under the terms of a will creating a testamentary trust of which petitioner was the income beneficiary, a class of trust income was under the discretion of the trustees to decide whether it should be treated as income or principal, and the decision of the trustees as to what constituted trust income was final. During the taxable year some of the trust income consisted of this special income, but the trustees did not decide during the taxable year whether it should be treated as income or principal of the trust. The trustees made their decision in April of the following year when they credited all of such income to the income account of petitoner. Held, that the special income was not deductible in the taxable year by the trustees from the gross income of the trust under section 162 (b) or (c) of the Revenue Act of 1938, and petitioner was not required to include the amount thereof in his gross income for the taxable year. J. W. Townsend, Esq., for the petitioner.E. L. Corbin, Esq., for the respondent. Harron, Judge. HARRON 2 T.C. 179">*180 Respondent determined a deficiency in income tax for the year 1938 in the amount of $ 1943 U.S. Tax Ct. LEXIS 129">*130 907.69. Petitioner concedes that respondent properly disallowed a deduction of $ 900 for charitable contributions. Respondent concedes that he erred in disallowing a deduction for commissions in the amount of $ 132.71. The only question to be considered is whether petitioner is taxable upon some of the income of a testamentary trust of which he was the income beneficiary. Respondent added the amount of $ 1,903.83 to petitioner's income as income which was distributable to him during 1938. The parties have agreed that $ 378.32 of the above amount represents nontaxable income.Petitioner filed his income tax return for the year 1938 with the collector for the district of Massachusetts.FINDINGS OF FACT.Petitioner resides in Boston, Massachusetts. He keeps his books and reports his income on the cash basis.Petitioner's father, Charles J. Paine, died in 1916 and his will was duly proved and allowed in the Probate Court of Middlesex County, Massachusetts, on January 11, 1917. Under the will of Charles J. Paine, his residuary estate was devised to trustees in trust. During the year 1938, and previously, the trustees held for petitioner a share in the residuary estate in trust, 1943 U.S. Tax Ct. LEXIS 129">*131 and they were to hold that share in trust during his lifetime, having previously distributed to him the other part of his share of the residuary estate to which he became entitled when he reached the age of 30 years, which was on April 19, 1900. The material terms of the will of petitioner's father are as follows:* * * As to the share of each son of mine living at my decease, to hold the same until such son attains the age of thirty years, paying over to him the net income thereof, and as each such son attains the age of thirty years, to transfer, pay over and convey to him one-half of the principal of his share, and to hold the other half of his share during his natural life, paying over to him the net income thereof, and on the decease of each such son to transfer, pay over and convey such other one-half of the principal of his share, or the whole thereof, if he die before attaining the age of thirty years, to such person or persons, and in such amounts and proportions, in trust or otherwise, as he by his last will and testament or any instrument of appointment in the nature thereof, duly established, may direct and appoint. [Italics added.]2 T.C. 179">*181 The will also contained1943 U.S. Tax Ct. LEXIS 129">*132 the following authorization to the trustees:* * * I authorize my trustees to retain as income any dividends from mines or other wasting investments, or to treat such dividends, and any extra or unusual dividends, as capital in their discretion, and the decision of my trustees as to what constitutes net income shall be final.The trustees carried an account on their books in the name of petitioner, to which they made credits of income at various times. The account was set up to show a principal account and an income account. Whatever the trustees determined to be principal, under their discretionary power under the will, was entered as a credit to principal in the petitioner's account, and whatever they determined to be income, was entered as a credit to income in the account. All of the income of the trust, other than the special receipts from mines, wasting investments, and extra or unusual dividends, was credited to income in the account in the year of receipt.The trustees were advised in 1937 by a revenue agent to set up a special account on their books as a suspense account in which receipts from mines, wasting investments, and extra or unusual dividends would be carried 1943 U.S. Tax Ct. LEXIS 129">*133 pending the decision of the trustees on whether to treat such receipts as principal or income. The suspense account was set up on the trustees' books in December of 1937, and at the end of 1937 it showed a balance of $ 2,779.25, no part of which was transferred by the trustees to either principal or income in petitioner's account during 1937. On March 1, 1938, the trustees transferred $ 2,779.25 to income in petitioner's account by appropriate book entries.During 1938 the trustees received dividends from the United States Smelting, Refining & Mining Co., Kennecott Copper Corporation, and Calumet & Hecla Copper Co., in the total amount of $ 1,973.75. (The parties are agreed that of this sum $ 69.92 represents depreciation, leaving a net amount of $ 1,903.83.) None of these receipts from mines was credited to income or to principal in petitioner's account during 1938, and no part thereof was paid to petitioner in 1938. The entire amount was carried in the suspense account during 1938 and the balance of the account at the end of 1938 was $ 1,973.75. On April 1, 1939, the trustees transferred $ 1,973.75 to income in petitioner's account.In their fiduciary return for 1938 the trustees1943 U.S. Tax Ct. LEXIS 129">*134 reported the receipts from mines which were received during 1938 and carried in the suspense account during that year, and they paid tax on such receipts. Petitioner did not include in income in his individual return for 1938 any of the net amount of $ 1,903.83. Exclusive of that amount, petitioner reported trust income in his return for 1938 in the amount of 2 T.C. 179">*182 $ 16,045.11. In his audit of petitioner's return for 1938, respondent added $ 1,903.83 to income as trust income which was distributable in 1938 to petitioner.OPINION.The parties are agreed that the net receipts in the amount of $ 1,903.83 were "dividends from mines" and, as such, were in the class of receipts which, under the will of petitioner's father were subject to the trustees' decision to treat them as income or principal of the trust. Petitioner argues that the receipts in question did not become trust income during 1938, the year of receipt, because the trustees did not make any decision in that year to treat them as income. Petitioner was entitled to receive the net income of the trust. Petitioner contends, however, that with respect to the special class of receipts from mines, etc., he had no right1943 U.S. Tax Ct. LEXIS 129">*135 to receive them until the trustees made the decision, which they were authorized to make, that the receipts should fall into income.Respondent contends that the receipts became vested in petitioner and subject to his demands as trust income at the end of 1938 upon the failure of the trustees during 1938 to add them to principal. Respondent takes the view that the trustees were obligated to exercise their discretion and make their decision within the year of the receipt because petitioner was entitled to receive the net income of the trust, and the trustees could not put off from year to year the making of their decision as to what constituted principal and income. Respondent refers to the rule that "The test of taxability to the beneficiary is not receipt of income, but the present right to receive it." .Respondent contends that the question is whether the receipts from mines in the taxable year were "income * * * which is to be distributed currently by the fiduciary to the beneficiaries." If they were such income, they were deductible by the trustees in their return and were to be "included in computing the net1943 U.S. Tax Ct. LEXIS 129">*136 income of the beneficiaries whether distributed to them or not." Sec. 162 (b), Revenue Act of 1938.The question must be decided under the terms of the will creating the trust of which petitioner is the beneficiary. The will provided that the trustees were to pay over to a beneficiary the "net income" of the testamentary trust. The terms of the will contemplated, however, that certain kinds of receipts, to wit, "any dividends from mines or other wasting investments, and any extra or unusual dividends" should constitute a special class of receipts, and that the trustees should decide whether to treat such receipts as income or capital. The will provided that "the decision of my trustees as to what constitutes net income shall be final." It would appear to follow that until the trustees exercised 2 T.C. 179">*183 their discretion and made their decision with respect to any receipts which came within the special class, no present right could vest in the income beneficiary of the trust to receive such special receipts. The will did not require the trustees to exercise their judgment within any stated period of time. Here there was no great delay. The decision was made in the early part1943 U.S. Tax Ct. LEXIS 129">*137 of the year following the payment to the trustees of the special receipts. Until the trustees made their decision, the receipts could not constitute income of the trust. The clause of the will which made a class of trust receipts subject to the trustees' discretion permitted, in our opinion, the holding of such receipts pending the making of the decision, and the receipts could not become income of the trust "which is to be distributed currently" until the trustees made their decision. The trustees did not until April 1, 1939, make their decision with respect to the special class of dividends which were received in 1938. It is held that the net amount of $ 1,903.83 was not income of the trust to be distributed currently during the year 1938, and that it was not required by the terms of the will to be currently distributed to the beneficiary. It was taxable to the trust in 1938, and not to petitioner.Section 161 imposes the tax liability for trust income primarily upon the fiduciary. Section 162, however, provides for specific deductions in computing the net income taxable to the fiduciary. Under section 162 (b) income is deductible by the fiduciary "which is to be distributed1943 U.S. Tax Ct. LEXIS 129">*138 currently by the fiduciaries to the beneficiaries," and the amounts so allowed as deductions shall be included in computing the net income of the beneficiaries, "whether distributed to them or not." As the amount in question was not income of the trust in 1938 which was to be currently distributed to the beneficiary, section 162 (b) does not apply here.Section 162 (c) 1 allows deduction by the fiduciary of income which, in his discretion, may be either distributed or accumulated and which is by him "properly paid or credited during such year" to a beneficiary. None of the special receipts were credited to trust income or to petitioner during 1938. They could not properly be credited to petitioner during 1938 because the trustees had not decided in 1938 to treat the receipts as income. Section 162 (c) does not apply here. 2 T.C. 179">*184 Since none of the special dividends received in 1938 were deductible by the trustees in their 1938 fiduciary return, the petitioner was not required to include the sum in question in his gross income for 1938.1943 U.S. Tax Ct. LEXIS 129">*139 Respondent's determination is reversed.Petitioner relies on . The facts there are substantially different from the facts here, and that case is not controlling in and of itself. It affords some authority for the result reached here, however, in that here we find nothing in the clause of the will placing a special class of trust income within the discretion of the trustees as characterizing such income as currently distributable immediately upon failure of the trustees to add it to principal; "nor do we find any provision directing the immediate addition by the trustee of the income to the principal, the failure of which would necessarily be the event automatically converting it into income to be 'distributed currently' to the beneficiaries." See page 187 of the report in the Orthwein case.Decision will be entered under Rule 50. Footnotes1. SEC. 162. NET INCOME.The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that --* * * *(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, 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 properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623005/ | Midland Empire Packing Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentMidland Empire Packing Co. v. CommissionerDocket No. 13340United States Tax Court14 T.C. 635; 1950 U.S. Tax Ct. LEXIS 221; April 19, 1950, Promulgated 1950 U.S. Tax Ct. LEXIS 221">*221 Decision will be entered under Rule 50. Petitioner, a meat-packing corporation, by lining the walls and floor of its basement with concrete, sought to protect it from the seepage of oil spilled on the ground by a neighboring refinery. The oil nuisance threatened continued operation of the packing plant. The purpose of the expenditure for the concrete liner was not to prepare the plant for operation on a changed or larger scale, nor to make it suitable for new or additional uses, but only to permit petitioner to continue the use of the plant, and particularly the basement, in normal operation. Held, the expenditure for lining the basement walls and floor was essentially a repair and as such is deductible as an ordinary and necessary business expense under section 23 (a) of the Internal Revenue Code. James R. Felt, Esq., for the petitioner.Wilford H. Payne, Esq., for the respondent. Arundell, Judge. ARUNDELL14 T.C. 635">*636 This case involves deficiencies in declared value excess profits tax in the amount of $ 321.34 and excess profits tax in the amount of $ 4,092.72 for the taxable year ended November 30, 1943. The issue presented for decision is whether or not the sum of $ 4,868.81 expended by the petitioner in oilproofing the basement of its meat-packing plant during the taxable year 1943 is deductible as an ordinary and necessary business expense under section 23 (a) of the Internal Revenue Code, or, in the alternative, as a loss sustained during the year and not compensated for by insurance or otherwise under section 23 (f) of the Internal Revenue Code.The case has been submitted on a partial stipulation of facts, documentary evidence, and oral testimony.FINDINGS OF FACT.The petitioner, herein sometimes referred to as Midland, is a Montana corporation and the owner of a meat-packing1950 U.S. Tax Ct. LEXIS 221">*223 plant which is located adjacent to the city of Billings, Yellowstone County, State of Montana. Its returns for the period here involved were filed with the collector of internal revenue for the district of Montana. Its books of account and its tax returns were, during the taxable year and at all other times, kept on the accrual basis of accounting. Petitioner's returns were based on a fiscal year ending November 30.The basement rooms of petitioner's plant were used by it in its business for the curing of hams and bacon and for the storage of meat and hides. These rooms have been used for such purposes since the plant was constructed in about 1917. The original walls and floors, which were of concrete, were not sealed against water. There had been seepage for many years and this condition became worse around 1943. At certain seasons of the year, when the water in the Yellowstone River was high, the underground water caused increased seepage in the plant. Such water did not interfere with petitioner's use of the basement rooms. They were satisfactory for their purpose until 1943.The Yale Oil Corporation, sometimes referred to herein as Yale, was the owner of an oil-refining1950 U.S. Tax Ct. LEXIS 221">*224 plant and storage area located some 300 yards upgrade from petitioner's meat-packing plant. The oil plant was constructed some years after petitioner had been in business in its present location. Yale expanded its plant and storage from year to year and oil escaping from the plant and storage facilities was carried to the ground surrounding the plant of petitioner. In 1943 petitioner found that oil was seeping into its water wells and into water which came through the concrete walls of the basement of its packing plant. The water would soon drain out through the sump, leaving a thick scum of oil on the basement floor. Such oil 14 T.C. 635">*637 gave off a strong odor, which permeated the air of the entire plant. The oil in the basement and fumes therefrom created a fire hazard. The Federal meat inspectors advised petitioner to oilproof the basement and discontinue the use of the water wells or shut down the plant.As soon as petitioner discovered that oil had begun to seep into its water wells and into the basement of its plant, its officers conferred with the officers of the Yale Oil Corporation and informed Yale that they intended to hold it liable for all damage caused by the oil1950 U.S. Tax Ct. LEXIS 221">*225 which had saturated the ground around its packing plant. They informed the officials of Yale that they believed this condition constituted a legal nuisance, which condition they expected would continue to exist for future years, and that they were discontinuing the use of their water wells. The officials of Yale were also informed that the Federal inspectors were requiring petitioner to oilproof the basement.A. F. Lamey, attorney at law in Billings, Montana, handled nearly all of the negotiations for the settlement of the claims made by Midland against the Yale Oil Corporation for damages resulting from the oil escaping from Yale's refineries to the premises of the packing company. He represented the Yale Corporation and the Maryland Casualty Co., which carried liability insurance with respect to Yale. Early in 1943 he went to the packing plant to inspect the basement and observed the situation as found above. He talked with Chris Shaffer, of the petitioner corporation, and informed him that Yale was not assuming any responsibility and that it was petitioner's duty to take whatever steps were necessary to minimize damages. Prior to that time, petitioner suggested piece-meal1950 U.S. Tax Ct. LEXIS 221">*226 settlements, which Yale declined to consider because they felt it would be to their disadvantage to assume responsibility for any damages without a complete release. Lamey wrote to the Maryland Casualty Co., Yale's insurer, in a letter dated March 31, 1943, with reference to this situation, in part as follows:Past experience indicates that little can be done through a conference with Mr. Shaffer, who is in charge of the plant. His demands are always exorbitant and he has never been willing to make any proposition for a complete and final settlement. He seems to have the idea that the Yale should make monthly payments on the water account, pay damages on hides each year as they are injured, etc. If we ever began making payments on that basis there would be no end to our difficulties. We therefore suggested to the Yale that we do nothing. We feel that we would have a better opportunity to dispose of this claim if the Packing Company obtained the services of a lawyer who could advise them with reference to their rights, and the limits of the Yale's responsibilities.On June 10, 1943, Lamey again wrote to the Maryland Casualty Co. with respect to the matter of Yale's liability 1950 U.S. Tax Ct. LEXIS 221">*227 to Midland:Since our letter of the 5th, we have held two conferences with representatives of the Midland Empire Packing Company. The claimant has employed M. J. 14 T.C. 635">*638 Lamb of this city as attorney. At the conferences, Mr. Frank Jacoby, a contractor, has also been present. It is our understanding that he has some interest in the packing plant. However, we know him very well. He is a competent and honest contractor.Frank Jacoby was a construction contractor, who also did repair and improvement work at various times for petitioner corporation. He owned one-third of the capital stock of the petitioner throughout the period here involved and later became vice president of the corporation. Jacoby talked with the officers of Yale about the nature of the oil-sealing work to be done on petitioner's plant in order to insure that the work was done to the satisfaction of Yale, inasmuch as petitioner was looking for reimbursement for that amount from Yale. Midland decided to proceed with the work in the basement and Yale agreed that it should be done and that in any litigation or in any settlement that ensued it would accept the testimony of Jacoby as to the reasonableness of the 1950 U.S. Tax Ct. LEXIS 221">*228 cost of the work done. They also agreed to acknowledge the bills for such work as an element of damages if a settlement was later effected. The Yale officials refused to do the repair work themselves.The president of Midland continued to refuse to give a complete release covering future damage. The letter of June 10, 1943, recited some of the items claimed by petitioner corporation, including several references to the repairs in petitioner's basement.With respect to the delay in giving the petitioner a definite answer to the settlement of its liability, the letter stated:It is rather difficult for the officers of the packing company to understand why we cannot give an immediate definite answer, in view of the fact that the offices of the Yale Petroleum Company are located in Billings. They have no knowledge that there is insurance coverage. We mention this so that you will understand the importance of making some decision with reference to a basis of settlement as soon as possible.Finally, regarding the legal basis of Yale's liability to the petitioner for the damages caused by the oil, Lamey wrote to the insurance company that it was his opinion that Midland would have little1950 U.S. Tax Ct. LEXIS 221">*229 difficulty in establishing liability on the part of the Yale Oil Corporation. He also noted that the item of damage claimed by the packing company could be considered as evidence of damages. The letter then stated that, while the amount needed to settle the claim might be large and the Yale Co. would not be able to get a release for future damages, when the basement repairs were completed there should be little future damage. He recommended that the claim be settled and concluded with a statement that it was to Yale's advantage that Midland was proceeding with repairs to the basement.The original walls and floor of petitioner's plant were of concrete construction. For the purpose of preventing oil from entering its 14 T.C. 635">*639 basement, petitioner added concrete lining to the walls from the floor to a height of about four feet, and also added concrete to the floor of the basement. Since the walls and floor had been thickened, petitioner now had less space in which to operate. Petitioner had this work done by independent contractors, supervised by Jacoby, in the fiscal year ended November 30, 1943, at a cost of $ 4,868.81. Petitioner paid for this work during that year.The oilproofing1950 U.S. Tax Ct. LEXIS 221">*230 work was effective in sealing out the oil. While it has served the purposes for which it was intended down to the present time, it did not increase the useful life of the building or make the building more valuable for any purpose than it had been before the oil had come into the basement. The primary object of the oilproofing operation was to prevent the seepage of oil into the basement so that the petitioner could use the basement as before in preparing and packing meat for commercial consumption.After the oilproofing was completed and prior to the close of the petitioner's taxable year ended November 30, 1943, negotiations for settlement were again conducted between representatives of petitioner and the Yale Oil Corporation, at which time Yale offered to pay petitioner in cash the sum of approximately $ 7,500 in satisfaction of all claims asserted by Midland against Yale, provided Midland would execute a general release to Yale. Because Midland was unwilling and refused to give such release for the payment offered, no amount was in fact paid to petitioner by Yale in that year. Petitioner continued to maintain that it was entitled to a much larger amount for the general damage1950 U.S. Tax Ct. LEXIS 221">*231 done to the plant by this nuisance. Negotiations had reached this point in the fiscal year ended November 30, 1943.The petitioner thereafter filed suit against Yale, on April 22, 1944, in a cause of action sounding in tort and on November 30, 1944, joined as a defendant in such action Yale's successor, the Carter Oil Co., which had acquired the properties of Yale Oil Corporation. This action was to recover damages for the nuisance created by the oil seepage. In those proceedings the defendants demurred to the joinder of parties in the petitioner's complaint. On appeal, the Montana Supreme Court sustained the demurrer.Petitioner subsequently settled its cause of action against Yale for $ 11,659.49 and gave Yale a complete release from all liability. This release was dated October 23, 1946. The recovery of the cost of the waterproofing only was reported in its excess profits and income tax returns for the year ended November 30, 1946.The petitioner is still making claim upon the Carter Oil Co. and is endeavoring to settle that claim without suit.Midland charged the $ 4,868.81 to repair expense on its regular books and deducted that amount on its tax returns as an ordinary 1950 U.S. Tax Ct. LEXIS 221">*232 14 T.C. 635">*640 and necessary business expense for the fiscal year 1943. The Commissioner, in his notice of deficiency, determined that the cost of oilproofing was not deductible, either as an ordinary and necessary expense or as a loss in 1943.OPINION.The issue in this case is whether an expenditure for a concrete lining in petitioner's basement to oilproof it against an oil nuisance created by a neighboring refinery is deductible as an ordinary and necessary expense under section 23 (a) of the Internal Revenue Code, on the theory it was an expenditure for a repair, or, in the alternative, whether the expenditure may be treated as the measure of the loss sustained during the taxable year and not compensated for by insurance or otherwise within the meaning of section 23 (f) of the Internal Revenue Code.The respondent has contended, in part, that the expenditure is for a capital improvement and should be recovered through depreciation charges and is, therefore, not deductible as an ordinary and necessary business expense or as a loss.It is none too easy to determine on which side of the line certain expenditures fall so that they may be accorded their proper treatment for tax purposes. 1950 U.S. Tax Ct. LEXIS 221">*233 Treasury Regulations 111, * from which we quote in the margin, is helpful in distinguishing between an expenditure to be classed as a repair and one to be treated as a capital outlay. In Illinois Merchants Trust Co., Executor, 4 B. T. A. 103, at page 106, we discussed this subject in some detail and in our opinion said:It will be noted that the first sentence of the article [now Regulations 111, sec. 29.23 (a)-4] relates to repairs, while the second sentence deals in effect with replacements. In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those1950 U.S. Tax Ct. LEXIS 221">*234 for replacements, alterations, improvements, or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings.14 T.C. 635">*641 It will be seen from our findings of fact that for some 25 years prior to the taxable year petitioner had used the basement1950 U.S. Tax Ct. LEXIS 221">*235 rooms of its plant as a place for the curing of hams and bacon and for the storage of meat and hides. The basement had been entirely satisfactory for this purpose over the entire period in spite of the fact that there was some seepage of water into the rooms from time to time. In the taxable year it was found that not only water, but oil, was seeping through the concrete walls of the basement of the packing plant and, while the water would soon drain out, the oil would not, and there was left on the basement floor a thick scum of oil which gave off a strong odor that permeated the air of the entire plant, and the fumes from the oil created a fire hazard. It appears that the oil which came from a nearby refinery had also gotten into the water wells which served to furnish water for petitioner's plant, and as a result of this whole condition the Federal meat inspectors advised petitioner that it must discontinue the use of the water from the wells and oilproof the basement, or else shut down its plant.To meet this situation, petitioner during the taxable year undertook steps to oilproof the basement by adding a concrete lining to the walls from the floor to a height of about four1950 U.S. Tax Ct. LEXIS 221">*236 feet and also added concrete to the floor of the basement. It is the cost of this work which it seeks to deduct as a repair. The basement was not enlarged by this work, nor did the oilproofing serve to make it more desirable for the purpose for which it had been used through the years prior to the time that the oil nuisance had occurred. The evidence is that the expenditure did not add to the value or prolong the expected life of the property over what they were before the event occurred which made the repairs necessary. It is true that after the work was done the seepage of water, as well as oil, was stopped, but, as already stated, the presence of the water had never been found objectionable. The repairs merely served to keep the property in an operating condition over its probable useful life for the purpose for which it was used.While it is conceded on brief that the expenditure was "necessary," respondent contends that the encroachment of the oil nuisance on petitioner's property was not an "ordinary" expense in petitioner's particular business. But the fact that petitioner had not theretofore been called upon to make a similar expenditure to prevent damage and disaster1950 U.S. Tax Ct. LEXIS 221">*237 to its property does not remove that expense from the classification of "ordinary" for, as stated in Welch v. Helvering, 290 U.S. 111">290 U.S. 111, "ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. * * * the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted 14 T.C. 635">*642 means of defense against attack. Cf. Kornhauser v. United States, 276 U.S. 145">276 U.S. 145. The situation is unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part." Steps to protect a business building from the seepage of oil from a nearby refinery, which had been erected long subsequent to the time petitioner started to operate its plant, would seem to us to be a normal thing to do, and in certain sections of the country it must be a common experience to protect one's property from the seepage of oil. Expenditures to accomplish this result are likewise normal.In American Bemberg Corporation, 10 T.C. 361,1950 U.S. Tax Ct. LEXIS 221">*238 we allowed as deductions, on the ground that they were ordinary and necessary expenses, extensive expenditures made to prevent disaster, although the repairs were of a type which had never been needed before and were unlikely to recur. In that case the taxpayer, to stop cave-ins of soil which were threatening destruction of its manufacturing plant, hired an engineering firm which drilled to the bedrock and injected grout to fill the cavities where practicable, and made incidental replacements and repairs, including tightening of the fluid carriers. In two successive years the taxpayer expended $ 734,316.76 and $ 199,154.33, respectively, for such drilling and grouting and $ 153,474.20 and $ 79,687.29, respectively, for capital replacements. We found that the cost (other than replacement) of this program did not make good the depreciation previously allowed, and stated in our opinion:In connection with the purpose of the work, the Proctor program was intended to avert a plant-wide disaster and avoid forced abandonment of the plant. The purpose was not to improve, better, extend, or increase the original plant, nor to prolong its original useful life. Its continued operation was1950 U.S. Tax Ct. LEXIS 221">*239 endangered; the purpose of the expenditures was to enable petitioner to continue the plant in operation not on any new or better scale, but on the same scale and, so far as possible, as efficiently as it had operated before. The purpose was not to rebuild or replace the plant in whole or in part, but to keep the same plant as it was and where it was.The petitioner here made the repairs in question in order that it might continue to operate its plant. Not only was there danger of fire from the oil and fumes, but the presence of the oil led the Federal meat inspectors to declare the basement an unsuitable place for the purpose for which it had been used for a quarter of a century. After the expenditures were made, the plant did not operate on a changed or larger scale, nor was it thereafter suitable for new or additional uses. The expenditure served only to permit petitioner to continue the use of the plant, and particularly the basement for its normal operations.In our opinion, the expenditure of $ 4,868.81 for lining the basement walls and floor was essentially a repair and, as such, it is deductible 14 T.C. 635">*643 as an ordinary and necessary business expense. This holding makes1950 U.S. Tax Ct. LEXIS 221">*240 unnecessary a consideration of petitioner's alternative contention that the expenditure is deductible as a business loss, nor need we heed the respondent's argument that any loss suffered was compensated for by "insurance or otherwise."Decision will be entered under Rule 50. Footnotes*. Sec. 29.23 (a)-4. Repairs. -- 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 expense, provided the plant or property account is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, should be charged against the depreciation reserve if such account is kept. (See sections 29.23 (l)-1 to 29.23 (l)-10, inclusive.)↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623007/ | JOHN I. BENSON AND ELEANOR M. BENSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBenson v. CommissionerDocket No. 25077-81.United States Tax CourtT.C. Memo 1983-679; 1983 Tax Ct. Memo LEXIS 107; 47 T.C.M. 294; T.C.M. (RIA) 83679; November 14, 1983. Louis Ginberg, for the petitioners. Warren P. Simonsen, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Chief Judge:* Respondent determined a deficiency of $25,328.47 in petitioners' Federal income tax for 1975. 1983 Tax Ct. Memo LEXIS 107">*108 At issue is whether the value of an interest in property transferred to petitioner Eleanor M. Benson to satisfy unpaid obligations owed to her under a property settlement agreement and a divorce decree is taxable income in 1975 under sections 71 1 or 61. 2FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of facts are incorporated herein by this reference. Insofar as objections were not made or were overruled regarding certain exhibits, the exhibits are incorporated herein by reference. 31983 Tax Ct. Memo LEXIS 107">*109 At the time they filed their petition, petitioners resided at Burtonsville, Maryland. 4 They timely filed their joint Federal income tax return for 1975 with the Philadelphia Service Center, Internal Revenue Service. Petitioner Eleanor M. Benson (hereinafter sometimes referred to as Eleanor or petitioner) married James A. Travis (hereinafter referred to as James) on January 16, 1944. Eleanor and James had seven children during their marriage. During the course of their marriage, petitioner and James acquired commercial property at 2123 Twining Court, N.W., Washington, D.C. (hereinafter referred to as the Twining Court property). The Twining Court property was held by them as tenants by the entirety. On September 1, 1960, Eleanor and James separated and on May 17, 1961, they entered into a "Property Settlement Agreement" (hereinafter agreement) in the District of Columbia. Although entitled "Property Settlement Agreement," the agreement also provided for Eleanor's custody of the seven minor children. Additionally, the agreement provided in pertinent part: 1983 Tax Ct. Memo LEXIS 107">*110 FOURTH: All * * * real, personal or mixed [property] * * * held by the Husband or the Wife, shall be the separate property of either of them in whose name such property now stands[.] * * * FIFTH: All property * * * in which the parties have a joint interest shall be divided between them as follows: (1) The Husband shall transfer and convey his interest in * * * Lots #5 and 6 in said subdivision; including the premises and structures thereon, and located at 15212 Burmingham Drive, Laurel, Maryland, which is now owned by the parties hereto as tenants by the entireties, to the Wife * * * it being understood and agreed that the Wife shall take said title to the premises subject to a first deed of trust, securing the balance of a purchase money note thereon in the approximate sum of $12,330.36, and shall assume and pay the same. * * * (2) The Wife shall also have and be the owner of all the furniture and household furnishings now located at 15212 Burmingham Drive, Laureal [sic], Maryland[.] * * * (3) The Husband shall assign and transfer to the Wife all of his right title and interest in and to that certain Pontiac Convertible which is now in the possession of the1983 Tax Ct. Memo LEXIS 107">*111 Wife and the Wife agrees to assume and pay all liens and encumberances [sic] against the same. (4) The Husband shall assign and transfer to the Wife all of his right title and interest in and to Policy #842-52-87 on the Life of the Husband in the principal sum of $50,000 * * * it being understood and agreed however that the Wife shall be responsible for the continuance of said policy in force and effect and for payment of all premiums. (5) The Wife shall transfer and assign to the Husband all of her right title and interest in and to 5 shares of the $1.00 par value common stock of Electrical Equipment Company. (6) The parties agree that the shares of the $1.00 par value common stock of the Twining Court Corporation issued to them jointly shall be owned and retained by them as tenants by the entirety. They further agree that the real estate * * * located at 2123 Twining Court, Northwest, Washington, D.C., shall likewise be owned and retained by the parties as tenants by the entireties. (7) The Husband and Wife agree that in the event the marriage between them is hereafter dissolved by divorce, that they shall continue to own and retain the said * * * stock and said real1983 Tax Ct. Memo LEXIS 107">*112 estate * * * as tenants by the entireties[.] * * * SIXTH: The Wife hereby waives, releases and bars herself of all right of dower in and to any and all real property or interest therein, now owned or that may be hereafter acquired by the said Husband. * * * SEVENTH: The Husband hereby releases * * * all right that he may have to curtesy * * *. * * * TENTH: The provisions for division of property between Husband and Wife hereinbefore set forth, are designed to provide the Wife with an independent income so long as she may live, regardless of divorce or remarriage, and to permit her to meet the obligation, assumed by her under the provisions of this agreement, to support, maintain and educate the minor children of the parties. For the purposes of guaranteeing to the Wife an income of at least $215.00 per week during the minority of the children of the parties hereto, it is further agreed as follows: (1) The Husband shall manage the real estate and securities held in tenancy by the entireties by Husband and Wife, and shall collect the net income, retaining for his own use all of the income from the securities, and distributing one-half (1/2) of the net income1983 Tax Ct. Memo LEXIS 107">*113 from the real estate held by the entireties to the Husband and one-half (1/2) thereof to the Wife[.] * * * (2) Commencing as of Saturday, May 6, 1961, and continuing for twenty-three (23) years from [that] date, the Husband shall pay to the Wife the sum of Two Hundred Fifteen ($215.00) Dollars per week. Such weekly payments shall be credited to the Wife's share of the net income received or receivable from the real property, and regardless of the amount of net income received or receivable. * * * (3) After twenty-three years from May 6, 1961, the Husband shall no longer have any obligation to pay to the Wife more than one-half of the net income from the real property * * * However, the Husband shall continue to manage the real estate and securities * * * and distribute one-half of the net income from the real property to the Wife * * * The Husband shall, however, continue to retain all of the net income from the securities. * * * (4) The power of the Husband to manage the real estate and securities * * * shall extend to the power to vote any securities so held * * * In the event of an agreed upon sale of the real property * * * the net proceeds thereof shall be divided1983 Tax Ct. Memo LEXIS 107">*114 equally * * * [and] and Husband shall no longer have any obligation to support and maintain the Wife, and the Wife shall accept one-half of the net proceeds of the sale of said real estate in full discharge of all obligations of the Husband for support and maintenance; her obligation to support and maintain and educate the minor children of the parties to continue. * * * The agreement provided that no alimony or maintenance fees would be sought other than stated above, that the agreement was to remain "in full force and effect" on the divorce of the parties, and that its provisions were not to be merged into any court judgment or decree. The agreement was not incorporated in the final divorce decree. On August 14, 1962, petitioner and James were divorced by a Decree of Divorce issued by the Circuit Court for Montgomery County, Maryland. The Decree did not mention the property settlement agreement, but ordered James to pay Eleanor "the sum of $215.00 per week as alimony * * * and as maintenance and support for the children." These $215.00 weekly payments were not intended to be either a gift or a loan from James to Eleanor. Eleanor married John I. Benson in 1967. James did1983 Tax Ct. Memo LEXIS 107">*115 not fulfill the "support" obligations imposed by the property settlement agreement. 5 In December 1974 he was $73,456 in arrears on the "support" payments. From 1964 to 1971, petitioner filed four actions and obtained four money judgments against James in the Family Division of the Superior Court of the District of Columbia. These judgments were not satisfied. A fifth action was filed in 1973, whereby petitioner sought another money judgment for arrearages and an award of property and relief. On February 13, 1975, the Superior Court, in its Findings and Judgment, awarded Eleanor a money judgment and ordered James to transfer to Eleanor his rights and interests in the Twining Court property on or before March 15, 1975. The order also stated that: As of the date that all of Defendant's rights and interests in the aforesaid property are transferred to Plaintiff, Defendant's1983 Tax Ct. Memo LEXIS 107">*116 outstanding obligations to Plaintiff in the amount of $73,456.31, and any further sums which may have accrued under the property settlement agreement from December 6, 1974 to the date of transfer, are fully satisfied and Defendant's obligation under the settlement agreement to pay $215 per week or one-half of the rental income from the property is terminated[.] The Superior Court found the value of the Twining Court property to be between $110,000 and $150,000 and that the property was subject to an outstanding deed of trust with a balance of $9,434.75 as of December 26, 1974. The Superior Court found that the value of the property was $123,000. On June 9, 1975, James executed and delivered to the trial judge a quit-claim deed to the Twining Court property in Eleanor's favor. The deed contained a "savings clause," providing that the property was released to Eleanor unless the decision of the Superior Court was reversed or modified. Both petitioner and James appealed the decision of the Superior Court. That decision, however, was upheld by the District of Columbia Court of Appeals in a decision dated July 14, 1976. 6 In its opinion, the court considered the authority1983 Tax Ct. Memo LEXIS 107">*117 of the trial court to convey James' interest in the Twining Court property to Eleanor. 7 In affirming the decision of the lower court, the Court of Appeals stated: The statute, which permitted the parties in this case to preserve the preferential incidents of the tenancy after the divorce was not intended to shelter the husband from enforcement of his support obligations under the agreement. Moreover, the property settlement agreement expressly provides that the property would continue to be held by the parties as tenants by the entirety, in order to help furnish support as agreed. The property, subject to an outstanding deed of trust in the balance of $9,434.75, was appraised at between $110,000 and $150,000. The husband was in default of support payments in the sum of $73,456.31, which represented more than his interest in the property. As a result, we see no valid reason preventing the trial court from awarding the husband's interest in the property to the wife as compensation for the husband's failure to fulfill his support obligations. [Travis v. Benson, 360 A.2d at 510.] The Superior Court released the deed to the Twining Court property to the petitioner1983 Tax Ct. Memo LEXIS 107">*118 by order dated October 21, 1976. On their Federal tax return for 1975, petitioners reported the net rental income received from the Twining Court property, but did not report the receipt of the one-half interest in the property attributable to the transfer of James' interest to Eleanor by quit-claim deed. Respondent determined that the fair market value of the Twining Court property was $123,000. In calculating the value of the interest transferred to petitioner, respondent took into account the balance of the mortgage remaining on the property in the amount of $9,434.75. Thus, respondent determined that the value of the interest transferred to Eleanor was $56,782.63. OPINION Petitioner argues that the transfer to her of James' interest in the Twining Court property is not taxable under section1983 Tax Ct. Memo LEXIS 107">*119 71. She contends that the transfer was not made as a result of the marital relationship because it was made to discharge a debt owed to her under a property settlement agreement. Petitioner also maintains that the February 13, 1975, Superior Court order was an adjudication of property rights and therefore the transfer was a property settlement. Finally, petitioner argues that if the transfer of James' interest in the Twining Court property is characterized as alimony, the amount taxable should be limited either to 10 percent of the principal sum under section 71(c)(2), or to the percentage of the award attributable to alimony arrearages. Respondent contends that the underlying obligation giving rise to the arrearages in this case was an alimony obligation. He argues that the transfer is taxable because under the case law, when a lump-sum payment is made to satisfy arrearages, it retains the character of the payments for which it is substituted. Respondent maintains that no allocation is called for under the present facts and contends that the 10 percent limitation rules are inapplicable because they apply to future payments and not to arrearage awards. Alternatively, respondent1983 Tax Ct. Memo LEXIS 107">*120 asserts that if the value of the Twining Court property is not taxable to petitioner as alimony, it should be characterized as rental income, taxable as ordinary income under section 61. Section 71(a)(1) and (2) provides that periodic payments made under a decree of divorce or separate maintenance or under a written separation agreement, and imposed because of the marital or family relationship, are includable in the income of the recipient. 8 The requirement that payments be made in discharge of a legal obligation imposed "because of the marital or family relationship" has been interpreted to require that the payments be for support, rather than a property settlement. Beard v. Commissioner,77 T.C. 1275">77 T.C. 1275, 77 T.C. 1275">1283 (1981); Warnack v. Commissioner,71 T.C. 541">71 T.C. 541 (1979); Bishop v. Commissioner,55 T.C. 720">55 T.C. 720 (1971); Secs. 1.71-1(b)(4) and 1.71-1(d)(3)(i)(b), Income Tax Regs.1983 Tax Ct. Memo LEXIS 107">*121 Section 71(c) provides that installment payments which discharge an obligation to pay a principal sum, specified in a decree, instrument or agreement, and payable or paid over a longer than 10-year period are treated as periodic payments for the purposes of section 71(a), but only to the extent of 10 percent of the principal sum in any one taxable year. See Sec. 1.71-1(d)(2), Income Tax Regs.Because the District of Columbia courts awarded petitioner an interest in property, she attempts to characterize the transaction as a property settlement. In determining how an arrearage award will be taxed, however, this Court has consistently looked at the obligation giving rise to the arrearage aware, not to the present nature of the award. See Olster v. Commissioner,79 T.C. 456">79 T.C. 456, 79 T.C. 456">462 (1982), on appeal to 11th Cir., 10-17-83; Davis v. Commissioner,41 T.C. 815">41 T.C. 815 (1964). If an alimony obligation were satisfied by the award, then the award must be further scrutinized. When a lump-sum payment is made to satisfy back alimony, then the sum is treated taxwise as alimony. Olster v. Commissioner,79 T.C. 456">79 T.C. 462; Davis v. Commissioner,41 T.C. 815">41 T.C. 820.1983 Tax Ct. Memo LEXIS 107">*122 If made in consideration for the release of an obligation to make future alimony payments, then the payment is not taxable under section 71(a) and is treated as a lump-sum payment. See Commissioner v. Senter,242 F.2d 400">242 F.2d 400, 242 F.2d 400">403 (4th Cir. 1957), affg. 25 T.C. 1204">25 T.C. 1204 (1956); 79 T.C. 456">Olster v. Commissioner,supra.Thus, the decisive question here is whether the obligation of James to pay petitioner the weekly sum of $215 was created by a property settlement or was a legal obligation arising out of the marital relationship. Respondent, in making an argument for the characterization of the obligation to pay as alimony, points to the decisions of the District of Columbia Court of Appeals which refer to James' "support obligations." See, e.g., 360 A.2d 506">Travis v. Benson,supra. It is well settled, however, that the determination of whether payments are in the nature of support or part of a property settlement does not turn on the labels assigned to the payments by the court in the divorce decree or by the parties in their agreement. Hesse v. Commissioner,60 T.C. 685">60 T.C. 685, 60 T.C. 685">691 (1973), affd. without published opinion 511 F.2d 1393">511 F.2d 1393 (3d Cir. 1975);1983 Tax Ct. Memo LEXIS 107">*123 Mirsky v. Commissioner,56 T.C. 664">56 T.C. 664, 56 T.C. 664">675 (1971); Thompson v. Commissioner,50 T.C. 522">50 T.C. 522, 50 T.C. 522">525 (1968). Furthermore, the issue is a factual one and requires an examination of all surrounding facts and circumstances. 9Beard v. Commissioner,77 T.C. 1275">77 T.C. 1284 and cases cited therein; Wright v. Commissioner,62 T.C. 377">62 T.C. 377, 62 T.C. 377">389 (1974), affd. 543 F.2d 593">543 F.2d 593 (7th Cir. 1976). After an examination of the facts herein, we think that the obligation underlying the arrearage award must be characterized as one arising from a property settlement. The intent of the parties to an agreement can indicate that payments should be characterized as a property settlement. Porter v. Commissioner,388 F.2d 670">388 F.2d 670, 388 F.2d 670">671 (6th Cir. 1968), affg. per curiam a Memorandum Opinion of this Court; 62 T.C. 377">Wright v. Commissioner,supra;Schwab v. Commissioner,52 T.C. 815">52 T.C. 815 (1969), affd. sub nom Houston v. Commissioner,442 F.2d 40">442 F.2d 40 (7th Cir. 1971).1983 Tax Ct. Memo LEXIS 107">*124 In the present case the parties to the agreement manifested an intent that the $215 weekly payments be a property settlement by making the payments an integral part of the division of the Twining Court real estate and securities. There is no evidence showing that Eleanor's need was taken into account in fixing the $215 payment amount. See McCombs v. Commissioner,397 F.2d 4">397 F.2d 4, 397 F.2d 4">7 (10th Cir. 1968), affg. a Memorandum Opinion of this Court. Another factor indicative of property settlement, and evidenced herein, is the surrender of valuable property rights in exchange for payments. Mann v. Commissioner,74 T.C. 1249">74 T.C. 1249, 74 T.C. 1249">1259-1262 (1980); Gammill v. Commissioner,73 T.C. 921">73 T.C. 921, 73 T.C. 921">928-929 (1980), affd. 710 F.2d 607">710 F.2d 607 (10th Cir. 1982); Warnack v. Commissioner,71 T.C. 541">71 T.C. 550-551. By the terms of their agreement, the parties agreed that Eleanor would give up her rights to the management of the real estate and all rights to vote and to collect interest from the securities. The fact that the payments were fixed in amount and not subject to change in the event of Eleanor's remarriage further supports our finding that1983 Tax Ct. Memo LEXIS 107">*125 they are properly characterized as property settlement payments. See 397 F.2d 4">McCombs v. Commissioner,supra;Beard v. Commissioner,77 T.C. 1275">77 T.C. 1285; Widmer v. Commissioner,75 T.C. 405">75 T.C. 405, 75 T.C. 405">409 (1980); Land v. Commissioner,61 T.C. 675">61 T.C. 675, 61 T.C. 675">683 (1974); 55 T.C. 720">Bishop v. Commissioner,supra. The agreement provided for fixed payments of $215 per week for twenty-three years. The amount would not change despite fluctuations in James' income or Eleanor's needs and was due without regard to the amount of net income, if any, earned from the Twining Court property. Furthermore, although the agreement states that the payments are for the support of the minor children, there are no provisions decreasing payments as each child attains majority. See 75 T.C. 405">Widmer v. Commissioner,supra.Eleanor's remarriage did not affect her right to the payments. The payments were subject to a contingency in the sense that they would stop on the sale of the Twining Court property. In the event of a sale, the net proceeds were to be divided equally and this amount would fully discharge James' obligation to keep up the payments1983 Tax Ct. Memo LEXIS 107">*126 under the agreement. The structure of this provision strongly indicates that a property settlement was intended. Cf. 61 T.C. 675">Land v. Commissioner,supra.The fact that payments are secured also evidences a property settlement. Widmer v. Commissioner,75 T.C. 405">75 T.C. 409; see Gammill v. Commissioner,73 T.C. 921">73 T.C. 929. In its arrearage award judgment, the District of Columbia court used the Twining Court property and not any other of James' assets to satisfy Eleanor's claim under the contract. We think this indicates that the $215 payments were secured by the property. On the award of the property to Eleanor, her rights to future payments under the contract were extinguished, further evidencing the "property settlement aura" of the payment obligation. As respondent argues, the main factor indicating that the agreement provided for alimony and not for a property settlement is that no other provision for Eleanor's support is made in the agreement. See Schottenstein v. Commissioner,75 T.C. 451">75 T.C. 451 (1980). Respondent presents another side of this argument as well, namely, that other provisions in the agreement do provide for1983 Tax Ct. Memo LEXIS 107">*127 property division. Respondent also contends that both the petitioner and the District of Columbia Court of Appeals described the amounts owed as support or alimony obligations. We disagree, however, with the contention that these factors control the characterization of the payments. First, the other property provisions in the agreement disposed of property owned separately by Eleanor and James, the marital residence, and its contents. We do not think it unusual that the agreement dealt with the Twining Court property separately. Second, with respect to the alimony-like terms used in the long litigation history of the Twining Court property, we again emphasize that labels used do not necessarily determine the nature of the obligation created by the original agreement. See 60 T.C. 685">Hesse v. Commissioner,supra.After considering all the facts and circumstances present in this case, and after weighing the arguments set forth by both parties, we conclude that the underlying obligation is best characterized as one arising from a property settlement. Accordingly, the arrearage award and transfer of James' interest in the property to Eleanor do not result in an event1983 Tax Ct. Memo LEXIS 107">*128 taxable to petitioner under section 71. See 41 T.C. 815">Davis v. Commissioner,supra.Because we have determined that the arrearage award is treated for tax purposes as a property settlement, we see no merit to respondent's argument that the award should be treated as ordinary income under section 61. It is well settled that payments under a property settlement are capital in nature and not taxable to the recipient. See 397 F.2d 4">McCombs v. Commissioner,supra;77 T.C. 1275">Beard v. Commissioner,supra;73 T.C. 921">Gammill v. Commissioner,supra;62 T.C. 377">Wright v. Commissioner,supra;56 T.C. 664">Mirsky v. Commissioner,supra.To reflect uncontested adjustments contained in the notice of deficiency, Decision will be entered under Rule 155.Footnotes*. This case was tried before Judge Norman O. Tietjens, who died on September 2, 1983. By order dated October 13, 1983, it was reassigned to Chief Judge Howard A. Dawson, Jr.↩ for disposition. 1. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year at issue, unless otherwise stated. ↩2. In their petition the petitioners also made a claim for attorneys' fees under the Equal Access to Justice Act. This matter was not raised at trial or on brief, and we consider it abandoned.↩3. After examining the record herein, we sustain respondent's objections on the grounds of relevance, hearsay, and incompleteness to our consideration of exhibits 20, 28, 32 and 33. All reservations and objections concerning other exhibits set forth by the petitioners or respondent are overruled.↩4. John I. Benson is a party to this case solely because he filed a joint return with Eleanor M. Benson.↩5. Although the parties have stipulated that James did not fulfill the obligations imposed under the property settlement agreement and the divorce decree, it is clear that the arrearage award giving rise to the present case was made only to satisfy obligations under the property settlement agreement.↩6. Travis v. Benson,360 A.2d 506">360 A.2d 506↩ (D.C. 1976). 7. In considering this issue, that Court determined that the laws of the District of Columbia permitted this tenancy by the entirety despite the entry of a final divorce decree, but did not prevent the Superior Court from ending the tenancy and awarding James' interest to Eleanor. 360 A.2d 506">360 A.2d at 509-510↩.8. Sec. 71(a) provides, in part: (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. (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.↩9. But cf. Beard v. Commissioner,77 T.C. 1275">77 T.C. 1275, at 77 T.C. 1275">1284↩ (factual analysis fraught with pitfalls and Congressional reform needed in this area). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623008/ | William H. Swan and Sons, Inc. v. Commissioner.William H. Swan & Sons, Inc. v. CommissionerDocket No. 47793.United States Tax CourtT.C. Memo 1955-30; 1955 Tax Ct. Memo LEXIS 315; 14 T.C.M. 105; T.C.M. (RIA) 55030; January 31, 19551955 Tax Ct. Memo LEXIS 315">*315 Petitioner corporation made payments to the widow of a deceased employee from the date of such employee's death on September 10, 1944, to and throughout the year 1950. It deducted such payments as ordinary and necessary business expenses on its returns for each of such years. Respondent disallowed the deduction of such payments in 1948, 1949, and 1950. Held, payments made by the petitioner from 1948 to 1950, inclusive, were not deductible by it as ordinary and necessary business expenses under section 23(a) of the Internal Revenue Code of 1939 or the provisions of section 29.23(a)-9 of Regulations 111. J. W. Oast, Jr., Esq., Citizens Bank Building, Norfolk, Va., for the petitioner. R.G. deQuevedo, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion1955 Tax Ct. Memo LEXIS 315">*316 This proceeding involves deficiencies determined by the respondent for the years 1948, 1949, and 1950 in the respective amounts of $1,208.40, $1,653.60, and $717.60. The issue is whether payments made by petitioner to the widow of a deceased employee in 1948, 1949, and 1950 are deductible by it as ordinary and necessary business expenses under the provisions of section 23(a) of the Internal Revenue Code of 1939, where there is no contractual liability on petitioner's part to make such payments. Some of the facts were stipulated. Findings of Fact The stipulated facts are so found and are incorporated herein by this reference. Petitioner, a Virginia corporation with principal offices at Norfolk, Virginia, filed its income tax returns for the years in issue with the collector of internal revenue at Richmond. Petitioner is engaged in business as a ship chandler. In the course of such business petitioner held itself responsible for supplying all needs of an ocean going vessel after the vessel was commissioned. The business is a highly specialized one and requires long periods of apprenticeship for persons engaged therein. In July 1935, petitioner employed a young man by the1955 Tax Ct. Memo LEXIS 315">*317 name of John R. Cobb, Jr. (hereinafter referred to as Cobb), at a starting salary of $22 per week. Cobb proved to be a valuable employee. In 1942 or 1943, he was offered employment by another ship chandler and discussed the offer with John Swan, petitioner's vice-president and manager in charge of its Norfolk, Virginia operations. In 1944, petitioner was a small organization employing only fifteen persons. Swan advised Cobb that petitioner considered him to be a permanent employee and would continue his employment for as long as Cobb wished. On the basis of such assurances, Cobb remained with petitioner and declined the offer of another job. Cobb was married and had four children, ranging from age 3 to age 9 when he died on September 10, 1944. He left a negligible estate. Petitioner paid his funeral expenses and other bills which he owned at the time of his death. It paid to his widow, until March 1945, $90 per week which was equivalent to his salary. Thereafter, to and throughout the year 1950, it paid her $60 each week. Respondent allowed all payments made to Cobb's widow at the time of his death to and throughout the year 1947 to be deducted by petitioner as ordinary and necessary1955 Tax Ct. Memo LEXIS 315">*318 business expenses. The sums of $3,180, $3,120, and $3,120 paid by petitioner to Cobb's widow in 1948, 1949, and 1950, respectively, were not deductible by it as ordinary and necessary business expenses. Opinion RICE, Judge: Despite petitioner's argument to the contrary, we are unable, from this record, to find that there was a fixed contractual obligation on its part to pay Cobb's widow any amount of money subsequent to Cobb's death. We have no doubt but that petitioner was the type of firm which felt a great measure of responsibility for the welfare of its employees and their families. It may well be that Cobb understood John Swan's statement that petitioner considered him to be a permanent employee as meaning that his job was secure and that in the event his family needed assistance upon his death that petitioner would take care of his widow and children. Even though this may have been Cobb's understanding, it was not a contract binding upon petitioner other than in a moral sense; and, hence, the payments which petitioner made to Cobb's widow are not payments pursuant to any contractual liability on its part. Cf. Seavey & Flarsheim Brokerage Co., 41 B.T.A. 198">41 B.T.A. 198 (1940).1955 Tax Ct. Memo LEXIS 315">*319 The record does not show that petitioner had any established practice of providing for the needs of a deceased employee's family. As heretofore noted in our findings, respondent permitted petitioner to deduct all payments to Cobb's widow from the time of his death in 1944 to and throughout the year 1947 as ordinary and necessary business expenses. This seems to us an eminently fair application of the provisions of section 29.23(a)-9 of Regulations 111 1 which provides that the amount of the salary of an officer or employee paid to his widow or heirs for a limited period after his death is deductible as an ordinary and necessary business expense. Philadelphia-Baltimore Stock Exchange, 19 T.C. 355">19 T.C. 355 (1952); I. Putnam, Inc., 15 T.C. 86">15 T.C. 86 (1950); McLaughlin Gormley King Co., 11 T.C. 569">11 T.C. 569 (1948). 1955 Tax Ct. Memo LEXIS 315">*320 While the action of petitioner in continuing the payments to Cobb's widow throughout the years in issue in recognition of the needs of his family is most commendable, we are unable to allow their deduction as ordinary and necessary business expenses because it would be an unwarranted extension of what we have heretofore recognized as being a "limited period" within the meaning of the Regulations. Decision will be entered for the respondent. Footnotes1. REGULATIONS 111. Sec. 29.23(a)-9. Pensions - Compensation for Injuries. - Amounts paid by a taxpayer for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lumpsum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. As to deductions for payments to employees' pension trusts, see section 23(p)↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623010/ | Charles F. Hubbs & Company v. Commissioner.Charles F. Hubbs & Co. v. CommissionerDocket No. 19431.United States Tax Court1949 Tax Ct. Memo LEXIS 64; 8 T.C.M. 903; T.C.M. (RIA) 49247; September 30, 19491949 Tax Ct. Memo LEXIS 64">*64 Petitioner seeks to include in its equity invested capital for 1944 an amount in addition to that allowed by respondent representing what it claims to be the value of intangibles and good will acquired incident to the exchange of its capital stock for the assets of a sole proprietorship in 1908. Held, petitioner has failed to sustain its burden of proof and particularly has failed to prove the factors necessary to apply the formula set forth in A.R.M. 34. John M. McEvoy, Esq., for the petitioner. Stephen P. Cadden, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion In the notice of deficiency, respondent determined an overassessment in income tax, and deficiencies in declared value excess profits and excess profits taxes for the taxable year 1944 in the following amounts: Over-assessmentDeficiencyExcess Profits Tax$2,996.84Declared Value ExcessProfits Tax141.07Income Tax$799.64Petitioner does not contest the several adjustments to its tax liability made by respondent in the notice of deficiency but alleges as error the respondent's disallowance of its claim for a refund in 1944 of excess1949 Tax Ct. Memo LEXIS 64">*65 profits taxes in the amount of $16,172.65. The sole issue herein is whether the petitioner, in computing its equity invested capital for 1944, is entitled to include therein any additional amount representing the value of intangibles and good will acquired incident to a transaction wherein the petitioner in 1908 exchange capital stock for the business and assets of a sole proprietorship. Findings of Fact The petitioner, Charles F. Hubbs & Company, is a corporation organized and existing under the laws of New York with its principal office at 383 Lafayette Street, New York City. Its Federal tax returns for the taxable year ended December 31, 1944, were filed with the collector of internal revenue for the second district of New York. Petitioner was organized on or about January 2, 1908, for the purpose of taking over a paper business conducted at that time by Charles F. Hubbs as a sole proprietorship under the name of "Charles F. Hubbs & Co.", hereinafter referred to as the proprietorship. In January, 1908, the petitioner, in exchange for all the assets, including the good will, of the proprietorship, issued in Hubbs 1,250 shares of its authorized capital stock of 2,000 shares1949 Tax Ct. Memo LEXIS 64">*66 with a par value of $100 per share. The agreement between petitioner and Hubbs read in part as follows: "* * * the directors of the Company have ascertained, adjudged and declared that the goodwill, business and property hereinafter described are of the fair value of One hundred and twenty-five thousand dollars ($125,000) * * *." The proprietorship did not carry any item on its books at the time of the transfer representing the value of good will or intangibles. The value of the net tangibles at the time of the transfer was $119,520.12 and the value of unexpired contracts was $5,479.88, totaling $125,000. The net tangible assets in excess of liabilities of the proprietorship at the beginning of each of the years 1899 to 1907, inclusive, as disclosed by its books and records of account, were as follows: NetNetYearTangiblesYearTangibles1899$40,696.011904$ 47,237.60 *190049,371.79190563,474.56190141,534.55190684,122.06190252,047.45 *1907105,327.50190344,090.96 *1949 Tax Ct. Memo LEXIS 64">*67 The books of the proprietorship disclose earnings for the years 1899 to 1907, inclusive, before and after the payment of a so-called "special salary" to Hubbs in each of the years 1903 to 1907 as follows: EarningsSpecialEarningsBeforeSalary PaidAfterYearSalaryto HubbsSalary1899 **$28,787.25190018,455.64190122,413.76190210,961.89190318,464.59$15,000.04$ 3,464.55190418,873.5215,000.003,873.08190532,498.5815,000.4417,498.14190642,939.6116,800.4426,139.17190738,015.8716,800.0021,215.87The sales as disclosed by the books of the proprietorship during the years 1903, 1905, 1906, and 1907, were as follows: YearSales1903$408,703.311905517,472.111906699,893.361907831,371.37Charles F. Hubbs was recognized as a business man of great ability and was well known and highly respected by the mills and merchants engaged in the domestic paper trade. He was possessed of exceptionally good judgment and experience. 1949 Tax Ct. Memo LEXIS 64">*68 Although he was principally occupied with the purchasing end of the business, he had personal contacts and a personal following. The business had been founded by the father of Charles F. Hubbs in 1855. At the time of its transfer to the petitioner in 1908, it was well known in the trade and was recognized as one of the best jobbing houses in New York, merchandising both domestic and imported paper, tissues, tape, and twine. It maintained an office, store, and warehouse in New York and a branch office in Philadelphia. It employed from 45 to 55 employees, including approximately 20 salesmen with sales territory embracing several northeastern states. Various names and numbers, such as "Ropene" "Sheepskin" and "Leather Paper" were used by the proprietorship to identify its different grades and types of paper which were well known in the trade. The proprietorship had agency contracts, some of which were exclusive, with approximately 10 domestic and foreign mills. At about the time of the organization of the petitioner, approximately 14 of the petitioner's employees subscribed for 336 shares of petitioner's stock at the par value of $100 per share. Only employees of the firm selected1949 Tax Ct. Memo LEXIS 64">*69 by Hubbs were offered the opportunity to purchase shares and no stock was sold to friends, strangers, or in over-the-counter sales. During 1905, 1906, and 1907, the proprietorship paid import duty and brokerage fees on the importation of foreign paper and pulp in the respective amounts of $10,522.08, $27,176.56, and $49,558.18. The duty was paid under protest and refund claims were filed for each year. During 1914 and 1915, petitioner received refund of the import duties it had paid from 1904 to 1910 in the following amounts: July 13, 1914$22,976.00Sept. 10, 191434,464.00Jan. 23, 19157,614.55Sept. 30, 19151,948.89Oct. 15, 19157,840.00Dec. 31, 19152,203.12Dec. 31, 19151,071.19$78,117.75Opinion ARUNDELL, Judge: The petitioner seeks in this proceeding to include in its equity invested capital for 1944 an amount which it claims is the value of certain intangibles and good will acquired incident to the exchange of its stock for the assets of a sole proprietorship. The Commissioner has allowed as equity invested capital the sum of $125,000 and the petitioner asks for an additional amount of $164,326.60. Equity invested capital, as defined1949 Tax Ct. Memo LEXIS 64">*70 by section 718(a) of the Internal Revenue Code, 1 includes property previously paid in for stock, or as paid-in surplus, or as a contribution to capital. The statute further provides that such property is to be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange, which in the instant case is the cost of the property. (See section 113(a)(14) of the Internal Revenue Code; Regulations 111, section 29.113(a)(14)-1.) Where the taxpayer's basis is cost and the property was acquired in exchange for stock, cost is the fair market value of the stock at the time of its issuance. In the event the stock had no established market value, the cost is the fair market value of the tangible and intangible property acquired. Regulations 112, section 35.718-1. 1949 Tax Ct. Memo LEXIS 64">*71 Petitioner contends that incident to its acquisition of Hubbs' business in 1908, it acquired certain intangible assets, including the Hubbs' name, agency contracts, brand names, and the good will of the business. Petitioner claims that these assets had a value at the time of the transfer of at least $164,326.60 and that it is entitled to include this amount in computing its equity invested capital. Petitioner has introduced no evidence bearing upon the fair market value of its stock other than the $100 par value, which appears to have been the price adopted by the petitioner and Hubbs for the purposes of the exchange and which was the price obtained in later sales of small blocks of its stock to selected employees. None of the petitioner's stock was ever offered for sale to persons outside of the organization, nor was it at any time traded in in over-the-counter sales. The record indicates, and the parties apparently agree, that petitioner's stock had no established market value at the time of the transaction. Thus, it is incumbent upon the petitioner to show the fair market value, if any, of the intangibles claimed to have been acquired in connection with the exchange. Petitioner1949 Tax Ct. Memo LEXIS 64">*72 submits that we may value such intangibles under the formula provided in A.R.M. 34, 2 C.B. 31. Simply stated, A.R.M. 34 provides a method of valuation based upon the average net tangible assets and the net earnings of the business over a period of years prior to the transfer which fairly reflects past earnings. White & Wells Co. v. Commissioner, 50 Fed. (2d) 120. It involves the selection of a rate representing a reasonable return on the average net tangible assets and the selection of a rate at which any excess earnings attributable to intangibles may be capitalized. Petitioner is correct in his contention that the principles of A.R.M. 34 have been frequently applied by this and other courts in cases involving the valuation of intangibles. However, underlying each determination has been a foundation of factual data from which the court was able to ascertain such vital elements as the existence and relative value of good will, and other intangible assets in the particular business; the rate of earnings which could reasonably be expected from the particular business on its intangibles during the years selected; the nature of the business, the risk involved; 1949 Tax Ct. Memo LEXIS 64">*73 and other factors material to the selection of a rate at which to capitalize any earnings determined to be attributable to the intangibles. Cf. Dwight & Lloyd Sintering Co., Inc., 1 B.T.A. 179">1 B.T.A. 179; House & Herrmann, 13 B.T.A. 621">13 B.T.A. 621; John Q. Shunk, 10 T.C. 293">10 T.C. 293, reversed on another point, C.C.A. 6th, May 4, 1949, 173 Fed. (2d) 747. Satisfactory evidence from which such facts may be drawn must be before the court and the burden of presenting such evidence is borne by the party seeking to prove value by the use of A.R.M. 34, which in the instant case is the petitioner. The only evidence of any value produced by the petitioner consists of figures which it claims represent the value of the net tangible assets and the net earnings of the proprietorship from 1899 to 1907, inclusive. These figures, without explanation or interpretation, fail to establish a basis for the application of A.R.M. 34. It appears that these figures should be adjusted each year to reflect the value of the services of Hubbs as the directing head of the proprietorship. The record clearly demonstrates that Hubbs was an unusually capable executive and was primarily responsible1949 Tax Ct. Memo LEXIS 64">*74 for the success of the business and that without his services the business would have been compelled to employ a manager or other supervisory personnel. Although the records of the proprietorship show that a so-called special salary was received by Hubbs during the years 1903 to 1907, inclusive, they fail to disclose what amount, if any, was paid as a salary in prior years. Nor is there any evidence from which we could determine an amount representing reasonable compensation for his services in any of the years selected by the petitioner for obtaining the average earnings of the proprietorship. It is evident however that, if the special salary may be regarded as reasonable compensation, the earnings no longer form a basis for the high value of good will contended for by the petitioner. A further examination of the petitioner's figures discloses that the net tangible assets and the net earnings of the business fluctuated to a wide degree from year to year. The earnings varied with no apparent relation to the value of the net tangibles employed and the petitioner has made no effort to explain the circumstances or to show which of the nine years reflect normal or abnormal business conditions. 1949 Tax Ct. Memo LEXIS 64">*75 Although the balance sheets of the proprietorship for each year from 1899 to 1907 disclose large amounts for accounts receivable, no reserve for bad debts appears on the books. Moreover, the record is devoid of any factual basis which would support the rate selected by petitioner or any rates which we might attempt to determine herein in applying A.R.M. 34. Petitioner has provided us with no evidence of what would constitute a fair return on the tangible property employed in such a business during the years 1899 to 1907, nor has it shown the existence or importance of good will or the value of brand names and agency contracts in the particular business acquired by the petitioner. The petitioner has wholly failed to produce evidence of the risk involved in the business, or any other basis for the determination of a rate at which to capitalize any earnings found to be attributable to intangibles. Finally, it is interesting to note that the agreement between Hubbs and the petitioner whereby the latter acquired the business recites that its directors ascertained that the good will, business, and property of Hubbs were of the fair value of $125,000 at the time of the exchange. It is1949 Tax Ct. Memo LEXIS 64">*76 now well established that the selection of rates, in applying the principle of A.R.M. 34, must rest upon a reasonable estimate and not upon sheer speculation. Although it may be extremely difficult at this late date for petitioner to produce the facts from which such rates may be determined, even the impossibility of obtaining competent evidence does not release the petitioner from the burden of proving its case. Burnet v. Houston, 283 U.S. 223">283 U.S. 223. In our opinion, petitioner has failed to sustain its burden of establishing that it is entitled to a greater invested capital than that allowed by respondent. Decision will be entered under Rule 50. Footnotes*. These figures do not include the value of certain non-business assets which were carried on the proprietorship's books during the years 1901, 1902 and 1903.↩**. The records of the proprietorship contain no evidence of any amount paid as a "special salary" to Hubbs during the years 1898 to 1902, inclusive.↩1. SEC. 718. EQUITY INVESTED CAPITAL. (a) Definition. - The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) - (1) Money Paid In. - Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital; (2) Property Paid In. - Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623011/ | MARTIN B. BRIFMAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrifman v. CommissionerDocket No. 868-90United States Tax CourtT.C. Memo 1992-375; 1992 Tax Ct. Memo LEXIS 397; 64 T.C.M. 3; July 2, 1992, Filed 1992 Tax Ct. Memo LEXIS 397">*397 Decision will be entered under Rule 155. P claimed losses from an investment in a multi-party equipment leasing transaction on his Federal income tax returns for the taxable years 1984, 1985, and 1986. R disallowed the claimed losses on the ground that P was not at risk under sec. 465(a), I.R.C., with respect to a particular debt obligation. Held, P effectively was protected against loss as described in sec. 465(b)(4), I.R.C., with respect to the debt obligation, and therefore P is not considered at risk under sec. 465(a), I.R.C.Thornock v. Commissioner, 94 T.C. 439">94 T.C. 439 (1990), followed. Held, further, P is liable for the addition to tax under sec. 6661(a), I.R.C., and increased interest under sec. 6621(c), I.R.C.Isaac W. Zisselman and Jack L. Hollander, for petitioner. Vincent J. Guiliano, for respondent. NIMSNIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: Respondent determined deficiencies in and additions to the Federal income tax liability of Martin B. Brifman (petitioner) as follows: Additions to tax -- SectionsYearDeficiency6651(a)6653(a)(1)6653(a)(2)665466611984$ 13,128$761.10$ 1,316.051$ 782.58$ 3,805.5019854,583191.65929.151253.08 -- 19865,416242.851,022.051598.501,214.251992 Tax Ct. Memo LEXIS 397">*398 Respondent further determined that petitioner is subject to increased interest pursuant to section 6621(c) for each of the years in dispute. (Section references are to the Internal Revenue Code as amended and in effect for the years in issue. Rule references are to the Tax Court Rules of Practice and Procedure.) After concessions, the issues for decision are: (1) Whether petitioner was "at risk" within the meaning of section 465 with respect to a promissory note reflecting a portion of his investment in an equipment leasing transaction during the taxable years 1985 and 1986; (2) whether petitioner is liable for the additions to tax for negligence pursuant to section 6653(a) for the taxable years 1985 and 1986; (3) whether petitioner is liable for the addition to tax for substantial understatement of tax liability pursuant to section 6661(a) for the taxable year 1986; and (4) whether petitioner is liable for increased interest pursuant to section 6621(c) for the taxable years 1985 and 1986. FINDINGS OF FACT Some1992 Tax Ct. Memo LEXIS 397">*399 of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Sacramento, California, at the time he filed his petition. During the years in issue, petitioner was an attorney admitted to practice law in the State of California. A. The First Tier Sale/Leaseback Transaction. On January 15, 1982, RCA American Communications, Inc. (RCA) launched a domestic communications satellite, Satcom IV, into orbit 22,300 miles above the earth. The satellite contains numerous transponders that are instrumental in processing signals that the satellite receives from antennae on earth. A transponder is a cigarette box-sized device that can transmit voice, data, and video from an orbiting satellite to almost any point within the United States. In August, 1982, American Broadcasting Companies, Inc. (ABC) acquired two of the transponders on Satcom IV from RCA for a purchase price of $ 13 million each, or a total price of $ 26 million. In May, 1983, ABC assigned all of its rights, benefits, responsibilities, and liabilities with respect to the two transponders to its wholly owned subsidiary, 1992 Tax Ct. Memo LEXIS 397">*400 ABC Video Enterprises, Inc. (ABC Video). By letter dated April 27, 1984, Integrated Resources Equipment Group, Inc. (IREG), submitted a proposal to ABC for the sale and leaseback of the transponders. IREG is a wholly owned subsidiary of Integrated Resources, Inc. (Integrated), a financial services company in the business of offering private investment programs. By letter dated September 17, 1984, IREG transmitted a confidential debt placement memorandum respecting the proposed sale and leaseback of the transponders to Nationwide Life Insurance Company (Nationwide). After reviewing the memorandum, Nationwide agreed to provide financing for the transaction according to the terms set forth in the memorandum. On October 30 and 31, 1984, Integrated Equipment Leasing Corp. (IELC), another wholly owned subsidiary of Integrated, acquired the two transponders from ABC Video for a purchase price of $ 9,774,701 each, or a total price of $ 19,549,402. This aspect of the transaction was documented through a bill of sale, an assignment of purchase agreement, and a so-called participation agreement. The participation agreement, identifying Nationwide as the lender, IELC as lessor, and ABC1992 Tax Ct. Memo LEXIS 397">*401 Video as lessee, stated that ABC Video, with RCA's consent, assigned its rights in the transponders to IELC. To secure financing for the transaction, IELC entered into two identical loan and security agreements with Nationwide. Pursuant to the loan and security agreements, IELC gave Nationwide two nonrecourse notes of $ 8,601,736.88 each (one for each transponder) to be paid quarterly from October 31, 1984, through July 31, 1989. Two identical funding memoranda dated October 31, 1984, state in pertinent part: 1. The Lender will make the Loan * * * to the Lessor in the amount of $ 8,601,736.88, pursuant to the Participation Agreement; 2. The Lessor will transfer or cause the transfer of the sum of $ 9,774,701.00 (consisting of the Loan in the amount of $ 8,601,736.88 and the investment by the Lessor in the amount of $ 1,172,964.12) to the Lessee for the purchase of the Leased Equipment * * *. On or about October 31, 1984, IELC entered into identical lease agreements (one for each transponder) with ABC Video whereby IELC leased the transponders back to ABC Video for a period of five years. (These leases will hereinafter be referred to as the user leases.) Pursuant to the1992 Tax Ct. Memo LEXIS 397">*402 user leases, ABC Video agreed to remit its quarterly rental payments directly to Nationwide in satisfaction of the amounts due to be paid to Nationwide under the IELC notes. ABC Video's rental payments approximately equaled in time and amount the payments owing to Nationwide under the IELC notes -- the rental payments were in fact applied in satisfaction of the IELC notes. Consistent with the terms of the user leases, ABC Video obtained insurance on the transponders to cover losses in the event the transponders should fail. On or about October 31, 1984, ABC agreed to unconditionally guarantee ABC Video's rental payments under the user leases. Nationwide relied upon the rental payments due from ABC Video under the user leases, ABC's guarantee with respect to those rental payments, and its own security interest in the transponders as the means for collecting on the IELC notes. B. The Second Tier Sale/Leaseback Transaction. On December 31, 1984, IELC sold the two transponders to Investors Credit Corp. (ICC), another wholly owned subsidiary of Integrated, for a total purchase price of $ 19,549,402. ICC paid the purchase price with $ 3,914,880 in cash and the balance in the1992 Tax Ct. Memo LEXIS 397">*403 form of a promissory note payable to IELC in the amount of $ 15,634,522. ICC was obligated under its note to pay IELC $ 6,080 on December 31, 1984, and varying quarterly payments from January 1, 1985, through October 1, 1992. The ICC promissory note purports to be a recourse note. On the same day, ICC agreed to lease the transponders back to IELC for a period of eight years subject to the rights of ABC Video under the user leases. (The ICC/IELC lease will hereinafter be referred to as the master lease agreement.) Pursuant to the master lease agreement, IELC agreed to pay ICC fixed rent in the amount of $ 8,496 on December 31, 1984, and varying quarterly payments thereafter from January 1, 1985, through October 1, 1992. These fixed rental payments approximately equaled in time and amount the payments ICC owed IELC under the ICC note. The lease agreement also called for the payment of additional contingent rent by IELC to ICC in an amount equal to 51 percent of all "remarketing proceeds" following the expiration of the ABC Video user leases. On December 31, 1984, as an inducement for ICC to enter into the master lease agreement with IELC, Integrated agreed to unconditionally 1992 Tax Ct. Memo LEXIS 397">*404 guarantee IELC's rental payments under the master lease agreement. The agreement stated in pertinent part: 1. Guaranty. Guarantor [Integrated] hereby absolutely, unconditionally and irrevocably guarantees to Lessor [ICC] and its successors and assigns, the prompt and unconditional payment, when due, of Aggregate Rent payable by Lessee [IELC] under the Master Lease (the "Obligations"). 2. Continuing Obligation. The obligations of Guarantor hereunder are and shall be absolute and unconditional, continuing under any and all circumstances including, without limitation, circumstances which might otherwise constitute a legal or equitable discharge of a surety or guarantor, it being further expressly agreed that the obligations of Guarantor hereunder shall not be discharged except by payment and/or performance as herein provided. * * * 9. Successors and Assigns. This Guaranty shall be binding upon Guarantor and its legal representatives, successors and assigns and shall inure to the benefit of and be enforceable by Lessor and its successors, transferees and assigns. Without limiting the generality of the foregoing, this Guaranty may be assigned, including as collateral1992 Tax Ct. Memo LEXIS 397">*405 security, by Lessor, its successors or assigns, in connection with the assignment by Lessor, its successors or assigns, of the Master Lease or any right to receive payment thereunder (including assignment by way of contribution to a trust); any such assignee of this Guaranty shall succeed to and shall have the right to exercise, upon the terms set forth herein, all of the rights and remedies of Lessor hereunder as if originally named Lessor herein. On the same day, IELC entered into a collateral assignment agreement with ICC whereby IELC assigned its obligations under the master lease agreement to ICC. C. Satellite Equipment Trust A. On December 31, 1984, ICC formed Satellite Equipment Trust A (trust) as a grantor trust with ICC as initial beneficiary and the J. Henry Schroder Bank & Trust Co. as trustee. On the same day, ICC transferred the transponders to the trust and assigned all of its rights and liabilities in the transponders to the trust. Pursuant to a confidential memorandum released prior to the actual formation of the trust, 40 units of beneficial interest in the trust were offered for sale to private investors at a price of $ 105,582 in cash plus an installment1992 Tax Ct. Memo LEXIS 397">*406 promissory note payable to ICC in the amount of $ 390,988. As an alternative to paying the full $ 105,582 amount in cash, each investor was given the option of executing a second installment promissory note in an amount up to $ 86,936 per unit with First Equipment Credit Corp. (FECC), another wholly owned subsidiary of Integrated. Prior to investing in the trust, petitioner completed an investor questionnaire. In the questionnaire, petitioner identified William Murray, a certified public accountant, as his advisor with respect to the investment. Petitioner acquired a one-half unit of beneficial interest in the trust by paying $ 9,323 in cash to ICC and issuing promissory notes to FECC and ICC in the amounts of $ 43,467 and $ 195,494, respectively. In addition, petitioner granted both ICC and FECC security interests in his beneficial interest in the trust. Petitioner's promissory note to ICC, purportedly recourse, required that petitioner pay ICC quarterly principal and interest payments in varying amounts from January 1, 1985, through October 1, 1992. These quarterly payments approximately equaled in time and amount petitioner's pro rata share of the quarterly rental payments1992 Tax Ct. Memo LEXIS 397">*407 due to be paid by IELC to the trust under the master lease agreement. In this regard, the fixed rental payments received by the trust under the master lease agreement have in fact been applied in satisfaction of the payments due under petitioner's promissory note to ICC. Pursuant to the promissory note in favor of FECC, petitioner promised to pay FECC four principal and interest payments in varying amounts by March 15 for the years 1985 through 1988. D. Subsequent Events. On August 8, 1989 (in apparent anticipation of the expiration of the ABC Video user leases), IELC entered into a lease agreement with Viacom International, Inc. (Viacom), whereby IELC leased one of the transponders to Viacom for the period from November 1, 1989, to the earlier of December 31, 1992, or the date the transponder ceases to function. Under the lease, Viacom agreed to pay IELC a total monthly rental fee of $ 110,000. On February 13, 1990, Integrated filed a petition with the United States Bankruptcy Court for the Southern District of New York seeking protection from its creditors under Chapter 11 of the United States Bankruptcy Code. On April 1, 1990, IELC entered into a lease agreement with1992 Tax Ct. Memo LEXIS 397">*408 Rainbow Network Communications (Rainbow) whereby IELC leased the second transponder to Rainbow from that date until the date the transponder ceases to function. Rainbow agreed to pay IELC a total monthly rental fee of $ 95,000. For the taxable years 1984, 1985, and 1986, petitioner claimed loss deductions with respect to his investment in the trust in the amounts of $ 36,655, $ 16,193, and $ 13,193, respectively. By notice of deficiency dated October 10, 1989, respondent determined deficiencies in, increased interest, and additions to petitioner's Federal income tax liability for the taxable years at issue on the ground that petitioner was not at risk under section 465 with respect to his beneficiary note to ICC in the amount of $ 195,494. Respondent now concedes that petitioner was at risk to the extent of $ 52,791 during the years in dispute reflecting the cash that petitioner paid to ICC as well as the note that petitioner gave to FECC. Because this amount exceeds the loss that petitioner claimed for the taxable year 1984, respondent agrees that petitioner is not liable for the deficiency, additions to tax, or increased interest as set forth in the deficiency notice for that1992 Tax Ct. Memo LEXIS 397">*409 taxable year. OPINION The "at risk" rules set forth in section 465 limit the amount of losses that a taxpayer may claim from certain activities. For purposes of the instant case, section 465 provides that losses arising from the leasing of depreciable property are allowed only to the extent that the taxpayer is financially at risk with respect to the activity. Sec. 465(a)(1) and (c)(1)(C); Levy v. Commissioner, 91 T.C. 838">91 T.C. 838, 91 T.C. 838">862 (1988). Section 465 is applied on the basis of the facts existing at the end of each taxable year. Capek v. Commissioner, 86 T.C. 14">86 T.C. 14, 86 T.C. 14">48 (1986). A taxpayer generally is considered to be financially at risk to the extent he contributes money to the activity. Sec. 465(b)(1)(A). In addition, a taxpayer generally is considered to be at risk with respect to amounts borrowed for use in an activity to the extent that he is ultimately financially responsible for the debt obligation. Sec. 465(b)(1)(B) and (b)(2). It is appropriate to take into account the substance and realities of the financing arrangement presented to us. Melvin v. Commissioner, 88 T.C. 63">88 T.C. 63, 88 T.C. 63">75 (1987), affd. per curiam 894 F.2d 1072">894 F.2d 1072 (9th Cir. 1990).1992 Tax Ct. Memo LEXIS 397">*410 The "economic reality" of the situation is the key factor in determining who is ultimately liable for a debt. Melvin v. Commissioner, 894 F.2d at 1075. In this regard, section 465 contains express exceptions to the general rule that borrowed amounts are considered at risk. In particular, section 465(b)(3) and (4) provides in pertinent part: (3) CERTAIN BORROWED AMOUNTS EXCLUDED. -- (A) IN GENERAL. -- Except to the extent provided in regulations, for purposes of paragraph (1)(B), amounts borrowed shall not be considered to be at risk with respect to an activity if such amounts are borrowed from any person who has an interest in such activity or from a related person to a person (other than the taxpayer) having such an interest. (B) EXCEPTIONS. -- (i) INTEREST AS CREDITOR. -- Subparagraph (A) shall not apply to an interest as a creditor in the activity. * * * (4) EXCEPTION. -- Notwithstanding any other provision of this section, a taxpayer shall not be considered at risk with respect to amounts protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements. In sum, section 465(b)(3) provides that1992 Tax Ct. Memo LEXIS 397">*411 amounts borrowed from any person who has an interest (other than a creditor) in an activity or from a person related to a person having such an interest are not considered at risk. On the other hand, section 465(b)(4) provides that even though a taxpayer nominally may be personally liable with respect to a debt obligation, for tax purposes such person will not be considered at risk for the debt obligation if protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements. Thornock v. Commissioner, 94 T.C. 439">94 T.C. 439, 94 T.C. 439">448 (1990). The legislative history of section 465(b)(4) indicates that the phrase "other similar arrangements" concerns situations where a taxpayer is effectively immunized from any realistic possibility of suffering an economic loss if the underlying transaction turns out unprofitable. Moser v. Commissioner, 914 F.2d 1040">914 F.2d 1040, 914 F.2d 1040">1048 (8th Cir. 1990), affg. T.C. Memo. 1989-142; American Principals Leasing Corp. v. United States, 904 F.2d 477">904 F.2d 477, 904 F.2d 477">483 (9th Cir. 1990); 91 T.C. 838">Levy v. Commissioner, supra at 863-864; Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229, 89 T.C. 1229">1272 (1987),1992 Tax Ct. Memo LEXIS 397">*412 affd. in part, revd. in part 909 F.2d 1360">909 F.2d 1360 (9th Cir. 1990). Respondent takes the position that petitioner is not personally liable on his note to ICC as required for at risk treatment under section 465(b)(1)(B) and (b)(2). Respondent contends that even if petitioner is considered to be nominally personally liable with respect to the note, petitioner nevertheless is not at risk within the meaning of section 465 because petitioner is effectively protected against loss on the note under subsection (b)(4). In support of these arguments, respondent points to a combination of factors including: (1) The nonrecourse nature of IELC's debt obligations to Nationwide; (2) the offsetting rental and note payments under both tiers of the transaction; and (3) the rental guarantees applicable with respect to both the user and master leases. Respondent contends that the transaction in dispute is virtually indistinguishable from the transaction at issue in 94 T.C. 439">Thornock v. Commissioner, supra.Petitioner counters that section 465(b)(4) does not apply under the particular facts of this case and that the leasing transactions in the cases relied upon by respondent1992 Tax Ct. Memo LEXIS 397">*413 are distinguishable. Relying on Brady v. Commissioner, T.C. Memo. 1990-626, and Emershaw v. Commissioner, T.C. Memo. 1990-246, affd. 949 F.2d 841">949 F.2d 841 (6th Cir. 1991), petitioner contends that the rental guarantees of ABC and Integrated do not protect petitioner against loss. In petitioner's view, Integrated's guarantee of IELC's rental payments merely enhanced IELC's credit standing. Petitioner cites Gefen v. Commissioner, 87 T.C. 1471">87 T.C. 1471, 87 T.C. 1471">1503 (1986), for the propositions that: (1) There is no requirement that a taxpayer must enter into a transaction with a high credit risk in order to be considered at risk in the general sense under section 465; and (2) the mere fact that a taxpayer has entered into a transaction with an entity posing a low credit risk does not lead to the conclusion that the taxpayer is protected against loss under section 465(b)(4). Petitioner further contends that respondent's analysis is flawed on the grounds that: 1. The IELC Notes matured on July 31, 1989, while the Beneficiary Note would not be fully paid until October 31, 1992 * * *. 2. A disposition by Integrated of its shares 1992 Tax Ct. Memo LEXIS 397">*414 in ICC at any time would not constitute a breach by Integrated of any of its obligations to petitioner or Trust A nor was ICC restricted in its ability to sell or otherwise dispose of the ICC Notes. 3. Integrated's bankruptcy filing on February 13, 1990 clearly indicates the fallacy of respondent's reasoning regarding the protection afforded to petitioner as a result of Integrated's guarantee of IELC's obligation * * *. With respect to the latter point, petitioner maintains that Integrated's bankruptcy in 1990 "is a material factor in assessing petitioner's ultimate potential liability on his Beneficiary Note." In 94 T.C. 439">Thornock v. Commissioner, supra at 449, we concluded that in applying section 465(b)(4) it is both appropriate and incumbent on us to take into account the substance and the commercial realities of the financing arrangements presented to us by each transaction. In this respect, economic reality, not the forms and labels used by the participants, is controlling. Moser v. Commissioner, 914 F.2d 1040">914 F.2d at 1048; see Young v. Commissioner, T.C. Memo. 1988-440, affd. 926 F.2d 1083">926 F.2d 1083 (11th Cir. 1991).1992 Tax Ct. Memo LEXIS 397">*415 In Thornock, we emphasized that: although equipment leasing transactions (that are economically sound and that are not sham transactions) appear to be a type of tax-oriented transaction that Congress intended to encourage, the significant tax-oriented aspects of such transactions require that the availability of the tax benefits be determined by the true underlying economic substance of the transactions and not by features of the transactions that are mere window dressing and that serve no economic purpose. [94 T.C. 439">Thornock v. Commissioner, supra at 450; fn. ref. omitted.] We agree with respondent that the equipment leasing transaction disputed herein is comparable to and shares many of the features of the transaction in question in Thornock. Moreover, based on our understanding of the entire transaction, we are compelled to conclude that petitioner was effectively protected against loss within the meaning of section 465(b)(4) with regard to his debt obligation to ICC. To discern the underlying economic substance of the transaction in dispute, it is necessary to focus on its various individual features. We begin by observing that Nationwide financed1992 Tax Ct. Memo LEXIS 397">*416 the first tier sale and leaseback transaction between ABC Video and IELC on a nonrecourse basis. In particular, Nationwide relied exclusively upon the ABC Video rental payments due under the user leases, ABC's guarantee with respect to those rental payments, and its own security interest in the transponders as the means for collecting on the IELC notes. Notably, neither Integrated nor any of its subsidiaries involved in the second tier transaction (ICC or FECC) had any legal obligation or liability with respect to the Nationwide loan to IELC. As we see it, Nationwide (like Citicorp Credit in Thornock) was the ultimate creditor with respect to the leased equipment. Further, as was the case in Thornock, the transaction was structured with offsetting lease and note payments in combination with an unconditional rental guarantee between related parties. Considered separately, these features are not particularly compelling for purposes of applying section 465(b)(4). Nevertheless, when considered in light of the transaction as a whole, both features bear prominently on the question of whether petitioner was protected against loss with respect to his debt obligation to ICC. 1992 Tax Ct. Memo LEXIS 397">*417 We have found that IELC's rental payments due to be paid to petitioner as an investor in Trust A were sufficient, and were in fact applied, to offset the amounts due under petitioner's note to ICC. By virtue of this circular arrangement, it appears that the rental and note payments were satisfied through offsetting bookkeeping entries. In conjunction with the foregoing, we find it significant that as a consequence of ICC's transfer of the transponders to Trust A, Integrated's unconditional rental guarantee ran directly to petitioner in his capacity as an owner of a beneficial interest in Trust A. Consequently, if IELC failed to satisfy its rental obligations, petitioner was entitled to demand those payments directly from Integrated (IELC's and ICC's common parent). Petitioner relies on 87 T.C. 1471">Gefen v. Commissioner, supra at 1501-1503, for the proposition that offsetting rental and note payments generally will not disqualify debt obligations for purposes of the at risk rules. While petitioner correctly states the general rule respecting such offsetting payments, we nevertheless have held that such arrangements are significant when it is evident that no party is1992 Tax Ct. Memo LEXIS 397">*418 in a position to enforce the taxpayer's note. See Thornock v. Commissioner, 94 T.C. 439">94 T.C. 453; Moser v. Commissioner, T.C. Memo. 1989-142, affd. 914 F.2d 1040">914 F.2d 1040 (8th Cir. 1990). As discussed more fully below, it does not appear that ICC would have any reason or incentive to enforce petitioner's note. Petitioner likewise argues that Integrated's rental guarantee is not particularly relevant to the at risk analysis because the guarantee was merely intended to enhance IELC's credit standing. Although IELC's credit standing may have been enhanced as a consequence of Integrated's guarantee, the fact remains that the guarantee was extended to petitioner as a beneficial owner in Trust A. In this light, we cannot agree that the guarantee is to be ignored for purposes of determining whether petitioner was protected against loss with respect to his debt obligation to ICC. Consistent with Thornock, we conclude that the combination of Nationwide's extension of nonrecourse financing at the first tier of the transaction, the offsetting nature of the rental and note payments, and Integrated's unconditional rental guarantee had the effect1992 Tax Ct. Memo LEXIS 397">*419 of protecting petitioner against loss if the transaction turned out unprofitable. In short, these features of the transaction seem to eliminate any incentive to enforce petitioner's note. Again, the transaction was structured so that the rental payments that petitioner was entitled to receive from IELC would be applied to offset the amounts due under petitioner's note to ICC. As we see it, so long as IELC continued to satisfy its rental obligation, there would never be any need for petitioner to be called upon to make payments on his note to ICC. Moreover, if IELC ever defaulted on its rental payments, petitioner would have the right to enforce Integrated's unconditional guarantee to make the payments on IELC's behalf. In our view, if Integrated were to refuse to honor its guarantee respecting the rental payments, petitioner would have an effective defense to any further payments on his debt obligation to ICC. 94 T.C. 439">Thornock v. Commissioner, supra at 451-452. Under these circumstances, we consider petitioner's purportedly recourse debt obligation to be merely window dressing fashioned to satisfy section 465 in form only. Petitioner's argument regarding the1992 Tax Ct. Memo LEXIS 397">*420 differing maturation dates of the IELC notes (July 31, 1989) and petitioner's note (October 1, 1992) is inapposite. In short, because Nationwide extended credit to IELC at the first stage of the transaction on a nonrecourse basis, it is evident that petitioner was not at risk with respect to those obligations. Thus, the maturation date of the IELC notes is irrelevant to our analysis. Similarly, we fail to see the significance of petitioner's assertion that Integrated could have disposed of its shares in ICC at any time without breaching its obligations to petitioner or Trust A. As previously indicated, section 465 is applied on the basis of the facts existing at the end of each taxable year. Capek v. Commissioner, 86 T.C. 14">86 T.C. 14, 86 T.C. 14">48 (1986). Because Integrated did not dispose of its interest in ICC during the years in issue, we see no merit in considering the impact that such a hypothetical disposition might have on our analysis. Petitioner further contends that Integrated's 1990 bankruptcy demonstrates that Integrated's rental guarantee was not effective to protect petitioner against loss with respect to his debt obligation to ICC. We disagree. The legislative1992 Tax Ct. Memo LEXIS 397">*421 history of section 465 (quoted in 86 T.C. 14">Capek v. Commissioner, supra at 53) states that it is to be assumed that the amounts due under a loss protection guarantee will be fully paid unless and until the taxpayer becomes unconditionally entitled to payment and at that time demonstrates that he cannot recover under the agreement. See S. Rept. 94-938 at 50 n.6 (1976), 1976-3 C.B. (Vol. 3) 49, 88. With the foregoing legislative history as background, we have repeatedly held that "the potential bankruptcy of entities providing guarantees or loss protection to investors is not a consideration in determining the application of section 465(b)(4) unless and until the bankruptcy actually occurs." 94 T.C. 439">Thornock v. Commissioner, supra at 454; 86 T.C. 14">Capek v. Commissioner, supra at 52-53. Accord American Principals Leasing Corp. v. United States, 904 F.2d 477">904 F.2d at 483. Because there is no indication in the record that petitioner was ever required to enforce or attempt to enforce the Integrated guarantee or that Integrated refused to honor its obligation, Integrated's bankruptcy is immaterial to the question1992 Tax Ct. Memo LEXIS 397">*422 of whether petitioner was at risk during the taxable years before the Court. In sum, petitioner effectively was protected against loss with respect to his promissory note to ICC. Pursuant to section 465(b)(4), it follows that petitioner is not considered to be at risk for the amount of the note, and we so hold. Additions to Tax and Increased Interest. Respondent determined that petitioner is liable for additions to tax for negligence pursuant to 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. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985). Petitioner contends that he is not liable for the addition to tax for negligence because he exercised extreme care prior to investing in Trust A. In particular, petitioner contends that he consulted with his accountant concerning the investment and reviewed the offering memorandum in detail prior to purchasing his beneficial interest. Respondent's determination of negligence is presumed correct, and petitioner bears the burden of proving otherwise. Rule 142(a); Hall v. Commissioner, 729 F.2d 632">729 F.2d 632, 729 F.2d 632">635 (9th Cir. 1984),1992 Tax Ct. Memo LEXIS 397">*423 affg. T.C. Memo. 1982-337; Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791 (1972). Under the circumstances, we conclude that petitioner exercised due care prior to investing in the trust. Specifically, we are persuaded that petitioner consulted with his accountant prior to investing in the trust and reviewed the offering memorandum in detail. Respondent further determined that petitioner is liable for the addition to tax pursuant to section 6661(a). With respect to returns filed after December 31, 1982, section 6661(a) imposes an addition to tax on any substantial understatement of income tax. The amount of the understatement is computed in accordance with section 6661(b)(2)(B) and (C). The amount of understatement is reduced if there is substantial authority for the tax treatment of the item at issue (section 6661(b)(2)(B)(i)) or if the relevant facts affecting the item's tax treatment are adequately disclosed (section 6661(b)(2)(B)(ii)). In the case of "tax shelters", the reduction for adequate factual disclosure does not apply, and the reduction for substantial authority applies only where the taxpayer reasonably believed that the tax treatment1992 Tax Ct. Memo LEXIS 397">*424 was more likely than not proper. Marine v. Commissioner, 92 T.C. 958">92 T.C. 958, 92 T.C. 958">993 (1989), affd. without published opinion 921 F.2d 280">921 F.2d 280 (9th Cir. 1991). Petitioner bears the burden of proof on this issue. Rule 142(a). Nevertheless, petitioner does not address any of the criteria for reduction of the section 6661 addition, i.e., the existence of substantial authority, the matter of adequate disclosure, or the question of "reasonable belief" vis-a-vis tax shelters. On the contrary, petitioner simply relies upon the blanket statement that "all amounts claimed by the petitioner on the applicable tax returns were proper." In his reply brief, petitioner simply does not respond to respondent's arguments in support of her section 6661 determination. For the foregoing reasons, if the parties' computations under Rule 155 demonstrate that a substantial understatement exists, respondent's determination is sustained. Respondent also determined that petitioner is subject to increased interest pursuant to section 6621(c). Section 6621(c)(1) provides for an increased interest rate on any substantial underpayment attributable to a tax motivated transaction. Section1992 Tax Ct. Memo LEXIS 397">*425 6621(c)(2) defines a "substantial underpayment" as any underpayment of income tax attributable to one or more tax motivated transactions if the resulting amount of the underpayment for that year exceeds $ 1,000. Section 6621(c)(3)(A)(ii) includes within the list of transactions that are deemed "tax motivated" any loss disallowed by reason of section 465(a). In Peters v. Commissioner, 89 T.C. 423">89 T.C. 423, 89 T.C. 423">444 (1987), and Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229, 89 T.C. 1229">1279 (1987), affd. in part, revd. in part 909 F.2d 1360">909 F.2d 1360 (9th Cir. 1990), we sustained respondent's determination of increased interest where the deficiencies arose from disallowed losses under section 465(a). In the instant case, we have sustained respondent's deficiency determinations on the ground that petitioner was not at risk under section 465(a). Accordingly, assuming there are substantial underpayments for the taxable years remaining in dispute, it necessarily follows that petitioner is liable for increased interest pursuant to section 6621(c). To reflect the foregoing, as well as the parties' concessions, Decision will be entered under1992 Tax Ct. Memo LEXIS 397">*426 Rule 155. Footnotes1. 50 percent of the interest due on the deficiency. The additions to tax for negligence for the taxable year 1986 are codified under sec. 6653(a)(1)(A) and (B)↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623012/ | ROBERT L. WHEELER and HELENE E. WHEELER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; MORTON S. ROSEN and BEVERLY ROSEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTWheeler v. CommissionerDocket Nos. 4346-80, 4347-80.United States Tax CourtT.C. Memo 1983-385; 1983 Tax Ct. Memo LEXIS 403; 46 T.C.M. 642; T.C.M. (RIA) 83385; June 30, 1983. 1983 Tax Ct. Memo LEXIS 403">*403 Milton A. Levenfeld and Alan F. Segal, for the petitioners. Stephen J. Morrow and Allan E. Lang, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined the following deficiencies in petitioners' Federal income tax: Docket No.YearDeficiency 14346-80 (Robert L.1975$15,240and Helene E.197622,580Wheeler)197713,8144347-80 (Morton197546,424S. and Beverly197642,537Rosen)197724,532These cases are consolidated for trial, briefing, and opinion. The issue is whether petitioners are entitled to various deductions and credits claimed in connection with their investments in a cattle breeding operation. FINDINGS OF FACT Some of the facts are stipulated and found accordingly. All petitioners herein resided in Illinois when they filed their petitions. Petitioners Morton S. Rosen1983 Tax Ct. Memo LEXIS 403">*404 and Robert L. Wheeler are dental partners practicing in Illinois. In 1973, petitioner Morton S. Rosen entered a commercial cattle breeding tax shelter promoted by Ralph A. Eckhardt (Eckhardt), an Iowa cattle operator and a dental patient of Rosen. In 1975, Rosen's partner, petitioner Robert L. Wheeler, entered the same tax shelter. Pursuant to this tax shelter, petitioners were to purchase a herd of cattle from American Land and Cattle Industries, Inc., (ALC), a corporation wholly owned and operated by Eckhardt. The herd was to be maintained for the production of cattle to be sold for feeding and slaughter. ALC hoped to retain superior female progeny to upgrade the quality of the herds while inferior female animals and steer calves would be sold for slaughter, a process referred to as "culling." ALC represented that unregistered cattle would be bred with purebred bulls. Breedable heifers would be added back to the basic herd to replace those that had been culled. In this manner, petitioners would have a constantly evolving herd. Petitioners allegedly purchased the following herds for the following stated purchase prices: Size ofStated PurchaseYearHerd (Brand)PricePetitioner197370 (Hereford)$70,000Morton S.197430 (Angus)60,000Rosen197530 (White Faced60,000Angus)197650 (Charolais)100,000Petitioner197530 (Angus)60,000Robert L.197630 (Hereford)60,000Wheeler1983 Tax Ct. Memo LEXIS 403">*405 Each herd was purchased with a small cash downpayment and a large nonrecourse note to ALC. In addition, a portion of the stated purchase price of each herd consisted of either a "bank loan" or an "ALC advance." The manner in which the herds were financed is illustrated by the following chart. PurchaseNonrecourse"Bank""ALC"HerdPriceCashNoteLoanAdvancePetitioner1973$70,000$7,700$45,5000$16,800Morton S.197460,0003,90039,000$16,800300Rosen197560,0003,00039,00018,00001976100,000070,000030,000Petitioner197560,0003,00039,00018,0000Robert L.197660,000042,000018,000WheelerEach "bank loan" was made with the Decatur County State Bank of Leon, Iowa. No loan applications, financial statements, or net worth statements were submitted by either Eckhardt, Rosen, Wheeler, or any other person in connection with these loans, and no inspections of any cattle or land owned by either Eckhardt or petitioners was conducted by the bank in connection with these loans. Proceeds of these loans never left the bank; they were used to purchase certificates1983 Tax Ct. Memo LEXIS 403">*406 of deposit which were retained by the bank as collateral for the loans. No part of the "ALC advances" which constitute a portion of the stated purchase price of several of petitioners' herds has been repaid by petitioners. Under the purchase agreements, ALC guaranteed to replace, at no cost to petitioners, any purchased breeding animal that died or was lost (from whatever cause). After two years, ALC guaranteed that cash from the sale of cattle would be equal to or greater than the annual payment due ALC on the nonrecourse note plus the maintenance fee. In addition, ALC guaranteed to purchase back petitioners' herds at their "Net Herd Value" whenever petitioners chose to terminate the agreement. After seven years, the "Net Herd Value" was guaranteed to be at least whatever portion of the purchase price exceeded the nonrecourse note. Thus, for instance, the "Net Herd Value" of Wheeler's 1975 herd was guaranteed at $21,000 as of December 31, 1981. ALC was to provide the requisite management service to care, feed, breed, and otherwise maintain and sell the cattle. In return, petitioners were required to pay an annual $98 maintenance fee per head for the 1973, 1974, and 19751983 Tax Ct. Memo LEXIS 403">*407 herds. The fee was $147 per head for the 1976 herd. In connection with this venture, petitioners claimed various farm expense deductions and investment tax credits. In his notices of deficiency, respondent disallowed all deductions to the extent they exceeded any reported income and all credits arising out of this cattle shelter for petitioners' taxable years 1975 and 1976. 2OPINION Respondent attacks the shelter on several grounds. He claims that the cattle, which were purported to be the sole assets of the venture, never existed; thus, he claims the entire venture was a sham and should be disregarded completely. Alternatively, he claims that, even if the cattle existed, the purchases did not constitute sales for tax purposes and/or that petitioners did not enter the venture with a profit motive. We agree with respondent. On August 31, 1982, respondent, accompanied by petitioner's counsel, made an inspection of petitioner's cattle. The location of the inspection was on land owned by Eckhardt in Iowa. The cattle inspected were represented1983 Tax Ct. Memo LEXIS 403">*408 to be the cattle owned by petitioners and pictures of the inspected cattle were taken. Prior to this inspection, on August 1, 1982, Eckhardt contacted Gordon Reisinger, a cattle broker for the Clifton Cattle Company, to acquire a load of cattle. Pursuant to a sales agreement, Reisinger delivered 170 cattle to Eckhardt just prior to the inspection. Subsequent to the inspection, Reisinger repossessed the cattle on October 1, 1982, upon Eckhardt's default of the sales agreement. Reisinger identified the cattle in the pictures taken at the August 31 inspection as the same cattle he sold to Eckhardt. We must agree with respondent that the cattle inspected on August 31, 1982, were nothing more than a "rent-a-herd" staged to lead respondent into believing they were owned by petitioners. It goes without saying that if petitioners did not own any cattle, none of the claimed deductions and credits are allowable. Respondent has shown to our satisfaction that no such herds, whether through the evolutionary product of the "culling process" or otherwise, existed either at the time of the inspection or at any time prior to the inspection. Therefore, we sustain respondent's determination. 1983 Tax Ct. Memo LEXIS 403">*409 Petitioners' counsel admit the cattle that were inspected were not petitioners' cattle although at the time of the inspection, they, too, assumed the cattle inspected were petitioners'. 3 Nevertheless, they infer, there could have been other cattle. Other than the "rent-a-herd", however, no evidence of any cattle identified as petitioners was presented to the Court. Moreover, no explanation for the "rent-a-herd" was given. If there were other cattle, we fail to see what purpose the "rent-a-herd" served. Furthermore, petitioners had no knowledge about the operation of this breeding program and they never visited or personally inspected any cattle; they relied totally on Eckhardt. We further hold for respondent on alternative grounds. The tax avoidance considerations so overwhelmingly pervade this tax shelter in comparison to any true economic objectives that, under the particular facts of this case, even if the cattle did exist, petitioners lacked the requisite profit motive to be allowed the disputed deductions. See recent1983 Tax Ct. Memo LEXIS 403">*410 decisions of this Court, Fox v. Commissioner,80 T.C. 972">80 T.C. 972 (1983); Flowers v. Commissioner,80 T.C. 914">80 T.C. 914 (1983); Brannen v. Commissioner,78 T.C. 471">78 T.C. 471 (1982). Petitioners are individual passive investors who essentially knew nothing about cattle. They were content to make small cash payments and report huge tax write-offs through highly inflated purchase prices by using nonrecourse liability and other financing techniques. 4 For instance, with respect to Wheeler, he has allegedly acquired an asset with a stipulated fair market value of $30,000 for a stated purchase price of $120,000. 5 Of this price, $81,000 is nonrecourse indebtedness while another $36,000 is represented by a "bank loan" and an "ALC advance." Through its promise to buy back at the "Net Herd Value," ALC guaranteed petitioners against any loss on both the "bank loans" and the "ALC advances." Moreover, sufficient operating income was guaranteed to cover all maintenance fees and purchase payments commencing the third year, the same year petitioners were obligated to begin making payments on the herds. 6 The obvious purpose of this arrangement was simply to shelter1983 Tax Ct. Memo LEXIS 403">*411 large incomes from petitioners' dental practices, all at the expense of the Federal government. See also Houchins v. Commissioner,79 T.C. 570">79 T.C. 570 (1982) and Grodt & McKay Realty, Inc. v. Commissioner,77 T.C. 1221">77 T.C. 1221 (1981), where this Court reached the same result with respect to other cattle breeding shelters since the taxpayers acquired no "ownership interest" in the cattle. Both of these cases likewise were marked by highly inflated purchase prices and nonrecourse liability which generated great tax benefits without any realistic objective of economic benefit. 1983 Tax Ct. Memo LEXIS 403">*412 Petitioners contend the burden of proof has shifted to respondent since he has raised an issue different from the issue asserted in the notice of deficiency. 7 Our decision is the same regardless of who has the burden of proof. Respondent has proved to our satisfaction that none of the claimed deductions and credits herein are allowable. The trial of this case was held November 18 and 19, 1982. On December 27, 1982, respondent filed a Motion to Reopen the Record in order to introduce newly discovered evidence that the cattle inspected were purchased by Eckhardt only days before the inspection. This Court granted respondent's motion and ordered the record be reopened for the sole purpose of receiving newly discovered evidence with respect to the ownership issue. There is no express provision in either the Tax Court Rules of Practice and Procedure or the Federal Rules of Civil Procedure directing itself to the authority of a court to reopen the record1983 Tax Ct. Memo LEXIS 403">*413 for the purpose of receiving additional evidence. Such authority, however, is inherent in the judicial administration of the law and a court's fact finding function. It is also implicit in Rules 59 and 60, Federal Rules of Civil Procedure, which authorize new trials and certain relief from judgments or orders. 8 A motion to reopen for additional proof is within the discretion of the trial court, Zenith Radio Corp. v. Hazeltime Research Inc.401 U.S. 321">401 U.S. 321 (1971); Thomas v. SS Santa Mercedes,572 F.2d 1331">572 F.2d 1331 (9th Cir. 1978), Nor-Cal Adjusters v. Commissioner,503 F.2d 359">503 F.2d 359 (9th Cir. 1974), affg. a Memorandum Opinion of this Court, and such court will sooner grant a motion to reopen made after submission, but before its decision, than when the motion comes to it after decision has been rendered. Caracci v. Brother Internat'l Sewing Machine Corp. of La.,222 F. Supp. 769">222 F. Supp. 769 (E.D. La. 1963), affd. per curiam 341 F.2d 377">341 F.2d 377 (5th Cir. 1965). Respondent's motion to reopen this case was based on newly discovered evidence that the cattle inspected on August 31, 1982, were not, in fact, owned by petitioners. This1983 Tax Ct. Memo LEXIS 403">*414 evidence was clearly material to the case and warranted reopening the record for this limited purpose. 9To reflect the foregoing and concessions, Decisions will be entered under Rule 155.Footnotes1. In his notice of deficiency, respondent originally determined deficiencies of $38,313 and $17,502 for 1976 and 1977 in docket No. 4347-80 (Morton S. and Beverly Rosen). By amended answer, respondent increased those deficiencies to reflect the above amounts.↩2. With respect to petitioners Morton S. and Beverly Rosen, the statute of limitations bars assessment of 1973 and 1974 taxes.↩3. This admission was made at the hearing to reopen the record for the purpose of receiving newly discovered evidence. See pgs. 10-11, infra.↩4. For instance, proceeds of the "bank loans" never left the bank. They were simply used to purchase certificates of deposit which were retained by the bank as collateral for the loans. Moreover, contrary to the bank's policy in granting cattle loans, no applications, financial statements, or net worth statements were filed in connection with these loans, and the bank made no inspection of any cattle or land pursuant to the granting of these loans. These loans were not based on petitioners' credit, or, for that matter, anyone's credit. The bank was totally free of any risk for these loans. The loans were made solely because the proceeds of the loans themselves were put up as security. We fail to see any purpose served by these loans. ↩5. The parties entered into this stipulation prior to the discovery of evidence regarding the "rent-a-herd." ↩6. We are not influenced in that Rosen and Wheeler may not have been aware of the ALC guarantee. The guarantee is unambiguously and prominently set forth in the agreement.↩7. In his notice of deficiency, respondent disallowed the claimed deductions and credits since petitioners lacked a profit motive.↩8. Rule 1 of the Tax Court Rules of Practice and Procedure↩ provides, in part, that where there is no applicable rule of procedure, the Court or the Judge before whom the matter is pending may prescribe the procedure, giving particular weight to the Federal Rules of Civil Procedure. 9. In reaching our decision, we limited our consideration of the evidence presented at the reopening hearing to the affidavit of Gordon Reisinger.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623013/ | TERRACE DRIVE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Terrace Drive Co. v. CommissionerDocket No. 7438.United States Board of Tax Appeals5 B.T.A. 1161; 1927 BTA LEXIS 3661; January 25, 1927, Promulgated 1927 BTA LEXIS 3661">*3661 Arthur B. Foye, C.P.A., for the petitioner. John D. Foley, Esq., for the respondent. ARUNDELL5 B.T.A. 1161">*1161 ARUNDELL: The Commissioner has determined a deficiency in income tax for the calendar year 1921 in the amount of $1,354.91 and overassessments amounting to $13,066.70 for the calendar years 1919, 1920, and 1922. The appeal was taken for all four years, but on the date the case was heard the taxpayer conceded that, under authority of the Board's decision in the , the Board would not have jurisdiction over the years in which overassessments were found, and it made no further contention with reference thereto. The deficiency is based on the profits alleged to have been made by petitioner from the sale of certain lots constituting a portion of 5 B.T.A. 1161">*1162 a large tract of land acquired by it at the time of its incorporation in 1917. The Commissioner determined the value of the property at the date of its acquisition by petitioner at $190,000 and used that figure as a basis for determining gain on the sale of certain lots in the tract, leaving in dispute only the question of the proper allocation1927 BTA LEXIS 3661">*3662 of the cost of the lots sold. Thereafter, the Commissioner filed an amended answer in which he denied that the value of the property at the time of its acquisition was $190,000, but asserted that the value was $80,000. He, however, failed to offer any proof in support thereof and later withdrew the affirmative part of his answer alleging the valuation of $80,000, thus leaving the valuation as originally determined in the deficiency letter, viz, $190,000. At the time of the hearing the following stipulation was filed: It is hereby stipulated by and between the parties to this appeal, the Appellant, Terrace Drive Company, and Respondent, Commissioner of Internal Revenue, that in the hearing of this appeal and trial of the issues therein, and for all purposes in this proceeding, the following facts shall be deemed to be true, and shall be accepted by the Board as established, and may be read into the record by either party with the same force and effect as if the same had been proved and established by competent testimony and evidence, namely: (1) The Terrace Drive Company was incorporated under the laws of the State of Oklahoma, as of July 16, 1917, and immediately thereafter, 1927 BTA LEXIS 3661">*3663 in consideration of its entire issue of capital stock of $25,000.00 par value, acquired a tract of land known as the "Terrace Drive Addition," located in the City of Tulsa, Oklahoma. (2) Said Terrace Drive Addition was recorded on the books of the company at the date of its acquisition at a value of $80,000.00. (3) In determining the profit on lots sold during the year 1921, including lots in said Terrace Drive Addition based on the value of $80,000.00 as used in the tax return, the cost of all lots sold was $14,265.05. (4) The cost of lots sold during the year 1921, including the lots in said Terrace Drive Addition, as used in determining the taxable income set forth in the deficiency letter was $15,534.82. (5) The cost of the lots sold during the year 1921, including the lots in said Terrace Drive Addition, based on a value of $190,000.00 at date of acquisition, would be $28,100.68. (6) That if the value at acquisition of the Terrace Drive Addition is determined by the United States Board of Tax Appeals to be $190,000.00, the net taxable income shown in the deficiency letter for the year 1921 shall be decreased $12,565.86. In view of the foregoing, it is the conclusion1927 BTA LEXIS 3661">*3664 of the Board that the net taxable income of petitioner as determined by the Commissioner for the year 1921 should be decreased $12,565.86. 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/4623014/ | STANDARD SLAG CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Standard Slag Co. v. CommissionerDocket No. 19028.United States Board of Tax Appeals20 B.T.A. 503; 1930 BTA LEXIS 2099; August 7, 1930, Promulgated 1930 BTA LEXIS 2099">*2099 1. The respondent's action relative to the amount that should be included in the petitioner's invested capital on account of certain contracts involved herein, and the amounts deductible from income as allowances for the exhaustion of said contracts, sustained. 2. In the year 1921 the petitioner realized profits from the operation of a certain contract. By the terms of the contract the petitioner was required to and did expend the profits during subsequent years in experimental work. Held, said profits constituted taxable income. 3. Petitioner is not entitled to have its profits taxes for the years 1919, 1920, and 1921 computed under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921. John T. Kennedy, Esq., and Blaine Mallan, Esq., for the petitioner. James L. Backstrom, Esq., and P. A. Sebastian, Esq., for the respondent. MARQUETTE 20 B.T.A. 503">*503 This proceeding is for the redetermination of deficiencies in income and excess-profits taxes asserted by the respondent in the amounts of $7,637.28 for 1919, $10,110.21 for 1920, and $56,008.83 for 1921. The petitioner alleges that the respondent erred in not1930 BTA LEXIS 2099">*2100 allowing: (1) Any amount as paid-in surplus for invested capital purposes with respect to the value of two contracts assigned to the petitioner. (2) Any amount as paid-in surplus for invested capital purposes with respect to the value of two contracts in payment for which the petitioner issued shares of its capital stock. (3) Annual exhaustion in the amount of $38,101.20 on said four contracts for each taxable year. (4) A deduction for 1921 of certain net proceeds which petitioner had agreed to use, and later did use, in experimental work. (5) Special assessment for each taxable year. FINDINGS OF FACT. The petitioner was incorporated under the laws of Ohio in December, 1914. Its principal place of business is in Youngstown. For tax purposes the petitioner is affiliated with the Seiple-Wolf Construction Co., which is also an Ohio corporation located in Youngstown. The petitioner's business consists in buying from iron and steel mills a by-product from their furnaces known as hard slag, and 20 B.T.A. 503">*504 reselling the slag after crushing and preparing it for commercial uses. This slag is used chiefly (1) in road construction, (2) as a high-grade ballast for railways, 1930 BTA LEXIS 2099">*2101 and (3) to some extent in the preparation of concrete. In localities where crushed stone is available that material is a strong competitor of hard slag. Gravel constitutes another competitor. Owing to freight charges the profitable use of both crushed stone and crushed slag is confined to territory within a radius of about one hundred miles from the crushing plants. The petitioner's business territory is eastern Ohio. That is, east of a line beginning midway between Cleveland and the northeastern corner of the State, running thence to Columbus, and from there to Portsmouth. Within that district there is but little, if any, competition from crushed stone. According to the method of cooling, the slag appears either in granulated form or as a hard, coherent mass. It is the latter form only which had commercial value during the taxable years and prior thereto. Before 1910 slag had no commercial value. Such as was not used by railroads for ballast was wasted. Some iron manufacturers had ample ground space for dumping their slag, but those who did not were obliged to have their slag removed. This removal was done by the railroads at first without charge, but in 1913 or1930 BTA LEXIS 2099">*2102 1914 they began to charge 15 cents per ton for the service. This charge was gradually increased until it reached 69 cents per ton. A large amount of storage space is necessary for a slag company such as the petitioner. It is also essential that such a company have a steady supply of slag of uniform quality. In the eastern Ohio district only three iron companies had sufficient ground space for unlimited slag storage. Two of these companies were under contract to sell their slag to the petitioner. The third, the Ohio works of the Carnegie Steel Co., was the only concern which attempted to compete with the petitioner. When it began business the petitioner had contracts with five iron companies for the purchase of their slag. It gradually added others, and thus was able to obtain 80 to 85 per cent of the entire hard slag output of the eastern Ohio district. The early method of salvaging slag required from six months to one year for aging before it could be used commercially, and it was practicable only to iron mills having a large amount of storage space. In 1914 one Leon L. Beeghley devised a method known as the small-pit system, whereby hard slag could be made ready1930 BTA LEXIS 2099">*2103 for crushing within a few days, and requiring much less space than did the old system. Beeghley, W. H. Kilcawley, and W. E. Bliss together owned 50 per cent of the outstanding capital stock of the France20 B.T.A. 503">*505 Slag Co., Beeghley owning one-fourth and Kilcawley and Bliss one-eighth each. Early in 1916 withdrew from the France Slag Co. and received in exchange for their stock about $40,000 in cash, two plans of the France Slag Co. located at Canal Dover and Latonia, Ohio, and two contracts, one with the Penn Iron & Coal Co. and the other with the United Iron & Steel Co., for the purchase of Slag produced by those mills. The remaining stockholders of the France Slag Co. obtained plants owned by the company at Detroit and Toledo. The France Slag Co. at that time had invested in these plants approximately $150,000, of which $90,000 represented the Toledo and Detroit plants and $60,000 to Canal Dover and Latonia plants. The France Slag Co.'s book surplus at the close of 1914 was $125,000. About that time 25 per cent of its outstanding capital stock was sold by W. G. France to G. A. France for $100,000. In addition to the two contracts turned over to Beeghley, Kilcawley, and1930 BTA LEXIS 2099">*2104 Bliss, the France Slag Co. owned two other contracts for the purchase of slag. The four contracts were not carried on the France Slag Co.'s books at any value. On March 18, 1916, Beeghley, Kilcawley and Bliss conveyed to the petitioner the Canal Dover and Latonia plants and equipment and the two contracts which they had secured from the France Slag Co., in consideration of $106,875 par value of the petitioner's capital stock. The Penn Iron & Coal Co. contract was valued by the petitioner at $11.640 and the United Iron & Steel Co. contract at $5,900 at the time it acquired them. At that time the Penn Iron & Coal Co. contract had a remaining life of four years and the United Iron & Steel Co. contract a remaining life of six years and five months. The principal provisions of each of these contracts were identical and were as follows: (a)The Iron Company agreed to lease to the France Company all lands required by the France Company for its operations under the contract at a rental of $1.00 a year. (b)The Iron Company agreed to deliver to the France Company all of its slag at the rate of Seven and one-half cents (7 1/2??) a ton of 2,000 pounds, for all slag sold by1930 BTA LEXIS 2099">*2105 the France Co. at a price of Forty Cents (40??) a ton or less, and if said slag sold at more than 40?? a ton agreed that the price would be one-half of the increased selling price over said 40?? in addition to the minimum of 7 1/2?? a ton. (c) The France Company agreed to sell to the Iron Company all iron scrap recovered by it from the slag at the rate of Four Dollars ($4.00) a ton of 2,240 pounds. (d)The Iron Company agreed to provide storage space for a limited quantity of crushed slag. In the early part of 1917 both these contracts were superseded by new ones directly with the petitioner, each with a life of ten years 20 B.T.A. 503">*506 from its date. The essential terms were the same as in the first contracts, except that the price of slag to the petitioner was increased to 15 cents per ton by the Penn Co. and to 10 cents per ton by the United Co. From the time when petitioner first acquired these contracts from Beeghley it has carried them or the superseding ones on its books at a total valuation of $17,540. The respondent has allowed this amount as invested capital. In November, 1914, Beeghley entered into a contract with the Shenango Furnace Co. for the purchase1930 BTA LEXIS 2099">*2106 of slag from the company's No. 1 and No. 3 furnaces at Sharpsville, Pa., for a period of 35 months from and after December 1, 1914. The essential provisions of this contract were: (a) Beeghley to have the right to grade and construct on the Shenango Company's property, two pits for the reception and chilling of molten slag. (b)The Shenango Company agrees to turn over to Beeghley their slag recovery plant in its present condition; and Beeghley to make at his own expense whatever alterations are necessary and to keep the plant in good operative condition, and restore it to the Shenango Company in as good condition as when he received it. Beeghley to pay a rental of $200 per month. (c)The Shenango Company agrees to sell and deliver a locomotive crane now at the plant for $5,000.00. (d)The Shenango Company agrees to furnish all the slag produced at their No. 1 and No. 3 furnaces, payment for which is to be as follows: 15?? per gross ton for slag delivered f.o.b. cars at No. 1 Furnace. 10?? per ton for slag loaded on cars at No. 3 Furnace. (e) Scrap iron to be recovered and sold to the Shenango Company at One Dollar ($1.00) per gross ton. 1930 BTA LEXIS 2099">*2107 (f) Beeghley shall have the right hereunder of assigning this contract to any corporation controlled by himself. On January 5, 1915, for a nominal consideration, Beeghley assigned the foregoing contract to the petitioner. On January 1, 1916, this contract was superseded by a new one between the Shenango Furnace Co. and the petitioner, with a life of five years from its date. This second contract was superseded by a third one on January 1, 1919, with a life of ten years from its date. On December 30, 1914, Beeghley entered into a contract with the Marting Iron & Steel Co. of Ironton, Ohio, for the handling of that company's slag. The contract was to run for ten years from its date. The essential provisions of the contract were: (a) Beeghley to locate and operate a slag crushing plant on the property of the Marting Iron & Steel Company, Ironton, Ohio. (b) Beeghley to furnish a suitable steam shovel and do the necessary excavating for the slag pits; the Marting Company to take care of material loaded by Beeghley in doing this work. Also the Marting Company is to take care of the track expense as well as all other expense, and work in connection with preparing1930 BTA LEXIS 2099">*2108 these pits in readiness for operation. 20 B.T.A. 503">*507 (c) The Marting Company to furnish and construct track connecting these pits with crushing plant. (d) The Marting Company to furnish as much space as possible on their property for slag stock piles. (e) Beeghley to furnish and construct a modern crushing and sizing plant, and furnish all tracks necessary for the operation of this plant and the stock piles, and to furnish a suitable steam shovel for loading slag from the pits into cars and to keep the pits in condition to receive at all times the slag as produced by the Marting Company. (f) Beeghley to pay ten cents (10??) per ton for the slag in pits for a period of ten years, and obtained an option to purchase for the following ten years at fifteen cents (15??) per ton. (g) Beeghley to reclaim as much iron as possible from the slag at cost, not to exceed one dollar ($1.00) per ton. (h) Beeghley authorized to assign this contract. This contract was assigned by Beeghley to the petitioner. Before the expiration of its term the contract was superseded by a new one, but its terms were not changed. On June 12, 1914, Beeghley entered into1930 BTA LEXIS 2099">*2109 a contract with the Jackson Iron & Steel Co. of Jackson, Ohio, for the handling of that company's slag for a period of 20 years. On January 5, 1915, this contract was assigned to the petitioner for a nominal consideration, and on September 1, 1918, was superseded by a new contract running for twenty years from January 1, 1918. On account of said five contracts petitioner was able to procure contracts with other mills in the district and to obtain control of 80 to 85 per cent of the entire slag output. The average annual output of the several companies with which the petitioner had contracts for the purchase of slag was as follows: TonsPenn Iron & Coal Co.75,000United Iron and Steel Co.75,000Shenango Furnace Co.200,000Marting Iron and Steel Co.200,000Jackson Iron and Steel Co80,000Andrews Hitchcock Iron Co150,000Brier Hill Steel Co125,000Strothers Furnace Co75,000United Iron and Steel Co75,000Sharon Steel Hoop Co75,000LaBelle Iron Works150,000Stuart Furnace Co75,000Wheeling Steel & Iron Co75,0001,430,000The basic rate paid by the petitioner to the iron companies for hard slag was 10 cents per ton, in the1930 BTA LEXIS 2099">*2110 cooling pits, and the petitioner did the loading. In some instances where the iron companies did 20 B.T.A. 503">*508 the loading, they were paid an additional 5 cents per ton for that service. The average price received by the petitioner for its prepared slag was 70 cents per ton at first. In 1916 the price advanced to $1 per ton. The petitioner at all times obtained from 10 to 15 cents more per ton than was received by other slag companies, due to the fact that the petitioner had practically no competition in its territory, either from other slag companies or from crushed stone. In other districts there was much competition. On April 30, 1921, the petitioner entered into a contract with the Republic Iron & Steel Co., of Youngstown, Ohio, for handling that company's output of granulated slag. The essential provisions of the contract are: Commencing not later than May 10th, we will assume responsibility for disposal of your entire output of granulated slag, you to pay us 50?? per net ton, weight to be determined in same manner as is done when wasted to the railroads. It is understood that you are not to be asked to make any capital expenditures but can turn the material out1930 BTA LEXIS 2099">*2111 the same as you are now doing. We are also to continue to pay the $3.00 per car for any No. 1 granulated slag ordered which will reimburse you for any unusual expense in loading this material at the pits. It is further understood that the price of 50?? per net ton is not fixed as a permanent price for the season or for any stated time. It is understood between us that we do not know what results can be accomplished under this new plan and it is possible that we can market more of this material than we are estimating at this time. This will depend largely on the number of blast furnaces in operation during the next six months. At any rate the agreement is that the matter can be reviewed at any time you desire to see if a lower rate can be established. The intention is that the benefits from the arrangement will be divided fairly between the two companies. At the same time we are accomplishing these results we will be developing the permanent wasting dumps and will be in shape next winter to take the output for wastage in case you are not accumulating hard slag by that time. Also, the dump will be ready to receive any other waste materials which you may have. It is understood1930 BTA LEXIS 2099">*2112 that any surplus remaining over and above the expenses of handling this slag during the summer months will not be considered as profit, but will be used in making preparation to waste the material during the winter season and in research and experimental efforts towards finding a permanent market for the material. The petitioner realized net proceeds amounting to $90,471.65 from its operations under this contract in 1921. The petitioner did not distribute any portion of this amount as dividends, but expended it all, during the five or six years following 1921, in research and experimental work. This amount was not included as income in the petitioner's tax return for 1921, but the respondent included it as income in his computation for that year. 20 B.T.A. 503">*509 OPINION. MARQUETTE: The first issue raised herein is as to the amount that should be included in the petitioner's invested capital for the years 1919, 1920, and 1921 on account of the Penn Iron & Coal Co., United Iron & Steel Co., Shenango Furnace Co., Marting Iron & Steel Co., and the Jackson Iron & Steel Co. contracts set forth in the findings of fact. The respondent has adopted a value of $17,540 for the first two1930 BTA LEXIS 2099">*2113 contracts and has computed the allowance for exhaustion on that basis, but has refused to allow any amount for the three other contracts either for invested capital or as a basis for computing allowances for exhaustion. The petitioner contends that the contracts with the Penn Iron & Coal Co. and the United Iron & Steel Co., had a total fair market value of $137,500 at the time it acquired them, and that the Marting Iron & Steel Co., the Shenango Furnace Co., and the Jackson Iron & Steel Co. contracts had a fair market value of at least $311,000 when they were assigned to the petitioner. The petitioner further claims that the depreciated values of the five contracts were $313,600 for 1919, $268,800 for 1920, and $224,000 for 1921, which should be included in invested capital for those years. The petitioner has presented no direct evidence respecting the fair market value of any of the contracts in question, but the alleged values are reached by a series of intricate and complicated calculations, which can be best stated by quoting from the petitioner's brief: 1. The contracts had a value of at least $448,000 when assigned to the petitioner.The discussion of the value1930 BTA LEXIS 2099">*2114 of these contracts will be offered in four steps, which are: (a) A sale of one-fourth of the capital stock of the France Slag Company, about one year prior to the assignment, shows that two of these five contracts, by themselves, had a value of about $137,500. (b) This value, according to Departmental rules of calculation, would be based on a premium of 11.9 cents a ton over the royalty provided in the contracts. (c) Applying a like differential to the production of the five contracts, without considering the production from other plants over which they gave control, results in a value of $459,119.27. (d) Taking into consideration the entire production over which these contracts gave the petitioner control, and applying a five cents per ton premium, results in a value of $448,968.86. About the beginning of 1915 one-fourth of the capital stock of the France Slag Company was sold for $100,000. At that time the entire capital stock and surplus of the France Slag Company was $125,000. The contracts were not carried on the books of that company at any value. The company owned no land, and hence the excess of this price over book value was not reflected in1930 BTA LEXIS 2099">*2115 an 20 B.T.A. 503">*510 increase in land values. Nor was such excess reflected in any secret or hidden reserves. The only source of income of the France Slag Company was from four contracts, of which two were assigned to the petitioner. Mr. Beeghley and his associates owned fifty per cent of the capital stock of the France Slag Company. When they left that company they received in distribution about one-half of the assets, exclusive of the contracts, and two of the four contracts of that company. Comsequently, the value of the two contracts received by Mr. Beeghley and his associates was one-half of the value of the four contracts owned by the France Slag Co. The following calculations are based on the foregoing facts: Selling price - 1/4 capital stock France Slag Co.$ 100,000Total market value capital stock France Slag Co.400,000Book value capital stock France Slag Co. exclusive of contracts125,000Market value of the four contracts275,000Inasmuch as the distribution of assets was based upon the Penn and United contracts having a like value to the two contracts retained by the France Slag Company, it follows that the value of the two contracts assigned1930 BTA LEXIS 2099">*2116 by these individuals to the petitioner was at least $137,500. The sale of this stock at a price which would give a value of 137,500 for the two contracts is equivalent to the payment of 11.9 cents a ton premium, as next explained. The average annual output of these two contracts, together, was 150,000 tons. They were for a term of ten years with a renewal clause for an additional ten years, and of this twenty-year period about five years had elapsed at the time of the sale. Accordingly, these calculations will be based on an unexpired fifteen-year term. Hoskold's Formula for a present worth on a fifteen-year term basis at eight per cent and four per cent, is 0.513053. The sale value of the contracts, as above given, was $137,500, which sum divided by 0.513053 gives $268,003.50 as the gross value of the fifteen annuities. This amount divided by fifteen, gives the value of the annuity as $17,866.90. The latter amount, $17,866.90, divided by the annual production, 150,000 tons, gives a per ton premium of 11.9 cents. Based then on the customary methods of calculation approved by the Treasury Department, the foregoing sale of stock is equivalent to the payment of a premium1930 BTA LEXIS 2099">*2117 of 11.9 cents a ton on the production of these contracts. The other three contracts assigned to the petitioner were on substantially the same basis as these two contracts. Production under the five contracts was as follows: Average annualoutput (tons)Penn Iron & Coal Co75,000United Iron and Steel Co75,000Shenango Furnace Co200,000Marting Iron & Steel Co200,000Jackson Iron & Steel Co80,000630,000Applying the same premium per ton that was determined from the sale of one-fourth of the capital stock of the France Slag Company, the following value is shown: Annual production of the five contractstons 630,000Above tonnage multiplied by 11.9 cents gives annuity of$ 74,970.00Multiply by effective control period of contracts (10 years)$749,700.00To get present worth by Hoskold's Formula 8 and 4 per cent, multiply by 0.612404$459,119.2820 B.T.A. 503">*511 Another method of determining the value of these five contracts is based on the control they gave over the slag output in this district. The testimony is clear that because these five contracts gave the petitioner substantially all of the storage facilities in1930 BTA LEXIS 2099">*2118 this district, the petitioner was able to obtain other contracts and to control eighty-five per cent of the slag output. The result was that the petitioner obtained control over 1,430,000 tons annual output. In determining the value on this basis we shall confine ourselves exclusively to the lower royalty rate which this control obtained, and shall not consider that it also enabled the company to obtain, upon sale, a price of ten or fifteen cents more than was obtained in any other district. This difference in royalty rate, supported by the testimony of three witnesses, and substantiated by the renewal rate specified in the Marting contract, was five cents a ton. The calculation on this basis follows: Annual output controlledtons 1,430,000Multiply above amount by 5?? a ton gives annuity of$ 71,500.00Multiply by effective control period of contracts (10 years)$ 715,000.00To get present worth by Hoskold's Formula, 8 and 4 per cent, multiply by 0.612404$ 448,968.86Of the values above shown, we propose the last, which shows the lowest amount, that is, $448,000.00. We respectfully submit that the facts above outlined clearly show that two of1930 BTA LEXIS 2099">*2119 these five contracts, by themselves, had a value of about $137,500 and that the value of the five contracts, computed by accredited methods of income tax practice, was at least $448,000.00 when assigned to the corporation. Invested capital should include the value of these contracts depreciated to the beginning of each taxable year.The years before the Board are 1919, 1920 and 1921. The 1916 value was $448,000 depreciated to the beginning of each of these years, using a ten per cent depreciation rate, would give the following amounts to be included in invested capital: 1919$313,600.001920$268,800.001921$224,000.00We are of the opinion that the petitioner has wholly failed to establish for the contracts in question the value it claims. The contracts were for the purchase of raw material, which the petitioner intended to prepare for commercial use and sell. We are not advised what markets, if any, the petitioner had for its product in 1915 and 1916, nor whether the demand for that product was large or small, steady or fluctuating, increasing or decreasing. The petitioner received 70 cents per ton for its crushed slag in 1915, and received $11930 BTA LEXIS 2099">*2120 per ton in 1916. But the evidence does not disclose the cost of preparing and marketing the product, nor whether it could be sold in paying 20 B.T.A. 503">*512 quantities, nor whether any profit was realized by virtue of these contracts in question. The only proven fact upon which the petitioner bases its contention is that early in 1915, $100,000 was paid by one member of the France family to another member in exchange for 25 per cent of the France Co.'s stock. We are not convinced that such a sale, without other corroborating evidence, fixes the fair market value of all that company's stock at $400,000 as claimed. And even if the stock did have that value, it does not follow that the four slag purchase contracts then owned by the France Company equaled one another in value. We are told that that company had no source of income other than that derived under its four contracts. But how much of that income, if any, was attributable to the two contracts later acquired by the petitioner, we are not told. The record establishes a theoretical, but not an actual market value for the contracts in question. From its inception the petitioner has carried on its books the Penn and the United1930 BTA LEXIS 2099">*2121 contracts at a total valuation of $17,540, which has been allowed by the respondent as invested capital. In our opinion the evidence does not warrant any further allowance for paid-in surplus with respect to the four contracts in question. The second contention is that the petitioner should be allowed annual exhaustion in the amount of $44,800 upon the five contracts which we have just discussed. As the contention is based upon the petitioner's alleged values of those contracts, which values we have found were not sustained by the record, it follows that this claim for annual exhaustion of those contracts must be denied. The next error alleged is that the respondent has included the amount of $90,471.65 as income to the petitioner for the year 1921. This amount represents the net proceeds derived during that year from a contract with the Republic Iron & Steel Co. It is contended that the amount is not taxable income because, under the terms of the contract, the petitioner had agreed that any surplus proceeds would not be treated as profit, but would be used by the petitioner in research and experimental work. These researches and experiments, if favorable in their outcome, 1930 BTA LEXIS 2099">*2122 ultimately would benefit the Republic Co. as well as the petitioner. No part of the amount in question was expended during 1921, but during subsequent years it was expended in research and experimental work. Section 213 of the Revenue Act of 1921 provides: SEC. 213. That for the purposes of this title (except as otherwise provided in section 233) the term "gross income" - (a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal services * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, 20 B.T.A. 503">*513 or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividend, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * * It is clear that under the above statute property is impressed with the character of income according to the manner in which it is acquired. Whether any such acquisition does or does not become income is not determined by the use to which the recipient may devote the1930 BTA LEXIS 2099">*2123 property, nor by his agreement that he will or will not treat it as profit. Here, the amount in question was derived from the operation of a business contract, in the due course of business. It comes within the scope of the rule stated by the Supreme Court in : "Income may be defined as the gain derived from capital, from labor, or from both combined." See also , and . The petitioner has cited a number of decisions by this Board, and also , in support of its contention that the amount in question was not income. In each of those cases contributions given to aid the taxpayer in establishing a factory, or in extending the service of a public utility, were held not to be income to the taxpayer. We do not question the correctness of those decisions but as they are founded on facts materially different from those now before us, we can not accept them as guiding authorities in this instance. In our opinion the respondent correctly included the amount received1930 BTA LEXIS 2099">*2124 under the Republic Co.'s contract as taxable income to the petitioner for 1921. The last issue for our consideration is whether the petitioner is entitled to special assessment for the years 1919, 1920, and 1921. The petitioner bases its contention upon the following allegations of abnormality: (a) Inability to satisfactorily determine invested capital. (b) Abnormality of income arising from inability to determine exhaustion of contracts. (c) Abnormality of income due to development work in prior years. (d) That assets employed to produce income were not owned by the petitioner but were placed at its disposal for a nominal rental. The provisions of section 327 of the Revenue Acts of 1918 and 1921 are identical. In so far as material here they are: SEC. 327. That in the following cases the tax shall be determined as provided in section 328: (a) Where the Commissioner is unable to determine the invested capital as provided in section 326; * * * (c) Where a mixed aggregate of tangible property and intangible property has been paid in for stock, or for stock and bonds and the Commissioner is 20 B.T.A. 503">*514 unable satisfactorily to determine the1930 BTA LEXIS 2099">*2125 respective values of the several classes of property at the time of payment, or to distinguish the classes of property paid in for stock and for bonds, respectively; (d) Where upon application by the corporation the commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply in any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital * * *. Section 328 provides for a special manner of assessing income tax in the cases specified in section 327. With respect to issues (a) and (b) we are of opinion that no abnormality exists. A determination that certain contracts have no value for invested capital purposes and, therefore, none for exhaustion1930 BTA LEXIS 2099">*2126 purposes, does not bring about such an abnormality as is contemplated by the statute providing for special assessment. See ; ; . In the decision last cited we find a condition very similar to the one now before us. There, the taxpayer had a contract giving it the exclusive rights to bottle and sell Coca-Cola within a specified territory, and it derived large profits from the business. The Commissioner did not allow any value for the contract for invested capital purposes. The taxpayer claimed special assessment on the ground that its profits were largely attributable to conditions not reflected in its invested capital, namely, the ownership of a valuable contract which was its chief income-producing factor. The taxpayer argued that its contract had a value of $400,000 and, since that value was not recognized for invested capital purposes, an abnormality existed. In refusing the claim for special assessment, it was said: Obviously, * * * the petitioner could not operate without the contract, 1930 BTA LEXIS 2099">*2127 but this does not necessarily make of the contract an income-producing asset. The same might be said of many sales or distribution contracts, * * * but the contract itself does not usually produce income; it is the operations under the contract which give rise to income. * * * But we do not think it necessarily follows that an abnormality exists as contemplated by the statute because a corporation has an asset which is of value * * * but which may not be included in invested capital. * * * The statute specifically provides that the special assessment provisions "shall not apply in any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable years a high rate of profit upon a normal invested capital." * * * Abnormality 20 B.T.A. 503">*515 means at least a deviation from a normal condition. What this petitioner had in the form of an unrecognized asset (for invested capital purposes) would not seem to be other than what is normally found in concerns of a similar character. The language just quoted is, we think, very applicable to the present proceeding. In 1930 BTA LEXIS 2099">*2128 , the petitioner enjoyed a monopoly by virtue of its contract; in the case under consideration the petitioner's contracts eliminated 80 to 85 per cent of the possible competition. In both cases the contracts were highly essential to the successful outcome of the business enterprises, but the profits realized were due to factors outside the contracts, such as a management, methods pursued, business zeal, working capital, etc. In each case the petitioner had invested capital which was determinable under section 326 of the Revenue Acts, and which was determined and credit therefor given to the taxpayer. In our opinion there is no ground in the present proceeding for granting special assessment under the petitioner's issues (a) and (b).In issue (c) abnormality of income is claimed because of development work in prior years. Presumably the petitioner had reference to the development of markets for crushed slag, and of the use of the small pit system of treating slag at the iron furnaces. We are not advised as to the nature or amount of any expenditures made to further such development, nor whether any such1930 BTA LEXIS 2099">*2129 expenditures were charged to capital or to operating expense, nor whether petitioner's records are in such condition that any erroneous bookkeeping entries may be rectified. Clearly, the mere expenditure of money to obtain new and wider markets for one's product, or to extend the use of a favorable method of production, does not prove the existence of an abnormality. In the present instance the development of the small pit system was not accomplished through any patent or secret process. It was open to the world, free to any who might wish to use it. The record does not show that any definite amount of the petitioner's income was due to this system. In our opinion, no abnormality has been shown under issue (c). See ; . The final allegation of abnormality is that the petitioner's income was produced by the use of assets owned by others, for which petitioner paid only a nominal rental. There is no evidence before us to indicate what would be a fair and proper rental for the facilities so used by the petitioner; but, assuming that the amount paid was greatly below the real1930 BTA LEXIS 2099">*2130 value of the facilities, we are not convinced that an abnormality existed within the meaning of the statute. 20 B.T.A. 503">*516 This Board has held that highly favorable contracts alone do not constitute abnormalities calling for special assessment. See ; . Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623015/ | HULETT C. FOSTER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFoster v. CommissionerDocket No. 13511-82.United States Tax CourtT.C. Memo 1988-59; 1988 Tax Ct. Memo LEXIS 59; 55 T.C.M. 121; T.C.M. (RIA) 88059; February 18, 1988. Hulett C. Foster, pro se. Juandell D. Glass, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined deficiencies in petitioner's Federal income taxes and addition as follows: Additions to TaxTaxable YearDeficiencySec. 6653 (b) 1Sec. 66541972$ 2,627.50$ 1,313.75$ 83.871973305.56152.789.7619744,085.892,042.95130.441988 Tax Ct. Memo LEXIS 59">*60 When this case was called from the trial calendar on May 18, 1987, in Guthrie, Oklahoma, petitioner did not appear in person or through counsel. 2 Respondent appeared through counsel and made an oral motion to dismiss for failure properly to prosecute. At trial, we granted respondent's motion with respect to the Federal income tax deficiency and the additions to tax under section 6654 and heard the testimony of Special Agent John Nance with respect to the additions to tax under section 6653(b). We must now decide whether petitioner is liable for the additions to tax under section 6653(b), or alternatively, whether petitioner is liable for the additions to tax under section 6651(a)(1) and 6653(a). 1988 Tax Ct. Memo LEXIS 59">*61 FINDINGS OF FACT On March 30, 1983, respondent served counsel for petitioner with a request for admissions. Neither petitioner nor his counsel responded to the request for admissions. Consequently, the facts set forth in respondent's request for admissions, not having been responded to within 30 days of its service, are deemed admitted for purposes of this case. Rule 90(c) and (e); . Petitioner, Hulett C. Foster, resided in Norman, Oklahoma, at the time he filed his petition. 3 Petitioner failed to file Federal income tax returns for the taxable years 1972 through 1974. Petitioner was a cash basis taxpayer and was required to file Federal income tax returns for the taxable years 1972 through 1974. During the taxable years in issue, petitioner engaged in the businesses of rendering services for compensation, farming and ranching. Petitioner derived taxable income from wages, farming or ranching income, and cattle sales. Petitioner also received farm subsidy1988 Tax Ct. Memo LEXIS 59">*62 payments. Petitioner told respondent's agents that his income had to be about $ 12,000 a year in order to service his debt. Petitioner did not maintain books and records of his income-producing activities during the taxable years in issue. On January 1, 1972, petitioner owned about 290 acres of land in McClain County, Oklahoma, of which 140 acres were purchased in 1971 for $ 56,000. On May 8, 1972, petitioner executed an application for a loan to the Federal Land Bank of Wichita wherein he claimed ownership of 540 acres of land acquired between the years 1955 and 1972. At the end of 1974, petitioner owned about 500 acres which he had in cultivation. The land held by petitioner was not purchased but acquired through the transfer of title from his father. Petitioner made conflicting statements to Special Agent John Nance about his ownership of farmlands. During 1972, petitioner earned farm and other income in a total amount of $ 15,000. Petitioner incurred interest expense of $ 1,000 and miscellaneous expenses of $ 2,000. Petitioner made conflicting statements to Special Agent John Nance about his farm income. During 1973, petitioner received $ 4,559.90 for sales of cattle1988 Tax Ct. Memo LEXIS 59">*63 to the Dempsey-Wright Live Stock Commission Co. These proceeds were not deposited in petitioner's bank account. 4 Petitioner did make deposits in his bank account in the amount of $ 2,507.17, withholding currency of $ 180.05 from such deposits. During 1974, petitioner received $ 10,080.71 for sales of cattle to the Dempsey-Wright Live Stock Commission Co. Petitioner deposited $ 5,829 in his bank account, withholding currency of $ 264.74 from such deposits. Petitioner made conflicting statements to Special Agent Nance about his ownership and sale of cattle. The Commissioner mailed a statutory notice of deficiency to petitioner for the taxable years 1972 through 1974 and determined the following amounts of unreported income: Taxable YearUnreported Income1972$ 12,000.0019732,687.22197416,174.45The Commissioner also determined that petitioner was liable for the additions to tax under sections 6653(b) and 6654. OPINION Section 6653(b) provides1988 Tax Ct. Memo LEXIS 59">*64 that if any part of an underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. Respondent bears the burden of establishing by clear and convincing evidence the elements of the section 6653(b) fraud addition. 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. . Respondent need not prove the precise amount of underpayment resulting from fraud, but only that some part of the underpayment is attributable to fraud. , affg. a Memorandum Opinion of this Court. Respondent must prove that petitioner intended to evade taxes that he knew or believed to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. , affg. a Memorandum Opinion of this Court; ,1988 Tax Ct. Memo LEXIS 59">*65 affg. a Memorandum Opinion of this Court. The issue of fraud poses a factual question that is to be decided on an examination of all the evidence in the record. , affg. , cert. denied ; . 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. , affd. per curiam ; . Fraud is never imputed or presumed and courts should not sustain findings of fraud upon circumstances that at most create only suspicion. . Although respondent carries a heavy burden, it is clearly established that a taxpayer's intent to evade tax may be proved by facts deemed admitted pursuant to the Rules of this Court. ;1988 Tax Ct. Memo LEXIS 59">*66 . We conclude that respondent has affirmatively shown various indicia of fraud through the facts deemed admitted. Petitioner failed to file Federal income tax returns for the taxable years in issue. Petitioner derived taxable income from wages, farming or ranching income, and cattle sales and was required to file Federal income tax returns for the taxable years in issue. Petitioner told respondent's agent that his income had to be about $ 12,000 a year in order to service his debt. Failure to file, even over an extended period of time, does not conclusively establish fraud. . However, failure to file is persuasive circumstantial evidence of fraud. , affg. a Memorandum Opinion of this Court. Petitioner also failed to maintain any books and records. Failure to maintain complete and accurate records is an indication of fraud. ; . Petitioner made conflicting1988 Tax Ct. Memo LEXIS 59">*67 statements to Special Agent Nance about his ownership of farmlands, his farm income, and his ownership and sale of cattle. This indicates to us an intent on the part of petitioner to mislead Special Agent Nance and thereby conceal his income for the taxable years in issue. ; see . In view of the foregoing we hold that respondent has shown by clear and convincing evidence that in each taxable year a part of the underpayment was due to fraud and, therefore, the additions to tax under section 6653(b) will be sustained. Our holding with respect to fraud under section 6653(b) eliminates the need to consider respondent's alternative position with respect to the additions to tax under section 6651(a)(1) and 6653(a). Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the relevant years, and all Rule references are to the Rules of Practice and Procedure of this Court. ↩2. Petitioner was originally represented by counsel. The Notice Setting Case for Trial was served December 17, 1986. On February 26, 1987, counsel filed a Motion to Withdraw which the Court granted. At the time of trial, petitioner was incarcerated in the John H. Lilley Correctional Center in Boley, Oklahoma. However, petitioner was a participant in a program which allowed him to leave the correctional facility in order to attend to legal matters. ↩3. Counsel's Motion to Withdraw provides that petitioner was incarcerated in the Oklahoma State Penitentiary at the time the petition was filed. ↩4. This amount was deposited in the account of petitioner's father and included in the computation of his taxable income. See . ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623016/ | Laurence P. Dowd and Juliet R. Dowd, Petitioners, v. Commissioner of Internal Revenue, RespondentDowd v. CommissionerDocket No. 84485United States Tax Court37 T.C. 399; 1961 U.S. Tax Ct. LEXIS 18; December 4, 1961, Filed 1961 U.S. Tax Ct. LEXIS 18">*18 Decision will be entered under Rule 50. Petitioner was in Japan from October of 1955 until July of 1957 as a Fulbright lecturer at Kobe University. He was paid in inconvertible Japanese currency by the United States Educational Commission in Japan. Held:1. Amounts paid to petitioner in 1956 and 1957 as a Fulbright lecturer were "paid by the United States or an agency thereof" within the meaning of section 911(a)(2) of the 1954 Code and thus were not excludible from gross income.2. Petitioner's tax residence remained in the United States during 1956 and 1957. As a Fulbright lecturer in Japan, petitioner was temporarily "away from home" in the pursuit of his trade or profession of teaching and was entitled to deduct his traveling expenses under section 162(a)(2) of the 1954 Code. Amount of such expenses in 1956 and 1957 determined. Laurence P. Dowd, for the petitioners.Cyrus A. Johnson, Esq., for the respondent. Raum, Judge. RAUM37 T.C. 399">*399 Respondent determined deficiencies in petitioners' income tax in the amounts of $ 863.11 in 1956 and1961 U.S. Tax Ct. LEXIS 18">*20 $ 801.86 in 1957.The principal issue is whether payments made to petitioner Laurence P. Dowd as a Fulbright lecturer in 1956 and 1957 by the United 37 T.C. 399">*400 States Educational Commission in Japan were "amounts paid by the United States or an agency thereof" and therefore not excludible from gross income under section 911(a)(2) of the 1954 Code. If such payments are includible in gross income, an alternative question is whether petitioner while a Fulbright lecturer in Japan was "away from home" within the meaning of section 162(a)(2) of the 1954 Code and thereby entitled to deduct his "traveling expenses" while in Japan.FINDINGS OF FACT.The facts stipulated by the parties are incorporated herein by this reference.Petitioners, husband and wife, filed joint income tax returns for the taxable year 1956 with the district director of internal revenue at Tacoma, Washington, and for the taxable year 1957 with the district director of internal revenue at Detroit, Michigan. Juliet R. Dowd is a petitioner herein only because joint returns were filed. Laurence P. Dowd will hereinafter be referred to as petitioner.Prior to September 1955 petitioner was employed by the University of Washington1961 U.S. Tax Ct. LEXIS 18">*21 at Seattle, Washington, as an assistant professor of Marketing, Transportation and Foreign Trade. In September 1955 petitioner was promoted to the rank of associate professor. He was granted a sabbatical leave from the university for the academic year 1955-1956.On March 5, 1955, petitioner was awarded a Fulbright grant for the purpose of lecturing in economics at Kobe University, Kobe, Japan, for a 10-month period beginning in October 1955. The notice which officially informed petitioner of the award was a Department of State form entitled a "United States Government Grant Authorization" with attached "Terms and Conditions of U.S. Government Grant." The grant authorization named the United States Educational Commission in Japan as the "administering U.S. educational foundation or commission" of the award. It provided a "maintenance allowance" for petitioner and four accompanying dependents amounting to 3,096,000 yen. During 1956 and 1957 the rate of exchange was 360 Japanese yen for 1 United States dollar.Among the "Terms and Conditions of U.S. Government Grant" which petitioner agreed to in accepting the award were the following:2. MEDIUM OF PAYMENT: * * * Since all funds1961 U.S. Tax Ct. LEXIS 18">*22 available under Public Law 584, 79th Congress (the Fulbright Act) are in foreign currencies, this grant and all payments thereunder are made only in the currency of the host country. These funds are to be used to meet the grantee's expenses abroad in carrying out his project. The foreign currency available under the program is not convertible into United States dollars.* * * *37 T.C. 399">*401 5. DURATION OF GRANT: * * *The Foundation may in its discretion at the request of the grantee extend the grant for a period not to exceed three months at the pro rata monthly rate of the allowance in order to permit the grantee to complete his activity.* * * *10. ITEMS NOT INCLUDED: * * * Persons who participate as grantees under this program are not entitled to receive certain services which may be available to officers and employees of the United States Government (for instance, PX privileges). It is the intention of the program that recipients of awards will utilize the economy of the countries in which they are temporary residents to meet their local living requirements.* * * *13. CONTINGENCIES: Neither the Department of State, the Board of Foreign Scholarships, nor the Foundation assumes1961 U.S. Tax Ct. LEXIS 18">*23 responsibility for any injury, accident, illness, loss of personal property, or other contingency which may befall the grantee or his dependents during or in connection with his stay abroad under this grant. It is recommended that the grantee personally obtain adequate health, accident, and personal property insurance. The Department of State, the Board of Foreign Scholarships, and the Foundation shall not be liable for any claim or claims which may arise from the grantee's failure to enter upon or to complete his project as contemplated in this award, even where such failure is due to circumstances beyond the grantee's control.* * * *18. TERMINATION OF GRANT: The Board of Foreign Scholarships and the Department of State reserve the right to revoke or terminate this grant, in their discretion, and to withhold payment of such allowances as have not been paid on the date of termination, as well as return transportation to the United States, should non-compliance with the provisions of the award warrant such action. Grounds upon which the Board of Foreign Scholarships and the Department of State may revoke this grant include, but are not limited to, the following: violation of the1961 U.S. Tax Ct. LEXIS 18">*24 laws of the United States or of the host country, including currency exchange regulations; misconduct; failure to maintain satisfactory scholastic standing; failure to complete the grant because of voluntary termination, including premature departure from the institution of affiliation or the host country; physical or mental incapacitation; engaging in political or unauthorized income-producing activities.19. RESPONSIBILITIES: An American citizen who accepts a grant under the United States Educational Exchange Program is not by virtue of such an official of the Department of State, of any other agency of the U.S. Government or of a foreign government agency. As far as the Department of State and the U.S. government are concerned, the grantee's status is that of a private citizen with the same professional freedom he enjoys as a representative of his profession in the United States. Nevertheless, the grantee should remember that his home institution and his country may be judged by his actions and utterances whether public or private. He should also be aware that critical or idle comments regarding foreign governments, institutions or customs may offend the people whose guest he1961 U.S. Tax Ct. LEXIS 18">*25 is. He should avoid giving the impression that he is an official spokesman of the United States Government.The so-called Fulbright Act (Pub. L. 584, 79th Cong., 2d Sess., 60 Stat. 754) is an amendment to the Surplus Property Act of 1944 and provides in part that in carrying out the provisions of the latter statute the Secretary of State is authorized to enter into executive 37 T.C. 399">*402 agreements with any foreign government "for the use of currencies, or credits for currencies, of such government acquired as a result of such surplus property disposals," for the purpose of providing, by the formation of foundations or otherwise, for financing studies, research, instruction, and other education activities of or for American citizens in schools or institutions of higher learning located in such foreign country or of citizens of such foreign country in American schools and institutions of higher learning.Pursuant to the provisions of the foregoing legislation, the United States Educational Commission in Japan was established by an agreement between the United States and Japan on August 28, 1951. This agreement provided in part as follows:SECTION 1There shall be established a Commission1961 U.S. Tax Ct. LEXIS 18">*26 to be known as the United States Educational Commission in Japan (hereinafter designated "the Commission"), which shall be recognized by the Government of the United States of America and the Government of Japan as an organization created and established to facilitate the administration of an educational program financed by funds to be made available by the Government of Japan on account of obligations incurred by the Government of Japan for surplus property sold to it by the Government of the United States of America. Except as provided herein the Commission shall be exempt from the domestic and local laws of the United States of America as they relate to the use and expenditure of currencies and credits for currencies for the purpose set forth herein. The funds and property shall be regarded in Japan as property of a foreign government.* * * *SECTION 2In furtherance of the aforementioned purposes, the Commission may, subject to the provisions of the present memorandum exercise all powers necessary to the carrying out of the purpose of this memorandum including the following:* * * *(4) Authorize the Treasurer of the Commission or such other person as the Commission may designate1961 U.S. Tax Ct. LEXIS 18">*27 to receive funds to be deposited in bank accounts in the name of the Treasurer of the Commission or such other person as may be designated. The appointment of the Treasurer or such designee shall be approved by the Secretary of State and he shall deposit funds received in a depository or depositories designated by the Secretary of State of the United States of America.* * * *(6) Provide for periodic audits of the accounts of the Treasurer of the Commission as directed by auditors selected by the Secretary of State of the United States of America;* * * *SECTION 3All commitments, obligations and expenditures authorized by the Commission shall be made pursuant to an annual budget to be approved by the Secretary of 37 T.C. 399">*403 State of the United States of America pursuant to such regulations as he may prescribe.SECTION 4The Commission shall consist of eight members, four of whom shall be citizens of the United States of America and four of whom shall be citizens of Japan. In addition, the principal officer in charge of the Diplomatic Mission of the United States of America to Japan (hereinafter designated "Chief of Mission") shall be Honorary Chairman of the Commission. He shall1961 U.S. Tax Ct. LEXIS 18">*28 cast the deciding vote in the event of a tie vote by the Commission and shall appoint the Chairman of the Commission. The Chairman as a regular member of the Commission shall have the right to vote. The Chief of Mission shall have the power to appoint and remove the citizens of the United States of America on the Commission. The Japanese members shall be appointed by the Government of Japan from a list of nominees concurred in by the Chief of Mission and may be removed by the Government of Japan.* * * *SECTION 8The Government of Japan, as and when requested by the Government of the United States of America for purposes of this memorandum, shall make available for deposit in an account of the Treasurer of the United States of America in Japan currency of the Government of Japan not to exceed the equivalent of One Million Dollars ($ 1,000,000) (United States currency) annually for a period of five (5) years, except that in the initial year of the operation of the Commission the amount to be made available in the currency of the Government of Japan shall not exceed the equivalent of Seven Hundred Fifty Thousand Dollars ($ 750,000) (United States currency). It is understood that1961 U.S. Tax Ct. LEXIS 18">*29 any funds not requested in accordance with the provisions of the preceding sentence shall be made available at such times, subsequent to the aforementioned five year period, as may be requested by the Government of the United States of America.* * * *The Secretary of State of the United States of America will make available for expenditure as authorized by the Commission currency of the Government of Japan in such amounts as may be required for the purposes of this memorandum but in no event in excess of the budgetary limitations established pursuant to Section 3 of the present memorandum.SECTION 9The Government of Japan shall, as far as possible, find ways and means of relieving United States grantees, on the basis of reciprocity, from Japanese taxation and other financial burdens affecting the grants made from funds available to the Commission in accordance with this memorandum. Details of the exemption may hereafter be arranged between competent authorities of the two governments.On September 22, 1955, petitioners together with their three minor children departed the United States for Kobe, Japan. From October 1955 until July 1957, a period of 21 months, petitioner and his1961 U.S. Tax Ct. LEXIS 18">*30 family rented a house at Kobe, Japan. During this period, petitioner lectured at Kobe University.Petitioners owned their home at 3826 46th Avenue NE., Seattle 5, Washington, from August 1951 to May 1958. While petitioners and 37 T.C. 399">*404 their family were in Japan and after their return to the United States in 1957, petitioners rented this home to others.Petitioner resigned from the faculty of the University of Washington in March of 1956. His resignation was accepted by the board of regents of the university on March 3, 1956, effective June 15, 1956.On May 3, 1956, petitioner was awarded a renewal of his Fulbright grant to cover a second year of lecturing at Kobe University for a 10-month period beginning in October 1956. Petitioner was officially notified of this renewal grant by receipt of a Department of State form entitled a "United States Government Grant Authorization."On May 18, 1956, petitioner was informed by a letter from the executive secretary of the United States Educational Commission in Japan that he had been granted an extension of his initial Fulbright grant from August 5 to September 30, 1956, to provide summer maintenance between the termination of his initial1961 U.S. Tax Ct. LEXIS 18">*31 award and the commencement of his renewal award.All funds paid to petitioner under his Fulbright grant, its extension and renewal, were paid by the United States Educational Commission in Japan in inconvertible Japanese currency. Petitioner received the equivalent of $ 10,320 in 1956 from the United States Educational Commission in Japan and the equivalent of $ 5,160 in 1957.While petitioner was in Japan, he was offered an appointment to the faculty of the University of Michigan as lecturer for the academic year 1957-1958 on April 4, 1957. Petitioner accepted the appointment and commenced employment at the University of Michigan on October 1, 1957.Petitioners departed Japan for the United States on July 8, 1957, and arrived at San Francisco on August 14, 1957.The chairman of the United States Educational Commission in Japan wrote to petitioner on September 19, 1957, and enclosed a copy of some mimeographed materials distributed by the Commission to all Fulbright grantees concerning tax matters. A portion of these materials reads as follows:The Department of State requested a ruling as to the tax treatment of grants received by American students, teachers, professors, and research1961 U.S. Tax Ct. LEXIS 18">*32 scholars as affected by Section 117 of the Internal Revenue Code of 1954. In a letter of January 10, 1957, the United States Treasury gave such a ruling, an exact copy of which follows:"It is our position that the law and regulations do not permit teachers and professors who are teaching in foreign countries to exclude from their incomes, any grants which they receive under the Fulbright Act for such teaching. Those teachers who are employed in teaching in the United States and who are merely temporarily absent from their regular employment in this country for the purpose of teaching, or lecturing abroad, may deduct the actual cost of their travel, meals and lodging, incurred in connection with their foreign teaching or lecturing activities. This deduction applies, of course, only to the expenses to the individual 37 T.C. 399">*405 teacher or professor, and not to any expenses incurred on behalf of any other person who may accompany him.Petitioner in 1959 wrote to the Department of State and requested information about the governmental status of Fulbright commissions and foundations. He was answered by John W. Keogh, Chief, Facilitative Services Branch, International Educational Exchange1961 U.S. Tax Ct. LEXIS 18">*33 Service, in a letter signed "for the Acting Secretary of State." This reply, dated April 22, 1959, read in part as follows:The United States Educational Commissions and Foundations abroad, about which you inquire in your letter of April 1, 1959, are created by executive agreement between the United States and the country in which the Commission or Foundation is located. Each agreement provides that the Commission or Foundation, whichever it might be called, shall be recognized by the two governments as an organization created and established to facilitate the administration of the educational exchange program financed by funds made available to the Commission or Foundation by the United States from funds acquired by the United States from the other government.The Department considers the Commissions and Foundations to be binational organizations. The Department does not consider that they have official status as agents of the United States Government as do other units such as the various branches of the Department of State or other government agencies operating abroad. The employees of the Commissions and Foundations are not considered to be employees of either the Foreign Service1961 U.S. Tax Ct. LEXIS 18">*34 or Civil Service for purposes of salary, leave, retirement, and other benefits normally accruing to government employees.On their 1956 income tax return petitioners reported $ 6,720 of the $ 10,320 received from the United States Educational Commission in Japan as taxable income and claimed in an attachment to the return that the remaining $ 3,600 was excludible from taxation. On their 1957 income tax return petitioners omitted the entire $ 5,160 received from the United States Educational Commission in Japan and claimed in an attachment to the return that such amount was excludible under the provisions of section 911(a)(2) of the 1954 Internal Revenue Code. In the deficiency notice sent to petitioners respondent determined that the entire amounts received by petitioner from the United States Educational Commission in Japan in 1956 and 1957 "were amounts paid by the United States or an agency thereof and are not excludable from gross income under the provisions of Section 911 of the Internal Revenue Code of 1954." Respondent determined that such amounts were fully taxable to the petitioners in 1956 and 1957.The amounts received by petitioner in 1956 and 1957 as a Fulbright lecturer1961 U.S. Tax Ct. LEXIS 18">*35 in Japan were paid by or on behalf of the United States or an agency thereof through the United States Educational Commission in Japan.Petitioner's tax residence in 1956 and 1957 remained in the United States. As a Fulbright lecturer at Kobe University in Japan, petitioner 37 T.C. 399">*406 was temporarily away from home in the pursuit of his trade or profession of teaching.The average traveling expenses applicable to petitioner while in Japan (including rent, utilities, food, maid service, and actual travel in Japan) were $ 400 a month. Petitioner incurred such expenses in the amounts of $ 4,800 in 1956 and $ 2,500 in 1957.OPINION.1. Petitioner's claim to exclusion from gross income rests solely upon section 911(a)(2) of the 1954 Code. 1 There is no contention before us that the amounts received by petitioner were excludible under section 117 pertaining to "Scholarships and Fellowship Grants." See Rev. Rul. 61-65, 1961-1 C.B. 17. The grants to petitioner related to his activities as a lecturer, and he seeks favored tax treatment only under section 911(a)(2) dealing with income earned outside the United States where the taxpayer "during any1961 U.S. Tax Ct. LEXIS 18">*36 period of 18 consecutive months is present in a foreign country or countries during at least 510 full days in such period." Petitioner complied with the requirements of presence in a foreign country, and the only ground relied upon by the Commissioner to deny him the benefits of section 911(a)(2) is the parenthetical provision making section 911(a)(2) inapplicable in the case of "amounts paid by the United States or an agency thereof." The question before us therefore is whether the amounts received by petitioner as a Fulbright lecturer were "paid by the United States or an agency thereof."1961 U.S. Tax Ct. LEXIS 18">*37 Petitioner makes an extended and persuasive argument that he was not an employee of the United States or any agency thereof. But that is not the true issue. Assuming that he was not such an employee there still remains the question whether the amounts were paid to him 37 T.C. 399">*407 by the United States or one of its agencies. If they were so paid then the statutory exclusion by its very terms is inapplicable.To be sure, the payments received by petitioner as a Fulbright lecturer were not paid to him directly by the United States. They were paid in inconvertible Japanese yen by the United States Educational Commission in Japan, and the real question before us is therefore reduced to whether the Commission was in substance acting as a disbursing agent for the United States or an agency thereof in paying petitioner. Cf. Robert W. Teskey, 30 T.C. 456">30 T.C. 456.In order to resolve this question it is necessary to examine the statutory basis of the Fulbright educational exchange program in general and the creation of the United States Educational Commission in Japan in particular. The Fulbright program was begun in 1947 by an amendment 2 to the Surplus Property1961 U.S. Tax Ct. LEXIS 18">*38 Act of 1944 3 which enabled the Secretary of State of the United States to enter into agreements with foreign countries whereby money owed to the United States for surplus property purchased by the foreign governments would be used to finance an educational exchange program between the United States and the foreign countries. 4 Pursuant to this enabling legislation on August 28, 1951, the United States and Japan entered into an agreement which established the United States Educational Commission in Japan to facilitate the administration of a program of educational exchange between the United States and Japan. Portions of this agreement are set forth in our findings. For present purposes, it should be noted that section 8 of this agreement provides that the funds for the program are to be paid by Japan in currency of the Government of Japan to "an account of the Treasurer of the United States" and that the Secretary of State of the United States then is to make available to the Commission such funds as are required to meet the budget of the program. Also noteworthy are the provisions in section 2 of the agreement that the treasurer of the Commission shall be appointed subject1961 U.S. Tax Ct. LEXIS 18">*39 to the approval of the Secretary of State of the United States, that the Commission's funds shall be deposited in a depository or depositories designated by the Secretary of State, that there shall be periodic audits of the Commission's accounts by auditors selected by the Secretary of State, and the provision in section 3 that the annual budget of the Commission is subject to the approval of the Secretary of State.37 T.C. 399">*408 We think it plain from these provisions in the agreement between the United States and Japan that it is the intent of that agreement that the funds which are used to1961 U.S. Tax Ct. LEXIS 18">*40 finance the operations of the United States Educational Commission in Japan, although in Japanese currency, are funds owned and supplied by the Government of the United States which before transferring such funds to the Commission received them from the Government of Japan in payment for surplus property sold to Japan. The United States retained substantial control over the use of these funds, not only through various powers given the Secretary of State in the agreement with Japan, but also by selecting the persons from the United States, such as petitioner, who become eligible to receive the benefit of a portion of the funds. Thus, although the United States Educational Commission in Japan may technically be a binational organization in concept and organization, as contended by petitioner, and not, strictly speaking, an agency or instrumentality of the United States Government, we conclude that the Commission is financed by the United States and that funds which it disburses are funds of the United States. 5 It follows that funds paid to the petitioner by the United States Educational Commission in Japan were in terms of true ownership and control paid by or on behalf of the 1961 U.S. Tax Ct. LEXIS 18">*41 United States for purposes of section 911 of the 1954 Code, supra. Cf. Erlandson v. Commissioner, 277 F.2d 70 (C.A. 9), affirming a Memorandum Opinion of this Court; Robert W. Teskey, 30 T.C. 456">30 T.C. 456.In this regard we think it significant that petitioner was notified of his selection as a Fulbright lecturer (and of the renewal of his award) on a State Department form entitled a "United States Government Grant Authorization" accompanied by separate "Terms and Conditions of United States Government Grant." Based1961 U.S. Tax Ct. LEXIS 18">*42 on all the evidence of record we are convinced that the Fulbright awards received by the petitioner were indeed grants from the United States Government which were in fact paid by the United States through the United States Educational Commission in Japan.As previously noted, petitioner argues in the main that as a Fulbright lecturer he was not an employee of the United States and was not entitled to any of the benefits of Government employment. As a result he contends that the statutory exception for amounts paid by the United States or an agency thereof should not apply. However, as this Court pointed out in 30 T.C. 456">Robert W. Teskey, supra at 461-462, the statute does not require an employer-employee relationship. Cf. 37 T.C. 399">*409 Erlandson v. Commissioner, supra at 72; Leif J. Sverdrup, 14 T.C. 859">14 T.C. 859, 14 T.C. 859">865-866. All that is required is that petitioner be paid by the United States or an agency thereof. Since we hold petitioner was so paid, the question whether petitioner as a Fulbright lecturer was an employee of the United States becomes moot. 61961 U.S. Tax Ct. LEXIS 18">*43 Finally, we think that Krichbaum v. United States, 138 F. Supp. 515">138 F. Supp. 515 (E.D. Tenn.), cited by petitioners, is also distinguishable. In that case it was found that the funds used to pay the taxpayer had been borrowed by the Government of Ethiopia from the International Bank and that the United States Bureau of Public Roads paid the taxpayer for Ethiopia as paymaster and not payor. In the present case, if there is a paymaster involved, it is the United States Educational Commission in Japan; we have found that the United States is the payor.2. We now turn to petitioner's alternative position. Petitioner argues that while a Fulbright lecturer he was traveling "away from home" in the pursuit of his trade or profession of teaching within the meaning of section 162(a)(2) of the 1954 Code 7 and, thus, that he is entitled to deduct his "traveling expenses (including the entire amount expended for meals and lodging)" while in Japan. Respondent's position is that the cited section is inapplicable because petitioner's work in Japan was of such duration and in such circumstances that Japan was his tax residence during 1956 and 1957.1961 U.S. Tax Ct. LEXIS 18">*44 We think petitioner qualifies for the disputed deduction. Petitioner is an American college professor by trade or profession. He went to Japan in pursuit of this calling as a Fulbright lecturer. By its very nature, the Fulbright grant was temporary, since it was for a fixed period of 10 months. Although petitioner in fact received a renewal of that grant for 10 months of the succeeding academic year and also an extension of his original grant for a brief period so that there would be no gap, and thus remained in Japan some 21 months, there is no indication in the record that petitioner at any time intended to remain in Japan indefinitely or permanently. But for the facts that petitioner's family accompanied him to Japan and that petitioner changed the location of his teaching position back in the United States37 T.C. 399">*410 while in Japan, we think it doubtful that respondent would ever have contended that petitioner's tax home was other than in the United States. 8 We think the presence of petitioner's family in Japan with him in no way detracts from the temporary status of his Fulbright grant in Japan. Since this grant was payable only in inconvertible Japanese currency, petitioner1961 U.S. Tax Ct. LEXIS 18">*45 would have found it difficult if not impossible to support his family except in Japan. Also, the added fact that petitioners retained the ownership of their home in Seattle when they went to Japan is some evidence that they assumed that they would return to Seattle upon the completion of petitioner's temporary teaching assignment in Japan.Respondent argues that even if petitioner is considered "away from home" when he began his Fulbright lectureship while on a sabbatical leave from the University of Washington, he should not be considered so after he resigned from the faculty of the University of Washington and thereby no longer had a permanent teaching position in the United States. However, we think petitioner's change in universities in the United States in no way changed the temporary nature of his presence in Japan as a Fulbright lecturer. While the record is not clear regarding petitioner's reasons for resigning from the University1961 U.S. Tax Ct. LEXIS 18">*46 of Washington, there is no indication that petitioner took this action with any intent to remain in Japan on a permanent or indefinite basis. We know petitioner was offered and accepted a teaching position at the University of Michigan while he was still in Japan and that he went to the University of Michigan after his return from Japan in 1957. We conclude, therefore, that petitioner's change in positions in the United States had no effect on his "away from home" status while in Japan, that he continued to be temporarily away from the United States as a Fulbright lecturer, that petitioner's tax residence remained in the United States in 1956 and 1957, and that during the entire time he was in Japan he incurred deductible "traveling expenses" under section 162(a)(2), supra.There remains the question of the amount of the deduction to which petitioner is entitled in 1956 and 1957. The parties have stipulated the average monthly expenses incurred by petitioner and his family while in Japan. Although the problem of allocating to petitioner the amounts properly chargeable to him is by no means free from difficulty, we have nevertheless used our best judgment and have made findings1961 U.S. Tax Ct. LEXIS 18">*47 of fact based upon our evaluation of the stipulated facts in the light of testimony given at the trial. We have accordingly found that the deductible expenses incurred by petitioner were in the amount of $ 4,800 in 1956 and $ 2,500 in 1957.Decision will be entered under Rule 50. Footnotes1. SEC. 911. EARNED INCOME FROM SOURCES WITHOUT THE UNITED STATES.(a) General Rule. -- The following items shall not be included in gross income and shall be exempt from taxation under this subtitle: * * * *(2) Presence in foreign country for 17 months. -- In the case of an individual citizen of the United States, who during any period of 18 consecutive months is present in a foreign country or countries during at least 510 full days in such period, amounts received from sources without the United States (except amounts paid by the United States or an agency thereof) if such amounts constitute earned income (as defined in subsection (b)) attributable to such period; but such individual shall not be allowed as a deduction from his gross income any deductions (other than those allowed by section 151↩, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this paragraph. If the 18-month period includes the entire taxable year, the amount excluded under this paragraph for such taxable year shall not exceed $ 20,000. If the 18-month period does not include the entire taxable year, the amount excluded under this paragraph for such taxable year shall not exceed an amount which bears the same ratio to $ 20,000 as the number of days in the part of the taxable year within the 18-month period bears to the total number of days in such year.2. Pub. L. 584, 79th Cong., 2d Sess., 60 Stat. 754.↩3. October 3, 1944, ch. 479, 78th Cong., 2d Sess., 58 Stat. 765.↩4. The legislation has since been amended to broaden its scope to cover other moneys owed the United States by foreign governments under legislation such as the Economic Cooperation Act of 1948 and the Mutual Security Act of 1954. See 50 U.S.C. App. sec. 1641↩, as amended.5. In Shirley Duncan Hudson, 20 T.C. 926">20 T.C. 926↩, the governmental status of the United States Educational Foundation in China (also a part of the Fulbright program) was not in issue. In that case which involved a Foundation employee rather than a Fulbright grantee, it was stipulated that the Foundation was an agency of the United States. Our finding of fact based on this stipulation is not controlling in the instant case.6. Petitioner suggests that respondent's determination herein is inconsistent with his recent ruling that the American National Red Cross is not an agency of the United States for purposes of section 911. Rev. Rul. 60-36, 1960-1 C.B. 279↩. Without passing on the validity of the ruling in question, we think the factual situation considered therein may easily be distinguished from the instant case. As noted in the ruling, the Red Cross is supported through voluntary contributions, not exclusively by the Federal Government, and due to the nature of its work it is necessarily independent of any particular government though it works in close cooperation with many governments.7. SEC. 162. TRADE OR BUSINESS EXPENSES.(a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including -- * * * *(2) traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; * * *↩8. See letter ruling of January 10, 1957, quoted in the findings, supra↩, at 6. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623017/ | WELLS WATSON AND LINDA WATSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWatson v. CommissionerDocket No. 5211-76.United States Tax CourtT.C. Memo 1978-201; 1978 Tax Ct. Memo LEXIS 317; 37 T.C.M. 857; T.C.M. (RIA) 780201; May 31, 1978, Filed Hugh O. Mussina, for the petitioners. Suzanne B. O'Neill, for the respondent. MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined the following deficiencies in petitioners' Federal income tax: YearDeficiency1972$ 598.6319732,514.6419741,451.43 The sole issue for decision is whether $30,000 paid by petitioners in 1972 in connection with the purchase of Kelley Gras Company can be amortized pursuant to section 167. 1 Petitioners claimed deductions for amortization of $2,500, $10,000 and $10,000 in 1972, 1973 and 1974, respectively. FINDINGS OF FACT 1978 Tax Ct. Memo LEXIS 317">*318 Some of the facts have been stipulated by the parties and are found accordingly. At the time they filed their petition, Wells and Linda Watson were residents of Arlington, Texas. Linda is a party only by virtue of having filed joint returns with her husband. When we hereafter refer to petitioner, we will be referring to Wells. In October 1972, petitioner purchased from Danny LeRoy Kelley a business known as the Kelley Grass Company ("Kelley Grass"). The purchase price of $45,000 was allocated in the Purchase Agreement as follows: Goodwill$30,000Equipment12,500Restrictive Covenant2,500TOTAL$45,000 Petitioner paid $13,000 cash and signed a promissory note for $32,000 payable in six semi-annual installments; the equipment sold was pledged as security for the note. The Agreement contained a restrictive covenant under which Mr. Kelley agreed not to engage in any business in competition with Kelley Grass for a period of three years. Petitioner also acquired the exclusive right to use the name "Kelley Grass Company" for a period of three years, after which time the right to use the name became nonexclusive. At the time petitioner purchased Kelley1978 Tax Ct. Memo LEXIS 317">*319 Grass, it was located at 3008 East Abram in Arlington, Texas. Kelley Grass had a month-to-month lease on that location. Several months after he purchased Kelley Grass, petitioner moved the business approximately 11 miles to 2412 South Cooper Street in Arlington because he believed that the new location would be better for business. Petitioner continued to use the name "Kelley Grass Company" at the new location until three years elapsed, at which time he changed the name to Arlington Grass Company. At the time he purchased Kelley Grass, petitioner thought that there might be a benefit to using the name "Kelley Grass Company." Also, his purchase money note was secured by the equipment he bought with the business and the trucks had "Kelley Grass Company" painted on them and he did not want to remove the name until he had paid for the business. Kelley Grass sold sod to both "retail" and "wholesale" customers. Approximately 80% of the customers were "retail" customers and 20% were "wholesale" customers. Petitioner considered "retail" customers those individuals who purchased sod only once and not for resale, while "wholesale" customers were individuals or firms that purchased sod1978 Tax Ct. Memo LEXIS 317">*320 more than once, often for resale (for example, builders and landscape architects). The grass business is cyclical in Texas. Sales of sod occur from March to October. In the first summer season after petitioner bought the business in October 1972, petitioner had 41 "wholesale" customers. Most of them were "wholesale" customers who had been patronizing Kelley Grass before petitioner purchased it. Petitioner was still doing business with at least seven of these "wholesale" sod purchasers in 1976. In addition, petitioner retained the services of one employee (a laborer) when he purchased the business, and that employee still works for petitioner. On his income tax returns for the years in issue, petitioner claimed a deduction for amortization of the "trade name" which he alleged he had purchased for $30,000. Petitioner determined that the "trade name" had a useful life of three years, and he amortized its cost accordingly. In the statutory notice, respondent determined that petitioner was not entitled to the claimed amortization deductions since the $30,000 was for the purchase of goodwill or other intangibles with an indeterminate life. OPINION The sole issue for decision1978 Tax Ct. Memo LEXIS 317">*321 is whether $30,000 of the $45,000 paid by petitioner in 1972 in connection with his purchase of the Kelley Grass Company can be amortized under section 167. Section 167(a) provides, in general, that a deduction is allowed for the exhaustion, wear and tear of property used either in a trade or business or held for the production of income. Section 1.167(a)-3, Income Tax Regs., states the following with respect to the depreciation of intangible assets: If an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy, such an intangible asset may be the subject of a depreciation allowance. Examples are patents and copy-rights. An intangible asset, the useful life of which is not limited, is not subject to the allowance for depreciation. No allowance will be permitted merely because, in the unsupported opinion of the taxpayer, the intangible asset has a limited useful life. No deduction for depreciation is allowable with respect to good will. Petitioner paid $45,000 in connection with his purchase of a going business. Of that amount, 1978 Tax Ct. Memo LEXIS 317">*322 $12,500 was allocated in the Purchase Agreement to equipment, $2,500 to the covenant not to compete, and $30,000 to goodwill. Clearly, if the $30,000 petitioner seeks to amortize over three years is for goodwill, he is not entitled to depreciate it. X-Pando Corporation v. Commissioner,7 T.C. 48">7 T.C. 48, 7 T.C. 48">53 (1946); Bills Bros. Memorial Corp. v. Commissioner,7 B.T.A. 1182">7 B.T.A. 1182 (1927), appeal dismissed 41 F.2d 988 (10th Cir. 1930); section 1.167(a)-3, Income Tax Regs., supra.Petitioner has not shown that the $30,000 was paid for other than goodwill. Goodwill is "nothing more than the probability that the old customers will resort to the old place" or it is "all that good disposition which customers entertain towards the house of business, identified by the particular name or firm, and which may induce them to continue giving their custom to it" or it is "any privilege that gives a reasonable expectancy of preference in the race of competition. * * * Such expectancy may come from succession in place or name or otherwise to a business that has won the favor of its customers" or it is "an opportunity to succeed to the advantageous position1978 Tax Ct. Memo LEXIS 317">*323 of [a] predecessor." [Footnotes omitted.] Brooks v. Commissioner,36 T.C. 1128">36 T.C. 1128, 36 T.C. 1128">1133 (1961), citing Watson v. Commissioner,35 T.C. 203">35 T.C. 203, 35 T.C. 203">213 (1960), appeal dismissed by stipulation (4th Cir. July 20, 1961). Here petitioner was entitled to take over his predecessor's place of business. In fact he moved the business several months after he purchased it. He had the exclusive right for three years to use the name "Kelley Grass Company," and he did use it for three years. Apparently this was primarily because he didn't want to paint out that name on the trucks he bought with the business until the purchase price had been paid in full--at the end of three years.Most of the business's customers (80%) were the drop-in type who could not be expected to purchase sod more than once.Only a few builders and landscape architects (20% of the customers) represented repeat customers. About a fifth of these customers who patronized Kelley Grass when petitioner purchased it was still with petitioner at the end of three years. We assume this is because they were satisfied with petitioner's product and service. There is no indication that the name "Kelley1978 Tax Ct. Memo LEXIS 317">*324 Grass Company" had much, if any, value to petitioner. He has not shown that he paid $30,000 for other than general goodwill, and any value attributable to the name alone is so intertwined with goodwill as to be inseparable. As the Fifth Circuit said in Winn-Dixie Montgomery, Inc. v. United States,444 F.2d 677, 681 (1971): [Goodwill] is acquired by the purchaser of a going concern where the "transfer enables the purchaser to step into the shoes of the seller." * * * We have also said that goodwill is transferred where, as here, the buyer continues the seller's business uninterrupted, using primarily the seller's employees, and utilizing the seller's name. [Citations omitted.] Moreover, the parties allocated $30,000 to goodwill and nothing to the trade name. It is well-settled that at least where there is no strong proof to disturb the allocation put upon the purchase price by the parties, where they act with adverse tax interests, the allocation they made will normally not be disturbed. Ullman v. Commissioner,264 F.2d 305 (2d Cir., 1959). We conclude that petitioner paid $30,000 for goodwill which he is not entitled to amortize. 1978 Tax Ct. Memo LEXIS 317">*325 Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623018/ | PYRAMID METALS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pyramid Metals Co. v. CommissionerDocket No. 102354.United States Board of Tax Appeals44 B.T.A. 1087; 1941 BTA LEXIS 1236; July 22, 1941, Promulgated 1941 BTA LEXIS 1236">*1236 DEDUCTION - TAXES. - The petitioner acquired Illinois realty on August 1, 1938. The real property taxes for the year 1938 accrued on April 1, 1938. The seller had not paid the taxes and the petitioner in the purchase settlement received credit for seven-twelfths of the taxes. It accrued the remaining five-twelfths on its books and deducted the amount from its 1938 income as taxes paid. It paid all of the taxes on the property for 1938 in 1939. Held, the petitioner may not deduct five-twelfths or any other portion of the 1938 taxes, since they accrued before it purchased the property. Morris Glasser, C.P.A., and Charles Melvoin, C.P.A., for the petitioner. Alvin B. Peterson, Esq., for the respondent. MURDOCK 44 B.T.A. 1087">*1087 OPINION. MURDOCK: The Commissioner determined a deficiency in income tax of $146.95 and a deficiency in excess profits tax of $49.37, each for the calendar year 1938. The only issue for decision is whether or not the petitioner is entitled to a deduction of $822.78 representing the portion of the real estate taxes for the year 1938 which was applicable to the period from August 1, 1938, to the end of the year. The1941 BTA LEXIS 1236">*1237 facts have been stipulated and the stipulation is adopted as the Board's findings of fact. The Cleveland Realty Corporation owned a piece of property in Chicago, Illinois, which was rented by Lakeside Upholstery Co. The latter had an option to purchase the property by meeting any outside offer. The petitioner made an offer on February 26, 1938, to purchase the property on August 1, 1938. This offer recognized the option of the Lakeside Upholstery Co. The Chicago Realty Corporation accepted the offer subject to its terms and conditions and gave notice of the offer to the Lakeside Upholstery Co. on February 26, 1938. Lakeside never exercised its option and sale was made of the premises to the petitioner on August 1, 1938. The petitioner, in the settlement, received credit for seven-twelfths of the real estate taxes on the property for 1938. The petitioner paid the real estate taxes on the property for 1938 in two installments of $987.34 each. The first was paid on June 2, 1939, the second on September 5, 1939. Five-twelfths of the real estate taxes for 1938 amounted to $822.78. The petitioner kept its books and filed its return for the calendar year 1938 upon an accrual1941 BTA LEXIS 1236">*1238 basis. The petitioner accrued on its books for 1938 and claimed on its return for that year an item of $900.16 representing 44 B.T.A. 1087">*1088 five-twelfths of the estimated amount of the real estate taxes on the property for the year 1938. The Commissioner, in determining the deficiency, disallowed the deduction. The petitioner claims the right to deduct $822.78 as taxes under section 23(c) of the Revenue Act of 1938. The parties agree that these real estate taxes in the State of Illinois accrued on April 1, 1938. The petitioner first endeavors to show that it became the equitable owner of the property prior to that date, on February 26, 1938, when its offer to purchase was accepted and a deposit of $5,000 was made. The facts show, however, that it did not acquire any title, equitable or otherwise, to the property at that time. The offer and acceptance involved only a sale of the property on August 1, 1938, and not on any prior date. Furthermore, the tenant of the property had the refusal of it after the owner had received the offer. The petitioner became the owner of the property on August 1, 1938, and not prior thereto. Thus, it was not the owner of the property when these1941 BTA LEXIS 1236">*1239 taxes accrued and became a lien. The case of , involved real estate taxes on property in Illinois and the Board held that they were deductible as taxes only by the owner of the property on April 1 in the year to which the taxes applied. The Board was simply following a long and consistent line of cases, the theory of which was that the purchaser, who is charged in his settlement with the seller, or who later pays the taxing authorities, amounts which had accrued as taxes or become a lien on the property prior to the time that he acquired title, had made no payment qua taxes but has merely paid a part of the purchase price to acquire a clean title. See discussion in . Although most of the cases have involved a claim by the purchaser to deduct all of the taxes for the year of purchase or for a prior year (see ; ; ; 1941 BTA LEXIS 1236">*1240 ; affirmed on this point, ; ; ; ; affd., ; ; ; ; ; ), proration of taxes was involved in at least two cases. , and . The claim to the deduction was denied in all of those cases where the taxes had accrued or become a lien before the purchaser had acquired title. The cases of , and Carondelet44 B.T.A. 1087">*1089 1941 BTA LEXIS 1236">*1241 , are not exceptions to the rule, since the taxes allowed as deductions in those cases did not accrue or become liens until after title had passed to the new purchaser. The one case out of line which has come to our attention is , from the District Court for the District of Maryland. The taxpayer in that case claimed the right to deduct taxes allocable to that portion of the year during which he was the owner of the property and the court allowed the deduction. Judge Chesnut, who wrote the opinion, attempted to distinguish prior cases on the ground that they involved claims to deduct taxes for prior years, but, as a matter of fact, many of the cases cited above involved taxes for the year of purchase, and in the two cases mentioned above prorating was considered and rejected. Furthermore, the question decided by the court in the Supplee case is present in practically every case, potentially at least, since most sales must take place within some taxing year. The long established rule based on sound reason should not be plowed under at this late date, and1941 BTA LEXIS 1236">*1242 with all due respect to the District Court, we do not agree with the Supplee decision. The petitioner also contends that this deduction should be allowed for 1938 in order to clearly reflect income. See section 43. That section was not designed to cover minor items such as this and, obviously, it has no application where the taxpayer can not show that it is entitled to a deduction of some kind under some other provision of the statute. Reviewed by the Board. Decision will be entered for the respondent.SMITH SMITH, dissenting: "Taxes paid or accrued within the taxable year" are deductible from gross income. Sec. 23(c), Revenue Act of 1938. On August 1, 1938, petitioner acquired real estate in the city of Chicago at a cost of $33,000. Under the terms of the contract of purchase, dated February 26, 1938, rents, water taxes, and insurance premiums were to be adjusted pro rata between the seller and the purchaser as of the date of delivery of the deed, which was on August 1, 1938. On that date there were delinquent taxes due on the property. The grantor was charged with those delinquent taxes and also with seven-twelfths of the taxes payable for1941 BTA LEXIS 1236">*1243 the year 1938. From August 1, 1938, the petitioner was the owner of the property and received the rents therefrom. It accrued upon its books for the balance of the calendar year five-twelfths of the taxes for the taxable year. It claimed the deduction of those taxes in its income tax return for 44 B.T.A. 1087">*1090 1938. The respondent says that these may not be deducted and that they must be treated as a part of the cost of the property. The Board sustains the respondent upon this point. The net result of this holding is that the full deduction of the taxes paid upon the real estate for 1938 is available to no one. I do not think that is the proper construction of the statute. I think that Congress intended that the full amount of the current year's taxes is deductible by some one. Manifestly, the grantor is not entitled to the deduction of the taxes for the period August 1 to December 31, 1938, because it was not chargeable with them and did not pay them. But I can not see why the grantee, which was the owner of the property and received the income of the property from August 1, 1938, and which paid the taxes, is not entitled to deduct them. It is quite apparent that the rulings1941 BTA LEXIS 1236">*1244 of the Board and of the courts in some tax cases which have come before them are entirely out of line with commercial practice. Ordinarily taxes are adjusted to the date of sale between seller and purchaser. They do not constitute a part of the price at which real estate is sold. The cost of the Chicago real estate purchased by the petitioner in 1938 was $33,000. That was the price that the seller received. Why should a portion of the taxes representing five-twelfths of the 1938 taxes be added to the cost? It seems to me entirely immaterial that the taxes became a lien on the property on April 1, 1938. I entirely agree with the opinion of the court in . The court's opinion is, I think, in line with the reasoning of many Board and court opinions. See ; affd. (C.C.A., 7th Cir.), ; ; ; 1941 BTA LEXIS 1236">*1245 ; ; affd., . It is furthermore to be noted that the petitioner kept its books of account on the accrual basis. In , the Supreme Court said that the accrual basis was for the purpose of enabling taxpayers to "make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period." Under the contract by which the petitioner purchased the Chicago real estate it was required to pay the taxes that were "properly attributable" to the period after August 1, 1938. It is in reason to say that those taxes were a charge against the income of the property during the ownership by the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623020/ | The National City Bank of New York, as Trustee under an Agreement with Charles F. Loudon, Dated October 4, 1921, Petitioner, et al., 1 v. Commissioner of Internal Revenue, RespondentNational City Bank v. CommissionerDocket Nos. 5941, 5944, 5960, 5962United States Tax Court7 T.C. 485; 1946 U.S. Tax Ct. LEXIS 116; July 31, 1946, Promulgated 1946 U.S. Tax Ct. LEXIS 116">*116 Decision will be entered under Rule 50. Decedent in 1921, 1924, and 1925 conveyed certain property to three irrevocable trusts, reserving to himself and his wife the income for life, with income payable upon his death and the death of his wife to his daughter and upon her death to his grandson. The trusts were to continue for the lives of his daughter and his grandson, and the trusts provided that upon their termination, if he were still living, the corpus should revert to decedent; but in case decedent or his wife did not survive the daughter and grandson, the trust corpus was to be paid to the children of the said grandson then surviving; but if said grandson left no child then surviving, the corpus was to be paid to the four nieces of decedent's wife in equal shares. Held, the facts show a survivorship case and the value of the corpora of the three trusts at decedent's death is includible in decedent's gross estate under section 811 (c), Internal Revenue Code. Estate of John C. Duncan, 6 T.C. 84, followed. John J. Smith, Esq., for the petitioners.Conway Kitchen, Esq., for the respondent. Black, Judge. BLACK 7 T.C. 485">*485 The petitioner in Docket No. 5944 requests a redetermination of a deficiency in Federal estate tax which was determined against estate 7 T.C. 485">*486 of Charles F. Loudon, deceased, in the amount of $ 61,332.60. The petitioners in Docket Nos. 5941, 5960, and 5962 request redeterminations of liabilities which were determined against them by the respondent for said deficiency1946 U.S. Tax Ct. LEXIS 116">*118 as trustees and transferees in the amounts of $ 61,332.60, $ 3,960, and $ 32,426.81, respectively, plus interest on said respective amounts as provided by law. The proceedings have been consolidated.The cases were submitted upon the stipulation of facts entered into by the parties and upon certain oral testimony adduced at the hearing.The respondent determined that the value of the decedent's gross estate should be increased in the respective amounts of $ 750 and $ 1,200 on account of the inclusion therein at increased values of certain real estate and certain shares of stock. The inclusion in the gross estate of said decedent of this real property and of the shares of stock at the respective increased values has been agreed to by the respective parties herein. The petitioner in Docket No. 5941 has agreed that it is liable as trustee and transferee under section 827 (b) of the Internal Revenue Code for any deficiency in Federal estate tax, plus interest as provided by law, which finally may be judicially determined herein to be due from the estate of Charles F. Loudon, deceased. The petitioners in Docket Nos. 5960 and 5962 have agreed that they are liable as trustees and transferees1946 U.S. Tax Ct. LEXIS 116">*119 under section 827 (b) of the Internal Revenue Code for any deficiency in Federal estate tax, plus interest as provided by law, which finally may be judicially determined herein to be due from the estate of Charles F. Loudon, deceased, to the extent of $ 3,960 and $ 32,426.81, respectively.In view of the foregoing there remains for our decision only one question, which is as follows: Were the values on the date of the decedent's death of the corpora of trusts created by him on October 4, 1921, July 3, 1924, and August 12, 1925, amounting to $ 223,613.52, $ 3,960, and $ 32,426.81, respectively, includible in his gross estate under section 811 (c) of the Internal Revenue Code?FINDINGS OF FACT.The stipulation of facts is incorporated by reference as a part hereof and the facts are found as stipulated. The following summary of facts is taken from the stipulation of facts:Charles F. Loudon died on January 17, 1942, a resident of Santa Fe County, New Mexico, leaving a last will and testament and a codicil thereto which were duly admitted to probate in the probate court of that county. At all times thereafter Helen S. Broome, who is the daughter and only child of the decedent, was duly1946 U.S. Tax Ct. LEXIS 116">*120 appointed, qualified, and acting executrix of the decedent's last will and testament. Helen S. Broome was referred to in the trust indentures involved herein as Helen S. Ricker.7 T.C. 485">*487 On December 22, 1942, the executrix filed a Federal estate tax return for the estate of the decedent with the collector of internal revenue at Albuquerque, New Mexico, and showed no estate tax due.Under an indenture dated October 4, 1921, the decedent created a trust, with the National City Bank of New York as trustee, and transferred to that trustee certain property to be held in trust by the latter upon the terms and conditions set forth in the indenture. This trust was in full force and effect on the date of the decedent's death and has continued to remain so to the present time. The provisions of the trust indenture of October 4, 1921, which are especially pertinent to the issue involved herein are as follows:I. To apply the income thereof to the use of Charles F. Louden, [sic] the party of the first part and his wife Luella S. Loudon and the survivor of them so long as either of them shall live during the continuance of the trust; and the receipt of either the party of the first part1946 U.S. Tax Ct. LEXIS 116">*121 or the said Luella S. Loudon shall be a sufficient discharge to the Trustee for the payment of such income.II. In case of the death of the party of the first part and the said Luella S. Loudon, to apply the income thereof to the use of the said Helen S. Ricker, during her life, and on her death to apply the said income to the use of her son, Charles Loudon Ricker, as follows: 1. So much thereof as the Trustee, in its absolute and uncontrolled discretion shall deem for his best interest, not exceeding One Hundred Dollars per month, until he shall attain the age of eighteen years, and not exceeding Two Hundred Dollars per month thereafter, until he shall attain the age of twenty-one years, accumulating for his benefit the surplus income.2. After the said Charles Loudon Ricker shall attain the age of twenty-one years to apply the entire income of the said trust to his use, until he attains the age of thirty-two years, and thereupon to convey, transfer and pay over to him the principal thereof, provided that the Trustee in its absolute and uncontrolled discretion shall deem it for his best interest to receive such payment; otherwise the Trustee shall continue to hold the said principal1946 U.S. Tax Ct. LEXIS 116">*122 in trust during his life or until, in the absolute and uncontrolled discretion of the Trustee it shall deem it for his best interest to receive the principal of the said trust fund.III. Upon the death of the survivor of the said Helen S. Ricker and Charles Loudon Ricker, to convey, transfer and pay over the principal of the said trust fund to the party of the first part or if he is not then living, to the said Luella S. Loudon, or in case neither of them is living to the children of the said Charles Loudon Ricker then surviving, in equal shares, or in case there is no child of the said Charles Loudon Ricker then living to the four nieces of the said Luella S. Loudon, in equal shares, Fern Skaats Ford, Gladys Skaats Briscoe and Louise C. Mitchell of Cincinnati, Ohio and Lucy Skaats of Los Angeles, California.Under an indenture dated July 3, 1924, the decedent executed a trust agreement, with the Terre Haute Trust Co. as trustee, and transferred to that trustee certain property to be held in trust by the latter upon the terms and conditions set forth in the indenture. This trust was in full force and effect on the date of decedent's death and has continued so to remain to the present1946 U.S. Tax Ct. LEXIS 116">*123 time. The provisions of this trust indenture which are especially pertinent to the issue involved 7 T.C. 485">*488 herein are essentially the same as those enumerated above from the trust indenture of October 4, 1921. There are some slight differences in the texts, but these seem unimportant and the parties in their briefs treat the meaning of the language used in the two trust indentures as the same.Under an indenture dated August 12, 1925, the decedent executed a trust, with the First National Bank of Terre Haute as trustee, and transferred to that trustee certain property to be held in trust by the latter upon the terms and conditions set forth in the indenture. This trust was in full force and effect on the date of decedent's death and has continued to remain so to the present time. The provisions of the trust indenture are different in some respects from those of the two other trust indentures referred to above. No point in the briefs of the parties has been made as to these differences. The provisions of this trust indenture of August 12, 1925, which are deemed especially pertinent to the issue involved herein are as follows:First: To receive, hold, manage, sell, invest and1946 U.S. Tax Ct. LEXIS 116">*124 reinvest the same and every part thereof, and to collect, recover and receive the rents, issues, interest, income and profits thereof, hereinafter called "Income," and after deducting all proper and necessary expenses in connection with the administration of said trust, including reasonable compensation to said Trustee, to pay the balance remaining (hereinafter called "Net Income") as follows, to-wit:(a) Unto the Party of the First Part and/or his wife, Luella S. Loudon, and the survivor of them, so long as either of them shall live during the continuance of said trust, and the receipt either of the First Party or Luella S. Loudon shall be a sufficient discharge to said Trustee for any such payment.(b) After the death of both the Party of the First Part and the said Luella S. Loudon prior to the termination of said trust, said net income shall be paid to Helen S. Ricker during her life, if she be living at the time of the death of the last survivor of said party of the First Part and Luella S. Loudon.(c) After the death of said Party of the First Part, said Luella S. Loudon and said Helen S. Ricker, said net income shall be paid to Charles Loudon Ricker during his life provided1946 U.S. Tax Ct. LEXIS 116">*125 that said Trustee, in his absolute and uncontrolled discretion, shall pay to said Charles Loudon Ricker until he shall attain the age of twenty-one (21) years only such part of said net income as may be necessary to make the total income of said Charles Loudon Ricker (including other income which may be payable to him) equal the sum of Two Hundred Dollars ($ 200.00) per month; any excess of net income from said Trust Fund shall be accumulated and added to the principal of said Trust Fund until Charles Loudon Ricker shall attain the age of twenty-one (21) years; after he shall so attain the age of twenty-one (21) years the net income from said Trust Fund shall be paid to him during the term of his life.Second. Said trust shall cease and terminate upon the death of the survivor of said Helen S. Ricker and Charles Loudon Ricker and upon the death of the survivor of them said Trustee shall convey, transfer and pay over the principal of said Trust Fund to the Party of the First Part if he should then be living, or if he be not then living, to the said Luella S. Loudon if she be then living. In case neither of said Party of the First Part, nor Luella S. Loudon are then living, said principal1946 U.S. Tax Ct. LEXIS 116">*126 of said Trust Fund shall be conveyed, transferred and paid 7 T.C. 485">*489 over to the children of the said Charles Loudon Ricker then living, if any, in equal shares and to the then living issue of any deceased child of said Charles Loudon Ricker such issue taking the share of said deceased child per stirpes and not per capita. Upon the termination of said trust if there be then living none of the parties hereinabove mentioned entitled to receive the principal of said Trust Fund, the same shall be conveyed, transferred and paid over to the then surviving widow of Charles Loudon Ricker, if any, and if there be no such widow, the same shall be paid to the four (4) nieces of said Luella S. Loudon, namely; Lucy L. Skaats, now of Los Angeles, California, Fern Skaats Ford, Gladys Skaats Briscoe and Louise C. Mitchell, all now of Cincinnati, Ohio, in equal shares or to the issue of such nieces as may then be dead leaving issue, such issue to take the share of such deceased niece per stirpes and not per capita. In case any of the said nieces shall then be dead leaving no issue, the said principal of said Trust Fund shall be divided among the survivors of said nieces and the issue of such of 1946 U.S. Tax Ct. LEXIS 116">*127 them as shall then be dead leaving issue then surviving, such issue taking the share of such deceased niece per stirpes and not per capita. In event that there be no one then living then entitled to take and receive the principal of said Trust Fund as hereinabove set out upon the termination of said trust, the said Trustee shall convey, transfer and pay over the principal of said Trust Fund to the then heirs-at-law of the Party of the First Part.The fair market value at the time of decedent's death of the corpus of each of the above named trusts has been stipulated and need not be separately set out here.On October 4, 1921, the date of the creation of the trust with the National City Bank of New York, the decedent's daughter, Helen S. Broome, and his grandson, Charles Loudon Ricker, whose lives measure all 3 trusts, were respectively approximately 41 and 15 years of age, the decedent was approximately 65 years of age, and his wife, Luella S. Loudon, was approximately 63 years of age. Luella S. Loudon died during the year 1931. Helen S. Broome and the grandson, Charles Loudon Ricker, survived the decedent.On or about September 15, 1945, the executrix of the will of Charles F. 1946 U.S. Tax Ct. LEXIS 116">*128 Loudon paid to the collector of internal revenue, Albuquerque, New Mexico, the sum of $ 70,225.84 on account of the deficiency in estate tax which respondent determined to be due, together with interest thereon, which amount was placed by the collector in a suspense account and has not been assessed.The following facts are found from the oral testimony in the proceedings:The decedent was in the canning business and was in good financial circumstances for some time prior to the years 1910 and 1911. As a result of successive crop failures, the decedent's business was wiped out in 1910 or 1911. In various discussions with his daughter the decedent stated that if he should ever get on his feet again he was going to take some steps which would secure for himself and his family a nest egg which would be outside the perils of the canning business. Shortly before the creation of the trust with the National City Bank of New York in 1921, the decedent discussed it with his 7 T.C. 485">*490 daughter. In the course of the discussions with his daughter the decedent stated that his purpose in establishing the trust was to make certain that his property so transferred would not be subject to the risks1946 U.S. Tax Ct. LEXIS 116">*129 of his business. In 1921 the daughter was married to one Ricker. The decedent did not have much faith in Ricker's integrity and one of his reasons for creating the trust was to prevent Ricker from ever getting his hands on the funds. In 1921 the decedent's daughter and grandson were alive and one of the decedent's purposes in creating the trust was to make the future safe for his daughter and his grandson.Shortly after the creation of the trust with the National City Bank of New York on October 4, 1921, the decedent had income from separate investments averaging above $ 30,000 per annum.OPINION.The question which we have to decide in these proceedings is stated by petitioners in their brief as follows: Whether the values of three irrevocable trusts created by Charles F. Loudon during his lifetime are includible in his gross estate for Federal estate tax purposes under the provisions of section 811 (c) of the Internal Revenue Code, printed in the margin. 11946 U.S. Tax Ct. LEXIS 116">*130 The petitioners contend that the trusts in question were not intended by the decedent "to take effect in possession or enjoyment at or after his death" within the meaning of section 811 (c). They support this contention with arguments in their brief which we have noted and carefully considered.Respondent concedes that the language added to section 302 (c) of the Revenue Act of 1926 by the amendment contained in the Joint Resolution of Congress of March 3, 1931, and section 803 (a) of the Revenue Act of 1932 is not applicable because the trusts herein involved were created prior to the enactments of such amendments. Hassett v. Welch, 303 U.S. 303">303 U.S. 303. In other words, respondent concedes that the corpora of such trusts is not includible in decedent's gross estate because he reserved to himself the income for life from such property. At least, respondent does not argue to that effect in his brief, and he 7 T.C. 485">*491 makes no contention that May v. Heiner, 281 U.S. 238">281 U.S. 238, has in effect been overruled by later decisions of the Supreme Court.Respondent bases his contention that the value of the corpora of the three trusts1946 U.S. Tax Ct. LEXIS 116">*131 should be included in decedent's estate upon the fact that each of the trust indentures contained an express reservation by the decedent that the corpus of each trust should revert to him if he survived his daughter and his grandson. "Such express reservation" says respondent, "constituted the retention by the decedent of a contingent interest in the trust property until his death. Therefore said transfers in trust constituted transfers intended to take effect in possession or enjoyment at or after decedent's death within the meaning of section 811 (c) of the Internal Revenue Code."Respondent cites in support of his contention Fidelity-Philadelphia Trust Co. ( Stinson Estate) v. Rothensies, 324 U.S. 108">324 U.S. 108, and Commissioner v. Field, 324 U.S. 113">324 U.S. 113. He also cites our recent decision in Estate of John C. Duncan, 6 T.C. 84; now on review, C. C. A., 2d Cir.The Duncan case is similar in its facts, we think, to the facts of the instant case. In the Duncan case the trust was created January 23, 1924, and provided, as the three trusts here provide, that the income of the trust1946 U.S. Tax Ct. LEXIS 116">*132 property was to be paid to the grantor for the term of his life. Upon the death of the grantor of the trust, the income of the trust estate was to be paid to John C. Duncan, Jr., for life and upon his death to his sons in equal shares until each respectively became 35 years of age, at which time each beneficiary would receive distribution of his proportionate share of the trust estate. The trust instrument carried the following specific provision:Upon the termination of said trust term by the death of the survivor of said John C. Duncan, Jr. and said John C. Duncan III, (if the trusts have not been previously terminated), the whole or any part of the principal of said trust fund shall remain in the hands of the trustee undistributed, such whole or part shall be transferred and paid over to the said Donor, if he then survive, or if he do not survive, shall be transferred and paid over to his issue then surviving, in equal shares, per stirpes and not per capita, and in default of such issue, in equal shares to and among the then survivors of the brother and sister of the said Donor, and the brother and sister of the deceased wife of said donor (the mother of said John C. Duncan, 1946 U.S. Tax Ct. LEXIS 116">*133 Jr.), the then surviving issue of any such brothers or sisters then deceased, to take per stirpes the share such brother or sister would have taken if living.Under these facts we held the case was a survivorship case and the value of the trust corpus was includible as a part of decedent's gross estate under section 811 (c).In the Duncan case, as here, the petitioner cited Frances Biddle Trust, 3 T.C. 832. In the instant case petitioners strongly urge Judge Opper's concurring opinion in the Biddle case as the line of reasoning we should follow in arriving at a decision in favor of petitioners. In 7 T.C. 485">*492 the Duncan case we distinguished the Biddle case and other similar cases in the following language:Petitioners cite our decision in Frances Biddle Trust, 3 T.C. 832. But this proceeding on its facts is clearly distinguishable from that case as well as from the facts in the later cases of Estate of Harris Fahnestock, 4 T.C. 1096, and Estate of Mary B. Hunnewell, 4 T.C. 1128. In those cases the grantor of the trust had done everything1946 U.S. Tax Ct. LEXIS 116">*134 possible to cut all ties to a reversion of the property. The only condition under which such result could have occurred would have been upon a complete failure of the grantor's line of descent. Here, the grantor has, by a specific provision in the trust, retained a reversion upon the death of the survivor of his son and grandson, under which title to the property would revest in him irrespective of how many direct descendants he might have living at the time, and has further provided that "if he do not survive, [the trust estate] shall be transferred and paid over to his issue then surviving * * * and in default of such issue, in equal shares to and among the then survivors of the brothers and sisters of the said Donor * * *." (Italics supplied.) Thus it seems clear that the instant case is a survivorship case and comes within the rule of Helvering v. Hallock, supra, and not within the rule of the Biddle, Fahnestock and Hunnewell cases, all supra.To the same effect we think we must hold in the instant case. The following provision in the trust indenture of October 4, 1921, seems clearly to make it a survivorship case and brings it within the rule of1946 U.S. Tax Ct. LEXIS 116">*135 the Duncan case, supra:III. Upon the death of the survivor of the said Helen S. Ricker and Charles Loudon Ricker, to convey, transfer and pay over the principal of the said trust fund to the party of the first part or if he is not then living, to the said Luella S. Loudon, or in case neither of them is living to the children of the said Charles Loudon Ricker then surviving, in equal shares, or in case there is no child of the said Charles Loudon Ricker then living to the four nieces of the said Luella S. Loudon, in equal shares, Fern Skaats Ford, Gladys Skaats Briscoe and Louise C. Mitchell of Cincinnati, Ohio and Lucy Skaats of Los Angeles, California.We see no difference in principle between the foregoing provisions of the trust in the instant case and the controlling provisions of the trust in the Duncan case which we have set out above. They seem to be in all essential respects the same, so far as the survivorship issue is concerned. As we have pointed out in our findings of fact, the provisions of the trust of July 3, 1924, are virtually the same as those of the trust of October 4, 1921. There are some differences in the language of the provisions of the trust1946 U.S. Tax Ct. LEXIS 116">*136 of August 12, 1925, as we have shown in our findings of fact. However, petitioners do not contend that the controlling provisions of this latter trust, in so far as the issue we have here to decide is concerned, are any different from the other two trusts. We do not think there is any difference in substance. Therefore, following our decision in Estate of John C. Duncan, supra, we sustain the Commissioner in his determination.Decision will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Helen S. Broome, as Executrix of the Last Will and Testament of Charles F. Loudon, Deceased, Docket No. 5944; The Merchants National Bank, as Trustee under an agreement with Charles F. Loudon, dated July 3, 1924, Docket No. 5960; Terre Haute First National Bank, as Trustee under an agreement with Charles F. Loudon, dated August 12, 1925, Docket No. 5962.↩1. (c) Transfers in Contemplation of, or Taking Effect at Death. -- To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money's worth. Any transfer of a material part of his property in the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this subchapter.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623021/ | JACKIE R. WILLIAMS and ROSELLA M. WILLIAMS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilliams v. CommissionerDocket No. 4759-74.United States Tax CourtT.C. Memo 1976-212; 1976 Tax Ct. Memo LEXIS 191; 35 T.C.M. 919; T.C.M. (RIA) 760212; June 30, 1976, Filed 1976 Tax Ct. Memo LEXIS 191">*191 Walter L. Mims and James E. Roberts, for the petitioners. Roy S. Fischbeck, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' Federal income tax and additions to tax for the years and in the amounts as follows: Tax Year EndedAdditions to Tax December 31DeficiencySec. 6653(b), I.R.C. 1954 11969$ 29,954.98$17,781.491970145,729.8475,900.27197122,042.8511,021.43The parties have agreed to the income tax deficiencies of petitioners for all of the years in issue leaving for our decision only whether petitioners are liable for the addition to tax for fraud for any or all of these years. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, who resided in Siluria, Alabama at the time of the filing of their petition in this case, filed joint Federal income tax returns for the calendar years 1969, 1970 and 1971 with the Internal Revenue Southeast Service Center, Chamblee, Georgia. 1976 Tax Ct. Memo LEXIS 191">*192 During the years 1969 through the early part of 1971, petitioners owned and operate da sole proprietorship under the name of Interstate X-Ray Company. The business operations of the proprietorship consisted of purchasing and selling new, outdated and scrap x-ray film, used x-ray equipment and machinery, x-ray supplies and selling silver extracted and reclaimed from scrap x-ray film. Interstate X-Ray Corporation was organized and incorporated under the laws of the State of Florida on June 28, 1967 and was in business during the years here in issue. Its business was similar to that of the proprietorship and its place of business was Alabaster, Alabama. Prior to May 1, 1969, Interstate X-Ray Corporation Operated under the names of Alabama Solutions, Inc. and Alabama Solutions Service, Inc. Effective with the taxable year beginning May 1, 1969, the name of the corporation was changed to Interstate X-Ray Corporation. During the years here involved, Jackie R. Williams was president of the corporation and Rosella M. Williams was vice president and treasurer.Until May 1, 1970, they owned 50 percent of the corporation's issued and outstanding stock. On May 1, 1970, they acquired1976 Tax Ct. Memo LEXIS 191">*193 an additional 40 percent of that stock. During the years 1969 through 1971, petitioners both actively participated in the business operations of the corporation and the proprietorship. Mr. Williams devoted his efforts primarily to purchases and sales and Mrs. Williams devoted her efforts primarily to office operations and management. From 1969 through September of 1972, a bookkeeper, Nellie Vance, was employed by Mr. Williams to keep records for both the proprietorship and the corporation. Miss Vance had previously been employed as an Accounts Receivable Clerk by one large corporation and in the Billing and Audit Department of another large corporation. During her employment by the proprietorship and corporation, she did general office work and was primarily responsible for posting sales to the sales journal of both the corporation and the proprietorship. In addition to Mr. Williams, there were five other salesmen working for the proprietorship and the corporation. Mr. Williams and the other salesmen all brought Miss Vance their sales tickets. She would price out the article sold and send out invoices and post the sales to either the sales journal of the proprietorship or1976 Tax Ct. Memo LEXIS 191">*194 the corporation. The proprietorship made certain sales which were subject to state sales tax and other sales to organizations such as hospitals that were not subject to sales tax. To make it more convenient to keep the sales tax record, separate journal sheets were kept for sales subject to state sales tax and for those not subject to state sales tax. The proprietorship maintained a regular bank account at Exchange Security Bank, Birmingham, Alabama. Sales subject to state sales tax were generally deposited in this account. During the period March 1969 to September 1970, the proprietorship maintained a bank account at the Birmingham Trust National Bank, Birmingham, Alabama in the name of Interstate X-Ray Company, by Jackie R. Williams and R. M. Williams. Sales not subject to state sales tax were deposited into this account. During the taxable years here involved, the corporation maintained a bank account at First Bank of Alabaster, Alabaster, Alabama, and petitioners maintained a special bank account at Exchange Security Bank, Birmingham, Alabama, and during a portion of the period here involved maintained a special bank account at First Bank of Alabaster, Alabaster, Alabama. 1976 Tax Ct. Memo LEXIS 191">*195 Mr. Williams purchased, on behalf of the proprietorship, new x-ray film from Jack B. Davis, an employee of Low X-Ray Corporation, Atlanta, Georgia in the months and amounts as follows: February 1969$67,731.21February 197036,420.00August 197080,001.11These x-ray film purchases were not evidenced by regular invoices but by a statement of account written and signed by Mr. Davis and by 13 tickets signed by him ranging in amounts from $10,000 to $20,352.32. These tickets reflect the following dates, purchase amounts, payments and balances for the x-ray film purchases: DatePurchasesPaymentsBalanceFebruary 1969$67,731.21 $$ 67,731.21December 20, 196920,200.0047,531.21February 197036,420.0083,951.21March 197015,000.0068,951.21June 197015,000.0053,951.21August 197080,001.11133,952.32September 5, 197015,000.00118,952.32December 20, 197015,300.00103,652.32March 15, 197112,000.0091,652.32June 197112,000.0079,652.32September 26, 197112,000.0067,652.32December 14, 197111,900.0055,752.32May 6, 197210,500.0045,252.32December 12, 197214,900.0030,352.32April 2, 197310,000.0020,352.32July 30, 197320,352.321976 Tax Ct. Memo LEXIS 191">*196 Jack B. Davis, from March 1967 to September 1970, was employed by Low X-Ray Corporation as operations manager of its warehouse in Atlanta, Georgia. His duties as operations manager included being responsible for security and maintenance of the inventories of Low X-Ray Corporation located in the Atlanta, Georgiia warehouse. Mr. Davis and Mr. Williams had become acquainted with each other during the time that both of them were employed by Low X-Ray Corporation prior to the years here involved. In June and September 1970, officials of Low X-Ray Corporation discovered losses of inventory, some of which were determined to be from the warehouse in Atlanta, Georgia. When Mr. Davis was unable to account for the inventory losses from the Atlanta, Georgia warehouse, Low X-Ray Corporation terminated his services and employment as operations manager of its warehouse in Atlanta, Georgia. It was not uncommon for Mr. Williams to pay for used x-ray film in cash. This film was bought by Mr. Williams from a number of sources. The film which Mr. Williams bought from Mr. Davis was paid for mostly in cash, but some of it was paid for by certified checks. In 1968, Mr. William Lampert, who at1976 Tax Ct. Memo LEXIS 191">*197 the time was approximately 70 years old, was employed by petitioners to set up an accounting system for the corporation and to prepare income tax returns for petitioners and the corporation. Although he visited the offices of the proprietorship and the corporation on a number of occasions during the years here involved, he did not audit the business books and records of either the proprietorship or the corporation. Mr. Lampert did install an accounting system for the corporation consisting of a sales journal on a so-called peg-board system, a purchase journal, a cash receipts record, a cash disbursements record and an individual receivable record. He advised petitioners to set up for the proprietorship a purchase journal, a sales journal, a cash receipts record, a cash disbursements record, an accounts receivable record, and an accounts payable record. He also advised Mr. Williams to keep the books and records of the corporation and proprietorship separate. Mr. Lampert in 1968 had been practicing accounting for approximately 40 years. He had a 4-year accounting course at New York University and a business administration course at Columbia University. From 1960 to 1966, when1976 Tax Ct. Memo LEXIS 191">*198 he retired, Mr. Lampert had managed the business and financial affairs of a physician which included the management of two offices, a trucking business, a restaurant and the installation of accounting systems for each of these business operations. When Mr. Lampert visited the offices of the proprietorship and corporation to prepare the income tax returns, he would ask for summaries of proprietorship sales, purchases and operating expenses. Petitioners would ask Miss Vance to furnish Mr. Lampert with the information he requested, which she attempted to do, and Mr. Lampert, in preparing the tax returns, relied on these summaries. Petitioners made no thorough review of the returns as prepared by Mr. Lampert before signing them. Mr. Lampert, in preparing the corporate tax return, relied on the records furnished him by petitioners, usually through Miss Vance. He did not use the bank accounts of the proprietorship in preparing the tax returns. In July 1972, Mr. Williams was advised by an Internal Revenue Agent that the 1971 income tax return of the corporation had been assigned for audit. On September 11, 1972, this audit began and shortly thereafter the audit was expanded to include1976 Tax Ct. Memo LEXIS 191">*199 the joint Federal income tax returns of petitioners for 1970 and 1971. On September 19, 1972, the revenue agent sent petitioners a letter pertaining to the examination of their 1970 and 1971 Federal income tax returns and requesting certain specific records of the proprietorship, including sales invoices and cash receipts records, purchase invoices and canceled checks. Mr. Williams instructed Miss Vance to furnish these records to the revenue agent. Sometime in September 1972, Miss Vance had left her work for the proprietorship and corporation but had begun working for an automobile tire business owned by Mr. Williams that had offices in the same building as the proprietorship and corporation. Miss Vance placed in boxes all of the records that she considered to have been requested and furnished them to the revenue agent. Specifically included in the boxes were canceled checks and other bank records of both of the bank accounts of the proprietorship. Mr. Lampert furnished to the revenue agents certain summary sheets of proprietorship sales, purchases and expenses, which he stated had been furnished him by petitioners. In January 1973, the revenue agent referred the examination of1976 Tax Ct. Memo LEXIS 191">*200 the income tax returns of the corporation to the Intelligence Division of the Internal Revenue Service. Shortly thereafter, Mr. Williams, as president of the corporation, was visited by the special agent and subsequently he was served with a summons to produce certain books and records of the corporation. This summons resulted in a proceeding for enforcement being brought in the United States District Court for the Northern District of Alabama in the case of United States v. Interstate X-Ray Corp., an unreported case ( N.D. Ala. 1973, 32 AFTR 2d 73-5742, 73-2 USTC par. 9667), which was decided on July 16, 1973. In this case the Court held that the corporation and Mr. Williams had submitted all of the available corporate books and records for the corporate fiscal years ended April 30, 1970 through April 30, 1972, to the agents of the Internal Revenue Service for examination and the petition was dismissed. About the time the special agent entered the investigation involving the corporation, Mr. Williams telephoned Mr. Lampert, who had represented him with respect to the audit of petitioners' personal tax returns which included on Schedule C the reported earnings1976 Tax Ct. Memo LEXIS 191">*201 of the proprietorship, and told him that he had discovered that approximately $60,000 of proprietorship sales had been omitted from petitioners' joint Federal income tax returns. Mr. Lampert suggested that an amended return be filed to report the omitted sales. Mr. Williams and Mr. Lampert advised petitioners' attorney of the omitted sales and were advised not to file an amended return at that time because of the investigation by the special agents into the tax liability of the corporation. This attorney also suggested that a certified public accountant be retained by petitioners to make a thorough audit of their books. Beginning in the latter part of 1970, after petitioners owned 90 percent of the corporation, many of the proprietorship invoices were put on invoice forms of the corporation. Even though on corporate invoice forms, these sales were posted to the books of the proprietorship and not to the corporate books. Sometime in October 1973, the fraud investigation of the corporation was dropped by the Intelligence Division and another revenue agent was assigned to investigate the petitioners' tax returns for the years 1969 through 1971, the agent who originally began the1976 Tax Ct. Memo LEXIS 191">*202 investigation having been assigned to another position. The second revenue agent resumed the examination in February 1974. When this revenue agent asked Mr. Williams and his attorney at the proprietorship's office in Alabaster, Alabama for the books and records of the proprietorship, they were told that they were just as the first revenue agent had left them. This revenue agent discovered that there were in November and December, 1970, certain sales to hospitals, the collection from which had been deposited in the proprietorship account at the Exchange Security Bank, which had not been recorded on the proprietorship books and records. The second revenue agent to his knowledge did not see the statement of account of the 13 tickets reflecting the purchases of x-ray film by Mr. Williams from Mr. Davis in 1969 and 1970 and did not see the records of the proprietorship account at the Birmingham Trust National Bank until these records were pulled out and furnished to him by Mrs. Williams. The certified public accountant employed by petitioners to audit the books and records and compute properly the proprietorship's income for the years 1969 through 1971 had been certified to practice1976 Tax Ct. Memo LEXIS 191">*203 in Alabama since 1951. Since 1951 he had practiced as a certified public accountant, all but the first 3 years being with his own firm. He was a graduate of the University of Alabama with an accounting major and had served as president of the local chapter of the Alabama Society of CPAs. This accountant discovered that the proprietorship had two parts to its sales journal, one in which sales not subject to state sales tax were recorded and the other in which sales subject to state sales tax were recorded. The journal pages were loose with paper clips to divide the two sections. The accountant put the pages in a binder and placed tabs on the journal for convenience in its use. The accountant found a complete set of records except for a general ledger. He discovered that the income of the proprietorship as shown on Schedule C of the returns filed by petitioners had been computed on an accrual basis in 1968, a cash receipts and disbursement basis in 1969, and that the gross receipts shown on Schedule C of the 1969 return represented the total debit to cash on hand from the proceeds of sales subject to state sales tax but did not include the sales not subject to state sales tax1976 Tax Ct. Memo LEXIS 191">*204 entered in another part of the journal. The 1969 return had marked on it that it was on the cash method. The 1970 return also indicated that it was on the cash method. The sales shown on that return represented total debits to accounts receivable as shown on the journal pages including sales tax and some other nonincome item. Therefore, even though the 1970 return indicated that it was prepared on the cash basis in fact the sales shown thereon were computed on an accrual basis. The certified public accountant completely recomputed the sales, cost of sales, other income and expenses of the proprietorship and the total income of petitioners for each of the years 1969 through 1971 and the parties now agree to the accuracy of the computations he made. The books and records used by the certified public accountant in computing the income of the proprietorship were the books and records he found in the Alabaster office of the proprietorship in which the revenue agent had been working and were the books and records which he was informed by petitioners were furnished to the revenue agent. The following schedule shows the corrected income of petitioners for the calendar year 1969 and1976 Tax Ct. Memo LEXIS 191">*205 the income as reported by them on their return for that year: Corrected Income-1969Reported Income-1969Interstate X-Ray CompanySales-Taxable$ 98,989.92Sales-Exempt-Regular Account13,123.75Sales-Exempt-Special Account67,144.34Total Sales$179,258.01Sales Returns & Allowances599.07$178,658.94$104,815.00Cost of SalesInventory - 1/1/69$ 9,500.00$ 9,500.00Purchases133,285.9580,212.00Total Cost$142,785.95$ 89,712.00Inventory - 12/31/696,000.006,000.00Cost of Sales136,785.9583,712.00Gross Margin on Sales$ 41,872.99$ 21,103.00ExpenseTravel Expense$ 1,728.89$ 1,729.00Depreciation1,899.001,049.00Telephone1,018.581,018.00License110.00110.00Labor90.00In CostFreight43.7344.00Bank Charges30.0317.00Office Supplies33.7534.00Accounting25.0025.00Home Expense109.00Total Expense4,978.984,135.00Net Operating Income$ 36,894.01$ 16,968.00Other IncomeInterest Income$ 1,115.02$ 1,115.00Salary-Low X-Ray Co.7,133.587,134.00Salary-Interstate X-Ray Corp.1,200.001,200.00(21.75)(22.00)Dividend21.7522.00Glen Green-Jacksonville, Fla.3,010.47Net Income-Alabaster Tire Shop414.34(105.00)Total12,873.419,344.00Adjusted Gross Income$ 49,767.42$ 26,312.00Deduction-2,216.77-2,401.00Exemption-1,800.00-1,800.00Taxable Income$ 45,750.65$ 22,111.001976 Tax Ct. Memo LEXIS 191">*206 The following schedule shows the corrected income of petitioners for the calendar year 1970 and the income as reported by them on their return for that year: Corrected Income-1970Reported Income-1970Interstate X-Ray CompanySales - Regular$291,145.03$117,031.02Sales - Silver39,385.6039,385.60Total Sales$330,530.63$156,416.62Less Returns & Allowances594.44$329,936.19416.08$156,000.54Cost of SalesInventory - 1/1/70$ 6,000.00$ 6,000.00Purchases197,246.64133,452.54Labor168.00Total$203,246.64$139,620.54Inventory - 12/1/700$203,246.640$139,620.54Gross Profit on Sales$126,689.55$ 16,380.00ExpenseLabor$ 2,905.17 $Depreciation2,191.741,049.00Commission1,548.624,285.79Travel587.4 0587.40Telephone423.78423.78Interest590.25150.00Repairs213.00213.00Freight676.08676.08Payroll Taxes382.29205.71Gasoline264.65264.65Taxes & Licenses135.00135.00Bank Charges25.0427.31Office Supplies100.70100.70Miscellaneous26.3426.34Accounting200.00200.00Insurance177.16Total Expense10,270.068,521.92Net Income - Interstate X-Ray$116,419.49$ 7,858.08Other IncomeCurlee X-Ray Co. - Loss$ (12,044.73)Salary Income21,322.8821,322.88Interest Income1,198.091,192.50Alabama Tire Center - Net8,827.927,259.67Self Insurance Plan Income703.88Sales Tax Discounts715.29(38.25)Dividend Income38.25(77.50)Gain on Sale of Hale Property155.00Informal Dividends2,389.9923,190.8229,775.05Rent and Farm IncomeRent Received$ 4,340.75$ 3,000.00Rent ExpenseDepreciation$ 2,721.71$ 2,850.00Interest2,614.622,967.00Insurance341.00357.00Utilities9.379.37Taxes375.18Total Expense$ 5,686.70$ 6,558.55Net Loss(1,345.95)(3,558.55)Adjusted Gross Income$138,264.36$ 34,074.58Deductions- 3,522.13- 7,471.07Exemptions- 1,875.00- 1,875.00Taxable Income$132,867.23$ 24,728.511976 Tax Ct. Memo LEXIS 191">*207 The following schedule shows the corrected income of petitioners for the calendar year 1971 and the income as reported by them on their return for that year: Corrected Income-1971Reported Income-1971Interstate X-Ray CompanySales$ 1,662.85Less Sales Discounts.06Net Sales$ 1,662.79Cost of SalesInventory 1/1/710Purchases87.00Total Cost87.00Inventory 12/31/71087.00Gross Profit$ 1,575.79ExpenseProperty Tax$ 47.12Accounting100.00Depreciation53.70Interest758.26Total Expense959.08Net Operating Income$ 616.71Rental Income & Farm$ 2,238.00Rent Received$11,337.909,000.00ExpenseDepreciation$ 8,547.06$ 5,783.00Insurance378.00548.00Interest6,037.734,360.00Other Expense16.452,005.00Total Expense$14,979.24$12,696.00Net Rental Income(3,641.34)(1,458.00)Other IncomeSalary Income$18,000.00$18,000.00Gain on Sale of Hale Property2,800.74Less Capital Gain Deduction(1,158.02)Interest Income2,676.161,545.00Alabaster Tire Store2,224.084,496.08Self Insurance Income1,086.02Dividend Income38.2538.25Dividend Exclusion(38.25)(38.25)Other Income3.19Storm Damage - Tire Store(64.93)Informal Dividends2,531.0028,098.2424,041.08Adjusted Gross Income$25,073.61$22,583.08Deduction3,243.806,424.00Exemption2,025.002,025.00Taxable Income$19,804.81$14,134.081976 Tax Ct. Memo LEXIS 191">*208 The following schedule shows the income of the corporation, Interstate X-Ray, for its Fiscal Year Ended April 30, 1971, and the income of that corporation as reported on its tax return for that year: Adjusted BalancePer Tax ReturnIncomeSales$701,824.20$720,200.14Sale of InventoryTotal$701,824.20$720,200.14Less: Returns & Allowances- 526.15- 13,655.86Net Sales$701,298.05$706,544.28Less: Cost of Goods Sold-424,340.25$276,957.80-402,820.59$303,723.69Other IncomeInterest Income$ 168.52$ 79.00Expense ReimbursementRealized Profits1,224.23Rent Income250.00Other Income88.80+ 1,481.55706.40+ 1,035.40Gross Profit on Sales$278,439.35$304,759.09ExpensesSalaries: Officer$ 23,750.00$ 27,000.00Other59,852.8257,623.27Salesmen's Commissions36,158.4435,835.75Professional Fees900.003,065.48Rent5,650.005,650.00Office Supplies2,853.332,802.19Telephone & Telegraph6,211.996,211.99Utilities897.23917.88Taxes5,220.34460.85Gas & Oil10,444.5412,625.36Travel Expense3,430.644,164.82Auto Allowance480.201,280.20Entertainment1,332.261,332.26Sales Promotion279.112,789.33Advertising913.38Truck & Car Rental1,655.901,655.90Repairs & Maintenance6,139.036,139.03Postage597.39597.39Freight & Expense2,314.512,284.51Dues & Subscriptions163.15163.15Donations10.00225.76Bad Debt Expense6,076.155,476.15Depreciation18,858.8415,261.93Insurance3,569.694,492.49Miscellaneous Expense1,242.891,374.31Bad Debt Expense645.32Repair PartsInterest2,500.304,933.68Service Department Supplies3,140.99Leased Equipment ExpenseAirplane Expense11,816.8010,473.76-213,964.25-217,978.43Net Operating Income$ 64,475.10$ 86,780.66Other Income (Less)Gain/Loss on Sale of Inventory$ (304.53) $Loss on Investments(2,590.25)Purchase Discounts(304.53)532.77(2,057.48)Net Income Before Taxes$ 64,170.57$ 84,723.181976 Tax Ct. Memo LEXIS 191">*209 The following statement shows the corrected income of the corporation, Interstate X-Ray, for its Fiscal Year Ended April 30, 1972, and its income as reported on its tax return for that year: Adjusted BalancePer Tax ReturnIncomeSales$703,275.97$710,686.06Sale of InventoryTotal$703,275.97$710,686.06Less: Returns & Allowances- 967.88- 11,902.97Net Sales$702,308.09$698,783.09Less: Cost of Goods Sold-433,543.22$268,764.87-462,695.35$236,087.74Other IncomeInterest Income$ 482.00 $Expense ReimbursementRealized Profits1,855.66Other Income1,553.72+ 3,891.381,760.99+ 1,760.99Gross Profit on Sales$272,656.25$237,848.73ExpensesSalaries: Officer$ 14,903.68$ 28,000.00Other68,429.1755,472.35Salesmen's Commissions21,165.0921,265.09Professional Fees5,707.551,432.07Rent8,425.008,225.00Office Supplies2,063.452,073.04Telephone & Telegraph4,717.964,913.65Utilities1,301.131,370.09Taxes7,243.675,427.74Gas & Oil10,415.4010,415.44Travel Expense3,753.815,493.42Auto Allowance1,302.851,302.85Entertainment547.51547.51Sales Promotion130.83Advertising690.89690.89Truck & Car Rental731.61634.11Repairs & Maintenance7,497.516,656.02Postage657.96657.78Freight & Expense2,344.902,350.26Dues & Subscriptions140.82140.82Donations130.83Bad Debt Expense1,128.131,128.13Depreciation12,005.058,304.43Insurance4,071.164,248.32Miscellaneous Expense200.002,229.84Repair Parts2,915.241,643.68Interest2,566.303,431.78Service Department Supplies517.48Leased Equipment Espense658.58Airplane Expense59.24Commission on Sale of Airplane-186,291.97(900.00)-177,285.14Net Operating Income$ 86,364.28$ 60,563.59Other Income (Loss)Gain/Loss on Sale of Equipment$ (7,041.58)$ 4,502.10Purchase Discounts5,451.25- (1,590.33)+ 4,502.10Net Income Before Taxes$ 84,773.95$ 65,065.691976 Tax Ct. Memo LEXIS 191">*210 Respondent in his notice of deficiency to petitioners increased their adjusted gross income from their business by the amounts of $88,270.89, $162,115.95 and $39,158 for the years 1969, 1970 and 1971, respectively. Respondent also determined that dividends of $104,147.33 and $11,627.65 in 1970 and 1971, respectively, had been received by petitioners from the corporation based on the proprietorship sales which had been billed on the invoice forms of the corporation. Respondent also determined that petitioners were liable for the addition to tax for fraud for each of the years here in issue. The explanation given by respondent for his determination with respect to increased business income was as follows: It is determined that your gross receipts from business and/or farming for the taxable year 1969 totaled $213,117.21 in lieu of $105,834.00 as reflected on your return, for the taxable year 1970 totaled $321,968.59 in lieu of $196,721.43 as reflected on your return, and for the taxable year 1971 totaled $128,156.00 in lieu of $88,998.00 as reflected on your return. It is determined that your cost of sales from business for the taxable year 1969 totaled $103,253.32 in lieu of1976 Tax Ct. Memo LEXIS 191">*211 $84,241.00 as reflected on your return, and for the taxable year 1970 totaled $125,494.57 in lieu of $162,363.36 as reflected on your return. Consequently, your taxable income is increased in the amount of $88,270.89 for the taxable year 1969, $162,115.95 for the taxable year 1970, and $39,158.00 for the taxable year 1971. Respondent merely explained with respect to the increase in dividend income that it had been determined that petitioners received such dividends, no part of which had been reflected on their income tax returns. OPINION The only issue remaining in this case is whether any part of petitioners' underpayment of tax for any of the years here in issue was due to fraud with intent to evade payment of tax. As both parties recognize, the burden is on respondent to establish such fraud by clear and convincing evidence. Cefalu v. Commissioner,276 F.2d 122 (5th Cir. 1960), affirming a Memorandum Opinion of this Court. As the Court stated in that case at 128-129, in a quote from Mitchell v. Commissioner: "* * * 'The fraud meant is actual, intentional1976 Tax Ct. Memo LEXIS 191">*212 wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing.' Mitchell v. Commissioner, 5 Cir., 1941, 118 F.2d 308">118 F.2d 308, 118 F.2d 308">310." In our view, the evidence here falls far short of any showing of fraud. It may well be that petitioners were careless in leaving their bookkeeping to a young woman whose previous experience had been somewhat limited and the preparation of their tax returns to a retired accountant who prepared them in reliance on information which this bookkeeper furnished him. However, carelessness of this type is not fraud. Respondent relies primarily on his contention that petitioners did not disclose their records to the revenue agent. However, the evidence here does not support respondent's contention in this respect. The evidence shows that all of the proprietorship records were made available to the revenue agents even though apparently some items were not specifically pointed out to them as being in the boxes furnished to them. In fact, one of the revenue agents in testifying about certain items not furnished to him stated in response to a question by the Court that he never specifically asked for the particular item1976 Tax Ct. Memo LEXIS 191">*213 and the testimony of other witnesses clearly indicates that this item along with other items requested were contained in the boxes of documents provided to this revenue agent for his examination. One of the major contentions is with respect to whether the records of the account at the Birmingham Trust National Bank were ever made available to the revenue agents. From the evidence, we conclude that the records of this account were contained in the boxes furnished to the agents and that the account was kept as a convenient means of segregating receipts from sales subject to state sales tax and those not subject to state sales tax. Clearly, all of the sales were not included on the tax returns, which petitioners filed, nor were all the purchases. Whether the failure to include all sales and purchases on the returns was because proper records were not furnished to Mr. Lampert or because he did not specify to petitioners' bookkeeper the records he needed is not clear from the record. The record, however, is clear that petitioners relied on the bookkeeper and Mr. Lampert to prepare the Schedule C of the tax returns showing the income from the proprietorship and that the proprietorship1976 Tax Ct. Memo LEXIS 191">*214 records were adequate to reflect the proprietorship income and were later used by a certified public accountant in properly computing the proprietorship income. Even though petitioners may have been careless to rely on the bookkeeper and Mr. Lampert, there is no evidence that this reliance by petitioners was with any fraudulent intent to evade taxes. The evidence in the record indicates that there was no such intent. Mr. Williams only casually glanced at the returns before he signed them since he assumed Mr. Lampert had properly prepared them from the proprietorship records which were completely adequate to show the correct income of the proprietorship. In certain instances, merely an understatement of income to the extent that petitioners' income here was understated might be some indication of fraud, though generally it has never been considered sufficient to be clear and convincing evidence of fraud. However, since proprietorship monies were being used in the business, it is doubtful that petitioners would have been aware of the understatement of income had they reviewed the income tax returns more carefully unless they had compared the figures shown on the returns with those1976 Tax Ct. Memo LEXIS 191">*215 shown in the business records. Respondent's other main reliance for his position that he has established fraud is the fact that Mr. Williams made cash purchases of film from Mr. Davis. Respondent even argues that this was film which Mr. Davis "had embezzled." The record totally fails to show where Mr. Davis acquired this film. Although Mr. Davis was discharged because of inventory shortages in the Atlanta warehouse of the Low X-Ray Corporation there is no indication in the record that Mr. Davis had misappropriated the film and certainly not the slightest indication that any action was commenced against him or that he was prosecuted criminally. Mr. Williams testified that it was not uncommon for him to buy film from employees of hospitals or other places where film was used and that he assumed the employee was able legally to acquire the film for resale to him. Even if Mr. Williams should have investigated how Mr. Davis acquired the film that the proprietorship purchased for him, which respondent has not shown to be a fact, the purchase of this film is not an indication of fraud in reporting petitioners' taxable income. Apparently some of the purchases of this film were part1976 Tax Ct. Memo LEXIS 191">*216 of the purchases that were not deducted on the income tax returns. Respondent argues that part of the sales not reported on the returns were sales of the film that Mr. Williams purchased from Mr. Davis but there is no evidence whatsoever in the record to support this contention. Insofar as this record shows, there was nothing amiss with Mr. Williams' purchase of film from Mr. Davis. Unsupported suspicions cannot substitute for evidence to sustain respondent's burden of proof of fraud. After considering all the evidence in the record in this case, we conclude that respondent has failed to establish by clear and covincing evidence that any part of the understatement of tax by petitioners for any one of the years 1969, 1970 or 1971 was due to fraud. We, therefore, hold respondent is not entitled to any addition to tax for fraud under section 6653(b). Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623022/ | Martin Dressen, Petitioner, v. Commissioner of Internal Revenue, RespondentDressen v. CommissionerDocket No. 32348United States Tax Court17 T.C. 1443; 1952 U.S. Tax Ct. LEXIS 258; March 6, 1952, Promulgated 1952 U.S. Tax Ct. LEXIS 258">*258 Decision will be entered for the petitioner. Gain from Sales of Lots -- Capital Gain. -- The petitioner purchased country lots in 1931 as an investment. He held the lots for 15 years. Some of the lots were sold in 1946 and 1947. Held, under the facts, that the lots were not held primarily for sale to customers in the ordinary course of petitioner's business within section 117 (a) (1), I. R. C., and that gain realized from sales in 1947 is taxable as long term capital gain. Alric Anderson, Esq., for the petitioner.Thomas A. Steele, Jr., Esq., for the respondent. Harron, Judge. HARRON 17 T.C. 1443">*1443 The respondent has determined a deficiency in income tax for the year 1947 in the amount of $ 334. The only question is whether the petitioner held lots primarily for sale to customers1952 U.S. Tax Ct. LEXIS 258">*259 in the ordinary course of a business so that the property is properly to be excluded 17 T.C. 1443">*1444 from capital assets under section 117 (a) of the Code. The petitioner contends that the property was held as an investment and that the profit realized upon the sale of 14 lots in 1947 constitutes long term capital gain.The petitioner filed his return with the collector for the district of Minnesota.FINDINGS OF FACT.The petitioner lived in Shakopee, Minnesota, from 1931 to September 1948, when he moved to Cumberland, Wisconsin. In 1931 and thereafter he carried on a business of selling soft drinks, candy, cigarettes, and tobacco. During 1946, 1947, 1948, and 1949 he was engaged in a tavern business, and his income from that business amounted to $ 2,100 in 1946, $ 1,100 in 1947, $ 1,000 in 1948, and $ 3,600 in 1949. The petitioner has never had a real estate dealer's license, and he has never engaged in a real estate business.In 1931, C. T. Weiland, a friend who worked in a bank in Shakopee, told the petitioner he could buy 67 lots cheaply in a subdivision known as Northwood at Prior Lake, from a widow who wanted to sell her lots. Weiland was not engaged in the real estate business. 1952 U.S. Tax Ct. LEXIS 258">*260 The Northwood subdivision was surveyed, platted, and subdivided in 1911, and the plat was recorded then. The lots were unimproved except one lot at one end of the tract where a summer cottage was located. There was no electric power line to the property. One side of the property had a lakeshore frontage. The 67 lots were contiguous, except for one lot. The petitioner bought the 67 lots at the end of 1931 for $ 3,000. In 1945 he bought the one lot remaining in the group for $ 20 at a tax lien sale. He then owned 68 lots which covered 34 acres. He purchased the lots to hold as an investment for himself and his family. The petitioner held the lots for 15 years during which time he made no effort to sell them. The only other real estate the petitioner has purchased are five lots in Shakopee which he bought in 1941 for $ 400. One of these lots was sold in 1947, at a profit of $ 313.57.During the time the petitioner held the Prior Lake lots, nothing was done by the petitioner to improve them except in minor ways. For example, he took out about 48 willow trees and replaced them with hardwood trees, he planted a lawn extending for an acre around his cottage, he planted a few1952 U.S. Tax Ct. LEXIS 258">*261 fruit trees, and he improved a bathing beach on the shore of the lake. During three years he let a farmer raise hay on 8 acres for one-third of the crops, i. e., for about $ 18 per year. The petitioner and his family occupied the cottage at one end of the tract in the summer until they moved to Wisconsin.However, there were some advancements in the vicinity of the property which were of benefit. In 1936, electric power was made 17 T.C. 1443">*1445 available by R. E. A., and the petitioner had an electric power line brought in over the property to the cottage. Also, in 1938, the county built a dam at the outlet of Prior Lake which raised the water level.Before the dam was built at Prior Lake, there was a road along the shore which the petitioner used to get to his cottage. The road could not always be used after the lake was closed by the dam because it was flooded at times. And so the petitioner used a cart road in the rear of the property. This road ran over on the property of others to the extent of about 20 feet. In 1945 or the early part of 1946, the petitioner had his property surveyed and marked so as to regrade the road and fix it on his property. In his income tax return1952 U.S. Tax Ct. LEXIS 258">*262 for 1946, the petitioner reported expenditures of $ 1,200 on the property (which were made during and before 1946) as follows: Surveying costs, $ 160; road grading, $ 706; road gravel, $ 174; clearing away overgrowth, $ 160. In 1947, he spent $ 98 for the removal of some willow trees and the filling in and leveling of a small area. The petitioner maintained the road in the rear of the property for two years, and thereafter it was maintained by the town of Shakopee. The petitioner also fixed a "spur road" into the property.In 1946, the petitioner needed some money to pay debts and borrowed some money through Weiland. Weiland suggested that he sell some of his lots. He was not anxious to sell them, but he needed money. He wanted to sell all of the lots at one time for seven or eight thousand dollars. Weiland brought a Minneapolis real estate dealer, Wood Schol, to the petitioner to purchase the lots, but the petitioner and Schol could not agree on a price for all of the lots. Schol offered to sell the lots for a commission of $ 150 per lot. The petitioner considered the proposed charge to be too high.The petitioner knew nothing about the handling of real estate transactions1952 U.S. Tax Ct. LEXIS 258">*263 or about the preparation of the documents required to convey title. Furthermore, he was fully occupied with his tavern business, where he often worked all day and until midnight. He asked Weiland to sell his lots so that he could raise money to pay his debts. Weiland worked in the bank in Shakopee, but he was willing to handle sales of the lots. There was no contract made by the petitioner and Weiland. It was understood, however, that Weiland would receive the customary commission of 10 per cent of the purchase price for bringing purchasers to the petitioner. It was customary to pay a commission to anyone who brought in a purchaser of property.The petitioner did nothing. Weiland submitted each offer for a lot which he obtained, some of which the petitioner rejected. In September 1948 the petitioner moved to Wisconsin.17 T.C. 1443">*1446 No sales office was located on or near the Prior Lake property. Weiland's sales activities were limited to the following: He replaced worn out markers on the property to show the locations of lots; he put notices in the newspaper that the lots were for sale, and he put a for sale sign on the property and on a road nearby, the expenses of which he1952 U.S. Tax Ct. LEXIS 258">*264 paid. The lots which were sold were sold under installment contracts for a down payment, part of which Weiland retained as his commission. The petitioner used the money he received to pay debts, and he did not reinvest any of the proceeds in other property.The number of lots sold and the net profit realized during the years 1946-1951 were as follows:YearLots soldNet profit19468 1/2$ 2,416.401947143,571.53194812 1/22,067.29194985,155.24195091,574.2819515(not shown)57The petitioner realized profit during 1947 in the total sum of $ 3,885 from sales of lots at Prior Lake and in Shakopee. He treated the gain as capital gain in his return for 1947 and included 50 per cent, or $ 1,942.55 in his taxable income. The Commissioner determined that the petitioner was a "real estate dealer" during 1947, and that, therefore, his gains were taxable in full as ordinary gain.The petitioner was not a real estate dealer during 1947. He did not hold the Prior Lake lots or the lots in Shakopee primarily for sale to customers in the ordinary course of his business. He held the lots as an investment from the time he purchased them, and the sales thereof1952 U.S. Tax Ct. LEXIS 258">*265 were in liquidation of capital assets from which he realized capital and not ordinary gain in 1947.OPINION.The question is whether the profit which the petitioner realized from the sale of the Prior Lake lots and one lot in Shakopee is taxable as capital or ordinary gain.The respondent has determined that the properties involved must be excluded from the class of capital assets, under section 117 (a) (1) of the Internal Revenue Code, because they were "held by the petitioner primarily for sale to customers in the ordinary course of his trade or business." He relies upon Richards v. Commissioner, 81 F.2d 369; Welch v. Solomon, 99 F.2d 41; Ehrman v. Commissioner, 120 F.2d 607; Brown v. Commissioner, 143 F.2d 468; McFaddin v. Commissioner, 148 F.2d 570; White v. Commissioner, 172 F.2d 629; and C. E. Mauldin, 16 T.C. 698 (on appeal C. A. 10).17 T.C. 1443">*1447 The petitioner contends that the properties were not so held and that he was not engaged1952 U.S. Tax Ct. LEXIS 258">*266 in a business of selling real estate. The petitioner relies upon Foran v. Commissioner, 165 F.2d 705; Thompson Lumber Co., 43 B. T. A. 726; Frieda E. J. Farley, 7 T.C. 198; and Harriss v. Commissioner, 143 F.2d 279, affirming 44 B. T. A. 999.There are several tests which are applied to determine whether a taxpayer is engaged in a real estate business in which he holds property primarily for sale to customers within the meaning of section 117 (a) (1) of the Code. In general, the courts have analyzed the records of proceedings before them for evidence which shows the extent of the taxpayer's activities in selling his property; and the frequency, continuity, and substantiality of sales is usually a factor which indicates that the taxpayer held property primarily for sale to customers and engaged in a business of selling the property. Boomhower v. United States, 74 F. Supp. 997">74 F. Supp. 997. However, the question is a question of fact in each case, to be determined in the light of all of the evidence; 1952 U.S. Tax Ct. LEXIS 258">*267 and no test can be regarded as determinative of the question. W. T. Thrift, Sr., 15 T.C. 366, 369.In this proceeding the facts differ distinctly from the facts in the cases of Richards, Solomon, Ehrman, Brown, White, McFaddin, and Mauldin on which the respondent relies. It is clear that the petitioner put his savings into the purchase of the lots in 1931 as an investment and as a way of securing his savings at a time when banks were having difficulties. See Foran v. Commissioner, supra.The petitioner had no intention of going into the real estate business, cf. Spanish Trail Land Co., 10 T.C. 430; and he had no intention of developing the property. The property had been subdivided in 1911, so that we do not have here the situation of a taxpayer who acquires acreage and later subdivides it into lots, and engages in developmental activities and extensive selling activities as was true in the Ehrman, Brown, White, McFaddin, and Mauldin cases. Cf., also, Oliver v. Commissioner, 138 F.2d 910. And when, in 1946, the petitioner first 1952 U.S. Tax Ct. LEXIS 258">*268 considered selling his lots, he was not motivated by a desire to go into a real estate business. He was not anxious to sell his property, and he gave consideration to disposing of it only because he was borrowing money to pay debts and needed funds.Of course, "Where liquidation of an asset is accompanied by extensive development and sales activities, the mere fact of liquidation will not be considered as precluding the existence of a trade or business," Frieda E. J. Farley, supra, page 204. The narrow question here is whether petitioner's activities in 1947 in connection with the sales which were made in liquidating his asset were sufficient to constitute the carrying on of a real estate business and to convert the lots which he bought and held as an investment into property held primarily for sale to customers in the course of his business.17 T.C. 1443">*1448 The record convinces us that the petitioner's activities in 1946 and 1947 were not sufficiently frequent, substantial, or engrossing to constitute the operation of a real estate venture or business. See Phipps v. Commissioner, 54 F.2d 469. In the first place, the petitioner1952 U.S. Tax Ct. LEXIS 258">*269 demonstrated by his testimony that he was thoroughly ignorant in matters pertaining to real estate transactions. His friend of forty years, Weiland, who worked in a bank which made real estate loans, interested the petitioner in the lots in the beginning. Although he had no intention of handling sales for the petitioner when, in 1946, the petitioner needed money, and brought a real estate dealer from Minneapolis to the petitioner, he was the only person who could give the petitioner the assistance he needed. Shakopee was a small town of about 1,800 people in 1946. The petitioner impressed the Court as a man of limited education and experience, whose business activities were restricted to the comparatively simple business of selling drinks -- soft and hard, who worked long hours in the operation of a tavern, and who did not have the faintest idea of what would be involved in a "land-office" business. His earnings were not large, and his means were modest. He had been a passive investor in the lots, and he was passive in 1946 and 1947 when some of his lots were sold. Compared to many cases where the familiar tests have been applied and discussed, the petitioner's investment was1952 U.S. Tax Ct. LEXIS 258">*270 small, and the sales in 1946 and 1947 were not the substantial sales which are found where it has been concluded that selling activities constituted the operation of a real estate business. This is quite apparent in making comparison with the facts in the White case, for example, on which respondent relies, where the taxpayers sold 267 lots in the two years preceding the taxable year, and in one year sold 250 lots for over $ 200,000.In this proceeding the respondent, by cross examination of the petitioner and Weiland, endeavored to elicit testimony to the effect that the two of them undertook a real estate operation to "cash in" on a large demand for lots, a little boom, but the responses to respondent's counsel's questions did not substantiate such hypothesis or theory at all. There is a suggestion in the record that Weiland later went into the real estate business, but the petitioner has testified that he never discussed such undertaking with Weiland and that he did not know whether Weiland did or did not later go into a real estate business. What Weiland may have done later, the record does not show clearly, and, in any event, is immaterial. The petitioner moved away from1952 U.S. Tax Ct. LEXIS 258">*271 Shakopee in 1948, and he did not reinvest the proceeds of sales in other real estate, but, rather, paid his debts. The evidence does not support the respondent's theory, and he misjudged the situation when he made the determination that the petitioner was a dealer in real estate in 1947.17 T.C. 1443">*1449 We have observed, before, that it is often difficult to draw the line between what amounts only to liquidating an asset and primarily holding property for sale to customers in the conduct of a business. Thomas E. Wood, 16 T.C. 213, 227. We do not have such difficulty here. There were no extensive development and sales activities and the sales of 14 lots in 1947 were not, in our opinion, substantial sales. It is concluded that the number of sales and the sales activities in connection therewith were insufficient to constitute the carrying on of a business and to convert the lots which had been held for investment into property held primarily for sale to customers in the course of a business.This proceeding resembles in several respects the cases of Farley and Wood. One factor common to those cases and to this one is that commissions were retained1952 U.S. Tax Ct. LEXIS 258">*272 by those who brought in purchasers, out of the purchase price. Whether that factor is important and critical depends upon all of the facts in a particular case. It was not regarded as critical in the Farley and Wood cases, but it was treated as having importance in the Erhman and Brown cases, for the reason, however, that all the evidence showed that selling activities were so substantial as to constitute the carrying on of a business.In this proceeding, we are satisfied that the petitioner really was passive in the matter of sales efforts and that as in the Farley case, offers came to him. The agency concept is not overlooked, either, but we are convinced, also, that Weiland acted independently of the petitioner. See Guthrie v. Jones, 72 F. Supp. 784">72 F. Supp. 784. And the fact that there was an element of continuity of sales is off-set by the length of time during which lots were sold. At the end of 6 years, all of the lots had not been sold, and in some years only 8 lots were sold. The average in 6 years was about 9 lots per year. If the petitioner had been able to sell all his lots at once, as he tried to do, for what he considered1952 U.S. Tax Ct. LEXIS 258">*273 a fair price, the element of continuity of sales would have been eliminated here. But we understand that test to mean that sales must be substantial as well as frequent and involve extensive sales activities. At any rate, we regard the sales of lots here as gradual and under the principles of Burnet v. Harmel, 287 U.S. 103">287 U.S. 103, believe that this petitioner is entitled to the application of the capital gains provision of the statute.It is held that the gains realized by the petitioner in 1947 from the sales of lots are capital gains and are not taxable as ordinary income.Decision will be entered for the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623024/ | Frank Stephen Ranz, Petitioner, v. Commissioner of Internal Revenue, RespondentRanz v. CommissionerDocket No. 65184United States Tax Court31 T.C. 91; 1958 U.S. Tax Ct. LEXIS 61; October 17, 1958, Filed 1958 U.S. Tax Ct. LEXIS 61">*61 Decision will be entered for respondent. Petitioner, a professional engineer and sales representative of machine tool manufacturers in an area including Cincinnati, Ohio, entered into an informal contract with the Rehnberg-Jacobson Manufacturing Co. in March 1951, to sell machine tools manufactured by it, on a commission basis. Shortly thereafter he contacted and began negotiations with the Automatic Transmission Division of the Ford Motor Company, located in Cincinnati, to sell it machine tools manufactured by Rehnberg for use in manufacturing the automatic transmission assembly which it was then developing. As a result of his efforts he obtained 13 orders from the Ford company on various dates in 1953 and thereafter serviced such orders until shipped and paid for. Petitioner received a total of $ 35,299.69 in commissions for such orders during the period May 1 to November 19, 1954. His contract with Rehnberg was terminated in 1956. The above commissions represented more than 80 per cent of the total compensation received by petitioner from Rehnberg during the entire period of such employment. Held, the commissions involved do not represent compensation received from1958 U.S. Tax Ct. LEXIS 61">*62 "an employment" within the meaning of section 1301 of the Internal Revenue Code of 1954, and consequently, petitioner is not entitled to compute his income tax thereon in accordance with the method provided by said section. Floyd Anderson, Esq., for the1958 U.S. Tax Ct. LEXIS 61">*63 petitioner.John J. Larkin, Esq., for the respondent. Bruce, Judge. BRUCE 31 T.C. 91">*92 Respondent has determined deficiencies in petitioner's income tax as follows:YearDeficiency1952$ 114.00195369.7119543,571.58At the hearing petitioner conceded certain issues with respect to respondent's disallowance of club initiation fees in the amounts of $ 375 and $ 120 claimed by petitioner as business expense deductions for the years 1952 and 1953. The sole issue for decision is whether the provisions of section 1301 of the Internal Revenue Code of 1954 are applicable to commissions in the amount of $ 35,299.69 received by petitioner in 1954.FINDINGS OF FACT.Petitioner is a resident of Cincinnati, Ohio. The returns for the period here involved were filed with the director of internal revenue for the first district of Ohio.During the taxable years, petitioner was a professional engineer and sales representative of machine tool manufacturers in an area covering Cincinnati, Dayton, Springfield, and Columbus, Ohio, and a part of the State of Kentucky. In March 1951, petitioner entered into an informal agreement with the Rehnberg-Jacobson Manufacturing Company (hereinafter1958 U.S. Tax Ct. LEXIS 61">*64 referred to as Rehnberg), a manufacturer of machine tools, to sell equipment manufactured by Rehnberg. The terms of this agreement were set forth in the following letter addressed to petitioner, dated March 27, 1951, and signed by the president of the company:I have your letter of March 24 and although, as you stated, the problem that now faces us is production and not sales, we are still willing to work with you. We have no representative in your district and if you could work in to be a good man for us, we can look forward past this rush period.All our sales representatives work on a strict commission basis of ten per cent. Some act as dealers and others as agents. In this case you would act as an agent. The difference, as you know, is that an agent does not handle the account, the billing is direct from the factory to the customer, and we pay the agent his commission after the machine is paid for.We have some quotations in at Ford Transmission. I covered this deal myself. These quotations should soon materialize in orders, and if you want 31 T.C. 91">*93 to, we will send you copies of the quotations. This would give you an "in" at the Ford plant, and we will pay you five per1958 U.S. Tax Ct. LEXIS 61">*65 cent commission on these orders. Please direct your communications to Mr. J. R. Hoaglund, our sales manager.Thereafter petitioner received the following letter from the sales manager at Rehnberg:Rehnberg-Jacobson Mfg. Co.2135 Kishwaukee StreetRockford, Illinois, April 5, 1951Mr. Frank S. Ranz,9617 Kenwood Road,Blue Ash, Ohio,(Cincinnati 27)Subject: Ford Motor CompanyAutomatic Transmission DivisionCincinnati, OhioDear Sir:As requested in your letter dated April 2, we have prepared and attach copies of our proposals numbered 2575 and 2576, each covering a Needle Bearing Assembly Machine as quoted to the above company. May we suggest, when you are free to do so, that you pursue this matter and if you are successful in obtaining the business you will be allowed a 5% commission as suggested in our Mr. Rehnberg's letter of March 27.Regarding your proposed visit to Rockford during the week of April 9, we will be glad to have you visit us and you have only to notify us of your exact arrival time a day or two in advance in order that we may make hotel reservation for you and otherwise anticipate your arrival.We look forward to meeting you personally and remainVery1958 U.S. Tax Ct. LEXIS 61">*66 truly yours,Rehnberg-Jacobson Mfg. Co./s/ J. R. HoaglundJ. R. HoaglundPetitioner visited the offices and plant of Rehnberg at Rockford, Illinois, and was furnished copies of bulletins relating to various machines and equipment manufactured by it. In addition to copies of the two proposals which had previously been submitted by the president of Rehnberg to the Automatic Transmission Division of the Ford Motor Company, petitioner was furnished correspondence pertaining to this customer. Thereafter petitioner contacted representatives of the Ford company and engaged in extensive promotional activities and negotiations for the purpose of selling them machine tools of the Rehnberg company for use in manufacturing the automatic transmission assembly to be used in Ford and Mercury automobiles. He obtained blueprints of the assembly plan (petitioner's Exhibit 9) and submitted numerous proposals for machine tools in connection therewith. He consulted frequently with the Ford representatives concerning the proposals and requoted them several times. These activities continued through 1951 and 1952 and finally resulted in Rehnberg receiving 13 31 T.C. 91">*94 orders for machine tools from the1958 U.S. Tax Ct. LEXIS 61">*67 Ford company in 1953. All of these orders were for the purchase of machine tools for use in the manufacture by Ford of its automatic transmission assembly. All of the orders resulted from petitioner's efforts and proposals which he had submitted and none was based on the quotations or proposals which the president of Rehnberg had submitted prior to petitioner's employment. These orders, the dates they were received by petitioner, and the amounts thereof are as follows:Order No.Date received byAmountpetitionerPE-12085 TApr. 22, 1953$ 9,425PE-12086 TApr. 22, 19536,265PE-11805 MApr. 22, 19536,265PE-11806Apr. 22, 19539,586PE-12177 TApr. 29, 195324,536PE-5902 MMay 21, 195325,021PE-12248 TMay 16, 195338,435PE-5983 MMay 27, 195340,965PE-6061 TMay 30, 195344,130PE-6057 TMay 30, 195344,495PE-6050 MJune 3, 195341,370PE-20121 MJune 26, 195343,900PE-35512 MJuly 13, 19536,435340,828After they were placed, petitioner was required to and did service the above orders until the machines were shipped and placed in operation. Deliveries on the 13 orders mentioned above were made during the first 6 months of 1954 and petitioner1958 U.S. Tax Ct. LEXIS 61">*68 continued to render services in connection therewith until about December 1954. His commissions were paid after the machines had been delivered and paid for by the Ford company. Petitioner received commissions based upon the above orders as follows:DateAmountMay 1, 1954$ 3,870.23May 14, 195413,619.20June 11, 19548,637.83July 19, 19548,063.61Sept. 16, 1954626.00Oct. 28, 195491.43Nov. 19, 1954391.39Total1 35,299.69During the period 1952 to 1954, petitioner also received small orders amounting from $ 5,000 to $ 8,000 from the Ford company for certain manufacturing equipment consisting of drill and tap units manufactured by the Rehnberg Company. These machines were not a part of the machine tools to be used in the manufacture of the Ford automatic1958 U.S. Tax Ct. LEXIS 61">*69 transmission assembly. Other than those relating to the 31 T.C. 91">*95 automatic transmission tools, petitioner received commissions from Rehnberg in the years and amounts as follows: 1DateAmount1952$ 1,254.4719532,422.18No part of these commissions was for equipment to be used in the manufacture of the Ford automatic transmission assembly.1958 U.S. Tax Ct. LEXIS 61">*70 By letter dated November 15, 1956, the sales manager of Rehnberg terminated petitioner's association with that company in the following language:November 15, 1956The Frank S. Ranz Company,111 East Fourth Street,Cincinnati 2, OhioGentlemen:In view of recent cancellations on jobs you have sold and other considerations, we are taking this opportunity to cancel the exclusive sales arrangement we have had with you since 1951.We are willing to work with you on individual inquiries, and depending on developments, we may later offer a standard contract, similar to that we have with other representatives.Yours truly,Rehnberg-Jacobson Mfg. Co./s/ Irving G. JacobsonIrving G. Jacobson,Sales ManagerIn his tax return for 1954 petitioner reported the commission of $ 35,299.69 which he received for selling the automatic transmission machine tools to Ford but computed his tax thereon in accordance with the provisions of section 1301 of the Internal Revenue Code of 1954. Respondent determined that the provisions of section 1301 were not applicable to the $ 35,299.69 commission and computed petitioner's income tax liability as follows:Computation of Taxable Income Year Ended December 31, 1954Adjusted gross income disclosed by return$ 1,807.85Additional income and unallowable deductions:(a) Commissions26,474.76(b) Business expense60.50Adjusted gross income adjusted28,343.11Less: Deductions allowable in computingtaxable income:(c) Standard deduction$ 1,000.00(d) Personal exemption600.00$ 1,600.00Taxable income26,743.11Computation of Income Tax Year Ended December 31, 1954Taxable income$ 26,743.11Income tax computed under section 1 (a) of theInternal Revenue Code of 195411,200.73Self-employment tax108.00Income tax liability11,308.73Income tax liability shown on original return,Acct. No. PC 1006359$ 260.39Income tax assessed on Acct. No. 56-5151897,476.767,737.15Deficiency3,571.581958 U.S. Tax Ct. LEXIS 61">*71 31 T.C. 91">*96 OPINION.Section 1301 (a) of the Internal Revenue Code of 19542 provides that if an individual (1) engages in an employment, (2) which covers a period of 36 months or more (from the beginning to the completion of such employment), and (3) the gross compensation from the employment received or accrued in the taxable year of the individual is not less than 80 per cent of the total compensation from such employment, then the tax attributable to any part of the compensation included in the gross income of the individual shall not be greater than the aggregate tax attributable to such part had it been included in the gross income of the individual ratably over that part of the period which precedes the date of receipt or accrual.1958 U.S. Tax Ct. LEXIS 61">*72 Petitioner contends that he is entitled to allocate over the period 1951 to 1954, inclusive, commissions totaling $ 35,299.69 which he received from the sale of machine tools to the Automatic Transmission Division of the Ford Motor Company, in accordance with the provisions of this section. Respondent argues, however, that the sales 31 T.C. 91">*97 involved did not result from services extending over a period of 36 months or more and further, that they resulted from a set of unrelated services which did not constitute "an employment" within the meaning of section 1301.We find no merit in respondent's first contention. The evidence establishes that petitioner contacted representatives of the Ford company shortly after he entered into an informal contract with the Rehnberg-Jacobson Company in March or April of 1951 and carried on extensive promotional activities and negotiations with them continuously thereafter until the 13 orders involved were received, shipped, and paid for. The orders were received in 1953. However, petitioner was required to service the orders until the machines were shipped and placed in operation. He was not entitled to the commissions thereon until the machines1958 U.S. Tax Ct. LEXIS 61">*73 were shipped and paid for by the Ford company. The commissions involved were received on various dates between May 1 and November 19, 1954, in each instance more than 36 months after his contract with Rehnberg was entered into. It has been held by this Court that time spent in unsuccessful efforts as well as in preliminary exploratory work may be included in the period required by the statute. James D. Gordon, 10 T.C. 772, affirmed per curiam 172 F.2d 864; Guy C. Myers, 11 T.C. 447. See also S. Rept. No. 1622, infra.The more difficult problem is whether the commissions involved represent compensation received from "an employment" within the meaning of section 1301. Section 1301 (b) defines the term "an employment" as "an arrangement or series of arrangements for the performance of personal services by an individual or partnership to effect a particular result, regardless of the number of sources from which compensation therefor is obtained."The term "an employment" was included in section 1301 for the purpose of clarifying the words "compensation for personal services" which were 1958 U.S. Tax Ct. LEXIS 61">*74 a part of section 107 (a) of the Internal Revenue Code of 1939. In commenting on the term "an employment," the Senate Committee on Finance stated:The existing law refers simply to "compensation for personal services." The new term "an employment" is a more specific concept and, therefore, more accurately expresses the intended meaning. This aspect of the existing law has been a source of difficulty in determining the particular unit of personal services involved. In order to meet the 36-month requirement there is a tendency to combine various sets of services which in total extend over the required period. Likewise, there is a similar tendency to separate various sets of services in order to meet the requirement that at least 80 per cent of the total compensation for all of the services be received or accrued in 1 taxable year. If a taxpayer has already received a substantial payment prior to the taxable year, he may attempt to segregate the prior payment to a different 31 T.C. 91">*98 service rendered by him. In order to dispose of these difficulties, this section adopts the term "an employment." The general idea underlying the new term is that the compensation for which tax relief1958 U.S. Tax Ct. LEXIS 61">*75 is provided under this section must relate to a particular project on which the taxpayer worked, such as a particular law case, and not to a set of unrelated services which the taxpayer may have performed for the same person.The definition of "an employment" is contained in subsection (b) of this section. There, the term is defined to mean an arrangement or series of arrangements for the performance of personal services by an individual or partnership to effect a particular result, regardless of the number of sources from which compensation for such services is received. This definition will preclude a separation of services relating to a particular project, merely because the taxpayer may have received compensation for such services from different sources. Whether the period over which services are performed includes conference and study time depends upon the circumstances of the case. In general, if the compensation received specifically includes conference and study time, such time is a part of the total period over which the services were performed. The total period of an employment includes, of course, portions of the period during which the efforts of a taxpayer were unsuccessful1958 U.S. Tax Ct. LEXIS 61">*76 in effecting the particular result.Senate Report No. 1622, 83rd Cong., 2d Sess.,"Internal Revenue Code of 1954," pp. 445-446.See also the report of the House Committee on Ways and Means, H. Rept. No. 1337, 83d Cong., 2d Sess., p. A289.Petitioner argues that the sale of machine tools to the Ford company for use in manufacturing its automatic transmission assembly represented a "particular project" for which he was employed by Rehnberg. We cannot agree. An examination of the letters of March 27 and April 5, 1951, indicates quite clearly that petitioner was employed as a general sales representative to sell Rehnberg machine tools to any customers he might find in his district and that, except as to the two quotations which had been submitted by Rehnberg's president and which are not involved herein, the reference to the Automatic Transmission Division of the Ford Motor Company was no more than a lead to a potential customer. The fact that Ford used the tools on a particular project of its own did not convert petitioner's employment into an arrangement "to effect a particular result."It remains to be determined whether the arrangements by which petitioner was to represent Rehnberg1958 U.S. Tax Ct. LEXIS 61">*77 as a general salesman constitutes "an employment" within the meaning of section 1301. In our opinion it does not.The statute with which we are dealing is one granting special tax relief and as such must be closely scrutinized. Smart v. Commissioner, 152 F.2d 333, affirming 4 T.C. 846; Slough v. Commissioner, 31 T.C. 91">*99 147 F.2d 836, reversing 3 T.C. 565. Referring to the original form in which section 107 of the 1939 Code was adopted and the several amendments thereto, the court, in Smart v. Commissioner, supra, at 335, observed:From all this it appears that we have to deal with a statute which not only has been amended, but amended with a precision which, it seems to us, should forbid any assumptions that it is infused with a broad purpose, which we should ramify as the occasion may demand.This would seem to be even more true in the instant case in view of the new term "an employment" which was used in section 1301 of the 1954 Code, and which the congressional committee stated "is a more specific concept and, therefore, 1958 U.S. Tax Ct. LEXIS 61">*78 more accurately expresses the intended meaning." Both the statute and the congressional reports emphasize the particular nature of the employment required in order for a taxpayer to be entitled to the benefits of section 1301. Section 1301(b) defines the term "an employment" as an arrangement for the performance of personal services "to effect a particular result." The congressional reports state that the general idea underlying the new term "an employment" is that the compensation for which tax relief is provided must relate to "a particular project" on which the taxpayer worked, and not to a set of unrelated services which the taxpayer may have performed for the same person. See also respondent's Income Tax Regs. sec. 1.1301-2 (b).Petitioner's employment by Rehnberg was not directed to any particular project. He was at liberty to sell Rehnberg machine tools to any customer he might find in his district. His only compensation was by way of commissions based on the amount of equipment sold. Also, although the machine tools involved were used by Ford on a particular project of its own, each of the 13 orders therefor were separate and distinct. None of the 13 depended for its1958 U.S. Tax Ct. LEXIS 61">*79 effectiveness upon any of the other orders. So far as petitioner's employment was concerned, they represented the results of unrelated services.Considering all the facts and circumstances we hold that the commissions involved do not represent compensation received from "an employment" within the meaning of section 1301, and consequently, that petitioner is not entitled to compute his income tax on the $ 35,299.69 received in 1954, in accordance with the method provided by section 1301 of the Internal Revenue Code of 1954.Decision will be entered for respondent. Footnotes1. This figure is in excess of 10 per cent of $ 340,828, the total amount of the 13 orders shown above and the record discloses no explanation for the discrepancy. Petitioner testified, however, that the entire $ 35,299.69 represented commissions received by him from the order relating to the Ford automatic transmission project and respondent, in his request for findings, apparently agrees.↩1. Petitioner's Exhibit 10 on which these amounts are shown also indicates that petitioner received commissions from Rehnberg during 1955 and 1956 in the amounts of $ 191.11 and $ 3,623, respectively. Such figures are not however, strictly speaking, in evidence since petitioner, after objection thereto by respondent on the ground of irrelevancy, withdrew his offer to that portion of the exhibit. They are mentioned here in the event it should become important to show that the compensation received by petitioner in 1954 represented more than 80 per cent of the total compensation received by him from the sale of Rehnberg tools over the entire period of his employment. Cf. Ralph E. Lum, 12 T.C. 375; William J. Morrison, Jr., 12 T.C. 709; Julia C. Nast, 7 T.C. 432↩.2. SEC. 1301. COMPENSATION FROM AN EMPLOYMENT.(a) Limitation on Tax. -- If an individual or partnership -- (1) engages in an employment as defined in subsection (b); and(2) the employment covers a period of 36 months or more (from the beginning to the completion of such employment); and(3) the gross compensation from the employment received or accrued in the taxable year of the individual or partnership is not less than 80 percent of the total compensation from such employment,↩then the tax attributable to any part of the compensation which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date of such receipt or accrual. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623025/ | Alfred J. Thomas and Edith B. Thomas v. Commissioner.Thomas v. CommissionerDocket No. 68169.United States Tax CourtT.C. Memo 1960-81; 1960 Tax Ct. Memo LEXIS 208; 19 T.C.M. 428; T.C.M. (RIA) 60081; April 28, 19601960 Tax Ct. Memo LEXIS 208">*208 John E. Walsh, Jr., Esq., 1900 Land Title Building, Philadelphia, Pa., and Bernard V. Lentz, Esq., for the petitioners. Paul D. Ritter, Esq., for the respondent. FISHERMemorandum Findings of Fact and Opinion FISHER, Judge: Respondent determined deficiencies and additions to tax against petitioners for the years 1947 to 1953, inclusive, in the following amounts: Additions to TaxSec. 294Income TaxSec. 293(b)(d)(1)(A)Sec. 294(d)(2)YearDeficiencyI.R.C. 1939I.R.C. 1939I.R.C. 19391947$ 975.35$ 559.24$ 86.88$ 52.131948713.32356.6662.1637.291949795.94397.9778.4347.0619501,935.761,209.72229.00137.4019512,223.121,111.06240.66144.3919522,078.181,399.54250.47150.2819532,870.981,435.49284.13170.48All of the issues have been disposed of by stipulation of the parties except the following: (a) whether any part of the deficiency for the year 1947 and for each of the years 1949 to 1953, inclusive, was due to fraud with intent to evade taxes, and (b) whether assessment and collection of deficiencies and additions to the tax for the year 1947, and each1960 Tax Ct. Memo LEXIS 208">*209 of the years 1949 to 1953, inclusive, are barred by the statute of limitations. Findings of Fact Some of the facts are stipulated and are incorporated herein by this reference. Petitioners Alfred J. Thomas and Edith B. Thomas, husband and wife, filed their income tax returns for the years 1947 to 1953, inclusive, with the collector or district director of internal revenue at Philadelphia, Pennsylvania. Late in 1945, David C. Peace and Ezra B. Whitman established Curtis Bailey Company, a partnership, to engage in the business of purchasing real estate, developing ground, and building and selling houses. Peace and Whitman had very little money when they formed the partnership, but they expected to make a profit in the future operation of the business. In early 1946, Peace and Whitman employed petitioner Alfred J. Thomas (hereinafter referred to as petitioner) to act as building superintendent for Curtis Bailey Company. At the time Peace and Whitman employed petitioner, they were aware that he had excellent qualifications for the position, and they believed that petitioner would be very valuable to the partnership. When Peace and Whitman employed petitioner, they agreed to1960 Tax Ct. Memo LEXIS 208">*210 pay him an established salary. However, in view of the financial condition of the partnership, Peace and Whitman did not feel that they could pay petitioner a salary which would fully compensate him for his services. Peace and Whitman therefore planned to pay petitioner additional compensation in the form of bonuses over and above his established salary. The amount of the bonus was to be determined by the success of the business in the particular year involved. Peace and Whitman told petitioner that they would pay him bonuses as additional compensation over and above his salary if the business was successful. Peace and Whitman did not tell petitioner how to report bonuses for Federal income tax purposes. Curtis Bailey Company paid petitioner salary in the amounts of $5,113.57 in 1947; $5,200 in 1949; $5,550 in 1950; $7,800 in 1951; $7,800 in 1952, and $8,650 in 1953. Curtis Bailey Company withheld taxes from petitioner's salary, and both the salary and the tax withheld were correctly reported on petitioners' tax returns for the years 1947 and 1949 to 1953, inclusive. In addition to salary, Curtis Bailey Company paid petitioner additional compensation in the form of bonuses in the1960 Tax Ct. Memo LEXIS 208">*211 amounts of $3,700 in 1947; $4,800 in 1949; $11,000 in 1950; $10,000 in 1951; $10,000 in 1952; and $9,150 in 1953. The bonus payments were made by check as follows: Date of CheckAmount4/ 7/47$1,0009/12/4770011/ 7/471,00012/24/471,0003/ 2/495008/26/4950012/ 2/4950012/23/493,3006/30/502,0009/ 1/502,00011/24/502,00012/21/505,0005/11/511,0007/20/511,0008/17/511,00010/ 1/512,00012/21/515,0006/20/521,0007/18/521,00010/10/521,00011/28/522,50012/23/524,5002/13/531,0006/16/532,0007/31/531,00010/ 2/531,50012/24/533,650 Curtis Bailey Company treated the bonuses as compensation paid to petitioner. The amounts paid were claimed as expenses in the partnership records and were deducted from income on the partnership returns. Curtis Bailey Company did not withhold taxes with respect to bonuses. On their returns for the years involved, petitioners failed to report the total bonus payments which they received, and the bonus payments which were reported were labeled on the return either wholly as reimbursed expenses, or they were labeled partly as bonuses and partly as reimbursed1960 Tax Ct. Memo LEXIS 208">*212 expenses. The amounts of bonus payments which were reported and which were not reported by petitioners were as follows: Bonus Payments ReportedTotal BonusBonus Pay-Reported asPaymentsments NotReported asReimbursedYearReceivedReportedBonusesExpenses1947$ 3,700$2,000$1,700.0019494,8001,5003,300.00195011,0006,000$3,000.002,000.00195110,0005,0003,000.002,000.00195210,0002,3005,000.002,700.0019539,1503,6503,043.502,456.50In addition to salary and bonuses, Curtis Bailey Company paid petitioner reimbursed expenses in the amounts of $270.15 in 1947; $488.23 in 1949; $643.53 in 1950; $1,274.05 in 1951; $624.55 in 1952; and $500.60 in 1953. Petitioners failed to report these reimbursed expenses on their income tax returns. Petitioners' correct net income for 1947, and petitioners' income as reported for 1947, are: CorrectReportedIncome: Salary$5,113.57$5,113.57Bonus3,700.00Reimbursed Expenses270.151,700.00$9,083.72$6,813.57Less Business Expenses: Reimbursed$ 270.150Not Reimbursed800.0001,070.150Adjusted Gross Income$8,013.57$6,813.57Less Other Deductions: Charitable Contributions$ 620.00$ 620.00Interest Paid30.0030.00Taxes Paid154.27154.27Losses100.00338.00Miscellaneous02,049.82904.273,192.09Net Income$7,109.30$3,621.481960 Tax Ct. Memo LEXIS 208">*213 Petitioners' correct net income for 1949, and petitioners' net income as reported for 1949, are: CorrectReportedIncome: Salary$5,200.00$5,200.00Bonus4,800.00Reimbursed Expenses488.233,300.00$10,488.23$8,500.00Less Business Expenses: Reimbursed$ 488.23$2,216.84Not Reimbursed900.0001,388.232,216.84Adjusted Gross Income$ 9,100.00$6,283.16Less Other Deductions: Charitable Contributions$ 575.00$ 575.00Interest Paid739.00739.00Taxes Paid232.00232.001,546.001,546.00Net Income$ 7,554.00$4,737.16Petitioners' correct net income for 1950, and petitioners' net income as reported for 1950, are: CorrectReportedIncome: Salary$ 5,550.00$5,550.00Bonus11,000.003,000.00Reimbursed Expenses643.532,000.00$17,193.53$10,550.00Less Business Expenses: Reimbursed$ 643.53$1,977.55Not Reimbursed900.0001,543.531,977.55Adjusted Gross Income$15,650.00$ 8,572.45Less Other Deductions: Charitable Contributions$ 1,150.00$1,150.00Interest Paid697.63697.63Taxes Paid475.60475.60Losses100.001,800.002,423.234,123.23Net Income$13,226.77$ 4,449.221960 Tax Ct. Memo LEXIS 208">*214 Petitioners' correct net income for 1951, and petitioners' net income as reported for 1951, are: CorrectReportedIncome: Salary$ 7,800.00$7,800.00Bonus10,000.003,000.00Reimbursed Expenses1,274.072,000.00Interest16.690$19,090.76$12,800.00Less Business Expenses: Reimbursed$ 1,274.07$1,996.03Not Reimbursed900.0002,174.071,996.03Adjusted Gross Income$16,916.69$10,803.97Less Other Deductions: Charitable Contributions$ 1,580.40$1,620.60Interest Paid377.37460.00Taxes Paid346.60433.60Losses0100.00Miscellaneous36.0036.002,340.372,650.20Net Income$14,576.32$ 8,153.77Petitioners' correct net income for 1952, and petitioners' net income as reported in 1952, are: CorrectReportedIncome: Salary$ 7,800.00$7,800.00Bonus10,000.005,000.00Reimbursed Expenses624.552,700.00Interest49.780Partnership Income (or loss)44.04(4,097.07)$18,518.37$11,402.93Less Business Expenses: Reimbursed$ 624.55$2,480.01Not Reimbursed900.0001,524.552,480.01Adjusted Gross Income$16,993.82$ 8,922.92Less Other Deductions: Charitable Contributions$ 1,221.71$1,784.58Interest Paid338.94520.00Taxes Paid461.00461.00Losses0195.00Miscellaneous43.5043.502,065.153,004.08Net Income$14,928.67$ 5,918.841960 Tax Ct. Memo LEXIS 208">*215 Petitioners' correct net income for 1953, and petitioners' net income as reported in 1953, are: CorrectReportedIncome: Salary$8,650.00$8,650.00Bonus9,150.003,043.50Reimbursed Expenses500.602,456.50Interest14.030Partnership Income1,274.221,080.64Capital Gain (or loss)0(1,000.00)$19,588.85$14,230.64Less Business Expenses: Reimbursed500.600Not Reimbursed1,000.0001,500.600Adjusted Gross Income$18,088.25$14,230.64Less Other Deductions: Charitable Contributions$1,349.352,085.26Interest Paid329.12448.87Taxes Paid387.19387.19Union Dues36.0036.00Business Expenses02,456.502,101.665,413.82Net Income$15,986.59$ 8,816.82In 1950, petitioners' 1947 income tax return was examined by a representative of the internal revenue service. After examining the records given to him by petitioner, the examining agent made no addition to income for bonuses. There was no issue raised between petitioners and the agent over bonus payments. In September or October of 1953, petitioners' 1950 income tax return was examined1960 Tax Ct. Memo LEXIS 208">*216 by another internal revenue agent. The second agent examined petitioner's check book, and found that petitioner had failed to report $1,000 of bonus income. The agent discussed the failure to report the bonus income with petitioner. Petitioners' 1953 return was filed on March 6, 1954. Petitioner prepared the returns for himself and his wife for all years involved except 1953. Petitioners' return for the year 1953 was prepared by an accountant. The 1953 return was prepared from the background of petitioners' previous year's return, petitioner's 1953 W-2 statement from Curtis Bailey Company, and from information supplied to the accountant by petitioner. The bonus item included in the 1953 return was the figure which petitioner furnished to the accountant. Petitioners reported gross income of $12,800 on their 1951 income tax return. Petitioners omitted from gross income in the 1951 return the amount of $5,000 in bonuses, and $1,274.07 in reimbursed expenses, a total omission of $6,274.07. In the voucher portion of the bonus checks dated December 21, 1950, and December 21, 1951, each in the amount of $5,000 is the notation "Merry Christmas." A part of the deficiency applicable1960 Tax Ct. Memo LEXIS 208">*217 to the year 1947, and to each of the years 1949 to 1953, inclusive, was due to fraud with intent to evade taxes. Petitioners' income tax return for the year 1947, and for each of the years 1949 to 1953, inclusive, was false and fraudulent with intent to evade taxes. Opinion Commendably, the parties have disposed of all issues in this by stipulation except the issues of fraud and limitations. Fraud On issues involving the application of section 293(b) of the Code of 1939, the burden is upon respondent to prove, by clear and convincing evidence, that some part of the deficiency, for each year involved, was due to fraud with inent to evade taxes. We may also point out, however, that there is seldom direct evidence of fraudulent intent, but that such intent may be inferred and established by circumstantial evidence, including of course, the acts and omissions of the taxpayer. . We discuss briefly each of the years involved, but for convenience in the inverse order, beginning with 1953, the last year involved. Stripped of unnecessary detail, it is clear that during 1953, petitioner received five bonus checks, totalling $9,150. 1960 Tax Ct. Memo LEXIS 208">*218 Of this amount, he reported a total of only $5,500, of which $3,043.50 was designated as bonus and $2,456.50 was designated as expense reimbursed. The unreported balance was $3,650. The return for 1953 was prepared by an accountant, who specifically asked for information as to the amount of any bonuses. The amount included in the return was the figure which petitioner gave to the accountant. The failure to inform the accountant of the $3,650 omitted must have been deliberate and intentional. Not only the accountant but a revenue agent who, in 1953, prior to the time the return for that year was filed, interviewed petitioner (with the accountant present) in relation to his 1950 return, made it clear that bonus payments were taxable income. Petitioner did not take exception to their statements (and, significantly, did not inform the agent that bonus payments had been omitted in other years, or file correct amended returns for such years). For 1953, petitioner merely continued to follow the ragged pattern of partial omissions begun in 1947. The view that he thought the omitted amount of $3,650 was a Christmas gift not includible in gross income because it was dated December 24, 1953, and1960 Tax Ct. Memo LEXIS 208">*219 was accompanied by some expression of compliments of the season is not worthy of acceptance or belief, especially in the light of petitioner's position as an employee and the understandings he had with his employers in relation to compensation over and above regular salaries. It is also clear that petitioner was in no way misled by the fact that the W-2 forms did not include the bonus payments. In 1953, as well as in earlier years, to be discussed, infra, he reported part of bonuses which were not reflected in the W-2 forms. During 1952, petitioner received five bonus checks, totalling $10,000. Of this amount, he reported only a total of $7,700, of which $5,000 was designated as bonus, and $2,700 as reimbursement of expenses. The unreported balance was $2,300. The fact that he reported part of the bonuses shows that he knew that such a bonus was taxable. What was said with respect to the W-2 forms in discussing the year 1953 is equally applicable to 1952. Here, the theme varies somewhat, however, because none of the 1952 bonus checks was the same as the amount which petitioner failed to report, and there is no support whatever for any suggestion that petitioner regarded one of the1960 Tax Ct. Memo LEXIS 208">*220 checks received near the year end as in fact a Christmas gift. During 1951, petitioner received five bonus checks totalling $10,000. Of this amount, he reported a total of only $5,000, designating $3,000 as bonus and $2,000 as reimbursement of expenses, leaving $5,000 unreported. He also failed to report $1,274.07 which he actually received as reimbursement of expenses. Included in the bonus checks was a check for $5,000 dated December 21, 1951. In the voucher portion of this check appear the words "Merry Christmas." Petitioner maintains that he thought the check was a Christmas gift, not includible in gross income. We cannot accept this testimony as worthy of belief. Assuming, arguendo, that the testimony raised a doubt in our mind as to fraudulent intent, it would not change the picture, because petitioner failed to report the amount of $1,274.07 which he actually received in reimbursement of expenses. The failure to report this item affected his net income as reported to the same extent as if it were the omission of a bonus check. There is no explanation of his failure to report this amount. While the item is, in a sense, not a large one, it is too substantial to be disregarded1960 Tax Ct. Memo LEXIS 208">*221 as de minimis in the light of the over-all picture of omissions. For completeness, we add at this point that respondent, in meeting his burden need only establish that some part of the deficiency in a particular year is due to fraud with intent to evade taxes. During 1950, petitioner received four bonus checks totalling $11,000. Of this amount, he reported a total of only $5,000, designating $3,000 as bonus and $2,000 as reimbursement of expenses, leaving a balance of $6,000 unreported. Included among the bonus checks was a check for $5,000 dated December 21, 1950. In the voucher portion of this check appear the words "Merry Christmas." Petitioner takes the same position with respect to this check as he did in relation to the like check received in 1951, discussed supra, and our views are the same here as those expressed with respect to the year 1951. Again, however, this is not the whole picture, because petitioner failed to report $1,000 of his bonus receipts in addition to the $5,000 above referred to. While the pattern is a ragged one, each year involved discloses a failure to report an item or items of $1,000 or more. At least in the absence of satisfactory explanation, we cannot1960 Tax Ct. Memo LEXIS 208">*222 view these omissions as other than wilful, deliberate, and with intent to defraud. During 1949, petitioner received four bonus checks totalling $4,800. Of this amount, he reported a total of only $3,300, all of which he designated as reimbursement of expenses, leaving a balance of $1,500 unreported. In view of our discussion, supra, with respect to the years 1950 to 1953, inclusive, we need not extend our expression of views to include a further analysis of 1949, except to say that the omission was obviously a part of the over-all pattern, and that the Christmas present theory need not be considered because the year-end check bears no relationship to the amount omitted. The issues relating to 1948 have been disposed of by stipulation of the parties. During the year 1947, petitioner received four bonus checks totalling $3,700. Of this amount, he reported only $1,700, all of which he designated as reimbursement for expenses, leaving a balance of $2,000 unreported. In view of our discussion, supra, with respect to the year 1949, any further claboration of our views relating to 1947 is unnecessary. It may be noted that the amount of unreported bonuses for the years in question1960 Tax Ct. Memo LEXIS 208">*223 total $20,850. We think that the omissions disclose a pattern of wilful partial failure to report bonuses with the fraudulent intent to evade taxes. We hold, on the basis of the foregoing discussion, that some part of the deficiency for the year 1947, and for each of the years 1949 to 1953, inclusive, was due to fraud with intent to evade taxes. Limitations From our discussion of the issue of fraud, it is apparent that petitioners' income tax return for 1947 and for each of the years 1949 to 1952, inclusive, was false and fraudulent with intent to evade taxes. No issue of limitations is before us with respect to the year 1953. It is clear, therefore, that limitations do not apply to any of the years discussed in this Opinion. The issue of limitations with respect to the year 1948 has been disposed of by stipulation of the parties. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4653912/ | IN THE SUPREME COURT OF PENNSYLVANIA
MIDDLE DISTRICT
COMMONWEALTH OF PENNSYLVANIA, : No. 481 MAL 2020
:
Respondent :
:
:
v. :
:
:
JORDAN MICHAEL WALLICK, :
:
Petitioner :
:
ORDER
PER CURIAM
AND NOW, this 20th day of January, 2021, the Motion to Quash Petition for
Allocatur/Petition for Allocatur Nunc Pro Tunc is GRANTED. The Petition for Allowance
of Appeal is DISMISSED, without prejudice. | 01-04-2023 | 01-22-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4537779/ | 05/21/2020
IN THE COURT OF CRIMINAL APPEALS OF TENNESSEE
AT NASHVILLE
Assigned on Briefs January 15, 2020
STATE OF TENNESSEE v. DANIEL T. GINTHER
Appeal from the Circuit Court for Williamson County
No. I-CR077403 Michael W. Binkley, Judge
No. M2019-00112-CCA-R3-CD
The Defendant, Daniel L. Ginther, appeals as of right from the Williamson County
Circuit Court’s revocation of his probation and reinstatement of the remainder of his
eight-year sentence for passing worthless checks in the amount of $1,000 or more but less
than $10,000. On appeal, the Defendant asserts that the trial court abused its discretion
by ordering the Defendant to serve the remainder of his sentence in confinement in spite
of the Defendant’s “serious medical issues.” Following our review, we affirm.
Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Circuit Court Affirmed
D. KELLY THOMAS, JR., J., delivered the opinion of the court, in which CAMILLE R.
MCMULLEN and J. ROSS DYER, JJ., joined.
Matthew J. Crigger, Brentwood, Tennessee (on appeal); and Chelsea Brooke Curtis,
Franklin, Tennessee (at trial), for the appellant, Daniel T. Ginther.
Herbert H. Slatery III, Attorney General and Reporter; Benjamin A. Ball,
Assistant Attorney General; Kim R. Helper, District Attorney General; and Carlin
Charles Hess, Assistant District Attorney General, for the appellee, State of Tennessee.
OPINION
On November 18, 2013, the Defendant pled guilty to four counts of passing
checks with the knowledge of insufficient funds, a Class D felony. See Tenn. Code Ann.
§§ 39-14-105, -121. In exchange for his plea, the Defendant received an eight-year
sentence as a Range II, multiple offender on all counts, which were to be served
concurrently and suspended to probation subject to paying restitution within six months.
A violation of probation affidavit was filed against the Defendant on February 6,
2015, for failure to pay restitution as ordered. On April 7, 2016, an amended violation of
probation affidavit was filed, specifically alleging that the Defendant violated the
conditions of his probation because he was convicted of multiple offenses on multiple
dates in Virginia.
At the November 16, 2017 revocation hearing, the Defendant testified that he was
living in Suffolk, Virginia when he was served with the violation of probation warrant.
His probation had been transferred to Virginia after his 2013 guilty plea, and he was soon
after diagnosed with non-Hodgkin’s lymphoma. In addition, the Defendant married a
woman within three months of meeting her after his move.
While in Virginia, the Defendant placed his wife’s name on his truck title and
soon after forged her name to have it removed. The Defendant forged her name to “get
[his] truck back in [his] name because [he] was trying to get money to pay” the restitution
he owed to the Tennessee victim from the 2013 charges. The Defendant was served with
the Tennessee violation warrant on March 3, 2015, and had been in continuous custody
since. The Defendant said that he had been “diagnosed with cancer” before he was
incarcerated on March 3, 2015.
The Defendant testified that he was receiving cancer treatment while he was
incarcerated in Virginia and that he “was also diagnosed with stomach cancer” while
there. The Defendant also indicated that he had a kidney removed while in custody and
that he had been prescribed further treatment for his cancer.
The Defendant’s father lived in Suffolk, Virginia, and the Defendant said that he
could reside with him if released. This was the same Virginia address that the Defendant
had previously used for his probation. Additionally, the cancer center that the Defendant
would use for treatment in Virginia indicated that it could provide transportation for the
Defendant.
The Defendant testified that he had previously obtained a bachelor’s degree.
Subsequently, while incarcerated, the Defendant had completed two “computer classes,”
a “prep class,” and a one-year re-entry program.
The Defendant’s sentence for the Virginia offenses was a “three-year/seven-year
split.” The Defendant had served three years’ incarceration and was sentenced to seven
years of probation for those convictions. The Defendant had a probation officer in
Virginia. He planned to return to Virginia and start medical treatment. The Defendant
averred that his Virginia probation officer had approved a living arrangement with his
-2-
father and that he would be entitled to Medicare and Social Security Disability upon his
release.
On cross-examination, the Defendant testified that he had been diagnosed with
cancer in 2014, but his pre-sentence report from his 2015 Virginia charges did not
mention cancer and reported that the Defendant was “in fair health.” The Defendant
confirmed that he was aware that he had six months to pay off his Tennessee restitution
after his 2013 guilty plea.
Upon questioning about his charges in Virginia, the Defendant testified that he
altered a motor vehicle title and forged his wife’s name to get a title loan to pay his
attorney in Tennessee for work on his violation of probation charge. Additionally, the
Defendant took three televisions from the marital home to a pawn shop and received
$200. The Defendant also took his wife’s coin collection to a pawn shop. At the hearing,
the Defendant claimed he needed this money “to get some Christmas gifts”; however, in
his 2015 presentence report he stated that his wife “needed money to get back” from
Pittsburgh and that was why he pawned the items. The Defendant pled guilty to the
charges in Virginia because the prosecutor “gave [him] a deal” that he found acceptable.
Upon being questioned about additional prior felony convictions, the Defendant admitted
that he had ten grand larceny convictions, “possibly two” drug charges, and a felony
conviction for forging a bank note.
When questioned by the trial court about his cancer, the Defendant testified that
his cancer was not arrested and had continued to spread. The Defendant indicated that he
was still in treatment, but he was unaware of the cancer level. The Defendant claimed
that his stomach cancer had been successfully removed but that the cancer of his lymph
nodes was still in active treatment. The Defendant was unable to provide information or
a diagnosis dated later than October 2016. The trial court ordered the Defendant to
obtain a recent diagnosis and treatment plan from his oncologist in order to make a ruling
about the violation of probation.
On May 2, 2018, the trial court judge entered an order that both parties were in
agreement that the trial court could receive medical records from Urology of Virginia and
Bon Secours Medical Group before making a ruling. The trial court indicated that it had
briefly reviewed those records and did not find the requested information. After waiting
several more weeks, the Defendant still had failed to provide the requested information.
In an order dated January 10, 2019, the trial court reviewed the medical records
that had been presented at the November 2017 probation revocation hearing. The trial
found that the records contained “no evidence of disease reoccurrence as feared by [the
Defendant].” The trial court also noted that there “was no other significant or relevant
-3-
information in the medical records as requested by the [trial] court.” Accordingly, the
trial court found that the proof did not establish that the Defendant’s medical issues
required further treatment or that his condition could not be adequately treated in the
Department of Corrections. As a result, the trial court revoked his probation and ordered
confinement in the Department of Corrections.
The Defendant timely filed a notice of appeal. The case is now before us for
review.
ANALYSIS
On appeal, the Defendant contends that because he has “serious medical issues”
the trial court abused its discretion by ordering him to serve the remainder of his eight-
year sentence in confinement. Specifically, the Defendant notes that he “was suffering
from cancer,” that “uncontroverted testimony was that he was set to begin chemotherapy
in Virginia shortly after the [probation revocation] hearing date[,]” and that “continuing
to incarcerate [the Defendant] in Tennessee could cause a harmful delay in his
treatment.” The State responds that the trial court properly exercised its discretion in
revoking the Defendant’s probation and ordering him to serve his sentence in
confinement.
A trial court may revoke a sentence of probation upon finding by a preponderance
of the evidence that the defendant has violated the conditions of his release. Tenn. Code
Ann. § 40-35-311(e). If the trial court revokes the probation, it has the right to “extend
the defendant’s period of probation supervision for any period not in excess of two (2)
years,” “commence the execution of the judgment as originally entered,” or “[r]esentence
the defendant for the remainder of the unexpired term to any community-based
alternative to incarceration.” Tenn. Code Ann. §§ 40-35-308(c), -311(e). In a probation
revocation hearing, the credibility of the witnesses is determined by the trial court. State
v. Mitchell, 810 S.W.2d 733, 735 (Tenn. Crim. App. 1991).
Furthermore, the decision to revoke probation is in the sound discretion of the trial
judge. State v. Kendrick, 178 S.W.3d 734, 738 (Tenn. Crim. App. 2005); Mitchell, 810
S.W.2d at 735. The judgment of the trial court to revoke probation will be upheld on
appeal unless there has been an abuse of discretion. State v. Harkins, 811 S.W.2d 79, 82
(Tenn. 1991). To find an abuse of discretion in a probation revocation case, “it must be
established that the record contains no substantial evidence to support the conclusion of
the trial judge that a violation of the conditions of probation has occurred.” Id. (citing
State v. Grear, 568 S.W.2d 285, 286 (Tenn. 1978); State v. Delp, 614 S.W.2d 395, 398
(Tenn. Crim. App. 1980)); see also State v. Farrar, 355 S.W.3d 582, 586 (Tenn. Crim.
App. 2011). Such a finding “‘reflects that the trial court’s logic and reasoning was
-4-
improper when viewed in light of the factual circumstances and relevant legal principles
involved in a particular case.’” State v. Shaffer, 45 S.W.3d 553, 555 (Tenn. 2001)
(quoting State v. Moore, 6 S.W.3d 235, 242 (Tenn. 1999)).
The Defendant concedes that he violated the terms of his probation and that it was
“properly revoked.” Relative to the Defendant’s medical issues, the Defendant was the
only witness at the probation revocation hearing. The trial court requested additional
medical information in order to inform its decision after hearing the Defendant’s
testimony about his medical issues. The Defendant twice failed to provide supplemental
medical records or affidavits with a more recent diagnosis or treatment plan.
We conclude that the trial court was within its discretion to determine that the
Defendant violated the conditions of his probation by a preponderance of the evidence
and that he should serve his sentence in confinement. The Defendant’s admission that he
pled guilty to multiple crimes in Virginia and failed to pay the required restitution for the
underlying Tennessee convictions supports the trial court’s ruling. Thereafter, it was
within the trial court’s authority to order the Defendant to serve his sentence in
confinement.
CONCLUSION
Based upon the foregoing, the judgment of the trial court is affirmed.
D. KELLY THOMAS, JR., JUDGE
-5- | 01-04-2023 | 05-29-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4475911/ | OPINION. TdeneR, Judge: Pursuant to the provisions of section 311 of the Internal Revenue Code,2 the respondent has determined that petitioner was transferee of property of Kay Jelwan and, as such transferee, is liable in an amount equal to the deficiency in income tax determined against Jelwan for 1948, the addition thereto for fraud, and interest. The petitioner in this proceeding contests both the determination of the deficiency and fraud penalty against Jelwan and the determination of transferee liability therefor against her. Under section 1119 of the Internal Revenue Code, the burden of proof in such proceeding is upon the respondent “to show that a petitioner is liable as a transferee of property of a taxpayer, but not to show that the taxpayer was liable for the tax.” In his income tax return for 1948, Jelwan reported a net loss of $5,081.33. He did not report any of the gain realized from the sale of the house and furnishings at 98 Estero Avenue, nor income from any source other than the operation of Wonderland. In his determination of deficiency, the respondent increased Jelwan’s income by $71,203.92, as representing bank deposits from undisclosed and unexplained sources made by or for Jelwan in his various bank accounts in 1948. The record discloses total deposits in that year of $171,715.70. Of that amount, $90,293.06 represented transfers between bank accounts, leaving $81,422.01 to be accounted for. Of this latter amount, $5,713 represented proceeds from Series E war bonds belonging to Jelwan in a prior year, and $28,709.01 represented the proceeds from the sale of the Estero Avenue property, leaving bank deposits still unexplained in the amount of $47,000. Of the deposits covering the proceeds from the sale of the Estero Avenue property, $8,354:.50 represents the amount of taxable capital gain realized on the transaction. While the petitioner did testify that according to her knowledge Jelwan had no business operations or sources of income other than Wonderland, it is not disputed that he did have in 1948 bank deposits from unexplained and undisclosed sources in the amount of $47,000. There is some suggestion or argument that $20,000 of the amount having been deposited by Alex Massad in the Jelwan-Massad joint account, the $20,000 so deposited did, or may have, belonged to Massad. The proof shows that 15 days later $20,650 was transfered from the Jelwan-Massad account, $2,650 to the Najeeb J. Jelwan checking account and $18,000 to the Najeeb J. Jelwan Savings Account No. 6477. The proof further shows that Jelwan was given an opportunity to explain or disclose the source of the deposits in question, but made no effort to do so. It also appears that in Jelwan’s presence his accountant stated that, except for the fact that his records indicated unexplained bank deposits in a greater amount, his data was in accord with that of the revenue agent. The respondent’s determination is presumed to be correct, and bank deposits from unexplained and undisclosed sources supply an adequate basis for such determination. Goe v. Commissioner (C. A. 3), 198 F. 2d 851. See also Halle v. Commissioner, 175 F. 2d 500, affirming 7 T. C. 245; Hague v. Commissioner, 132 F. 2d 775, affirming 45 B. T. A. 104; Hoefle v. Commissioner, 114 F. 2d 713; and Leonard B. Willits, 36 B. T. A. 294. The reduction of unexplained bank deposits from $71,203.92, added to income in determining the deficiency, to $47,000, now shown of record, came about by concessions made by counsel for the respondent at the time and in the course of the trial herein. In preparing for trial, counsel caused a revenue agent to be assigned to further check and verify the évidence at hand and to obtain any other pertinent information that might be had. In the course of his investigation, the agent succeeded in further identifying Jelwan’s 1948 deposits, thereby reducing the unexplained deposits to $47,000, as above set forth. Part of the deposits were identified as proceeds of the sale of the Estero Avenue property, of which $8,354.50 represented the amount of taxable capital gain realized by Jelwan on the sale. He also discovered that during 1948 Jelwan had expended $4,624.42 for medical expenses of the type deductible under the provisions of section 23 (x) of the Internal Revenue Code, for the deduction of which no claim had been made. It is the contention of counsel for the petitioner that, by reason of these concessions at or in the course of the trial, the burden of proof as to the correctness of the deficiency has shifted from the petitioner to the respondent. The contention is wholly devoid of merit. The concessions made by counsel were not only in the interest of orderly procedure, but they relieved petitioner of a substantial portion of her burden of proof and this court of what could have been an even longer and more burdensome trial. His action was in keeping with his duty as a lawyer and officer of the Court. To rule with petitioner, would be to say that counsel, whether for respondent or petitioner, who, by concession or stipulation of pertinant facts, relieves opposing counsel of a portion of his burden of proof and the Court of needless labor, does so at the jeopardy of having the burden of the opposing party as to remaining matters shift to himself. Justice and common sense would countenance no such rule. On the facts as they appear of record, the deficiency in Jelwan’s income tax for 1948 is $15,194.86, and has been so found in our findings of fact. With respect to the fraud issue, we have concluded, and found as a fact, that the deficiency was due to fraud with intent to evade tax, and, in that connection, there is no need to again discuss the matter covered above in connection with the determination of the deficiency, which facts, along with other evidence of record, amply sustain the respondent’s determination that the deficiency was due to fraud with intent to evade tax. See Goe v. Commissioner, supra. The addition to tax determined by the respondent, pursuant to the provisions of section 293 (b) of the Code, to the extent óf 50 per cent of the above deficiency, is accordingly sustained. On the transferee issue, the evidence of record discloses that the transfers by Jelwan to petitioner were made in fraud of creditors and in partial consideration for petitioner’s executory promise to pay his future living expenses, and, by reason of the transfers so made, Jelwan was rendered insolvent. That petitioner thus became liable “at law or in equity” as transferee of Jelwan’s property, does not in our opinion require discussion or amplification. For a case where the consideration for the transfers was the promise of future support, and the determination of transferee liability was sustained, see Margaret Wilson Baker, 30 B. T. A. 188. Having shown that petitioner did become so liable, the respondent has made a prima facie case of transferee liability and the burden of going forward shifted to petitioner, .and unless the prima facie case so made is answered or rebutted by petitioner, the respondent must be regarded as having borne his burden of proof. Hutton v. Commissioner, 59 F. 2d 66, affirming 21 B. T. A. 101. To the same effect, see Robinette v. Commissioner, 139 F. 2d 285; Commissioner v. Renyx, 66 F. 2d 260; Estate of L. E. Mcknight, 8 T. C. 871; Margaret Wilson Baker, supra H. W. Trout, 27 B. T. A. 1210; and Edward H. Garcin, 22 B. T. A. 1027. For refutation of the case so made by the respondent, petitioner relies on her own testimony, certain canceled checks, various bills, invoices and other writings and, to a more limited extent, on the testimony of other witnesses, as showing that the transfers were, in part, payment of money owing by Jelwan to her; that the transfers were also made in consideration of her promise of future support and that she actually did expend $13,362.71 therefor, and to that extent the consideration was adequate and relieved her of any transferee liability which may have arisen with respect thereto; that she also paid for Jelwan’s benefit from the money received $5,609.88, to cover taxes, attorneys’ fees and payments to Wonderland; and that she thereafter paid, turned over or retransferred to Jelwan United States bonds, the Cadillac sedan, the furniture and furnishings from the basement apartment in her home, proceeds from the sale of Wonderland, and cash, amounting in the aggregate to $31,100, all to the end that she received and retained no property from Jelwan which would supply a basis, at law or in equity, for transferee liability on her part in respect of any income tax, fraud penalty, and interest found to be due and owing by Jelwan. In addition to the testimony given by petitioner at the trial herein, there are of record copies of her answer to the complaint in the Jelwan litigation, her cross complaint, both subscribed and sworn to by her, and her deposition given on August 17,1949, in preparation for trial of the said suit. The allegations in these pleadings and the testimony so given by deposition vary greatly from much of her testimony here, and in numerous instances are in direct contradiction. In fact, her testimony at the trial herein was that much of the matter stated under oath in connection with the Jelwan litigation was not true. Her explanation of such admitted disregard of her oath was that the litigation there was between herself and another individual and she was fighting back, while in this proceeding where the United States is a party the situation is wholly different and, for that reason, her testimony here should be accepted as true. Even in that statement there is contradiction of record, it being noted that the copies of the above pleadings, together with a new covering affidavit to the effect that the allegations were true of her own knowledge, were submitted to the Bureau of Internal Revenue under date of December 6, 1949, in denial of the transferee liability asserted by the respondent and now here for determination. For reasons thus appearing, and on the basis of impressions made by her while testifying at the trial herein, we are unable to give credence to her testimony except when corroborated by other evidence or where it was in the nature of admissions against interest. In support of her testimony as to the amounts expended in constructing and furnishing the apartment for Jelwan, the petitioner has placed in evidence canceled checks, amounting in the aggregate to $7,580.78, and sales slips and invoices, in a total amount of $647.93. While some of the amounts covered by the checks, sales slips, and invoices were undoubtedly used for the purposes stated, and,' to some extent, do corroborate the petitioner’s oral testimony as to use of part of the money received from Jelwan, it is apparent that all of the amounts covered thereby were not so expended. For one thing, there were duplications between the canceled checks and the sales slips and invoices. In addition, one of the checks appears to have been in payment of the premium on an insurance policy, presumably on petitioner’s home. Furthermore, there is no way of connecting various checks and sales slips with the apartment and its furnishings, except by petitioner’s oral testimony. Being convinced that some fairly substantial amount was so expended by petitioner, we have arrived at $5,500 as being in our best judgment the amount shown by the evidence to have been expended. Coha/n, v. Commissioner, 39 F. 2d 540. Of that amount, we have concluded that $1,500 covered furniture and furnishings. One of the difficulties in fixing the amount expended for furniture and furnishings was that it was not possible to determine with respect to some expenditures what amounts were attributable to movables and what amounts were for items which were attached to and became a part of the premises. Furthermore, despite petitioner’s denials, we are not convinced that all of the expenditures were for Jelwan and none for petitioner’s own account. To the contrary, we have concluded, and found as a fact, that the conversion of the garage in the basement of her home into an apartment, consisting of a living or “rumpus” room, bedroom, bath and kitchen, enhanced the value of her home in the amount of $1,500. Similarly, following the rule in the Cohan case, we have concluded, and found, that petitioner also expended in Jelwan’s behalf $1,400 to cover nursing fees, food for the nurse and Jelwan, spending money for Jelwan, and other incidentals. As to hospital and ambulance fees, doctors’ fees, attorneys’ fees, repayment of a loan to a third party, and taxes paid for Jelwan, we have accepted the canceled checks as proof of the amounts so expended. As in case of the expenditures made in Jelwan’s behalf covered in the preceding paragraph, the retransfers found by us to have been made by petitioner to him also fall substantially short of the amount claimed. We have satisfied ourselves and found from evidence of record that on some date prior to August 3, 1949, possibly in July, petitioner delivered to Jelwan United States Savings bonds which had cost $7,500 and had been issued in his name. By the instrument executed under date of October 22,1949, in settlement of the suit instituted by J elwan against her, petitioner assigned and transferred the Cadillac sedan, additional United States Savings bonds which likewise had cost $7,500, the furniture and furnishings from the basement apartment and the proceeds from the sale of Wonderland, and we have so found. We do not know, however, that Jelwan at any time actually received any part of the Wonderland sale proceeds. The sale was made in July 1949 for $13,000, of which $3,000 was applied immediately in payment of back rent, while the remaining $10,000 was placed in escrow for the payment of Wonderland’s debts. What amount, if any, remained after the debts were paid is not shown. We have been unable to find that the petitioner returned any amount to Jelwan in cash, or that any part of the money received from him was received in payment of a $3,700 balance of a prior loan to him or for salary owing for services rendered to Wonderland. Her claim that, in addition to the bonds and other property set forth above, she also returned $3,000 in cash to Jelwan in settlement of their litigation is wholly uncorroborated and, for reasons already stated, has been rejected. As to her claim that Jelwan was indebted to her, it is true that the books of Wonderland did show that the business was indebted to her in 1948 and that the balance thereof per books at December 31, 1948, was $3,700. It is further shown of record, however, that even before the transfer of the business to her on December 10, 1948, petitioner had substantial control thereof. She had equal power with Jelwan to draw checks on its bank account, had been in charge during Jelwan’s sojourns in the hospital and, from and after the transfer, and until its sale, she operated the business as her own. It does appear that between February 17,1949, and May 17,1949, petitioner did draw checks on her own bank account payable to Wonderland, aggregating $3,150, of which two checks, totaling $2,500, were deposited in Wonderland’s bank account. Except, however, for some uncorroborated general statements made by petitioner in the course of her testimony, there is nothing of record as to the operations of Wonderland in 1949 and prior to its sale in July of that year. Beyond the' above deposits of $2,500, we do not know what came into Wonderland nor what went out, whether to petitioner or to others. Such being the state of the record, the claims and contentions of petitioner with respect to Wonderland must be rejected. Our conclusions and findings as to the use and disposition of the cash transferred to petitioner by Jelwan may be summarized as follows: Cash received_ $45, 618. 09 Returned to Jelwan: U. S. Savings Bonds, at cost (delivered prior to August 31, 1949)_$7, 500. 00 U. S. Savings Bonds, at cost (transferred in October 1949, in settlement of suit)_ 7, 500. 00 Furniture and Furnishings, at cost_ 1, 500. 00 - 16, 500. 00 $29,118. 09 Expended in Jelwan’s behalf: Cost of construction of apartment, less $1,500, the amount by which the value of petitioner’s property was increased_$2, 500. 00 Hospital, ambulance, doctors’ and attorneys’ fees, repayment of loan and taxes_ 2, 960. 88 Miscellaneous, including nursing fees, food for nurse and Jelwan, spending money for Jelwan and other incidentals_ 1, 400. 00 - $6, 860. 88 Received and retained by petitioner_$22, 257. 21 One of the arguments advanced by petitioner is that by and through the retransfers made by her Jelwan’s solvency was restored and, by reason thereof, she was relieved of any liability she may have had theretofore as transferee of his property; and further, that it was incumbent on the respondent to show that Jelwan was insolvent on January 5, 1950, when the notice of transferee liability was mailed to her. The short answer is that petitioner has not shown that Jel-wan’s solvency was so restored. To the contrary, the evidence, in our opinion, shows that by reason of the transfers made to petitioner Jelwan was insolvent at all times from and after January 3,1949, and we have so found. Petitioner’s liability as transferee of Jelwan’s property up to $22,-257.21 follows from our conclusions and findings of fact to the effect that she received and retained that amount for her own benefit, and as to her liability in that amount, no further discussion is required. The question remaining is whether she is relieved of liability as to the amounts expended in Jelwan’s behalf and the amounts returned to him. By section 3439.04 of the California Civil Code, it is provided that “Every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made or the obligation incurred without a fair consideration.” Section 3439.07 of the code is to the effect that “Every conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.” Petitioner argues, however, that the return of money and property to Jelwan purged the transaction of fraud to the extent of the property so returned, and further, that a transaction in consideration of future support is valid as against creditors to the extent of the support actually furnished pursuant thereto. In support of the latter proposition above, the petitioner quotes from 37 Corpus Juris, Secundum, 971, and cites and relies on First National Bank v. Smith, 217 Cal. 394, 396; Potts v. Mehrmann, 50 Cal. App. 622, 626; Baxter v. Baxter, 19 Cal. App. 238, 239; and Taylor v. Collins and Taylor, 299 S. W. (Ky.) 1097. At no place, however, has the petitioner offered any proof or made any argument to show that the debts and fees paid in Jelwan’s behalf or that the expenditures for his subsequent support had priority over the indebtedness to the Government herein. Transferee liability having been prima facie established, it is incumbent on petitioner to make such a showing. Hutton v. Commissioner, supra; Estate of L. E. MeKnight, supra; and Margaret Wilson Baleer, supra. As to priority of claims of the United States, see also Commonwealth of Massachusetts v. United States, 333 U. S. 611; Price v. United States, 269 U. S. 492; and Powers Photo Engraving Co., 17 T. C. 393, remanded on another point (C. A. 2), 197 F. 2d 704. Petitioner’s claim that she is relieved of liability by reason of the expenditures made by her in Jelwan’s behalf is accordingly rejected. For the proposition that the return of property to Jelwan purged the fraud from the prior transfer thereof to her, to the end that she is no longer liable to the extent of the property so returned, the petitioner quotes from 37 Corpus Juris, Secundum, 1101, 24 American Jurisprudence 263, Wait on Fraudulent Conveyances, section 398, and Bigelow on Fraudulent Conveyances (rev. ed.) 482, and cites and relies on Roseman v. DeHart, 80 Cal. App. 2d 737; Taylor v. Collins and Taylor, supra; Hughes v. Hughes, 221 S. W. 970, 972; Martin v. Martin, 150 S. W. 696, 700; Fulton v. McCullough, 7 N. W. 2d 910; Cramer v. Blood, 48 N. Y. 684; Matthews v. Buck, 43 Me. 265, 268; and McCann v. Commissioner, 87 F. 2d 275, reversing 30 B. T. A. 102. The cases and authorities cited by petitioner appear to support the proposition for which petitioner contends. The respondent makes no argument except to contend that the petitioner’s claim as to the money and property returned to Jelwan is likewise defeated by the priority rights of the United States Government as against Jelwan’s general creditors. As to the money and property returned to Jelwan, it is our conclusion that petitioner should prevail, and we so hold. As to the retransfers, there was no preferring of any of Jelwan’s creditors. Jelwan was not a general creditor, but the original owner of the property in question. The return of the property to him, to the extent of the property so returned, would, in logic at least, leave his creditors, including the United States, in the same position they were in prior to the transfer by him to petitioner. It is, of course, possible that such a retransfer might be the result of collusion between the parties and made in such manner that it also would be in fraud of creditors. Such, however, was not the case in this instance. The retransfers were made in settlement of a suit which was of public record in the California court. We accordingly sustain the petitioner as to the property returned. Decision will be entered under Rule 50. SEC. 311. TRANSFERRED ASSETS. (a) Method op Collection. — The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this chapter (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting claims and suits for refunds) : (1) Transferees. — The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this chapter. | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4475912/ | OPINION. Van Fossan, Judge: The parties have, by stipulation, made certain concessions and have eliminated various items from controversy. These concessions and stipulations will be reflected in a recomputation under Rule 50. The ten questions remaining will be considered in the sequence set out in the preface to the Findings of Fact. We first consider whether the petitioner’s margin account liability to Bear, Stearns is allowable as borrowed invested capital within the meaning the section 719, Internal Revenue Code.2 During the years under review, petitioner maintained a margin account through which it purchased a large quantity of securities. These securities were held in this account to secure the payment of the balance due therein. Petitioner claimed its indebtedness on this margin account as “borrowed capital.” Respondent disallowed the inclusion of such amount within petitioner’s “borrowed capital” and here argues that such indebtedness was not evidenced by one of the seven types of instruments specifically called for in the statute. Petitioner, on the other hand, contends that in margin account transactions the relationship between customer (here petitioner) and broker (here Bear, Stearns) is that of pledgor-pledgee; that á margin account arrangement is a pledge of securities with the broker to secure loans made by the broker to the customer; and that such an arrangement as is here in question, as evidenced by the documents executed incident thereto, in law, constitutes a mortgage for borrowed capital purposes. Petitioner cites, and relies upon, Brewster Shirt Corporation v. Commissioner, 159 F. 2d 227, reversing our Memorandum Opinion. In that proceeding Brewster, in order to acquire necessary operating capital, entered into a written agreement in which it agreed to assign, as collateral security, its accounts receivable to a factor. The factor agreed to advance 90 per cent of the face value of the accounts and to pay the balance, less a stipulated charge of three-fourths of 1 per cent per month upon payment of the accounts assigned. Brewster agreed to repurchase at face value those accounts not paid at maturity, and otherwise assumed all credit risks incident to the accounts. The Court of Appeals held that the instrument, pursuant to which amounts were advanced to Brewster, constituted in law a mortgage and that the amounts so advanced were allowable as borrowed invested capital. The Brewster case is, we believe, distinguishable from the one before us and is inapplicable here. In the instant proceeding the basic agreement, as witnessed by the documents in evidence, pursuant to which the petitioner’s margin account was established and maintained, was of the sort commonly found in the investment brokerage business. As we read it, it did nothing more than establish a certain line of credit to petitioner for the purchase in the financial market of securities which were to be held as collateral against default in payment of the full purchase price. There was no actual assignment of specific securities to secure the repayment of any fixed sum to be advanced. In fact, the record discloses no advance of moneys actually received by petitioner. We cannot say that the instruments involved legally constituted a mortgage within the meaning of section 719, supra. Cf. Consolidated Goldacres Co. v. Commissioner, 165 F. 2d 542, affirming 8 T. C. 87, certiorari denied 334 U. S. 820; Bernard Realty Co. v. United States, 188 F. 2d 861; Pendleton & Arto, Inc., 8 T. C. 1302. If our judgment, that the situation here involved is distinguishable from that present in Brewster, be ill founded, then with all respect for the distinguished court that reversed our holding in the Brewster case, we adhere to the rationale of our opinion therein. We hold, therefore, that respondent did not err in his determination that petitioner’s margin account liability did not represent “borrowed capital” within the intendment of section 719, supra. The next issue involves the question of whether certain Federal Land Bank bonds, purchased and sold by petitioner in 1943, were capital assets or were held primarily for sale to customers in the ordinary course of petitioner’s business. Petitioner’s president, during the period here involved, testified that these Federal Land Bank 4 per cent bonds were purchased purely for petitioner’s house investment account. Having considered his testimony in the light of the other evidence of record, we have come to the conclusion, and found as a fact, that the bonds were not acquired for resale to petitioner’s customers in the ordinary course of its trade or business. Consequently, we hold that the bonds represented capital assets to petitioner from the sale of which it sustained a capital loss in the amount of $89,440.45. Having determined that the bonds represented capital assets to petitioner, two additional questions arise, first, whether the money borrowed to carry them represented borrowed capital, and, second, the method to be employed in computing the amortization of the bond premium paid by petitioner. As to the first, whether the amount borrowed to carry these bonds is includible in petitioner’s borrowed capital within the purview of section 719, it is to be noted that the purchase price of the bonds in question was based upon a .65 per cent interest basis yield. When petitioner effected their purchase, it borrowed substantially all of the purchase price at an interest rate of .75 per cent. Respondent has declined to include the amount so borrowed within petitioner’s “borrowed capital.” He argues in support that since the interest yield of the bonds was less than the amount actually paid to carry them, they were not acquired with any prospect of profit; that clearly no business purpose could have been served thereby; and that the transaction comes within the regulations disallowing the inclusion of an indebtedness incurred merely to increase excess profits credit. Hart-Bartlett-Sturtevant Graina Co. v. Commissioner, 182 F. 2d 153, affirming 12 T. C. 760, cited by respondent, is inapposite here. In that case, the taxpayer purchased bonds merely to create good will in the communities in which it did business. It had no intent to profit otherwise. Here, at the time the bonds were acquired, petitioner’s management entertained the mistaken belief that the interest received from the bonds would be tax exempt and the interest paid to carry them would be deductible, and that, accordingly, a profit would ensue. There is substantial evidence to the effect that this hope of profit was the only motivating factor in petitioner’s action in entering into the transaction. As soon as petitioner learned of its mistake, it forthwith took steps culminating in the sale of the bonds. There is no evidence of record which tends to show that the purchase of these bonds was motivated by petitioner’s desire to increase its excess profits credit. We are of the opinion that there was a business purpose served by petitioner’s acquisition of these bonds and in the indebtedness incurred to carry them. See Mahoney Motor Co. v. Commissioner, 192 F. 2d 508, reversing 15 T. C. 118. Respondent suggests, on brief, that it is extremely doubtful whether the form of petitioner’s obligation to carry the bonds meets the requirements of a note, mortgage, or other form of indebtedness specified in section 719. On April 5, 1943, petitioner executed a continuing loan agreement pursuant to which on the same date it executed a printed form requesting a loan of “* * * $5,014,000, payable on demand with interest at the rate of % per cent per annum, payable monthly * * When this latter instrument is considered, together with the continuing loan agreement, we think that it legally constitutes a fixed obligation to pay a sum certain on demand at a fixed rate of interest, and hence, was a de facto note. We, therefore, hold that the amount so borrowed represents “borrowed capital” within the meaning of section 719, and respondent erred in not so including it. We turn to a consideration of the proper period over which the bond premium should be amortized. In determining the deficiency here involved, the respondent reduced the cost of the bonds by amortization computed and applied pursuant to section 125, Internal Revenue Code, the pertinent portions of which appear in the margin.3 The amortization so computed and applied, was spread over the period from the date the bonds were purchased by petitioner to the earliest call date thereof. Petitioner argues that it has the right to select the period over which the amortization is spread by electing to use either any call date or the maturity date; that as soon as it was called upon to do so it expressed its election to have the bond premium amortized over a period extending from the purchase date to the maturity date thereof; that the respondent is without authority under the law to substitute his selection therefor; and that, therefore, respondent err.ed in so computing and applying the amortization to the earliest call date. We disagree. Section 125, supra, provides for the amortization of bond premiums by the obligee. It is mandatory with respect to purely tax exempt bonds. See Report No. 1631, Senate Finance Committee, 77th Cong., 2d Sess., p. 92. The amortizable bond premiums of the taxable year is the amount of the bond premium attributable to such year. Section 125 (b) (2). In the case of tax exempt bonds no deduction for the amortizable premium is allowable. Section 125 (a) (2). The legislative history of section 125 clearly shows that the total premium is to be amortized over a period extending down to the earliest call date rather than down to the maturity date. In this connection, Report No. 1631, supra, at page 94, reads, in part, as follows: The fact that a bond is callable * * * does not of itself prevent the application of this section. In the case of a callable bond, the earliest call date will, for the purposes of this section, be considered as the maturity date. Hence, the total premium is' required to be spread over the period from the date as of which the basis of the bond is established down to the earliest call date, rather than down to the maturity date. * * * See also Regs. Ill, sec. 29.125-5. In view of the foregoing, we must sustain respondent in his determination of the bond premium amortization and the period over which such amortization should be spread. The next issue involves the amounts borrowed by petitioner to finance its April 16, 1943, and September 15, 1943, subscriptions for certain United States Treasury bonds, and the amount which petitioner borrowed for its purchase in 1944 of A. T. & T. convertible debenture bonds. With respect to the indebtednesses incurred in connection with both purchases of United States Treasury bonds the specific question is whether the full amounts of such loans are includible in petitioner’s borrowed capital rather than 50 per cent thereof as determined by respondent. As for the amount borrowed to purchase the A. T. & T. bonds, the issue is whether or not any of that indebtedness is so includible. In both instances the pertinent portion of the Code is section 719. In or about April 1943, petitioner and its business associate, Blair, entered into an arrangement whereby petitioner would borrow funds to carry the purchase in its own name of $20,000,000 worth of United States Treasury bonds. On April 19, 1943, petitioner borrowed $19,800,000 of the necessary funds from Guaranty Trust Co. of New York at an interest rate of three-fourths per cent, and the bonds thus purchased were pledged as collateral therefor. On its books petitioner maintained a special account with Blair wherein it was charged 50 per cent of the interest paid to carry the bonds and credited the interest accruing on 50 per cent of the bonds. The net amount was subsequently paid to Blair. In September 1943 petitioner again entered into a similar arrangement with Blair pursuant to which petitioner borrowed an additional $19,800,000 from the Bank of America to finance the purchase in its own name of more United States Treasury bonds in the net amount of $20,000,000. This time the arrangement with Blair differed from the earlier one in that it contemplated a sharing of the profits on the bonds as well as a sharing of the interest accruing thereon. In all other respects the transaction was similar to the preceding one. A bond account was kept on petitioner’s books and 50 per cent of the net amount derived therefrom paid to Blair. Respondent has allowed 50 per cent of the indebtedness so incurred by petitioner as borrowed invested capital until November 16, 1943, and 100 per cent thereafter. He argues, on brief, that “* * * Where monies are borrowed in a joint venture or enterprise the borrower is not entitled to include in invested capital borrowing in excess of his interest in the venture.” On the record, we believe respondent made a correct determination. Albeit petitioner made the purchase of bonds in its own name, the arrangement supporting the purchase and the manner in which petitioner handled the transaction on its books, convince us that Blair was more than a passive recipient of the benefits of the deal, and, had occasion arisen to present the question, Blair would have been held to account for a 50 per cent responsibility in the loans and purchases, not only in the profits. Since each case turns on the particular facts appearing, and since no two cases present identical facts, we get little help from the cited cases. We sustain respondent’s action in respect to this item. We turn now to the question involving petitioner’s purchase in 1944 of certain A. T. & T. 3 per cent convertible debentures and the money borrowed to carry them. These bonds were bought by petitioner in the face amount of $1,000,000. The purchase price paid therefor was $1,170,000. Petitioner borrowed $1,050,000 thereof at an interest rate of 1 per cent per annum. Respondent determined that the indebtedness so incurred was not includible in petitioner’s borrowed invested capital for the reason that the primary purpose thereof was one of tax avoidance. He advances no argument on brief to support such determination. While the evidence tends to show that petitioner’s management was aware of possible tax advantages flowing from the transaction in the form of the amortization of the bond premium out of earned income, it also shows that this consideration was secondary to petitioner’s decision to enter into the transaction with the bona fide business purpose of realizing the profit which it subsequently derived. In our opinion, therefore, respondent erred in his disallowance of the amount in question as a part of petitioner’s borrowed invested capital for 1944, and we so hold. The next issue is whether respondent erred in disallowing as part of petitioner’s equity invested capital for the years 1943 and 1944 the amount of $278,240.98. Petitioner was organized in 1930 as the wholly owned subsidiary of Corporation of America, a wholly owned subsidiary of Transamerica Corporation. It was so organized to take over the assets and liabilities of two other corporations, the capital stock of which was also wholly owned by Transamerica. Upon its organization, petitioner’s capital stock, consisting of 500 shares at a par value of $1,000 per share, was issued for cash at $2,500 per share, or a total of $1,250,000. Shortly thereafter, the Liquidating Committee of the Corporation of America caused petitioner to take over certain assets of the two Trans-feror Companies, namely, seats on the San Francisco and Los Angeles Stock Exchanges at an aggregate price of $335,000. The market value of these memberships at the time they were thus taken over totaled approximately $46,500. In a later quasi reorganization Trans-america revalued its assets. During this revaluation of assets, Transamerica set up a reserve of $278,240.98, representing the difference between the value ascribed to its investment in petitioner’s capital stock and the appraised value of that investment. This reserve was subsequently credited to petitioner’s account. In computing its invested capital, petitioner has treated the $1,-250,000 cash received upon issuance of its stock as equity invested capital and added thereto the $278,240.98 subsequently so credited to it by Transamerica. Respondent, on the other hand, has determined that the amount of $1,250,000 paid in by Transamerica for petitioner’s stock at the time of its formation, in effect, included the stock exchange memberships taken in at the stated value of $335,000; that after various adjustments, this stated value was $278,240.98 in excess of the bases to the transferors; that this excess represents an abatement of the original sum paid in or a distribution to the parent corporation within the meaning of section 718 (b) and (c), Internal Revenue Code;4 and that the later credit to petitioner’s account of $278,240.98 was, in effect, a capital contribution to petitioner to reimburse it for the excessive amount at which the stock exchange memberships were taken in. Accordingly, respondent has computed petitioner’s paid-in capital to be $1,250,000. He now points out on brief that certain clerical errors were made in petitioner’s favor with respect to the computation of the amount by which the stated value of the above stock exchange memberships exceeded their bases to the transferors. However, respondent makes no affirmative claim for the sum so erroneously omitted from his original notice of deficiency and we will proceed without further references to it. At the time petitioner took over the seats in question, it gave credit to transferors in the sum of $46,250, which amount represented the market value of those assets. The balance of the price was left to the decision of a committee selected by the parties which shortly thereafter decided that petitioner should take in these memberships at a stated value aggregating $335,000. The committee rendering this decision was denominated the Liquidating Committee of the Corporation of America and was apparently formed incident to the plan whereby petitioner was organized to take over the assets and liabilities of the transferors. In any event, its activities in connection with petitioner’s organization may be regarded as an integral part of the plan therefor inasmuch as they occurred approximately contemporaneously therewith. Moreover, since the parties to the transaction were all members of the affiliated group controlled by Transamerica, the committee which was selected by them was effectively under the domination of that parent corporation and reflected its decisions. The additional charge to petitioner for these exchange memberships, pursuant to the committee’s action, actually resulted in Transamerica’s being credited back with a portion of the amount which it simultaneously therewith had paid in to petitioner’s capital. It makes no difference whether we consider this transaction as an abatement of such an amount or as a distribution under section 718, sufra. The fact is that petitioner’s authorized capital was, from its beginning, diminished by the difference between the amount which was charged for the memberships and the market value thereof. This interpretation of the transactions surrounding petitioner’s organization is lent credence by Transamerica’s subsequent actions in first creating a reserve for revaluation of the seats and then later actually crediting petitioner with the amount thereof. Respondent is, therefore, affirmed as to this issue. The next issue is whether certain securities sold by petitioner in each of the taxable years were capital assets. The securities thus sold had been held by petitioner for varying periods of time — some for more than six months, others for less than six months. Petitioner reported tbe results of all such sales as capital gains or losses. It here argues that the securities involved were held by it in its capacity as trader for its own account and risk. Respondent has determined that the securities disposed of by petitioner were not capital assets within the definition of section-117 (a), I. R. C.,5 and, therefore, the sales resulted in ordinary income or loss. In support of his determination, respondent argues that the sales in question were of securities held by petitioner, as a dealer therein, primarily for sale to customers in its ordinary course of business. This Court has consistently recognized the fact that a taxpayer, such as petitioner herein, may trade in securities on its own account and risk at the same time it is a dealer with respect to similar securities held for sale to customers. E. Everett Van Tuyl, 12 T. C. 900; Carl Maries & Co., 12 T. C. 1196; Stern Bros. & Co., 16 T. C. 295; and George R. Kemon, 16 T. C. 1026. As to those held for investment or speculation on its own account, the taxpayer is not a dealer and is not entitled td compute income on the inventory method. Such securities properly constitute capital assets. E. Everett Van Tuyl, sufra; Stern Bros. & Co., supra; George R. Kemon, supra. On the other hand, those acquired and held primarily for sale to customers in the ordinary course of business are specifically excluded from “capital assets” by the statutory definition thereof. However, securities originally acquired and held for either purpose may be freely appropriated to the other purpose at the discretion of the taxpayer exercised in good faith. Carl Maries <& Co., supra. Therefore, the ultimate question to be resolved is the purpose for which a particular security is held at the time of its sale. Such question is essentially one of fact. Stem Bros. (& Co., supra. In determining whether a particular security was or was not thus held for sale to customers in the ordinary course of business, the most crucial factor to consider is the phrase “to customers.” George R. Kemon, supra. Securities sold on an exchange are not considered as having been sold to “customers.” Thomas E. Wood, 16 T. C. 213. For that reason, a stock speculator trading on his own account is not considered to have customers. George R. Kemon, supra. In this connection, we said in the Kemon case: * * * Those who sell “to customers” are comparable to a merchant in that they purchase their stock in trade, in this case securities, with the expectation of reselling at a profit, not because of a rise in value during the interval of time between purchase and resale but merely because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost. This excess or mark-up represents remuneration for their labors as a middle man bringing together buyer and seller, and performing the usual services of retailer or wholesaler of goods. Cf. Schafer v. Helvering, supra; Securities-Allied, Corp. v. Commissioner, 95 F. 2d 384, certiorari denied, 305 U. S. 617, affirming 36 B. T. A. 168; Commissioner v. Charavay, 79 F. 2d 406, affirming 29 B. T. A. 1255. Such sellers are known as “dealers.” Contrasted to “dealers” are those sellers of securities who perform no such merchandising functions and whose status as to the source of supply is not significantly different from that of those to whom they sell. That is, the securities are as easily accessible to one as the other and the seller performs no services that need be compensated for by a mark-up of the price of the securities he sells. The sellers depend upon such circumstances as' a rise in valu.e or an advantageous purchase to enable them to sell at a price in excess of cost. Such sellers are known as “traders.” The record in the instant proceeding discloses that during the taxable years petitioner engaged in extensive trading on its own account and risk aside from its regular “dealer” business. Often such trading was in securities similar to those which petitioner was at the same time, as a dealer, selling to its customers; and during the greater part of 1943 petitioner made no segregation or identification on its general ledger accounts as to the purpose for which a particular security was held. No such identification or segregation was begun and effected until October or November, 1943. While such lack of identification and segregation is of some significance and may not be totally disregarded, we by no means feel that it decisively indicates that petitioner engaged in no trading activities on its own account or that all of the securities acquired by it, and here in dispute, were devoted to petitioner’s retail or wholesale “dealer” business. Most of the securities here in question and which petitioner claims were held for trading and speculation on its own account, were acquired through the margin account which petitioner established with Bear, Stearns. Such securities were generally held in that account until later sold through it. Prior to the establishment of the account, in January 1943, the securities involved in petitioner’s trading activities were, for the most part, purchased from or through Bear, Stearns, held in a New York depository, and then sold to or through Bear, Stearns. On a number of occasions during 1943 and 1944, various securities held in petitioner’s margin account were transferred and withdrawn to be used for retail distribution. There were a few instances when securities acquired through other means were deposited in the account. There were even times when a particular block of securities would be withdrawn, presumably to be used for retail distribution, only to be redeposited in the margin account. We do not agree -with respondent’s contention that such withdrawals and deposits conclusively show that all of the securities in question were held by petitioner, as a dealer, for sale to customers in the ordinary course of its business and, therefore, includible in petitioner’s inventory. To the contrary, the evidence, as a whole, is quite convincing that the primary purpose for the establishment and maintenance of the margin account was its use in conjunction with petitioner’s trading activities aside from its dealer business. Further, we are satisfied that such securities as were purchased through the account, held or deposited therein, were held in petitioner’s capacity as a trader on its own account until they were later either sold in that capacity or appropriated to retail distribution and sale. In its income tax return for 1943, petitioner reported long term capital gains derived from the sales of certain blocks of bonds of Kansas City, Fort Scott & Memphis Railway, Milwaukee, Sparta & Northwestern Railway, and Chicago, Milwaukee & St. Paul Railway Co. We have found that the $500,000 Kansas City, Fort Scott & Memphis bonds here in dispute were acquired through the margin account on May 3,1943; that this block was held intact in the margin account until September 17,1943, when $12,000 thereof was withdrawn to cover an earlier sale to retail of such bonds in that amount; and that bonds in the face amount of those so withdrawn were delivered into the margin account on September 27,1943, where they were held together with the remaining $488,000 thereof until sold during November and December, 1943. We hold that $488,000 face amount of the bonds in dispute was held for investment and speculation on petitioner’s own account and, therefore, constituted capital assets from the date of purchase, May 3, 1943, until the respective dates of sale in November and December, 1943. As for the $12,000 block deposited in the margin account to replace the bonds in that amount earlier withdrawn and appropriated to retail distribution, we hold that the bonds included in such block represented capital assets from and after September 27,1943. The $271,000 block of Milwaukee, Sparta & Northwestern bonds in dispute was originally acquired as a part of a $300,000 block of such bonds purchased in March 1942. An aggregate of $29,000 of the block originally acquired was sold to the public. No segregation or identification was made on petitioner’s books as to the purpose for which such bonds were bought and held. We note, also, that the bonds in question were sold to Bear, Stearns prior to the time the margin account was opened, and there is no evidence of their having been otherwise physically segregated. While the record made might possibly warrant the assumption that such bonds were sold for petitioner’s own separate trading account, there is no evidence of record to show on what date the bonds were definitely appropriated to such purposes. Consequently, for want of such evidence, we sustain respondent’s determination that these bonds were held for sale to petitioner’s customers in the ordinary course of its business. The disputed bonds of Chicago, Milwaukee & St. Paul, in an aggregate face amount of $377,000, were purchased by petitioner at various times in 1942, and $234,000 thereof was held in a New York depository until their delivery in petitioner’s margin account in January 1943. No part of this $377,000 block of bonds was ever sold to retail and the entire block was sold to or through Bear, Stearns in January 1943. On the record made, we hold that the bonds, comprising the Ijjock here in dispute, were acquired, held and sold in conjunction with petitioner’s trading activities on its own account and represented capital assets to petitioner from their respective dates of purchase. For 1944 petitioner reported as long term capital gains the profits derived from transactions involving sales aggregating 20,000 shares of United Electric & Power preferred stock. We have made detailed findings as to the purposes for which this stock was acquired and held until subsequently sold. The evidence shows that 9,300 of such shares were at one time appropriated and held to cover contracts for the sales of 46,500 shares of United Light and Railways common, when, as, and if issued to petitioner’s retail customers, and that for aught there is in the record, the 9,300 shares were so held until the date of their sale to Bear, Stearns. There is no evidence of a change in the purposes for which the shares were held prior to such date. Consequently, respondent’s action is approved in so far as it relates to 9,300 shares of the 20,000 shares in dispute. With respect to the remaining 10,700 shares, the evidence preponderates in favor of petitioner’s position that the shares were acquired, held, and sold for petitioner’s investment and speculation purposes on its own account. Respondent erred in his determination with regard thereto, and we so hold. Also, in its 1944 return, petitioner reported the loss sustained on the sale of 2,000 shares of Rustless Iron & Steel Company stock as a long term capital loss. We have found as a fact, and here hold, that such shares were acquired for petitioner’s own account and risk and not for resale to its customers. These shares, therefore, represented capital assets to petitioner, and respondent’s determination to the contrary is reversed. We turn now to those transactions during the taxable years involving the sales of securities which had been held for less than six months. There were 17 such transactions during 1943. We have found as a fact that those disposed of in 12 of the transactions had, in each instance, been acquired through petitioner’s margin account and held therein from their respective dates of acquisition, without transfer to or withdrawal for retail distribution, until sold therefrom to or through Bear, Stearns. We here hold that the securities involved in these 12 transactions were purchased, held, and sold by petitioner in pursuit of its individual trading and speculating activities, and, therefore, constituted capital assets to petitioner from the time they were respectively acquired until their respective dates of sale. The remaining five transactions in controversy included the sales of certain securities of the Colorado & Southern, Commonwealth & Southern, Consolidated Natural Gas, WAII, Pacific Mutual, and United. We have found as a fact that the Colorado & Southern bonds were acquired through petitioner’s margin account and held therein until after their retirement by the obligor. We here hold that such bonds represented capital assets to petitioner, having been purchased, and, at all times material, held by petitioner for its investment or speculation in its individual capacity as a trader. The 6,000 shares of Commonwealth & Southern stock in question were purchased through petitioner’s margin account. Thereafter, 14 such shares were withdrawn and delivered into petitioner’s possession, apparently for retail distribution. The remaining 5,986 shares were retained in petitioner’s margin account until the time of sale. On the basis of the evidence adduced relative thereto, we hold that the 5,986 shares in dispute were at' no time held by petitioner, in its capacity as dealer, for sale to customers in the ordinary course of business but were bought, held and sold incident to petitioner’s trading on its own account and risk. They constituted capital assets from the date of acquisition to the date of sale. The 6,200 shares of Consolidated stock involved herein were acquired through Bear, Stearns, by petitioner on a when, as, and if issued basis to cover its prior short sales thereof in that amount and on such basis. The evidence shows little else. In respect to these items, we are of the opinion petitioner has not successfully carried its burden of proof. We accordingly hold for respondent. Petitioner’s transactions in the Pacific Mutual stock shares were with Akin-Lambert & Co., presumably another stockbroker. During the period in question petitioner purchased an aggregate of 8,363 such shares from Akin-Lambert and sold 7,363 shares thereof to Akin-Lambert. The other 1,000 shares were transferred and sold to a retail customer. The evidence here is insufficient to enable us to determine, with assurance, the character of the transaction. Wherefore, petitioner, which had the burden of proof, must bear the onus of a failure, of proof. Respondent is affirmed. With respect to the United preferred stock disposed of by petitioner in 1943, we have found as a fact that petitioner acquired 4,000 such shares through its margin account and that 3,800 thereof were carried in that account until sold therefrom to Bear, Stearns, 200 such shares having been appropriated and withdrawn for retail distribution. We here hold that the sale of the 3,800 shares in controversy resulted in short term capital gain derived from petitioner’s trading activities on its own account and risk. In 1944 petitioner entered into a number of transactions wherein it sold certain securities which had been held by it for less than six months. Such securities had, in most instances, been purchased for petitioner’s margin account and held therein intact until sold. There were, however, those instances where the securities sold were the remainder of a larger block which had been so acquired and portions of which had been transferred and withdrawn for retail distribution. There was also one transaction entailing the sale of certain bonds that had been purchased on a when, as, and if issued basis and held until after the issuance thereof. Moreover, some of the securities in question were held in a bank as collateral. Certain of the transactions, which are here the subject of controversy, culminated in the sale of 4,500 shares, 17,400 shares and 3,595 shares of Allis-Chalmers, Electric Bond & Share, and North American, respectively. Excepting these latter transactions and those involving the securities of Chicago & North Western and Western Pacific, both of which have been presented and considered as separate issues herein, it is our conclusion that none of the securities involved therein were property held by petitioner primarily for sale to customers in the ordinary course of its business. Bather, they were acquired for petitioner’s speculation purposes on its own account and were thus capital assets. ' Begarding the securities of Allis-Chalmers, Electric Bond & Share, and North American that were sold, our conclusion is the same only with respect to 4,400 shares, 17,100 shares, and 2,675 shares thereof, respectively. The next issue is whether 20,000 shares of Chicago & North Western preferred stock sold by petitioner subsequent to October 14,1944, represented capital assets to petitioner. Bespondent has determined that the entire 20,000 shares represented stock in trade to petitioner available for sale to" customers in the ordinary course of its business. As noted above, whether the status of a particular security held by an investment broker is that of stock in trade, held primarily for sale to customers in the ordinary course of business, is purely a question of fact. Those pertinent to this issue have been set forth in our findings of fact. As to the 14,725 shares purchased WAII subsequent to May 8, 1944, the evidence clearly shows that they were acquired and held by petitioner as a trader for investment or speculation. The record is specific that petitioner’s acquisition of such shares was part of a plan to accumulate a sizeable block thereof in anticipation of a proposed dividend. With regard to the remaining 5,275 shares, the contracts under which they were acquired may well have been purchased for petitioner’s retail business, the record not showing otherwise. However, upon issuance of the stock, on July 21, 1944, these shares were placed, together with the foregoing 14,725 shares, in an account where they were held for the same purposes pursuant to the above-described plan for accumulation until later sold. The appropriation of these shares to such ends indicates a definite change of petitioner’s intentions with respect thereto and effects a transmutation of the shares from whatever their earlier nature may have been to property held for investment or speculation purposes on petitioner’s own account. See Stern Bros. & Co., supra. We hold, therefore, that the shares in question constituted capital assets to petitioner from and after July 21,1944. The next question presented is whether petitioner’s sale in 1944 of 22,174 shares of Western Pacific preferred stock, pursuant to its earlier WAII sell contracts, resulted in short term capital gain, as reported by petitioner, or in ordinary income, as determined by respondent. Prior to the time the transaction at issue took place, petitioner had contracted to purchase 38,928 shares of Western Pacific Pfd. stock WAII. It had contracted to sell a total of 16,754 such WAII shares to its customers and an aggregate of 22,174 such WAII shares to Bear, Stearns. We are here concerned with the sale made pursuant to petitioner’s contracts with Bear, Stearns. These contracts included those for the sale of 9,774 shares, which contracts were executed prior to November 1, 1944, and those entered into after November 1, 1944, for the sale of 12,400 shares. The sales contracts were covered by similar purchase contracts with Bear, Stearns, executed before and after November 1, 1944, respectively. Such purchase contracts were, at all times material, in excess of petitioner’s sell contracts with its customers. It is our conclusion that both blocks represented capital assets to petitioner at the time of their acquisition and sale. Accordingly, we so hold. The next issue relates to certain dividends that petitioner received during the taxable years on its holdings of 2,986 shares of Commonwealth & Southern stock, 3,400 shares of Allis-Chalmers stock, 20,000 shares of Chicago & North Western 5 per cent Pfd. stock, and 2,000 shares of Rustless Iron & Steel stock. The specific question is whether or not the securities involved represented capital assets to petitioner on the dates such dividends were respectively declared and received. If so, the amount of the dividends so. received thereon is not includible in petitioner’s excess profits net income pursuant to section 711 (a) (2), I. R. C.6 Our holdings hereinabove set forth are dispositive of this issue. In view thereof, we now answer the question posed in the affirmative and hold that the securities in dispute, namely, 2,986 shares of Commonwealth & Southern stock, 3,400 shares of AUis-Chalmers stock, 20,000 shares Chicago & North Western 5 per cent Pfd. stock, and 2,000 share of Rustless Iron & Steel stock, constituted capital assets to this petitioner on the critical dates involved. The next issue is whether petitioner’s assignments in 1944 of certain contracts for the purchase of new securities of Chicago & North Western WAII resulted in long term capital gain, as reported by petitioner. The facts pertinent to this issue are briefly these: During 1942 and 1943, petitioner entered into contracts with its customers to sell them various new securities of Chicago & North Western WAII. These sell contracts were usually covered by purchase contracts made with Bear, Stearns on or about the same dates. On December 31,1943, the quantity of new bonds and preferred stock which petitioner had contracted to sell WAII exactly equalled the quantity it had contracted to purchase WAII. With reference to the new common stock, petitioner had such contracts for the purchase of 49,995 shares and for the sales of 37,924 shares. Between April 29 and May 18, 1944, petitioner assigned certain of the purchase contracts for each type to Bear, Stearns, Contemporaneous with such assignments, petitioner entered into contracts with Bear, Stearns for the purchase of the same quantity of new securities which it had so assigned. The assignments were recorded on petitioner’s books as being of property having been held for house investment account, while the securities in the same quantity repurchased concurrently therewith were set up “To cover short sales.” Petitioner’s position that the contracts so assigned were property held for its own investment or speculation purposes separate and apart from its dealer business, is based primarily upon the testimony of its president during the period involved. This testimony was to the effect that beginning in late 1943, petitioner segregated the contracts and securities and identified them as to the purposes for which they were held. However, the documentary evidence relative to the Chicago & North Western Pfd. stock WAII, while strongly indicating that such securities were originally acquired and held to cover petitioner’s sales contracts with its customers, fails to show that any segregation or appropriation to other purposes was made prior to the time each individual assignment was effected and recorded. Moreover, petitioner’s actions prior to and during the period of transactions here constitute better evidence of its purposes than does testimony based upon memory and hindsight. In this connection, it is of significance to note that no other securities of the type were acquired to cover petitioner’s sales to its customers until the time of the assignments in controversy. Further, simultaneously therewith, petitioner entered into contracts with its assignee for the purchase of the same quantity of new securities WAII as the quantity which it had assigned. Such transactions enabled petitioner to derive a substantial profit on which it would be taxed at capital gains rates and at the same time contract to repurchase the identical securities to cover its customer commitments with any loss subsequently sustained thereon being deductible. Under such circumstances, we are of the opinion that the Commissioner was justified in disregarding the transaction, Higgins v. Smith 308 U. S. 473, and in determining that the amounts in controversy are taxable as ordinary income. Cf. Stewart Silk Corporation, 9 T. C. 174. Inasmuch as the parties have stipulated that the accounts and entries with respect to the Chicago & North Western bonds WAII and common stock WAII, also here involved, were of the same nature, what we have said above is equally applicable to the transactions involving those securities. It is our conclusion that respondent did not err in his determination with respect thereto, and we so hold. There remains for our consideration the question of admissible and inadmissible assets for computing petitioner’s excess profits credit under the invested capital method. The pertinent portion of the statute involved is section 720,1. R. C.7 The parties are in agreement that such corporate stocks as we have herein held to represent capital assets and the tax exempt bonds involved, constitute inadmissible assets. They are in disagreement as to the proper treatment to be accorded the various contracts to purchase and to sell certain securities'when, as, and if issued. Petitioner cites and relies upon I. T. 3721, 1945 C. B. 164, to support its contention that the contracts to buy securities WAII constitute items of property separate and apart from the contracts to sell securities WAII, and that, therefore, its assets must include not only the investment in the purchase contracts but also the gross amounts receivable under the sales contracts. Respondent presents no argument as to the applicability or inapplicability of the cited ruling. He takes the position that such contracts have no cost until the liability to perform comes into force; that having no cost, the contracts cannot increase the total of admissible assets; and that, furthermore, the contracts to buy were, in the main, a hedge against the contracts to sell and offset each other. Thus, the question here resolves itself into whether the contracts, as assets, are to be recognized as individual items of property, or “gross basis,” rather than on an “offset” or “net basis” in which the total of contracts to buy and contracts to sell are set off against each other and the net result of all items is utilized. The ruling cited and relied upon by petitioner provides, in part: The usual situation in which trading in securities on a “when issued” basis takes place is one in which there is submitted a plan of reorganization of a corporation providing for the issuance, in exchange for its outstanding securities, of securities of a new corporation or of new securities of the reorganized old corporation. Before such a plan of reorganization actually becomes effective the approval of the interested security holders must be obtained or the plan must be approved by regulatory bodies or the courts. There is often litigation as a result of which the plan of reorganization may be abandoned or approved in a modified form. The time elapsing between the submission of the plan and the actual exchange of old securities for new securities under the plan, or the plan as modified, may be as much as several years. After the submission of the plan of reorganization, trading may be commenced in the new securities which are to be issued under the plan of reorganization. Inasmuch as these new securities are not in existence, and will never come into existence if the plan of reorganization is not carried out, the trading is on the basis of “when, as, and if issued,” commonly called “when issued.” The trading is carried on by the execution of contracts for the purchase and sale -of the new securities “when issued” at specified prices. Continuing, the ruling sets out several specific examples in which it is held that when a taxpayer, who does not own old stock of a particular corporation, enters into a contract to buy or sell the new securities of that corporation when, as, and if issued, “* * * acquires the right to purchase (or to sell) that s'tock when it is issued * * *” and that “* * * the right so acquired constitutes a ‘capital asset’ as that term is defined in section 117 (a) (1) of the Code * * Further, when such taxpayer “* * * enters into a ‘when issued’ buy or sell contract and some time thereafter enters into a ‘when issued’ sell or buy contract at a different price with the result that, provided the reorganization is consummated, he is assured of a profit from the combination of the two contracts * * *, the contract to buy and the contract to sell are to be treated as entirely separate capital assets.” Moreover, it is ruled that while a “when issued” contract to buy or to sell may have cost the taxpayer nothing in cash at the time it was executed, nevertheless, such taxpayer had obligated himself to carry out the contract pursuant to its terms, and this obligation should be treated as part of the contract’s basis in the taxpayer’s hands in determining his gain or loss on its disposition. I. T. 3721, supra, is an interpretation of section 117,1, it. C., and involves the question of whether “when issued” contracts are capital assets within the meaning of that section, and, if so, the proper treatment thereof for Federal tax purposes. Hence, the conclusions expressed therein are restricted “* * * to transactions entered into by investors and traders in securities but are not applicable to transactions entered into by dealers in securities where such transactions constitute a part of the business of dealers in securities.”8 No question arises here as to the status of the contracts in dispute, i. e., whether or not they are capital assets. However, the rationale of the foregoing ruling would appear applicable to the instant situation in so far as it relates to the treatment of such contracts as separate items of property and as to the tax bases to be used therefor. Such application devitalizes the position taken by respondent. Therefore, we hold that the contracts in controversy are to. be recognized as individual assets, i. e., on a “gross basis” rather than on a “net basis” in computing the percentage of inadmissible to total assets under section 720, supra. Cf. Modesto Dry Yard, Inc., 14 T. C. 374. Reviewed by the Court. Decision will be entered under Rule 50. SEC. 719. BORROWED INVESTED CAPITAL. (a) Borrowed Capital. — The borrowed capital for any day of any taxaole year shall be determined as of the beginning of such day and shall be the sum of the following: (1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus, ******* (b) Borrowed Invested Capital. — The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day. SEC. 125. AMORTIZABLE BOND PREMIUM. (a) General Rule. — In the case of any bond, as defined in subsection (d), the following rules shall apply to the amortizable bond premium (determined under subsection (b)) on the bond for any taxable year beginning after December 81, 1941: ******* (2) Interest wholly tax-exempt. — In the case of any bond the interest on which is excludible from gross income, no deduction shall be allowed for the amortizable bond premium for the taxable year. ******* (b) Amortizarle Bond Premium.— (1) Amount of bond premium. — For the purposes of paragraph (2), the amount of bond premium, in the case of the holder of any bond, shall be determined with reference to the amount of the basis (for determining loss on sale or exchange) of such bond, and with reference to the amount payable on maturity or on earlier call date, with adjustments proper to reflect unamortized bond premium with respect to the bond, for the period prior to the date as of which subsection (a) becomes applicable with respect to the taxpayer with respect to such bond. In no case shall the amount of bond premium on a convertible bond include any amount attributable to the conversion features of the bond. (2) Amount amortizable. — The amortizable bond premium of the taxable year shall . be the amount of the bond premium attributable to such year. (3) Method op determination. — The determinations required under paragraphs (1) and (2) shall be made— (A) in accordance with the method of amortizing bond premium regularly employed by the holder of the bond, if such method is reasonable. (B) in all other cases, in accordance with regulations prescribing reasonable methods of amortizing bond premium, prescribed by the Commissioner with the approval of the Secretary. • * * * * * * (d) Definition of Bond. — As used in this section, the term “bond” means any bond, debenture, note, or certificate or other evidence of indebtedness, issued by any corporation and bearing interest (including any like obligation issued by a government or political subdivision thereof), with interest coupons or in registered form, but does not include any such obligation which constitutes stock in trade of the taxpayer or any such obligation 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 any such obligation held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. [[Image here]] SEC. 718. EQUITY INVESTED CAPITAL. [[Image here]] (b) Reduction in Equity Invested Capital. — Tbe amount by which the equity invested capital for any day shall be reduced as provided in subsection (a) shall be the sum of the following amounts— (1) Distributions in previous years. — -Distributions made prior to such taxable year which were not out of accumulated earnings and profits; (2) Distributions during the year. — Distributions previously made during such taxable year which are not out of the earnings and profits of such taxable year; ******* (c) Rules for Application of Subsections (a) and (b). — Por the purposes of subsections (a) and (b).— (1) Distributions to shareholders. — The term “distribution” means a distribution by a corporation to its shareholders, and the term “distribution in stock” means a distribution by a corporation in its stock or rights to acquire its stock. To the extent that a distribution in stock is not considered a distribution of earnings and profits it shall not be considered a distribution. A distribution in stock shall not be regarded as money or property paid in for stock, or as paid-in surplus, or as a contribution to capital. [[Image here]] SEC. 117. CAPITAL GAINS AND LOSSES. (a) Definitions. — As used in this chapter— (1) Capital assets. — The term “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include— (A) 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; [[Image here]] SEC. 711. EXCESS PROFITS NET INCOME. (a) Taxable Teaks Beginning After December 81.1939.. — The excess profits net income for any taxable year beginning after December 81, 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: ******* (2) Excess profits credit computed under invested capital credit. — If the excess profits credit is computed under section 714, the adjustments shall be as follows: (A) Dividends Received. — The credit for dividends received shall apply, without limitation, to all dividends on stock of all corporations, except that no credit for dividends received shall be allowed with respect to dividends (actual-or constructive) on stock of foreign personal holding companies or dividends on stock which is not a capital asset. [[Image here]] SEC. 720. ADMISSIBLE AND INADMISSIBLE ASSETS. (a) Definitions. — For the purposes of this subchapter— (1) The term “inadmissible assets” means— (A) Stock in corporations except stock in a foreign personal-holding company, and except stock which is not a capital asset; and (B) Except as provided in subsection (d), obligations described in section 22 (b) (4) any part of the interest from which is excludible from gross income or allowable as a credit against net income. (21 The term “admissible assets” means all assets other than inadmissible assets. (b) Batió of Inadiiissip.les to Total Assets. — The amount by which the average invested capital for any taxable year shall be reduced as provided in section 715 shall be an amount which is the same percentage of such average invested capital as the percentage which the total of the inadmissible assets is of the total of admissible and inadmissible assets. For such purposes, the amount attributable to each asset held at any time during such taxable year shall be determined by ascertaining the adjusted basis thereof (or, in the case of money, the amount thereof) for each day of such taxable year so held and adding such daily amounts. The determination of such daily amounts shall be made under regulations prescribed by the Commissioner with the approval of the Secretary. The adjusted basis shall be the adjusted basis for determining loss upon sale or exchange as determined under section 113. By special letter ruling dated August 18, 1950, I. T. 3721 was held to apply to a corporate dealer in securities where such contracts are acquired for investment purposes and not in conjunction with its business as a dealer in securities. | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623054/ | SPIRITUAL OUTREACH SOCIETY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSpiritual Outreach Soc. v. CommissionerDocket No. 23387-87XUnited States Tax CourtT.C. Memo 1990-41; 1990 Tax Ct. Memo LEXIS 41; 58 T.C.M. (CCH) 1284; T.C.M. (RIA) 90041; January 23, 1990Michael A. Markenson, for the petitioner. William I. Miller, for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined that Spiritual Outreach Society (petitioner) was a private foundation within the meaning of section 509(a). 1 Having exhausted its administrative remedies, petitioner is before this Court, pursuant to section 7428, seeking a declaratory judgment as to the correctness of*44 respondent's action. The issues for decision are whether respondent properly determined that petitioner does not qualify as a church within the meaning of sections 509(a)(1) and 170(b)(1)(A)(i) and whether respondent properly determined that petitioner is not a publicly supported organization as described in sections 509(a)(1) and 170(b)(1)(A)(vi). This case was submitted under Rule 122. The parties have filed a joint stipulation as to the administrative record pursuant to Rule 217(b)(1). The evidentiary facts and representations contained in the administrative record are presumed to be true for the purpose of this proceeding. Petitioner was incorporated on December 5, 1978, under the laws of Missouri, by Thomas H. Ward, Dennis R. Hammond, and Michael A. Markenson. Petitioner's initial board of directors and officers included Thomas H. Ward, president, Richard M. Ward, vice president, and James E. Johnson, treasurer. Petitioner's purposes, as set forth*45 in Articles of Incorporation, were as follows: ARTICLE SIXThe corporation is formed for the following religious purposes: (1) To spread the message of God's Love and Hope throughout the world; to bring all people to an awareness of the similarities present in the world's different religions and of the fact that the different religions of the world are but alternate pathways to a single goal - the one Supreme Being, God; that, though the world's different religions worship God in different ways, the object of that worship is, in each instance, the one, omnipotent God. (2) To provide a place in which religious teachers who believe in the existence of God may espouse their views and teachings. (3) To provide a place in which those who believe in the existence of God may present religious music to any persons interested in hearing such. (4) To provide a place in which those who believe or are interested in the existence of God may listen to the exposition of the various religious teachings and religious music described in Sections 2 and 3, above. (5) To distribute books, pamphlets, literature, records, tape recordings and other miscellaneous items relating to the various*46 religious teachings and religious music described in Sections 2 and 3, above and to provide a library where such may be borrowed by interested persons. (6) To write, print and distribute a newspaper relating to the various religious teachings and religious music described in Sections 2 and 3, above. (7) To disseminate the various religious teachings and religious music described in Sections 2 and 3, above, through whatever medium or media, including the public media, may be available. (8) To provide a campsite in which those interested in the various religious teachings and religious music described in Sections 2 and 3 above, might camp on a temporary basis when visiting to take part in the activities of the Society. (9) To provide various commodities to the needy and thereby spread the teachings of God. (10) To exercise any and all powers necessary, convenient or proper to carry into effect any of the foregoing purposes and for the execution of said purposes, the corporation shall have all powers granted to corporations formed under "The General Not For Profit Corporation Law of Missouri," as now enacted or hereafter amended. Petitioner's Articles of Incorporation further*47 provided: ARTICLE SEVENThe corporation shall have authority to issue one hundred (100) certificates of membership at a price of One and No/100 Dollar ($ 1.00) each, subject to the following terms and conditions: (1) No membership certificate shall be transferable other than by testamentary succession, except with the affirmative vote of two-thirds of the membership. (2) The holders of membership certificates shall be entitled to cast one (1) vote at the election of directors of the corporation for each membership certificate held by such holders. * * * In March 1979, petitioner applied for exemption as an organization described in section 501(c)(3) by filing Form 1023, on which it claimed it was a church. Petitioner's counsel later requested that its application be treated as an application as a religious organization rather than a church. On February 27, 1980, respondent issued petitioner an advance determination letter granting it tax exempt status until November 30, 1983. This letter also stated that because petitioner was a newly created organization, a final determination of its foundational status under section 509(a) was being withheld but that it could reasonably*48 be expected to be a publicly supported organization described in sections 509(a)(1) and 170(b)(1)(A)(vi). On May 9, 1984, respondent issued a favorable determination letter stating that petitioner was not a private foundation within the meaning of section 509(a) because it was an organization of the type described in sections 509(a)(1) and 170(b)(1)(A)(vi). On February 27, 1984, petitioner revived the request for classification as a church. On April 23, 1987, respondent issued a final adverse determination letter concluding that petitioner was not a church and was not a "public charity." Based upon this adverse determination, petitioner instituted the instant proceeding. At the outset, it is important to note that respondent does not challenge petitioner's qualification as a religious organization under section 501(c)(3). Rather, respondent asserts that petitioner is a private foundation within the meaning of section 509(a)2 and that petitioner fails to establish itself within the exceptions set forth in section 509(a)(1) for a church, under section 170(b)(1)(A)(i), and a publicly supported charity, under section 170(b)(1)(A)(vi). 3*49 Petitioner bears the burden of proof. Rule 217(c)(2)(ii); Foundation of Understanding v. Commissioner, 88 T.C. 1341">88 T.C. 1341, 1356 (1987). *50 We first address respondent's determination that petitioner is not a church. Respondent contends that petitioner does not qualify as a church because it does not satisfy the associational requirement and because it fails to meet the bulk of the 14 criteria used by respondent to identify organizations which qualify for church status. 4 Petitioner counters by contending that it satisfies the associational test and most of the 14 criteria. We agree with respondent. *51 As we stated in Foundation of Understanding v. Commissioner, 88 T.C. at 1356: "The term 'church' is not defined in the Internal Revenue Code. Nor are the regulations promulgated under section 170 helpful in deciding what is a church. They simply restate the statutory language of section 170(b)(1)(A)(i). Sec. 1.170A-9(a), Income Tax Regs. It seems clear, however, that Congress intended that the word 'church' have a more restrictive definition than the term 'religious organization.'" (Fn. ref. omitted.) Although fundamental to determining whether an organization is a church, religious purposes alone do not serve to establish it as a church. Equally important are the means by which its religious purposes are accomplished. We take a common sense approach and posit our conclusion on the meaning of "church" in ordinary, everyday parlance. The word "church" implies that an otherwise qualified organization bring people together as the principal means of accomplishing its purpose. Chapman v. Commissioner, 48 T.C. 358">48 T.C. 358, 367 (1967) (Tannenwald, J., concurring). See also *52 Foundation of Understanding v. Commissioner, 88 T.C. at 1357, quoting from American Guidance Foundation , Inc. v. United States, 490 F. Supp 304, 306 (D. D.C. 1980), affd. without opinion (D.C. Cir., July 10, 1981)("At a minimum, a church includes a body of believers or communicants that assembles regularly in order to worship").5 Thus, a church is a cohesive group of individuals who join together to accomplish the religious purposes of mutually held beliefs. "In other words, a church's principal means of accomplishing its religious purpose must be to assemble regularly a group of individuals related by common worship and faith. * * * To qualify as a church, an organization must serve an associational role in accomplishing its religious purposes." Church of Eternal Life v. Commissioner, 86 T.C. 916">86 T.C. 916, 924 (1986). Petitioner has failed to establish that it satisfies the associational requirement. Petitioner maintained an outdoor amphitheater on its grounds. During June through October 1, 1983, petitioner held bimonthly musical*53 programs at the amphitheater, for a total of approximately 8 events during 1983. Also, similar programs were held from April 28 through October 13, 1984, for a total of 12 events during this year. No other regularly scheduled religious or musical services were held during these years. Petitioner held its bimonthly musical programs on Saturdays so that people could attend their own churches on Sundays. While it did not charge admission as such to these events, there was a published schedule of "donations" for adults, senior citizens, and children which, under the circumstances herein, are akin to charges for admission, particularly since there is nothing in the record to show that a person could attend the event without making the appropriate "donation." During 1983 and 1984 petitioner held various other sporadic events and gatherings. During the summer of 1983, several retreats were held on the church grounds wherein followers of different religions met for the purpose of meditation study and spiritual advancement. In July 1983, a revival was conducted by guest ministers. In addition, during 1983 and 1984, petitioner made use of its outdoor amphitheater to hold a total of*54 three other music festivals open to the public. The musical festival and revival held on May 28 and May 29, 1983, attracted approximately 300 persons. The festival held on May 26 and 27, 1984, attracted several hundred people, and the festival held on September 1, 1984, attracted at least 1,400 people. A typical regularly scheduled bimonthly program consisted of two or three hours of singing and playing gospel music. Congregational singing was always a part of the program. A typical summer special event included a variety of religious music featuring a nationally known individual or group. A minister always opened and closed the program with prayer. Petitioner maintained a chapel on its grounds which was open to the public daily for meditation and individual prayer. Persons attending the programs at the outdoor amphitheater also utilized the building for such meditation and prayer as did others from time to time during the year. No other religious services were conducted in the chapel. Two wedding ceremonies were conducted in petitioner's chapel during 1983 and 3 were conducted during 1984 by ministers from guest churches. *55 Although we have declined to adopt respondent's 14 criteria as a test for determining what constitutes a church, we have stated that they are helpful in deciding what is essentially a factual question. Foundation ofUnderstanding v. Commissioner, 88 T.C. at 1358. We are not unmindful that there are some factors militating in petitioner's favor, including the fact that petitioner has a distinct legal existence and a building used for meditation and prayer. Further, we are aware that petitioner is a newly-created rural organization and that some of the stated criteria may therefore be inapplicable. We note, however, that petitioner has no ecclesiastical government, reflecting the belief of Thomas Ward that "Jesus Christ's whole life and teaching contradicted ecclesiastical government and forms, procedures, liturgy, formalities, and ceremonies and emphasized the spirit, and not the letter, of the law; indeed, Jesus Christ had no requirement for meetings, dress, and ceremonies and had no chain of command." Petitioner does not have its own literature, songs, or prayers; rather, it uses those of world-wide recognized religions. This type of activity does not constitute*56 a recognized creed and form of worship. Petitioner does not have an organization of ordained ministers nor does it have a school for the preparation of its ministers. Petitioner does not have a Sunday school for the religious instruction of the young. Nor does the record reflect that petitioner has ever had an ordained minister of its own. While a definitive form of ecclesiastical government or organizational structure may not be required, we are not persuaded that musical festivals and revivals (even if involving principally gospel singing, as petitioner's activities along these lines did) and gatherings for individual meditation and prayer by persons who do not regularly come together as a congregation for such purposes should be held to satisfy the cohesiveness factor which we think is an essential ingredient of a "church." See p. 8, supra. This critical associational factor was present in our resolution of the church issue, which we described as a "close question," in Foundation of Understanding v. Commissioner, supra, as were other factors not present herein. See *57 88 T.C. at 1359-1361. We hold that petitioner has not carried its burden of proof that it is entitled to classification as a church under sections 509(a) and 170(b)(1)(A)(i). See note 4, supra. We next address the issue of whether respondent properly determined that petitioner was a private foundation within the meaning of section 509(a) because it does not fit within the exception of section 170(b)(1)(A)(vi). Under section 1.170A-9(e)(2), Income Tax Regs., an organization is to be treated as publicly supported if the contributions which it normally receives from governmental units and contributions from the general public equal at least 33-1/3 percent of the support the organization normally receives. An organization may also qualify as a publicly supported organization if it meets the facts and circumstances test set forth in section 1.170A-9(e)(3), Income Tax Regs. Petitioner does not claim to satisfy the mechanical 33-1/3 percent test; rather, it argues that it qualifies as a publicly supported organization under the facts and circumstances test. We disagree. Under the facts and circumstances test, an organization must: (1) receive at least 10 percent*58 of its support from governmental or public contributions ( sec. 1.170A-9(e)(3)(i), Income Tax Regs.); (2) be so organized and operated as to attract new and additional public support on a continuous basis ( sec. 1.170A-9(e)(3)(ii), Income Tax Regs.); and (3) satisfy some or all of a number of factors relating to the percentage of financial support ( sec. 1.170A-9(e)(3)(iii), Income Tax Regs.), sources of support ( sec. 1.170A-9(e)(3)(iv), Income Tax Regs.), representative governing body ( sec. 1.170A-9(e)(3)(v), Income Tax Regs.), availability of public facilities or services and public participation in programs or policies ( sec. 1.170A-9(e)(3)(vi), Income Tax Regs.), and other factors pertinent to membership organizations (sec. 1.170A-9(e)(3)(vii), Income Tam Regs.). In determining whether petitioner satisfies the 10 percent public support requirement of section 1.170A-9(e)(3)(i), Income Tax Regs., contributions by an individual, trust, or corporation shall be taken into account, in determining the numerator of the applicable fraction, only to the extent that the total amount of the contributions by any such individual, trust, or corporation does not exceed 2 percent of the organization's*59 total support for the prescribed time period; all contributions made by a donor and by any person or persons standing in a relationship to the donor which is described in section 4946 (a)(1)(C) through (G) and the regulations thereunder are treated as made by one person. Sec. 1.170A-9(e)(6), Income Tax Regs. Grouping related persons into three groups and utilizing the prescribed periods designated in section 1.170A-9(e)(4), Income Tax Regs., respondent has recalculated his original figures and has determined that petitioner received 8.67 percent from public support for taxable year ending November 30, 1983, 10.72 percent from public support for taxable year ending November 30, 1984, and 10.74 percent from public support for taxable year ending November 30, 1985. Petitioner has not made any meaningful challenge to respondent's revised calculations and therefore we conclude that petitioner has failed to satisfy the 10 percent public support requirement for its 1983 taxable year and has scarcely satisfied this requirement for its 1984 and 1985 taxable years. Petitioner fails to satisfy the second requirement of the facts and circumstances test, namely, that it be so organized and*60 operated as to attract new and additional public or governmental support on a continuous basis. Petitioner has made no effort to solicit funds from the general public or the community other than to give notice through the local media of its regularly scheduled summer musical programs and special events. In this regard, we recognize that there were requested donations for both the regularly scheduled bimonthly programs and the special presentations. However, we think that this is not the type of public support embodied in the regulations, and, as we have previously indicated, see p. 9, supra, is more accurately characterized as an admission price. We recognize that petitioner's building was available to the public for silent worship and devotions and its library (consisting of religious books of various faiths, records, and tape recorded sermons and lectures) was open to the public. But these elements are insufficient to support a conclusion that, under the facts and circumstances test, petitioner was a publicly supported organization, particularly when we take into account the facts that petitioner has satisfied the 10 percent public and government support requirement by*61 a narrow margin and received a substantial amount of its support from three families or their businesses. We hold that respondent's determination that petitioner is a private foundation should be sustained for the foregoing reasons. Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code as amended and in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Such section provided in pertinent part: (a) General Rule. -- For purposes of this title, the term "private foundation" means a domestic or foreign organization described in section 501(c)(3) other than -- (1) an organization described in section 170(b)(1)(A) (other than in clauses (vii) and (viii) [which have no relevancy to the instant case]); * * * ↩3. Sec. 170(b)(1)(A)(i) and (vi) provided: (b) Percentage Limitations. -- (1) Individuals. -- In the case of an individual, the deduction provided in subsection (a) shall be limited as provided in the succeeding subparagraphs. (A) General Rule. -- Any charitable contribution to -- (i) a church or a convention or association of churches, * * * (vi) an organization referred to in subsection (c)(2) which normally receives a substantial part of its support (exclusive of income received in the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501(a)) from a governmental unit referred to in subsection (c)(1) or from direct or indirect contributions from the general public. * * *↩4. These criteria were first announced in a speech by former Commissioner Jerome Kurtz. See Remarks of IRS Commissioner Jerome Kurtz, PLI Seventh Biennial Conference on Tax Planning (Jan. 9, 1978), reprinted in Fed. Taxes (P-H) par. 54,820 (1978). These criteria include: (1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a definite and distinct ecclesiastical government; (4) a formal code of doctrine and discipline; (5) a distinct religious history; (6) a membership not associated with any other church or denomination; (7) an organization of ordained ministers; (8) ordained ministers selected after completing prescribed studies; (9) a literature of its own; (10) established places of worship; (11) regular congregations; (12) regular religious services; (13) Sunday schools for religious instruction of the young; and (14) schools for the preparation of its ministers. [See Internal Revenue Manual 7(10)69, Exempt Organizations Examination Guidelines Handbook 321.3(3)(Apr. 5, 1982).]↩5. See also First Church of In Theo v. Commissioner, T.C. Memo. 1989-16↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623055/ | L.W. HARDY CO., INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentL.W. Hardy Co. v. CommissionerDocket Nos. 12736-81, 24243-81.United States Tax CourtT.C. Memo 1987-63; 1987 Tax Ct. Memo LEXIS 59; 52 T.C.M. (CCH) 1540; T.C.M. (RIA) 87063; January 29, 1987. Stephen E. Silver and Brad S. Ostroff, for the petitioner. David W. Otto, for the respondent. CLAPPMEMORANDUM FINDINGS OF FACT AND OPINION CLAPP, Judge: Respondent determined deficiencies in petitioner's Federal income taxes as follows: YearDeficiency1975$1,022,3401976497,878197768,8301978157,322Following concessions by the parties, 1 the issues for decision are: (1) Whether the sale and leaseback transactions in question were part of a tax avoidance scheme without business purpose or economic substance and which must be disregarded for Federal income tax purposes; and (2) Whether petitioner held sufficient attributes of ownership to be treated as the owner, for Federal*60 tax purposes, of property that was the subject of the sale and leaseback transactions. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. BackgroundPetitioner L.W. Hardy Co., Inc. ("petitioner") is an Arizona corporation with its principal place of business at Kingman, Arizona. During the years in issue, the primary business of petitioner was the mining and sale of turquoise. Petitioner mined turquoise at various locations in Arizona, and after the application of certain processes to the turquoise, sold it on the wholesale market. Petitioner was formed in 1968 by Leonard Hardy ("Hardy") and his wife Geraldine Hardy, who are the controlling shareholders of petitioner. Beginning in 1974, the worldwide market*61 for turquoise increased substantially primarily due to an increased demand for Indian and turquoise jewelry. Petitioner was a primary beneficiary of the increased demand since it controlled much of the world's production of turquoise. By 1975, the gross revenues of the company had increased dramatically to approximately $13,000,000. The market for turquoise peacked in 1975. GCCIn 1974, Greyhound Computer Corporation ("GCC"), a subsidiary of the Greyhound Corporation ("GHC"), whose stock was publicly traded, was one of the largest IBM computer equipment leasing corporations in the United States, with operations in Canada, Mexico, the United Kingdom, and Europe. GCC owned computer equipment with a cost basis of $425,000,000, comprised if IBM System 360 and 370 equipment, as well as computer equipment from various other manufacturers, and operated 10 data centers in the United States providing computer services to customers. In 1973, GCC purchased the stock of Bresnahan Computer Corporation (Bresnahan"), Traleascorp, Inc. ("Traleascorp"), and its sister corporation, D.S., Inc. In 1974, GCC purchased the stock of EDP Resources, Inc. ("EDP"). GCC made these purchases to*62 acquire the underlying portfolios of computer equipment owned by these companies. Richard Stephan ("Stephan"), a Certified Public Accountant, was vice president and controller of GCC. In late 1973 or early 1974, Stephan was contacted by someone of E. F. Hutton in Rochester, New York, about the possibility of a sale and leaseback of computer equipment with GCC. Stephan had meetings with E. F. Hutton in Rochester during the summer and fall of 1974 to discuss a possible sale and leaseback transaction which E. F. Hutton would syndicate. The transaction was not consummated. However, a sale and leaseback transaction with E. F. Hutton was consummated at a later date. Clarence RenouardClarence Renouard ("Renouard"), who first brought petitioner and GCC together, had a substantial background in computer sales and computer price performance analysis. In 1972, Renouard established Hamilton Investment Co., which was predominantly involved in real estate transactions and personal property investments. Renouard and Stephan began discussing the possibility of Hamilton Investment Co. representing GCC in the sale and leaseback of computer equipment in Arizona. Stephan was interested*63 in entering into sale and leaseback transactions with Arizona investors, believing that transactions with local investors could be structured with smaller overhead than the E. F. Hutton transaction. Renouard was retained by GCC in February 1975, to represent GCC in the sale and leaseback on IBM 360 and plug compatible computer equipment. Renouard was to receive a commission of 2.4 percent of the investor purchase price, of which 1.7 percent would be paid on closing and .7 percent paid throughout the term of the lease. Renouard was also to participate in GCC's marketing fee. In June 1975, Hamilton Investment Co. brought to GCC 3 Arizona investors -- petitioner and 2 individuals -- who entered into sale and leaseback transactions with GCC's subsidiaries. Analysis of InvestmentIn 1973, John Cronkhite ("Cronkhite"), a partner in Collins, Davies and Cronkhite, Ltd., a law firm specializing in the commercial and tax areas, was retained to represent petitioner on all legal matters. As part of his duties, Cronkhite was requested to review investment opportunities for petitioner. In April 1975, Cronkhite's senior partner, Robert Collins, informed Cronkhite that he had reviewed*64 a computer equipment investment proposal submitted by Renouard to one of his clients, found it meritorious, and suggested that Cronkhite review it for petitioner. Cronkhite reviewed the offering memorandum prepared by Hamilton Investment Co.: Proposed Computer Systems Investment * * * a leveraged computer purchase-leaseback investment potentially capable of generating significant tax savings and other cash profit benefits." The offering memorandum proposed the purchase of used IBM 360 computer equipment for $730,000 from GCC or one of its subsidiaries and the leaseback of the equipment for a term of 74 months. The introductory paragraph of the offering memorandum stated: The proposed computer system "purchase-leaseback" is a "leveraged lease" offering significant economic and tax benefits to the investor. This is especially true for the investor whose combined federal and state income tax rate is in the 54% or higher bracket and who has continuing investmentincome from other sources. A portion of the offering memorandum entitled "Highlights of Proposed Computer Investment" gave a brief summary of the terms of the investment as follows: LESSOR: Individuals, corporations, *65 or partnerships that will invest 9.2% or more of equipment cost as investment equity. LESSEE: Greyhound Computer Corp and/or other subsidiary company. LEASE TERM: 6 years, 2 months with rentals payable monthly. EQUIPMENT: IBM 360 systems equipment (used). EQUIPMENT COST: $730,000 INVESTMENT: $67,000 equity investment (9.2% of equipment cost). FINANCING: $620,000 loan at 12% annual interest, plus a $43,000 balloon note at 12% interest only with principal due in 74th month. FINANCING SOURCE: D.S. Inc., or EDP Resources, or other financing sources. FINANCING TERMS: Notes are non-recourse liability to investor. Debt is secured by assignment of lease rentals and a first lien on the computer equipment by D.S. Inc., EDP Resources, or other financing source. INVESTMENT TAX CREDIT: Not applicable. MANAGEMENT: The lease is a net lease with Greyhound Computer Corp and/or a subsidiary company responsible for all maintenance, insurance, taxes (other than taxes on investor's net income), and other costs in connection with the possession and use of the equipment during the lease term. EQUIPMENT RESALE OR RE-LEASE: Greyhound Computer Corp. or a subsidiary will sell or re-lease*66 the computer equipment at the end of the lease term, under an incentive arrangement, at maximum fair market value for top profit potential to the investor. The tax benefits outlined in the offering memorandum were deductions for depreciation on the equipment and for interest paid on the financing of the purchase price. The memorandum advised, however, that well before the expiration of the lease term, the investment might generate income tax liabilities in excess of the monthly net rental proceeds. Additionally, the memorandum warned that the ultimate disposition of the computer equipment as well as other events might result in a substantial tax liability to the investor. The offering memorandum also included charts reflecting the tax writeoff by year assuming a 54 percent tax bracket (combined Federal and state). As described in the memorandum, a $67,000 cash investment would produce a $34,000 net loss over the 6 year 2 month period of the transaction. The net cash flow to the investor would total $39,738 over the term of the lease and if a 15 percent residual value were realized at the end of the lease term, after paying off the balloon note ($43,000), an investor would realize*67 additional cash before taxes of $43,050. Under these circumstances, the cash received by the investor on the entire transaction would total $82,788 on an investment of $67,000. The following chart is included in the memorandum: INVESTORTOTAL EXPENSES AND DEPRECIATIONRENTALDEPREC-INTERESTINCOMEIATION *BALLOONNOTE **TOTALTOTALSat 12%at 12%INTEREST1 1975 - 7 mos.$ 90,825($219,000)($3,010)($55,135)($58,145)($277,145)2 1976155,700(153,300)(5,160)(65,123)(70,283)(223,583)3 1977155,700(119,233)(5,160)(55,108)(60,268)(179,501)4 1978155,700(119,233)(5,160)(43,822)(48,982)(168,215)5 1979155,700(82,734)(5,160)(31,106)(36,266)(119,000)6 1980155,700(5,160)(16,777)(21,937)(21,937)7 1981 - 7 mos.90,825(2,580)(2,456)(5,036)(5,036)$960,150($693,500)($31,390)($269,527)($300,917)($994,417)NET TAXABLEINVESTORINCOMETAX SAVINGS *(LOSS) *(PAYMENTS)at 54% RATE1 1975 - 7 mos.($186,320)$100,613 2 1976(67,883)36,657 3 1977(23,801)12,853 4 1978(12,515)6,758 5 197936,700 (19,818)6 1980133,763 (72,232)7 1981 - 7 mos.85,789 (46,326)($34,267)$18,505 *68 The memorandum described the income tax risks of the investment as including (1) that the tax aspects of the proposed transaction are complex and not completely free from doubt, and (2) that the tax benefits of the investment might not be realized and substantial tax liabilities incurred by reason of changes in the tax law and that proposals for changes are being considered by Congress. The offering memorandum described the economic risks associated with the investment as including that at the end of the lease term the marketing agent might not be able to re-lease or sell the computers on reasonable terms due to, among other things, obsolescence of the computers, and that the investor may suffer an overall economic loss on the purchase, lease, and ultimate disposition of the equipment. The memorandum described at length the residual*69 value aspect of the investment, which would determine whether the investor would realize a profit. The memorandum charted taxable income projections, tax savings, after-tax cash flow and potential earnings from the after-tax cash flow. Cronkhite thoroughly reviewed the offering memorandum with his partner, Robert Collins, met with Renouard on at least 4 or 5 separate occasions and had a similar number of telephone conversations with Renouard to go over various aspects of the proposal. At one of the early meetings, Renouard gave Cronkhite a copy of GCC's 1974 annual report, a copy of "A Special Datapro Report" and a copy of an article from the April 18, 1975, edition of the Wall Street Journal. The Wall Street Journal article, entitled "Planned Outlays for Computers, Related Gear are Slashed by Big Firms as Recession Move," was provided to Cronkhite to show that, at the time, major corporations were looking at IBM 360 equipment rather than newer IBM 370 equipment because of better price and performance considerations. The Datapro Report, published by Datapro Research Corporation, was given to Cronkhite because it provided a description of the features, functions, risks, and*70 benefits of the equipment that would form the portfolio of computer equipment to be acquired from GCC and/or its subsidiaries. GCC's Annual Report was given to Cronkhite to underscore the size and expertise of GCC, GCC's involvement with the IBM 360 line of computer equipment, and the value to an investor of having GCC involved in ths transaction. The Annual Report, however, also identified potential risks which could prevent the recovery of the investment in GCC's computer equipment, including uncertainties as to rental and interest rates and the significant decline in sales values of certain IBM System 360 equipment during 1974. Cronkhite was concerned with the residual value of the equipment, as he concluded early in his review that this would affect whether or not petitioner would realize a profit in this transaction. Accordingly, Cronkhite posed questions to Renouard to satisfy himself that the residual value projections in the offering memorandum were realistic. Cronkhite die not, however, attempt to independently verify the residual value projections. Renouard told Cronkhite that the residual value of the equipment after the 74-month lease term would be conservatively*71 15 to 20 percent of petitioner's purchase price, which would result in a profit of between $62,644 and $121,044. Renouard stated that this would be a profitable transaction and that 15 percent was the minimum residual value as this translated to approximately 5 percent of the original cost of the equipment purchased new. Renouard also told Cronkhite that the ratio of CPUs (Central Processing Units) to peripherals would be one-third to two-thirds and that the mix of equipment was important because peripherals should generally have a longer useful life due to their compatibility with newer generation IBM equipment. In May 1975, Renouard presented Cronkhite with samples of the legal documents which would be used to effectuate the sale and leaseback. Cronkhite met with the principals of petitioner to show them the offering memorandum and explain the transaction, including profit potential and tax deferral. Cronkhite informed them that his law firm believed the investment to be meritorious and recommended that petitioner enter into the investment. The principals questioned Cronkhite about the investment and were informed of his belief that it had a profit potential of approximately*72 $100,000, was a good investment, and had tax advantages. Petitioner, relying on this advice, agreed to purchase $2,920,000 worth of IBM 360 (and plug compatible) equipment from the GCC subsidiaries. A few days prior to closing, Cronkhite reviewed the underlying documentation, including lists of the actual computer equipment petitioner was purchasing, the purchase price allocable to each piece of equipment, the name of the end user, and the location of the equipment, along with a revised offering memorandum for petitioner. Stephan assigned dollar amounts to each piece of equipment, the sum of which made up the purchase price paid by petitioner. Stephan consulted GCC personnel responsible for monitoring computer equipment prices. In determining the purchase price, Stephan took into account the fact that the computer equipment (1) was properly configured into a working system, (2) was (or soon would be) on lease and generating income, (3) did not have to be moved, installed, or tested, and (4) was under maintenance by IBM or other appropriate maintenance vendors. Neither GCC nor Cronkhite sought an independent appraisal. The new offering memorandum presented to Cronkhite before*73 the closing was identical to the earlier one except that it provided for the purchase of $2,920,000 of computer equipment and the down payment and note amounts were changed in proportion to the new purchase price. The residual value schedule, the remarketing and promotional fees, and the various charts were changed to reflect the purchase price. The TransactionOn June 13, 1975, the sale and leaseback transactions between petitioner and GCC and its subsidiaries, EDP, Bresnahan and Traleascorp, were closed. Present for petitioner were Hardy and Cronkhite. Attending for GCC and its subsidiaries were Stephan, GCC attorney L. Gene Lemon, GCC general counsel and secretary Lavan Kasarjian, and Renouard. Three separate equipment purchase agreements were executed by the parties, covering $292,000 of IBM 360 computer equipment (CPUs and peripherals) from Bresnahan, $2,190,000 of IBM 360 computer equipment (CPUs and peripherals) from EDP, and $438,000 of Tracor and Bucode IBM 360 plug compatible computer equipment (peripherals only) from Traleascorp. The purchase agreements were identical except for the purchase price and payment terms and the schedule of equipment purchased. *74 Each purchase agreement contained a schedule identifying the manufacturer, unit, model/feature, and serial number of the computer equipment, the name of the sublessee, location of the equipment, expiration date of the sublease and the purchase price paid by petitioner for the equipment. Each purchase agreement warranted that the equipment was "in good operating condition and repair, is not subject to any known defects or deficiencies and is either (i) on lease and subject to an effective maintenance agreement with the manufacturer, or (ii) on lease and subject to an effective maintenance agreement which is the substantial equivalent of that described in clause (i) hereof." The agreements warranted that the seller owned all of the equipment free and clear of all liens and encumbrances except for the rights of lessees under the leases described in the schedules attached to the agreements. Pursuant to each of the purchase agreements, petitioner made a cash down payment, executed a promissory note secured by the computer equipment pursuant to a separate chattel mortgage and security agreement, and paid a loan fee or points in the following amounts: SellerDown PaymentPromissory NoteLoan Fee or PointsBresnahan$26,800265,200$5,190EDP201,0001,989,00038,925Traleascorp40,3002 397,8007,785*75 The promissory notes, each executed on June 13, 1975, accrued interest at the rate of 12 percent per annum and obligated petitioner to make 73 equal consecutive monthly payments of principal and interest commencing July 13, 1975, plus a final principal payment with one month's interest on August 15, 1981, in the following amounts: Final PaymentSellerMonthly PaymentsPrincipalInterestBresnahan$4,975$17,200$172EDP37,314129,0001,290Traleascorp7,46325,800258The three secured promissory notes provided for an extension of the final principal payments by the execution of replacement notes bearing the same rate of interest and payable in installments not less frequent than quarterly and due not more than two years from the date of issue if all of the following conditions were met on the August 15, 1981, due date: (1) the fair market value of the computer equipment was at least equal to the principal amount outstanding on the secured promissory note; (2) petitioner was still the*76 true and lawful owner of the computer equipment, free of all liens, encumbrances, and security interests other than the chattel mortgage and security agreement executed with the payees and any subleases with users of the equipment; (3) the previously executed chattel mortgage and security agreement remained a valid and enforceable lien on the equipment; (4) petitioner was not in default in any of its obligations to the payee; and (5) petitioner had given the payee thirty days' written notice that the final payment on the secured promissory note would be made by the issuance of a replacement note specifying the final maturity. Three separate lease agreements were executed between petitioner, as lessor, and EDP, Bresnahan, and Traleascorp, as lessees, commencing on June 13, 1975, and terminating on August 15, 1981. The agreements provided for monthly rental payments over the 74 month period of the lease due on the 13th day of each month commencing of June 13, 1975, and ending on July 13, 1981, in the following amounts: 3Bresnahan$5,190EDP38,925Traleascorp7,785$51,900*77 The lease agreement provided that the lessee's use of the equipment was restricted to the purpose for which it was designed and that modifications could be made only with petitioner's approval and at lessee's expense. The location of the equipment could be changed by the lessee only if reports showing the location of each item of equipment were furnished by the lessee. At the end of the lease term, the lessee was required, at its own expense, to deliver possession of the equipment to petitioner at the equipment's then location, or in the case of equipment not under sublease, to a mutually agreed upon location. The lease agreement also provided that the lessee was responsible for the cost of maintenance under an IBM or equivalent maintenance agreement, and was required to make the equipment or records relating to performance available for inspection by authorized representatives of petitioner. The lessee was also to assume the entire risk of loss, damage or destruction of the equipment during the term of the lease. Further, the lessee could not encumber the equipment, and was required to pay all assessments, taxes, etc. on the lessor's net income. The lessee was authorized to*78 provide a sublessee with the option to buy the equipment. In the event a sublessee exercised any option to purchase the leased equipment, the lessee could substitute similar equipment of substantially equal value upon prior written notification to petitioner identifying by manufacturer, model, and serial number the substituted equipment and the substituting equipment. All subleases had to be with terms and conditions generally as favorable as the terms and conditions in the lessee's leases on its own equipment. The lessee was required to obtain petitioner's consent to any assignment of the leases and no assignment or subleases relieved the lessee of its obligations under the lease. Petitioner could assign the lease by giving notice of the assignment to the lessee. Title to the equipment was to remain in petitioner, and the lessee was obligated to protect such title from any adverse claims. The lessee was to be entitled to possession of the equipment so long as no event of default occurred. Default was defined as the lessee's failure to make any payment of rent within 10 days of the due date, failure to perform any required act upon 10 days' written notice, or insolvency or*79 bankruptcy of the lessee. Upon default, petitioner could declare the entire remaining rent due and payable, obtain return of the equipment at lessee's expense, re-lease or sell repossessed equipment with 5 days' notice of sale to the lessee. In the event of a re-lease or sale, the lessee was required to pay the difference between the purchase price obtained at sale, or the rental to be received from any third person, and the total unpaid rents for the balance of the lease, together with all costs and expenses, including attorney fees, incurred by petitioner. The lease agreements provided petitioner a security interest in all of the lessee's contract rights under subleases. The monthly payments of rent to petitioner were made by the lessee's wire transferring monthly rental payments to petitioner's account at First National Bank of Arizona. The bank then disbursed, after each such receipt, the monthly payments due by petitioner on the promissory notes. An exclusive marketing agency agreement was executed appointing GCC as petitioner's exclusive marketing agent for a term of two years after the expiration of the original leases. Pursuant to this agreement, GCC was empowerd to, *80 for and on behalf of Owner, to either sell the Equipment, or to lease the Equipment or otherwise to transfer possession or ownership thereof, at the option of the Owner, and Agent shall use its best efforts to negotiate and consummate the most favorable arrangements for such leasing, sale or disposition of the Equipment; provided, however, Agent shall not consummate any such arrangement prior to the delivery of the Equipment to Owner pursuant to the lease agreement entered into by Owner on the same date as the date of this Agreement and concurrently herewith. For these services, petitioner agreed to pay GCC a commission based upon the net proceeds realized from GCC's efforts. The commission schedule set forth the following schedule of payments: It the net proceeds were:The amount to GCC was:Between $176,000 and20% of the excess over $176,000$232,000 Between $232,000 and$11,200 plus 25% of the excess$292,000 over $232,000Between $292,000 and$26,200 plus 30% of the excess$350,400 over $292,000Between $350,400 and$43,720 plus 50% of the excess$408,800 over $350,400Over $408,800 $72,920 plus 60% of the excessover $408,800*81 The term "net proceeds" was defined in the exclusive marketing agency agreement as the total proceeds received from the sale of the equipment and the then present value of all firm rent proceeds due under any sublease of the equipment, less all direct expenses of sale or lease, property taxes, and costs of relocating, insuring, and maintaining the equipment. Any outstanding debt owed by petitioner on the equipment would not reduce "net proceeds." GCC was authorized to collect the proceeds due petitioner as owner from the sale or lease of the equipment, withhold any commissions due GCC under the terms of the agreement, and remit the remainder to petitioner, along with an itemized statement of gross proceeds received, the nature of the transaction, GCC's fee, and all direct expenses and relocation costs charged to petitioner. GCC was permitted to purchase or lease the equipment from petitioner for fair market value, which would be established by a good faith third party bid made within the last 30 days or, if there were no bids, at an independently determined appraised value. The exclusive marketing agency agreement provided petitioner with the right to (1) take any lawful action*82 with respect to the sale or lease of the equipment, (2) specify the manner of sale, and (3) examine GCC's books and records pertaining to the equipment. The 1975 Computer MarketIBM 360 computer equipment was first introduced into the market place in the mid 1960s. The IBM 360 was the first line of computer equipment which offered a wide range of compatibility with other IBM computer equipment. The IBM 370 line of computers, first introduced about 1971, was considered only a half-generation advancement from the IBM 360 line. As a result of an economic recession in the United States, large corporations were cutting back on planned outlays for computer equipment in 1975 and began actively purchasing or leasing IBM 360 CPUs and peripherals rather than the newer lines of IBM 370 equipment. IBM 360 equipment could perform much the same work as IBM 370 equipment, the programs were interchangeable, and IBM 360 peripherals could be used with IBM 370 CPUs. In March 1975, IBM abandoned plans for its "Future System" (its next generation of computers). In May and June of 1975, the prices for used IBM 360 equipment increased. Certain publications also speculated around this time*83 that the useful life of IBM 360 equipment could be expected to lengthen as a result of IBM's announcement and an increased demand for used equipment due to the recession. The History of the TransactionOn June 13, 1975, the computer equipment purchased by petitioner and leased to EDP, Bresnahan, and Traleascorp, for monthly rent totalling $51,900, was being subleased to various end users comprised of substantial corporations, banks, universities, and GCC data centers for monthly rents totalling over $74,676. During the next 74 months, petitioner received quarterly reports on its computer equipment. For the period through the quarter ended December 31, 1978, such quarterly reports separately identified the lessee, each piece of computer equipment, the name of the sublessee, the location of the equipment, and the monthly rental paid by the sublessee. For the period up to the quarter ended June 30, 1981, a condensed quarterly report was sent to petitioner identifying the lessee and the total monthly rental paid by all sublessees to that lessee. During the term of petitioner's leases, EDP, Bresnahan, and Traleascorp were liquidated and all their assets and liabilities, including*84 these leases, were transferred to and assumed by GCC. By letter dated June 26, 1981, GCC informed petitioner that its final note payments were due on August 15, 1981. Along with this letter, petitioner received a current listing of its computer equipment, indicating that the equipment was generating monthly rental income from subleases in June 1981 of $16,205 and that such equipment, based upon existing subleases, would produce firm rental income after August 15, 1981, of $165,526.58 without regard to extensions of such subleases, any future subleases, or sales. Petitioner's options at the expiration of the leases were to (1) forfeit the equipment and allow foreclosure on the nonrecourse balloon notes, (2) retain the equipment and pay GCC $173,270, or (3) retain the equipment and exercise its option under the secured promissory notes to execute a new note secured by petitioner's equipment, providing the conditions of the original notes were met. Renouard advised petitioner's then legal counsel, James Silhasek, that based upon his meetings with GCC, the firm future rentals of $165,526.58, and his review of the equipment and subleases, petitioner would be best to satisfy its obligation*85 on the balloon notes and not forfeit the equipment. On August 15, 1981, petitioner, through receipt of rental payments, had recovered all but $111,196 of its initial cash payments of $319,900 ($268,000 principal and $51,900 loan fees), had paid off all 3 promissory notes except for the balloon obligations due GCC in the amount of $173,720, and its equipment was on lease with firm lease payments due petitioner of $165,526.58. Petitioner elected to pay off the outstanding balance of $173,720 by executing a new secured promissory note dated August 15, 1981, at 12 percent interest with a term of two years. The terms of the August 15, 1981 note authorized GCC to apply all proceeds derived from the marketing of petitioner's equipment pursuant to the June 13, 1975 exclusive marketing agency agreement to the outstanding principal and interest obligation. Following the execution of these notes, GCC sent petitioner quarterly reports reflecting for each month (1) rental proceeds; (2) sales proceeds; (3) description of the equipment sold including sales price; (4) monthly interest on the replacement note; (5) direct expenses chargeable to petitioner; and (6) marketing commissions paid to*86 GCC. Based upon the continued leasing and sales of the computer equipment, petitioner was able to pay off the replacement note and all interest thereon in full by November 1982. Thereafter, the computer equipment continued to be marketed by GCC, which then charged marketing commissions based upon the schedule set forth in the exclusive marketing agency agreement. For the period November 1982 through March 31, 1984, petitioner received rental and sales proceeds totalling $56,582.81 after deductions for direct expenses and GCC commissions. During this time, petitioner paid direct expenses on the equipment -- property taxes, insurance, maintenance, relocation costs, and amounts other than to GCC to facilitate sales -- totalling $45,576.29. As of March 31, 1984, petitioner paid off all promissory notes and interest accruing thereon and had recovered all but $54,613.14 of its cash down payments totalling $319,900. Further, petitioner's computer equipment was on firm lease contracts with sublesses which assured future revenues of at least $24,000 without regard to extensions of such subleases, future subleases, sales, or scrap value. On or around November 23, 1983, petitioner extended*87 the exclusive marketing agency agreement with GCC. Substitution of EquipmentIn marketing petitioner's computer equipment, GCC and its subsidiaries sometimes provided a purchase option to the sublessee. This was a common practice in the computer leasing industry by the mid-1970's and such options were in a good percentage of the leases written.GCC and it subsidiaries offered its customers two types of purchase price options -- one at fair market value and one at a fixed price. While such purchase options were the exception rather than the rule in 1975 with respect to subleases of petitioner's computer equipment, GCC and its subsidiaries were forced to include more and more purchase options in subleases in the later years to remain competitive. The lease agreements with petitioner provided for substitutions of computer equipment when such equipment was sold to a sublessee by reason of election of a purchase option. GCC and its subsidiaries were obligated to make all substitutions with equipment which was similar and of substantially equal value. The substitutions could not always be made with identical equipment but, due to the substitution policy of GCC and its subsidiaries,*88 the substitution of equipment which was not identical to that which was replaced lead to an overall increase in the value of petitioner's computer equipment portfolio. Before substitutions were made, a list of the equipment to be disposed of and a list of the substitute equipment was provided to petitioner in the form of an amendment to the lease agreement. These amendments were to be executed by petitioner and returned to GCC. During the period June 13, 1975, through 1978, substitutions were infrequent and had essentially no effect on the portfolio value. Substitutions increased, however, in later years because (1) GCC was granting more purchase options; (2) the non-IBM peripherals purchased from Traleascorp began to develop maintenance problems which caused customers to return the equipment, and (3) the market for IBM 360 equipment, especially CPUs, decreased. Based upon its contractual agreements with petitioner, GCC and its subsidiaries were required to keep the equipment under maintenance and to effectively market it. When GCC found that it could not meet these obligations, it substituted equipment that could be maintained and marketed. With respect to the non-IBM peripherals,*89 GCC periodically replaced such equipment with IBM peripherals because it found that it could not keep the non-IBM equipment operating. Because of the demise of the market for IBM 360 equipment, especially CPUs, GCC found that it was no longer able to lease some of petitioner's equipment. GCC was concerned that its failure to lease such equipment might give petitioner an actionable lawsuit against GCC based on the terms of the exclusive marketing agency agreement. As a result, GCC began to substitute some of this equipment with equipment which it could lease. Many of petitioner's IBM 360 CPUs were replaced with IBM 360 and 370 peripherals and many IBM 360 peripherals were replaced with IBM 370 peripherals. Peripheral equipment, however, was never replaced with a CPU. Reporting of the TransactionPrior to closing the transaction, all underlying documents were reviewed by legal counsel for GCC who concluded that the transaction was a sale and leaseback under local law. A Form 8K is required to be filed by a publicly traded corporation whenever a significant business event occurs, such as the sale of a substantial amount of corporate assets. On July 1975, GCC filed a "Form*90 8K, Current Report," with the Securities and Exchange Commission ("SEC") for June 1975 reflecting that computer equipment had been sold by EDP, Bresnahan, and Traleascorp to petitioner. Separate Forms 8K were also filed by EDP and Bresnahan reflecting the sale of computer equipment. On November 12, 1975, GCC filed a "Form 8 Amendment to Application or Report" with the SEC attaching copies of the underlying legal documents for the sales and leasebacks of the computer equipment to petitioner. GCC's 1975 Annual Report stated that the sale and lease-back transactions were not treated as sales for financial accounting purposes. Rather than eliminating the equipment which was the subject of the sale and leasebacks from their equipment accounts, GCC credited the net cash proceeds received at dates of sale and leaseback over the present value of related net lease obligations to the carrying value of the equipment. In a GCC internal memorandum dated June 27, 1975, the equipment which was the subject of the sale and leaseback was identified, and with respect to this equipment it was stated that ownership codes were to be changed and the covenants in the lease agreement were to be observed. *91 The memorandum went on to state: Basically, we [GCC and subsidiaries] are responsible for insuring the equipment, must keep it in the U.S., should not sell it, and when off-rent should assign it to new lease without any discrimination between GCC owned units and the leased units. In the event of damage/destruction, exercise of a purchase option by a customer, or necessity to ship outside the U.S. and/or sell off-rent leased units, we have certain rights to unilaterally substitute or request permission to substitute equipment having comparable fair market value. Petitioner treated the transaction on its own income tax returns as a sale and leaseback of computer equipment, reporting as income the rental proceeds received, deducting the interest payments made, and claiming depreciation deductions on the equipment. Petitioner also reflected its ownership of the subject computer equipment on business property tax returns filed with the state of Arizona. OPINION Respondent has challenged the above-described transaction on several grounds. First, respondent claims that the transaction was a tax avoidance scheme without business purpose or economic substance and which must be*92 disregarded for Federal income tax purposes. Second, respondent claims that, during the years in dispute, petitioner lacked the attributes of ownership necessary to be treated as the owner of the computer equipment for income tax purposes. Economic SubstanceIn the sale and lease back context, we have set forth a standard by which a transaction will be disregarded for Federal income tax purposes if the Court finds "that the taxpayer was motivated by no business purpose other than obtaining tax benefits in entering the transaction, and that the transaction has no economic substance because no reasonable possiblity of a profit exists." Rice's Toyota World, Inc. v. Commissioner,752 F.2d 89">752 F.2d 89, 91 (4th Cir. 1985), affg. in part, revg. in part 81 T.C. 184">81 T.C. 184, 209 (1983). This standard makes a finding of "tax sham" inappropriate if either a business purpose or a reasonable possibility of economic profit apart from tax benefits is shown to have been present in the transaction. Mukerji v. Commissioner, 87 T.C. (Oct. 29, 1986); Packard v. Commissioner,85 T.C. 397">85 T.C. 397, 417 (1985); see also Gefen v. Commissioner, 87 T.C. (Dec. 30, 1986). *93 Based on a thorough review of the record in this case, we believe that petitioner has demonstrated that the transaction here under consideration had a reasonable possibility of profit and, hence, had sufficient economic substance to be recognized for Federal income tax purposes. 4The agreements which make up this transaction guarantee the amount of lease payments which petitioner will receive for the first 74 months following the purchase of the equipment. As GCC, the guarantor of the lease payments, is the subsidiary of a major publicly traded corporation, the risk associated with receipt of the lease payments is minimal. Petitioner's initial cash investment upon entering the transaction was $319.900, the sum of the down payments and loan fees or points. During the 74-month term of the leases, petitioner was guaranteed the receipt of net cash payments totalling $208,704. Further, as of the end of the lease terms, all but $173,720 of the principal and interest*94 due on the purchase notes would have been paid. On these facts, therefore, whether a reasonable prospect of economic profit existed at the time petitioner entered into the transaction depends upon whether the residual value of the equipment of the end of the 74-month lease term, less any marketing costs and the marketing fee due GCC at such time, could reasonably have been expected to exceed $284,916. 5Three expert witnesses offered reports and testimony on the residual value of the portfolio of computer equipment originally acquired by petitioner. Each expert report purported to establish the residual value which the equipment would be expected to have on August 15, 1981, as viewed from the perspective of an investor in 1975. Respondent's expert witness, Dee Morgan, calculated the residual value of the equipment by (1) estimating the fair market value of the equipment in 1975 by assigning to each piece of equipment a fair market value equal to the lower of the price shown for*95 the piece of equipment in the Computer Price Guide 6 for the summer of 1975 or the price assigned by GCC in the purchase agreement and (2) applying straight-line depreciation to these values based on the estimated remaining useful lives of the equipment. Morgan estimated the remaining useful lives of the equipment by examining historical precedent prior to 1975. One of petitioner's expert witnesses, Frederick G. Withington, calculated the residual value of the equipment based upon a report he had prepared in 1975. Withington's 1975 report was done for a computer leasing company that wanted a basis upon which to make financial decisions relating to its portfolio of computer equipment. The equipment covered by the report included most of the same types and models of IBM equipment present in petitioner's original portfolio.*96 The report projected the residual value of the equipment through 1980. This report established the trends of residual value for the individual types of equipment as a percentage of their original list price. Withington extended the trends into 1981 in preparing his report on petitioner's portfolio and applied the percentages so developed to the 1970 IBM list prices for petitioner's equipment. For non-IBM equipment, Withington used the residual value percentages developed for equivalent IBM equipment and the list prices of such equivalent IBM equipment decreased by 20 percent to take into account the market premium paid for the IBM label. Petitioner's other expert witness, Robert Djurdjevic, calculated the residual value of the equipment by first determining the equipment's fair market value in 1975 through the use of the IBM list prices for the equipment in 1975 and applying to such prices the Computer Price Guide's listing of the percentages of list price which used equipment would be selling for in 1975. Djurdjevic then mathematically evaluated the market trends for the period 1970 through 1975, for each type of equipment, and projected these trends forward with adjustments*97 for the perception in 1975 of how much certain items of the equipment would depreciate in the following years. Djurdjevic developed a total residual value for the equipment which he then decreased by 15 percent to account for what he believed would be a necessary cost of marketing the equipment in 1981. Using the above methods, each of the experts estimated the total residual value for petitioner's equipment portfolio which could reasonably have been expected in 1975. The estimated residual values, the commission GCC would receive on a sale at these prices, and the net amount which would be received by petitioner on such a sale are as follows: Petitioner'sExpert WitnessResidual ValueGCC's CommissionNet AmountMorgan7 $309,200$31,360$277,840Withington695,500244,940450,560Djurdjevic646,000215,240430,760Petitioner objects to Morgan's valuation of the residual interest in the equipment on several grounds. First, petitioner*98 contends that rather than using a consistent approach in determining the 1975 value of each piece of equipment, Morgan improperly used the lower of the Computer Price Guide's 1975 value estimates or the sales prices assigned by GCC. These values were depreciated by Morgan in determining the residual value of the equipment. Second, petitioner contends that Morgan failed to assign a residual value to the equipment which she found to have exceeded its useful life in 1981, and as a result she improperly assigned a zero value to such equipment. Third, petitioner contends that Morgan treated the remaining useful life of the equipment in 1975, other than input/output equipment, as no more than 5 years, even though the special 5-year edition of the Computer Price Guide Published in 1975 indicated that the useful life should be longer. After a careful review of the record, we agree with petitioner's contentions regarding Morgan's residual value determination. Morgan determined that the remaining useful life in 1975 of all of the equipment other than the input/output equipment would not have been expected to exceed 5 years, and therefore, assigned a zero residual value to such equipment. *99 Morgan did not assign a residual value to this equipment based on scrap value because she felt that the valuation was intended to be on an "in use" basis. Withington gave uncontradicted testimony that the scrap value of the CPUs, after a reduction process, would be at least $30,000 to $40,000. Further, the special 5-year edition of the Computer Price guide published in 1975 stated: The IBM 360 computer is now approximately ten years old and some observers believe that many 360's are going to be around for the next ten years. One should expect that useful life will be extended if future systems remain compatible with the older computers. In other words, if IBM brings out a "380" and it is compatible with the 370, which is now compatible with the 360, the 360 may be around until the end of the 1980's. We also do not believe that Morgan provided an adequate explanation for her use, in her valuation of the individual pieces of equipment, of the lower of the Computer Price Guide's value estimates or the prices assigned by GCC. This hybridization of 2 methods of valuing the equipment seems calculated to create as low a valuation as possible. If Morgan's figure for the residual*100 value of the equipment is adjusted for the apparent scrap value of the CPUs alone, her estimate of the residual value would be at least $340,000. This residual value would provide petitioner with a net amount on the sale of the equipment of approximately $300,000, an amount sufficient to give petitioner a small profit on the overall transaction. The record demonstrates that a larger adjustment to Morgan's valuation is appropriate. Respondent's main objection to Withington's determination of residual value relates to Withington's valuation of the non-input/output equipment.Respondent contends that the values placed upon such equipment by Withington represent such a small percentage of the original list price of the elquipment that such values are too speculative to be used. Respondent apparently contends that anytime the estimated residual value of a piece of equipment drops below 10 percent of its list price, the residual value must be treated as zero because of the speculative nature of such an estimate. We fail to see a rational basis for this contention. Further, we find Withington's report to have special indicia of reliability. Withington's estimate of residual value was*101 based upon a report which he had prepared in 1975. This report was prepared for a computer leasing company that needed a basis upon which to make financial decisions relating to its own portfolio of computer equipment. The credibility of Withington's estimate is, therefore, bolstered by the fact that it is based upon a report which was prepared contemporaneously with petitioner's entry into the transaction in question and which was prepared for financial purposes and relied upon as a basis for making financial decisions. The assumptions made in preparing the report are inherently more reliable than assumptions made nearly 10 years later in reports prepared for litigation purposes. Withington's estimate of the residual value of the computer equipment would clearly provide petitioner with a substantial profit from the transaction. Further, Djurdjevic's estimate and Morgan's estimate, adjusted for the above-mentioned reasons, also support a finding that the computer equipment would have been projected in 1975 to have a residual value sufficient to provide petitioner with a reasonable prospect of a substantial economic profit. Accordingly, we hold that the transaction in question*102 was not without economic substance, and hence, may not be disregarded for Federal tax purposes. 8Benefits and Burdens of OwnershipThe second issue for decision is whether petitioner held sufficient benefits and*103 burdens of ownership to be regarded as the owner of the computer equipment for Federal income tax purposes. Our holding that the transaction in question is not a "tax sham in substance" does not foreclose further discussion of whether the form of the transaction must be accepted for Federal tax purposes. Packard v. Commissioner,supra at 419, citing Commissioner v. Court Holding Co.,324 U.S. 331">324 U.S. 331, 334 (1945). Respondent contends that petitioner does not possess sufficient attributes of ownership to be considered the owner of the computer equipment and that petitioner's interest is more in the nature of a lender or option holder. Petitioner's position, of course, is to the contrary. In Grodt & McKay Realty, Inc. v. Commissioner,77 T.C. 1221">77 T.C. 1221 (1981), we stated, "The term "sale" is given its ordinary meaning for Federal income tax purposes and is generally defined as a transfer of property for money or a promise to pay money. Commissioner v. Brown,380 U.S. 563">380 U.S. 563, 570-571 (1965). The key to deciding whether petitioners' transactions * * * are sales is to determine whether the benefits and burdens of ownership*104 have passed * * * to petitioners. This is a question of fact which must be ascertained from the intention of the parties as evidenced by the written agreements read in light of the attending facts and circumstances. Haggard v. Commissioner,24 T.C. 1124">24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288">241 F.2d 288 (9th Cir. 1956). * * * [77 T.C. at 1237.] In Estate of Thomas v. Commissioner,84 T.C. 412">84 T.C. 412 (1985), we found the following factors to be essentially neutral in making the determination of whether a taxpayer is the owner of property: (1) the existence of a net lease, 84 T.C. at 433; (2) the absence of significant positive net cash flow during the leaseback term or rent geared to interest and mortgage amortization, 84 T.C. at 434; and (3) the use of nonrecourse liability. 84 T.C. at 436. Factors which we found to be relevant to the determination of ownership included: (1) the taxpayer's equity interest in the property as a percent of the purchase price, 84 T.C. at 436; (2) the existence of useful life of the property in excess of the leaseback term, 84 T.C. at 436; (3) renewal*105 rental at the end of the leaseback term set at fair market rent, 84 T.C. at 436; and (4) the expectation of a "turn around" point which would result in the investors' realizing income in excess of deductions in the later years and net tax benefits during the leaseback term less than the unrecovered cash investment. 84 T.C. at 438. In Estate of Thomas, we looked to the facts of Frank Lyon Co. v. United States,435 U.S. 561">435 U.S. 561 (1978), as establishing a level of ownership attributes sufficient to satisfy the requirements of ownership for Federal tax purposes. In Frank Lyon Co. the taxpayer's cash investment in the property purchased (and subject to a leaseback) was approximately 6 percent. In the case now before us, petitioner's initial cash investment in the property was approximately 9 percent.9 Similarly, in Frank Lyon Co., the potential lease term was probably close to the useful life of the property involved, while in this case, the evidence entered with respect to the equipment's residual value demonstrates that the useful life of most of the equipment significantly exceeded the lease terms. *106 During the two years in which the exclusive marketing agency agreements would be in effect, following the end of the lease term, GCC was permitted to purchase or lease the equipment, but only for fair market value or rental. As we stated in Estate of Thomas, the existence of an option to purchase or re-lease the property at fair market value or rental is not inconsistent with the taxpayer's status as owner of the property. 84 T.C. at 434. During the fifth year of the lease term, the transaction was expected to reach a "turn around" point such that the income produced by the rental of the equipment would begin to exceed the deductions for depreciation and interest. At the end of the lease term the net tax savings were expected to be considerably less than petitioner's unrecovered cash investment. This is further evidence that the form of the transaction should be respected for tax purposes. Estate of Thomas v. Commissioner, supra at 438. The substitution of equipment by GCC is not contrary to petitioner's ownership under the circumstances present in this case. The agreements executed by the parties allowed for substitution of equivalent equipment*107 when market factors made such substitutions prudent. The substitutions were accompanied by notification to petitioner and the amending of documentation necessary to treat petitioner as the owner of the substituted equipment. Petitioner had a real potential for loss of at least part of his cash investment in the property and, as we discussed in reference to residual value, a real opportunity for economic profit. Accordingly, we find that petitioner held sufficient benefits and burdens of ownership to be regarded as the owner of the computer equipment for Federal income tax purposes. Decisions will be entered under Rule 155.Footnotes1. These concessions include concessions by petitioner that, due to a failure to file a proper election, the property in question must be depreciated over 7 years rather than 5 years and that petitioner is not entitled to utilize the averaging convention provided in sec. 1.167(a)-11(c)(2), Income Tax Regs. See sec. 1.167(a)-11(f), Income Tax Regs.↩*. 150% declining balance with shift to straight line method in 3rd year. 5% Salvage ($36,500) not included in total shown ($693,500 + $36,500 salvage = $730,000). Assumes full year ownership and uses the modified 6 month depreciation convention. Depreciation Period: 5 years. ** Assumes $12,975 in points to fund transaction in first month.↩2. The promissory note executed pursuant to the agreement with Traleascorp was actually executed in favor of D.S., Inc., its sister corporation.↩3. These rental payments were approximately equal to 1.774 percent of the purchase prices of the equipment.↩4. This finding makes it unnecessary to consider the more subjective question of petitioner's motivations for entering into the transaction. Packard v. Commissioner,85 T.C. 397">85 T.C. 397, 417↩ (1985).5. This amount is calculated as follows: ↩Initial cash investment$319,900 Less: Net cash receipts(208,704)$111,196 Plus: Outstanding debt173,720 $284,916 6. 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. (Oct. 29, 1986).7. Morgan testified that this amount should be decreased by 15 percent as an average marketing cost. Whether all or part of such marketing costs are represented by GCC's commission is unclear.↩8. Respondent also argues that a lack of economic substance is demonstrated by the inflation of the purchase price. Each of the expert witnesses made estimates of the fair market value of the equipment as of the date of purchase. Morgan's estimate was based on her approach of using the lesser of the Computer Price Guide's figures and the prices set by GCC. For this reason, we consider Morgan's estimate to be unpersuasive. The other two experts estimated fair market values which were less than the total purchase price, based on the Computer Price Guide's figures. The evidence shows, however, that a "lease premium" is appropriate where such equipment is on lease and being marketed by a respected computer leasing corporation. See Mukerji v. Commissioner,supra.↩ Based on the record, we believe that the fair market value of the equipment as of the time the transaction was entered was approximately equal to the purchase price agreed to by the parties.9. The record indicates that petitioner's cash investment approximately equals his initial equity in the property. See supra↩ n.8. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623056/ | FAIRFIELD COMMUNITIES LAND COMPANY AND AFFILIATED SUBSIDIARIES v. COMMISSIONER OF INTERNAL REVENUEFairfield Communities Land Co. v. CommissionerDocket No. 6164-78.United States Tax CourtT.C. Memo 1984-100; 1984 Tax Ct. Memo LEXIS 571; 47 T.C.M. (CCH) 1194; T.C.M. (RIA) 84100; March 1, 1984. *571 Fairfield, a land development company, with few stockholders, sought to acquire the assets and liabilities of Oceans, an unrelated company that was in liquidation. Oceans had cash in the amount of about $575,000, few known liabilities, and its stock was publicly traded. It had a net operating loss carryover of $1,645,767; Fairfield had net operating loss carryovers of in excess of 2 million dollars. In June 1971 an agreement was reached whereunder Greers Ferry, a wholly owned subsidiary of Fairfield with little or no income and few assets, acquired all the assets and liabilities of Oceans in exchange for Fairfield stock, which would be distributed to the Oceans stockholders on liquidation of that company. The cash received by Greers Ferry from Oceans was transferred to Fairfield. Greers Ferry later merged with a profitable company and Fairfield changed its tax accounting method to reflect taxable net income. The net operating losses of Oceans were claimed as deductions on the consolidated returns filed by Fairfield and its subsidiaries for its fiscal years ending February 28, 1974 and 1975, and February 29, 1976.Held: Respondent erred in disallowing the net operating loss carryover *572 deductions claimed by petitioner. Petitioner carried its burden of proving that its principal purpose in acquiring the assets and liabilities of Oceans was not to evade or avoid Federal income taxes within the meaning of Section 269, I.R.C. 1954. Alston Jennings,Terry L. Mathews, and Elizabeth Blaich, for the petitioner. Deborah A. Butler, for the respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: Respondent determined deficiencies in petitioner's consolidated income taxes for the fiscal years ending February 28, 1974 and 1975, and February 29, 1976 in the amounts of $458,878, $218,846, and $3,297, respectively. The sole issue for decision is whether petitioners are precluded by section 269, I.R.C. 1954, 1 from deducting the net operating losses of Oceans General, Inc. (hereinafter "Oceans"), incurred prior to the date, June 9, 1971, that Oceans transferred all of its assets and liabilities to Greers Ferry Insurance Agency, Inc. (hereafter "Greers Ferry"), a wholly owned subsidiary of Fairfield Communities Land Company (hereinafter "Fairfield") in exchange for stock of Fairfield in a non-taxable transaction under section 368(a)(1)(C). This in turn depends *573 on whether Fairfield indirectly acquired the property of Oceans for the principal purpose of evading or avoiding Federal income taxes by acquiring the net operating loss carryover attributable to Oceans. FINDINGS OF FACT Fairfield was organized in January, 1966, as an Arkansas corporation named Fairfield Bay, Inc., and was reorganized as a Delaware corporation in January, 1970 under its present name. Its principal office at the time the petition herein was filed was in Little Rock, Arkansas. It is primarily engaged, directly and through subsidiaries, in acquiring large tracts of unimproved real estate and developing these tracts into recreational and retirement communities from which lots, houses, mobile homes and related improvements are sold. Greers Ferry was organized in Arkansas in March, 1970, primarily to insure various aspects of Fairfield's operations. Its name was changed several times prior to 1971 when its name was Greers Ferry, Inc., a Delaware corporation. It is a wholly owned subsidiary of Fairfield. Its net income for the year ended February 28, 1971, was *574 stated to be zero. Fairfield's first development was in Fairfield Bay, Arkansas, consisting of approximately 5,500 acres. In January 1970, Fairfield acquired a large parcel of land in Tennessee which it developed into a community known as Fairfield Glade. Fairfield's sales promotion program has been based primarily upon the use of direct mail to invite prospective lot purchasers to visit its facilities. Fairfield also utilized an "off-site" sales program which included visits to customers who had previously purchased lots to sell such persons homes or homesite improvement packages. Fairfield's on-site sales program was seasonal in nature, beginning approximately in April and ending in the middle of October. Fairfield sold most of its properties on the installment basis, receiving relatively small amounts as down payments. It was a volume producer. Due to this factor, coupled with its large up front development and sales program expenditures, Fairfield was constantly in a squeeze for cash. For financial purposes, Fairfield used the accrual method of accounting. Sales of lots and homesite improvement packages were recognized and included in income in the accounting period in *575 which the down payment was received. For Federal income tax purposes, Fairfield reported its income using the installment sales method, under which only a small portion of the sales price was recognized when the sale was consummated. The use of the accrual method of accounting for financial purposes, under which the entire sales price was included in income at the time of the sale, resulted in Fairfield showing a profit for financial purposes; the accrued income exceeded costs. But for income tax purposes, Fairfield reported rather large operating losses during the earlier years of its operations. On its tax returns for the taxable years ended February 28, 1967, 1968, 1969, 1970 and 1971, as adjusted, Fairfield claimed net operating losses in the amounts of $110,200, $157,950, $334,500, $202,947 and $1,795,556, respectively. As of February 28, 1971, Fairfield had net operating loss carryovers in excess of two million dollars. Fairfield reported gross sales of $6,079,364 on its tax returns for the year ending February 28, 1971. Initially, Fairfield alleviated its cash deficits by borrowing, selling common stock in private placements and other financing transactions. In November *576 1969, Walter E. Heller and Company of Louisiana, Inc. (Heller) agreed to lend fairfield up to $2,000,000 on a revolving credit basis. The credit bore interest at rates of 15%-16%, was secured by mortgages and contracts receivables, and was subject to various limitations related to the loan value of installment sales contracts. In December 1969 Fairfield raised $500,000 by issuing 80,000 shares of common stock to Lombard, Vitalis, Paccanucci and Nelson, Inc., an investment firm, in a private sale. In January 1970 Fairfield acquired the land in Tennessee known as Fairfield Glade. In order to develop this land, Fairfield required additional cash. Since its contract receivables were rather "green," their values for borrowing purposes were not substantial. Heller refused to increase its line of credit unless Fairfield could match the increase with additional equity capital. In January 1970 Fairfield filed a registration statement with the Securities and Exchange Commission proposing to issue additional stock for an aggregate offering price of $4,500,000. A few weeks subsequent to the filing an article appeared in Barron's magazine criticizing the accounting method used by land development *577 companies, including Fairfield, resulting in a weakening of the market for this type of security. Fairfield's underwriters informed Fairfield that the proposed public offering could not be sold. On July 7, 1970, Fairfield withdrew the registration statement. This left it in a rather critical cash position to complete its selling program for the summer of 1970 and to prepare for its selling season for 1971. In August and October 1970, Fairfield raised $525,000 by selling common stock in a private placement to a limited group of the 1969 private placement investors. Heller thereupon extended its line of credit to $2,500,000. This enabled Fairfield to cover expenses already incurred for the 1970 selling season, but additional cash was needed for the 1971 selling season. Fairfield began a search to raise additional cash for the 1971 selling season without which it would have to curtail its planned business activities In September 1970, John Rex, Vice-President of Finance for Fairfield, responded to several ads in the Wall Street Journal and let it be known that Fairfield was interested in negotiating with a company that had cash, no liabilities, and a large number of public shareholders.He *578 came in contact with Joseph Bianco, Vice-President of Marantette & Co. of Detroit, which was representing Oceans, a financially unsuccessful company which nevertheless had about $600,000 in cash. Bianco's objective was to put Oceans' stockholders into a promising corporation through a sale or merger to avoid having to liquidate Oceans, which would require the stockholders of Oceans to liquidate their investments and realize losses at that time. Oceans also had a relatively large number of stockholders and a net operating loss carryover of about $1,600,000. On November 15, 1970, George Jacobus, President of Fairfield, and C. Randolph Warner, Secretary and General Counsel of Fairfield, met with J. A. Mullen, Chairman of Oceans and Alfred Moses, an attorney in Washington representing Oceans, to conduct negotiations. After this meeting Warner recommended that Fairfield acquire Oceans or its assets and liabilities, primarily because of Oceans' cash and, secondarily, to have the numerous Oceans stockholders become stockholders of Fairfield so that Fairfield would automatically become a publicly held corporation. Warner also recognized that Oceans' operating loss carryover was an intangible *579 asset having some value but he discounted that value to Fairfield because Fairfield had a larger operating loss carryover of its own. Warner also believed that under the tax laws (section 382), since the Oceans stockholders would receive less than 20 percent of the stock of Fairfield, Fairfield would be entitled to utilize at best only 25-30 percent of Oceans' loss carryovers, if any at all. An agreement was reached whereby Fairfield was to acquire all of Oceans' assets and assume its liabilities in exchange for Fairfield stock. However, counsel for Oceans objected to a provision that Fairfield's assumption of Oceans' liabilities would be limited to known and recorded liabilities which would not include unknown warranty liabilities. He insisted that Oceans stockholders be relieved of all liabilities, known and unknown. Because Fairfield did not want to assume unknown liabilities that might arise from warranties issued by subsidiaries of Oceans upon the sale of boats that they manufactured, an alternative method of acquisition was sought. It was decided that Greers Ferry, a wholly owned subsidiary of Fairfield which had little net income and very few assets, would acquire Oceans' *580 assets and liabilities in exchange for Fairfield stock. A contract carrying out the alternative plan was agreed upon by all three corporations. As a result of negotiations, including the value of Fairfield's stock, it was agreed that slightly less than 80,000 shares of Fairfield stock would be transferred to Oceans in exchange for its assets, such stock being approximately equal in value to Oceans' net assets, which consisted principally of $575,000 in cash. Oceans, which was already in the process of liquidation, would then be liquidated and the Fairfield stock would be distributed to the Oceans stockholders on liquidation. These negotiations continued into February of 1971, when an agreement was finalized. 2On March 17, 1971 counsel for Oceans filed a ruling request with the Internal Revenue Service seeking a determination that the proposed plan of reorganization would qualify as a tax free reorganization within the meaning of section 368(a)(1)(C) of the Code. The Internal Revenue Service issued a private letter ruling on May 14, 1971 holding that the proposed transaction *581 qualified as a reorganization under section 368(a)(1)(C). The plan of reorganization was consumated June 9, 1971, with Greers Ferry receiving from Oceans approximately $575,000 in cash and net operating loss carryovers in the amount of $1,645,767. The shareholders of Oceans became shareholders of Fairfield, receiving slightly over 5 percent of the outstanding stock of Fairfield. Subsequent to the acquisition of Oceans, Fairfield became a publicly owned corporation under the Securities and Exchange Act of 1934 with the common stock being traded on the over the counter market. During the course of the negotiations with Oceans, Fairfield's management realized that even if the Oceans' cash became available, Fairfield would either have to curtail its selling activities in 1971 or acquire additional financing. Fairfield began negotiations with the First National Bank of Boston for a substantial loan to replace Heller and other creditors. On February 25, 1971 the First National Bank of Boston agreed that Fairfield could borrow up to $10,000,000 from it and other participating banks on a revolving credit basis, subject to certain conditions and at an interest rate of 2 percent above prime, *582 plus an annual service charge of 2-1/2 percent. The loan was secured by a deed of trust or mortgage on all the unsold Tennessee and Arkansas real estate, and by assignment of all receivables from installment sales contracts at the date of the loan agreement at both the Tennessee and Arkansas locations. One of the limitations was that the amount of the loan could not exceed $4,000,000 prior to October 31, 1971, and $6,000,000 prior to February 28, 1973. Oceans, a Delaware corporation, was incorporated in May, 1968 to provide engineering support operations and services for business enterprises and governmental agencies engaged in oceanography and other marine related activities, and to design and develop surface and underwater recreational facilities and equipment. In 1968 Oceans acquired all the capital stock of Bay Tech Associates, Inc., an engineering consulting firm since 1967. In 1969 Oceans established a boat building subsidiary, Ocean Marine Products, Inc., and another subsidiary, Oceanside Marina, Inc. to purchase and develop property as a marina. Prior to the summer of 1970, Ocean Marine Products, Inc. manufactured and sold 18, 21 and 28 foot sports fishing boats; and *583 Oceanside Marina, Inc. purchased a 12 acre tract of undeveloped land in Marathon, Florida, which was planned to be developed into a marina. Oceans and its subsidiaries were not financially successful and by the end of 1970 they had ceased operations and liquidated their assets to avoid further erosion of the investments of the Oceans stockholders. At that time Oceans had about $641,000 in cash and few known liabilities. It also had a net operating loss carryover of $1,645,767. Oceans had claimed on its tax returns for 1968, 1969, 1970 and 1971 net operating losses in the respective amounts of $196,962, $346,503, $931,834 and $134,787. In the summer of 1970, Oceans engaged the services of Marentette and Company, an investment banking firm, to sell Oceans, merge it, or otherwise dispose of the company in a fashion that would be advantageous to the current stockholders of Oceans. Joseph Bianco, then the Vice-President of Marentette in charge of the corporate finance department, proceeded to evaluate the company and its assets, prepare a prospectus on the company and seek out prospective buyers for the company. He thereafter placed an ad in the Wall Street Journal indicating the financial *584 and other facts about Oceans and soliciting offers to merge or buy the company. This ad led to the contact with John Rex, representing Fairfield, and the negotiations that followed, which have been related above and which resulted in the sale of Oceans to Greers Ferry. Computer Property Corporation, also known and herein referred to as CPC, a Delaware corporation organized in 1967, was engaged in the business of leasing, selling and programing computer equipment. CPC was a profitable company. Paul Paganucci, a member of the investment banking firm of Lombard, Vitalis, Paganucci & Nelson, Inc., was a stockholder, officer and director of both CPC and Fairfield. He was active in the financial affairs of both CPC and Fairfield. Other investors were also stockholders in both CPC and Fairfield. In August of 1971 negotiations began between CPC and Fairfield with regard to a possible merger of the two companies. On November 15, 1971 Fairfield, Greers Ferry, and CPC entered into a plan of reorganization under which CPC would be merged into Greers Ferry with each share of stock of CPC being converted into 1.8 shares of Fairfield common stock. Greers Ferry was the surviving corporation and *585 it assumed all the assets and liabilities of CPC. CPC ceased to exist but the name of Greers Ferry was changed to Computer Property Corporation. Fairfield continued to own all the outstanding stock of CPC (formerly Greers Ferry). The merger became effective on December 31, 1971. Subsequent to the merger the operating losses that Greers Ferry had acquired from Oceans were used to offset the income of CPC. In July of 1973 the tax manager of Fairfield met with Leon Teske, an accountant with Peat, Marwick & Mitchell, who had taken over as tax manager in charge of the Fairfield account for Peat, Marwick & Mitchell, to discuss the possibilities for utilizing Fairfield's available operating loss carryovers for tax purposes. Teske undertook extensive tax planning to accomplish this objective. He found no evidence that any such tax planning had been undertaken on behalf of Fairfield before. He realized that in crder for Fairfield to take advantage of its own available operating loss carryovers before they expired, Fairfield would have to generate taxable income. This would involve a change in its method of accounting for its installment sales for tax puposes.He determined that under *586 the revenue laws and regulations Fairfield could account for some of its sales on the accrual basis and the others on the installment basis. This was done and Fairfield began reporting a profit before operating losses for tax purposes. For the taxable years before us, February 28, 1974, 1975 and 1976, Fairfield and its subsidiaries claimed net operating loss deductions on their consolidated returns in the amounts of $1,176,069, $446,139 and $8,860, respectively. 3 Respondent disallowed the deductions claimed as net operating loss carryovers. ULTIMATE FINDING The principal *587 purpose of Fairfield in acquiring the assets and liabilities of Oceans was not to evade or avoid Federal income taxes by acquiring Oceans' net operating loss carryovers. OPINION The only issue for decision is whether the principal purpose motivating the acquisition of all the property of Oceans, a loss corporation, by Greers Ferry, a wholly owned subsidiary of Fairfield, was the evasion or avoidance of Federal income tax within the meaning of section 269 of the Code. 4Section 269(a)(2) provides that if any corporation acquires, directly or indirectly, property of another corporation not controlled immediately before the acquisition by the 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 such acquisition is to evade or avoid Federal income tax by securing the benefit *588 of a deduction, credit, or other allowance, which such corporation would not otherwise enjoy, then the Secretary may disallow such deduction, credit or other allowance. The deductions disallowed in this case are the net operating losses of Oceans, incurred prior to the acquisition, which were utilized by Fairfield and its subsidiaries in their consolidated returns for the years involved. Sections 381(a)(2) and 381(c) permit a corporation acquiring the assets of another corporation, under certain specified circumstances, to succeed to the net operating loss carryovers of the transferor corporation. The requirements of section 381(a)(2) are satisfied here (section 361 is applicable and the transaction qualified as a tax free reorganization described in section 368(a)(1)(C)) so the only question is what was the principal purpose for the acquisition. For section 269(a) to be applicable, a tax evasion or avoidance motive must have been the principal purpose for the acquisition of Oceans' assets and it must have outranked or exceeded in importance any other purpose. Hawaiian Trust Co. v. United States,291 F.2d 761">291 F.2d 761 (9th Cir. 1961); Daytona Beach Kennel Club, Inc. v. Commissioner,69 T.C. 1015">69 T.C. 1015 (1978).To *589 prevail, petitioner need prove only that the avoidance of tax was not the principal purpose; nevertheless, petitioner has the burden of proving that the respondent's determination on this issue was incorrect. Capri, Inc. v. Commissioner,65 T.C. 162">65 T.C. 162 (1975); Rocco, Inc. v. Commissioner,72 T.C. 140">72 T.C. 140 (1979). We find that petitioner has carried that burden. It is well settled that the principal purpose at the time the transaction took place is the determining factor and that events which take place after the transaction, unless shown to be a step in the same transaction, are not determinative of the principal purpose within the meaning of section 269. Hawaiian Trust Co. v. United States,supra;Capri, Inc. v. Commissioner,supra.However, evidence of subsequent events which tend to support or negate the purported purpose may be offered for that purpose. In determining the purpose for which an acquisition was made, we must scrutinize the entire circumstances in which the transaction occurred, and make a subjective evaluation of petitioner's motives. Scroll, Inc. v. Commissioner,447 F.2d 612">447 F.2d 612 (5th Cir. 1971), affg. a Memorandum Opinion of this Court. 5Petitioner *590 contends that its primary purpose in acquiring the assets of Oceans was to obtain Oceans' cash, which it needed to continue its expanding business, and, secondarily, to make the relatively large number of stockholders of Oceans stockholders of Fairfield, thereby qualifying Fairfield to offer its stock on the over the counter market to raise badly needed additional equity capital. Petitioner admits that its officers were aware of the fact that Oceans had a large operating loss carryover but that this was not bargained for because they thought it was doubtful, given certain tax laws and Fairfield's own large operating losses, that Fairfield would be able to use more than 25 to 30 percent of Oceans' losses at the most, if it was able to use any at all. In support of its contention, petitioner introduced into evidence financial records of Fairfield illustrating its continuing need for cash to carry on and expand its business due to its method of developing and selling its real estate, and its efforts to raise cash in the past through bank loans, private sales of its stock, and finally through its aborted effort to "go public" with its stock. There can be little question based on the *591 record in this case that Fairfield had a continuing need for cash to conduct its business and that it was initially, at least, attracted to Oceans by its large amount of cash. Petitioner also offered the testimony of its officers, directors, and accountants who participated in both the decision to open negotiations with Oceans and in the actual negotiations themselves.Their uncontradicted testimony indicates that while some thought may have been given by them to the operating loss carryovers of Oceans, this was minimal and the principal reasons for acquiring Oceans were to obtain its cash and increase the number of Fairfield's stockholders. The ad placed in the Wall Street Journal by Oceans, which prompted Fairfield's investigation, mentioned Oceans' cash status but did not mention the operating losses. These witnesses, the testimony of all of whom we found to be forthright and credible, also testified that the withdrawal in the Spring of 1970 of the proposed public offering of its stock left Fairfield in an "almost terminal condition" cashwise both with respect to completing its summer selling program for 1970 and preparing for its summer selling program for 1971. They pointed *592 out that the cash raised through the private placement of stock in the Fall of 1970 only enabled Fairfield to pay its bills incurred during the 1970 selling program. They also testified that no consideration was given to the operating loss carryover by either side in the negotiations for the price Fairfield would pay for Oceans' assets. That price was based on the value of Oceans' book assets less its liabilities, and it was to be adjusted downward if the cash and net assets of Oceans were ultimately determined to be less than anticipated.Minutes of directors meetings held during the course of the negotiations, correspondence between the negotiators, and memoranda prepared contemporaneously by the negotiators for their own use support the testimony of the witnesses. Petitioner also offered the testimony of Mullen, the then chairman of Oceans who represented that company in the negotiations, and the testimony of Bianco, who in 1970 was vice president of Marantette and Company, an investment banking firm that had been employed by Oceans to try to sell the assets of the company. They both testified that Fairfield appeared to be primarily interested in Oceans' cash and the fact that *593 Oceans was a public company, that in their discussions with the representatives of Fairfield there was no indication that Fairfield was interested in the operating losses of Oceans, that neither Oceans nor Fairfield attempted to negotiate any consideration for the losses, and that the subject simply did not come up for discussion. Respondent did not call any witnesses to testify but relies on cross examination of petitioner's witnesses and objective facts, some of which relate to events that occurred after the acquisition, to support its determination that the principal purpose for Fairfield's acquisition of Oceans' assets was tax avoidance. Respondent contends that the top management of Fairfield was aware of the net operating losses of Oceans, that the value of those loss carryovers to Fairfield and its subsidiaries would far exceed the value of the Oceans' book assets, and that the original plan of reorganization (Fairfield to buy Oceans' assets directly) was restructured to avoid the restrictions of section 382(b) and permit Greers Ferry to take full advantage of Oceans' losses. This, respondent contends, is strong evidence that Fairfield's principal purpose for acquiring the *594 assets of Oceans was tax avoidance. While this scenario might support respondent's position, it is just not developed by the evidence. The uncontradicted testimony of Fairfield's top management was that while they were aware of the losses they considered them to be of little value to Fairfield because Fairfield had its own loss carryovers, and they also believed that even if Fairfield could claim the losses, the amount thereof would be severely limited by other provisions in the law. Fairfield sought no tax advice to determine whether this was true because it was not very much interested in the losses. Knowledge of and even consideration of the tax aspects in connection with an acquisition does not mandatorily require application of section 269. D'Arcy-MacManus & Masius, Inc. v. Commissioner,63 T.C. 440">63 T.C. 440 (1975); VGS Corp. v. Commissioner,68 T.C. 563">68 T.C. 563 (1977). It was not until two years later that Fairfield was advised that it could change its method of accounting for certain sales to produce net income which would permit it to absorb its own prior years' losses. Later tax planning after the acquisition to better use the net operating loss carryovers is not relevant to petitioner's *595 purpose at the time of the acquisition. Glen Raven Mills, Inc. v. Commissioner,59 T.C. 1">59 T.C. 1 (1972). Also the evidence is clear that the structure of the acquisition was changed because counsel for Oceans insisted that the acquiring corporation assume any unknown and conditional liabilities of Oceans and its subsidiaries. Therefore, Fairfield decided to have Greers Ferry, which had practically no assets, become the acquiring corporation using Fairfield's stock to pay the purchase price. Petitioner also points out that its management was aware of the possibility that if Greers Ferry acquired the assets and deductions of Oceans, the Oceans' operating loss carryovers might be limited to offsetting the net income of Greers Ferry only. Since Greers Ferry had no net income and very little prospects at that time of having any in the future, the restructuring of the form of the transaction might preclude Fairfield from ever realizing any tax benefit from the Oceans' losses. Therefore, the restructuring of the planned acquisition might have been detrimental rather than beneficial taxwise to Fairfield. 6*596 Respondent argues that petitioners sought a tax ruling that the transaction as finally agreed upon qualified as a tax free reorganization to make sure that the losses of Oceans would be available to Fairfield and its subsidiaries after the acquisition. But, the evidence reflects that counsel for Oceans wanted and obtained a ruling that the transaction would be tax free under section 368(a)(1)(C) so that Oceans stockholders would not have to recognize their losses upon liquidation of Oceans. Respondent also contends that the subsequent merger of CPC into Greers Ferry was an integrated step in the overall plan to permit Fairfield to take advantage of Oceans' loss carryovers by making Greers Ferry a profitable corporation through the use of CPC's income. Here again the record does not support respondent's contention and there is not a scrap of evidence that has been called to our attention that a merger with CPC was even considered by anyone prior to August of 1971, two months after the acquisition of Oceans' *597 assets was completed. The merger of CPC into Greers Ferry was not accomplished until December 31, 1971. It is true that several of the directors of CPC were also directors of Fairfield but this does not prove that there was a preconceived plan on the part of Fairfield at the time of the acquisition of Oceans to have CPC merged into Greers Ferry. Their testimony was to the contrary. As previously noted, steps taken after the transaction in question that were not a part of the transaction are irrelevant to petitioner's purpose in entering into the transaction. Respondent further contends that Fairfield was not in need of cash at the time of the acquisition so that acquiring Oceans' cash could not have been the primary purpose for the acquisition. Respondent points to the fact that Fairfield had cash on hand as of February 28, 1971 in the amount of $641,610, and that Fairfield had received a line of credit of up to $10,000,000 from the First National Bank of Boston and other participating banks in February of 1971. Petitioner has demonstrated that the cash on hand was insufficient to carry Fairfield through its 1971 summer selling programs without curtailing its operations. The *598 Bank of Boston line of credit was limited to $4,000,000 in the first year and had other conditions that restricted its use. That line of credit was also used to pay off the Heller loan and several bank loans. It is also evident that the agreement between Fairfield, Greers Ferry and Oceans had been finalized, except for obtaining a tax ruling, at the time the Bank of Boston line of credit was obtained. Furthermore, the Oceans' cash would provide Fairfield with additional equity capital upon which it would not have to pay interest. We cannot find that Fairfield's cash position as of February 28, 1971 changed its purpose for acquiring Oceans' assets. Respondent argues that the value of the Fairfield stock exchanged for Oceans' assets was substantially disproportionate to the aggregate of the assets and transferable deductions acquired which, under section 269(c), is prima facie evidence of a tax avoidance motive for the acquisition, and that this should add further weight to the presumption of correctness of respondent's determination. Section 269(c) was repealed on October 4, 1976 7 for years after 1976. The legislative history of this repeal indicates that section 269(c) was *599 redundant, given the general principle of tax litigation that the Commissioner's determination is presumptively correct and the tax-payer has the burden of proving otherwise. See H.R. Rept. No. 94-658, 94 Cong. 1st Sess. 377 (1975), 1976-3 C.B. (Vol.2) 1069. In fact, section 269(c) generally has been viewed more as a "procedural device" than a conclusive presumption. See Industrial Suppliers, Inc. v. Commissioner,50 T.C. 635">50 T.C. 635, 646 (1968); H.F. Ramsey Co. v. Commissioner,43 T.C. 500">43 T.C. 500, 517 (1965). 8 Furthermore, there is no proof that the value of the Fairfield stock exchanged was substantially disproportionate to the value of the assets acquired. We are not convinced by the above and other arguments of respondent that Fairfield's primary purpose in acquiring the assets of Oceans was tax avoidance. Respondent has relied on assumptions and inferences unsupported by the record to determine that the primary purpose for the acquisition was to obtain the use of Oceans' net operating loss carryover. The record indicates that such was not the *600 primary purpose for the acquisition and respondent's determination was in error. Decision will be entered for the Petitioner.Footnotes1. All section references are to the Internal Revenue Code of 1954, as effective for the years here involved.↩2. Fairfield did not seek tax advice, other than that of its own officers, prior to or during these negotiations.↩3. The net operating loss carryover utilized to offset the income of Fairfield itself appears to have been the net operating loss carryovers of Fairfield and the net operating loss carryovers of Oceans appear to have been offset against the income of CPC. This was not stipulated and cannot be determined from the notice of deficiency. The reproduced tax returns stipulated into evidence are too indistinct to be sure of this fact. Neither party argues that the available net operating losses, if usable, were improperly utilized on the returns. See section 1.1502-21(c), Income Tax Regs.↩, relative to consolidated returns.4. The limitations on net operating loss carryovers contained in section 382 do not apply to this transaction, as structured, by virtue of section 382(b)(6). Respondent agrees with this on brief and raised no issue with reference to section 382.↩5. See also Power-Line Sales, Inc. v. Commissioner,T.C. Memo. 1977-43↩.6. We need not and do not decide whether Fairfield's management correctly interpreted the law in this respect. But, see section 1.1502-21(c), Income Tax Regs.↩ It is simply illustrative of one consideration that may have entered into the purpose for the acquisition.7. Section 1901(a)(38) of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1771. ↩8. See Princeton Aviation Corp. v. Commissioner,T.C. Memo 1983-735">T.C. Memo 1983-735↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623057/ | HARRIET EDELSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; JOSEPH EDELSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEdelson v. CommissionerDocket Nos. 14143-82, 14145-82.United States Tax CourtT.C. Memo 1986-223; 1986 Tax Ct. Memo LEXIS 385; 51 T.C.M. (CCH) 1109; T.C.M. (RIA) 86223; June 3, 1986. *385 J filed Forms 1040 for 1975, 1976 and 1977 which contained no information as to his income, deductions or credits for those years. J claimed on these forms that only dollars of gold and silver are taxable. In 1976, J transferred his one-half interest in two parcels of real estate to H, his wife, for inadequate consideration. Held, income tax deficiencies and additions to tax under section 6653(b), I.R.C., and section 6654, I.R.C., sustained. Held further, H is liable for J's tax liabilities and additions to tax to the extent of $74,550 as a transferee of J's assets. Joseph Edelson and Harriet Edelson, pro se. Michael R. Rizzuto, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: Respondent determined deficiencies in and additions to the Federal income taxes of petitioner Joseph Edelson (Joe) as follows: Additions to TaxYearDeficiencySec. 6653(b) 1Sec. 66541975$35,665$17,833$1,497197662,83731,4192,340197773,01936,5102,601In a separate notice of deficiency issued to Joe's wife, Harriet Edelson (Harriet), respondent determined that Harriet was liable for these deficiencies and additions to tax to the extent of $169,800 as a transferee of Joe's assets. *386 On brief, respondent concedes that the amount of Harriet's transferee liability should be reduced to $74,550. The issues for decision in these consolidated cases 2 are: 1) whether respondent's deficiency determinations and additions to tax under section 6653(b) and section 6654 should be sustained as to petitioner Joseph Edelson and, if so, 2) whether petitioner Harriet Edelson is liable for these deficiencies and additions to tax to the extent of $74,550 as a transferee of Joe's assets. FINDINGS OF FACT Petitioners Joseph Edelson and Harriet Edelson, husband and wife, resided in California at the time their respective petitions were filed. During the years in issue, Joe, a self-employed real estate salesman and real estate broker, owned and operated Joe Edelson Realty, a real estate business located at 62 Washington Avenue, Dumont, New Jersey. The real estate business was located *387 in a four-family building which Joe and Harriet jointly purchased in 1973. From 1973 through 1977, Joe realized substantial income from his real estate business in the form of real estate commissions. During this period, Harriet was employed as a secretary. Petitioners filed joint income tax returns for their taxable years 1973 and 1974 on which they reported the real estate commissions and wage income they received during those years. 3 Petitioners filed separate Forms 1040 for taxable years 1975 through 1977. The Forms 1040 filed by Harriet for 1975, 1976 and 1977 constitute valid income tax returns and have not been challenged by respondent. However, the Forms 1040 filed by Joe for the years in issue contained no information as to his income, deductions or credits for those years. On his 1975 Form 1040, dated April 14, 1976, Joe listed wages, dividends and interest income as "less than $10.00." At the bottom *388 of the front page of this form, Joe explained that "[t]his figure is expressed in Constitutional dollars of silver and/or gold. Constitutional dollar is here used with the statutory definition of 412.5 grains of standard silver, or the relative equivalent in pure silver or gold." Joe provided no additional information in the remaining spaces on the Form 1040. In the right margin of the front page of the form, Joe wrote "specific objection is taken to the specific question[s] on the grounds of the 1st, 4th, 5th, 7th, 8th, 9th, 10th, 13th, 14th and 16th Amendments, as to Federal Reserve Notes." In the left margin of the frong page of the form, Joe wrote "[n]ote: I offer to amend or re-file this return heretofore submitted to exactly as you wish them, if you can show me how to do so without waiving my constitutional rights." Joe attached to the Form 1040 a 49-page explanation of his specific objections. By letter dated June 7, 1976, respondent informed petitioner that his 1975 Form 1040 did not constitute a valid Federal income tax return and that he should file another Form 1040 with the appropriate information. Petitioner responded by letter dated June 17, 1976, as follows: I received *389 your enclosed letter and I am shocked. I prepared my returns, answered every question complete and accurately, explained why I answered every question complete and accurately in a 49 page return, and you send back one page -- photo copied -- with omissions, and inform me that my returns are unacceptable. Sir, I worked very hard preparing my returns. I did an awful lot of research - checked your code and thought I did an excellent job. In accordance with your letter my returns are not acceptable, but you fail to say what it is that is unacceptable. Please refer back to my return in its entirety, and I will be happy to consider any reasonable constitutional recommendations. Joe subsequently filed an amended 1975 Form 1040 which contained the same constitutional objections as the original form. Joe also failed to include on this amended form any additional information concerning his income, deductions or credits for 1975. Joe also failed to include any information concerning his income, deductions and credits of 1976 and 1977 on the Forms 1040 he filed for those years. These forms contained the same constitutional objections as appeared on Joe's 1975 Form 1040. On March 22, 1976, *390 prior to the filing of his original 1975 Form 1040, Joe transferred to Harriet by deed his one-half interest in the four-family building he and Harriet jointly owned. On this date, Joe also transferred to Harriet by deed his one-half interest in their personal residence located at 33 Eastbrook Drive, River Edge, New Jersey. Joe received consideration of $200 from Harriet for his one-half interest in these properties, which had a net fair market value of $149,500 on the date of the transfers. 4On October 18, 1977, Joe and Harriet jointly purchased certain real property located at 626 Glenwood Avenue, Teaneck, New Jersey, for $40,000 and then resold the property for $50,000. Neither Joe nor Harriet reported any gain from this sale on their separate 1977 Forms 1040. On April 15, 1977, a special agent with the Criminal Investigation Division of the Internal Revenue Service first met with Joe to discuss potential criminal tax violations with respect to his 1975 taxable year. Joe, however, refused *391 to answer any questions concerning 1975 until the special agent responded to a questionnaire prepared by Joe containing numerous personal questions. Because the special agent refused to answer the questionnaire, the interview was terminated. The special agent met with Joe again on April 26, 1977, to discuss potential criminal tax violations. Joe, however, claimed his Fifth Amendment rights and refused to answer any questions regarding his 1975 income tax return. Respondent expanded his investigation to include Joe's 1976 taxable year. As a result of Joe's lack of cooperation, the special agent contacted third party sources for information concerning Joe's income for both 1975 and 1976. The special agent first presented a summons to First National State Bank in Tenafly, New Jersey, requesting information concerning personal and business accounts maintained by Joe with the bank. The bank, after informing Joe of respondent's request, received a mailgram from Joe informing the bank that he would hold the bank liable for damages if it complied with the summons. The bank consequently refused to disclose the requested information in the absence of a court order enforcing the summons. *392 During the course of his investigation, the special agent also inspected the mortgage files of Valley Savings and Loan Association in Closter, New Jersey, which disclosed that Joe Edelson Realty had received commissions of $31,797 and $43,112 on real estate transactions which occurred during 1975 and 1976, respectively. These files also revealed that two attorneys, Felix Angelillis and Allan Horowitz, had closed most of these real estate transactions. The special agent subsequently contacted Felix and Allan and requested that they disclose any closing documents in which Joe was listed as the real estate broker. Both men, however, refused to turn over the requested documents, explaining that Joe had threatened to sue them if they turned over the requested records. The special agent thereafter served subpoenas duces tecum on both individuals to obtain the documents. The special agent also asked Donald Zackim, President of Mercury, Inc., a mortgage brokerage company which conducted substantial business with Joe, to disclose any records the company possessed concerning real estate commissions earned by Joe on real estate transactions which occurred during 1975 and 1976. Although Mr. *393 Zackim initially agreed to the request, he subsequently refused to disclose the records after Joe threatened to sue him if he disclosed the requested information. Respondent eventually expanded the criminal investigation of petitioner's income taxes to include his 1977 taxable year. Petitioner also refused to cooperate in this investigation. On January 22, 1979, the United States District Court for the District of New Jersey found Joe guilty under section 7203 of willful failure to file tax returns for taxable years 1975, 1976 and 1977. This conviction was subsequently affirmed by the Third Circuit in United States v. Edelson,604 F.2d 232">604 F.2d 232 (1979). In a notice of deficiency addressed to Joe dated April 2, 1982, respondent, relying on cancelled commission checks payable to Joe Edelson and Joe Edelson Realty, records of closing escrows and bank deposit records, determined that Joe failed to report the following amounts of commission income he received during the years in issue: YearIncome1975$75,4411976109,8181977115,578Respondent further determined that Joe failed to report a short term capital gain of $10,000 which he realized on the 1977 sale of certain real property located at 626 *394 Glenwood Avenue, Teaneck, New Jersey. Respondent also determined additions to tax for fraud under section 6653(b) and additions to tax for failure to pay estimated income tax under section 6654. In a separate notice of deficiency addressed to Harriet, respondent determined that she was liable for Joe's income tax deficiencies and additions to tax to the extent of $169,800 as a transferee of his assets. On brief, respondent concedes that the property interests Harriet received from Joe had a value of only $74,750 and, therefore, that her transferee liability does not exceed $74,550, the value of the property interests less the consideration she paid for such interests. On June 21, 1982, both Joe and Harriet filed petitions with this Court in which they contested respondent's determinations. Each petition listed petitioners' address as P.O. Box 29 and Drobish Road, Bangor, California, and LaPorte Star Route, Marysville, California. Also on this date, we granted petitioners' requests that the trial of these cases be held in San Francisco, California. On November 15, 1982, petitioners filed motions requesting that the trial of these cases be moved from San Francisco, California to *395 San Diego, California. Petitioners represented in their motions that they had recently moved to San Diego. We granted Joe's motion on November 17, 1982, and Harriet's motion on November 19, 1982. On August 5, 1983, this Court mailed to Joseph and Harriet notice that their cases were set for trial on October 24, 1983, at San Diego, California. On August 23, 1983, petitioners filed motions for continuance requesting that their cases be removed from the October 24, 1983, San Diego calendar and placed on a later San Diego calendar. Petitioners explained that they were presently living in New Jersey but anticipated that they would return to San Diego sometime in 1984. We granted Joe's motion by order dated August 24, 1983, and stamped Harriet's motion granted on August 25, 1983. On July 24, 1984, this Court served petitioners with notice that their cases were set for trial on October 15, 1984, at San Diego, California. On August 14, 1984, we served petitioners with notice that the San Diego session would begin on October 16, 1984, rather than on October 15, 1984. On August 7, 1984, petitioners filed a motion for continuance requesting that their cases be removed from the October *396 16, 1894, San Diego session. Petitioners explained that they were still living in New Jersey and did not anticipate returning to San Diego until after 1984. We denied this motion on August 14, 1984. On October 1, 1984, petitioners filed a motion requesting that the trial of their cases be moved to Newark, New Jersey, on the ground that "[c]ircumstances have brought Petitioners to New Jersey and Petitioners' attempts to return to California have been unavoidably detained." We granted petitioners' motion by order dated October 10, 1984. On February 28, 1985, we served petitioners with notice that their cases had been set for trial on May 28, 1985, at Newark, New Jersey. On April 18, 1985, petitioners filed a motion in which they requested that the trial of their case be moved from Newark, New Jersey, to San Diego, California. In the motion, petitioners, claiming that San Diego County had been their permanent residence since October, 1982, maintained that "[t]he unnecessary cost and inconvenience for Petitioners to travel across the country to appear in Tax Court would cause Petitioners a great hardship." We denied this motion on May 16, 1985. On May 22, 1985, respondent served a *397 subpoena duces tecum on Harriet commanding her to 1) appear before the United States Tax Court at 10:00 a.m. on May 28, 1985, at Room 300, Military Park Building, 60 Park Place, Newark, New Jersey and 2) bring "deeds, closing statements and related documents indicating an interest that you held in real property from 1974 through 1978." On May 24, 1985, respondent served a subpoena duces tecum on Joe commanding him also to appear at the Court's May 28, 1985, Newark session and to bring with him copies of Forms 1040 that he filed for the taxable years 1974 through 1983. When these cases were called for trial from the trial calendar of this Court in Newark, New Jersey, on May 28, 1985, no appearance was made by or on behalf of petitioners. The trial of this case was held on June 6, 1985. Neither petitioners nor a representative of petitioners appeared at the trial. Respondent appeared and orally moved the Court to consolidate petitioners' cases for trial, briefing and opinion. We granted respondent's motion. Respondent then moved the Court to dismiss Joe's case for lack of prosecution insofar as the income tax deficiencies are concerned and to enter a decision for respondent in the *398 amount of the deficiencies determined in the notice of deficiency mailed to Joe. We granted respondent's motion at trial, and decision will be entered for respondent that there are deficiencies in Joe's income taxes for 1975, 1976 and 1977 and follows: YearDeficiency1975$35,665197662,837197773,019We then received evidence consisting of oral testimony and exhibits concerning the issues of fraud and transferee liability. OPINION The first issue for decision is whether Joe is liable for additions to tax for fraud under section 6653(b) for 1975, 1976 and 1977.Fraud is defined as an intentional wrongdoing designed to evade tax believed to be owing. Professional Services v. Commissioner,79 T.C. 888">79 T.C. 888, 930 (1982). The burden of proof rests on respondent to show by clear and convincing evidence that some portion of an understatement of income for each year was due to fraud with the intent to evade tax. Miller v. Commissioner,51 T.C. 915">51 T.C. 915 (1969); section 7454(a); Rule 142(b). Respondent must establish (1) that Joe underpaid his taxes during each year and (2) that some part of his underpayment each year was due to fraud. Hebrank v. Commissioner,81 T.C. 640">81 T.C. 640, 642 (1983). Although respondent *399 may establish fraud with circumstantial evidence, Stephenson v. Commissioner,79 T.C. 995">79 T.C. 995, 1005, 1006 (1982), affd. per curiam 748 F.2d 331">748 F.2d 331 (6th Cir. 1984), fraud cannot be inferred from a mere understatement of income, Holland v. United States,348 U.S. 121">348 U.S. 121, 137 (1954), or from a deficiency in taxes due to an honest mistake or poor judgment. Iley v. Commissioner,19 T.C. 631">19 T.C. 631, 635 (1952). On the record before us, we find that respondent has satisfied his burden of proving an underpayment of tax for each of the years in issue and that some part of each underpayment was due to fraud. To establish that Joe underpaid his taxes for each of the years in issue, respondent presented cancelled checks payable to Joe Edelson or Joe Edelson Realty totalling $31,023.40, $58,277.00 and $42,258.40 for 1975, 1976 and 1977, respectively. Although the record does not contain all of the records relied on by respondent to reconstruct Joe's taxable income for the years in issue, these cancelled checks, alone, represent a substantial underpayment of tax in each of the years 1975, 1976 and 1977. Joe's written statement on his Forms 1040 that these amounts are not taxable because they do not represent *400 dollars of gold and silver is frivolous. This Court has repeatedly held that the statutory gold content of the dollar is irrelevant for purposes of determining taxable income. White v. Commissioner,72 T.C. 1126">72 T.C. 1126, 1129 (1979); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 80-81 (1975), affd. in an unpublished opinion 559 F.2d 1207">559 F.2d 1207 (3d Cir. 1977); Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 194-195 (1976), affd. in an unpublished opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). Consequently, we find that respondent has established an underpayment of tax in each of the years in issue. We also find that respondent has established by clear and convincing evidence that at least part of Joe's tax underpayment for each of the years in issue was due to fraud and not the result of an inadvertent omission or an honest mistake. During the years in issue, Joe earned substantial amounts of commission income from his real estate business which he failed to report on income tax returns for those years. This Court has held that "consistent understatements of income in substantial amounts over a number of years by knowledgeable taxpayers, standing alone, are persuasive evidence of fraudulent intent to evade taxes." Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 108 (1969). *401 Moreover, on this record, we are satisfied that Joe was aware of his obligation to report and to pay taxes on this income. For 1973 and 1974, Joe and his wife, Harriet, jointly filed valid income tax returns on which they reported and paid tax on substantial amounts of commission income. Because the Forms 1040 individually filed by Joe for the years in issue did not contain sufficient data from which respondent could compute and assess Joe's tax liability for the years in issue, such forms did not constitute income tax returns. See Reiff v. Commissioner,77 T.C. 1169">77 T.C. 1169 (1981). Although failure to file a return is not conclusive evidence of fraud, it is persuasive evidence of an intent to defraud the government. Stoltzfux v. United States,398 F.2d 1002">398 F.2d 1002 (3d Cir. 1968); Habersham-Bey v. Commissioner,78 T.C. 304">78 T.C. 304 (1982). Further, the IRS special agent assigned to investigate potential criminal tax violations regarding Joe's 1975, 1976 and 1977 taxable years testified at trial that Joe had repeatedly refused to answer any questions or provide any documents during the course of his investigation.Joe's failure to cooperate in respondent's investigation of the taxable years in issue is additional *402 evidence of fraud. Gajewski v. Commissioner,supra.We also find Joe's transfer of his one-half interest in two parcels of real estate valued at $149,500 to his wife for consideration of $200 to be persuasive evidence of fraud. These transfers occurred on March 22, 1976, approximately three weeks before Joe executed his 1975 Form 1040. We also point out that prior to 1975 Joe and Harriet had filed joint income tax returns. During the years in issue, however, Harriet separately filed her income tax returns on which she reported and paid tax on her income for those years. In conclusion, after a careful review of all the facts before us, we find that respondent has satisfied his burden of proof. Petitioner's attempt to divest himself of substantially all of his assets shortly before he filed his incomplete 1975 Form 1040, his failure to file valid income tax returns for the years in issue and his lack of cooperation all support a finding that he fraudulently underpaid his taxes during 1975, 1976 and 1977. Accordingly, respondent's additions to tax for fraud are sustained. The next issue for decision is whether Joe is liable for additions to tax under section 6654. Section 6654*403 provides for an addition to tax for underpayment of estimated taxes. The record contains no evidence that this addition to tax does not apply. Consequently, respondent's determination is sustained. Rule 142(a). The final issue for decision is whether Harriet is liable for Joe's income tax deficiencies and additions to tax to the extent of $74,550 as a transferee of Joe's one-half interest in two parcels of real estate jointly owned by them. Section 6901(a)(1)(A) authorizes the assessment and collection of transferee liability, at law or in equity, in the same manner as the liability for income taxes. 5 This provision, however, only provides a procedure by which a transferor's taxes may be collected from a transferee. Mayors v. Commissioner,T.C. Memo 1984-401">T.C. Memo. 1984-401, revd. and remanded on another issue 785 F.2d 757">785 F.2d 757 (9th Cir. 1986); Segura v. Commissioner,77 T.C. 734">77 T.C. 734, 742 (1981). The substantive question of whether a transferee is liable for the transferor's obligation is determined by state law. Commissioner v. Stern,357 U.S. 39">357 U.S. 39, 45 (1958). Respondent bears the burden of proving that Harriet is a transferee within the meaning of New Jersey state law. 6 Section 6902(a); Rule 142(d). *404 To support his claim against Harriet, respondent relies upon N.J. Stat. Ann. sec. 25:2-13 (West 1970), which provides as follows: Every conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors is fraudulent as to both present and future creditors. Respondent maintains that the record *405 is replete with evidence that Joe actually intended to defraud the United States government when he transferred to Harriet for inadequate consideration his one-half interest in two parcels of real estate jointly owned by them. Respondent further maintains that the United States was a present as well as future creditor of Joe on March 22, 1976, when the transfers in issue occurred. Respondent therefore concludes that Harriet is a transferee within the meaning of New Jersey state law and, as such, is liable for Joe's income tax deficiencies and additions to tax to the extent the value of the property interests she received from Joe exceeded the consideration she paid Joe for such interests. We agree. Initially, we note that the Federal government was a "present or future creditor" of Joe within the meaning of New Jersey state law at the time the property transfers occurred. N.J.S.A. sec. 25:2-7 defines a creditor as "a person having any claim, whether matured or immatured, liquidated or unliquidated, absolute, fixed or contingent." As of March 22, 1976, the date of the property transfers in issue, the United States had a present or future claim against Joe for his 1975, 1976 and *406 1977 income tax liabilities. The Federal government is therefore a creditor as defined by N.J.S.A. sec. 25:2-7. On the record before us, we are also satisfied that petitioner actually intended to hinder, delay or defraud the Federal government of its lawful taxes when he transferred his one-half interest in the River Edge and Dumont properties valued at $149,500 to Harriet, his wife, for consideration of $200. Our finding is based on the following facts: 1) petitioner transferred his interest in the properties to Harriet only three weeks before he filed a 1975 Form 1040 on which he failed to report any income or income tax liability and Harriet separately filed a 1975 income tax return on which she fully reported her wage income for that year; and 2) although petitioners had filed joint income tax returns prior to 1975, they filed individual income tax returns for 1975, 1976 and 1977. We think that these facts are persuasive evidence that the transfers in issue were part of a plan "to hinder, delay or defraud" the Federal government within the meaning of N.J.S.A. sec. 25:2-13. Consequently, we find that respondent has satisfied his burden of proving that Harriet is a transferee *407 within the meaning of New Jersey state law and, as such, is liable for Joe's income tax deficiencies and additions to tax to the extent of $74,550. To reflect the foregoing, Decisions will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 in effect for the years in question. All rule references are to the Tax Court Rules of Practice and Procedure.↩2. At trial, we granted respondent's oral motion to consolidate these cases for trial, briefing and opinion.↩3. Petitioners' 1973 and 1974 taxable years were the subject of a prior Tax Court case, Edelson v. Commissioner,T.C. Memo. 1979-431↩. In that case, we sustained respondent's determination that petitioners were liable for self-employment income tax under sections 1401 and 1402.4. At the time of the transfers, the properties had a combined fair market value of $170.000. However, on March 22, 1976, petitioners' personal residence was subject to a mortgage of $20,500.↩5. Section 6901(a)(1)(A) provides, in pertinent part, as follows: SEC. 6901. TRANSFERRED ASSETS. (a) METHOD OF COLLECTION.--The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, paid and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred: (1) INCOME, ESTATE, AND GIFT TAXES.-- (A) TRANSFEREES.--The liability, at law or in equity, of a transferee of property-- (i) of a taxpayer in the case of a tax imposed by subtitle A (relating to income taxes), * * * ↩6. Both petitioners were residents of New Jersey on March 22, 1976, the date on which the real estate transfers occurred, and therefore subject to the jurisdiction of that state.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623058/ | LYNN J. HOLMES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHolmes v. CommissionerDocket No. 19050-92United States Tax CourtT.C. Memo 1993-387; 1993 Tax Ct. Memo LEXIS 395; 66 T.C.M. (CCH) 516; August 25, 1993, Filed *395 Decision will be entered for respondent. Lynn J. Holmes, pro se. For respondent: Linette Angelastro. NAMEROFFNAMEROFFMEMORANDUM OPINION NAMEROFF, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. 1 Respondent determined a deficiency in petitioner's 1989 Federal income tax in the amount of $ 683, plus a penalty under section 6662(a) in the amount of $ 136.60. The issues for decision are: (1) Whether petitioner is entitled to deduct various Schedule C expenses for the taxable year 1989; and (2) whether petitioner is liable for the penalty under section 6662(a). Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. At the time of the filing of the petition herein, petitioner resided *396 in Los Angeles, California. Petitioner bears the burden of showing respondent's determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Schedule C ExpensesIn 1982, petitioner received a Ph.D. in biology with a subspeciality in arachnids (spiders). Due to a poor job market, petitioner has been unable to obtain a permanent faculty position. Thus, since 1982, petitioner has held various jobs, many of them unrelated to her field of study. During 1989, petitioner was employed by various employers, from which she received wages totaling $ 14,648.75. 2*397 In addition, petitioner was engaged in various activities which she called "consulting, writing, personal asst., etc." on her Schedule C. Petitioner testified that such activities consisted of working as a scientific consultant on the film "Arachniphobia", 3 acting as a personal assistant to her ill mother, and writing a play with her mother about the latter's impending death. (We note that respondent has not raised any questions regarding section 183.) Petitioner reported gross receipts in the amount of $ 2,828, 4 and claimed expenses in the amount of $ 7,119.90 on her 1989 Schedule C with respect to the various activities. In the notice of deficiency, respondent disallowed $ 2,198 for car expenses, $ 1,189 for interest expense, and $ 1,148 for rent on business property based on lack of substantiation. We must decide whether petitioner properly claimed various business expense deductions *398 for such activities. Deductions are strictly a matter of legislative grace, and the taxpayer bears the burden of proving that she is entitled to any deductions claimed. Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934). If certain claimed deductions are not adequately substantiated, we may be permitted to estimate them when we are convinced from the record that the taxpayer has incurred such expenses and we have a basis upon which to make an estimate. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731">85 T.C. 731, 743 (1985). 1. Car ExpensesPetitioner claimed $ 2,197.85 on her 1989 Schedule C for car expenses. Petitioner testified that her automobile was used for both personal and business use, but that she only claimed expenses attributable to the business use of the automobile, based on an estimated 10,000 business miles. According to petitioner, such business use consisted of driving incurred with respect to her activity as personal assistant to her mother, including driving to and from her mother's home, driving to and from job *399 interviews, and driving to and from the studio for her consulting work on "Arachniphobia". For tax years beginning after December 31, 1985, we are precluded from estimating deductions for local use of vehicles. Walker v. Commissioner, T.C. Memo. 1992-416. Section 274(d)(4) provides that no deduction is allowable with respect to any listed property unless certain substantiation rules are met. Listed property, as defined in section 280F(d)(4)(A)(i), includes any passenger automobile. Petitioner must substantiate the amount of each separate expenditure (i.e., repairs and gasoline), the amount of business and total use (i.e., mileage) of the car, the date of the expenditure or use, and the business purpose for the expenditure or use. Sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Although petitioner presented repair bills which indicate that she drove approximately 15,000 miles during 1989, petitioner has failed to present any records, such as a mileage log, which would establish the portion of the mileage which is attributable to her alleged business activities. Moreover, based on this*400 record, it appears that a significant portion of her purported business use of her automobile was for nondeductible commuting. Accordingly, as petitioner has failed to meet the stringent substantiation requirements of section 274, we sustain respondent on this issue. 2. Interest ExpensePetitioner claimed $ 1,189.32 for interest expense on her 1989 Schedule C. Such amount consisted of $ 537.85 representing 54 percent of the interest incurred on five bank credit cards, a portion of the annual fee for such bank cards in the amount of $ 60, and $ 591.47 as interest on student loans incurred to obtain her Ph.D. in biology. With respect to the amounts claimed by petitioner for bank card interest and fees, petitioner testified that she was unsure of which actual purchases the interest pertained to, as they were made in previous years, although she believed them to be for computer supplies. Thus, petitioner has failed to prove that this interest pertained to her business activities and was not personal. Therefore, this amount is not deductible under section 162. In addition, petitioner claimed $ 591.47 in interest on student loans incurred to obtain her Ph.D. in biology. *401 Petitioner contends that such interest is deductible as a business expense because her "long-term ability to earn a living in the field I've chosen is dependent on my doctorate degree, and some of the activities that I began in [1989] * * * were directly related to having a doctorate degree." Section 162 allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. In order for the interest on the student loan to be considered a business expense, the educational costs themselves must be deductible business expenses. Furthermore, the loan proceeds must have been used for deductible educational expenses and not personal expenditures such as food and lodging. Suffice it to say that petitioner has not proven either of these elements. Although section 162 does not explicitly mention expenditures for education, section 1.162-5, Income Tax Regs., provides objective tests for determining whether such expenditures are deductible. Diaz v. Commissioner, 70 T.C. 1067">70 T.C. 1067, 1072-1073 (1978); Taubman v. Commissioner, 60 T.C. 814">60 T.C. 814, 817 (1973). Generally, this regulation*402 provides that educational expenses are deductible if the education maintains or improves the skills required by the individual in his or her employment or other trade or business or meets the express requirements of the employer. Sec. 1.162-5(a), Income Tax Regs. However, educational expenditures are nondeductible if they are made for education which is part of a program of study which will lead to qualifying the taxpayer for a new trade or business. Baist v. Commissioner, T.C. Memo. 1988-554; sec. 1.162-5(b)(3), Income Tax Regs.At trial, petitioner failed to testify with respect to any trade or business she was engaged in either prior to or during her course of study for her Ph.D. in biology. Petitioner has failed to show how the courses taken by her to obtain her Ph.D. maintained or improved the skills required in her then trade or business, if any. Rather, based on petitioner's sketchy testimony, the Ph.D. was necessary for the type of work which she hoped to obtain -- writing scientific articles, consulting, and teaching. In other words, the loans and interest thereon, were incurred to further education in order to obtain a new trade or business. *403 Therefore, such interest is not deductible under section 162(a). Accordingly, we sustain respondent on this issue. 53. Rent on Business PropertyPetitioner claimed $ 1,148 for rent on business property on her 1989 Schedule C. The amount claimed is a portion*404 of the rent and utilities paid by petitioner for her residential apartment. Respondent does not dispute the amount claimed, but contends that petitioner does not meet the requirements of section 280A. Petitioner testified that her apartment consisted of a living room, bedroom, kitchen, and bathroom, and that each of the primary rooms was approximately the same size. Petitioner further testified that she used the living room exclusively for writing articles, stories, and proposals. Petitioner testified that the living room contained a desk, file cabinets, book shelves, easy chair, lamp, stereo, and pictures, but contained neither a couch nor television. Moreover, petitioner testified that she lived alone and did not entertain family or friends in the living room. Section 280A(a), in general, denies deductions 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) permits the deduction of expenses allocable to a portion of the dwelling unit which is exclusively used on a regular basis as "the principal place of business for any trade or business of the taxpayer". Thus, to qualify under section*405 280A(c) for a home office deduction, petitioner must establish that a portion of her dwelling is (1) exclusively used, (2) on a regular basis, and (3) as the principal place of business for her trade or business. Hamacher v. Commissioner, 94 T.C. 348 (1990). However, section 280A(c)(5) limits the amount of deductions to the excess of the gross income derived from the use of the home office over the deductions allocable to the home office which are otherwise allowable. Although we believe that petitioner used the living room exclusively for her writing activities, we are unable to determine any gross income earned in 1989 from such activities. Her income as wages was attributable to performing various secretarial services or as consultant on the movie, all of which was done outside of the residence. Her nonwage income reported on Schedule C consisted of $ 1,800 from her mother for service rendered outside of the residence and $ 200 for a seminar given for Target. This record does not justify a conclusion that the home office was used in connection with the seminar, and no income was derived from the stated use of "writing articles, stories and proposals." *406 Accordingly, even if we were to find that the living room was used exclusively by petitioner in a business activity, no deduction would be allowable because of the limitation imposed by section 280A(c)(5). Moreover, the amount claimed for use of the home office as an employee business expense (such as, perhaps, in connection with the film) should have been claimed on Schedule A subject to the limitations of sections 67 and 280A(c)(5). However, as discussed previously, petitioner's standard deduction exceeds her itemized deductions. Accordingly, we sustain respondent on this issue. Addition to TaxSection 6662(a) and (b)(1) imposes a penalty on any portion of an underpayment which is attributable to negligence or disregard of rules and regulations. The term "negligence" includes any failure to make a reasonable attempt to comply with the statute, and the term "disregard" includes any careless, reckless or intentional disregard. Petitioner has the burden of proof on this issue. Rule 142(a). Based on this record, petitioner has failed to demonstrate that she was not negligent. Accordingly, we sustain respondent on this issue. To reflect the foregoing, Decision will*407 be entered for respondent. Footnotes1. All section references are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The following is a schedule of petitioner's 1989 employers and the amount of wages reported on the corresponding Form W-2: EmployerWages Word Processors Personnel SVC LA$ 6,473.75Los Angeles Unified School District1,375.00Eastern Producers Payments, Inc.1,250.00UC, Los Angeles5,550.00In addition, petitioner received a Form W-2 from Janway Employment Agency, Inc., which reported wages in the amount of $ 828, but such amount was included on petitioner's Schedule C.↩3. However, petitioner received a Form W-2 from Eastern Producers Payments, Inc., for such income. Such amount was not included on petitioner's Schedule C, but rather, was included on line 7 of petitioner's return.↩4. The following schedule lists the source, activity, and the amount of the income reported on petitioner's Schedule C. ↩SourceActivityAmountJanway Employment Agency Inc.secretarial$ 828Helen Justyne Allen (mother)personal assistant1,800Targetseminar2005. The interest claimed by petitioner for her bank cards and student loans constitutes personal interest, the deduction of which on Schedule A would be limited under the phase-out provision of sec. 163(h)(5). Sec. 163(h)(5) provides that for any taxable year beginning in calendar years 1987 through 1990, the amount of personal interest that is disallowed under sec. 163 is equal to the applicable percentage of such amount. The applicable percentage for 1989 is 80 percent. See sec. 1.163-9T(c), Temporary Income Tax Regs., 52 Fed. Reg. 48410↩ (Dec. 22, 1987). However, petitioner did not itemize because her standard deduction exceeded her itemized deductions; therefore, she would not be entitled to deduct any personal interest. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623062/ | RALPH R. DeVILLARS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDe Villars v. CommissionerDocket No. 15656-85.United States Tax CourtT.C. Memo 1986-374; 1986 Tax Ct. Memo LEXIS 234; 52 T.C.M. (CCH) 180; T.C.M. (RIA) 86374; August 12, 1986. *234 Held, by failing to make a timely response to a Request for Admissions served upon petitioner and filed with the Court by respondent in the manner provided by Rule 90, Tax Court Rules of Practice and Procedure, and by showing no basis upon which the matters thereby deemed admitted under the Rule should be modified or withdrawn, and the matters contained in the Request for Admissions being comprehensive as to all matters contained in respondent's determination of deficiencies in income tax and additions to tax upon which petitioner has the burden of proof, petitioner has accordingly admitted the correctness of respondent's determination in all respects. Ralph R. DeVillars, pro se. Russell F. Kurdys and Edward J. Laubach, Jr., for the respondent. NIMSMEMORANDUM OPINION NIMS, Judge: This case is before the Court on respondent's Motion for Summary Judgment filed April 2, 1986, for a decision in the total amount of the deficiencies in income tax and additions to tax determined by respondent in a deficiency notice sent to petitioner on March 6, 1985. Rule 121, Tax Court Rules of Practice and Procedure. Respondent determined the following deficiencies: Additions to TaxTax Year EndedDeficiencySec. 6651(a)(1) 1Sec. 6653(a)(1)Sec. 6654(a)December 31, 1977$6,391.50$1,597.88$319.58$227.68December 31, 197811,586.702,896.68579.34369.88December 31, 197916,008.904,002.23800.45669.21December 31, 19805,497.281,374.32274.86350.26*236 Respondent's motion is based entirely upon facts deemed admitted by petitioner as a result of his failure to make a timely response to respondent's Request for Admissions (the Request) served by mail upon petitioner on February 20, 1986, and filed with the Court on February 24, 1986. At a hearing on this matter petitioner admitted the correctness of the address to which the Request was mailed, although in a previous document he had denied receiving same. We hold that the Request for Admissions was properly served and filed in compliance with Rule 90. Although Rule 90(c) requires a response within 30 days after service of a request for admissions, no response was forthcoming from petitioner until May 2, 1986, a date subsequent to the date on which respondent filed his Motion for Summary Judgment and 71 days after service of the Request. Under Rule 90(c), each matter is deemed admitted in the absence of an adequate response within the aforementioned 30-day period. The petition in this case raises Fifth Amendment objections, as exemplified by the following paragraphs: C. Petitioner has validly claimed his right against self-incrimination as grounds for refusing to produce*237 the financial information demanded of him by The Internal Revenue Service, has requested a grant of immunity as provided by law, and indicated his willingness to supply the financial information demanded of him provided he is granted immunity against its use against him in a later prosecution. D. Petitioner is not unwilling to assume the burden of proof at Tax Court if the Court can secure for him a grant of immunity; but, in the absence of a grant of immunity Petitioner alleges that placing the burden of proof of him would constitute unlawful coercion, compulsion, and infliction of penalties to compel potentially incriminating information which has not been immunized. The facts contained in respondent's Request which are deemed admitted are as follows: 1. For each of the years 1977, 1978, 1979 and 1980 petitioner Ralph R. DeVillars, without reasonable cause, did not file Federal income tax returns. Said failure to file continues to date. 2. During the years 1977, 1978, 1979 and 1980, Ralph DeVillars had gross income from business in the following amounts: 1977$35,224.62197844,156.43197950,035.37198027,198.493. During those years, petitioner's*238 cost of goods sold were as follows: 1977$4,072.1319782,166.5419793,101.7419801,301.034. During those years, petitioner had deductible business expenses from his sales activities as follows: 1977$5,349.3319786,160.0019795,456.6019806,017.515. During those years, petitioner had interest income in the following amounts: 1977$20.871978133.591979129.2119806. During the years in issue, petitioner had deductible alimony expenses as follows: 19771978$1,500.0019791,800.0019801,800.007. During the years in issue, petitioner had deductible itemized deductions as follows: 1977$1,863.961978197919808. Petitioner's correct taxable income for those taxable years are as follows: 1977$22,460.07197832,963.48197938,806.24198018,079.95 (tax table income)9. For these years, petitioner's correct income tax is as follows: 1977$6,391.50197811,586.70197916,008.9019805,497.2810. For 1977, 1978, 1979 and 1980, petitioner filed no Federal income tax return, and no assessments or payments*239 in tax were made by petitioner for any of those years. 11. The deficiencies in tax due from petitioner for the years in question are as follows: 1977$6,391.50197811,586.70197916,008.9019805,497.2812. Since petitioner, without reasonable cause, failed to file tax returns, there are additions to the tax due for the taxable years 1977, 1978, 1979 and 1980 under I.R.C. sec. 6651(a)(1) in the amounts of $1,597.88, $2,896.68, $4,002.23 and $1,374.32, respectively. 13. Part of the underpayment of tax for the taxable years 1977, 1978, 1979 and 1980 is due to negligence or intentional disregard to the rules and regulations by petitioner. Consequently, the 5 percent addition to the tax under I.R.C. sec. 6653(a)(1) is applicable. 14. There are due from petitioner for the taxable years 1977, 1978, 1979 and 1980 additions to the tax under I.R.C. sec. 6653(a)(1) in the following amounts: 1977$319.581978579.341979800.451980274.8615. Petitioner underpaid his estimated tax for each of the years, and consequently is liable for the additions to the tax under*240 I.R.C. sec. 6654(a) in the following amounts: 1977$227.681978369.881979669.211980350.26Petitioner's late response to respondent's Request for Admissions was as follows: 1. Untrue, for the years 1977, 1978, 1979, and 1980. Petitioner Ralph R. DeVillars was not required to file Federal tax returns due to lack of income, Connors v. U.S., Civ. A No. 68H721. 2. Untrue, for the years 1977, 1978, 1979, and 1980. Ralph DeVillars had no gross income, but compensation for labor in exchange for time. 3.Denied, blatant understatement of costs. 4. Denied, blatant understatement of expenses. 5. Denied. 6. Denied, blatant understatement of expenses of raising a child. 7.Denied. 8. Untrue. Petitioner had no taxable income, for any year much less a taxable income for taxable year. 9. Untrue. Petitioner had no income since all he ever received was compensation. 10. For the years 1977, 1978, 1979 and 1980, petitioner was not required to file Federal tax returns due to lack of income. 11. Denied, pure assumption. 12. Petitioner has every reasonable cause not to file. Privacy Act and Paperwork Reduction Act. *241 Oliver v. Halsteadt, 96 S.E.2d 858">96 S.E. 2d 858, 859. 13. Denied. No underpayment of tax was made for any of these years. There is no negligence or intentional disregard of any mandatory rules or regulations. Voluntary regulations may be disregarded without punishment or these regulations would be mandatory. 14. Denied.No taxable years for petitioner have been established. 15. Denied. Petitioner never underpaid any estimated tax. NEW MATTERPetitioner respectfully petitions this court to take judicial notice of U.S. v. Aitken 84-1614 and give petitioner a determination of the word income, or in the alternate tell petitioner which code section I can find the word defined at. The prosecution is moving forward under assumptions which have never been declared to be so. There rests a responsibility with the senior attorney of the Internal Revenue Service to know what income is. Bothke v. US 713 F2d 1405 (1983). Petitioner motions this court to dismiss this harassment due to lack of income for the years in question. Petitioner also respectfully requests to appear in the Court of proper jurisdiction, which should be the tax court of the United States*242 since petitioner is a Citizen of one of the United States and not one that is included in the United States' tax code. This case was placed on a calendar for trial in Pittsburgh, Pennsylvania, commencing May 27, 1986, and respondent's Motion for Summary Judgment was also placed on that calendar for disposition. Previously, petitioner had filed an "Objection to Respondent's Motion for Summary Judgment" stating that he had never previously received the Request (a copy of which was attached to respondent's Motion for Summary Judgment) upon which respondent's motion was based (although he subsequently admitted that the address to which the Request for Admissions was mailed was his correct address), and asserting various frivolous tax protester objections. When the case was called from the calendar in connection with respondent's Motion for Summary Judgment, petitioner appeared in person and was heard. At the hearing the Court read into the record or summarized therein each of petitioner's responses to the matters contained in respondent's Request. Petitioner continued to press his contention that compensation for labor is not income. He also continued to demand that he be cited*243 to the Code section which defines the term "income." At this point the following colloquy occurred: THE COURT: Well, I'm sorry. I just don't think we're going to get anywhere with this hearing. Do you have any wish to try to prove any of your income or your deductions in this Court? Because if you don't, we might as well conclude this proceeding right now. MR. DeVILLARS: I have nothing now -- THE COURT: Okay. MR. DeVILLARS: -- to prove that. Although Rule 90(f) permits the withdrawal or modification of admitted matters when the presentation of the merits of the case will be subserved thereby and the party (here, respondent) who obtained the admission fails to satisfy the Court that the withdrawal or modification will prejudice him in prosecuting his case or in its defense on the merits, we think it is clear that the frivolous and peremptory nature of petitioner's tardy responses to the Request, his adamant pressing of tax protester arguments at the hearing and his declining the opportunity to offer substantive evidence as to his income and deductions at the trial make it evident that no basis exists for our directing the withdrawal or modification of the deemed admissions. *244 The matters deemed admitted by petitioner will therefore stand. Dahlstrom v. Commissioner,85 T.C. 812">85 T.C. 812, 818-819 (1985). Respondent's Motion for Summary Judgment will be granted. Petitioner is deemed to have admitted the amounts of gross income from business, cost of goods sold, deductible business expenses for sales activities, interest income, alimony expenses, deductible itemized expenses, taxable income and income tax, income tax deficiencies and additions to tax under sections 6651(a)(1), 6653(a)(1) and 6654(a) as stated in the Request, which are the same as those determined in the deficiency notice. Petitioner has the burden of proof as to all of these items. Rule 142(a). Petitioner further has admitted that he could produce no evidence to challenge the Commissioner's determination. Compensation for services is taxable income, not forbidden by the Constitution. Lonsdale v. Commissioner,T.C. Memo. 1981-122, affd. 661 F.2d 71">661 F.2d 71 (5th Cir. 1981). In addition, we patiently repeat a long-standing definition of income contained in an opinion by Judge Learned Hand: "[i]ts meaning [of income] is * * * to be gathered from the*245 implicit assumptions of its use in common speech." United States v. Oregon-Washington R. & Nav. Co.,251 F. 211">251 F. 211, 212 (2d Cir. 1918). We have adopted this definition as our own. Hellermann v. Commissioner,77 T.C. 1361">77 T.C. 1361, 1366 (1981). To reflect the foregoing, An appropriate order will be entered.Footnotes1. Unless otherwise noted, all section references are to sections of the Internal Revenue Code of 1954 in effect for the years in question. All rule references are to the Tax Court Rules of Practice and Procedure.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623063/ | PAUL M. HANSEN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHansen v. CommissionerDocket No. 11617-77.United States Tax CourtT.C. Memo 1981-98; 1981 Tax Ct. Memo LEXIS 654; 41 T.C.M. (CCH) 1023; T.C.M. (RIA) 81098; February 26, 1981. Gregory M. Hansen and Howard S. Landa, for the petitioner. Stewart C. Walz, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies*656 in petitioner's income tax for the calendar years 1968, 1971 and 1972 in the amounts of $ 2,035.24, $ 6,681.14 and $ 12,734.54, respectively, and additions to tax under section 6653(b), I.R.C. 1954, 1 in the respective amounts of $ 1,017.62, $ 3,340.57 and $ 6,367.27. The determination of the deficiency and addition to tax for the year 1968 resulted from the disallowance of a net operating loss carryback to that year from the year 1971, which carryback loss had previously been allowed by respondent. In his reply brief respondent conceded the deficiency and addition to tax with respect to the year 1972. The issues for decision are: (1) whether there was a deficiency in petitioner's income tax for the calendar year 1971, a part of which was due to fraud, and if not was the loss carryback to 1968 overstated due to fraud; and (2) whether the assessment and collection of deficiencies for the years 1968 and 1971 are barred by the statute of limitations. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. *657 Petitioner, who resided in Victoria, British Columbia, Canada at the time of the filing of the petition in this case, filed a joint Federal income tax return with his wife on July 12, 1972, with the Internal Revenue Service Center in Ogden, Utah. On this return petitioner showed adjusted gross income of a loss in the amount of $ 16,083.40. Petitioner filed a carryback claim carrying back this loss to the year 1968 and as a result of the carryback claim was allowed a refund of the tax he paid for the year 1968 in the amount of $ 2,035.24. Petitioner filed a joint Federal income tax return with his wife for the taxable year 1968 on May 7, 1969, reporting taxable income of $ 10,332.94. Petitioner is both a lawyer and a certified public accountant. He was admitted to practice law in the State of Utah in 1956 and became a certified public accountant in Utah in 1960. Prior to 1970 and after 1971 petitioner was a professor of accounting at Weber State College, Ogden, Utah. During 1970 and 1971 petitioner took a leave of absence from his position with Weber State College to work in the tax department of Elmer Fox & Company, a CPA firm. The leave of absence was taken by petitioner*658 in order that he might establish an internal tax training program for the employees of Elmer & Company. In 1967 petitioner published a book entitled "1968 Utah Capital Tax Guide as Related to the Internal Revenue Code." Also prior to the years in issue petitioner had served as tax adviser for a number of corporations and businesses and also as a management consultant for businesses and corporations. While petitioner taught at Weber State College he engaged in the practice of law. During 1971 petitioner was a Justice of the Peace and in this capacity received fees for which he was issued a Form W-2 by South Odgen City. Apartment Enterprises (Apartment) was incorporated on September 24, 1970. During 1971, 1972 and the first half of 1973 petitioner was the president of Apartment. During its fiscal years July 1, 1971 to June 30, 1972, and July 1, 1972 to June 30, 1973, Apartment paid petitioner compensation for serving as its president. Petitioner represented Apartment in negotiating the purchase of the Bellevue Estates apartments, the 88th East apartments, the Casino Terrace apartments, the Lynnview apartments, and the Norlang Estates apartments. The agreements to purchase these*659 various apartments were negotiated by Apartment for the benefit of limited partnerships of which Apartment was the general partner and the rights under each agreement were assigned to the partnership which was to own the apartments. These limited partnerships were B & L Partnership Limited (B & L), Norlang Estates Partnership Limited (Norlang), and 88th East & Casino Terrace Partnership (88th East). Apartment participated in the management of the properties acquired by the limited partnerships. The Bellevue Estates apartments and the Lynnview apartments were acquired by B & L, the Norlang Estates apartments were acquired by Norlang, and the 88th East apartments and the Casino Terrace apartments were acquired by 88th East. In March 1971 petitioner and four other individuals organized a partnership named Chateau. There was no written partnership agreement but each of the partners owned an equal interest in the partnership. The partnership was organized to construct, own and operate the Chateau apartments and shortly after its formation began construction of the apartments. Before the end of 1971, Mr. J. Blair Jones, the partner who was actually engaged in supervising the construction*660 of the apartment buildings, withdrew from the partnership. As of December 31, 1971, petitioner and each of the remaining four partners held a 25 percent interest in Chateau. The principal place of business of petitioner and of Apartment during the years here in issue was Ogden, Utah. The apartments owned by B & L were in Seattle, Washington, and the partnership address was Seattle, Washington. The apartments owned by Norlang were in British Columbia, Canada, and the address of that partnership was Vancouver, British Columbia, Canada. The apartments owned by 88th East were also in Seattle, Washington, and this was the address of that partnership. The apartments owned by Chateau were in Centerville, Utah, which is approximately 16 miles from Ogden, Utah. The books of Chateau were maintained in its office of Main Street in Centerville, Utah, near the place the apartments were constructed. During 1971 until Mr. Blair Jones withdrew from the partnership, petitioner would visit the Chateau office two or three days a week and after Mr. Jones withdrew from the partnership he visited the office daily. On occasions he would visit the office more than once in the same day. Apartment*661 was also the general partner and participated in the management of apartment properties of several partnerships other than those heretofore listed. Petitioner's books and records for the year 1971 and the books and records of B & L, Norlang and 88th East were maintained on a cash basis of accounting. Petitioner's income tax returns were filed on a cash basis and the Forms 1065 (U.S. Partnership Return of Income) were filed by the partnerships on a cash basis. In 1971 petitioner had a 1.19 percent interest in the income and loss of Norlang and a 6.616 percent interest in the income and loss of B & L. The contract by which Norlang purchased the Norlang Estates apartments was signed on October 29, 1971. On the first page of the contract it is stated that the contract is made on the 31st day of August 1971. The deed transferring the Norlang Estates apartments to Norlang was recorded on October 29, 1971. The final sales contract for the purchase of the Norlang Estates apartments was drafted by a Canadian attorney. This attorney was given an interim agreement which had been signed by Apartment and Omega Concrete Pumping Co. Ltd. in April 1971. The Agreement entered into between*662 Norlang and Norlang Development Limited the seller of the Norlang Estate apartments, provided in part as follows: 2. The purchase price shall be $ 1,555,000.00 (subject to a discount of $ 50,000.00 as hereinafter referred to). In addition the purchaser shall pay $ 175,000.00 for construction interest, financing points, and all other financing fees incurred by the Seller during the construction of said apartments. Said amounts payable in the following manner: (a) It is agreed that there exists as of the 20th day of April, 1971, a first mortgage in the amount of $ 1,379,632.50, with a five year term, amortized over 30 years, at 9-3/4% interest, the first payment due on or about October 1, 1971, in favour of National Trust Company, Limited and that Purchaser shall acquire the property described herein, subject to said mortgage.(b) Purchaser shall pay $ 175,000.00 for all construction interest, financing points, and all other financing fees and/or standby fees upon closing and upon receipt of title to said apartments * * *. The closing statement for the purchase of the Norlang Estates apartments was as follows: VENDOR: NORLANG DEVELOPMENTS LTD. PURCHASER: NORLANG*663 ESTATES LTD. PROPERTY: LANGLEY APARTMENTS [Norlang Estates apartments] ADJUSTMENT DATE: NOVEMBER 1, 1971. DEBITCREDITTO PURCHASE PRICE$ 1,730,000.00BY DE DEPOSIT$TO Adjustment of Taxes389.82TO Adjustment of Insurance(Sept. 17)2,075.11TO Tax debit held by National Trust11,100.00BY National Trust mortgage balance1,379,632.50BY Rental deposits2,014.00BY November rents11,550.93BY Construction interest payableto National Trust175,000.00BY Balance due to North Road HoldingsLtd. Mortgage175,367.50$ 1,743,564.93$ 1,743,564.93E. & O. E. NOTES: 1. All utilities such as electricity, gas, fuel oil, etc., to be adjusted in cash on the possession day directly between the Vendor and the Purchaser. 2. Fulton, Cumming, Bird, Richards are authorized to pay the above sums where applicable. The $ 50,000 discount was to be received by Norlang if the second mortgage on the property was paid off before a specified date. This second mortgage was paid in January 1972 which was before the specified date. On the Form 1065 filed by Norlang for the year 1971, which return was signed by petitioner in*664 his capacity as president of the general partner, Apartment, a deduction was taken for interest expense in the amount of $ 185,284 which included the $ 175,000 paid under the purchase contract for the Norlang Estates apartments. On this return in the depreciation schedule the acquisition date of the Norlang Estates apartments was shown as July 1, 1971. On this return, for depreciation purposes buildings were shown as having a basis of $ 1,271,000 and equipment, furniture and appliances were shown as having a basis of $ 279,000. The $ 50,000 discount provided for in the contract was not deducted in determining the basis of the Norlang Estates apartments. A note beneath the depreciation schedule stated as follows: Partnership property is Depreciated in accordance with Canadian Tax Law. Partnership assets are located entirely in Canada. The Partnership does not have any assets within the United States, nor does it conduct business within the United States. All Partnership business is conducted in Canada. On this Form 1065 return of income of Norlang a net loss of $ 320,711 was reported and this loss was allocated to the general partner and the various limited partners, including*665 petitioner, on the basis of their respective interests in the partnership. The loss allocated to petitioner was $ 3,817. Of the $ 175,000 paid by Norlang to the seller of the Norlang Estates apartments, $ 30,000 went to Russell B. Swartz in discharge of his real estate commission. One-half of this commission, or $ 15,000, was paid by Mr. Swartz to petitioner pursuant to an agreement dated August 9, 1971. In January 1973 the Revenue agent who was performing an aduit of the return of income of Norlang and petitioner's income tax return requested information from petitioner corroborating the interest deduction claimed on the Norlang 1971 return of income. On January 17, 1973, petitioner wrote the National Trust Company asking for the information requested by the Revenue agent and suggested that the response be purchased as follows: In response to your request for interest paid to us, we have determined from our records that we received the total amount of $ interest to November 1, 1971. On or about January 28, 1973, petitioner received a letter from the National Trust Company stating that "Interest paid from date of first advance, May 29th, 1971 to Ocotober 31st, 1971*666 -- $ 41,038.82." When petitioner presented this letter to the Revenue agent, the date May 29, 1971, had been changed to May 29, 1970, and the interest figure appearing in the letter had been changed from $ 41,038.82 to $ 141,038.82. The Revenue agent wrote the National Trust Company on February 15, 1973, for information regarding the interest expense claimed by Norlang on its 1971 return of income. The agent received in reply a letter dated February 21, 1973, which showed the interest paid as originally shown in the letter to petitioner before alterations were made in the document. The alterations made in the letter to petitioner from the National Trust Company were made by petitioner before the document was presented to the Revenue agent. On the 1970 Form 1065 return of income of B & L, which return was signed by petitioner as an officer of Apartment, the Bellevue Estates apartments and the Lynnview apartments were shown on the depreciation schedule as having been acquired on October 1, 1970. The contract for purchase of the Bellevue Estates apartments by Apartment was signed by the parties to the contract on December 22, 1970, but recited that the agreement was made on October 1, 1970. *667 The Bellevue Estates apartments were transferred by Apartment to B & L. The cash was received from the buyer in the transaction involving the Bellevue Estates apartments on December 28, 1970, and the escrow agent opened the escrow on that date. The real estate contract for the purchase and sale of the Bellevue Estates apartments was drafted by the escrow agent from an earnest money agreement submitted to the escrow agent by the real estate agent in the transaction and from an interim or proposed contract supplied to the escrow agent by petitioner. Petitioner had written to the real estate agent on December 12, 1970, enclosing a preliminary offer to purchase the Bellevue Estates apartments. The earnest money receipt and the agreement relative to the purchase of the Bellevue Estates apartments which was submitted to petitioner by a letter dated December 18, 1970, recites that the purchase price of the apartments is $ 1,700,000 payable as follows: $ 50,000 in cash, including above earnest money of $ 10,000.00, as full down payment which be deposited in the form of certified or Cashier's check with Herbert J. Droker, Escrowee, the purchasers on or before 5:00 P.M. on December 31, 1970. *668 The sellers shall credit the $ 50,000.00 as pre-paid interest on the unpaid balance of the purchase contract hereinafter shown herein. Further payments by purchaser are to be made as follows: $ 25,000.00 on January 15, 1971: $ 25,000.00 on July 15, 1971; and $ 50,000.00 on January 15, 1973. The sale shall be closed as of December 31, 1970. The contract for the purchase of the Bellevue Estates apartments, signed December 22, 1970, provides in part: The date of closing of said sale and purchase is October 1, 1970. 2. The total purchase price is ONE MILLION FIVE HUNDRED FIFTY THOUSAND DOLLARS ($ 1,550,000.00), payable as follows: a. ONE MILLION ONE HUNDRED THIRTY NINE THOUSAND, EIGHTY FIVE and 73/100 DOLLARS ($ 1,139,085.73), herein called "Schedule A balance", which sum is identical to the principal balance adjusted for interest of the Deed of Trust dated August 20, 1968, recorded September 6, 1969, under King County Auditor's File No. 6402888, executed by Seller to Firstbank Mortgage Corporation as beneficiary, assigned by Firstbank Mortgage Corporation to and held by United Benefit Life Insurance Company, known as "United of Omaha". The Schedule A balance shall be paid*669 as follows: * * * b. The Purchaser shall pay FIFTY THOUSAND DOLLARS ($ 50,000.00) interest on the 31st day of December, 1970; TWENTY-FIVE THOUSAND DOLLARS ($ 25,000.00) interest on the 15th day of January, 1971; TWENTY-FIVE THOUSAND DOLLARS ($ 25,000.00) on the 1st day of July, 1971; and FIFTY THOUSAND DOLLARS ($ 50,000.00) interest on the 15th day of January, 1973. It is fully agreed between the parties hereto that Seller's equity shall bear interest in the following amounts for the period specified, in addition to the interest payments provided in section (3) below: PeriodInterestOctober 1, 1970 through December 31, 1971$ 60,000January 1, 1971 through December 31, 197245,000January 1, 1973 through December 31, 197345,0003. The balance of the purchase price in the amount of $ 410,914.27, being Seller's equity, shall be increased by $ 4,761.63 (the resultant of prorated deposits, real estate taxes, insurance premiums and reserve accounts) to $ 415,675.90, herein called "Schedule B Balance". The Schedule B Balance shall bear interest determined as follows: * * * The prorating of th insurance policy and other charges relative to the Bellevue Estates*670 apartments sale were done ad of January 1, 1971. Although the instructions to the escrow agent by the parties were that the transaction was to close as of the last day of 1970, the prorating was done as of January 1, 1971, to avoid the necessity of calculating the expenses of 1970 to be charged to the seller for one day of that year. The rent for the entire year 1970 from the Bellevue Estates apartments was received and kept by the seller and the seller did not bill petitioner or Apartment for any expenses for 1970, nor was any 1970 income allocated to Apartment. Petitioner negotiated on behalf of Apartment the purchase of the Lynnview apartments which Apartment transferred after purchase toB & L. The contract for the purchase of the Lynnview apartments states that it was made on the first day of October 1970. The transaction was closed in late December 1970 although the contract provided that the "closing date shall be October 1, 1970" and further provided for adjustments of taxes, insurance and various other items as of the closing date. The prior owner, Harry Pryde, operated the apartments until the end of December 1970. He collected the rent on those apartments through*671 December 1970, deducted the expenses for that period of time and did not turn any portion of the receipts or receive any reimbursement of the expenses from petitioner or Apartment of B & L. When the transaction with respect to the Lynnview apartments was closed in late December and B & L took over the operation of the apartments on January 1, mortgage payments with respect to the apartments were made directly to the prior owner, Harry Pryde. The contract for the sale of the Lynnview apartments to Apartment provided that the property was subject to the following liabilities, with the balances as of the date of sale as listed: Union Federal Savings& Loan Association$ 586,693.05Reuben Gunst10,224.24Harry Pryde (Seller'sEquity)93,296.67The contract recites that the total purchase price of the Lynnview apartments is $ 686,000. It further recites that-- Fourteen Thousand Dollars ($ 14,000) (b) The Purchaser shall pay Fifteen Thousand Dollars ($ 15,000) interest on or before the 31st day of December, 1970. It is fully agreed between the parties hereto that Seller's equity shall bear interest for the period specified below, and that thereafter interest*672 shall be as provided in section (3). PERIODINTEREST10-1-1970 through 9-30-71$ 14,0003. The balance of the purchase price in the amount of ($93,296.67), designated as Seller's equity shall be increased or decreased by those prorated amounts contained in and set forth on the closing statement, which is incorporated by reference herein. The closing date shall be October 1, 1970. On the original partnership return of income of 88th East, which was signed by petitioner Paul M. Hansen as the chief executive officer of Apartment, the depreciation schedule showed that the 88th East apartments and the Casino Terrace apartments were acquired on July 1, 1971. On a first amended partnership return of income for 88th East these apartments were shown as having been acquired on November 1, 1971, and this same acquisition date was shown on a second amended return. Petitioner represented Apartment in the acquisition of the 88th East apartments and the Casino Terrace apartments from G & M. Investments. These apartments were turned over by Apartment to 88th East after their acquisition. The real state contract was dated November 5, 1971, although negotiations with respect*673 to the purchase of the apartments took place in the fatter part of November and December 1971 and the final closing and release of the escrow funds with respect to the purchase and distribution of funds to the sellers occurred on January 6, 1972. In May 1972 the Revenue agent examining the 88th East partnership return of income looked at the prospectus for this partnership. He placed paper clips on certain pages of the prospectus and asked for copies of those pages. One of the pages on which a paper clip was placed was a letter dated November 29, 1971, addressed to "Mr. Paul Hansen, B & L Enterprises, Ltd., 817 Oak Drive, South Ogden, Utah" and signed by M. R. Mastro for G. & M. Investments. This letter stated: The following is submitted as per our telephone conversation of November 25, 1971. 88th East Apartments (* * *) Completed November 1, 1971 Casino Terrace Apartments (* * *) To be completed January 1, 1971 Recap88 Units144 Units232 Units at 10,500$ 2,436,000.00The last sentence of the letter stated: Terms can be arranged with considerable flexibility and I do feel that this represents an attractive long term investment. After requesting*674 photostatic copies of items in the prospectus, including a copy of the letter dated November 29, 1971, the Revenue agent receive in the mail a document which was a copy of the November 29, 1971, letter with the date removed and the price per unit as shown in the letter of $ 10,500 with a total of $ 2,436,000 also removed. Also removed were the statements "Completed November 1, 1971" under the 88th East apartments and "To be completed January 1, 1971" under the Casino Terrace apartments. Later at a meeting between the Revenue agent and a representative of the seller of the 88th East apartments and the Casino Terrace apartments, the agent received a copy of the requested letter from the representative with the dates and amounts shown thereon. The various buildings in the Chateau apartments complex were designated by letters. In addition to the apartment buildings there was a clubhouse building in the complex. Records of the Utah Power and Light Company show the following information with respect to electrical hookups to tenants' apartments during 1971: ConnectionApartmentPower to UnitTenantDateNumberDate SetDon Hansen9-27-713-D9-27-71Jay P. Clark10-04-711-D9-27-71Larry Castano9-27-712-D9-27-71Chateau Corporation9-27-71H & B - D9-27-71Frank A. Jones11-01-714-D9-27-71Kent H. Saxey10-05-712-D9-27-71Leo J. Millner10-11-716-D9-27-71Elden Zuchetto11-02-715-D9-27-71James Veruille9-27-7110-D9-27-71[Illegible] Brown11-01-719-D9-27-71[Illegible] Dalby9-27-718-D9-27-71Andrew S. Jensen11-01-7110-E10-11-71[Illegible] Porter11-04-719-E10-11-71Linda Callihan10-11-718-E10-11-71Joe L. Swapp12-24-717-E10-11-71Wayne Newton10-11-716-E10-11-71Richard Brady5-05-725-E10-11-71Hal Lines11-9-714-E10-11-71Chateau Corporation10-04-71H & B - E10-04-71Kent Pantone11-17-713-E10-11-71Jerry W. Wheeler11-02-712-E10-11-71George B. LeSueurSee old sheet1-E10-11-71Bruce Foster2-15-723-F10-11-71John M. Beasley9-01-727-F10-11-71Delores Hannen5-07-721-F10-11-71Chateau Corporation9-28-71H & B - F9-28-71Richard B. Roberts8-14-724-F10-11-71John K. Busenback4-01-725-F10-11-71Kenneth R. Kotter5-19-726-F10-11-71Russell D. Street2-02-727-F10-11-71[Illegible] Sparks12-26-7110-F10-11-71[Illegible] Unck12-27-719-F10-11-71Arthur Thumball1-19-728-F10-11-71James W. MaGaughey1-10-7210-T10-11-71Steven D. Page1-28-729-T10-11-71[Illegible] Blosen4-15-728-T10-11-71Chateau Corporation9-28-71H & B - T9-28-71Charles Fields3-12-727-T10-11-71Fred M. Owen2-22-726-T10-11-71John Barton5-01-725-T10-11-71Larry G. Brady2-28-724-T10-11-71Gary S. Miller8-07-723-T10-11-71Kent H. Saxey1-24-722-T10-11-71James Veruille2-07-721-T10-11-71*675 Prior to the date of setting of power to the units, Chateau had a temporary hookup for electric power to the buildings. The records of Chateau show a payment to Utah Power and Light of July 21, 1971, in the amount of $ 453. The record also shows that power to building A was set on January 12, 1972. When apartments were rented in the various buildings of the Chateau apartments, the power units in the apartments were never transferred to the tenants' names until after the tenants moved into the apartments, and at times when a tenant moved into an apartment prior to the time the power was transferred to the tenant's name, the tenant would use power from the hookup in the name of Chateau. There were persons living in the Chateau apartments on September 9, 1971. Building A was completed in 1971 and apartments rented in it. Chateau tried to get tenants moved in before Christmas and some actually moved in right after Christmas. There was a furnished model apartment in building T. This building was finsihed in September 1971 and the model apartment was open for inspection at that time. Each of the apartments in the various buildings of the Cheteau apartments contained appliances, *676 draperies and carpeting which were installed prior to a tenant moving into an apartment. The clubhouse was completed and furniture and fixtures installed therein sometime prior to the end of the 1971. Chateau did not maintain a double entry set of books for the year 1971. The records kept in the single entry set of books were transferred to a computer and the records kept on a computer. Anna Rae Nelson was the bookkeeper for Chateau from the time it commenced operations until February of 1972. She kept the books under the general direction of petitioner. She verified bills and the drew the checks in payment thereof and entered the amounts in the books. Beginning in April 1971 petitioner received checks from Chateau. The following shows the check number, date and amount of the checks received: Check NumberDateAmount1234/01/717501344/13/711,0001354/13/717501394/15/715001655/07/717501786/01/717502457/12/717502788/03/717503719/03/7175040310/04/7175048411/01/7175059912/20/71750The total amount of these checks--$ 9,000--was treated on the books of Chateau as a partner's draw. The*677 following shows how the partners' accounts were handled on Chauteau's books through the end of 1976: Chateau Partnership Analysis of Capital Account PaulByronPaulEvanHansenNaisbittNaisbittEvans1971--Capital Contributed0000Loss - Ordinary(43781)(43781)(43781)(43780)Draw -9000000Blance 1971(52781)(43781)(43781)(43780)1972--Capital ContributedSchedule I28454132551325513255Loss - Ordinary( 337)( 337)( 337)( 337)Draw -( 8000)000Loss - Sect. 1231(29663)(45380)(45380)(45381)Balance 1972(62327)(76243)(76243)(76243)1973--Capital ContributedSchedule II3317331733173317Loss - Ordinary( 60)( 60)( 60)( 60)Draw -( 5250)000Loss - Sect. 1231( 6662)( 6661)( 6662)( 6661)Balance 1973(70982)(79647)(79648)(79648)1974--Capital ContributedSchedule II39494387353873438735Loss - Ordinary(57357)(57358)(57357)(57358)Draw -( 3500)000Balance 1974(92345)(98270)(98271)(98271)1975--Capital ContributedSchedule IV11368263632636326369Loss - Ordinary(78496)(78496)(78496)(78497)Balance 19751594731504031504041503991976--Capital ContributedSchedule V3500800080008000Loss - Ordinary(47711)(47711)(47711)(47711)Gain - Long term4395439543954395Draw(80767)(80774)(80773)(80773)Balance 1976280056266493266493266487CASH PAID IN91723855378553785537Ending Balance274460270626270626270626*678 J. Blair Jones, a partner in Chateau until about November 1, 1971, who supervised the construction of the buildings, received checks in the amount of $ 1,500 a month from Chateau which were also treated on the books of Chateau as partner's draw. The total amount received in 1971 by Mr. Jones from Chateau Partnership was $ 13,000. Chateau took no deduction for the draws it showed on its books of either petitioner or Mr. Jones. When Mr. Jones withdrew from the partnership about the first of November 1971 because of disagreements with petitioner, his partnership interests and accounts were settled. Chateau claimed an interest deduction on its tax return of $ 114,887.39 for the year 1971. The records of Chateau show payments of this amount of interest. A letter from the Utah Mortgage Loan Corporation to an agent of respondent stated that during 1971 Chateau paid the Utah Mortgage Loan Corporation $ 106,696.70 and during 1972 paid it $ 117,206.05. Chateau of its 1972 partnership return of income claimed a deduction of $ 113,347.61 for interest paid. On its 1971 tax return Chateau claimed a deduction for legal and professional fees in the amount of $ 8,220.85. The Chateau apartments*679 were constructed from pre-cut components. Some of the constructon was average and some below average. The buildings constructed in 1971 were mostly below average construction. During the calendar year 1971 petitioner maintained jointly with his wife, Marie B. Hansen, the following bank accounts: BankAccount No.TypeBank of Utah301804-0SavingsOgden, UtahBank of Utah3-21-229-7CheckingOgden, UtahDavis County Bank8260SavingsFarmington, UtahDavis County Bank7998SavingsFarmington, UtahDavis County Bank101-10522-12CheckingFarmington, UtahPetitioner did not personally conduct any of the transactions at the Davis County Bank, Farmington, Utah, with respect either to the checking or savings accounts. All transactions in these three accounts were conducted by petitioner's wife, although checks made payable to petitioner were deposited in these accounts. A check for $ 2,500 to petitioner from Apartment was deposited in petitioner's checking account in the Davis County Bank on December 6, 1971. Petitioner received a check dated October 8, 1971, from Apartment for $ 1,000. On the face of the check there appeared in handwriting*680 "Payment for 60 day land option for Chateau Partnership." On October 9 this check was endorsed by petitioner to Dean Real Estate in Ogden, Utah. On the back of the check in handwriting appeared the following note: Land Deposit for Evan Evans, Paul Naisbitt, Byron Naisbitt and Paul Hansen. Land owned by Doug Stephens. Oakridge area. Evan Evans, Paul Naisbitt, and Byron Naisbitt were doctors who owned an interest in Apartment and who were the other three partners in Chateau. The $ 1,000 was shown by Dean Real Estate on its books as earnest money. The ledger sheet reflecting the $ 1,000 check shows that the $ 1,000 was repaid by Dean Real Estate on April 12, 1972. Petitioner received interest income in 1971 in the amount of $ 72.92 which was not reported on his Federal income tax return for that year. Petitioner, on his Federal income tax return for 1971 showed adjusted gross income as a loss of $ 16,083.40 computed as follows: Wages, salaries, tips, etc.$ 17,328.58Interest167.38Income other than wages, dividends, and interest(33,579.36)Adjusted gross income(16,083.40)The income other than wages, dividends, and interest was computed as follows: *681 Professional Income$ 39,183.41Expenses11,731.13Net Fees and Other Professional Income$ 27,452.28Net Long Term Capital Loss( 235.77)Partnership Loss from B & L Enterprises(13,434.00)Partnership Loss from Chateau Partnership(43,780.64)Norlang Estates Limited, Partnership Loss( 3,817.00)Net Business Income or Loss(33,579.36)The loss of $ 16,083.40 shown by petitioner on his 1971 return was carried back to 1968 to offset taxable income shown on that return of $ 10,332.94. On the basis of the loss carryback claim respondent refunded to petitioner the entire $ 2,035.24 tax paid by petitioner for the year 1968 plus interest. Attached to petitioner's 1971 return were letters from B & L, Chateau and Norlang setting forth the partnership losses and petitioner's prorata share thereof. The Chateau letter stated in part: Taxpayer's share of the operating loss of Chateau Partnership for 1971 is $ 39,780.64 plus $ 4,000.00 1st year depreciation for a total operating loss of $ 43,780.64. * * * Included in the business expenses shown on petitioner's return as connected with his professional income including his work as a Justice of the Peace*682 was $ 2,099.16 stated to be "Auto expenses, travel research, 18,324 miles 12" for 15,000 miles - 9" for 3,324 miles." Petitioner's tax return shows that he was entitled to six exemptions and that he had the following personal deductions: Contributions, $ 4,245, with a notation "No charitable contributions claimed--contributions carried over to 1972;" Taxes, $ 1,466.66; Interest expense, $ 2,296.25. The Chateau partnership return for the year 1971 shows rental income for September, October, November and December totaling $ 5,967.55 and expenses of $ 165,090.13 resulting in a loss of $ 159,122.58, and additional first year depreciation of $ 16,000 resulting in a total loss of $ 175,122.58. The depreciation schedule on that return shows the following: Date acquiredJuly 1, 1971 BuildingsCost$ 574,900Method & LifeDDB 25 years1971 Reg. Dep.$ 22,9961971 Additional1st Yr. Depreciation$ 160,000 [sic]The schedule of the partners' share of loss in the Chateau partnership for the year 1971 shows each partner's share of the loss as $ 39,780.64 and that each partner's share of first year depreciation is $ 4,000, making a total loss for each of $ 43,780.64. *683 Included in the expenses deducted on the return was interest of $ 114,887.39 and legal and professional services of $ 8,220.85. Respondent in his notice of deficiency to petitioner showed the taxable income as shown on petitioner's return as a loss of $ 23,896.31, total adjustments of $ 50,732.80, with a taxable income as revised of $ 26,836.49. The adjustments to petitioner's income were shown as follows: Partnership Income or (Loss) - ordinary -Norlang Estates Ltd.3,715.56Partnership Income or (Loss) - ordinary -B & L Enterprises7,904.00Partnership Income or (Loss) - ordinary -Chateau Partnership8,358.56Additional First Year Deprec. - ChateauPartnership4,000.00Section 1231 Loss - Chateau PartnershipCapital Gains & Losses(235.77)Charitable Contributions(4,245.00)Other Income - Unexplained Deposits16,354.27Unreported Interest Income72.92Unreported Fees12,709.10Auto Expense2,099.16In explanation of the first adjustment respondent showed a recomputation of the 1971 loss of Norlang reducing its reported loss of $ 320,711 to a loss of $ 8,524.47, with petitioners' distributive share of the revised loss being $ 101.44*684 rather than the claimed loss of $ 3,817. In the computation respondent disallowed management and consulting fees as a deduction and capitalized them, and reduced the purchase price of the Norlang apartments by $ 50,000 for a discount allowed. Respondent recomputed depreciation as claimed on the Norlang partnership return on the basis of his revised cost of the property arriving at allowable depreciation of $ 14,957.76 rather than the claimed $ 119,350. Other major adjustments resulting in this decrease in depreciation were an allocation of $ 1,584,900 of the price paid for the apartments to the buildings rather than the $ 1,271,000 allocated on Norlang's return and the allocation of $ 52,500 to furniture and fixtures rather than the $ 279,000 allocated on the return, a use of a 10-year useful life rather than the 6 years shown on the Norlang return for furniture and fixtures, a 40-year useful life rather than the useful life shown on the return for the buildings and a beginning date for depreciation of November 1, 1971, rather than July 1, 1971. Respondent disallowed claimed interest expense in the amount of $ 174,394.19, which represented basically the $ 175,000 paid by Norlang*685 to the seller and denominated in the contract of sale as construction interest. Respondent disallowed the claimed deductions for $ 26,400 management fees and $ 7,000 for consulting fees which amounts as heretofore stated were capitalized and added to the basis of the property acquired. Respondent in his notice of deficiency determined that petitioner's loss from B & L in 1971 was $ 5,530 rather than the claimed $ 13,434. The loss reported by B & L on its 1971 return was $ 233,752. Respondent adjusted this claimed loss by disallowing $ 50,000 claimed to be deductible as mortgage interest expense and $ 100,166.76 of the claimed depreciation expense deduction. The $ 50,000 mortgage interest expense represented the two $ 25,000 payments of amounts denominated as interest referred to in the contract with respect to the purchase of the Bellevue Estates apartments. In making this adjustment respondent determined that the basis of the building of the Bellevue Estates was $ 1,402,285.50 rather than the $ 1,105,500 shown by B & L on its partnership return of income and that the basis of furniture and fixtures was $ 83,475 rather than $ 304,500. With respect to the Lynnview apartments,*686 respondent determined that the basis of the building was $606,683.69 rather than $ 506,182 shown on the B & L partnership return and the basis of the furniture and fixtures was $ 47,651.94 rather than the $ 93,818. Respondent further determined that the useful life of each of these buildings was 37 years rather than the 25 years shown on the B & L return and that the useful life of the furniture and fixtures in each building was 5 years rather than the 6 years shown on the return. Respondent also determined that the furniture and fixtures should be depreciated on the declining balance rather than on the double declining balance basis and that the date the apartments were acquired was January 1, 1971, rather than October 1, 1970, as shown on the return so that there was no depreciation allowed or allowable for prior years. Respondent in his notice of deficiency determined that petitioner's share of the ordinary loss of the Chateau partnership was $ 31,422.08 rather than the $ 39,780.64 claimed and that petitioner as a member of the Chateau partnership was entitled to no first year depreciation. The adjustments made by respondent in arriving at the reduction in petitioner's partnership*687 loss from Chateau was a reduction in the depreciation deduction claimed by the partnership of $ 17,022.72, a reduction in interest expense deduction of $ 8,190.69 and a disallowance of the deduction claimed for legal and professional services of $ 8,220.85, making a total reduction in the loss reported by Chateau on its 1971 return of partnership income of $ 33,434.26. Respondent in computing depreciation for Chateau at $ 5,973.28 rather than the $ 22,996 shown as depreciation other than first year depreciation on the return, computed depreciation from September 1971 on Building D and from October 1971 on Building E and the clubhouse. Respondent's computation of depreciation for 1971 and 1972 is as follows: KIND OFPROPERTYCOST OR(If buildings,state type ofOTHER BASISconstruction.Exclude landDATE(Lessand salvage valuefrom basis)ACQUIREDexclusions)Building D9/71$ 135,535Furniture &FixturesBldg. D9/715,442Building E10/71135,535Furniture &FixturesBldg. E10/715,442Building T1/72135,535Furniture &Fixtures Bldg.T1/725,442Building F2/72135,535Furniture &Fixtures Bldg.F2/725,442Building A4/72142,587Furniture &Fixtures Bldg.A4/725,725Building G5/72135,536Furniture &Fixtures Bldg.G5/725,441Building H7/72135,536Furniture &Fixtures Bldg.H7/725,441Building B7/72142,588Furniture &Fixtures Bldg.B7/725,725Building C8/72142,588Furniture &Fixtures Bldg.C8/725,725ClubhouseBuilding10/7181,719ClubhouseFurniture &Fixtures10/713,281Total Depreciation Expense Allowable on Items ChangedDepreciation Expense Claimed on Items ChangedAdjustment - Increase/(Decrease)*688 REMAININGCOST OR OTHERKIND OFPROPERTYDEPRECIATIONBASIS TO BE(If buildings,state type ofALLOWED ORRECOVEREDconstruction.Exclude landALLOWABLE INand salvagevalue frombasis)PRIOR YEARS(Date)METHODBuilding D$ 0$ 135,535DBFurniture &Fixtures Bldg.D05,442DBBuilding E0135,535DBFurniture &Fixtures Bldg.E05,442DBBuilding T0135,535DBFurniture &Fixtures Bldg.T05,442DBBuilding F0135,535DBFurniture &Fixtures Bldg.F05,442DBBuilding A0142,587DBFurniture &Fixtures Bldg.A05,725DBBuilding G0135,536DBFurniture &Fixtures Bldg.G05,441DBBuilding H0135,536DBFurniture &Fixtures Bldg.H05,441DBBuilding B0142,588DBFurniture &Fixtures Bldg.B05,725DBBuilding C0142,588DBFurniture &Fixtures Bldg.C05,725DBClubhouseBuilding081,719DBClubhouseFurniture &Fixtures03,281DBTotal Depreciation Expense Allowable on Items ChangedDepreciation Expense Claimed on Items ChangedAdjustment - Increase/(Decrease)KIND OFPROPERTYRATEDEPRECIATION ALLOWABLE(If buildings,state type of(%) ORYEAR ENDED (or Period)construction.Exclude landLIFEand salvagevalue frombasis)(YEARS)12/31/197112/31/1972Building D40$ 2,258.92$ 6,108.49Furniture &Fixtures Bldg.D8453.501,143.20Building E401,694.196,134.37Furniture &Fixtures Bldg.E8340.121,169.18Building T406,212.02Furniture &Fixtures Bldg.T81,247.13Building F405,647.29Furniture &Fixtures Bldg.F81,133.75Building A404,752.90Furniture &Fixtures Bldg.A8954.17Building G403,953.13Furniture &Fixtures Bldg.G8793.48Building H402,823.67Furniture &Fixtures Bldg.H8566.77Building B402,970.58Furniture &Fixtures Bldg.B8596.35Building C402,376.47Furniture &Fixtures Bldg.C8477.08ClubhouseBuilding401,021.493,698.63ClubhouseFurniture &Fixtures8205.06704.90Total Depreciation Expense Allowable on ItemsChanged$ 5,973.28$ 53,463.56Depreciation Expense Claimed on Items Changed22,996.000Adjustment - Increase/(Decrease)17,022.72(53,463.56)*689 In explanation of "Other income - unexplained deposits" of $ 16,354.27 for the year 1971 set forth in the notice of deficiency respondent stated as follows: Unidentified deposits in Davis County Bank Acct.#8260$ 589.00Unidentified deposits in Davis County BankAcct. 101-10522-1215,255.27Unidentified deposits in Davis CountyBank Acct. #7998510.00Total other income2 $ 16,354.27In explanation of his increase in petitioner's income because of the unreported fees for services, respondent*690 in his notice of deficiency stated: It is determined that you received fees, for services rendered, of $ 9,209.10 from Chateau Partnership and $ 3,500.00 from Utah Apartment Enterprises in 1971 that were not reported on your income tax return. Therefore, your taxable income is increased in the amount of $ 12,709.10 in 1971. 3OPINION The record in this case is clear that absent the showing of fraud for the year 1971 the statute of limitations bars any assessment of a deficiency. Section 6501(c)(1) provides that-- In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time. Therefore, unless respondent can show that petitioner filed a false and fraudulent return with intent to evade tax, no deficiency may be assessed or collected for the year 1971. Section*691 6653(b) provides that-- 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. * * * Therefore, in order for respondent to be entitled to an addition to tax, he must show that petitioner's return for the year 1971 was false or fraudulent and that there was an underpayment of tax for the year 1971 a part of which was due to fraud. Since respondent relies in great part in his argument on the presumption of correctness of his determination in the notice of deficiency and petitioner's failure to show error in that determination, in our view the starting point in considering this case is whether respondent has shown any underpayment of tax by petitioner in 1971. Initially the burden is on respondent to show that there is some deficiency in petitioner's tax for 1971 in order to show that the statute of limitations does not bar that year and, likewise, respondent must establish an underpayment of tax before he has shown that a part of the underpayment is due to fraud. While, as respondent points out, it is not necessary that he show that*692 the deficiency or underpayment arises solely from items fraudulently omitted from the return, Lowy v. Commissioner,288 F.2d 517">288 F.2d 517 (2d Cir. 1961), affirming a Memorandum Opinion of this Court, it is necessary for respondent to show enough omitted items or improper deductions by petitioner to result in a deficiency or underpayment of tax. For this reason we have first approached this case by determining to what extent respondent has shown either omissions of income or improper deductions taken by petitioner. If, after this analysis, the result is that there is some deficiency or underpayment of tax, then we must determine if any part of this underpayment or deficiency is due to fraud. Only if respondent has shown that there is some underpayment of tax by petitioner in 1971 a part of which is due to fraud, may he rely on the presumption of correctness of his notice of deficiency to include in petitioner's income items set forth therein with respect to which evidence is lacking. The adjustments made by respondent in his notice of deficiency total $ 55,212. Respondent determined that petitioner was entitled to an additional capital loss of $ 235.77. He also allowed*693 petitioner a deduction for charitable contributions of $ 4,245 thus arriving at his adjustment of $ 50,732.80 to petitioner's reported loss of $ 23,896.31. Since charitable contribution deductions are limited to a percentage of adjusted gross income, we will first consider whether respondent has shown either improper deductions by petitioner or additions to petitioner's income in an amount necessary to cause petitioner to have some income before deductions for charitable contributions. Unless respondent has shown either income not reported by petitioner or improper deductions by petitioner to this extent, he has failed to show that any fraud committed by petitioner resulted in any underpayment of tax. 4*694 Respondent conceded that he improperly included $ 14,409 of amounts of unexplained deposits in petitioner's income for 1971.Respondent also conceded that he improperly included $ 209.10 of unreported fees in petitioner's 1971 income. After these two concessions, it is necessary that respondent show either omissions from income by petitioner or improper deductions by petitioner totaling $ 16,462.90 in order for any underpayment to exist. In making this showing, respondent cannot rely, as he does throughout his brief, on any presumption of correctness of his notice of deficiency. See Jenkins v. United States,313 F.2d 624">313 F.2d 624, 627 (5th Cir. 1963); Elfmon v. United States,209 F.2d 642">209 F.2d 642-643 (4th Cir. 1954). 5 In George v. Commissioner,338 F.2d 221">338 F.2d 221 (1st Cir. 1964), remanding a Memorandum Opinion of this Court, it was specifically pointed out that in establishing that there is a deficiency or underpayment in tax where the statute bars the deficiency absent fraud, respondent cannot rely on the presumption of correctness of his determination to support any item necessary to show some deficiency but must establish these items by evidence. *695 The court stated this principle as follows (at 223): *696 Since the burden was on the Commissioner to prove fraud, it must follow that he had the burden of proving every subsidiary fact relied upon by the court to support that ultimate conclusion. To permit, in satisfying this burden, the use of a Commissioner's finding that was to be accepted only because the taxpayer had failed to meet a burden of overcoming it, would be to allow the Commissioner to raise himself by his own bootstraps. Goldberg v. Commissioner, 5 Cir., 1956, 239 F.2d 316">239 F.2d 316; Olinger v. Commissioner, 5 Cir., 1956, 234 F.2d 823">234 F.2d 823; cf. Valetti v. Commissioner, 3 Cir., 1958, 260 F.2d 185">260 F.2d 185, 188. See also Spitaleri v. Commissioner,32 T.C. 988">32 T.C. 988, 993 (1959), in which we pointed out that in a year that was closed, absent respondent's proof of fraud "we must make our assumptions in petitioner's favor where clear and convincing proof is lacking." Viewing the evidence in this record in the light of the burden on respondent to prove some underpayment of tax, we conclude that respondent has failed to establish that a deficiency exists in 1971. Respondent has totally failed to show that petitioner was not entitled to the deduction*697 of $ 2,099.16 taken on his return for automobile expenses. Respondent in his argument in this regard relies primarily on petitioner's failure to carry his burden of proof. The record here clearly establishes that petitioner was entitled to some deduction for automobile expenses. The diary kept by petitioner with respect to these expenses was identified by petitioner's wife. She also specifically testified with respect to certain trips he took on which she accompanied him. Respondent argues that these trips may have been in connection with activities which would require that the expense be capitalized rather than deducted. However, respondent has totally failed to show that the activities of petitioner on many of these trips were not in connection with his activities as a partner in a partnership or in his personal professional business or in his capacity as an officer of Apartment. Other witnesses testified with respect to petitioner's trips to the site of the Chateau apartments and the office where the financial and bookkeeping activities of Chateau were conducted.It is true that during a part of this time the apartments were under construction, but during a part of the time*698 the apartments were available for rental and being rented. When petitioner travels in connection with his business as an officer of Apartment, the cost of such automobile expense is deductible. Respondent has likewise failed to show that $ 2,500 of the $ 3,500 paid to petitioner by Apartment in 1971, which respondent included in unreported fees, was not included in the $ 39,000 of professional income reported by petitioner on his tax return. The record shows that Apartment in its fiscal year ended June 30, 1972, claimed a substantial deduction for compensation in the form of fees and commissions paid to petitioner, as well as to its other officers.The record of course does not show the amount paid to petitioner by Apartment in 1971 as distinguished from 1972, nor does it show the composition of the $ 39,000 of fees reported by petitioner. In this state of the record we conclude that respondent has failed to show that the $ 2,500 which he included in unreported fees by petitioner received from Apartment was not in fact reported on petitioner's return. See Spitaleri v. Commissioner,supra.The remaining $ 1,000 of the amount included by respondent in his notice*699 of deficiency as unreported fees from Apartment was an amount used by petitioner as an earnest money payment on land to be acquired by the partners in Chateau. Respondent argues that this $ 1,000 was a payment by Apartment to petitioner and that petitioner then lent $ 750 of the amount to the three other partners in Chateau. However, the conclusion that the $ 1,000 was an advance or loan to Chateau by Apartment is equally reasonable and, with the burden of proof on respondent, he has failed to sustain his position that this $ 1,000 was income to petitioner. The other items that respondent has totally failed to show should properly be added to petitioner's income are the $ 8,358.56 reduction in ordinary loss reported by petitioner from Chateau and the $ 4,000 additional first year depreciation claimed by petitioner to be deductible in that year as his prorata share of Chateau's first year depreciation. The adjustments reducing the loss claimed by Chateau by $ 33,434.26, of which petitioner's 25 percent interest is $ 8,358.56, consist of three items. One of these items is a disallowance of a deduction to Chateau for legal and professional services in the amount of $ 8,220.85. Respondent*700 in his brief frankly admits there is no evidence in the record concerning this item and argues that petitioner has failed to show error in his determination. However, this payment shows on the records of Chateau which are in evidence. The lack of evidence to the contrary results in respondent's failing to carry his burden of showing that this amount was not properly deductible by Chateau on its return. The second of these items is $ 8,190.69 of disallowed interest expense. To support this disallowance respondent relied exclusively on a letter from Utah Mortgage Loan Corporation stating that during 1971 Chateau paid Utah Mortgage Loan Corporation $ 106,696.70 in interest. The record, however, does not show that petitioner did not make other interest payments and the records of the partnership show total interest paid in 1971 of $ 114,887.39. For the year 1972 Utah Mortgage Loan Corporation in a letter to an agent of respondent stated that Chateau paid interest to it of $ 117,206.05. Chateau of its 1972 return of income deducted as interest paid to Utah Mortgage Loan Corporation only the amount of $ 113,347.61. In this state of the record we conclude that respondent has failed*701 to show that the deduction taken by Chateau for interest was not proper. The final item of adjustment to the Chateau return was a decrease in depreciation of $ 17,022.72. This decrease was the result of respondent changing the date when the buildings were first "placed in service," and therefore subject to depreciation, and increasing the useful life of the buildings from 25 years to 40 years. The record shows that construction on the buildings started on March 1, 1971, and that five of the buildings had at least some units rented before the end of the year 1971. Respondent relied entirely for his computation on dates of electrical hookups in the names of the tenants in specific apartments. On this basis he allowed depreciation only on two buildings and the clubhouse for any part of 1971. However, the record shows that the power units were in and electricity set to at least two of the buildings in September of 1971 and to two other buildings in October 1971. Testimony by Mr. Jones was to the effect that tenants were in some of the buildings as early as September 9, 1971. Another witness testified that often the electrical service was not changed from the name of the partnership*702 to the name of the tenant on the date the tenant moved into the apartment. She also testified that tenants moved into some apartments when the temporary electrical hookup was still in use and that a fifth building, Building A, was completed and tenants were in the building before the end of 1971. Considering this record as a whole, it is totally inadequate to establish that the amount of depreciation claimed on these buildings by Chateau in 1971 was incorrect. Furthermore, the evidence with respect to the useful life of the buildings is contradictory. There is evidence in the record supporting the position that the construction of the building was below average and the buildings were of a type that would not normally be expected to have a useful life of 40 years. The only evidence respondent offered to support a 40-year useful life for the buildings was the testimony of an engineer Revenue agent who had looked at the exterior of the buildings in 1979 after they had been converted to condominiums. This witness did not even know which of the buildings in the complex were the ones built in 1971. On the basis of this record, respondent has totally failed to show that Chateau was*703 not entitled to the amount of depreciation on the buildings claimed on its return. Respondent's argument with respect to the first year depreciation is not that Chateau did not have personal property subject to first year depreciation but rather that Chateau did not comply with section 1.179-4(a), Income Tax Regs., in that it did not-- maintain records which permit specific identification of each piece of section 179 property and reflect how and from whom such property was acquired. * * * The testimony, however, is that the records of Chateau were kept on a computer system and the computer printout did show the section 179 property on which Chateau claimed first year depreciation. The testimony was that the Revenue agent declined to look at the computer printout when investigating the Chateau partnership return. All other requirements necessary in claiming first year depreciation were complied with by Chateau. The property on which Chateau claimed first year depreciation was tangible property property acquired by purchase during 1971 for use in Chateau's trade or business, which Chateau determined to have a useful life of 6 years at the date of acquisition*704 ( section 1.179-3, Income Tax Regs.). Chateau did elect on its return to take first year depreciation and the return indicates that the property on which the first year depreciation was elected was not included in the depreciation under section 167 claimed on the return. Chateau had records of the personal property with respect to which first year depreciation was claimed. The Revenue agent in his report identified some such property. Also, the very fact that apartments were rented and the rented apartments, according to the testimony of several witnesses, contained appliances, drapes and carpeting, shows that Chateau had personal property in 1971 on which it could properly claim first year depreciation. On the state of this record, we conclude that respondent has failed to show that Chateau was not entitled to the first year depreciation claimed. The total amount of the items conceded by respondent plus the items heretofore discussed that respondent has failed to establish should be used to increase petitioner's income is § 32,575. On this record respondent has therefore failed to show that there was any underpayment of tax by petitioner in the year*705 1971. Respondent in his brief, however, contends that-- even if there is no actual deficiency redetermined to be due from the petitioner in 1971, his fraudulent acts in that year result in an overstated 1971 loss and, thus, an overstated carry back to 1968, which produces a deficiency due to fraud from the petitioner for the year 1968. * * * The only authority respondent cites for this contention is Rev. Rul. 60-215, 1 C.B. 642">1960-1 C.B. 642. This Revenue Ruling deals only with the addition to tax for fraud under section 6653(b) in a year to which the loss is carried and not with the question of whether that year is open for assessment of a deficiency. Respondent in his brief does not discuss section 6501(h) or its relationship to the opening of an otherwise closed year.Section 6501(h) provides that-- In the case of a deficiency attributable to the application to the taxpayer of a net operating loss carryback or a capital loss carryback (including deficiencies which may be assessed pursuant to the provisions of section 6213(b)(2)), such deficiency may be assessed at any time before the expiration of the period within which a deficiency for the taxable year of the*706 net operating loss or net capital loss which results in such carryback may be assessed. * * * under this section the question is whether the statute had expired for the year 1971, which clearly it had absent fraud.Before deciding whether under the facts in this case of no tax due by petitioner for 1971 the provisions of section 6501(h) and section 6501(c) could properly be interpreted to cause the year 1968 to be open, we will examine whether respondent has shown sufficient omissions or improper deductions by petitioner in 1971 to result in petitioner's loss for that year being less than the $ 10,333 needed as a carryback to 1968 to cause some deficiency in tax for that year.In making this determination we do not start with the $ 23,896.31 loss as shown on petitioner's return used in respondent's computation for 1971 but with the $ 16,083.40 of adjusted gross income loss. We must start with this figure because section 172(d) provides that in computing the net operating loss for the year from which it is to be carried back deductions for personal exemptions shall not be allowed and deductions not attributable to the taxpayer's trade or business shall be allowed only to the extent*707 of the amount of gross income not derived from such trade or business. Certainly there would be some allowance of deductions under this provision in computing the loss carryback since apparently petitioner reported some non-trade or business income. However, we will analyze the various adjustments made by respondent and what he has established to determine if we need to reach the point of the exact computation of any loss carryback from the year 1971.The items with respect to which there is the most evidence to support respondent's position in this record are the adjustments made by respondent to the return of Norlang resulting in an adjustment to the loss claimed by petitioner from his interest in that partnership. We will therefore consider whether respondent has shown that petitioner in fact did have $ 9,000 of unreported fees from Chateau and the extent to which he has shown overstatement of the loss of B & L in 1971. The evidence in the record is clear that petitioner was a partner in Chateau and that he handled the financial aspect of Chateau' operation and oversaw the keeping of Chateau's books. The record shows that J. Blair Jones, along with petitioner and three doctors, *708 Drs. Paul Naisbitt, Byron Naisbitt, and Evan Evans, originally formed the Chateau partnership in early 1971. Mr. Jones was a contractor and it was understood that he would oversee the building of the apartments. There was no written partnership agreement but it was Mr. Jones and petitioner who primarily put time and effort into partnership activities. Because of disagreements between petitioner and Mr. Jones, which began around the first of September 1971, Mr. Jones withdrew from the partnership around the first of November 1971. Mr. Jones testified that sometime after construction got under way on the apartments in March 1971 it was agreed that he and petitioner would take draws from the partnership and that the initial draw would be $ 1,000 each because of work they had done making the plans for building the apartments and obtaining the finances, and that thereafter Mr. Jones would draw $ 1,500 a month and petitioner $ 750 a month. The record shows that on March 4, 1971, Mr. Jones was given a check by Chateau for $ 2,500 and at around the beginning of each month from April to October he was given a check from Chateau for $ 1,500, making a total of $ 13,000. The record shows*709 that these amounts were treated by Chateau as draws and not deducted or capitalized by Chateau was either an expense or as an additional cost of the buildings. Mr. Jones testified that when he withdrew as a partner on November 1, 1971, he had a settlement with respect to his partnership interest. The record shows that a check for $ 750 was issued to petitioner on April 1, checks for $ 1,000 and $ 750 were issued to petitioner on April 13, and a check for $ 500 was issued to him on April 15, 1971, by Chateau. Petitioner was then issued a check for $ 750 by Chateau around the first of each of the months of May through December with the exception of the month of September. The record also shows that these amounts were treated on the partnership books as draws by petitioner and charged on the Chateau books against his partnership account. Our outline of the facts above is all that the record in this case shows.Respondent, however, argues that the amounts received by petitioner from Chateau should properly be held to be income to petitioner under the provision of section 707(c). Section 707(c) deals with guaranteed payments to partners and provides that "to the extent determined*710 without regard to the income of the partnership, payments to a partner for services * * * shall be considered as made to one who is not a member of the partnership * * *." There is nothing in this record to show whether the amounts designated on the books of Chateau as draws were "determined without regard to the income of the partnership." Respondent's argument in this regard is that this fact should be assumed since until approximately September of 1971 Chateau had no income. In our view, respondent's assumption is unwarranted. The amounts were treated on Chateau's books as draws and so entered in petitioner's partnership account. This would indicate that the amounts were not without regard to income. Certainly there is nothing in section 707(c) that indicates that "without regard to income" means the income of the current month of the draw. Since Chateau had no written partnership agreement, the nature of these payments would depend on the oral partnership agreement. The one partner who testified, J. Blair Jones, indicated in his testimony that the amounts both he and petitioner received were draws. No testimony was produced from the other three partners. Clearly the nature*711 of the services that petitioner was rendering to Chateau was the type of services a partner would be expected to render to his partnership. They were general management and overseeing services. See Pratt v. Commissioner,64 T.C. 203">64 T.C. 203 (1975), affirmed in part and remanded 550 F.2d 1023">550 F.2d 1023 (5th Cir. 1977). On the basis of this record, we conclude that respondent has failed to establish that the $ 9,000 received by petitioner from Chateau in 1971 was income to petitioner. Respondent has also failed to produce evidence sufficient to support most of his adjustments to the 1971 partnership loss reported by B & L. The record shows errors in the partnership return of income of B & L for 1970, but that year is not involved in this case. For the year 1971 the evidence is insufficient to support the adjustments made by respondent to depreciation and his disallowance of part of the claimed interest deduction. The depreciation adjustment resulted partially from a reallocation of basis between buildings and personal property.This reallocation was made on the basis of a tax assessment on personal property without any showing of how the valuation of the personal property*712 for tax purposes was made or its accuracy. The balance of the depreciation adjustment was due to a change in the useful life of the property. The evidence in this respect is meager and respondent relies primarily on the presumption of correctness of his notice of deficiency which is not sufficient to carry his burden of proof. The amount of prepaid interest is recited in the contract for purchase of the apartments. There is no showing in this record that all parties to the contract did not treat this payment as interest. The correctness of some other minor adjustments made by respondent have not been shown by the evidence to be correct. We therefore conclude that respondent has failed to show that petitioner did not have a loss carryback from 1971 in the amount of his reported 1968 income. Because we have concluded that respondent has failed to establish an underpayment of tax by petitioner or a deficiency in petitioner's tax in either the year 1971 or 1968, we find it unnecessary to discuss whether the returns signed by petitioner on behalf of Norlang and 88th East were false and fraudulent or to reach the issue of whether petitioner's personal return for 1971 fraudulently*713 reported any items.Decision will be entered for the petitioner.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue.↩2. In the stipulation filed in this case respondent conceded that none of the $ 589 listed as unexplained deposits in the Davis County Bank Acct. 8260 were properly includable in petitioner's income and that $ 310 of the $ 510 deposits in the Davis County Bank Acct. 7998 was not income, and that $ 13,510.27 of the amount shown in the deficiency notice as unidentified deposits in the Davis County Bank Acct. 101-10522-12 was either not income to petitioner or consisted of items which he had included in petitioner's income in his determination of unreported fees.Of the remaining amount, $ 363.51 consisted of a refund petitioner received from his 1970 State income tax.↩3. Respondent conceded that $ 209.10 of the amount shown as fees to petitioner from Chateau partnership were not in fact fees or income to petitioner. The remaining $ 9,000 represented checks drawn to petitioner by Chateau which were shown on Chateau's books as a partnership draw.↩4. In order for respondent to show any underpayment of tax by petitioner for 1971 he must show sufficient incorrect items to overcome petitioner's reported loss of $ 23,896.31. Since respondent made adjustments to petitioner's income, aside from the allowance of the charitable contribution deduction of $ 54,977.80 for the year 1971, if the record shows that respondent has failed to substantiate $ 31,081 or more of his adjustments he has failed to carry his burden as to that year.↩5. In Brown v. Commissioner,T.C. Memo 1968-29">T.C. Memo. 1968-29, affirmed per curiam 418 F.2d 574">418 F.2d 574 (9th Cir. 1969), we stated this principle as follows: The general guidelines are familiar ones. Respondent has the burden to prove fraud for each year. Section 7454, Internal Revenue Code of 1954.To carry this burden requires proof by clear and convincing evidence of intentional wrongdoing with the specific purpose of evading a tax believed to be owing. The test is the intent at the time the return is filed, not some earlier or later date. Harry Gleis [Dec. 21,204], 24 T.C. 941">24 T.C. 941 (1955), affd. per curiam [57-1 USTC par. 9451] 245 F.2d 237">245 F.2d 237 (C.A. 6, 1957); Estate of William Kahr [Dec. 28,617], 48 T.C. 929">48 T.C. 929 (1967). But intent alone is insufficient, for fraud requires both intent and action. If the taxpayer intends to defraud the Government, but his return is inadvertently correct, he cannot be found liable for fraud. If there is no deficiency there is no fraud. Jenkins v. United States [63-1 USTC par. 9289], 313 F.2d 624">313 F.2d 624, 627 (C.A. 5, 1963); Elfmon v. United States [54-1 USTC par. 49,017], 209 F.2d 642">209 F.2d 642, 643 (c.a./ 4, 1953); In re Parr [62-2 USTC par. 9708], 205 F. Supp. 492">205 F.Supp. 492, 496↩ (S.D. Tex. 1962). However, if any part of the deficiency is due to fraud, then the penalty attaches to the total deficiency. * * * | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623064/ | GEORGE H. BAKER, SR., AND BESSIE J. BAKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBaker v. CommissionerDocket No. 12100-88United States Tax CourtT.C. Memo 1990-635; 1990 Tax Ct. Memo LEXIS 707; 60 T.C.M. (CCH) 1443; T.C.M. (RIA) 90635; December 18, 1990, Filed *707 Decision will be entered under Rule 155. Held: The net capital gain deduction claimed by petitioners on their 1984 return is a tax preference item under section 57(a)(9)(A) for the purpose of computing their alternative minimum tax under section 55. Petitioners' liability for the alternative minimum tax is sustained. Held further: Petitioners are liable for additions to tax under section 6653(a)(1) and (2) for negligence. George H. Baker, Sr., pro se. John W. Duncan, Terry W. Vincent, and Jeff P. Ehrlich, for the respondent. HALPERN, Judge. *HALPERN*2078 MEMORANDUM OPINION By the notice of deficiency dated February 29, 1988, respondent determined a deficiency in petitioners' Federal income tax for calendar year 1984 in the amount of $ 39,816, 1 together with additions to tax under section 6653(a)(1) and (2). 2 This case presents two questions: First, whether the net capital gain deduction claimed by petitioners for 1984 was a tax preference item under section 57 for the purpose of computing petitioners' alternative minimum tax under section 55, and, second, if we answer the first question in the affirmative and there is a resulting underpayment, whether such underpayment is due to petitioners' negligence or intentional disregard of rules or regulations*712 so as to give rise to the additions to tax determined under section 6653(a)(1) and (2). Following a dispute between the parties with regard to stipulations of facts proposed by each party, this Court ordered certain facts and evidence deemed accepted as established for purposes of this case. Subsequently, the parties submitted this case fully stipulated by the facts and evidence so deemed established. By this reference, such facts and evidence are incorporated into this opinion. We summarize below the pertinent facts. BACKGROUNDPetitioners are husband and wife. They resided in Dunlap, Illinois, when they filed the petition in this case. In 1967, petitioner George H. Baker, Sr. (Baker), received*713 U.S. patent No. 3,296,651 and Canadian patent No. 770,972, concerning a drapery support and related accessories conceived and developed by Baker (the Patents). In 1971, Baker assigned his interest in the Patents to the Baker Drapery Corporation (the Corporation) in consideration for $ 1 million, to be paid to Baker in installments. Baker previously had requested and received a ruling from respondent that, subject to the provisions of section 1231, any gain realized on the assignment to the Corporation of the Patents would constitute gain from the sale of a capital asset held for more than six months (i.e., long-term capital gain). Beginning in 1971, Baker received installments of the $ 1 million owed to him by the Corporation. Petitioners reported those payments under the installment method of accounting. In 1984, Baker received the final payment due him from the Corporation, in the amount of $ 337,569. Petitioners reported the full amount as long-term capital gain on their joint U.S. Individual Income Tax Return for 1984 (line 9 of Schedule D). After including several other capital gain items relatively small in amounts, petitioners reported on their 1984 return a net long-term*714 capital gain of $ 333,740 (line 19 of Schedule D) and a net capital gain of $ 322,713 (line 20 of Schedule D). The net capital gain resulted in a net capital gain deduction under section 1202 of $ 193,628 (line 22 of Schedule D). Petitioners neither included in their 1984 return any computation of the alternative minimum tax nor paid any such tax for 1984. Instead, petitioners computed and claimed an income tax refund for 1984 under the regular income tax provisions of section 1(a). On February 29, 1988, respondent mailed to petitioners a notice of deficiency. In the notice, respondent determined that petitioners' capital gain deduction was an item of tax preference and that petitioners were subject to the alternative minimum tax for 1984 in the amount of $ 39,816, along with additions to tax for negligence pursuant to section 6653(a)(1) and (2). In his notice of deficiency, however, respondent incorrectly calculated the alternative minimum tax and the deficiency. On line 15 of Schedule 3 attached to respondent's notice, total items of tax preference are stated incorrectly as $ 194,664, rather than correctly as $ 193,628. Respondent, thus, should have determined a deficiency*715 of $ 39,609, rather than $ 39,816. This Court notes that respondent has not recomputed the additions to tax under section 6653(a). If we hold for respondent with regard to the two questions at issue here, petitioners would be liable for a deficiency in the amount of $ 39,609 and for additions to tax properly computed pursuant to section 6653(a)(1) and (2). DISCUSSIONAlternative Minimum TaxNo dispute exists as to the facts. Whether petitioners are liable for any alternative minimum tax is purely a question of law. The answer depends on whether the net capital gain deduction allowable to petitioners by section 1202(a) *2079 is a tax preference item under section 57(a) for the purpose of computing alternative minimum taxable income under section 55(b). If it is, then petitioners are liable under section 55(a) for the alternative minimum tax in the amount of $ 39,609. We hold that they are so liable. Sections 55, 57, and 58 as applicable to 1984 imposed on individuals an alternative minimum tax. The alternative minimum tax is a tax, in addition to the regular income tax, imposed on various tax preference items. The alternative minimum tax generally is the*716 amount by which the tentative tax computed under the alternative minimum tax rules exceeds the taxpayer's regular income tax. See sec. 55(a). Congress first enacted a minimum tax in 1969. See Tax Reform Act of 1969, Pub. L. 91-172, sec. 301, 83 Stat. 487, 580-586, 1969-3 C.B. 10, 63-67. The U.S. Court of Appeals for the Ninth Circuit has stated that: "In enacting the minimum tax, Congress attempted to remedy general taxpayer distrust of the system growing from large numbers of taxpayers with large incomes who were yet paying no taxes." Okin v. Commissioner, 808 F.2d 1338">808 F.2d 1338, 1342 (9th Cir. 1987), appeal dismissed and cert. denied 484 U.S. 802">484 U.S. 802 (1987). See S. Rept. 91-552 (1969), 3 C.B. 423">1969-3 C.B. 423, 495-496. The alternative minimum tax regime is complicated, and need not be detailed here. For our purposes, it is sufficient to understand certain aspects of computing alternative minimum taxable income. 3 Alternative minimum taxable income is defined in section 55(b). Section 55(b) provides, generally, that an individual's alternative minimum taxable income is determined by adding and subtracting certain sums to and from the taxpayer's*717 adjusted gross income. Specifically, section 55(b)(2) requires the taxpayer's adjusted gross income to be "increased by the amount of items of tax preference." Items of tax preference are listed in section 57(a). For individuals, section 57(a)(9)(A) includes as a tax preference item "an amount equal to the net capital gain deduction for the taxable year determined under section 1202." Section 1202(a) permits an individual to claim as a deduction from gross income an amount equal to "60 percent of the amount of the net capital gain" for any taxable year. Net capital gain is defined as "the excess of the net long-term capital gain for the taxable year over the net short-term*718 capital loss for such year." Sec. 1222(11). Net long-term capital gain equals "the excess of long-term capital gains for the taxable year over the long-term capital losses for such year." Sec. 1222(7). Further, long-term capital gain means the "gain from the sale or exchange of a capital asset held for more than 1 year, if and to the extent such gain is taken into account in computing gross income." Sec. 1222(3). In 1984, petitioners received $ 337,569 pursuant to the assignment agreement. The parties have stipulated that Baker's gain from the assignment of the Patents was capital gain and that the sum of $ 337,569 received in 1984 constituted long-term capital gain. This stipulation is consistent with the conclusion reached by respondent in the ruling issued to Baker. As such, the sum of $ 337,569 needed to be included in the calculations of net long-term capital gain and net capital gain as defined in section 1222(7) and (11). Petitioners properly included the results of those calculations on lines 19 and 20, respectively, of Schedule D of their 1984 return. Section 1202(a) permits petitioners to take a deduction equal to 60 percent of the net capital gain. Accordingly, petitioners*719 claimed for 1984 a net capital gain deduction in the amount of $ 193,628, as reflected on line 22 of Schedule D to the 1984 return. Petitioners' net capital gain deduction in the amount of $ 193,628 constituted for 1984 a tax preference item. See sec. 57(a)(9)(A). We, thus, are justified in holding petitioners liable for the alternative minimum tax in the amount of $ 39,609. Before turning to respondent's determination on additions to tax under section 6653, we feel obligated to state that, while petitioners obviously are very talented people, they have presented several arguments that are difficult to understand. We here try to respond directly to a few of those arguments. Petitioners seemingly argue that, since the Patents were assigned to the Corporation in 1971, section 55 added to the Internal Revenue Code in the late 1970's did not apply to the installment payments received by Baker in 1984. See Revenue Act of 1978, Pub. L. 95-600, sec. 421(a), 92 Stat. 2763, 2871, 1978-3 C.B. (Vol. 1) 1, 105-111 (adding section 55). Petitioners cite part of the following language from the legislative history of the Revenue Act of 1978 to support their argument: *720 In general the provision is effective for taxable years beginning after 1978. * * * Thus, fiscal year taxpayers are to first be subject to the new minimum tax for their taxable year beginning in 1979. However, the provisions changing the effective date for the preferences for capital gains (to 70 percent of net capital gain) for purposes *2080 of the present law minimum tax is to apply for all sales or exchanges taking place after October 31, 1978. For purposes of both effective dates payments received after the effective date with respect to pre-effective date installment sales are to be taxed under the new provisions applicable generally to sales made after the effective date. S. Rept. 95-1263 (1978), 1978-3 C.B. (Vol. 1) 315, 505. Petitioners misread the above language. The first two paragraphs respectively suggest that certain provisions became effective for taxable years beginning in 1979 and that other provisions became effective for sales or exchanges taking place after October 31, 1978. The third paragraph then considers installment payments received after those two effective dates as a result of sales completed before those effective dates. *721 Such installment payments are subject to the provisions that are effective at the time the payments are received, rather than the provisions in effect at the time the sales are made. The quoted language indicates congressional intent that section 55 was to apply to installment payments made after section 55 became effective. That intent reflects the well-settled principle that installment payments are subject to taxation under the provisions of the law in effect at the time the gain is recognized. Picchione v. Commissioner, 440 F.2d 170">440 F.2d 170, 172 (1st Cir. 1971), affg. 54 T.C. 1490">54 T.C. 1490 (1970), cert. denied 404 U.S. 828">404 U.S. 828 (1971); Snell v. Commissioner, 97 F.2d 891">97 F.2d 891, 893 (5th Cir. 1938); Estate of Kearns v. Commissioner, 73 T.C. 1223">73 T.C. 1223, 1225 (1980). The fact that section 55 became effective after Baker's patents were assigned in 1971 is irrelevant to whether such section applies to the installment payment that petitioners received in 1984. The U.S. Court of Appeals for the Fifth Circuit described the effect of installment sales as follows: As to the instalment sales made in 1923, the taxpayer might have elected to*722 take his whole profit then and have had it taxed under the Revenue Act of 1921. He chose to defer realization of the profits on the deferred instalments. These thereby were left to fall under such provisions of the law as might be of force at their maturity. That the law might be changed, not only in the tax rate but in any other of its provisions, was a risk the taxpayer took in deferring the realization of his gains. * * * Snell v. Commissioner, 97 F.2d 891">97 F.2d 891, 893 (5th Cir. 1938). In addition, petitioners seemingly are confused also as to what constitutes net long-term capital gain and net capital gain. Petitioners suggest that, since the assignment of the Patents involved no loss that could have been applied against the gain, no net capital gain could have resulted. In contradiction, petitioners also argue that Baker's basis in the Patents was determined by the price for which the Corporation purchased the patents from Baker. Petitioners are incorrect. In fact, sections 1011-1016 determine a taxpayer's adjusted basis in property for the purpose of computing the taxpayer's gain or loss from the sale or other disposition of the property. Section 1012*723 provides that generally the taxpayer's basis in property is the cost of such property to such taxpayer (i.e., not the purchaser of the property). Section 1001(a) establishes that a taxpayer's gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis. The term "long-term capital gain" in section 1222(3) focuses on a taxpayer's capital gain from a single transaction. The terms "net long-term capital gain" and "net capital gain" in section 1222(7) and (11) concern a taxpayer's net gain from one or more transactions involving capital assets. Additions to TaxIn the notice of deficiency, respondent determined that, for 1984, petitioners were subject under section 6653(a) to the additions to tax for negligence or intentional disregard of rules or regulations. Petitioners bear the burden of proving that respondent's determination concerning such additions was erroneous. Tweeddale v. Commissioner, 92 T.C. 501">92 T.C. 501, 505 (1989); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791-792 (1972); Rule 142(a). Petitioners' burden of proof is not affected by the fact that the parties submitted this case fully stipulated. *724 Borchers v. Commissioner, 95 T.C. (1990), appeal filed October 9, 1990 (8th Cir.); Service Bolt & Nut Co. Profit Sharing Trust v. Commissioner, 78 T.C. 812">78 T.C. 812, 819 (1982), affd. 724 F.2d 519">724 F.2d 519 (6th Cir. 1983). Section 6653(a)(1) imposes an addition to tax equal in amount to 5 percent of the underpayment if any part of the underpayment is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2) imposes a further addition to tax equal in amount to 50 percent of the interest due on the underpayment of tax attributable to negligence or intentional disregard of rules or regulations. In the context of section 6653(a), negligence has been defined as the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Ferrell v. Commissioner, 90 T.C. 1154">90 T.C. 1154, 1201 (1988); *2081 Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioners have presented no evidence to counter the conclusion that their failure to report an alternative minimum tax for 1984 was due to negligence. 4 Section 57(a)(9)(A) clearly establishes the net capital*725 gain deduction as a tax preference item for the purpose of computing the alternative minimum tax under section 55. In addition, we observe that, although petitioners emphasize in their briefs how they carefully followed the instructions in preparing their 1984 return, they left blank line 52 of their return providing for the alternative minimum tax and failed to include Form 6251 showing the results of the computation of their alternative minimum tax. Furthermore, we note that line 22 of Schedule D of the 1984 return states that: "If line 22 is more than zero, [the taxpayer] may be liable for the alternative minimum tax. See Form 6251." Petitioners reported the amount of $ 193,628 on line 22 -- an amount considerably larger than zero. Petitioners' apparent failure to take note of the quoted language can be due only to negligence. A reasonable and ordinarily prudent person would have undertaken to determine whether any liability for the alternative minimum tax existed. Such an inquiry here would have produced an affirmative answer. *726 Under the circumstances, we are impelled to sustain respondent's determination that petitioners' entire underpayment is due to negligence and hold that petitioners are liable under section 6653(a)(1) and (2) for additions to tax. In light of the foregoing, Decision will be entered under Rule 155. Footnotes*. By Order of the Chief Judge, this case was reassigned to Judge James S. Halpern for disposition.↩1. Respondent since has stated that the correct deficiency is $ 39,609, not $ 39,816.↩2. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩3. After alternative minimum taxable income is computed, an exemption amount is subtracted from the computed figure. The difference is multiplied by 20 percent and the product is compared with the regular income tax for the taxable year. Any excess of the former over the latter is the alternative minimum tax liability for that year. Sec. 55(a).↩4. We note that, while petitioners' U.S. Individual Income Tax Return for 1984 was prepared professionally, petitioners have presented no evidence to show that the failure to report an alternative minimum tax was due to the negligence of the preparer of the return.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623065/ | Anna Eliza Masterson, Petitioner, v. Commissioner of Internal Revenue, RespondentMasterson v. CommissionerDocket No. 107280United States Tax Court1 T.C. 315; 1942 U.S. Tax Ct. LEXIS 8; December 22, 1942, Promulgated *8 Decision will be entered under Rule 50. 1. Failure to report income in petitioner's individual return in excess of 25 percent of that shown thereon, held, to make five-year statute of limitations applicable, notwithstanding that the omitted income was included in an estate return filed by petitioner as executrix. Revenue Act of 1934, sec. 275 (c).2. Prior determination in which petitioner's interest was adjudicated to be a conventional life estate by the Circuit Court of Appeals, which had before it, but refused to follow, a state court's adjudication of petitioner's interest to the contrary, held, res judicata as to petitioner's interest in this proceeding.3. Income tax improperly paid by petitioner as executrix on the estate income, held, not a proper offset against the deficiency in petitioner's individual income tax. George H. Jones, Executor, 34 B. T. A. 280, followed. Harry C. Weeks, Esq., and Benjamin L. Bird, Esq., for the petitioner.Frank B. Appleman, Esq., for the respondent. Opper, Judge. OPPER*315 Petitioner, by this proceeding, challenges respondent's determination of a deficiency in her 1935 income*9 tax in the amount of $ 7,069.84.The questions presented are whether respondent's right to assess additional 1935 income tax against petitioner is barred by the statute of limitations; whether the income during the year 1935 from the properties of the estate of petitioner's deceased husband, R. B. Masterson, was taxable to petitioner in its entirety or only in such part as was distributed to her for her support and maintenance; if the entire income is taxable to petitioner, whether she is entitled to an offset against the deficiency for 1935 of taxes paid by and on behalf of the R. B. Masterson estate. As to the issue relating to the amount of R. B. Masterson estate income which is properly taxable to petitioner, respondent, by amended answer, affirmatively pleads that it is res judicata by reason of a prior proceeding between the parties involving petitioner's gift tax.Other issues have been conceded or withdrawn.FINDINGS OF FACT.R. B. Masterson and petitioner became residents and citizens of Texas while infants and at all material times they have been residents and citizens of that state. R. B. Masterson was first married to petitioner's sister and of that marriage two *10 sons, T. B. Masterson and R. B. Masterson, Jr., were born. While these two sons were quite young their mother died and R. B. Masterson thereafter married petitioner. There are four children of the last marriage -- Sallie Lee (Scott), *316 Anna Belle (Kritser), Mary (Fain), and Fannie Fern (Weymouth). All the property owned by R. B. Masterson and petitioner at the time of R. B. Masterson's death had been acquired during their marriage. On December 6, 1928, R. B. Masterson and petitioner executed a joint will and covenant, "to take effect at the time of the death of either of us and at the time of the death of the survivor," in which they recognized and declared that "all of the property * * * of either of us * * * is and constitutes our community estate," that all of their properties pending distribution to children, "shall remain intact," and that it was their intention to treat all of the children equally and as of the full blood, and by which they covenanted and agreed that neither was to change, modify, or revoke the joint will or any part thereof, except by mutual written consent, and that it was their "mutual, solemn covenant and agreement with each other that neither*11 of us shall hereafter execute any will other than as mutually agreed," and "that all the terms, provisions and conditions hereof shall be from and after the execution hereof binding upon us and the survivor of us as the agreed means and method of making effective our desires and directions as to the disposition of said community estate." Each waived his or her respective community rights and interests in their properties, and agreed that the survivor should be independent executor of the estate of the one first to die, and that no action was to be taken in or by the probate court except to probate the will and file an inventory and appraisement. The will further provided that the survivor was to have, with certain rights and duties, all of the estate for the purposes of managing and controlling it, receiving the rents and revenues, investing all moneys, and paying all taxes and debts and claims; but that the survivor should have no power to sell or dispose of any of the property except to pay debts, provide for the survivor's support and maintenance, and distribute the estate equally among the six children. It authorized the survivor, at discretion, to distribute one-half of the*12 estate to the six children, share and share alike, and, upon the death of the survivor, the then executor to divide and distribute the estate to the six children equally. The will gave to the executor who qualified at the time of the survivor's death the same powers of management given to the survivor and independent executrix. This joint will and covenant was never revoked or altered thereafter. R. B. Masterson died on August 1, 1931, and upon petitioner's application this joint will and covenant was duly admitted to probate in the County (probate) Court of Potter County, Texas, on August 17, 1931. Petitioner announced her acquiescence in the joint terms of the will and covenant, elected to accept under it, and qualified as independent executrix of the estate of R. B. Masterson.At the time of Masterson's death the estate was indebted to the approximate amount of $ 300,000 and at least until the date of the *317 transfer of August 19, 1935, some $ 56,000 of these debts were still owing. At that time the legacy provided in the joint will and covenant to Bettie McGregor had not been paid. These unpaid debts consisted of moneys which Masterson owed his daughters at the time*13 of his death for collections made on their accounts, rentals on their pastures, and amounts he had borrowed from them. The estate had sufficient funds or convertible current assets with which to have paid off the children prior to 1935. There was no discharge or disposition of the debt to the children on August 19, 1935, when petitioner made the gift to the children as hereinafter set forth.Subsequent to Masterson's death and petitioner's qualification as independent executrix in 1931, all transactions pertaining to the estate and its properties have been handled in the name of the R. B. Masterson estate. All funds have been deposited in the name of the R. B. Masterson estate in one bank account; all checks thereon have been signed "Anna Eliza Masterson, individually and as Independent Executrix of R. B. Masterson Estate" by petitioner, or pursuant to her instructions, by C. E. Weymouth, who was petitioner's son-in-law and business manager of the estate. Petitioner maintained no separate bank account. All of her expenses were paid by her with the estate funds or by the estate for her. Petitioner has made no claim that she, individually, owned any part of the estate properties*14 or any part of the income therefrom except what she required for support and maintenance. From the death of R. B. Masterson in August 1931 to August 19, 1935, no segregation of the properties of the estate was made. No part of the estate was set off, credited, conveyed or delivered to petitioner. All income from the properties was handled by petitioner as independent executrix of the estate. During the period 1931 to 1935 there was a substantial amount of income from the properties over and above its expenses and the amounts required to support and maintain petitioner, and such income is hereinafter referred to as accretions.On August 19, 1935, petitioner, pursuant to the authority given her by paragraph II 2 of the joint will and covenant, conveyed to the six children, share and share alike, all of her individual right, title, and interest in and to an undivided one-half of the properties of the R. B. Masterson estate and the accretions thereof, excepting only the residence in Amarillo, occupied by petitioner. Thereafter and in due time petitioner filed a gift tax return with respect to this relinquishment and a controversy developed with respondent with respect to petitioner's*15 gift tax liability for 1935, which was subsequently decided in , promulgated July 23, 1940. Motion for rehearing was filed and denied and on December 5, 1940, the decision was entered. In its opinion the Board held that, under the joint will and covenant, petitioner was vested with a full conventional *318 life estate in all of the estate properties, that therefore all of the net income of the estate belonged to petitioner individually in fee simple, and that the subject matter of the 1935 gift consisted of (1) an undivided one-half fee simple interest (valued at $ 92,050.55) in the accretions which had accrued between August 1, 1931, and August 19, 1935; and (2) an undivided one-half interest in all of petitioner's right, title, and interest in the estate properties, i. e., petitioner's full life estate therein.After the decision had been entered in the gift tax case petitioner and Weymouth consulted with the estate's attorneys and were advised that, while the holding of the Board of Tax Appeals was not binding or controlling on titles in Texas, such holding should not be ignored; that if the Board's views*16 were correct and all of the accretions belonged to petitioner individually, there would have to be an accounting to charge the estate with such parts thereof as had been used by the estate and that henceforth the income should be segregated and the books corrected; that such accretions, which were substantial, would constitute a "separate" estate at petitioner's death which would not pass under the joint will and covenant; that as she was barred by the covenant of the joint will and covenant from making any other will, petitioner would die intestate as to this separate estate, which would go to her children, the four daughters, to the exclusion of the two boys. The attorneys recommended that a suit be brought in an appropriate Texas court to have the will construed, all property rights definitively determined, and all questions settled. Petitioner was a woman of advanced age and did not want any trouble to come up among her children. While there was no dissention in her family at that time, the situation was such as would lead to serious difficulty, and to maintain peace and harmony in her family, and to procure a final determination of property rights during her lifetime, petitioner*17 concluded to adopt the attorney's recommendation. It was recognized that the suit would have a bearing on tax questions and this was one of the purposes in bringing it.An action was brought by petitioner, individually, and as independent executrix of the R. B. Masterson estate, in the early part of 1941 (after the Board's decision in the gift tax case and before the decision of the Circuit Court of Appeals for the Fifth Circuit, to which Circuit the case had been appealed) against the six children and the surviving legatee, Bettie McGregor. The action was brought in the 108th District Court of Potter County, Texas. In the petition petitioner as plaintiff alleged that:* * * serious questions have arisen and will arise as to the rights of the Plaintiff, individually, the estate of R. B. Masterson, deceased, and the aforesaid six children, to-wit, R. B. Masterson, Jr., T. B. Masterson, Sallie Lee Scott, Anna Belle Kritser, Fannie Fern Weymouth and Mary Masterson Fain, *319 in and to said estate, the properties thereof, and the accumulated and unexpended revenues thereof. These questions are chiefly: Whether the Plaintiff individually owns outright the net accumulated revenues, *18 or whether these revenues fall into and become a part of the estate and pass at her death by the terms of said will; and whether she can during her lifetime, or at her death, dispose of these net accumulations as she may see fit, or whether her individual rights in and to said estate and its income are limited to such amounts as may properly be expended by her for her support and maintenance.The prayer of the petition was for service upon all of the defendants and that upon final hearing the court construe the joint will and covenant, hear and determine the adverse claims of all parties in and to the estate and to the properties thereof, and determine the nature and character of the rights, privileges, and estates bestowed upon plaintiff in her individual capacity and upon the defendants by the joint will and covenant, to examine and approve plaintiff's accounts as independent executrix, and:Adjudge and determine the respective claims and rights of plaintiff in her individual capacity, and the estate of R. B. Masterson, deceased, and the defendants in and to all net income which has been realized heretofore by said estate, and determine and clear the title to such net income and*19 properties into which said net income has gone and, if need be, require an accounting, make and lay such charges on or against the estate of R. B. Masterson, deceased, and the assets and properties thereof as may be necessary in the premises in order to do justice.In these proceedings plaintiff was represented by Adkins, Pipkin, Madden & Keffer of Amarillo, Texas, and Weeks, Bird & Cannon of Fort Worth, Texas.In due time after the petition was filed the four defendant daughters, joined pro forma by their husbands, filed an answer in which they took the position that their mother had an unqualified life estate in all of the Masterson properties, which "life estate was in no wise limited to such reasonable sums as might properly be expended by such survivor for his or her maintenance" and that in any accounting "that said accounting shall credit to the individual account and separate estate of said Anna Eliza Masterson the net income derived from the whole of said estate up until August 19, 1935, and with all of the income derived from an undivided one-half of said estate from said last-mentioned date until the date of such accounting, less all sums of money used or expended by*20 her on her own behalf." These defendants were represented by Otis Truelove of Amarillo, Texas.The defendants, R. B. Masterson, Jr., and T. B. Masterson, filed an answer to plaintiff's petition alleging that "by reason of the premises the plaintiff herein became vested with a limited life estate in the community estate of herself and the said R. B. Masterson, Deceased, and the increase thereof, and the rents, revenues and income thereof, and these defendants each became vested with one-sixth" of the Masterson *320 properties "subject only to the limited estate vested by such joint will and covenant in the plaintiff herein * * * which life estate of the plaintiff herein was limited to her support and maintenance throughout her natural life, and that other than the right to use the income and revenue from said estate, and the corpus thereof, if necessary, for her support and maintenance throughout her natural life, the plaintiff herein was not vested with any interest" in the Masterson properties or the income thereof. These defendants prayed that their title to an undivided one-half interest in the Masterson properties, and all increase, rents, and revenues realized, and to be*21 realized, therefrom in the future, subject only to plaintiff's limited life estate be cleared. These defendants were represented by Clayton & Bralley, attorneys of Amarillo, Texas.The judgment of the District Court of Potter County, dated June 19, 1941, recited:On the 16th day of May, A. D., 1941, the above styled and numbered cause came on regularly to be heard, and came all parties in person and by their attorneys and announced ready for trial. A jury being waived, all matters of fact as well as law were submitted to the Court. The Court thereupon heard the pleadings, the evidence and argument of counsel and after considering the same, made and filed herein Findings of Fact, and Conclusions of Law, * * *In the court's findings of fact and conclusions of law it found that on December 6, 1928, petitioner and Masterson entered the joint will and covenant, which had never been altered, that Masterson died "and on that date the plaintiff qualified as independent executrix of said estate and continuously since that time has been acting as such," and that on August 19, 1935, pursuant to authority granted by the joint will and covenant, petitioner transferred to the six children*22 her right, title, and interest in and to an undivided one-half of the Masterson properties and accretions, that petitioner's accounting of her stewardship to April 1, 1941, was correct, that the acts and conduct of petitioner and Masterson showed an entire equality of treatment of all of the six children, that except for amounts needed for her support and maintenance, petitioner had never withdrawn any of the funds or income from the estate but that, with that exception, all of the funds had been left in the estate and devoted to estate purposes, and further:Questions and controversies have arisen between the plaintiff and the six children above named as to the nature of plaintiff's interest in the revenues from the estate in her hands not used to care for the estate and to provide for her support and maintenance, as to the rights of plaintiff with respect to revenues used either to improve the estate or to discharge the indebtedness existing at the death of R. B. Masterson, and as to the rights of the six children in said accumulated funds, which present under the circumstances of this case a bona fide controversy.XII.The dominating purpose and intention or the scheme of testamentary*23 disposition which the plaintiff and R. B. Masterson had in executing the aforesaid *321 joint contract and will, as the same is disclosed by the instrument itself when viewed in the light of the family situation and surrounding circumstances as disclosed by the record in this case and without giving any weight to testimony offered at the trial of this case as to the intention or understanding of either the plaintiff or R. B. Masterson in executing said will or in its effect, was this: They desired to provide for the support, maintenance and comfort of the survivor of them in a manner suitable to people of their means, age and station in life. They desired that all of the properties of the estate -- including accretions thereto and the unexpended revenues thereof -- not used to support and maintain the survivor should be held intact during the lifetime of the survivor, and that all of this property, including accretions and accumulated revenues, should go at the death of the survivor, share and share alike and without any distinction whatsoever, to all of the aforesaid six children, with the right given to the survivor to anticipate this ultimate disposition by transferring, *24 whenever he or she might see fit, during his or her lifetime, one-half of the properties, accretions and accumulated revenues to said six children, share and share alike. They desired that no differences in treatment should be brought about, or discriminations made, as between the six children, on the ground that the two boys were of the half blood, while the four girls were of the whole blood, and they intended that such differences in treatment or discriminations should be impossible.And further:The controversies above referred to have also arisen in respect to various Federal tax matters relating to said estate. The Attorney General of the United States, the Commissioner of Internal Revenue Agent in Charge at Dallas, Texas, and the United States Attorney for the Northern District of Texas were duly notified of the filing of this suit, but have taken no action with respect thereto. * * *With respect to these findings the court concluded that it had jurisdiction of the controversy, that the joint will and covenant became irrevocable upon Masterson's death, that it dealt with the entire community properties of petitioner and Masterson, and that after Masterson's death and her*25 acceptance petitioner had only such rights in all of the estate properties as were given to her by the joint will and covenant, that the dominant purposes and intentions of the makers of the joint will and covenant were as set out in the findings of fact and that:The revenues which have accumulated from said estate and which have not been expended in caring for said estate or in supporting and maintaining plaintiff do not belong to her, individually, but fall into and remain a part of the estate in her hands to go ultimately to the six children named in said will. Plaintiff, individually, has no rights or claims by virtue of the fact that revenues of the estate have heretofore been used to pay the debts of the estate or to make improvements or betterments thereto, or in and to the investments and acquisitions of the estate, but plaintiff has the right to be supported and maintained out of the estate now in her hands as Independent Executrix, and its revenues and accretions, in a manner in keeping with her station in life and the value of said estate; * * *At the death of R. B. Masterson all of the property then on hand vested, share and share alike, in the aforesaid six children*26 (subject to the special provisions for Mary Masterson Fain, Mrs. Flora Masterson and Mrs. Bettie McGregor), *322 but with the rights of control and management granted to plaintiff, as Independent Executrix by said contract and will, and charged with the liability to pay the debts of said estate, and also charged with the burden of supporting and maintaining the plaintiff, as heretofore set forth. The plaintiff's rights to support and maintenance from said estate are personal to her. The plaintiff cannot make any testamentary disposition with respect to the revenues which have or will accumulate in said estate, but the disposition of the same upon the death of plaintiff is and will be controlled by the terms and provisions of the aforesaid joint contract and will.The accounts of the independent executrix to April 1, 1941, were approved.Based on the findings of fact and conclusion of law, the court, in its judgment, adjudged that upon Masterson's death title to all of the properties and the estate vested in the six children equally, subject to special bequests, debts, administration expenses, and the support and maintenance of petitioner; that the independent executrix has*27 the right and duty of holding, managing, and controlling the estate's assets and properties during her lifetime; that "Anna Eliza Masterson, individually, is entitled, as a right personal to her, to be supported and maintained from said assets and properties and the receipts and revenues thereof," but that "other than this right to be supported and maintained, Anna Eliza Masterson, individually, was not given and does not have any right, title or interest in the aforesaid properties and assets"; that all income from the properties not used for expenses, debts, and the survivor's support and maintenance fell into and became a part of the corpus of the estate, and that similar revenues and income which may arise in the future should be treated in the same manner; that, except for support and maintenance, petitioner individually "was not given, nor does she have any right, title or interest in such accumulated revenues"; that the claims of petitioner, individually, to a conventional life estate in the properties and the revenues and income thereof should be and were denied and that the titles of the six children thereto were cleared and quieted and that the petitioner's claims with respect*28 to charging the estate with accumulated revenues used by it were denied; that petitioner's accounts as independent executrix were confirmed; and, further:That Anna Eliza Masterson, as Independent Executrix of the estate of R. B. Masterson, deceased, shall, during her lifetime, hold, control and manage said estate and the properties thereof in keeping with the terms and provisions of the aforesaid joint contract and will as construed by the foregoing findings, conclusions and orders.This judgment became final.On March 14, 1936, petitioner filed her 1935 income tax return with the collector of internal revenue for the second district of Texas. It disclosed a tax liability of $ 1,866.34. This amount was paid by petitioner by check drawn on the R. B. Masterson estate bank account and *323 signed "Anna Eliza Masterson, individually, and as independent executrix of the Estate of R. B. Masterson," by C. E. Weymouth. An additional income tax for 1935 of $ 208.79 was assessed against petitioner and paid in a similar fashion.On March 14, 1936, petitioner, individually, and as independent executrix of the estate of R. B. Masterson, filed a 1935 income tax return in the name of *29 the estate with the collector of internal revenue for the second collection district of Texas. This return was signed "Anna Eliza Masterson, individually, and as independent executrix of the Estate of R. B. Masterson" and disclosed a tax liability of $ 2,919.93. Additional income tax for the year 1935 of $ 499.80 was asserted by respondent. The taxes shown by the return and the additional tax asserted were paid by petitioner by checks drawn on the R. B. Masterson bank account and signed Anna Eliza Masterson, individually, and as independent executrix of the estate of R. B. Masterson, by C. E. Weymouth.Each of the above mentioned returns, in answer to question No. 5 of the preliminary questions, referred to the other return. Question No. 5 reads: "5. State name of husband or wife if a separate return was made and the Collector's office to which it was sent."No claims for refund have been filed with respect to any taxes paid for 1935 and no refunds thereof have been made.In her 1935 return petitioner included in her gross income for that year all of the amounts physically received by her from the R. B. Masterson estate and all of the amounts expended in her behalf by the estate*30 during that year. Other than these amounts and those in controversy, petitioner had no income in 1935. The amounts reported on the income tax return of the R. B. Masterson estate in the year 1935 represented the balance of income from the estate properties not physically received by petitioner nor actually expended in her behalf.Respondent, in the notice of deficiency dated February 21, 1941, seeks to add to the gross income shown on petitioner's return, $ 31,636.64, the corrected net income, $ 28,351.94, of the R. B. Masterson estate.OPINION.A preliminary question is raised by petitioner's plea of the statute of limitations. The deficiency notice was concededly subsequent to the expiration of the three-year period prescribed as the general rule. Revenue Act of 1934, sec. 275 (a). It is asserted that it was nevertheless timely as being within the five-year period specified in section 275 (c) for cases in which the "taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return * * *." The addition to petitioner's taxable income proposed by the deficiency *324 notice is incontrovertibly*31 in excess of 25 percent of the gross income shown on the return which petitioner filed on her own behalf; but she contends that by filing a further return for the estate showing the balance of the income, she has in effect reported the entire income by considering the two returns together, so that there was in fact no actual omission of income under the principle of .This is reasoning which we are unable to approve. The question in the Germantown case was whether a return filed by a fiduciary on the theory that the organization in question was a trust could be considered as its return when the same organization was shown to be an association taxable as a corporation. The Court held that it could, since all the information necessary to the determination of the correct amount of tax was included in the return. There was no question of treating two returns as one, and the interpretation of section 275 (c) was not involved.That section is explicit in its reference to "the taxpayer." The "gross income" from which an omission brings the section into play must be the gross income of that taxpayer*32 and "the return" referred to must be his return. If the provision were to be construed so that an omission from one taxpayer's return would be without effect upon a showing that the unreported income was contained in the return of some other taxpayer, its effect would be largely nullified. In other words, it does not comport with the purpose or language of the statute to say that the gross income shown on the return of another taxpayer is the same as "the gross income" of "the taxpayer." It might as well be argued that the return of the omitted income for another year would equally constitute a complete return of all the income even though on two different returns. Yet it is clear that this is one of the exact situations to which the provision was directed, it being assertedly designed to cover a taxpayer who "might report as income for one year an item of income which properly belonged in another year." Senate Report 558, 73d Cong., 2d sess., p. 43.The section is not punitive and was enacted in its ultimate form in order not to bear too heavily on "a taxpayer who makes an honest mistake * * *." Ibid. The statute is extended for only two years, not indefinitely, as by the*33 provision considered in the Germantown case. And, finally, the facts necessary to a correct determination of the tax due would not appear from two returns of the type before us here, since there might be nothing on the face of either to show that the income included in the estate return was the same as that omitted from the beneficiary's. For these reasons we think it inadmissible to say that this income was included in petitioner's gross income or that there is any reason for reducing the period of limitation below five years. The plea in bar must therefore be overruled. ; .On the merits the controversy is whether petitioner's interest in what had formerly been the community property of herself and her deceased husband was a conventional life estate or the limited right to maintenance and support. It is on the former assumption that the respondent has taxed to petitioner, as constructively received, the entire income from the property in question; and it is on the latter that petitioner returned and paid*34 tax on only so much of the income as she actually received for living expenses, which she now contends was the limit of her tax liability.The same issue, that is, the nature of petitioner's interest in this income, was before the Board in connection with an asserted gift tax deficiency, in a proceeding decided at . It was there held, contrary to petitioner's contention, that her interest was a conventional life estate and that the gift which she made to her children in the present tax year included the unspent and accumulated income. This result was reached in the face of the same contention which petitioner makes here, that the unused income did not belong to her, but was from the beginning the property of the remaindermen, who were there also the donees.An appeal from that determination was taken to the Circuit Court of Appeals for the Fifth Circuit. But in the meantime the question was litigated in what appears to have been the appropriate local court, and a decision was there obtained that petitioner was entitled to no conventional life estate but merely to the right of maintenance. The proceedings in that case were tendered to the*35 Court of Appeals upon its review of the Board's decision. That court refused to accept them "as evidence," but held that, "so far as the legal questions decided by the Texas State Court are concerned we take judicial knowledge of the decision * * *. We are not bound by that decision, and to the extent that it differs from what we have said we do not agree with it." . The court, affirming the Board, held that what petitioner "then owned was a life estate in all the property, and she, therefore, conveyed to the children one-half of her life estate, plus the accretions earned and on hand from this one-half."In that posture of this proceeding respondent contends that the judgment of the Circuit Court of Appeals constitutes res judicata here. Petitioner, on the contrary, rests upon the state court decision as being binding, notwithstanding the prior adjudication, in reliance upon , and .In the absence of complicating factors, a prior adjudication of the same issue in litigation between *36 the same parties would foreclose all *326 further consideration. . A recognized exception exists, however, where a subsequent change in the applicable law may be said to affect the fundamental question. Such a change can be supplied by a subsequent state court decision adjudicating the property rights in issue. ;The circumstance then existing, as described in Blair v. Commissioner, is that "after the decision in the first proceeding, the opinion and decree of the state court created a new situation." 1*37 But there is nothing to indicate that the principle of res judicata is inapplicable merely because there is involved a decision of a state court settling the property rights of the parties. The cases cited are no more than instances of an acceptance of the general principle, from which they emerge as exceptions due to a change in the state of the law. Cf. .In the present case, the issue is whether the decision of the Circuit Court of Appeals for the Fifth Circuit in a proceeding in which these parties litigated the same question is conclusive; and in disposing of that question we can not resort to the concept of a changed situation. Here the Texas court's decision did not follow but preceded the previous adjudication. By taking judicial notice of that decision the appellate court had before it the action taken by the state court to precisely the same extent as if it had been introduced in evidence. ; see . There is no more than that before us here. *38 Nor is the adjudication by the Circuit Court of Appeals any the less conclusive because it may be said that the issue it decided was partly one of law. The binding effect of an application of the principle of res judicata is as inescapable in the one case as in the other. "* * * a right, question or fact distinctly put in issue and directly determined by a court of competent jurisdiction, as a ground of recovery, can not be disputed in a subsequent suit by the same parties or their privies." . The disposition of the issue is what is conclusive and it follows that whatever was involved in the question originally decided as to both fact and law is subsequently binding. For example, in :The question for determination in this case relates to the effect of the former judgment upon the present action, which is upon different coupons, though attached to the same series of bonds. * * * Is the litigation any the less concluded because the fact upon which the judgment rested was established *39 by the *327 demurrer? * * * In the former action against the present defendant the adjudication was that the bonds themselves were never signed by the proper officers required by the statute of the State to sign them, and therefore they were not legal obligations of the township. * * * the bonds being found to be invalid and void, he is precluded from attempting to show the contrary, either of the fact of their wanting the signature of the county clerk, or of the law that for that reason they were not binding obligations of the municipality. The fact and the law are adjudged matters between the parties, and not open, therefore, to any further contest.See also ; . The doctrine of res judicata is, it might be said, a device for easing the burden of the courts as a desideratum of public policy. It assumes that there must be an end to litigation. Where the parties and the issue are the same the adjudication of a question of law is hence completely controlling in subsequent proceedings. *40 .Nor would it be of any consequence, if this can be suggested without presumption, whether the decision in the prior proceeding were completely erroneous. The function of res judicata is to make it unnecessary that the correctness of the former adjudication be reexamined. If it were only prior decisions with which the subsequent triers of the question could independently agree, to which the rule applied, there would be no need for or benefit from the rule. It is for that reason at least that the former decision is said to make white black, black white, the crooked straight, the straight crooked. . "'Matters once determined in a court of competent jurisdiction may never again be called in question by parties or privies against objection, though the judgment may have been erroneous and liable to, and certain of, reversal in a higher court.'" .Here there can be no question but what the issue in this case, namely the character of petitioner's interest*41 in this income, was "distinctly put in issue and directly determined by a court of competent jurisdiction" in the prior litigation; and that it was there determined to be a conventional life estate, notwithstanding the state court decision to the contrary. We can not hold in these proceedings that petitioner's interest in the income in question was limited to the right to maintenance without flying in the face of the previous adjudication of the same question between the same parties by the Fifth Circuit Court of Appeals. We can not disregard that disposition of the issue without doing violence to the accepted principles of res judicata. And there is nothing here to justify departing from those principles under the Blair doctrine, since nothing has in the meantime "created a new situation." We conclude that the Fifth Circuit Court's decision is binding and that accordingly petitioner's interest was a legal life estate. *328 It follows that the respondent correctly charged her with the entire income.The final question is whether we can grant petitioner's claim to an offset, against the deficiency, of the income tax paid on behalf of the estate. However desirable *42 might be such a procedure, we think the difficulties to be overcome are too great. If the estate has overpaid its tax, it will not do to permit the tax liability of a different taxpayer to be reduced thereby. ; ; reversed on other grounds (C. C. A., 3d Cir.), . Any claim for refund which the estate may have on account of the overpayment is not before us, since the estate is not a party to these proceedings, but if it has such a claim and the refund is still permissible, see Revenue Act of 1938, section 820, the possibility that respondent might there be subjected to a double detriment is too great to justify the deduction of the same claim here. Cf. . The result must be to deny the set-off.Other issues are now conceded.Decision will be entered under Rule 50. Footnotes1. The principle has been thus stated with the Blair↩ case cited as authority: "However, where, after the rendition of a judgment, subsequent events occur, creating a new legal situation or altering the legal rights or relations of the litigants, the judgment may thereby be precluded from operating as an estoppel." 30 Am. Jur. 943. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623066/ | C. FLORIAN ZITTEL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Zittel v. CommissionerDocket No. 14111.United States Board of Tax Appeals12 B.T.A. 675; 1928 BTA LEXIS 3496; June 15, 1928, Promulgated *3496 Respondent sustained in computing tax on the salary actually received by petitioner in 1921. C. Florian Zittel pro se. J. L. Deveney, Esq., for the respondent. ARUNDELL*675 The petitioner seeks a redetermination of a deficiency in income tax for the year 1921 in the amount of $7,637, claiming that an item of salary which the respondent included in 1921 income was income in 1920. FINDINGS OF FACT. In March, 1919, petitioner entered the employ of William Randolph Hearst under a three year contract as theatrical advertising solicitor of the New York Evening Journal and as manager of the International Film Co., at an agreed salary of $52,000 per year. Hearst directed that the petitioner's salary be paid by the Star Publishing Co. of New York. Under the contract petitioner was to maintain his own office and pay his own expenses. The Star Publishing Co. in 1919 paid the petitioner the salary agreed upon, and $19,000 in the first half of 1920. About the first of July, 1920, the company advised him that it was short of funds and requested that it be allowed to withhold further payments for awhile. To this the petitioner assented, as he*3497 felt that his contract with Hearst was good and was satisfied in his own mind that he would get the money. During the remainder of the year he continued to perform his duties, maintained his office, and paid his expenses out of his pocket, receiving nothing from the Star Publishing Co. In December, 1920, the petitioner began to need money and called upon the Star Publishing Co. for payment, but was unable to effect collection. His attorneys also attempted by interviews and correspondent to collect the amount owing to petitioner, but without success. The Star Company did not deny that the money was owing to the petitioner but contended that the contract was with Hearst and that petitioner should collect from him. Hearst being out of town at that time, petitioner was unable to see him until the middle of February, 1921, when upon presentation of the matter he ordered the Star Publishing Co. to pay the petitioner the amount due him for 1920 and 1921 up to that time. The company complied with Hearst's order. Prior to filing his income-tax return for 1920 petitioner inquired of attorneys in New York City and also of some one in the Bureau *676 of Internal Revenue in Washington*3498 as to how he should report his 1920 income. From both sources he received advice that the entire contract salary of $52,000 should be reported as 1920 income. He filed his return for 1920 on March 15, 1921, and reported thereon as salary received the amount of $52,000. To this return he attached a typewritten schedule of the deductions claimed and at the top of the schedule there was this statement: This report is based on accrual basis, yearly contract of $52,000 of which only $19,000 has been collected. In his return for the year 1921 petitioner reported as his gross income salary of $52,000. Petitioner did not accrue any expenses during the years involved. His books have been destroyed by fire. In his return for 1919 he indicated that it was filed on a receipts basis and in his 1920 return that it was filed on an accrual basis. As a result of a revenue agent's investigation and report, the respondent in auditing petitioner's returns for 1920 and 1921 determined petitioner's income in each year in the amounts actually received and computed the taxes accordingly. These computations resulted in an overassessment of $1,994.70 for 1920 and a deficiency of $7,637 for*3499 1921. OPINION. ARUNDELL: The petitioner seeks a redetermination of taxes for the years 1920 and 1921, but as the respondent has found an over-assessment for 1920 which does not arise out of the rejection of an abatement claim, we have no jurisdiction over the respondent's finding for that year. We may, however, consider the facts with reference to that year for the purpose of deciding whether the deficiency in the 1921 taxes was correctly determined. The respondent has found that the petitioner was on a cash receipts and disbursements basis and has taxed his salary in the years in which it was actually received. According to the petitioner's testimony he kept books and records of some kind during the years 1920 and 1921, but we do not know on what basis they were kept. All that we have on this phase of the case is that on his return for 1919 he wrote in reply to the question on the face of it that it showed "income received" and on his 1920 return he indicated that he kept books on an accrual basis. Certain it is that his accounts in 1920 were not strictly on an accrual basis for he took into consideration only expenses paid. On this state of the record we can not find*3500 that the respondent erred in holding that the petitioner was on a receipts and disbursements basis. *677 Taxpayers on a receipts and disbursements basis are required to report only income actually received no matter how binding any contracts they may have to receive more. So for the year 1920 it was necessary for this taxpayer to include in the salary reported for taxation only the amount he actually received. For the year 1921 he was required by law to report all that he actually received and the fact that a part of it was for services rendered in 1920 can not make it taxable income for the earlier year. See . We have repeatedly held that even where salary is credited on the books of the employer it is not income to the taxpayer until actually received in the absence of evidence of constructive receipt. , and cases there cited. There can be no valid argument of constructive receipt made here in view of the showing of petitioner's vain efforts to collect in the year 1920. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623067/ | James T. Shiosaki v. Commissioner.Shiosaki v. CommissionerDocket No. 2365-70 SC.United States Tax CourtT.C. Memo 1971-24; 1971 Tax Ct. Memo LEXIS 309; 30 T.C.M. (CCH) 110; T.C.M. (RIA) 71024; February 1, 1971, Filed James T. Shiosaki, pro se, 555 E. 8th St., Azuza, Calif. Robert H. Feldman, for the respondent. SACKS Memorandum Findings of Fact and Opinion SACKS, Commissioner: Respondent determined a deficiency in the income tax of petitioner for the taxable year 1967 in the amount of $393.76. The sole issue for decision is whether or not expenses incurred by petitioner in traveling to and from Las Vegas, Nevada for the purpose of engaging in gambling are deductible as ordinary and necessary expenses paid or incurred for the production of income within the purview of section 212(1) of the Internal Revenue Code of 1954. Findings of Fact Some of the facts have been stipulated by the parties. Their stipulation, together with an attached exhibit, is incorporated herein by this reference. James T. Shiosaki, hereinafter referred to as petitioner, is an individual who resided in Azuza, California at the time of filing his petition herein. His Federal income tax return for the taxable year 1967, made on the cash basis and for the calendar year period, was filed with the district director of*311 internal revenue, Los Angeles, California. Petitioner is an electrical engineer. He graduated from college in 1957 and has been employed regularly as an electrical engineer since then. Between 1960 and the present, his annual salary has been approximately $15,000.00. During the summer of 1957 petitioner took a trip to Las Vegas, Nevada for the purpose of recreation. On this trip he was introduced to the gambling game of craps. His curiosity was stimulated by this game, and he thereafter began to read books dealing with craps as well as to observe others gambling at craps in order to devise a method of pursuing the game which would give him some assurance of being able to make winnings. Beginning approximately in 1959 petitioner regularly went to Las Vegas, on the average of six or seven times a year, for the purpose of gambling - principally at craps. Initially, he was quite successful, aggregating net winnings of $6,426.00 during 1959. Since 1959, however, his annual performance has been uniformly bad, and he has suffered net losses in each of the years 1960 through 1969, the sum total of which is approximately $50,000.00. For example, he lost between $3,500.00 and $8,500.00*312 in 1966, $8,700.00 in 1967, $5,600.00 in 1968, and between $5,000.00 and $10,000.00 in 1969. By comparison, his gross winnings during the entire period 1960 through 1969 are not significant when measured against his gross losses for the same period. Moreover, during all of this time his primary source of funds for gambling remained his wages - of about $15,000.00 per year - derived from his regular employment as an electrical engineer. Throughout the years 1959 through 1969 petitioner made an extensive study of the game of craps. He has been able, however, to evolve no "system" which is consistent in producing winnings, and has therefore adopted the expedient merely of betting large amounts when winning and small amounts when losing. Familiarity with gambling has led him to the observation that while everyone who gambles does so with the intent of winning, only a small percentage, i.e., very few individuals, win at the game of craps. Petitioner made twelve trips to Las Vegas in 1967 for the purpose of engaging in gambling. These twelve trips produced, 111 in the aggregate, gross winnings of $1,300.00, and gross losses of $10,000.00. Petitioner also incurred the following expenses*313 in connection with the twelve trips: Transportation to and from airport$ 72.00Air tickets413.70Air insurance22.00Hotels372.31Meals167.00Cabs129.00Auto storage 54.50Total $1,230.51 On his Federal income tax return for the taxable year 1967 petitioner reported gambling winnings of $1,300.00 and gambling losses of $1,300.00 (the maximum loss allowable under section 165(d) 1 of the Internal Revenue Code of 1954). He also claimed a deduction in the amount of $1,230.51 as "expenses incurred in obtaining gambling income." In his notice of deficiency respondent disallowed this claim on the ground that the same was a nondeductible personal expense. *314 Ultimate Finding Petitioner has failed to prove that the expenses he incurred in traveling to and from Las Vegas, Nevada for the purpose of engaging in gambling were ordinary and necessary expenses paid or incurred for the production of income within the purview of section 212(1) of the Internal Revenue Code of 1954. Opinion It is petitioner's position that the expenses which he incurred in connection with his trips to Las Vegas for the purpose of gambling are expenses paid "for the production of income" and should therefore be allowable as a deduction under section 212(1) 2 of the Internal Revenue Code of 1954. In support of this position petitioner argues that gambling is an income producing activity - indeed, that he would not pursue this activity were it not for the fact that income can be produced - and that the continuity, regularity and financial depth with which he has engaged in gambling demonstrate his intent to become successful in making it a source of income. Therefore, he contends, any expenses incurred in connection with this activity fall within the ambit of section 212(1). *315 Respondent takes an opposite position. He argues that the expenses in question do not qualify for deduction under section 212, nor any other section, but rather fall within the category of personal expenses specifically denied deduction under section 262. 3At the outset we must observe that the exact question thus presented is one of uniqueness for this Court. In Edward T. Dicker, 22 T.C.M. (CCH) 345">22 T.C.M. 345 (1963), we were faced with similar facts, but our decision turned upon a different section of the Code. There, the taxpayer claimed expenses of $600.00 incurred on a trip to Las Vegas (where he won $1,600.00) as a loss sustained in a "transaction entered into for profit" within the meaning of section 165(c) (2). 4 We disallowed the claim, with little discussion, on the ground that the expense was a personal one within the purview of section 262 and section 1.212-1(c) of the Income Tax Regs.5*316 112 Petitioner, in contradistinction to Edward T. Dicker, supra, has predicated his claim upon section 212(1). That section allows as a personal deduction all the ordinary and necessary expenses paid or incurred during the taxable year "for the production * * * of income." Although this statute is silent as to the meaning of the phrase "for the production * * * of income," our view is that these words envision a transaction motivated by a profit seeking purpose. Margit Sigray Bessenyey, 45 T.C. 261">45 T.C. 261, 273 (1965), affd. 379 F. 2">379 F. 2d, 252 (C.A. 2, 1967), cert. den. 389 U.S. 931">389 U.S. 931 (1967). 6 As we said in the Bessenyey case: That purpose [i.e., the profit seeking purpose] may in fact exist even in the face of a history of losses unaccompanied by any gains whatever, but the deductibility of those losses must depend upon the taxpayer's proven intention that he sought to realize a profit. It is to be noted that we recognized*317 in the Bessenyey case it was not "crucial that the expectation of profit be a reasonable one." We pointed out that It is enough that the taxpayer has a bona fide expectation of realizing a profit irrespective of the reasonableness of his expectation; but a record of continued losses over a series of years or the unlikelihood of achieving a profitable operation may be an important factor bearing on the taxpayer's true intention. In the instant case, petitioner has testified as to his consistent and substantial losses over the period 1960 through 1969. While he has stated that he is hopeful that he will not continue to lose, and that he hopes future gains will more than make up for past losses, he has also rather candidly testified as to his dearly purchased knowledge that only a small percentage, or very few individuals, win at the crap table. The Court has thought long and hard about this case. Of the many opinions which we have read in an effort to be guided toward a resolution of the issue presented, perhaps the most apt is that of Citizens & Southern Nat'l. Bank v. United States, 14 F. Supp. 915">14 F. Supp. 915 (Ct. Cl., 1936). There the Court of Claims was called upon to decide*318 whether a taxpayer's gambling transactions were motivated by a profit seeking purpose where the evidence showed that he had consistently lost in many previous years. The Court said, ibid. at p. 918: In spite of the lack of success attending his efforts over six or seven years, and in the face of the fact that the [taxpayer] realized the odds were against him, and his past experience bore eloquent testimony to that effect, he testified that he played the game in 1931 for profit when he lost the large amounts which are now claimed as deductions * * *. What the [taxpayer] would have us believe is that, in a game where he had consistently lost for years and where he realized the odds were against him, he proceeded to that source for the purpose of realizing a profit * * *. * * * Such testimony overtaxes our credulity and stretches credence to the breaking point. We do not understand that every time a game of chance is entered into with the evanescent hope that the player will win constitutes a transaction entered into for profit within the meaning of the statute. In our opinion, the words used connote transactions for profit in the reasonable sense that any business is undertaken. *319 Surely, a reasonably prudent business man would not embark in a business venture where the odds were admittedly against him and where his own unbroken line of experience had demonstrated over a period of years that losses would be the only fruit of his efforts. Of course, many people engage in such pastimes, even though the vast majority of them lose, and it must be so, otherwise the gambling casino could not stay in existence. But profit in the business sense is not what usually motivates the continued playing; it is the thrill and exhilaration which are inherent in taking a chance. As the Board of Tax Appeals said in Louis D. Beaumont v. Commissioner, all gambling transactions are not entered into for profit within the meaning of the statute. The system evolved and used by the decedent, as a result of the study which he said he had made of the game, seems nothing more than a vaporous supposition that luck would attend his efforts if followed in a certain sequence, even though he knew the odds were against him and that losses by players made possible the continued operation of the club. It is our opinion that petitioner has failed to show that in incurring expenses for trips *320 113 to Las Vegas in 1967 to engage in gambling he was motivated by a bona fide profit seeking purpose. We have drawn this conclusion not from any determination that some hypothetical "reasonable man" faced with petitioner's consistent and continued losses could not expect a profit, but from a conviction that petitioner himself, were he not so inextricably caught up in the gambling game, could not expect, by reason of these sustained losses, to turn a profit. Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered for respondent. Footnotes1. SEC. 165. LOSSES. (a) General Rule. - There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. * * * (c) Limitation on Losses of Individuals. -in the case of an individual, the deduction under subsection (a) shall be limited to - (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. * * * (d) Wagering Losses. - Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.↩2. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year - (1) for the production or collection of income; * * *↩3. SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES. Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.↩4. See fn. 1. ↩5. SEC. 1.212-1(c)↩. Expenses of carrying on transactions which do not constitute a trade or business of the taxpayer and are not carried on for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income, but which are carried on primarily as a sport, hobby, or recreation are not allowable as nontrade or nonbusiness expenses. The question whether or not a transaction is carried on primarily for the production of income or for the management, conservation, or maintenance of property held for the production or collection of income, rather than primarily as a sport, hobby, or recreation, is not to be determined solely from the intention of the taxpayer but rather from all the circumstances of the case. For example, consideration will be given to the record of prior gain or loss of the taxpayer in the activity, the relation between the type of activity and the principal occupation of the taxpayer, and the uses to which the property or what it produces is put by the taxpayer.6. See also and compare Samuel Yanow, 44 T.C. 444">44 T.C. 444↩ (1965) at 452 wherein the phrase "for the production of income" as used in sec. 167(a)(2), concerning depreciation, was similarly construed. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623068/ | S. C. TOOF & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.S. C. Toof & Co. v. CommissionerDocket Nos. 14932, 15003, 15004.United States Board of Tax Appeals21 B.T.A. 916; 1930 BTA LEXIS 1763; December 29, 1930, Promulgated *1763 1. The statute of limitations held not to have expired at the time an assessment for the calendar year 1918 was made on June 5, 1925. 2. Respondent disallowed as deductions from gross income seven items consisting of contributions made by petitioner to various organizations. Upon the record respondent's determination is approved as to one item and disapproved as to the remaining six. 3, 4. Upon the evidence, held, respondent erred in restoring to petitioner's opening and closing inventories for the years 1918, 1919, and 1920, a deduction of 10 per cent made by petitioner to allow for the goods that were sold during the period the inventory was being taken. 5. Respondent admits that he erred in reducing the amount of current earnings available for payment of dividends by a tentative tax. 6. The inclusion in invested capital for the years 1918 to 1921, inclusive, of a part of the income and profits taxes for the preceding years was in accordance with the respondent's regulations in force in respect of such taxable years, and, under section 1207 of the Revenue Act of 1926, "shall be considered as having been correctly made." 7. Amount of depreciation allowable*1764 for the years 1918 to 1921, inclusive, determined. 8 and 13. Upon the evidence, held that the amount of depreciation written off by petitioner and substantially allowed by the respondent was not excessive. 9, 10. An item of $6,579.55 expended by petitioner for a new building held to constitute a capital expenditure. 11. Respondent admits that he erred in reducing petitioner's invested capital for the years 1918 to 1921, inclusive, by a certain amount representing a contingent reserve. 12. Upon the evidence, held, petitioner is not entitled to any deduction on account of alleged losses due to the obsoleteness of standing type and forms. 15. During 1919 and 1920 petitioner sold to certain of its employees a portion of its own capital stock, at par, to be paid for by deducting from the employees' weekly salary a certain percentage of the total amount of stock sold, and by crediting to the purchase price of such stock all dividends declared and paid thereon. Held, petitioner is not entitled to deduct from its gross income such dividends as additional compensation. 17. Petitioner held not entitled to deduct from its gross income an amount paid*1765 its president for the purpose of reimbursing him for a loss he sustained in connection with an investment amde by him in his individual capacity. Leo H. Hoffman, Esq., for the petitioner. R. W. Wilson, Esq., for the respondent. LOVE *917 These proceedings, which were consolidated, are for the redetermination of deficiencies in income and profits taxes for the calendar years 1918 to 1921, inclusive, in the following amounts: YearDocket No.Deficiency191815004$6,605.591919150033,236.161920150034,461.831921149324,086.83The entire amount of the above deficiencies is in controversy, and, in addition thereto, petitioner asks that the Board find that it has made an overpayment of taxes for the three years 1918, 1919, and 1920. The petitions, as amended, allege that the respondent committed errors as follows: (1) In assessing an additional tax for the year 1918 after the statutory period of limitation for assessment had run; (2) In disallowing as deductions from gross income for the years 1918, 1919, and 1920, certain donations alleged by petitioner to be in the form of advertising or ordinary*1766 and necessary business expenses; (3) In refusing to allow petitioner to decrease its opening and closing inventories for the years 1918, 1919, and 1920 by a flat rate of 10 per cent; (4) In increasing petitioner's invested capital for the years 1918, 1919, and 1920 by $7,932.43, $10,420.92, and $11,727.07, respectively, on account of inventory adjustments; (5) In reducing petitioner's invested capital for the year 1918 by $705.48, on account of dividends paid; (6) In reducing petitioner's invested capital for the years 1918 to 1921, inclusive, by alleged erroneous amounts on account of Federal income and profits taxes for prior years; (7) In disallowing as deductions from gross income for the years 1918 to 1921, inclusive, a portion of the depreciation claimed by petitioner for those years; (8) In not increasing the prewar income and invested capital in arriving at the deficiency for the year 1918 by all of the excessive depreciation charged off during the prewar period and prior thereto; (9) In not increasing the prewar income and invested capital in arriving at the deficiency for the year 1918 by certain capital items alleged to have been improperly charged to expense*1767 by petitioner during the year 1913; (10) In not increasing the invested capital for the years 1918 to 1921, inclusive, by certain capital items alleged to have been improperly charged to expense by petitioner during the year 1913; *918 (11) In reducing invested capital for the years 1918 to 1921, inclusive, by a contingent reserve of $3,945.97; (12) In not allowing, as deductions from gross income for the years 1918, 1919, and 1920, losses alleged to have been sustained in those years due to the obsoleteness of standing type and forms; (13) In refusing to further increase petitioner's invested capital for the years 1918 to 1921, inclusive, by an alleged excessive depreciation charged off by petitioner in years prior to the respective taxable year in question; (14) In refusing to determine petitioner's profits-tax liability for the years 1918 to 1921, inclusive, under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921, respectively; (15) In refusing to allow, as deductions from gross income for the years 1919, 1920, and 1921, certain alleged additional compensation paid to petitioner's employees in the form of dividends on petitioner's capital*1768 stock not fully paid for by the employees; (16) In increasing petitioner's contingent reserve by an excessive amount in arriving at the deficiency for the year 1920; (17) In refusing to allow as a deduction from gross income for the year 1921, or any other year, an amount of $500 paid to petitioner's president during the year 1921; and (18) In not finding refunds due petitioner for the years 1918, 1919, and 1920. The respondent admits that he committed the above alleged errors numbered 5 and 11, and petitioner waives the alleged error numbered 16. In connection with the alleged error numbered 14 a motion was granted to confine the hearing in the first instance to the issues defined in subdivisions (a) and (b) of Rule 62 of the Board's rules of practice. FINDINGS OF FACT. Petitioner is a corporation organized and existing under the laws of the State of Tennessee, with its principal office at Memphis. 1. On March 13, 1919, petitioner filed with the collector of internal revenue at Nashville, Tenn., on Form 1031-T, a "Tentative Return and Estimate of Corporation Income and Profits Taxes and Request for extension of Time for Filing Return," for the calendar year 1918. *1769 In this tentative return petitioner requested an extension of 45 days in which to file a completed return. The tentative return also shows that at that time petitioner estimated its tax liability for the year 1918 to be $28,639.27, of which $8,000 was remitted by petitioner at the time of filing the return. *919 On June 6, 1919, petitioner filed its completed corporation income and profits-tax return for the calendar year 1918. On February 5, 1924, petitioner duly filed a waiver coverivg the calendar year 1918. The waiver by its own limitation expired "one year after the expiration of the statutory period of limitation." On June 5, 1925, the respondent made a jeopardy assessment, under the provisions of section 274(d) of the Revenue Act of 1924, of a deficiency of $6,605.59 for the year 1918. The collector served a notice of demand for the payment of the deficiency, and, within the time provided for in section 279(a) of the Revenue Act of 1924, petitioner duly filed a claim for abatement, accompanied by a bond as prescribed in the statute. On January 30, 1926, the respondent rejected petitioner's claim for the full amount of the deficiency, and issued the deficiency*1770 letter, from which petitioner duly filed with this Board a petition for the redetermination of the deficiency. 2. During the years 1918, 1919, and 1920 petitioner contributed certain amounts to certain organizations, as follows: Name191819191920Tri State Fair Association $150Baptist Hospital100 $100Citizens League $100Methodist Hospital100Presbyterian College250Chamber of Commerce100The Tri State Fair Association was a fair organized about 20 years ago to exhibit the products of the three States of Tennessee, Mississippi, and Arkansas. During 1918 it operated at a deficit and the different business houses of Memphis, showing a civic spirit, subscribed to a fund to cover this deficit. The association did an annual business with petitioner amounting to several thousands of dollars, and in order to retain this business, petitioner contributed the amount of $150. The Baptist Hospital was also a very good customer of petitioner. They ordered a steady line of work all of the time and were paying their bills promptly. Petitioner considered it a very good business proposition to subscribe $100 in 1918 and $100*1771 in 1920 toward a building program then being conducted by the hospital. Petitioner is receiving a great deal of business from the Methodist Hospital. The Presbyterian College was operating at Clarksville, Tenn., and decided to move to Memphis, and had a campaign on for funds. The campaign committee spent a great deal of money with petitioner for printing, and the contribution of $250 was made to maintain that business. *920 The subscription of $100 to the chamber of commerce was to meet a part of the budget of that organization, and entitled petitioner to a membership therein. Petitioner received considerable business from this source. The various individuals interested in the campaigns for funds for the above organizations (except Citizens League) were also good patrons of the petitioner, and in making the contributions in question, petitioner also retained the good will of the individuals. It was the opinion of the treasurer and office manager of petitioner that had the contributions in question (except those to the Citizens League) not been made, petitioner would have lost considerable of the business then being enjoyed from those organizations. Petitioner's*1772 reputation in printing, bookbinding, commercial lithographing and steel engraving was not confined to the city of Memphis. It was represented at the International Convention of Lithographers in London, and also at the St. Louis Exposition. There was no other plant at Memphis that was as large as petitioner's. The above items were deducted by petitioner on its returns for the respective years as advertising expenses. The respondent disallowed the claimed deductions on the ground that they constituted donations rather than ordinary and necessary business expenses. 3. Prior to 1916 and every year thereafter, beginning about December 20 of each year and lasting from about 10 to 14 days, petitioner has consistently taken a physical inventory of its merchandise and manufactured stock on hand at that time. It valued its inventories upon the basis of "cost or market, whichever was lower." Petitioner continued to make sales throughout each inventory period, but did not deduct the cost or market value (whichever might have been lower) of the goods sold during this period from the total cost or market value of the inventory then being taken until the inventory had been completed, *1773 at which time petitioner would then deduct a flat rate of 10 per cent from the total inventory. These 10 per cent deductions were explained on petitioner's inventory work sheets as "Less errors & omissions and sales after stock taking," and for the close of the years 1917, 1918, 1919, and 1920 amounted to $7,677.55, $10,420.92, $11,727.07, and $12,840.88, respectively. Petitioner's business was seasonable, with the busy months from September to April, inclusive, and the dull months from May to August, inclusive. Usually December was its best month of the year. The number of inventory turnovers in petitioner's business during the years 1917 to 1920, inclusive, was as follows: YearNumber of inventoryturnovers19174.3319183.3219193.5319204.02Total during 4-year period15.20Average annual turnover (1/4 of 15.20)3.80Average turnover every 10 days (10/365 of 3.80).104+*921 During the years 1917 to 1920, inclusive, the average sales and average cost of sales over a 10-day period in the month of December, were as follows: For a 10-day Average Average cost period insalesof salesDecem,ber1917$15,715.80$11,752.51191817,774.3011,499.97191923,524.5014,573.38192024,549.2017,037.14*1774 The respondent restored the above 10 per cent reductions to petitioner's opening and closing inventories for the years 1918, 1919, and 1920, which resulted in increasing petitioner's net income for each of the years, as follows: YearRestored to openingRestored to closingIncrease in net income1918$7,677.55$10,420.92$2,743.37191910,420.9211,727.071,306.15192011,727.0712,840.881,113.814. The restoration by the respondent of the above 10 per cent deductions to petitioner's opening inventories for the years 1918, 1919, and 1920 also resulted in increasing petitioner's invested capital for those years by the amounts so restored, namely, $7,677.55, $10,420.92, and $11,727.07 for the years 1918, 1919, and 1920, respectively. 5. Petitioner's invested capital for the year 1918 was reduced by the respondent in the amount of $705.48, on account of dividends paid March 18, 1918, by petitioner in the amount of $9,000. The respondent made this deduction on the finding that $891.01 of the dividends paid was paid out of surplus and not from current earnings. This finding was obtained by respondent by reducing current earnings to the date*1775 the dividend was paid by a so-called "tentative" tax theoretically set aside out of 1918 earnings pro rata over the year 1918. *922 The earnings from January 1, 1918, to March 18, 1918, were greater than $9,000. 6. The respondent decreased petitioner's invested capital for the years 1918 to 1921, inclusive, on account of Federal taxes for prior years. The principle there employed was in accordance with respondent's regulations in force in respect of such taxable years. For the year 1918 invested capital was reduced by $732.23 on account of Federal taxes in the amount of $1,336.32, based upon the income for the year 1917. For the year 1919, the reduction was the amount of $14,780.47 on account of Federal taxes in the amount of $34,974.86, based on the income for 1918 as originally reported by petitioner and as increased by respondent. For the year 1920 the reduction was the amount of $16,677.83 on account of Federal taxes in the amount of $39,573.45, based on the income for 1919 as originally reported by petitioner and as increased by respondent. For the year 1920 the invested capital was also reduced by the amount of $6,602.23 on account of additional taxes for*1776 the year 1918. For the year 1921 the reduction was the amount of $22,004, on account of Federal taxes in the amount of $52,068.16, based on the income of 1920 as originally reported by petitioner and as increased by respondent. The deficiency letter for the year 1920 shows the total tax liability for that year to be $51,583.84 instead of $52,068.16. For the year 1921 the invested capital was also reduced by the amounts of $1,888.52, $6,762.84, and $3,350.51 on account of additional taxes for the years 1917, 1918, and 1919, respectively. For the year 1917 respondent has never proposed or assessed any additional taxes against petitioner, nor has he ever commenced any suit or proceeding for additional tax for that year. For the year 1918 respondent has proposed and assessed a deficiency of $6,605.59, with respect to which a claim for abatement was duly filed and disallowed by respondent in his deficiency letter dated January 30, 1926. For the year 1919 respondent has proposed a deficiency of $3,236.16, as set forth in his notice of deficiency dated January 30, 1926. For the year 1920 respondent has proposed a deficiency of $4,461.83, as set forth in his notice of deficiency*1777 dated January 30, 1926. 7. Petitioner was incorporated during October, 1899, for the purpose of taking over the business then being conducted by a partnership composed of S. C. Toof and W. H. Bates, trading under the firm name of S. C. Toof & Co. The partnership began business in *923 the year 1864. Petitioner began actual operation on January 1, 1900. The authorized capital stock of petitioner was $100,000, consisting of 1,000 shares of the par value of $100 each. The cost of "equipment" (exclusive of metals) together with the additions and reductions thereto, as shown on petitioner's books from January 1, 1900, to December 31, 1921, is as follows: Year ended Dec. 31AdditionsReductionsNet additionsAccumulated totalBalance Jan. 1, 1900$54,788.021900$2,899.56$145.00$2,744.5657,532.581901876.99876.9958,409.5719024,208.034,208.0362,617.6019036,299.12300.005,999.1268,616.7219046,817.566,817.5675,414.2819054,903.531,519.693,383.8478,818.1219066,467.62185.306,282.3285,100.4419074,364.554,364.5589,464.9919085,211.345,211.3494,676.3319097,012.897,012.89101,689.2219108,917.698,917.69110,606.9119119,413.259,413.25120,020.1619123,248.27891.252,357.02122,377.18Jan. 1, 1913 to Mar. 1, 1913287.85450.00(162.15)122,215.03Total to Mar. 1, 191370,918.253,491.2467,427.01122,215.03Mar. 1, 1913, to Dec. 31, 191327,954.09439.6527,514.44149,729.47Mar. 1, 1913, to Dec. 31, 19136,579.556,579.55156,309.02Total, Dec. 31, 1913105,451.893,930.89101,521.00156,309.02191413,253.1325.0013,228.13169,537.1519153,320.42221.073,099.35172,636.5019164,107.40225.003,882.40176,518.9019174,467.51586.003,881.51180,400.41Total130,600.354,987.96125,612.39180,400.4119183,822.38765.003,057.38183,457.79191913,400.781,079.5712,321.21195,779.00192022,658.367,332.2915,326.07211,105.0719219,726.56312.509,414.06220,519.13Total, Dec. 31, 1921180,208.4314,477.32165,731.11220,519.13*1778 The parties have stipulated that the proper annual rate for depreciation of all of petitioner's assets during the years 1918 to 1921, both inclusive, is a composite rate of 10 per cent. The amount of depreciation written off the books by petitioner, the amount allowed by the respondent, and the amount disallowed by the respondent, for the years 1918 to 1921, inclusive, are as follows: YearWritten off Allowed by Disallowed by byrespondentrespondentpetitioner1918$10,215.73$7,149.43$3,066.30191912,093.208,727.353,365.85192013,940.8010,555.693,385.11192115,164.5111,470.753,693.76*924 For the years 1918, 1919, and 1920 respondent arrived at the amount of depreciation allowed by him as follows: CALENDAR YEAR 1918Equipment5 per cent10 per cent 15 per cent Depreciationof costof costof costallowableOffice$4,221.96$422.20Composing room$16,008.91800.45Motor room2,634.63263.46Cylinder11,309.801,130.98Ruling machines1,561.26156.13Platen press3,238.55323.86Monotype6,164.90616.49Linotype5,021.50502.15Stock-room fixtures360.0036.00Shipping room838.6383.87Steel dies, etc3,154.30$331.04365.08Lithograph8,212.04600.00911.20Bindery cutting K547.001,221.56237.93Bindery folding F2,209.50479.30292.85Bindery hand B. & A113.38192.1040.15Bindery D2,339.622,639.54629.89Metals, linotype1,751.68175.17Metals, monotype1,615.78161.57Total16,008.9155,294.585,463.547,149.43CALENDAR YEAR 1919Office$4,675.21$467.52Composing room$16,008.91$506.69876.45Motor room2,634.63263.46Cylinder11,329.801,132.98Ruling machines1,667.46166.75Platen press4,512.15451.22Monotype machine6,164.99616.50Linotype machine5,021.50502.15Stock-room fixtures477.2347.72Intertype machine3,598.88359.89Shipping room838.68858.05212.58Steel dies, etc3,006.75457.31369.27Lithograph8,212.04600.00911.20Bindery cutting K547.003,001.52504.93Bindery folding F2,209.50479.30292.85Bindery hand B. & A91.739.17Bindery D2,339.626,480.121,205.98Metals, linotype1,751.68175.16Metals, monotype1,615.78161.57Total16,008.9160,694.6312,382.998,727.35CALENDAR YEAR 1920Autos, $1,285.95, at 25 per cent$321.49Office$4,835.51483.55Composing room$16,008.91$1,430.031,014.95Motor room2,634.63263.46Cylinder13,386.801,338.68Ruling machines3,174.96317.50Platen press7,399.02739.91Monotype machine7,137.40713.74Linotype machine5,021.50502.15Stock-room fixtures477.2347.72Shipping room838.68756.22197.30Steel dies, etc4,001.94457.31468.79Lithograph9,022.04600.001,052.20Bindery cutting K547.003,001.52504.93Bindery folding F4,894.50479.30561.35Bindery hand B. & A325.6332.56Bindery D5,013.767,715.211,658.66Metals, linotype1,751.68175.17Metals, monotype1,615.78161.58Total16,008.9172,678.0614,439.5910,555.69*1779 *925 The total cost on which respondent allowed depreciation for the years 1918, 1919, and 1920 was as follows: 1918$76,767.03191989,086.531920104,412.518 and 13. From the time of incorporation until January 1, 1922, petitioner wrote off on its books the following amounts as depreciation in the following years: YearDepreciation written off1902$2,250.00190625,000.00190820,000.0019095,000.0019106,000.00191110,000.00191210,000.00191321,218.62Subtotal99,468.621914$7,645.4919157,984.0219168,175.0519179,960.87Subtotal133,234.051918$10,215.73191912,093.20192013,940.80192115,164.51Grand total184,648.29The respondent, in determining the income of petitioner for the prewar period (calendar years 1911, 1912, and 1913), increased such prewar income on account of excessive depreciation charged off during those years as follows: Prewar yearsIncome increased1911$3,807.1119124,117.4519131,954.73In determining the income of petitioner for the prewar period, the respondent also increased such prewar income by the amount of $11,218.62, *1780 and made the following explanation for so doing: The amount of $11,218.62 written off in 1913 should be restored, inasmuch as it was an entry made to reduce assets to their actual value. In determining the invested capital of petitioner for the prewar period, the respondent increased such invested capital on account of excessive depreciation charged off during prewar years as follows: Increase in invested capital for excessive depreciationPrewar yearsYears charged offAmount19111909-1910$214.7819121909-19114,021.8919131909-19128,139.34*926 The prewar income and invested capital as determined by the respondent for each of the prewar years were as follows: YearPrewar incomePrewar invested capital1911$36,802.12$127,832.14191239,699.37146,444.5119139,973.15155,981.12Average28,824.88143,419.26The net income, invested capital, and excess-profits credits as determined by the respondent for the years 1918 to 1921, inclusive, were as follows: YearNet incomeInvested capitalExcess-profits credit1918$74,462.46$196,508.70$18,720.701919113,029.38230,188.6121,415.091920143,143.81265,409.7624,232.781921100,242.19337,204.4329,976.36*1781 In determining the deficiency for the year 1918, the respondent determined the war-profits credit provided for under section 311(a) of the Revenue Act of 1918 to be the amount of $37,133.82, which he computed as follows: Average net income for prewar period$28,824.88Plus 10% of increase in invested capital5,308.9434,133.82Exemption3,000.00War-profits credit as determined by the respondent37,133.82The respondent in determining the invested capital of petitioner for the years 1918 to 1921, inclusive, included therein certain amounts which he determined to be excessive depreciation charged off by petitioner in prior years, as follows: 19181,279.8319194,346.1319207,711.981921None.9 and 10. In a schedule set out under issue No. 7 above, showing the cost of equipment, together with the additions and reductions thereto, appears an item of $6,579.55 in the column headed "Additions" from March 1, 1913, to December 31, 1913. Petitioner charged this item to expense in 1913. The item was recorded on petitioner's *927 books in a separate account styled "New Building Expense" and consisted of expenditures for the following*1782 items: Electrical and plumbing$1,026.25Steam heat and connections346.96Sheet metal work224.00Lumber and building material308.21Machine work, hardware, etc148.28Erectors material and expense470.21Freight and drayage981.11Labor and petty cash disbursements859.40Contractors, consulting engineers and architects2,098.74Miscellaneous116.396,579.55The total amount of $6,579.55 was expended by petitioner during 1913 in erecting a new building on leased premises on which petitioner had a 10-year lease expiring August 31, 1923. The respondent refused to permit petitioner to restore this item of $6,579.55 to its capital account. 11. The parties have stipulated that the respondent reduced petitioner's invested capital for each of the years 1918 to 1921, inclusive, by $3,945.97, and that "This item represents a contingent reserve created by charges to the surplus account, also charges against income in years prior to 1918." 12. On March 1, 1913, petitioner owned certain assets referred to in the record as "Standing Type and Forms." During the latter part of 1917, or early in 1918, petitioner discontinued to use such assets in*1783 its business on account of the Railroad Administration printing standard tariff forms. The assets became worthless either in 1917 or 1918. 15. During the years 1919 and 1920, petitioner entered into written agreements with certain of its employees wherein petitioner sold to such employees certain shares of its capital stock, at par, payment to be made by deducting one-fourth of 1 per cent of the total amount of stock so purchased from the respective employee's weekly salary, and by crediting to the purchase price of such stock all dividends declared and paid. A copy of the standard contract employed in each of the several agreements referred to above is as follows: THIS CONTRACT, made and entered into this the day of , 192 , by and between S. C.Toof and Company, a corporation chartered and existing under the laws of the State of Tennessee, as party of the first part, and of Memphis, Tennessee, as party of the second part, WITNESSETH: WHEREAS, as the party of the second part is now in the employ of the party of the first part, and the party of the first part is desirous of having the said party of the second part interested in its business as a stockholder therein, *1784 to *928 the end that he may receive in the form of dividends on his stock, a share in the earnings of the party of the first part, which he helped to produce; Now, THEREFORE, the party of the first part has this day sold to the party of the second part shares of stock, at par, upon the following terms and conditions, to-wit; 1. The party of the second part is to pay weekly on the purchase of said stock, one fourth (1/4) of one (1) per cent of the total amount of stock purchased, the same to be deducted from the weekly salary of the party of the second part, and credited on said stock; said deferred payments to be without interest. 2. All dividends declared by the party of the first part from time to time shall be credited on the purchase of said stock. 3. The stock certificate covering the aforesaid stock has this day been issued to and in the name of the party of the second part, and he has indorsed the same in blank and deposited it with the Treasurer of the party of the first part, to be held by him as security for the full performance of this contract and until said stock has been paid for in full, in the manner and form as herein recited, and not otherwise. *1785 4. Should the connection of the party of the second part with the party of the first part be severed, either by resignation, dismissal or death, the party of the first part shall promptly repay the party of the second part, his heirs, personal representatives or assigns, all payments made hereunder, together with all dividends declared on the stock hereby purchased and credited to the purchase of same, and thereupon all further right, title or interest of the party of the second part in, to and under this contract shall terminate, and the stock certificate or certificates issued hereunder shall be returned to the Treasury of the party of the first part. 5. The party of the second part does hereby grant unto the President of the party of the first part, whomsoever he may be, the irrevocable proxy of voting the stock covered hereby, at any and all stockholders meetings, until said stock is fully paid for in the manner and form as herein recited, whereupon said proxy shall automatically terminate, and the power to vote said stock be restored to the holder or owner of the same, and the party of the second part does hereby name, constitute and appoint the President of the party*1786 of the first part as his attorney-in-fact, with full, complete and absolute power to act for the party of the second part in all matters affecting the stockholders of the party of the first part, with complete authority to act therein according to his own judgment and discretion, and this power of attorney to be absolute and irrevocable, for the valuable consideration aforesaid, until the stock issued hereunder has been fully paid for and delivered to the party of the second part, whereupon this power of attorney shall automatically become null and void. 6. This contract is non-negotiable and non-assignable, and is personal to the party of the second part. 7. If after the stock purchased hereunder has been fully paid for and delivered to the party of the second part, he should desire to pledge or sell same, the party of the first part shall be given the option of accepting the pledge of said stock or of purchasing the same. IN WITNESS WHEREOF, said parties of the first and second part have hereunto set their names and seals the day and year above written. *929 The date, name of employee (party of the second part), number of shares purchased, together with the amount*1787 of the purchase price, of all such contracts entered into during the years 1919 and 1920, are as follows: DateEmployeeNumber of sharesPurchase priceJuly 2, 1919A. J. Taylor30$3,000DoJ. R. Curtis313,100DoN. B. Hamilton252,500DoW. H. Adams505,000DoChas. Holder101,000DoR. E. Linn202,00016616,600Feb. 12, 1920R. E. Linn202,00018618,600Petitioner declared dividends which were credited to the employee's stock purchase accounts as follows: Date of dividendPercentageAmount of dividend credited to account ofemployees1919Dec. 1515$2,4901920Mar. 1661,116July 74904Dec. 2761,1163,1361921Mar. 156$1,116June 2061,116Sept. 1261,116Dec. 1561,1164,464All the terms and conditions of the contract with each of the above mentioned employees were performed without any variation. The book value of petitioner's stock at the time the contracts were entered into was from about $200 to $250 per share. The respondent refused to allow as deductions from gross income for the years 1919, 1920, and 1921, as additional*1788 compensation, the various amounts of the above dividends which were credited to the stock purchase account of the several employees, totaling $2,490, $3,136, and $4,464, respectively. 17. The Memphis Terminal Corporation was one of petitioner's customers with whom petitioner did an annual business of several thousand dollars. About 1916, W. G. Turner, who was president of the Memphis Terminal Association, was promoting a new corporation called the Safety-Light Co. Turner approached Otto Zahn, who was then the president of petitioner, with a view of selling Zahn some stock in the Safety-Light Co. Zahn, in order to retain the business of the Memphis Terminal Corporation for petitioner, *930 purchased in his individual capacity stock in the Safety-Light Co. at a cost of $500. The Safety-Light Co. never operated and its stock became worthless in the year 1918. During the period from 1916 to and through the year 1921, petitioner kept and maintained its books of account on an accrual basis. At either a directors' or stockholders' meeting held in 1921, either the directors or stockholders of petitioner unanimously decided to reimburse Zahn for the full amount of his loss*1789 in connection with his investment in the Safety-Light Co. In accordance with that decision, petitioner during 1921 paid Zahn $500 and deducted the amount paid from its gross income for the year 1921 as an ordinary and necessary business expense. The respondent determined that the amount of $500 paid to Zahn was a gift to Zahn, and accordingly disallowed such payment as a deduction from gross income. 18. Petitioner duly filed its income and profits-tax returns for the calendar years 1918, 1919, 1920, and 1921, pursuant to the provisions of the Revenue Acts of 1918 and 1921, respectively. The taxes originally assessed and paid are set forth in the following schedule: Year involvedAssessment Amount of Amount Date paiddateassessmentpaid1918Feb. 10, 1920$28,372.63$8,000.00Mar. 13, 19196,186.32June 16, 19197,093.16Sept. 13, 19197,093.15Dec. 11, 19191918June 5, 19256,605.591919June 22, 192036,337.299,084.33Mar. 15, 19209,084.32June 9, 19209,084.32Sept. 14, 19209,083.32Dec. 15, 19201.00Jan. 20, 19211920May 12, 192147,122.0111,780.51Mar. 15, 192111,780.50June 13, 192111,780.50Sept. 13, 192111,780.50Dec. 13, 19211921Dec. 18, 192224,489.476,122.37Mar. 14, 19226,122.37June 14, 19226,122.37Sept. 13, 19226,122.36Dec. 13, 1922*1790 The returns for the calendar years 1919, 1920, and 1921 were filed on March 12, 1920, March 14, 1921, and March 14, 1922, respectively. On January 26, 1925, both petitioner and respondent executed an agreement whereby "in pursuance of the provisions of existing internal revenue laws" petitioner and respondent "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 petitioner for the year 1919. The agreement then provided: * * * This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1925, and shall then expire except that if notice 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 sixty 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. On September 23, 1925, a similar agreement was executed between the same*1791 parties except that the years involved were the "Calendar Years Begun January 1, 1919 and Ended Dec. 31, 1920," and the waiver was to remain in effect until December 31, 1926, instead of December 31, 1925. All the other provisions were the same. On April 1, 1926, both petitioner and respondent entered into the following agreement: In pursuance of the provisions of existing Internal Revenue Laws S. C.Toof & Company, taxpayer, of Memphis, Tennessee, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income and excess profits, or war profits taxes due under any returns made by or on behalf of said taxpayer for the year 1921 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 *931 notice 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 one hundred and twenty days, or (2) if an appeal is filed with said*1792 Board this waiver shall remain in effect until the expiration of sixty days after final decision by said Board. Petitioner has filed with the respondent claims for refund as follows: YearDate filedAmount of claim1918Feb. 29, 1924$16,121.831919do21,034.231920do27,236.611918Mar. 14, 1925$5,973.721919do8,265.491920do6,974.41On January 30, 1926, the respondent mailed petitioner a deficiency letter for the years 1919 and 1920. On February 6, 1926, he mailed petitioner a deficiency letter for the year 1921. Petitioner duly appealed to this Board from both notices of deficiencies. OPINION. LOVE: The issues will be discussed in the order previously mentioned. The first issue is whether the assessment made by the respondent on June 5, 1925, for the year 1918, in the amount of $6,605.59 was barred by the statute of limitations. Section 277(a)(2) of the Revenue Act of 1924, and section 277(a)(3) of the Revenue Act of *932 1926 provide that, except as provided in section 278, the amount of income and profits taxes imposed by the Revenue Act of 1918 "shall be assessed within 5 years after the return was filed. *1793 " Petitioner filed a tentative return on March 13, 1919, and a completed return on June 6, 1919. The statute commences to run from the date of filing the latter return. ; and . Sections 278(c) of both the Revenue Acts of 1924 and 1926 provide: Where both the Commissioner and the taxpayer have consented in writing to the assessment of the tax after the time prescribed in section 277 for its assessment the tax may be assessed at any time prior to the expiration of the period agreed upon. In its brief petitioner contends that "the record contains no evidence of a consent between the Commissioner and petitioner extending the time within which to make assessments." In its petition, however, petitioner alleges that: On February 5, 1924, the taxpayer duly filed a waiver covering the calendar year 1918. Said waiver by its own limitations expired "one year after the expiration of the statutory period of limitation," to-wit, March 13, 1925. In his answer to the petition, the respondent "denies that the taxpayer filed its return on March 13, 1919, but*1794 admits that on February 5, 1924, the taxpayer duly filed a waiver covering the calendar year 1918." It is apparent from the petition that at the time it was filed, petitioner was relying on the filing of the tentative return as being the time from which the statute began to run, which position has been overruled by the United States Supreme Court in the two cases cited above. In its reply brief petitioner maintains that: No evidence was introduced to show, nor is it stipulated, that the Commissioner or a duly authorized agent ever accepted said waiver. The burden is upon the Commissioner to prove an extension upon the limitation period and to prove the validity of the waiver. We see no merit in the above contention. The petition alleges and the answer admits that the consent in question was "duly filed," and that it expired "one year after the expiration of the statutory period of limitation." The statutory period of limitation was "five years after the return was filed," or June 6, 1924. One year thereafter would be June 6, 1925. The assessment made the day before was, therefore, within the period provided by law. *1795 The second issue is whether petitioner is entitled to deduct from its gross income for the years 1918, 1919, and 1920, the contributions to the various organizations listed in our findings. As a general proposition corporations are not entitled to deduct donations as *933 such. It is only when the so-called donation is in fact an "ordinary and necessary expense" of doing business that authority is found for allowing it as a deduction from gross income. See section 234(a)(1) of the Revenue Act of 1918, and , and cases cited therein. See also . The question of allowing corporations to deduct contributions was recently before the United States Circuit Court of Appeals for the Sixth Circuit in the case of . In the course of its opinion the court said: * * * The question always is whether, balancing the outlay against the benefits to be reasonably expected, the business interest of the taxpayer will be advanced. * * * We cannot accept the contention that to permit the petitioner to make this contribution*1796 would give to a corporation the right to make donations to charity which is given exclusively to individuals by Section 214(a) 11 of the Act of 1918. The contention entirely overlooks the distinction that the contribution was not a philanthropy, but was a business expenditure to be reflected in increased earnings. The right to make such expenditure is not confined to corporations but is also given to individuals. The individual has the additional right, under the statutes, to make gifts to charity that have no relation to business expenses. * * * The evidence in the instant case, with the exception of the $100 contributed to the Citizens League in 1919, shows that the amounts expended were so directly related to petitioner's current business as to warrant their deduction from gross income as ordinary and necessary business expenses. The evidence pertaining to the Citizens League item is too indefinite to support the same conclusion reached with respect to the other items, and the respondent's determination as to that item is, therefore, approved. The third and fourth issues will be discussed together. The disposition of both depends upon whether the respondent was justified*1797 in restoring to petitioner's opening and closing inventories for the years 1918, 1919, and 1920, the 10 per cent deduction made by petitioner to allow for the sales made during the time the inventory was being taken which lasted from 10 to 14 days from about December 20 of each year. At the outset, it is noted from the record that petitioner has treated these issues as if they also pertained to the year 1921. But the pleadings in Docket No. 14932 raise no such issues, and the question will, therefore, be limited to the years 1918, 1919, and 1920. Section 203 of the Revenue Act of 1918 provides: That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with *934 the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. Petitioner took its inventories upon the basis of cost or market, whichever was lower, which basis has always been recognized by the respondent as a proper basis. One*1798 of the purposes of the inventories was to show the amount of goods on hand as of December 31 of each year. It took from 10 to 14 days to complete the inventories and for that reason petitioner always commenced taking inventories about December 20. It, however, continued to make sales during the inventory period. The merchandise sold during this period was included by petitioner as a part of the inventory before making the 10 per cent deduction. It is, therefore, quite obvious that the inventories as determined by the respondent are erroneous, since they include all of the goods that were sold during the period the inventory was being taken. The 10 per cent deduction made by petitioner was made for the purpose of taking out of the inventory as of December 31 the goods sold between the period from about December 20 to December 31. We think that some such an adjustment may properly be made, and that it only remains to be determined whether the 10 per cent deducted by petitioner was reasonable under all the circumstances. We think it was. The evidence shows that the month of December was petitioner's busiest time; that the inventory turnover during a 10-day period in December was*1799 greater than 10 per cent; that the average cost of sales during a 10-day period in the month of December of each of the years 1918, 1919, and 1920 was greater in every instance than the amount of the 10 per cent deduction made by petitioner; and that this method of taking inventory has been consistently used by petitioner since prior to the year 1916. In , we said: The sole purpose of inventory valuation is to reflect income as clearly as possible. * * * However faulty the taxpayer's method was, we believe that greater weight should be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used substantially reflects the income. This rule has been given great weight both by the Commissioner and the Board. , and . To the same effect see also ; *1800 ; ; ; and . The consistent practice must reflect income as clearly as possible. Otherwise, little weight can be given to consistency. . *935 In the instant case it might be said that both parties are consistent in the method contended for by each, in that petitioner contends it was justified in reducing the inventory, as taken, by the 10 per cent in question, and respondent contends he was justified in restoring the percentage deducted by petitioner. The problem narrows down to a determination of which of the two inventories more clearly reflects petitioner's income. The trouble with the inventories as used by the respondent is that such inventories include all of the goods that were sold during the periods of taking inventory, or in other words, that the inventories as used by him were inventories of goods on hand on December 20 of each year instead of December 31. *1801 Petitioner reported its income on the calendar year basis and the inventories to be used in arriving at such income should be those of goods on hand on December 31 of each year. The petitioner has attempted to ascertain what the latter inventories were and we think the result obtained is as nearly correct as could be had under the circumstances and more clearly reflects petitioner's income. We hold, therefore, that the respondent erred in restoring the 10 per cent deduction made by the petitioner. Similar results have been reached in ; ; ; and . It follows that the net income as determined by the respondent for the years 1918, 1919, and 1920 should be reduced by the amounts of $2,743.37, $1,306.15, and $1,113.81, respectively; and that the invested capital as determined by him for the same years should be reduced by the respective amounts of $7,677.55, $10,420.92, and $11,727.07. The fifth issue is the same as the one involved in *1802 , and was conceded by the respondent at the hearing. Petitioner's invested capital as determined by the respondent should, therefore, be increased by the amount of $705.48. With respect to the sixth issue, petitioner contends, first, that the respondent erred in principle, in that he should not have reduced invested capital at all on account of taxes for prior years, and, second, if the reduction should have been made, the amounts used by the respondent were erroneous. Petitioner's first contention relative to this issue is denied. . The seventh issue is whether the respondent erred in disallowing a portion of the depreciation claimed by petitioner for the years 1918 to 1921, inclusive. For the years 1918, 1919, and 1920 the respondent computed the depreciation on total cost of $76,767.03, $89,086.53, and $104,412.51, respectively, and at rates on different assets of 5, 10, 15, and 25 per cent. He now concedes that he should have used a composite *936 rate on all assets of 10 per cent, and the parties have stipulated that the cost of the assets is as set forth*1803 in the findings of fact. The amount of depreciation for the years 1918, 1919, and 1920 should be recomputed in accordance with the present agreement of the parties. For the year 1921 we do not know upon what basis the respondent computed the allowance of $11,470.75. Neither do we know the rate used by him in his determination for this year. In a statement attached to the deficiency letter the respondent says, "Excessive depreciation is in accordance with the revenue agent's report." The report is not before us. Since the parties have stipulated that a composite rate of 10 per cent should be used for all the years 1918 to 1921, inclusive, the respondent should apply this rate, if he has used a different one, to whatever basis was used by him in his deficiency letter. The petitioner contends that, in computing the depreciation for the year 1921, the composite rate of 10 per cent should be applied to the cost of the assets set out in our findings. A large portion of petitioner's assets were acquired prior to March 1, 1913. Section 234(a)(7) of the Revenue Act of 1921 provides in part that: "In the case of such property acquired before March 1, 1913, this deduction shall be*1804 computed upon the basis of its fair market price or value as of March 1, 1913." No evidence was offered as to the fair market price or value of the property in question as of March 1, 1913, and in the absence of such evidence the basis used by the respondent must stand. The eighth and thirteenth issues will be discussed together. Their solution depends upon the single question of whether petitioner charged off excessive depreciation in years prior to 1914 and in years prior to 1918. The parties have stipulated that prior to the year 1914, petitioner charged off depreciation in the amount of $99,468.62, and prior to the year 1918, petitioner charged off depreciation in the amount of $133,234.05. The parties have also stipulated that the respondent determined that petitioner charged off excessive depreciation as follows: Prior to the yearAmount1911$214.7819124,021.8919138,139.341914$10,094.0719181,279.8319194,346.131920$7,711.981921None.The parties have also stipulated that the proper annual rate for depreciation of all of petitioner's assets during the years 1918 to 1921, inclusive, is a composite rate of 10 per cent. Petitioner, *1805 in attempting to show that it charged off too much depreciation in years prior to 1918, offered the testimony of four witnesses for the purpose of showing that a proper composite rate *937 for depreciation for the years 1900 to 1913, inclusive, was 2 1/2 per cent, and that a proper composite rate for depreciation for the years 1914 to 1917, inclusive, was 5 per cent. The first witness, J. R. Curtis, was a certified public accountant. He was employed by petitioner as office manager and auditor from January 1, 1913, to January 1, 1919, at which time he became treasurer of petitioner and retained that office until he resigned in May, 1922. He testified that he was familiar with petitioner's assets from 1913, to a certain extent; that "as far as the operation of the machines was concerned, a great many pieces of machinery would last a great many years, but new improvements were coming out and would make them obsolete, and consequently the depreciation would be greater than if the new machines had not come out"; that "some of the machines would have a life of 25 or 30 years, but new improvements made them obsolete"; that "taking into consideration the conditions that existed during*1806 the War period, the wear on the machinery was greater than it was before that, for the reason that the plant was working overtime a good deal, and the help we had was inefficient as compared to our regular help"; and that in his opinion, if 10 per cent were a proper rate for the years 1918 to 1921, inclusive, 5 per cent would be a proper rate for the years 1914 to 1917, inclusive. The second witness, L. R. Zeimer, was an appraiser with 29 years of experience in appraising manufacturing plants. During this period he had appraised between 250 and 300 plants similar to petitioner's. He testified that he was familiar with the machinery used by petitioner and plants similar to petitioner's for about 12 years prior to 1913, and that in his opinion, the fair composite annual rate of depreciation of petitioner's assets for the years 1900 to 1913, inclusive, was about 2 1/2 per cent, and for the years 1914 to 1917, inclusive, was about 5 per cent, and for the years 1918 to 1921, inclusive, was about 10 per cent. His reasons for having such an opinion were that prior to 1914, a great deal of the machinery was hand and foot power, which, on account of its slow movement did not wear out*1807 so fast; that, beginning about 1913 or 1914, automatic feed attachments came in which accelerated the speed of the machines and wore them out much faster than formerly; and that, beginning about 1918, the machines were run overtime, and with inefficient help. The third witness, W. H. Carr, was petitioner's factory superintendent, who has been with petitioner since its incorporation in 1889. He testified to a rate of 3 per cent for the period prior to 1914, and 5 per cent for the years 1914 to 1917, inclusive. Upon cross-examination, when asked how he arrived at those percentages, he said: "Well, I am basing it on 10 per cent, the correct percentage *938 at this time, just to take the 10 per cent as a basis to get the basis for the other." The fourth witness, J. K. Neel, was petitioner's foreman of its pressroom. He has been with petitioner since September, 1918, and also during the period from 1911 to 1913. He testified that he "understood" depreciation had always been figured at 2 1/2 per cent or 3 per cent prior to March 1, 1913, and that from 1913 to 1918 "it is generally understood it is about 5 per cent for that period of time." Neel was asked upon cross-examination*1808 to tell in detail how he arrived at the percentages mentioned in his direct testimony, and his answer was: "Well, it is not customary for me to do that figuring, but it is generally understood that a machine has so much life-time, and it has to be taken care of some way, and it is generally understood around a printing plant that the depreciation is so much." Petitioner is contending that the depreciation which it wrote off its books during the years 1900 to 1917, inclusive, was excessive. It has not explained how it arrived at the amounts written off or the circumstances which caused it to write off the depreciation in question. It asks us, however, to find that the amounts so written off were erroneous. The only evidence offered in support of such a contention is the testimony of the four witnesses outlined above. With all due regard to the sincerity of the testimony of these witnesses, we do not think that such evidence, standing alone, is sufficient to overcome the burden which was upon petitioner to prove that the practical judgment exercised by its officers 12 to 28 years ago was inferior to the more or less theoretical judgment of the witnesses who testified at the recent*1809 hearing of this case. In fact, the testimony of some of the witnesses even strengthened the action taken by petitioner's officers during the years 1902 to 1917, inclusive, in that the testimony showed that the old machines were becoming obsolete and had to be replaced by more modern machinery, and it is not unreasonable, under such circumstances, to believe that petitioner's officers made allowance for this fact in arriving at the amounts written off by them. Furthermore, it is quite significant to note from the following schedule that the additions made by petitioner to its equipment account were substantially the same as the amounts written off, which would indicate that petitioner was maintaining its plant at a certain standard throughout. The schedule showing the additions and amounts written off over the three periods for which petitioner is now contending that three different rates for depreciation should apply, is as follows: PeriodAdditionsDepreciation written off1900 to 1913$105,451.89$99,468.621914 to 191725,148.4633,765.431918 to 192149,608.0851,414.24Total180,208.43184,648.29*939 We are, therefore, of opinion*1810 that respondent's determination in connection with the eighth and thirteenth issues should be approved. The ninth and tenth issues will be treated together. The question is whether respondent erred in refusing to permit petitioner to restore to its capital account an amount of $6,579.55 which it expended in 1913 for a new building. The building was erected on premises leased until August 31, 1923, the petitioner being the lessee. Petitioner charged this item to expense in 1913, but now contends that it erred in so doing. We think the item in question was a capital expenditure, and that the respondent erred in not permitting petitioner to so treat it. Exhaustion should be computed in accordance with the stipulated composite rate. With respect to the eleventh issue, the respondent conceded at the hearing that the invested capital as determined by him for the years 1918 to 1921, inclusive, should be increased by the amount of $3,945.97. The twelfth issue was raised by petitioner for the first time at the hearing in the form of amendments to the petitions, alleging that respondent had erred in not reducing the income of petitioner for the calendar years 1918, 1919, and 1920*1811 "by the loss sustained due to the obsoleteness of standing type and forms." Counsel for the respondent objected very strenuously to the granting of petitioner's motion to amend its petition in this respect, on account of being taken entirely by surprise and having had no opportunity to prepare to meet such an issue. The respondent's objection was sustained with this reservation, that petitioner be given permission to introduce all of its evidence relative to its contention that it sustained losses as alleged, and, if in the discretion of the Board, the former ruling should be vacated, it would be done. But this will not be necessary for the reason that even if the respondent's objection were overruled and petitioner be given permission to amend its petition in this respect, the evidence is entirely insufficient to allow the alleged losses as claimed. In the first place, the evidence is very much confused as to whether the alleged loss was sustained in 1917 or 1918. The only years before us are the years 1918 to 1921, inclusive, and if the loss were sustained in 1917, it would not constitute a deduction in the latter years. In the second place, there is no evidence as to the cost*1812 of *940 the assets in question, and without evidence as to cost, no deduction for a loss is warranted. See ; and . The fourteenth issue was reserved for further hearing under Rule 62 of our rules of practice. The question involved in the fifteenth issue is whether petitioner is entitled to deduct from its gross income for the years 1919, 1920, and 1921 the dividends which were credited to the stock purchase accounts of certain of petitioner's employees in the amounts of $2,490, $3,136, and $4,464, respectively. Petitioner contends that until the stock in question was fully paid for by the employees, the latter were not stockholders and the so-called dividends were, therefore, not dividends, but amounts paid as additional compensation. In , a corporation taxpayer reissued certain shares of its treasury stock to certain of its employees, charged the book value of such shares to the personal accounts of the recipients, and credited against such accounts the amounts of dividends declared on such*1813 stock. In that case we denied the corporation's contentions that the amounts so credited constituted additional compensation, rather than dividends. To the same effect see . We believe that, from a reading of the contracts in the instant case, the unescapable conclusion to be reached is that the employees or parties of the second part became stockholders of petitioner from the date the respective contracts were entered into, and that the amounts in question which were credited to the stock purchase accounts of such employees were dividends within the meaning of that term as defined in section 201(a) of the Revenue Act of 1918. The respondent's determination with respect to this issue is approved. The seventeenth issue is whether the respondent erred in disallowing as a deduction from gross income the $500 paid by petitioner in 1921 to its president for the purpose of reimbursing the latter for a loss which the latter sustained in a personal investment. It appears that about the year 1916, petitioner's president purchased some stock in the Safety-Light Co. at a total cost of $500, which stock became worthless during*1814 the year 1918. It also appears that Zahn's motive in purchasing the stock was to retain certain business which petitioner was then enjoying from the Memphis Terminal Corporation, whose president was then promoting the Safety-Light Co., and had called upon Zahn to purchase stock in the new corporation. The evidence does not show that Zahn purchased the stock in question for anyone's account but his own, or that petitioner had anything whatever to do with the transaction until the year 1921, at which time either its directors or stockholders discussed the matter and decided *941 to reimburse Zahn for his loss, which petitioner did in 1921. The question is whether the amount paid Zahn in 1921 by petitioner was an "ordinary and necessary" business expense within the provisions of section 234(a)(1) of the Revenue Act of 1921. We think it was not. The stock was not purchased for petitioner, but was purchased for and by Zahn in his individual capacity. The loss resulting therefrom was Zahn's loss, and not petitioner's. The fact that petitioner later decided to reimburse Zahn for his loss was a pure grantuity on the part of petitioner which it was under no obligation to make. *1815 The respondent's determination on this issue is approved. The eighteenth issue is whether petitioner has made overpayments of taxes in respect of the taxable years 1918, 1919, and 1920. Decision relative thereto will be reserved until after the parties have submitted their computations in accordance with Rule 50. Reviewed by the Board. Further proceeding will be conducted under Rule 62(a) and (b).STERNHAGEN did not participate in the consideration of this report. MURDOCK MURDOCK, dissenting: I dissent from that part of the opinion which under the third and fourth issues approves the inventory method used by the petitioner. This method was inadequate and inaccurate, and so far as we know there was no justification or excuse for its use. It is not in accordance with the best accounting principles and it is not authorized by the Commissioner's regulations or the revenue acts. Consequently, the petitioner should have no relief from such adjustments as were here made until it changes its method of taking inventory. Otherwise, I concur in the result reached in the prevailing opinion. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623069/ | ST. LOUIS SOUTHWESTERN RAILWAY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.St. Louis S. W. Ry. v. CommissionerDocket Nos. 13319, 27768, 33938.United States Board of Tax Appeals24 B.T.A. 917; 1931 BTA LEXIS 1569; November 25, 1931, Promulgated *1569 The total amount of compensation to a railroad company for the use of its property during the period of Federal control, as finally agreed upon, and also interest on the cost of additions and betterments, received from the United States Government, constituted income for each of the accounting periods for which the allowances were made, although the exact amounts of such compensation and interest, were not determined until a later date. Claude W. Dudley, Esq., Chester A. Gwinn, Esq., and E. T. Carter, Esq., for the petitioner. E. C. Algire, Esq., for the respondent. MARQUETTE *918 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes asserted by the respondent as follows: Docket No.YearDeficiency133191920$42,811.3127768192220,495.17339381923254,895.16A number of errors were assigned by the petitioner, but most of the issues were eliminated at the hearing by agreement of parties. Docket No. 13319.Respondent admitted that he had overstated petitioner's taxable income for 1920 in the following amounts: (a) $1,974.40, *1570 with respect to contributions made by business concerns for the construction of special service railway tracks; (b) $1,544.50, respecting profit received on the sale of town lots; (c) $18,724.81, with respect to increased inventory values of materials and supplies received from the United States Railroad Administration; (e) $142,799.78, representing partial reimbursement for the cost of equipment retired during the period of Federal control; (f) $68,359.78, with respect to expenditures for equipment repairs; (h) $2,348.07, respecting a duplicate credit as to one of petitioner's affiliated companies. Respondent admitted error as to assignment (g) in computing, at the rate of 10 per cent instead of at the rate of 8 per cent, petitioner's income tax upon earnings for the first two months of 1920; and also in allowing as a credit the amount of $10,807.58, representing taxes paid by the Director General of Railroads in behalf of petitioner and its affiliated companies. As to error (d), petitioner conceded that there should be included in its net income for 1920 the amount of $518,591.53, representing expenditures made to rehabilitate its property to the extent of undermaintenance of way*1571 and structures during Federal control. In the final settlement with the Railroad Administration, in 1923, there was allowed to the petitioner and its affiliated companies, as *919 just compensation for the use of their properties during the period of Federal control, an amount which was $2,368,395.31 in excess of the amount of standard return for those properties as finally certified by the Interstate Commerce Commission. There were also allowed as rentals for some additional properties amounts aggregating $93,001.92. The parties agreed that if the aforesaid sums are not to be considered as taxable income for 1923, and that if portions thereof are to be considered as taxable income for 1920, then the proportionate amounts to be included for 1920 shall be $179,423.89, $9,077.68 and $4,465.97, respectively. Of the larger amount, the respondent has already included $13,254.60 in his determination of deficiency. One issue remains. The Interstate Commerce Commission certified $640,248.24 as the standard return applicable for the use of petitioner's properties for the first two months of 1920. The amount finally allowed for those months was $819,672.13. The question is, *1572 which amount should be included as income for that taxable year. Docket No. 27768.Respondent conceded the following errors: (a) Disallowing $32,333.15 from a total of $41,056.05 deducted for uncollectible account; (c) disallowing a deduction amounting to $5,391.18 representing cancellation of a bill against the United States War Department; (f) disallowing a deduction of $57 representing fines paid by petitioner; (g) including as taxable income for 1922 the amount of $14,782.55 representing contributions by private interests for the construction of spur tracks; (h) disallowing a deduction in the amount of $1,840 for contribution to the Y.M.C.A.; (i) in overstating petitioner's taxable income in the amount of $326,314.40 in respect of equipment repairs. The petitioner conceded that the respondent's determination was correct in (b) reducing the total deduction claimed on account of amortization of discount on bonds, in the amount of $6,301.80; (d) disallowing a deduction of $2,348.07 representing cancellation of a bill against the Main Street Warehouse; (e) disallowing a deduction of $799.94 representing Federal fines and penalties. No other errors were assigned. *1573 Docket No. 33938.The errors assigned were: (a) Adding to petitioner's net income as reported the amount of $2,261,154.25 representing Federal control adjustments; (b) disallowance of a deduction from gross income in the amount of $6,229,966.89 representing loss to petitioner in its settlement with the United States; (c) adding to petitioner's net income *920 as reported the amount of $2,368,395.31 representing compensation from the Railroad Administration; (d) adding to petitioner's net income as reported the amount of $93,001.92 representing rental interest paid to petitioner by the Railroad Administration. At the hearing the petitioner waived the prosecution of error (a) above, but did not concede the correctness of respondent's adjustments in errors (c) and (d). Petitioner also conceded the correctness of the disallowance of deduction set forth in (b) above. Errors (c) and (d) are left for decision by the Board. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of Missouri, and during the taxable years involved herein was affiliated, within the meaning of section 240 of the Revenue Acts of 1918 and 1921, with the*1574 St. Louis Southwestern Railway Company of Texas, Valley Terminal Railway Company, Gray's Point Terminal Railway Company, Paragould Southeastern Railway Company, Central Arkansas & Eastern Railroad Company, Pipe Bluff Arkansas River Railway Company, Shreveport Bridge & Terminal Company, Dallas Terminal Railway & Union Depot Company, Stephenville North & South Texas Railway Company, Eastern Texas Railroad Company, and Main Street Warehouse Company. The petitioner and its affiliated companies have agreed that the assessment of all the income tax due from the petitioner and its affiliated companies under a consolidated return for each of the years here involved, and all the deficiency in tax or overpayment of tax which may be found upon a redetermination of the income-tax liability of the petitioner and its affiliated companies for each of the years here involved, shall be allocated to the petitioner. The petitioner and its affiliated companies are engaged in the business of operating systems of transportation and furnishing services incident thereto and were so engaged at all times pertinent to this appeal. They kept their books in accordance with the classification of accounts prescribed*1575 by the Interstate Commerce Commission and returned their income upon an accrual basis and in accordance with the method employed in keeping their accounts, at all times pertinent to these proceedings. By proclamation dated December 26, 1917, the President of the United States took possession and assumed control of the transportation properties and facilities of the petitioner, St. Louis Southwestern Railway Company, Gray's Point Terminal Railway Company, Paragould Southeastern Railway Company, Central Arkansas & Eastern Railroad Company, Pine Bluff Arkansas River Railway Company, Shreveport Bridge & Terminal Company, *921 Dallas Terminal Railway & Union Depot Company, Stephenville North & South Texas Railway Company, and Eastern Texas Railroad Company. During the period January 1, 1918, to February 29, 1920, both inclusive, hereinafter referred to as the Federal control period, the properties of the petitioner and its aforesaid affiliated companies were in the possession and under the control of the President of the United States, and operated by him and/or by such agents as were appointed by him under the authority of law. The properties of Valley Terminal Railway Company*1576 were uncompleted as of January 1, 1918. This company had no property in operation during any part of the three-year period ended June 30, 1917. For this reason no ascertainment and certification to the President of the United States of the average annual railway operating income of the said company was made by the Interstate Commerce Commission. The properties of the Valley Terminal Railway Company were taken over by the United States as of August 31, 1918, and continued under the use, possession and control of the United States from that date to and including February 29, 1920. The cost of the properties of the Valley Terminal Railway Company was in excess of $800,000 during the entire period from August 31, 1918, to March 1, 1920. The petitioner did not, during the period of Federal control, nor prior to July 20, 1923, enter into an agreement with the President of the United States, or the Director General of Railroads or any other agency representing the President, with respect to the compensation to be paid the petitioner for the use of its properties during the Federal control period; nor did any of the petitioner's affiliated companies enter into such an agreement prior*1577 to the said date. Pursuant to section 1 of the Federal Control Act of March 21, 1918, the Interstate Commerce Commission ascertained and made tentative and final certifications to the President of the United States of the average annual railway operating income of the petitioner and certain of its affiliated companies for the three-year period ended June 30, 1917. The petitioner and the said affiliated companies accepted the final certification of the Interstate Commerce Commission as representing a correct mathematical computation of the average annual railway operating income based upon the railway operating income for the three years ended June 30, 1917, as provided by the Federal Control Act, but they denied that such basis of computation constituted just compensation or was a fair measure of the just compensation to which the corporations were entitled, and at various and sundry times during the period of Federal control and subsequent thereto, they protested to the Director General of Railroads *922 against his acceptance of the amount so certified by the Interstate Commerce Commission as the standard return, as constituting just compensation. The petitioner and*1578 its affiliated companies, whose properties were under Federal control, refused at all times to enter into any agreement with the President or any of his authorized agencies for the payment and acceptance of an annual compensation equivalent to the standard return so certified by the Interstate Commerce Commission. On or about November 26, 1918, January 1, 1922, and January 29, 1923, respectively, they filed with the Director General of Railroads claims for compensation. On July 20, 1923, petitioner and its affiliated companies whose properties were under Federal control entered into an agreement and final settlement of accounts with the Director General of Railroads under which $700,000 was paid by the petitioner to the Director General of Railroads. In that settlement petitioner and its affiliated companies whose properties were under Federal control were allowed as compensation for the use of their respective properties during the Federal control period a total amount of $10,819,672.13, this being at the rate of $5,000,000 per annum for the period of Federal control. The amount so allowed was $2,368,395.31 in excess of the standard return as finally certified by the Interstate*1579 Commerce Commission. Of the total compensation allowed, $819,672.13 was for compensation for the first two months of the year 1920. The Director General of Railroads also allowed, as rental for properties not included in the foregoing settlement, $45,107.48 as interest at the rate of 4 per cent per annum upon the cost of additions and betterments to roadway, and $47,894.44 as interest at the rate of 6 per cent per annum upon the cost of additions and betterments to equipment. No part of the aforesaid sums of $2,368,395.31, $45,107.48 and $47,894.44 was included by the petitioner as income for the taxable year 1923 in the consolidated return filed by the petitioner for said taxable year. In the notice of deficiency for that taxable year respondent included as income the sum of $2,240,264.66, which he later, at the hearing, increased to $2,368,395.31, said amount being a part of the total allowed in final settlement by the Director General as compensation for the use of the properties of the petitioner and its affiliated companies. The respondent has also included as income for the said taxable year the said amounts of $45,107.48 and $47,894.44, determined as aforesaid. *1580 In the event that the aforesaid item of $2,368,395.31 is not to be considered as taxable income to the petitioner and its affiliated companies for the taxable year 1923 and a portion thereof is to be considered *923 as taxable income to the petitioner for the taxable year 1920, the parties agree that the portion thereof to be included in taxable income for the taxable year 1920 is $179,423.89, being the portion thereof applicable to the two months of 1920 during which the properties of the petitioner and its affiliated companies were under Federal control. In the deficiency letter $13,254.60 of the said item has been included in income for 1920. In the event that the aforesaid items of $45,107.48 and $47,894.44 are not to be considered as taxable income to the petitioner and its affiliated companies for the taxable year 1923, and a portion thereof is to be considered as taxable income to the petitioner and its affiliated companies for the taxable year 1920, the parties agree that the portions thereof to be included in taxable income for the taxable year 1920 are $9,077.68 and $4,465.97, respectively, being the portions thereof applicable to the two months of 1920 during which*1581 the properties of the petitioner and its affiliated companies were under Federal control. In its income-tax return for 1920, which was a consolidated return for all its affiliated companies, the petitioner included as accrued income the amount of $678,452.65, representing compensation due to it from the Railroad Administration for the first two months of that year. The respondent, after audit, included only $653,502.84 as such compensation. OPINION. MARQUETTE: The assignments of error which have been admitted by the respondent necessitate adjustments respecting the deficiencies as follows: Docket No. 13319.Taxable income should be reduced by: (1) $1,974.40, contributed to petitioner for construction of spur tracks for private concerns; (2) $1,544.50, with respect of profits on the sale of town lots; (3) $18,724.81, relating to increased inventory values of materials and supplies; (4) $142,799.78, partial reimbursement for cost of equipment retired during the Federal control period; (5) $68,359.78, expenditures for equipment repairs; (6) $2,348.07, a duplicate credit as to one of petitioner's affiliated companies. Petitioner's tax upon income earned during the*1582 first two months of 1920 should be recomputed, at the rate of 8 per cent. The amount of $10,807.58 representing taxes paid by the Director General of Railroads on behalf of petitioner and its affiliated companies should not be allowed as a credit against petitioner's tax liability for 1920. *924 Docket No. 27768.There should be deducted from petitioner's gross income for 1922: (1) The amount of $32,333.15, representing an uncollectible account; (2) $5,391.18, cancellation of bill against the United States War Department; (3)$57 representing fines paid by petitioner; (4) $14,782.55 contributed to petitioner for construction of spur tracks for private concerns; (5) $1,840 contributed by petitioner to the Y.M.C.A.; (6) $326,314.40, the amount by which respondent in his deficiency determination overstated petitioner's income. Docket No. 33938The petitioner contends that the full amount of compensation allowed for the use of its properties during the period of Federal control was accrued, and constituted taxable income for that period, although the exact amount of such compensation was not determined and allowed until 1923. The respondent's contention is that*1583 so much of the compensation allowed as was in excess of the amount certified as a standard could not be accrued during the Federal control period because such excess was not determined until later, after a long controversy between petitioner and the Director General of Railroads. Respondent's theory is that the controversy as to the amount was a legal dispute and he cites decisions to the effect that where a taxpayer disputes an alleged liability against him the amount of that liability, as finally determined, can not be accrued prior to such determination. We do not concur with respondent's viewpoint. In the present instance the Government did not deny its liability to pay just compensation to the petitioner. That liability was never in dispute. The only question in controversy was one of fact, namely, what amount of money would be just compensation. That question was settled through conferences and negotiations. The issue here presented has been decided by the Board, adversely to the respondent's contention, in a number of cases. See *1584 ; ; ; affd., ; ; affd., ; ; . In each of those cases, with the possible exception of , there was the same situation as that now before us, viz., a controversy between the taxpayer and the Government as to the amount of compensation to be paid, more or less lengthy negotiations, and a final agreement reached after the Federal *925 control period had ended. In each of the above cited cases it was held that the full amount of compensation as finally determined constituted accrued income pro rata over the period of Federal control. In our opinion, the present proceedings can not be distinguished upon the facts, as respondent contends. We conclude, therefore, that the entire amount of compensation allowed*1585 to the petitioner and its affiliated companies by the Government should be prorated as income over the period of Federal control. What we have held, and the decisions cited, apply with equal force in respect of interest received from the United States upon the cost of additions and betterments. Such interest constituted a part of the just compensation due the petitioner and its affiliated companies and should be prorated over the Federal control period. ; Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623028/ | SANFORD HOMES, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSanford Homes, Inc. v. CommissionerDocket No. 8277-83.United States Tax CourtT.C. Memo 1986-404; 1986 Tax Ct. Memo LEXIS 203; 52 T.C.M. 310; T.C.M. (RIA) 86404; August 27, 1986. Melvin A. Coffee and Michael T. McDonnell, for the petitioner. Mark H. Howard, for the respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: Respondent1986 Tax Ct. Memo LEXIS 203">*204 determined a deficiency in petitioner's Federal income tax of $580,713.00 for 1979, or alternatively, $294,736.00 for 1980. There are two issues: (1) whether property distributed by a partnership to petitioner's subsidiary 1 was held by the partnership for investment or for sale to customers; and (2) whether section 751 2 applies to distributions made upon the termination of a partnership. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation and exhibits attached thereto are incorporated herein by reference. Petitioner, Sanford Homes, Inc. ("Sanford Homes"), had its principal place of business in Englewood, Arapahoe County, Colorado, at the time the petition in this case was filed. At all relevant times Charles H. Sanford ("Sanford") was its sole shareholder, president, 1986 Tax Ct. Memo LEXIS 203">*205 and chief executive officer. In 1971, a partnership called SMS Joint Venture ("SMS") was organized by Sanford and two Colorado corporations, Medema Building Corp. ("Medema"), and Skufca and Shelton Company ("Skufca"), as equal partners. Each of the partners had previous experience in home-building, but none of them had any experience in the development of shopping centers. The partnership agreement, signed in 1971, stated that the purpose of the partnership was to purchase a 1080 acre tract of land located in Arapahoe County and zoned agricultural, divide the tract into parcels, classify each parcel as residential, commercial, or some other acceptable designation, and then sell the parcels, or in the alternative, some of the parcels could be "committed by [SMS] to be retained as investment property." Under the agreement, each partner had the right to purchase any of the residential parcels, but commercial parcels could be sold to a partner only by unanimous consent of the partners. Parcels committed to investment were not to be sold. In November 1971, SMS purchased the tract of land for $5,000,000. Within a year SMS also acquired three smaller tracts of unimproved land. With1986 Tax Ct. Memo LEXIS 203">*206 the exception of a small portion of the combined tracts which was leased to farmers for grazing horses, SMS proceeded to develop the property in accordance with the partnership agreement. In 1972, SMS prepared a comprehensive plan which contemplated a division of the land into approximately 46 parcels, with each parcel being designated for residential, public, commercial, or office use. Upon completion, the plan was filed by SMS with the Board of Arapahoe County Commissioners ("County Commissioners") as part of a request to have the property rezoned as set out in the plan. While the rezoning request was pending, each of the original three partners transferred their partnership interests to newly-formed corporations owned by the respective partners, with the result that Sanford's partnership interest was transferred to Development West Corporation ("Development West"), Medema's partnership interest was transferred to Wilridge Corporation ("Wilridge"), and Skufca's partnership interest was transferred to Oxford Development Company ("Oxford). Development West and Wilridge then bought the interest of Oxford. Consequently, thereafter SMS had only two equal partners, i.e., Development1986 Tax Ct. Memo LEXIS 203">*207 West, Sanford's successor; and Wilridge, Medema's successor. In the meantime Sanford had transferred all of the outstanding stock in Development West to petitioner; thus, Sanford was the sole shareholder of petitioner, which in turn was the sole shareholder of Development West. In December 1973, the County Commissioners approved all of SMS' rezoning requests with respect to the residential parcels, but allowed only the commercial request with respect to parcel 11 and disallowed the commercial requests with respect to parcels 5, 7, 24, and 46. Prior to the time that the County Commissioners acted on the rezoning requests, Dayton Hudson Properties, the owner of Target Stores, had contacted SMS about the possibility of locating a store on parcel 7. These negotiations continued after the rezoning request for parcel 7 was denied. Sanford and the president of Medema met with the representatives of Dayton in February of 1974, and during this meeting Medema's president told Dayton's representatives that Wilridge was willing to sell its interest in parcel 7. At this time, Sanford was undecided about what to do with Development West's interest and was even considering the possibility1986 Tax Ct. Memo LEXIS 203">*208 of acquiring Wilridge's interest. In April 1974, SMS filed a second rezoning request with the County Commissioners which sought office zoning for parcels 4, 5, and 24 and commercial zoning for parcels 7 and 46. The second request was accompanied by a detailed report concerning the proposed office developments for parcels 4, 5, and 7. In December 1974, the County Commissioners denied all of the rezoning requests except for parcel 24 which was changed from agricultural to commercial. After the initial meeting between Dayton and SMS in 1974, Sanford continued to meet with the Dayton representatives. Representatives of American Continental Corporation, Medema's parent corporation, attended one of these meetings and again indicated that Wilridge's interest was for sale. Off and on for the next three years Sanford and Dayton talked about the possibility of building a shopping center on parcel 7, and in December 1977, Sanford and Dayton representatives were discussing the terms under which Dayton would purchase a portion of parcel 7 if commercial zoning were obtained. Medema did not take part in any of these negotiations. In April 1978, SMS filed with the County Commissioners a1986 Tax Ct. Memo LEXIS 203">*209 third rezoning request, in which it sought to have parcels 4, 5, and 7 rezoned to a mixed use of residential and commercial. This request was accompanied by a comprehensive report on the shopping center proposed for part of parcel 7. In October 1978 the rezoning for parcels 4 and 5 was approved, but the rezoning was denied for that part of parcel 7 which was to be the site of the proposed shopping center. After the denial of the third request to rezone, Development West and Wilridge dissolved SMS.At that time, the partnership owned only parcels 4, 5, and 7 and two pieces of land zoned for use as open space and drainage. All of the rest of the property had been sold by SMS during the previous six years, the residential sites in approximately twenty-four sales, going for the most part to petitioner, Sanford, and Medema. The two commercial sites, parcels 11 and 24, had been sold to petitioner and the other to a non-related party. SMS reported the gain on all of these sales as ordinary income. Upon the dissolution of SMS in November 1978, all of the remaining real estate was distributed to the partners. Wilridge received parcels 4 and 5, the portion of parcel 7 that had been rezoned1986 Tax Ct. Memo LEXIS 203">*210 for mixed use, and twelve acres zoned for open space. Development West received 131 acres zoned for open space and that part of parcel 7 for which rezoning for use as a shopping center had been denied in the third request. As part of the dissolution, Wilridge assigned to Development West any right which Wilridge had to appeal the denial of the rezoning. The total value of the properties received by each partner upon the dissolution of the partnership was $2,238,000. Immediately after the dissolution, Development West filed a suit against the County Commissioners for an order directing the Commissioners to rezone that portion of parcel 7 distributed to Development West. In 1980, Development West sold the property to Kaiser Foundation Health Plan of Colorado ("Kaiser") for $2,732,120, and the suit was dismissed. Kaiser succeeded in having the property rezoned for use as a site for a hospital. On their consolidated return for 1980, petitioner and its subsidiary, Development West, reported the gain on the sale to Kaiser as a capital gain. On the consolidated return for 1979 no gain from the dissolution of the partnership was reported. OPINION In the notice of deficiency respondent1986 Tax Ct. Memo LEXIS 203">*211 took alternative positions. First, that parcel 7 was held by SMS primarily for sale to customers and, therefore, under section 735 petitioner's gain on the sale to Kaiser in 1980 was ordinary income. Second, if parcel 7 is found to have been held by SMS for investment, then petitioner had a recognized gain under section 751 upon SMS' dissolution in 1979. If a partner receives property in a distribution from a partnership which has been held by the partnership primarily for sale to customers in the ordinary course of its trade or business and the partner sells such property within five years of the distribution, any gain from the sale will be ordinary income. Sections 735(a)(2), 751(d)(2), and 1221(1).3 Respondent contends that the above sections are applicable to this case because parcel 7 was held by SMS primarily for sale to customers, whereas petitioner claims that the property was held by SMS for investment and the sections are not applicable. The manner in which the property was held is a question of fact, , and petitioner has the burden of proving that respondent's characterization of the1986 Tax Ct. Memo LEXIS 203">*212 holding of the property is erroneous. ; Rule 142(a).1986 Tax Ct. Memo LEXIS 203">*213 In prior similar cases, we have looked at several factors, including: (1) the purpose for which the property was acquired; (2) the purpose for which the property was subsequently held; (3) the frequency, number, and continuity of sales; (4) the extent to which improvements, if any, were made to the property; (5) the business of the holder; and (6) the purpose for which the property was held at the time of its sale. See . No one of the above factors is conclusive standing alone. All of the factors taken as a whole must be considered. . From our findings it is apparent SMS was formed for the primary purpose of acquiring and selling residential and commercial properties. A secondary purpose was to hold some properties for investment. Under the partnership agreement, investment property was to be designated as such by the partnership and thereafter was not to be sold. The activities of SMS during its seven-year existence centered almost entirely on the tracts acquired in 1971. It bought the land with the intent to divide it into parcels,1986 Tax Ct. Memo LEXIS 203">*214 have the parcels rezoned to increase their value, and then either sell or hold the parcels. SMS succeeded in rezoning all of the residential parcels and two of the six parcels designated at one time or another as commercial. SMS eventually sold the two commercial parcels and all but two of the residential parcels in numerous sales spread over the life of the partnership. From the time SMS acquired the land until its dissolution, all of the parcels were treated in the same manner on its books. Not a single parcel was ever designated as being held for investment, and the gain from every sale was reported as ordinary income. In fact, the record before us contains no evidence which tends to indicate that any of the property was ever "committed" by the partnership to being investment property. As we said in : While it is true that one can be in the real estate business with certain properties and at the same time hold other properties for investment, it is incumbent upon such a real estate dealer to make a clear distinction on his books and records of the various properties held by him and, where he fails to make1986 Tax Ct. Memo LEXIS 203">*215 such a segregation, he is subject to ordinary income treatment for sales or dispositions of such property. * * * Nevertheless, petitioner contends that this Court should treat parcel 7 differently from the other parcels because, according to petitioner, SMS intended to keep parcel 7 and develop it with a shopping center. Although containing some evidence that Development West, one of the partners, had an interest in developing a shopping center, the record as a whole clearly shows that Wilridge, the other partner, was primarily interested in selling parcel 7 just as the other parcels were sold when rezoning was obtained. In any event, it is the intent of the partnership that governs, , affd. without published opinion , and petitioner has failed to produce any evidence that SMS intended to hold parcel 7 and develop it. We concude, therefore, that parcel 7 was held by SMS primarily for sale to customers in the ordinary course of its business. We further conclude that since part of parcel 7 was distributed by SMS to one of its partners, Development West, and was sold by such1986 Tax Ct. Memo LEXIS 203">*216 partner within five years of the distribution, the gain on the sale is taxable as ordinary income and not as capital gain. 4Because we find that parcel 7 was held by SMS for sale to customers, it is not necessary to address respondent's alternative argument concerning the applicability of section 751 to SMS's dissolution. Decision will be entered under Rule 155.Footnotes1. For 1979 and 1980 petitioner filed consolidated income tax returns with its wholly-owned subsidiary, Development West Corporation. ↩2. All section references are to the Internal Revenue Code of 1954, as amended during the years in issue, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure unless otherwise provided.↩3. The pertinent portions of sections 735, 751 and 1221 are as follows: SEC. 735. CHARACTER OF GAIN OR LOSS ON DISPOSITION OF DISTRIBUTED PROPERTY. (a) Sale or Exchange of Certain Distributed Property. -- * * * (2) Inventory items. -- Gain or loss on the sale or exchange by a distributee partner of inventory items (as defined in section 751(d)(2)) distributed by a partnership shall, if sold or exchanged within 5 years from the date of the distribution, be considered as ordinary income or as ordinary loss, as the case may be. SEC. 751. UNREALIZED RECEIVABLES AND INVENTORY ITEMS. * * * (D) Inventory Items Which Have Appreciated Substantially in Value. -- * * * (2) Inventory items. -- For purposes of this subchapter the term "inventory items" means -- (A) property of the partnership of the kind described in section 1221(1). SEC. 1221. CAPITAL ASSET DEFINED. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include -- (1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.↩4. Petitioner has conceded that the property was "substantially appreciated" within the meaning of section 751(d).↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623030/ | Michael J. Carroll, Petitioner, v. Commissioner of Internal Revenue, RespondentCarroll v. CommissionerDocket No. 37600United States Tax Court20 T.C. 382; 1953 U.S. Tax Ct. LEXIS 154; May 20, 1953, Promulgated 1953 U.S. Tax Ct. LEXIS 154">*154 Decision will be entered for the respondent. Petitioner was employed by the War Department as a civilian to act as banking and taxation consultant for the Government of South Korea. Petitioner's employment lasted for a period of about a year, and he was stationed at Seoul, Korea. That was his principal place of employment. Petitioner incurred certain expenses for meals and lodging in Korea. Petitioner's permanent station, according to his employer, was in Korea. Held, petitioner's "home" within the meaning of section 23 (a) (1) (A) was in Korea, and, therefore, petitioner's expenses in Korea were not "away from home" and are not deductible under section 23 (a) (1) (A). Held, further, these expenses were not deductible under section 23 (a) (2) of the Code. Michael J. Carroll1953 U.S. Tax Ct. LEXIS 154">*155 , pro se.W. D. Crampton, Esq., for the respondent. Black, Judge. BLACK 20 T.C. 382">*382 The Commissioner has determined a deficiency of $ 322.14 in the income tax of petitioner for the year 1948. Petitioner contests only one of the adjustments made by respondent in the deficiency notice. Petitioner alleges error as follows:Commissioner describes Korea as my post of duty and holds that expenses of $ 1540.00 incurred in Korea are not allowable as a deduction in computing net income.FINDINGS OF FACT.Petitioner and his wife filed a joint tax return for the taxable year 1948 with the collector at Baltimore, Maryland.During 1946, petitioner purchased a home in Edgewater, Maryland, where he and his wife and son lived. During 1948, while petitioner was in Korea, petitioner rented his home in Maryland. Meanwhile petitioner's wife and son lived in Elyria, Ohio.In the fall of 1947, petitioner entered into an employment agreement with the War Department. The details of the agreement are set forth in an agreement dated October 9, 1947. Clause 3 of the agreement provided:3. Your appointment is of indefinite tenure. You are required to remain in service with this command at least a1953 U.S. Tax Ct. LEXIS 154">*156 year from the time of arrival at permanent 20 T.C. 382">*383 duty station, except where otherwise noted on the face of the WD-Form 50, in order to be entitled to return transportation to your point of hire at Government expense, unless you are separated sooner for reasons acceptable to the Government not involving misconduct. The particular employing unit, the location of the work, and the advisability of any transfer within the command will be in the sole discretion of this command.On October 21, 1947, travel orders were issued to petitioner. The pertinent parts of these travel orders are:1. Mr. Michael J. Carroll, Advisor, Bur. of Banking and Taxation, CAF-12, $ 5905.20 p/a, (Req. K-1108), is hereby directed to proceed by air on or about 23 October 1947 from Washington, D. C., to Fairfield-Suisum Army Air Field, California for further movement by air on or about 24 October 1947 to Korea, for further assignment to permanent duty. NW-US-3D-0016-WD-11.2. Travel by military aircraft is directed as necessary in the military service for the accomplishment of an emergency mission and is chargeable to 801-95 P415-02, 03 A2182700 S99-999.* * * *4. a. Baggage to accompany the individual by1953 U.S. Tax Ct. LEXIS 154">*157 air will be marked with the owner's full name, will be limited to sixty-five (65) pounds and will accompany the individual to the port of aerial embarkation.b. Baggage to be shipped by water must not exceed three hundred thirty-five (335) pounds * * ** * * *6. In lieu of subsistence, a flat per diem of $ 6.00 while within and $ 7.00 while outside the continental limits of the United States is authorized in accordance with existing law and regulations while traveling and absent from permanent station. No per diem is authorized while traveling on board vessels where the cost of passage includes meals.The basic salary of petitioner was $ 5,905.20 per year. In addition, the War Department agreed to pay petitioner a 25 per cent overseas differential, or $ 1,476.30 additional. The petitioner's annual rate of compensation based on a 40-hour week was $ 7,381.50. Petitioner, according to the personnel report of the War Department had a minimum tour of duty of 1 year and his employment was described as an "Excepted Appointment." During 1948, petitioner earned wages of $ 7,113.70 from the War Department and was paid that amount.While in Korea petitioner served as an advisor to the South1953 U.S. Tax Ct. LEXIS 154">*158 Korean Government on banking and taxation. On October 30, 1948, travel orders were issued to petitioner ordering him to return to the United States for the purpose of separation.On the 1948 tax return petitioner claimed a deduction of $ 1,540, describing it as follows:For cost of living away from home while still maintaining my home for my wife and son on East River St., Elyria, Ohio, during the period of my assignment in Korea, January 1, 1948 to date of departure, Nov. 4, 1948, a total of 308 days at an estimated cost of $ 5.00 per day.The length of my stay in Korea was necessarily indefinite, because of local conditions.20 T.C. 382">*384 Petitioner kept no detailed account of these expenditures which are now claimed by him as a deduction from gross income.Petitioner's home within the meaning of section 23 (a) (1) (A) of the Code was in Korea while he was employed there by the War Department.OPINION.Petitioner has submitted no brief in this proceeding but we have considered his case carefully.The reasonableness of the $ 5 a day for meals and lodging which petitioner claims for 1948 while employed by the War Department in a civilian capacity for service in Korea is not questioned, 1953 U.S. Tax Ct. LEXIS 154">*159 if petitioner is entitled to any deduction at all. Respondent has not disallowed the deduction on the ground of the unreasonableness of the amount. He stated his ground for disallowance in the deficiency notice as follows:It is held that alleged traveling expenses of $ 1,540.00, incurred at your post of duty in Korea, are not allowable as a deduction in computing net income for the taxable year 1948.Petitioner contends that he is entitled to a deduction of $ 1,540 for traveling expenses during the year 1948, and he relies on section 23 (a) (1) (A) and (a) (2) of the Code as applied in , and . The facts in the instant proceeding do not bring petitioner's expenses within the ambit of the holdings of either of these two cases.First, we consider section 23 (a) (1) (A) of the Code. The particular phrase we are concerned with is "traveling expenses * * * while away from home." This phrase has been considered by various courts, including the Supreme Court in . In reaching a decision1953 U.S. Tax Ct. LEXIS 154">*160 in this type case, a preliminary fact to be determined is where is the taxpayer's home within the meaning of the applicable statute. Once this fact has been decided, frequently the correct result then becomes readily apparent. Respondent contends that within the meaning of the applicable statute petitioner's home was in Korea. Petitioner contends that his home during 1948 was in Elyria, Ohio, where his wife and son lived and that his employment in Korea was "temporary." Petitioner's contentions are inconsistent with his travel orders and employment agreement as set forth in our Findings of Fact. As we understand these documents, petitioner's employment was for an "indefinite" term, rather than a "temporary" one. What we said in , is applicable here:Petitioner cites , in support of the disputed deductions. In that case the taxpayer husband was temporarily employed at numerous locations during the course of a taxable year. A deduction for travel expenses was allowed by this Court on the ground that the taxpayer had no regular post of 20 T.C. 382">*385 duty or place of employment1953 U.S. Tax Ct. LEXIS 154">*161 during the taxable year. In the case at bar petitioner was continuously employed at one post of duty, the Navy Yard in Charleston, South Carolina, for more than two years. His employment there was not temporary, but indefinite. There is a well recognized difference between "indefinite" employment and "temporary" employment. John D. Johnson, supra. * * *An examination of paragraph 6 of petitioner's employment agreement reveals that "while traveling and absent from permanent station" petitioner was to be paid either $ 6 or $ 7 per day. No such per diem for travel was paid to petitioner during the 308-day period in question. In other words, petitioner's employer, the War Department, considered petitioner's permanent station to be in Seoul, Korea, and, as far as the employer was concerned, petitioner was not in a travel status. In other cases where the taxpayer incurred like expenses under similar circumstances we have denied the deduction claimed. , affirming our Memorandum Opinion; . The circumstances which were 1953 U.S. Tax Ct. LEXIS 154">*162 present in the Todd case, supra, were very similar to those in the instant case except that Todd, who was employed by the army in a civilian capacity, was stationed at an army post here in this country, whereas petitioner was stationed in a foreign country, but we think this makes no difference tax-wise.Based upon all the facts, we have determined that petitioner's home within the meaning of section 23 (a) (1) (A) was in Korea, the place of petitioner's employment. It is settled that the taxpayer may not use section 23 (a) (1) (A) in order to secure a deduction from gross income for traveling expenses incurred at the taxpayer's principal place of employment. ; Virginia Ruiz Carranza ( ; . Since the expenses in question were incurred by petitioner at his principal place of employment, they are not deductible under section 23 (a) (1) (A) of the Code.We now consider petitioner's alternative argument based upon deductibility under section 23 (a) (2) of the Code. 1 Petitioner reasons that in order to 1953 U.S. Tax Ct. LEXIS 154">*163 produce income (the overseas salary differential of $ 1,422.74 earned during 1948) he spent $ 1,540 in Korea. Section 23 (a) (2) of the Code was added to the Code by the Revenue Act of 1942. This Code section is limited in scope by the prohibitions of Code section 24 (a) (1) against deduction of personal, living, or 20 T.C. 382">*386 family expenses, . What we said there is applicable here: "Personal expenses are not deductible, even though somewhat related to one's occupation or the production of income." These expenses of the petitioner are his personal expenses, and even though incurred in Korea are not deductible by him under section 23 (a) (2). See Regulations 111, section 29.23 (a)-15.1953 U.S. Tax Ct. LEXIS 154">*164 Decision will be entered for the respondent. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions: (a) Expenses. -- * * * *(2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623032/ | Roy E. Jones and Merle S. Jones v. Commissioner.Jones v. CommissionerDocket No. 31108.United States Tax Court1951 Tax Ct. Memo LEXIS 11; 10 T.C.M. 1234; T.C.M. (RIA) 51363; December 26, 1951Leonard A. Marcussen, Esq., for the respondent. VAN FOSSAN Memorandum Opinion VAN FOSSAN, Judge: Respondent determined a deficiency of $1,225.11 in petitioners' income tax for 1945, to which he added a 5 per cent negligence penalty of $61.25 under the sanction of section 293 (a). Petitioners did not appear at the hearing of the case to contest the deficiency or penalty and respondent moved for judgment for failure to prosecute. In their petition, petitioners plead the bar of the statute of limitations. Respondent denies the bar, contending that petitioners omitted from gross income an amount in excess of 25 per cent of the gross income stated in the return. (Section 275 (c), I.R.C.). Thus an issue is raised by the pleadings. To establish his contention, respondent submitted in1951 Tax Ct. Memo LEXIS 11">*12 evidence only the tax return of petitioners for the year 1945, which was received March 15, 1946. The notice of deficiency is dated August 8, 1950. Since August 8, 1950 is more than three years after the filing of the return, the statute of limitations stands as a bar to the action of respondent unless the provisions of section 275 (c), allowing five years for action by the Commissioner, may be invoked. In the posture of the parties here existing, respondent had the burden of proof that section 275 (c) is applicable. Such burden was not discharged by the submission of petitioners' tax return, with nothing more. The notice of deficiency is not here a part of the evidence, nor is it self-proving. See C. A. Reis, 1 T.C. 9">1 T.C. 9, affirmed 142 Fed. (2d) 900. We hold that respondent's motion for dismissal is not well based and that, on the issue before us, respondent has not proved the prime essential to the invoking of section 275, namely, the amount of petitioners' income. Accordingly, the statute of limitations is not extended from three to five years and the statute stands as a bar to the tax and penalty here involved. Decision will be entered for the petitioners. 1951 Tax Ct. Memo LEXIS 11">*13 | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623033/ | ALBERT K. MILLER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Miller v. CommissionerDocket No. 86438.United States Board of Tax Appeals40 B.T.A. 515; 1939 BTA LEXIS 841; September 6, 1939, Promulgated 1939 BTA LEXIS 841">*841 Section 218(a) of the National Industrial Recovery Act, which repealed section 117 of the Revenue Act of 1932 as of January 1, 1933, is not unconstitutional, and hence a statutory net loss sustained in 1932 is not deductible in 1933. F. David Mannoccir, II, Esq., for the petitioner. Harry R. Horrow, Esq., for the respondent. HARRON 40 B.T.A. 515">*515 OPINION. HARRON: The respondent determined a deficiency in income tax for the year 1933 in the amount of $2,170.46. The deficiency results from respondent's disallowance of certain minor deductions and of net loss, carried over from 1932, in the amount of $63,226.02. The Petitioner concedes the correctness of the adjustments made, except the disallowance of the net loss deduction. The facts were stipulated and, in so far as material, are as follows: (1) The petitioner is a resident of San Francisco, California. Petitioner filed his income tax return for the year 1933 with the collector at San Francisco. During the calendar years 1932 and 1933, petitioner was engaged in business as a trader in securities listed on various stock exchanges in the United States. (2) During the calendar year 1932 the1939 BTA LEXIS 841">*842 petitioner sustained a net loss, attributable to the operation of his business, in the amount of $63,426.02, which he brought forward and claimed as a deduction from gross income in his income tax return filed for the year 1933 under section 117 of the Revenue Act of 1932. The respondent, in determining the deficiency, disallowed the amount of $63,226.02 instead of the full amount claimed by the petitioner on his return. (3) Claim is made by the respondent for the increased deficiency in tax which would result from the disallowance of the full amount of $63,426.02 instead of $63,226.02. The respondent disallowed the deduction on the ground that, since section 117 of the Revenue Act of 1932 had been specifically repealed by section 218(a) of the National Industrial Recovery Act, effective as of January 1, 1933, petitioner could not deduct in 1933 net loss brought forward from 1932. The petitioner contends that section 218(a) of the Recovery Act is unconstitutional and that, consequently, section 117 of the Revenue Act of 1932 was not repealed, and that therefore the statutory net loss sustained in 1932 is deductible in 1933. 40 B.T.A. 515">*516 Section 117 of the 1932 Act allowed1939 BTA LEXIS 841">*843 deduction of a net loss sustained in a preceding year, to be taken in computing the net income for the succeeding taxable year. By section 218(a) of the Recovery Act, 1 the Congress repealed section 117 of the 1932 Act, effective January 1, 1933. The Congress repealed, outright, the provisions of section 117, and did not delegate any authority or power to any officer of the Government to effect the repeal. The Congress revoked a privilege it had given previously. This was within the legislative power of Congress. The allowance of deductions from gross income for the purpose of determining taxable income is a matter of "legislative grace." New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435; Helvering v. Independent Life Insurance Co.,292 U.S. 371">292 U.S. 371. The Recovery Act was approved June 16, 1933. Repeal of section 117 of the Revenue Act of 1932 was effective January 1, 1933. 1939 BTA LEXIS 841">*844 It thus appears that the period of retroactivity involved in the enactment of the repeal provision was very short. It is well settled that retroactivity in income tax statutes is consistent with the due process of law clause of the Fifth Amendment. Brushaber v. Union Pacific R.R. Co.,240 U.S. 1">240 U.S. 1; United States v. Hudson,299 U.S. 498">299 U.S. 498; Fesler v. Commissioner, 38 Fed.(2d) 155; Phipps v. Bowers, 49 Fed.(2d) 996; certiorari denied, 284 U.S. 641">284 U.S. 641; Edgar Stanton et al., Executors,34 B.T.A. 451">34 B.T.A. 451; affd., 98 Fed.(2d) 739; Chester A. Souther,39 B.T.A. 197">39 B.T.A. 197, 39 B.T.A. 197">219. The cases of Nichols v. Coolidge,274 U.S. 531">274 U.S. 531; Untermeyer v. Anderson,276 U.S. 440">276 U.S. 440; and Milliken v. United States,283 U.S. 15">283 U.S. 15, cited by the petitioner, are not applicable, no income tax statutes being involved in any of those cases. The petitioner also contends that since Title I of the Recovery Act was declared invalid by the Supreme Court by its decision in 1939 BTA LEXIS 841">*845 Schechter Poultry Corporation v. United States,295 U.S. 495">295 U.S. 495, all other titles and provisions of the Recovery Act are invalid. As far as we know it has never been contended that Title II of the Recovery Act is unconstitutional. See Allied Agents, Inc. v. United States,26 Fed.Supp. 98, 104. The general authorization to the President, contained in section 209 of Title II, to make necessary rules and regulations clearly has no application to section 218(a), which directly repealed section 117 of the 1932 Revenue Act. Further, there is a separability clause in the Recovery Act, section 303, and the effect of this clause is to create a presumption in favor of separability. Carter v. Carter Coal Co.,298 U.S. 238">298 U.S. 238, 298 U.S. 238">312. Petitioner has failed to show that the provisions of Title II of the Recovery 40 B.T.A. 515">*517 Act, particularly section 218(a), are not separable from the provisions of Title I thereof. "A provision within the legislative power may be allowed to stand if it is separable from the bad." 1939 BTA LEXIS 841">*846 Lynch v. United States,292 U.S. 571">292 U.S. 571, 292 U.S. 571">586. Other sections of Title II of the Recovery Act have been held constitutional. See A. J. Crowhurst & Sons, Inc.,38 B.T.A. 1072">38 B.T.A. 1072. involving section 215(d) and (f) of the Recovery Act; W. & K. Holding Corporation,38 B.T.A. 830">38 B.T.A. 830, involving section 216(a); Allied Agents, Inc. v. United States, supra, involving sections 215, 216. See also Cereal Products Refining Corporation,39 B.T.A. 92">39 B.T.A. 92, where it was held that a taxpayer obtained new rights in the matter of filing separate income tax returns by reason of the enactment of new revenue provisions enacted in section 218(e) of the Recovery Act, and where it is pointed out also that as a matter of reality a new revenue act was enacted by Congress in 1933 by virtue of the enactment of the various revenue provisions, some new and some amendatory, in the Recovery Act. Petitioner's argument would have little merit it the repeal of section 117 of the Revenue Act of 1932 had been made in a separate revenue Act, and it has scarcely more merit, if any, as the matter stands because of the separability of the revenue1939 BTA LEXIS 841">*847 provisions of the Recovery Act from other provisions thereof. It is our opinion that section 218(a) of the Recovery Act is valid, not violating any provisions of the Constitution of the United States as far as this record shows. It is held that respondent properly disallowed deduction in 1933 of the statutory net loss sustained in 1932. Recomputation of the deficiency is necessary. Disallowance of the full amount of the net loss deduction, as taken on the return, will result in increase of the deficiency. Decision will be entered under Rule 50.Footnotes1. [National Industrial Recovery Act, Title II, Public Works and Construction Projects Reemployment and Relief Taxes.] SEC. 218. (a) Effective as of January 1, 1933, sections 117, 23(i), 169, 187, and 205 of the Revenue Act of 1932 are repealed. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623034/ | HERMANN S. VATH, EXECUTOR OF LAST WILL AND TESTAMENT OF CHARLES J. VATH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Vath v. CommissionerDocket No. 95888.United States Board of Tax Appeals41 B.T.A. 487; 1940 BTA LEXIS 1177; February 29, 1940, Promulgated 1940 BTA LEXIS 1177">*1177 Where property is included in the estate tax return for the wife who died six days before her husband's death and the tax thereon is paid simultaneously with the filing of the return, but the Commissioner on audit determined that her estate was not liable for the tax and tendered a refund check, which was refused by the executor of her extate, held, that such property is not "prior taxed property" deductible from the estate of the husband under section 303(a), Revenue Act of 1926, as amended by section 806, Revenue Act of 1932. Emmet W. Gottenberg, Esq., for the petitioner. T. M. Mather, Esq., for the respondent. VAN FOSSAN 41 B.T.A. 487">*487 This proceeding was brought to redetermine a deficiency in the estate tax of the estate of Charles J. Vath, deceased, in the sum of $2,633.54. The petitioner alleges that the respondent erred in disallowing a deduction from the decedent's gross estate of $43,567.96 representing property previously taxed to the estate of the decedent's wife. FINDINGS OF FACT. Charles J. Vath and Frances L. Vath were husband and wife, residing in San Jose, California, at the time of their respective deaths. Frances L. Vath1940 BTA LEXIS 1177">*1178 died November 29, 1936, and Charles J. Vath, on December 5, 1936. The decedent's son, Hermann S. Vath, was named and qualified as executor of his father's will, which was probated in the Superior Court of Santa Clara County, California. As such executor, on July 3, 1937, he filed an estate tax return showing a gross estate of $92,023.30, deductions of $8,106.21, and an exclusion of $43,567.96, claimed as a "net deduction for property previously taxed." Frances L. Vath died testate. On June 24, 1937, her executor filed an estate tax return showing gross estate of $48,165.32, with deductions of $4,597.36, or a net estate of $43,567.96. A check for $71.35, appearing to be the tax due, accompanied the return. The collector of internal revenue acknowledged the receipt of the check on the usual form. The tax was duly assessed and listed on the records of the first collection district of California. Charles J. Vath was the sole beneficiary of his wife's will. After auditing, the Commissioner determined that the estate of Frances L. Vath was not liable for an estate tax and issued a certificate 41 B.T.A. 487">*488 of overassessment. A refund Treasury check for the amount of the tax, 1940 BTA LEXIS 1177">*1179 plus interest, was tendered to the executor, who refused to accept it on the ground that the estate was properly taxable. The check was then forwarded to the General Accounting Office in Washington, D.C., for safekeeping and proper disposition. OPINION. VAN FOSSAN: The statute under which the petitioner claims a deduction for "property previously taxed" is section 303(a)(2) of the Revenue Act of 1926, as amended by section 806 of the Revenue Act of 1932. 11940 BTA LEXIS 1177">*1180 Counsel for the petitioner argues on brief that there has been no "final determination" that the estate of Frances L. Vath is or is not subject to the estate tax. He submits that only after a taxpayer has pursued his remedy to its ultimate disposition by the Board and the courts can the determination be final. He contends, however, that, since there has been no final determination that Mrs. Vath's estate is not subject to the estate tax and no one has been given an opportunity to have that question decided on its merits, the respondent is precluded from asserting that there is no tax due from that estate. There are several reasons why petitioner can not prevail. The statute allows a deduction for prior taxed property where such property can be identified as having been transferred to the decedent by the prior decedent by gift, bequest, devise, or inheritance. The record in this case fails to establish such identification. There was testimony as to certain properties that "they belonged to them both." But there was no proper identification of the property. Moreover, there was no evidence as to source or quality of title or time of transfers, if any; as to disposition1940 BTA LEXIS 1177">*1181 of rents received; as to payment of property taxes. In short, there is neither direct nor collateral evidence sufficient to establish the identity and ownership of the property alleged to have been previously taxed. 41 B.T.A. 487">*489 The statute further provides that the deduction shall be allowed only where an estate tax "was finally determined and paid" by or on behalf of the estate of the prior decedent. Here the Commissioner "finally determined" that there was no tax due from the estate of Frances L. Vath. No tax has been "finally determined and paid", as provided by the statute. The check for $71.35 was not tendered to nor received by the collector as a result of a final determination. The accepting of the check was an administrative act in nowise conclusive of the rights of the Government to audit the return, to demand additional taxes, or to declare a refund due. The fact that the estate of Frances L. Vath has declined to accept the refund check gives petitioner no rights. Thus petitioner can not qualify under this provision of the statute for the sufficient reason that no tax has been "finally determined and paid" as to the estate of Frances L. Vath. On the other1940 BTA LEXIS 1177">*1182 hand, if we accept petitioner's contention advanced on brief that there has been no final determination in the estate of Frances L. Vath because there has been no appeal from the ruling that no tax is due, we arrive at the same conclusion. If there has been no final determination petitioner can not qualify under the statute. It matters not that a proceeding before the Board may not be predicated on an overassessment. There is no way by which the Board can, as requested by counsel, take jurisdiction of the estate of Frances L. Vath and reverse the ruling of the Commissioner. Decision will be entered for the respondent.Footnotes1. SEC. 303. For the purpose of the tax the value of the net estate shall be determined - (a) In the case of a resident, by deducting from the value of the gross estate - * * * (2) An amount equal to the value of any property (A) forming a part of the gross estate situated in the United States of any person who died within five years prior to the death of the decedent, or (B) transferred to the decedent by gift within five years prior to his death, where such property can be identified as having been received by the decedent from the donor by gift, or from such prior decedent by gift, bequest, devise, or inheritance, or which can be identified as having been acquired in exchange for property so received. This deduction shall be allowed only where a gift tax imposed under the Revenue Act of 1932, or an estate tax imposed under this or any prior Act of Congress, was finally determined and paid by or on behalf of such donor, or the estate of such prior decedent, as the case may be, and only in the amount finally determined as the value of such property in determining the value of the gift, or the gross estate of such prior decedent, and only to the extent that the value of such property is included in the decedent's gross estate. * * * ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623037/ | SAM J. SYRACUSE AND ALMA I. SYRACUSE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSyracuse v. CommissionerDocket No. 14787-79.United States Tax CourtT.C. Memo 1981-340; 1981 Tax Ct. Memo LEXIS 403; 42 T.C.M. 288; T.C.M. (RIA) 81340; June 30, 19811981 Tax Ct. Memo LEXIS 403">*403 Held: Petitioners are entitled to a business bad debt deduction under ec. 166(a), I.R.C. 1954, for a debt which became worthless in 1975. Vetus J. Syracuse, for the petitioners. David D. Dahl, for the respondent. EKMANMEMORANDUM FINDINGS OF FACT AND OPINION EKMAN, Judge: Respondent determined a deficiency of $ 30,862.03 in petitioner's Federal income tax for the year 1975. After a concession by petitioner, the sole remaining issue is whether a debt which became worthless in 1975 was a "nonbusiness" debt within the meaning of section 166(d). FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts, the first supplemental stipulation of facts, and attached exhibits are incorporated herein by this reference. Sam J. Syracuse (petitioner) and Alma I. Syracuse, husband and wife, resided in Euclid, Ohio at the time they filed their petition herein. Their Federal income tax return for 1975 was filed with the Office of Internal Revenue Service at Cincinnati, Ohio. Until the end of 1969 petitioner was a member of a partnership, A. R. Syracuse & Sons, engaged in the topsoil, sand, and gravel business. Due to poor economic conditions, petitioner left that business and became involved in landfill operations. On August 27, 1969 and October 28, 1969, petitioner1981 Tax Ct. Memo LEXIS 403">*405 and his wife purchased three parcels of property in Painesville, Ohio specifically for use in his landfill operations. The "Painesville property" contained approximately 21 acres and had a deep excavation, 40 to 50 feet in depth. The property was hidden from public view and had adequate road access, characteristics desirable in the landfill business. Prior to March, 1970 petitioner owned, in addition to the Painesville property, approximately 20 acres in Eastlake, Ohio and Willoughby, Ohio. A portion of the "Eastlake" property was leased to the DeMaltie Brothers who used it in the landfill business 1 they operated pursuant to a permit held by the City of Eastlake. Petitioner's landfill activity on the Eastlake and Willoughby properties included "diking" or building high walls, the purpose of which, inter alia, is to contain refuse so that it can easily be complacted. He also kept equipment used for landfill operations on the Eastlake property. Although he did not have a permit for a landfill, in 1970 such a permit was not difficult to secure and often not necessary. 1981 Tax Ct. Memo LEXIS 403">*406 Petitioner felt his prospects were good that the City of Eastlake would use his property for the overflow refuse that could not be accommodated in the DeMaltie Brothers' landfill property, abutting that of petitioner. Petitioner frequently met with public officials in an effort to secure business for his landfill property. He spoke with mayors of various cities and towns in Lake County, the County in which Eastlake, Willoughby, and Painesville are located, and attended numerous meetings. Associates in the landfill business, to whom petitioner was known as engaged only in the landfill business, considered petitioner's properties suitable for a successful landfill. While engaged in his landfill operations, petitioner was also engaged in the sewer construction business as S.S. Construction, Inc. 2 Prior to the incorporation of S.S. Construction, Inc., petitioner owned a backhoe, a front end loader, and a dragline, equipment used in landfill operations. Petitioner purchased the backhoe in February, 1970, and used it in the diking activity for his landfill business although the backhoe is also useful in the sewer construction business. 1981 Tax Ct. Memo LEXIS 403">*407 In his efforts to secure landfill business for his properties, petitioner developed a relationship with Solid Waste Sciences, Inc. (hereinafter SWS), a company which was marketing a system of resource recovery from waste. The product reclaimed from the solid waste that would come into the SWS system would eventually be sold as new soil; the residue would either be incinerated or taken to a landfill, depending upon what was recovered and what remained. Charles Crown, a long time acquaintance of petitioner who became a vice president of SWS in April, 1970, was present at numerous meetings with petitioner and was very familiar with the properties owned by petitioner. Those properties were continually discussed by Crown and petitioner and a working map of SWS designated them as possible sites for the landfill if SWS obtained a contract with Lake County for waste treatment. On May 11, 1970, a contract was entered into between SWS and Lake County which provided for SWS to submit a detailed proposal with extensive plans and specifications for a waste disposal system. The properties of petitioner, because of their location and transportation access, were contemplated as the sites1981 Tax Ct. Memo LEXIS 403">*408 to be used in the SWS system although there was no written contract between SWS and petitioner to that effect. 3 Had his properties been used in the SWS system in Lake County petitioner would have been compensated on a per ton basis. Petitioner was also offered an executive position with SWS. The contract of May 11 contained provisions, contingent upon acceptance by the County of the proposal and the implementation of the project, that the County would contract with SWS to operate or supervise operation of the plant for the first 15 years of its operation or perhaps longer. The contract also contained other provisions applicable in the event1981 Tax Ct. Memo LEXIS 403">*409 that the County abandoned the project and determined not to proceed or was unable to proceed with construction of the solid waste disposal facility. Mr. Crown felt that there was never any doubt that the project would go through once the contract of May 11, 1970 had been signed. On June 8, 1970, petitioner loaned $ 11,666.67 to SWS. The loan was used, at least in part, to prepare the voluminous plans and specifications necessary for completion of the contract between SWS and Lake County. At the time petitioner made the loan to SWS, there was no indication that the SWS system would not be constructed or that he would not be repaid in full. Petitioner owned to stock in SWS. The contract of May 11, 1970 was subsequently the subject of a lawsuit between SWS and Lake County and the SWS system was never adopted by Lake County; thus petitioner's properties were not used by SWS. The debt owed petitioner by SWS became worthless during calendar year 1975. 4 On Schedule D of his 1975 return, petitioner listed, under the heading Long-Term Capital Gains and Losses - Assets Held More than 6 Months, "SWS Stock and Note Became Insolvent". 1981 Tax Ct. Memo LEXIS 403">*410 OPINION Section 166(a) provides a deduction for debts that become worthless in a taxable year. However, section 166(d) provides that a nonbusiness debt of a noncorporate taxpayer which becomes worthless shall be treated as a short term capital loss. Respondent contends that petitioner's loan of $ 11,666.67 to SWS was a nonbusiness debt; petitioner contends that it was a business debt. A nonbusiness debt is defined in section 166(d)(2) as a debt other than (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. The question whether a debt is a business or nonbusiness debt is a question of fact. , affg. a Memorandum Opinion of this Court, , affd. per curiam . In order for petitioner to be entitled to treat the debt as a business debt, he must show that he was engaged in a trade or business at the time the debt was created. A showing that1981 Tax Ct. Memo LEXIS 403">*411 he was engaged in an income or profit making activity will not satisfy the narrower category of "trade or business". . At the outset we note that the parties have stipulated that the $ 11,666.67 received by SWS from petitioner was in fact a loan and respondent on brief concedes that it was not a contribution to capital. Petitioner contends that at the time the debt was created he was engaged in the landfill trade or business and that the loan was proximately related to that business, while respondent contends that at that time petitioner's landfill activity constituted merely investigation, promotion, and preparation to enter into a trade or business. Alternatively, respondent argues that petitioner's landfill activity was an activity for production of profit or income which did not rise to the level of a trade or business. Neither the Internal Revenue Code nor the regulations contains an explicit definition of the statutory phrase "trade or business". See ; . All relevant factors are1981 Tax Ct. Memo LEXIS 403">*412 to be considered and the question is essentially one of fact. ; see . The statutory phrase "trade or business" presupposes an existing trade or business with which the taxpayer is directly connected. . When a taxpayer investigates a potential new trade or business or prepares to enter such a business, he is not engaged in the trade or business at that time. See , affd. on another issue . Thus, expenses incurred in investigating, promoting or otherwise preparing to enter a trade or business have been held to be nondeductible. See (preliminary expenses also held nondeductible as expenses incurred in the production or collection of income or in the management, conservation, or maintenance of property held for the production of income). After careful examination of the entire record, we are persuaded that petitioner was engaged in the1981 Tax Ct. Memo LEXIS 403">*413 landfill trade or business at the time the debt was created. The Painesville property was purchased specifically for the landfill business. Witnesses testified that this property, which was described as merely "a big hole in the ground", could only be used for landfill. Petitioner attended numerous meetings in an effort to secure business for his landfill. He continuously held himself out to the public authorities and associates as being in the landfill business, and persons in that field associated him only with that landfill business. See (Frankfurter, J., concurring). He owned and operated machines for his business and was diking walls on the Willoughby and Eastlake properties well before June 8, 1970, the date the debt was created. Furthermore, at the time of the loan it appeared that petitioner was about to receive the rewards from his continuing and persistent efforts since SWS had designated his landfill business for its resource recovery project in the Lack County. Respondent, pointing to "trade or business" as used in section 162 and citing the facts of ,1981 Tax Ct. Memo LEXIS 403">*414 and , contends that petitioner's activities with respect to the landfill business constituted only preliminary, investigatory, preparatory activities. However, respondent's reliance on Westervelt and Ward is misplaced because they are factually different from the case at bar; the business activity in those cases was far less than the business activity of petitioner in his landfill operations. 51981 Tax Ct. Memo LEXIS 403">*415 Respondent contends in the alternative that even if petitioner's activities constitute more than preparation to enter the landfill business, they were activities engaged in for profit which do not rise to the level of trade or business. Respondent points to the chronological order and the legislative history of sections 162 and 212 in support of his analysis. Although there is a distinction between "trade or business" and an activity for the production of income or profit, see , section 212 was designed to expand the scope of allowable deductions and not intended to preclude the deduction of expenses otherwise allowable under section 162. See , on appeal (9th Cir., Nov. 24, 1980). Although it is true petitioner was engaged in the sewer construction business as S.S. Construction, Inc., during the taxable year 1970, a person may have two trades or businesses, see ; , affg. a Memorandum Opinion of this Court, ,1981 Tax Ct. Memo LEXIS 403">*416 and this is even more likely in fields which are so closely related. Respondent also points out that the backhoe is useful in the sewer construction business and the frontend loader useful in the topsoil, sand, and gravel business. However, petitioner purchased the backhoe prior to the incorporation of his sewer construction business, and he retained the frontend loader, as opposed to selling it or allowing it to be retained by A.R. Syracuse & Sons, well after he left the topsoil, sand, and gravel business. Respondent attempts to minimize petitioner's actual landfill activities by contending that those activities were related to the DeMaltie Brothers' landfill. This contention is unsupported by the record. The factors enumerated above which indicate that petitioner was engaged in the landfill business more than adequately establish that petitioner was engaged in that business on his own account and not on behalf of the DeMaltie Brothers. Having made the preliminary determination that petitioner was engaged in the landfill business, we must determine whether the loan to SWS was proximately related to that trade or business. See .1981 Tax Ct. Memo LEXIS 403">*417 In , the Supreme Court stated that: * * * in determining whether a bad debt has a "proximate" relation to the taxpayer's trade or business, as the Regulations specify, and thus qualifies as a business bad debt, the proper measure is that of dominant motivation, and that only significant motivation is not sufficient. * * * Also see , remanded on remand. A debt is a business debt if the dominant motive for its creation or acquisition is to benefit the lender's trade or business. See ; ; ; In the case at bar, petitioner's dominant motive for creating the debt was to benefit his landfill business. Petitioner loaned the funds to SWS so it could prepare the voluminous plans and specifications necessary for completion of its contract with Lake County. Had the1981 Tax Ct. Memo LEXIS 403">*418 SWS resource recovery system been implemented in Lake County, the rewards for petitioner's landfill business, including compensation on a per ton basis, would have been substantial or, in petitioner's own words, "had this gone through, I wouldn't have to worry about money any more". Petitioner had expended much time and effort in attempting to secure business for his landfill and the loan to SWS brought him one step closer to having SWS use his property. Clearly, there is a direct, proximate relation between the debt and petitioner's landfill business and petitioner has sustained his burden of showing that his dominant motive in making the loan was proximately related to this trade or business. Respondent points out that even had the SWS system been implemented, SWS was not contractually bound to use petitioner's landfill. However, it is not necessary that there have been a contractual commitment by SWS in order for us to determine that petitioner's dominant motive was proximately related to the landfill business. Petitioner was well aware that SWS had entered into a contract with Lake County, that SWS was using his funds to prepare the plans and specifications, that this property1981 Tax Ct. Memo LEXIS 403">*419 was considered the prime site for the landfill needs under that contract, and that consequently his landfill business would substantially benefit from completion of the contract. These facts amply support our conclusion as to petitioner's motive. Although petitioner may have been over optimistic, the only reason for the existence of the debt 6 was its direct relation to his landfill business. See . In sum, we find that petitioner was engaged in the landfill trade or business at the time the debt was created, that the dominant motive for creation of the debt was proximately related to that trade or business and that accordingly, petitioner is entitled to deduct the $ 11,666.67 as a business bad debt created or acquired in connection with a trade or business. Due to a concession by petitioner, Decision will be entered under Rule 155. Footnotes1. The DeMaltie Brothers also owned property adjacent to the property they leased from petitioner.↩2. S.S. Construction, Inc. was incorporated in March, 1970.↩3. The SWS system was not the only system considered for Lake County. Petitioner, in an effort to assure landfill business for his properties, also developed a relationship with a company employing a transfer satellite concept system and which was competing with SWS for the Lake County contract. Harry Fedele, an employee of that company, testified that during the period of competition for the Lake County contract his company was most interested in petitioner's properties and considered them suitable for fulfilling its landfill needs.↩4. The parties have stipulated to this effect.↩5. In , the taxpayer explained on his return that the expenses incurred were "in primary stages of investigation and examination, and collection of information and data" and were undertaken with the intention of going into the cattle business at a favorable time" and his activities in that business were only minimal at that time; thus his expenses were clearly preparatory in nature. In , affd. , the taxpayer, after being a partner in the Ward Refrigerator & Mfg. Co., expended $ 2,075 in investigating the possibility of entering the business of manufacturing and selling concrete blocks, such expenses being incurred immediately after leaving one business and prior to the incorporation of his new concrete block business. Those expenses were for organization and development in preparation for, and prior to, the incorporation of his new business. In the case at bar, petitioner, as a sole proprietor and not as an officer or stockholder in the landfill business, had expended considerable sums in relation to the amount needed for a landfill business and had taken substantial steps in relation to the total steps needed for that business. He had already made a substantial commitment, and not merely a cursory investigation of a possible commitment, to the landfill business in terms of energy, assets, and money well before the debt was created.↩6. We have found that petitioner owned no stock in SWS. At trial, counsel for respondent reserved the right to contend that the debt was a contribution to capital rather than a loan but this issue was subsequently conceded by respondent.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623038/ | CLARENCE M. FREEDMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Freedman v. CommissionerDocket No. 79424.United States Board of Tax Appeals34 B.T.A. 956; 1936 BTA LEXIS 621; August 19, 1936, Promulgated 1936 BTA LEXIS 621">*621 Compensation received by petitioner for services rendered to the Department of Banking of Pennsylvania, held, not exempt from Federal income tax. J. W. Townsend, Esq., for the petitioner. R. N. McMillan, Esq., for the respondent. ARUNDELL34 B.T.A. 956">*956 This proceeding involves a deficiency in income tax for the year 1932 in the amount of $142.79. Only so much of the proposed deficiency is in controversy as arises from the respondent's addition to income of the sum of $3,000 received by the petitioner as compensation for services rnedered to the Department of Banking of the Commonwealth of Pennsylvania. Petitioner contends that his compensation is exempt from tax on the ground that he was an 34 B.T.A. 956">*957 employee of the commonwealth engaged in carrying on a governmental function. FINDINGS OF FACT. The petitioner is a lawyer, practicing his profession in Philadelphia, Pennsylvania. On October 2, 1931, the attorney general of the Commonwealth of Pennsylvania directed to the petitioner a letter reading as follows: It gives me pleasure to appoint you an attorney in this Department assigned to the liquidation work of the Department of Banking. 1936 BTA LEXIS 621">*622 Your salary will be at the rate of $3,000.00 per annum. The Special Deputy Attorneys General who are assigned to this work in Phladelphia are being advised of your appointment and that you will be available to assist them in any way in which they may find it necessary to call upon you. The petitioner accepted the appointment conferred by the above letter. He was thereafter continuously employed on matters relating to the liquidation of closed banks, as hereinafter more fully related, until March 9, 1935, when his employment was terminated on the occasion of a change in the political party in control of the state government, whereupon he was directed to turn his files over to his successor. The department of justice and the department of banking are administrative divisions of the Commonwealth of Pennsylvania. The head of the department of justice is the attorney general and the head of the department of banking is the secretary of banking, these offices being provided for by statute. The attorney general has statutory power "to appoint and fix the compensation of Special Deputy Attorneys General and Special Attorneys to represent the Commonwealth, for any department, board, 1936 BTA LEXIS 621">*623 or commission thereof, in special work or in particular cases." Purdon's Penna. Stats., title 71, §296. The secretary of banking is by statute given broad powers over banks within the commonwealth. When it appears to him that a bank is in an unsafe or unsound condition he may, after notice and hearing and with the consent of the attorney general, take possession of the business and property of the bank; under certain conditions he may take possession without hearing and without the attorney general's consent. When he takes possession of a bank, he is vested with "all the rights, powers, and duties of a receiver appointed by any court of equity in this Commonwealth"; while in possession of the bank he is "the representative of the creditors" thereof. The banking law provides that, in the case of banks the property of which is in the possession of the secretary of banking, all expenses in connection with such possession and of continuing the business or of liquidation "shall first be payable out of the funds of" such bank 34 B.T.A. 956">*958 "including the compensation of special deputies, assistants, and others employed by the Secretary to assist him in such proceedings; the allowance1936 BTA LEXIS 621">*624 of all such expenses to be subject to the approval of the Court." Purdon's Penna. Stats., title 7, §§ 29, 49. The petitioner was assigned to work under special deputy attorneys general in Philadelphia County in connection with legal matters pertaining to closed banks in that county. Such closed banks were being liquidated by the secretary of banking pursuant to statute. The petitioner's duties consisted of attempting to collect dubts due such closed banks, rendering legal opinions to the deputy receivers in charge thereof, handling the legal matters for the banking department that came up from surrounding counties, prosecuting suits in court, consulting with creditors, depositors, and stockholders of closed banks concerning their claims, procuring substitute trustees for trust estates being administered by such banks, preparing, filing, and presenting accounts in the Orphans' Court, preparing data in connection with the proposed state banking code, and "in general anything that was assigned by the Special Deputy Attorney General at the time." Such attorneys were considered by the department of justice as "available for any purpose at any time." The petitioner handled legal matters1936 BTA LEXIS 621">*625 for the state banking department in connection with the liquidation of the Northern Central Trust Co., the Darby Bank & Trust Co., the United States Bank & Trust Co., the Central Trust & Savings Co., the Mortgage Security & Trust Co., the Park Trust Co., and the Wharton Turst Co., among other closed banks in the Philadelphia area. The petitioner was one of approximately twenty lawyers assigned to like work in Philadelphia County. The particular work and the matters to which the petitioner gave attention were determined by the attorney general's office. He was free to use his discretion only in simple matters. In regard to all proposed litigation and appeals, he was required first to consult with his superior officers. He was required to follow prescribed forms issued by the attorney general's office as to preparation of documents and pleadings. His legal opinions were reviewed and often revised by his superiors before being issued. Likewise, briefs were reviewed and frequently entirely redrafted. All matters of policy in particular cases were decided by the attorney general and his deputies. The petitioner's advice to depositors of closed banks was limited to matters on1936 BTA LEXIS 621">*626 which his superiors had ruled. All such attorneys were instructed to take no steps and render no opinions on any legal problem involved in closed banks without approval of the attorney general. The petitioner's duties and the manner in which they should be performed were prescribed in part by a large number of mimeographed 34 B.T.A. 956">*959 circulars issued by the attorney general at Harrisburg at frequent intervals and sent to all attorneys handling closed bank matters. Also, his instructions were received periodically from a deputy attorney general at regular meetings held for the purpose of discussing their problems and deciding on procedure. The petitioner received no compensation for his services other than his $3,000 salary, but was reimbursed for his expenses. He was furnished with necessary office facilities. He was required to use official letterheads furnished by the department of justice, and signed his letters as "attorney" for the department of justice. The files in matters handled by him were considered the property of the state and were turned over by him to his successor when his employment was terminated. While the department of justice could have required all1936 BTA LEXIS 621">*627 his time and had first call on his services, he was permitted to engage in private practice. In 1932 he spent more than 50 percent of his time on state business. He had to give up certain regular employment to accept the employment in the department of justice. His professional income for 1932, aside from the $3,000 salary, was $2,735.60. He was not a member of a law firm. Petitioner's salary was paid to him semimonthly by checks drawn by representatives of the state banking department in charge of closed banks in Philadelphia, the checks being countersigned by the secretary of banking at Harrisburg. In the early part of 1932 his salary was charged against funds of three closed banks whose assets had been taken over by the secretary of banking, but later in the year it was charged against funds of four closed banks, although his services were not confined to matters relating to the affairs of those particular banks. The banks against which the petitioner's salary was charged were determined by the attorney general and the secretary of banking. The salaries of attorneys handling matters relating to the several closed banks were ordinarily paid out of the funds of such banks1936 BTA LEXIS 621">*628 in approximate proportion to the amount of work done for each bank. Petitioner did not include in his income tax return for 1932 the $3,000 salary received as compensation for services rendered to the department of banking. OPINION. ARUNDELL: This case involves the application of the principle of immunity of state instrumentalities from Federal taxation. As Mr. Chief Justice Hughes puts it in Willcuts v. Bunn,282 U.S. 216">282 U.S. 216, 282 U.S. 216">225: The familiar aphorism is "that as the means and instrumentalities employed by the General Government to carry into operation the powers granted to it are exempt from taxation by the States, so are those of the States exempt from taxation by the General Government". Ambrosini v. United States,187 U.S. 1">187 U.S. 1, 187 U.S. 1">7. 34 B.T.A. 956">*960 Many of the recent cases involving this principle carefully point out, in juxtaposition with the statement of it, its limitations. "The limitation of this principle to its appropriate applications is also important to the successful working of the governmental system." 1936 BTA LEXIS 621">*629 282 U.S. 216">Willcuts v. Bunn, supra."It is a principle implied from the necessity of maintaining our dual system of government. * * * Springing from that necessity it does not extend beyond it." Board of Trustees of the University of Illinois v. United States,289 U.S. 48">289 U.S. 48, 289 U.S. 48">59. "Of course, the reasons underlying the principle mark the limit of its range." Indian Motocycle Co. v. United States,283 U.S. 570">283 U.S. 570. "This Court, in drawing the line which defines the limits of the powers and immunities of state and national governments, is not intent upon a mechanical application of the rule that government instrumentalities are immune from taxation, regardless of the consequences to the operations of government." Educational Films Corporation v. Ward,282 U.S. 379">282 U.S. 379, 282 U.S. 379">391. The immunity question has many facets and in this case the parties are at odds on nearly all of them. They argue the questions of whether petitioner was either an officer or employee of the state; whether his services were rendered in connection with the exercise of an essential governmental function; the materiality of the source of his compensation; 1936 BTA LEXIS 621">*630 and whether the tax will result in any burden on the state. Our conclusion, based on reasons hereinafter given, is that the $3,000 compensation received by the petitioner in 1932 is not exempt from taxation by the Federal Government. In the first place, we are not satisfied that petitioner can properly be classified as an employee of the Commonwealth of Pennsylvania. The facts are that in 1932 the petitioner, while appointed and supervised by the attorney general, was actually performing the duties of counsel for the liquidator for a group of banks in the Philadelphia area. The duties performed, as set out in the findings of fact, were those that would usually be performed by an attorney for a liquidator or receiver of insolvent corporations. These duties did not require all of his time, but left him free ot follow his profession in private practice, which he did, resulting in income of $2,700 from outside sources. These considerations leave considerable doubt as to whether it can be said that petitioner was an employee of the commonwealth in the usually accepted sense of the term. His relation with the secretary of banking appears to be that of attorney and client rather1936 BTA LEXIS 621">*631 than that of employee and employer. The basic ground for denying the petitioner's claim to immunity from tax, however, is that the source of his income precludes any possibility of a burden on the state resulting from a tax thereon. We do not think it can seriously be urged that petitioner was compensated 34 B.T.A. 956">*961 by the state merely because his checks were issued by the officers of the state, as the fact is that both by statute and in actual practice the source of his compensation was the assets of the several banks in the process of liquidation. These assets were not public funds as are taxes; they were not susceptible of appropriation by the legislature for general public use; they were private property being administered by the secretary of banking in a fiduciary capacity. Therefore, if any burden falls elsewhere than on petitioner, it is on those banks or their creditors, for whose benefit the petitioner was acting, rather than on the state. We held in Ned R. Harman,34 B.T.A. 654">34 B.T.A. 654, that fees received by a statutory court reporter from litigants for transcripts of stenographic records are not exempt from tax because they are not paid by the state itself1936 BTA LEXIS 621">*632 and no burden on the state was shown. Similarly, it has been held that the compensation of an auditor appointed by the Orphans' Court in Pennsylvania to report on the financial condition of corporations applying as sureties on bonds tendered to the court was taxable since it was paid out of deposits made by the surety companis for that purpose with the clerk of the court, and was not paid by the state itself. Miller v. McCaughn, 22 Fed.(2d) 165; affd., 27 Fed.(2d) 128. The District Court in that case pointed out that the "moneys paid are never in any sense public moneys" and held: The compensation must not merely come to a state officer or employee, but it must come to him from the state, to be exempt. Unless this second line is drawn, and drawn where we have drawn it, it is difficult to determine where it should be drawn. A moment's thought will bring to mind scores of instances in which the recipient might well be held to be such "officer or employee," but in which the compensation does not come directly or indirectly from the state, otherwise than in the sense that he would not be in the enjoyment of it, were it not for the relation of officer1936 BTA LEXIS 621">*633 or employee of the state which he enjoys. The Circuit Court of Appeals for the Third Circuit, affirming the District Court, held that the taxpayer could not be regarded as an officer or employee of the state and also emphasized the lack of any burden on the state, saying: The exemption of state employees from federal income tax rests on the ground that the agencies the state employs in government should not be burdened by federal taxes, which would lessen the state's power to employ, and compel it to pay more for the services of its employees. But no such reason exists in the case of this examiner. No power of the state is crippled or lessened by his paying tax on his income. Neither the state nor the court pay Mr. Miller. Following the Third Circuit in the Miller case, the Board held, as one of the grounds for denying exemption in two cases decided by memorandum opinions, that no burden resulted to the state from taxation of compensation received from a source other than the state. Robert S. Spangler, Docket No. 46386 (1933); Charles A.34 B.T.A. 956">*962 Roberts, Docket No. 74214 (1934). In the Spangler case, the taxpayer was a "special attorney" appointed1936 BTA LEXIS 621">*634 by the commissioner of banking of the State of Pennsylvania to represent him in the liquidation of a state bank and his compensation was paid out of the assets of the bank, and in the Roberts case the taxpayer was an attorney appointed by the superintendent of banks of the State of New York to assist in the liquidation of a trust company, his compensation being paid by the bank in liquidation. To the same effect see Mim. 3838, dated January 17, 1936, I. R. Bulletin XV, No. 5. Following the above cases it must be held here that the petitioner's compensation was not exempt from tax. The petitioner advances the view that, once he has established himself to be an officer or employee of the state engaged in performing a governmental function, his immunity from Federal taxation is absolute, irrespective of the source of his compensation or of any other consideration. In view of the disposition that we have made of the petitioner's premise it is unnecessary to decide this matter, but it is worthy of brief note. The petitioner's contention is based on expressions in some of the cases to the effect that where the principle of immunity applies it is absolute and is not affected by1936 BTA LEXIS 621">*635 the amount of tax or the extent of the resulting interference. Cf. 283 U.S. 570">Indian Motocycle Co., supra.This contention, often urged in tax cases, has its genesis in the apprehension expressed in McCulloch v. Maryland,4 Wheat. 316">4 Wheat. 316. in the maxim that "The power to tax is the power to destroy." The cases quoted at the outset of this opinion establish that the courts are not stampeded into broadly granting exemption by the quotation of the McCulloch maxim. On the contrary, they inquire into all the facts and circumstances of the case. They inquire into whether an officer or employee is engaged in an essential governmental function, Helvering v. Powers,293 U.S. 214">293 U.S. 214; Brush v. Commissioner, 85 Fed.(2d) 32; Ohio v. Helvering,292 U.S. 360">292 U.S. 360; whether the tax works any substantial interference with governmental functions, Metcalf & Eddy v. Mitchell,269 U.S. 514">269 U.S. 514; or whether it exerts but a remote influence, Willcuts v. Bunn,282 U.S. 216">282 U.S. 216; 1936 BTA LEXIS 621">*636 Brush v. Commissioner, supra.They also inquire, as we have here, into the source of the funds taxed, Miller v. McCaughn, supra.These cases indicate that the so-called rule of absolute immunity is not so broad in its application as is indicated by a literal reading of the words apart from the context of the case in which they are used. They also establish the right of inquiry into all matters affecting petitioner's employment, including that of the source of the funds from which he receives his compensation. In view of the conclusion we have reached we do not deem it necessary to discuss other arguments advanced. Decision will be entered for respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623039/ | JOHN AND NORMA OGIONY, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Ogiony v. CommissionerDocket Nos. 1044-76, 1045-76, 1046-76, 1047-76, 1072-76.United States Tax CourtT.C. Memo 1979-32; 1979 Tax Ct. Memo LEXIS 495; 38 T.C.M. 125; T.C.M. (RIA) 79032; January 23, 1979, Filed Ralph J. Gregg, for the petitioners. Barry J. Finkelstein, for the respondent. 1979 Tax Ct. Memo LEXIS 495">*496 HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined the following deficiencies in petitioners' income tax: PetitionersYearsDeficiencyJohn & Norma Ogiony1967 $ 1,155.2519686,124.90196911,386.00197012,180.28197115,590.90$ 46,437.33John J. & Glorida Nasca1971 $ 5,760.88Joseph M. & Nancy Nasca1971 $ 5,707.90Edward L. & Ruth M. Ogiony1967 $ 1,224.5619686,169.24196911,519.13197012,910.59197116,593.09$ 48,416.61Peter & Enis Santin1967 $ 2,379.83196813,054.6919699,138.75197025,622.2619714,183.37$ 54,378.90Petitioners (or their wholly-owned corporations) were members of two partnerships, Garden Village Partnership ("Garden Partnership") and Lossen Gardens Company ("Losson Partnership"). The partnerships wanted to develop certain parcels of unimproved real estate; however, due to New York's usury law, the partnerships were unable to obtain financing. Corporations, on the other hand, were exempt from New York's usury law. Petitioners John Ogiony, Edward Ogiony and Peter Santin utilized a corporation, 1979 Tax Ct. Memo LEXIS 495">*497 Garden Village Builders, Inc. ("Garden Corporation"), to develop one apartment complex; petitioners John Ogiony, Edward Ogiony, Peter Santin, John Nasca and Joseph Nasca utilized another corporation, Losson Gardens, Inc. ("Losson Corporation"), to develop another apartment complex. In both instances petitioners used a corporate entity in order to avoid New York's usury law. The issues remaining for decision are: 1. Whether Garden Corporation and Losson Corporation may be disregarded for Federal tax purposes; and 2. If the corporations may not be disregarded, whether Garden Partnership and Losson Partnership had any net operating losses with respect to which petitioners are entitled to deductions. FINDINGS OF FACTMost of the facts have been stipulated by the parties and are found accordingly. At the time they filed their petition, all petitioners resided in New York State. Petitioners Norma Ogiony, Gloria Nasca, Nancy Nasca, Ruth M. Ogiony and Enis Santin are parties only by virtue of having filed joint returns with their husbands during the years in question. When we hereafter refer to petitioners, we will be referring to John and Edward Ogiony, John and Joseph Nasca, 1979 Tax Ct. Memo LEXIS 495">*498 and Peter Santin. 1. Garden Village. In 1965, Mr. Alfred Stangl negotiated for and acquired from Sereth Properties, Inc. ("Sereth") an option to purchase a 48.6 acre tract of land at French and Union Roads in the Town of Cheektowaga, New York. Shortly thereafter Peter Santin became associated with Stangl and, on November 1, 1965, Garden Village Builders, Inc., ("Garden Corporation") was formed by Stangl and Peter Santin Construction Co., Inc., Santin's closely-held construction company. Garden Corporation adopted a fiscal year ending September 30. Santin and Stangl's initial endeavor--to create a townhouse community--was unsuccessful, however, and in its corporation income tax return for the fiscal year ended September 30, 1966, Garden Corporation reported a loss of $ 26,307.50 upon abandonment of its townhouse project. On May 2, 1966, Roxborough Homes Corp. ("Roxborough") acquired a one-third interest in Garden Corporation. John and Edward Ogiony ("the Ogionys") were the principal stockholders and officers of Roxborough. The acquisition by Roxborough of a stock interest in Garden Corporation was incidental to the formation of a joint venture known as "P. Santin, 1979 Tax Ct. Memo LEXIS 495">*499 J. & E. Ogiony, A. Stangl--Joint Venture" ("Garden Partnership"). Garden Partnership filed partnership information returns on a calendar year basis. Santin, Stangl and the Ogionys ("the Partners") 2 agreed to build rental apartments on the land on which Stangl had an option. Profit and loss from the Garden Partnership were to be shared equally, the Ogionys and Santin were to provide all funds required, and the land was to be bought in the names of and for the benefit of the Partners, individually, as tenants in common. In August 1966, Santin, Stangl and the Ogionys exercised the option on the Sereth property. They acquired the property in the following stages: DateAcresPurchase Price8/15/6611 plus$ 110,0008/15/668 plus45,0003/1/6712 plus65,0001/15/6816 plus80,00048.6$ 300,000In addition to the listed purchase price, they paid Sereth interest at 5 percent from October 11, 1965 to the date of closing of each purchase. When they1979 Tax Ct. Memo LEXIS 495">*500 purchased 12 acres on March 1, 1967, they paid Sereth interest of $ 4,505.47 and county and school taxes of $ 561.42. When they purchased the last parcel on January 15, 1968, they paid Sereth $ 9,006.42 interest and county and school taxes totaling $ 956.50. The purchase price, closing costs and expenses incurred for the land purchase were paid either with checks drawn on the Ogionys' or Santin's personal accounts or by checks drawn on the bank accounts of Garden Partnership. Although Garden Partnership wished to develop the property, it was unable to obtain a loan because of New York's usury laws.Under section 5-501 of the New York General Obligations Law, 3 the maximum interest rate that could be charged individuals in financial transactions of the type involved in the instant case at that time was 6 percent; anything over 6 percent was usurious. Section 5-501 was amended in 1968 to allow, in effect, a maximum interest rate of 7 1/2 percent, and in 1973 a maximum interest rate of 8 percent. Corporations, however, were not able to interpose a defense of usury. Santin approached Western Savings Bank ("Western"), with which he had dealt for many years, and requested a loan on1979 Tax Ct. Memo LEXIS 495">*501 behalf of Garden Partnership; this request was denied. In essence, Santin was informed that because of a "money crunch" loans at 6 percent interest (the maximum rate allowable for individual and, hence, Garden Partnership) were unavailable; Santin was informed that loans on investment property were limited to loans to corporations. Since neither the Partners nor Garden Partnership could obtain the financing necessary for the apartment project, the Partners decided to "go the corporate route." The Partners decided to use Garden Corporation, which was inactive by this time, 4 since Western preferred a corporate borrower which was already in existence to a new "shell" corporation formed for that purpose. In fact, the suggestion that Garden Corporation should be the borrower originated with Mr. Frantzen, an officer at Western, who believed that the Partners were already shareholders of Garden Corporation. 51979 Tax Ct. Memo LEXIS 495">*502 A special meeting of the board of directors of Garden Corporation was held on March 24, 1967. The subject of discussion was the problem of financing the construction of apartments on the tract owned by Garden Partnership. It was reported to the meeting that "the Western Savings Bank was not interested" in advancing the mortgage money to the individuals because of "the going interest rate that could be charged to corporations." The following two motions were passed: (1) That the individuals convey to this Corporation a portion of the land held by them as individuals so that the Corporation would be the title owner, which would be done solely for the purpose of obtaining from the Western Savings Bank a $ 720,000 mortgage for apartment construction on the premises, with interest at the rate of 6-1/2% per annum, which rate could not be obtained by the parties as individuals. (2) During the term of the building loan advances under said $ 720,000 mortgage, the property would continue to remain in the corporate name until such time as the final draw had been obtained by the Corporation and the permanent mortgage was then placed against the said property. At that time the Corporation1979 Tax Ct. Memo LEXIS 495">*503 would re-convey the subject premises to the respective parties, or their assigns with an assumption of the $ 720,000 mortgage by the Western Savings Bank, it being understood that this transaction is being done solely for the purpose of obtaining the financing from the Western Savings Bank at the interest rate as requested by them. That other than this transaction, it was generally agreed that the Corporation was to remain in an inactive status. It was further agreed that none of the $ 720,000 proceeds shall in anywise be used by the Corporation for any corporate obligations, but shall be used strictly for the construction of the apartments and pursuant to the terms of the mortgage, and for no other reason. On the same date, Western issued a commitment letter for a $ 720,000 mortgage loan to Garden Corporation payable over a 25-year period with interest at 6 1/2 percent per annum, the purpose of the loan being to finance nine eight-unit brick apartments and 72 garages on two parcels totaling 4.93 acres of the tract the Partners had acquired from Sereth. On August 11, 1967, the Partners conveyed their undivided interests in the two parcels of land described in the commitment1979 Tax Ct. Memo LEXIS 495">*504 letter to Garden Corporation. On the same day Garden Corporation executed and recorded a mortgage for $ 720,000 to Western. During the ensuing four years, the Partners deeded to Garden Corporation the various parcels of land and all improvements thereon and they executed various 8ortgages to Western covering all fixtures permanently attached to the property. The Partners believed that they owned all fixtures not permanently attached. A summary of the dates of transfer, the acreage transferred by the Partners to Garden Corporation, and the amount of each mortgage is set forth below: DateAcresMortgageInterest Rate8/11/674.93 $ 720,0006 1/2%9/20/684.03600,000 67 1/2%4/10/693.21740,0008%5/10/701.41345,0009 1/2%12/14/701.39489,0009 1/2%6/1/712.23585,0008 3/4%17.20$ 3,479,000 7On August 1, 1972, Western issued a commitment letter to Garden Corporation for a conventional permanent1979 Tax Ct. Memo LEXIS 495">*505 consolidation of all of the above loans in the amount of $ 3,600,000 at 8.2% interest. Although Garden Corporation was the mortgagee of record for all mortgage loans obtained from Western, on two occasions Garden Corporation transferred title of a portion of the land which it owned back to the Partners.On January 2, 1968, Garden Corporation deeded 4.93 acres back to the Partners; the land was reconveyed to Garden Corporation on January 23, 1968. On December 17, 1968, Garden Corporation conveyed back title to the same 4.93 acres; this same parcel was reconveyed to Garden Corporation on April 10, 1969. Garden Corporation owned the following percentages of the land during the years listed: YearPercentage Owned19676.0%196811.5%196920.7%197027.0%197130.6%Although all the loans from Western were made to Garden Corporation, the corporation's shareholders intended at all times that Garden Corporation would be nothing more than a financing vehicle. Santin, Stangl and the Ogionys did not intend to have Garden Corporation take over the apartment project; rather, they viewed the development project as strictly a personal investment. 8 All draws1979 Tax Ct. Memo LEXIS 495">*506 on the mortgage loans from Western were transferred by Garden Corporation, either by check or by endorsement, to the construction account of Garden Partnership. All rental income from the apartments was deposited in Garden Partnership's rental account; the leases listed Garden Partnership as lessor. However, the Partners obtained the benefit of financing from using Garden Corporation in this transaction. Apartment houses were built on the land. The construction and related activities were under the supervision of Santin and the Ogionys. The individual partners--as well as their suppliers--viewed the liabilities incurred in the course of the construction project as the individuals' personal liabilities. All of the expenses 9 incurred in connection with the development and operation of the Garden Village Apartments were paid either by the Partners or by Garden Partnership. Income received and expenses incurred by the Partners and Garden Partnership during the years in issue were as follows: 1979 Tax Ct. Memo LEXIS 495">*507 YearAmount1967INCOMEnoneEXPENSESInterestSereth Properties $ 4,809.38Western Savings2,902.57Manufacturers' & Traders' Trust2,957.55Realty Taxes 101,744.24Telephone20.09Bank Service Charges1.00Advertising1,314.70Office Expense113.521/1/68 thru 9/30/68 11INCOMERent$ 45,061.00Common land sale4,528.88EXPENSESRealty Taxes7,738.35Interest44,905.23Commission5,875.60Telephone403.13Utilities2,825.13Supplies157.96Repairs294.25Maintenance2,209.78Insurance2,089.65Office Supplies 12301.36Wages1,187.50Legal and Accounting425.00Miscellaneous995.89Advertising484.08Equipment Rental81.32Payroll Taxes52.2510/1/68 thru 12/31/68INCOMERent $ 33,350.00EXPENSESInterest23,080.02Accounting Fee150.00Payroll Taxes93.95Commissions2,340.50Telephone141.31Utilities2,501.33Maintenance2,136.45Wages1,348.33Miscellaneous207.36Insurance1,203.96Supplies149.411969INCOMERental Income$ 243,142.56Machine Income 13803.00Other Income375.84EXPENSESInterest115,635.27Real Estate Taxes22,445.73Commissions14,807.00Wages5,200.00Payroll Taxes427.02Insurance6,087.70Legal Fees131.00Accounting1,800.00Telephone809.22Utilities - Gas10,905.73- Electric5,513.04- Water3,231.92Maintenance16,903.95Pool Expense3,510.25Office Expense1,036.97Gasoline and Oil342.55Miscellaneous Expense $ 1,472.12Advertising571.20Dues & Subscriptions250.00Repairs215.52Bank Service Charges36.98Amortization of Mortgage Costs690.511970INCOMERental Income$ 398,421.44Machine Income3,155.55EXPENSESInterest178,322.77Real Estate Taxes44,084.11Commissions15,578.75Wages16,095.05Payroll Taxes975.68Insurance7,687.78Legal and Accounting1,638.40Telephone1,322.57Utilities - Gas18,499.56- Electric10,883.19- Water7,258.46Maintenance14,775.15Pool Expense1,661.31Gasoline and Oil1,200.30Miscellaneous Expense3,438.83Advertising281.25Dues & Subscriptions95.00Repairs1,503.20Bank Service Charges67.10Amortization of Mortgage Costs1,522.38Office Supplies313.08Supplies1,992.72Contributions375.00Travel Expense114.001971INCOMERental$ 481,405.99Interest609.28Other7,353.09EXPENSESInterest 14234,138.68Real Estate Taxes70,380.76Commissions18,330.00Wages23,883.49Payroll Taxes1,687.70Insurance7,369.06Legal and Accounting2,775.00Telephone1,518.66Utilities - Gas25,209.46- Electric13,186.34- Water8,864.98Maintenance11,819.53Pool Expense424.31Gasoline and Oil1,293.25Miscellaneous1,255.32Advertising585.49Dues and Subscriptions96.75Repairs7,504.10Bank Service Charges80.41Amortization Mortgage Cost1,993.43Office Supplies628.23Supplies10,020.11Contributions1,152.50Postage70.001979 Tax Ct. Memo LEXIS 495">*508 1979 Tax Ct. Memo LEXIS 495">*509 In addition to the expenses listed above, Garden Partnership purchased various assets, including equipment, and machines, which it used in connection with its own activities as well as the operation of the apartment project. The only assets for which title was transferred to Garden Corporation were parcels of land and improvements thereon. During the years in issue, Garden Partnership claimed depreciation on assets as follows: YearAssetsDepreciation1967NoneNone1/1/68 -Buildings $ 9,706.759/30/68Snowblower and Lawnmower27.79Adding Machine8.09Garbage Containers48.13Office Furniture4.15Rugs2,118.12Appliances1,487.88Hot Water Tanks135.00Parking Lots1,751.4010/1/68 -12/31/68Buildings9,561.15Snowblowers and Lawnmowers27.79Adding Machine8.09Garbage Containers73.13Office Furniture4.15Car Radio58.05Office Building & Warehouse180.62Rugs1,985.72Appliances1,413.49Hot Water Tanks128.25Parking Lots1,663.831969Buildings66,962.96Snowblowers and Lawnmowers111.15Adding Machine32.37Garbage Containers328.54Office Furniture16.61Car Radio232.21Office Furniture $ 7.80Office Building & Warehouse722.48Rugs17,391.08Appliances11,417.56Hot Water Tanks1,270.36Parking Lots10,023.811970Buildings100,328.96Rugs22,609.82Appliances16,990.99Hot Water Tanks2,059.93Parking Lots12,993.59Additions8,286.21Recreation Building3,022.28Snowblowers and Lawnmowers111.15Adding Machine32.37Garbage Containers436.66Office Furniture56.35Car Radio232.21Office Building & Warehouse722.48Copy Machine16.85Typewriter4.71Litter Vacuum22.55Pool Table-Rec. Hall10.50Dodge Truck 15272.26Dumpsters108.291971Buildings84,090.06Rugs18,279.25Appliances14,595.60Hot Water Tanks1,842.31Parking Lots9,503.38Additions7,026.99Recreation Building5,863.83Snowblowers and Lawnmowers111.15Adding Machine32.37Garbage Containers436.66Office Furniture56.35Car Radio232.21Office Building & Warehouse722.48Copy Machine22.47Typewriter9.42Litter Vacuum45.10Pool Table-Rec. Hall42.00Dodge Truck1,089.06Dumpsters275.87Furniture-model apartments282.75Sign13.301979 Tax Ct. Memo LEXIS 495">*510 During the years in issue, Garden Corporation reported no income, and it claimed deductions for expenses as follows: Fiscal Year EndedExpenseAmount9/30/67Bank Charges $ 2.00Other (unlisted)22.509/30/68Bank Charges10.00Franchise Taxes25.00Accounting Fees125.009/30/69Bank Charges23.20Franchise Taxes81.259/30/70Bank Charges17.11Franchise Tax100.009/30/71Bank Charges.50Franchise Tax118.75In his statutory notice, respondent disallowed the distributive shares of operating losses claimed by the individual partners for 1967 through 1971 on the ground that the losses belonged to Garden Corporation. Respondent did not cite any section of the Internal Revenue Code as the basis for his determination in the notices. 2. Losson GardensLosson Gardens Company ("Losson Partnership") was a joint venture organized in 1969 by Peter Santin Construction Co., Inc., Roxborough Homes Corp. and John and Joseph Nasca. The partnership adopted a fiscal year ending September 30. 16 The purpose of this partnership was to purchase1979 Tax Ct. Memo LEXIS 495">*511 land and build apartments on Losson Road in Cheektowaga. On July 1, 1969, Losson Partnership purchased 36.02 acres of land on the north side of Losson Road. On January 6, 1971, Losson Partnership acquired a contiguous parcel of land 3 acres from a local school district. Losson Gardens, Inc. ("Losson Corporation") was incorporated on August 12, 1969. The partners in Losson Partnership formed the corporation solely to satisfy bank requirements for obtaining a loan.Losson Partnership had to transfer title of parcels of land which it wished to develop to the corporation in order to receive financing. On June 10, 1968, Losson Partnership conveyed 2.74 acres to Losson Corporation; on August 24, 1971, 3.15 acres were conveyed by the partnership to the corporation; and on October 21, 1971, an additional 2.82 acres were conveyed to the corporation. Losson Corporation owned 7.9% of the land in 1971. Mortgages on the property conveyed by Losson Partnership to Losson Corporation were obtained from Western. The following mortgage loans were received by Losson Corporation from Western: DateAmount6/12/70$ 530,0008/24/71672,00010/20/71467,0001979 Tax Ct. Memo LEXIS 495">*512 All draws received from Western were in the form of checks payable to Losson Corporation. These checks were either deposited in Losson Corporation's checking account, with checks being drawn against these deposits to Losson Partnership, or the checks were endorsed over to the partnership and deposited in its construction account. Title to the entire tract, other than portions conveyed to Losson Corporation, was retained by Losson Partnership during the year in issue. All of the expenses incurred in connection with development of the Losson Garden Apartments, and all rents therefrom, were in the name of Losson Partnership. The partnership also incurred its own expenses. 17 The expenses and income of Losson Partnership for its fiscal year ended September 30, 1971, were as follows: IncomeRental Income$ 43,750.22Misc. Receipts1,006.90ExpensesInterest Cost64,495.55Real Estate Taxes3,882.88Amortization of Mortgage Fees218.95Rental Commissions6,906.49Office Expenses590.30Utilities & Services5,732.32Supplies, Repairs & Maintenance3,390.03Insurances2,589.251979 Tax Ct. Memo LEXIS 495">*513 In its partnership information return for its fiscal year ended September 30, 1971, Losson Partnership claimed depreciation deductions as follows: Depreciation of Buildings$ 14,642.16Depreciation of Furnitureand Fixtures5,593.06Depreciation of Parking Lot1,122.82Depreciation of Machineryand Equipment199.50On their returns, the Ogionys, the Nascas and Santin claimed distributive shares of the net operating loss which Losson Partnership had reported for its fiscal year ended September 30, 1971. In the statutory notices respondent disallowed these claims on the grounds that the losses belonged to Losson Corporation. Respondent did not cite any section of the Internal Revenue Code in his statutory notices as the basis for his determinations. OPINION The first issue for decision is whether Garden Corporation and Losson Corporation may be disregarded for Federal tax purposes. Petitioners' position is generally that the corporations should be ignored. Respondent, on the other hand, contends that we should follow our recent decision in Strong v. Commissioner,66 T.C. 12">66 T.C. 12 (1976), affd. without published opinion (2d Cir. Feb. 14, 1977), 1979 Tax Ct. Memo LEXIS 495">*514 and recognize the corporations as owners of the property transferred to them. We agree with respondent.The facts in this case are virtually identical to those presented in 66 T.C. 12">Strong,supra. Economic conditions pushed the market rate of interest above the New York usury law limit of 6 percent. Petitioners (or their wholly-owned corporations) were members of two partnerships, Garden Partnership and Losson Partnership. Petitioners desired to improve certain properties with apartment buildings. Due to New York's usury law they were unable to obtain financing in their individual capacity or through their partnerships. Corporations, however, are unable to interpose a defense of usury in New York. Accordingly, petitioners used two corporations, Garden Corporation and Losson Corporation, as corporate borrowers in order to obtain the funds which the partnerships needed to construct the apartment building. As a precondition to obtaining the desired mortgage construction loans, the corporations had to own the property which was to be developed. For most of the time during the years in question, title to the developed portions of the land remained in the corporations. The partnerships1979 Tax Ct. Memo LEXIS 495">*515 collected all rent and paid all expenses connected with the operation of the apartment complexes; the partnerships also retained title to some undeveloped land. 18 On their partnership information returns the partnerships reported the rent as income and deducted all expenses related to the apartment complexes, including interest, taxes, depreciation, wages, etc. Petitioners then claimed net operating losses in the amounts of their individual shares of the partnerships' reported losses. 19 Respondent determined that all income and deductions properly belonged to the corporations, not the partnerships, and respondent disallowed the claimed net operating losses. 1979 Tax Ct. Memo LEXIS 495">*516 Petitioners present three arguments as the basis of their contention that the corporations should be disregarded for tax purposes. They contend, first, that 66 T.C. 12">Strong v. Commissioner,supra, was wrongly decided; second, that the corporations were their agent or nominee and, accordingly, should be disregarded; and, third, that since all income was received by and expenses of the apartment complexes were paid by the partnerships, they are entitled to the net operating losses. As to petitioner's first contention, that Strong was wrongly decided, we disagree. Strong is a reviewed opinion which was approved without dissent. We follow that decision here. See also Collins v. United States,386 F. Supp. 17">386 F. Supp. 17 (S.D. Ga. 1974), affd. per curiam 514 F.2d 1282 (5th Cir. 1975). Petitioners' second contention is that the corporations were merely their agents or nominees. Although their brief is not clear on this point, petitioners appear to argue that the corporations were, at best, mere conduits for the activities of the partnerships. But it has been held by the Supreme Court that a taxpayer who utilizes, and obtains the economic1979 Tax Ct. Memo LEXIS 495">*517 benefit of, the corporate form may not evade the tax consequences thereof by the characterization of the corporation as merely an agent. Moline Properties v. Commissioner,319 U.S. 436">319 U.S. 436 (1943); National Carbide Corp. v. Commissioner,336 U.S. 422">336 U.S. 422 (1949). 20 Similarly, in 66 T.C. 12">Strong v. Commissioner,supra, we specifically rejected the argument that the corporation was "a mere tool or conduit." 66 T.C. 12">66 T.C. 21. Our determination that Strong is controlling here requires us to reject petitioners' contention that the corporations herein be treated as mere nominees. Petitioners' third contention is that they are entitled to the net operating losses since all rental income was received by and all expenses of the apartment complex were paid by the partnerships. We recently considered these arguments in another context in Klausner v. Commissioner, T.C. Mmeo. 1978-405 (October 11, 1978), 37 T.C.M. 1688, 47 P-H Memo. T.C. par. 78,405 (1978). In Klausner,1979 Tax Ct. Memo LEXIS 495">*518 on similar facts, respondent determined that rents received by the taxpayers constituted dividends to them from their corporation. We held that the corporation lacked earnings and profits and, hence, that the rents could not be treated as dividends. 21 We also held that the rents should be treated as paid to the Corporation and used by it to pay corporate expenses. At least to the extent of expenses paid by the shareholder, the cash received should be treated as a reimbursement by the Corporation of an advance made by the shareholder. * * * [The excess of the taxpayer's expenditures over rent received should be] treated as a contribution to the capital of the Corporation and as being at least part of the basis for [the taxpayer's] interest in the Corporation * * *. In view of the foregoing, we conclude that none of the [rent] should be treated as a dividend to [the taxpayer] during 1973. By the same token, the excess amount of expenses * * * should not be treated as a loss * * *. We concur in Klausner's1979 Tax Ct. Memo LEXIS 495">*519 resolution of the problem of the treatment of rents and expenses. As the owners of the property, the corporations were the proper parties to take the rents into income. Although the partnerships received the rent and paid the expenses, the rents are not income to them and the excess of their payments from their own funds, if any, over rents constitutes a contribution to the capital of the corporations. The next issue is whether the partnerships had net operating losses with respect to which petitioners are entitled to deductions. Petitioners contend, first, that they are entitled to all their claimed deductions since respondent's determinations were an arbitrary and capricious application of section 482. Second, petitioners contend that respondent has issued private letter rulings allowing other taxpayers the deductions petitioners claim here. Finally, petitioners contend that they are entitled to some of the deductions which respondent determined were the corporations'. The basis for petitioners' final position is that not all of the partnerships' property was transferred to the corporations. Although we disagree with petitioners' first two contentions, we agree with their1979 Tax Ct. Memo LEXIS 495">*520 final contention in part. Petitioners' first contention, that respondent's determinations were an arbitrary application of section 482, is without merit since respondent's determination in this case did not rest on section 482. Rather, respondent's determinations were based on the fact that the corporations were the legal owners of the apartment complexes and, hence, should report all income and deductions with respect thereto. Petitioners were well aware of this since their requests for admissions that section 482 was the basis of respondent's determinations were repeatedly denied. Nevertheless, petitioners ask us to look "behind" the statutory notices issued to them; they stress that prior correspondence from respondent indicated that respondent was relying on section 482. It is well established, however, that this Court generally will not look behind the statutory notice. Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 62 T.C. 324">327 (1974); Branerton Corp. v. Commissioner,64 T.C. 191">64 T.C. 191, 64 T.C. 191">200 (1975). We see no reason to depart from that practice1979 Tax Ct. Memo LEXIS 495">*521 here. Petitioners' second contention, that they are entitled to rely on private letter rulings issued to other taxpayers, is equally meritless. It is well settled that "where the Commissioner has issued a private ruling to one taxpayer, another taxpayer )who has not received a ruling) may not rely on the holding in the issued ruling so as to require that he be given the same treatment that the first taxpayer was accorded." Teichgraeber v. Commissioner,64 T.C. 453">64 T.C. 453, 64 T.C. 453">456 (1975); TennesseeNatural Gas Lines, Inc. and Subsidiary v. Commissioner,71 T.C. No. 7 (October 30, 1978). No exception to this rule is applicable here. See International Business Machines Corp. v. United States,343 F.2d 914 (Ct. Cl. 1965). Moreover, there is no evidence that petitioners relied on these private rulings. Petitioners' final contention is that they are entitled to some of the deductions allocated by respondent to the corporations since not all of the partnerships' properties were transferred to the corporations. 1979 Tax Ct. Memo LEXIS 495">*522 The questions petitioners have raised are purely factual, and the burden of proof is on them. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.Generally, to be deductible an expense must be incurred in a taxpayer's own trade or business. Interstate Transit Lines v. Commissioner,319 U.S. 590">319 U.S. 590 (1943); Columbian Rope Co. v. Commissioner,42 T.C. 800">42 T.C. 800, 42 T.C. 800">815 (1964). In this case, petitioners contend that they are entitled to deduct all the expenses they paid in connection with operation of the apartment complexes. However, we have already concluded that the corporations were the proper parties to include the rents as income. Consequently, only the corporations are entitled to deduct expenses related to the production of this rental income. Respondent disallowed the partnerships' claimed deductions solely on the grounds that the corporations, as owners of the property, were the proper parties to claim the deductions. On brief, respondent notes1979 Tax Ct. Memo LEXIS 495">*523 that "respondent's position in this case is limited to periods of actual corporate ownership of the property involved." Turning to the specific expenses which the partnerships claimed were deductible during the years in issue, we conclude that these can be separated into several classifications: (1) items deductible only by the corporations; (2) items deductible only by the partnerships; (3) real estate taxes; (4) interest; and (5) depreciation. 1. Items deductible only by the corporations.In light of all the evidence in this case, we conclude that the following expenses were solely related to the operation of the apartment complexes and, accordingly, must be deducted by the corporations for all the years in issue: commissions, wages, payroll taxes, insurance, utilities (except telephones), maintenance (listed as supplies, repairs and maintenance by Losson Partnership), pool expense, gasoline & oil, miscellaneous, advertising, dues and subscriptions, repairs, amortization of mortgage costs, and supplies (except office supplies). Although the corporations transferred some of their property back to the partnerships for brief periods in 1968 and 1969, we must deny deductions1979 Tax Ct. Memo LEXIS 495">*524 for these expenses is their entirety for all the years at issue. Deductions are a matter of legislative grace, New Colonial Ice Co., Inc. v. Helvering,292 U.S. 435">292 U.S. 435 (1934), and petitioners bear the burden of proving that they are entitled to their claimed deductions. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rockwell v. Commissioner,512 F.2d 882 (9th Cir. 1975), rehearing denied June 13, 1975, cert. denied 423 U.S. 1015">423 U.S. 1015 (1975). Respondent does not contend that petitioners are not entitled to the deductions for the periods when they owned the property.Petitioners, however, have failed to present us with any means to allocate these expenses for the periods that the partnerships owned a portion of the developed property. Accordingly, they have failed to carry their burden of persuasion, and we must deny the claimed deductions. 2. Items deductible only by the partnerships. In light of all the evidence presented, we conclude that petitioners have carried their burden of proving that the following expenses of the partnerships1979 Tax Ct. Memo LEXIS 495">*525 are deductible by them: legal and accounting, telephone, bank service charges, office supplies and office expenses, travel expenses, contributions and postage. Respondent has not challenged these claimed deductions on any other grounds, including substantiation of the claimed deductions. 3. Real estate taxes.Only the owner of property may deduct real estate taxes. Section 1.164-6(a), Income Tax Regs. We have found that the partnerships paid real estate taxes as follows: YearPartnershipTaxes1967Garden Partnership$ 1,744.241968Garden Partnership7,738.351969Garden Partnership22,445.731970Garden Partnership44,084.111971Garden Partnership70,380.761971Losson Partnership3,882.88The partnerships paid the real estate taxes on the entire tracts, including the lands (and improvements thereon) transferred to the corporations. We concluded that the corporations owned the percentages of the tracts as follows: YearCorporationPercentage Owned 221967Garden Corporation6.0%1968Garden Corporation11.5%1969Garden Corporation20.7%1970Garden Corporation27.0%1971Garden Corporation30.6%1971Losson Corporation7.9%1979 Tax Ct. Memo LEXIS 495">*526 The remainder of each tract, for which the partnerships paid real estate taxes, were owned by the partnerships. At first blush, it appears that we should simply allocate real estate taxes paid on the basis of percentage ownership of the land; i.e., since Garden Partnership owned 94 percent of the land in 1967, it should be entitled to deduct 94 percent of the real estate taxes. The problem with this approach, however, is that it does not recognize that the portion of the land owned by the corporations was developed and, hence, taxed at a higher rate. Garden Partnership is entitled to deduct the real estate tax on the undeveloped portion of the property. We do know, however, that Garden Partnership's property was subject to real estate taxes of $ 58.14 per acre in its undeveloped state. The total tax on 48.6 acres of undeveloped land would have been $ 2,825.67 in 1967. Since petitioners have not presented any evidence proving that real estate taxes1979 Tax Ct. Memo LEXIS 495">*527 increased during the years in issue, we conclude, on the basis of the burden of proof, that this amount ($ 2,825.67) represents the real estate tax on the entire tract in its undeveloped state during the years in issue. Accordingly, Garden Partnership is entitled to real estate tax deductions during the years in issue as follows: YearDeduction1967$ 1,639.5919682,500.7219692,240.7619702,062.7419711,961.02As to the tract of land owned by Losson Partnership and Losson Corporation, we have no evidence of the real estate taxes on that land in its undeveloped state.We know, however, that Losson Partnership owned 92.1 percent of the 36-plus acres of the tract. We also know that Garden Partnership paid $ 58.14 tax per acre of undeveloped land. Making an approximation, Cohan v. Commissioner,39 F.2d 540, 544 (2d Cir. 1930), we conclude that real estate taxes on the entire tract in its undeloped state were $ 2,093 and, accordingly, Losson Partnership is entitled to deduct $ 1,927.65 4. Interest.Interest is generally deductible. Section1979 Tax Ct. Memo LEXIS 495">*528 163. The taxpayer, however, must own the property subject to a mortgage to deduct mortgage interest. Section 1.163-1(b), Income Tax Regs. In this case, with respect to the mortgages obtained by Garden Corporation and Losson Corporation on the land which the corporations developed, petitioners (and their partnerships) were not owners of the property. With the exception of interest paid by Garden Partnership in 1967 and 1971, petitioners have presented no evidence establishing that either partnership paid interest to anyone other than Western. 23 We conclude that petitioners have failed to carry their burden of proving that they are entitled to any interest deductions with respect to payments by Garden Partnership in 1968, 24 1969 and 1970, and with respect to interest payments by Losson Partnership in 1971. 1979 Tax Ct. Memo LEXIS 495">*529 As to Garden Partnership's interest payments in 1967 and 1971, in 1967 Garden Partnership paid Western $ 2,902.57, Sereth $ 4,809.38, 25 and Manufacturers' and Traders' Trust Company ("Manufacturers") $ 2,957.55. The interest paid to Western and Manufacturers is not deductible, since both obligations were corporate obligations. 26 The interest paid Sereth in 1967 was on the obligation arising from the purchase of the original 32 acres. We held, above, that Garden Partnership owned a total of 94 percent of that property during 1967 and, correspondingly, Garden Partnership is entitled to deduct 94 percent of the interest paid to Sereth in that year, or a total of $ 2,728.42. In 1971 Garden Partnership paid interest of $ 916.65 to Peter Santin Construction Company, Inc., $ 916.65 to Roxborough Homes, Inc., and $ 568.75 to Manufacturers. The remaining interest was apparently paid to Western.For reasons discussed above, Garden Partnership is not entitled to the claimed interest deduction for the interest paid to Western and Manufacturers, but the partnership is entitled to deduct the interest paid to Peter Santin Construction Company, Inc. and Roxborough Homes, Inc.271979 Tax Ct. Memo LEXIS 495">*530 5. Depreciation.Section 167 allows a deduction for depreciation; in general, only the holder of an economic interest in property may deduct depreciation.See Hunter v. Commissioner,46 T.C. 477">46 T.C. 477, 46 T.C. 477">489-490 (1966). In this case, the partnerships claimed depreciation deductions for many assets, including improvements on land which had been transferred to the corporations. We conclude that the partnerships are not entitled to depreciation deductions for any of the buildings (including the office building, warehouse, and recreation building) or the fixtures 28 attached thereto, including rugs, appliances, and hot water tanks. 29 We further hold that the partnerships are not entitled to deduct depreciation on the parking lots, since petitioners have failed to carry their burden of proving that the land underlying the parking lots was not transferred to the corporations. 30 The partnerships are entitled to deduct claimed depreciation on the following assets: 311979 Tax Ct. Memo LEXIS 495">*531 YearPartnershipAssets1968Garden Partnershipsnowblower and lawnmoweradding machinegarbage containersoffice furniturecar radio1969Garden Partnershipsame as 19681970Garden Partnershipsame as 1969, pluscopy machinetypewriterlitter vacuumpool tableDodge truckdumpsters1971Garden Partnershipsame as 1970, plusfurniture--model apartmentsign1971Losson Partnershipmachinery and equipmentDecision will be entered under Rule 155.Footnotes1. Cases of the following petitioners are consolidated herewith for purposes of trial, briefing and opinion: John J. and Gloria Nasca, Docket No. 1045-76; Joseph M. and Nancy Nasca, Docket No. 1046-76; Edward L. and Ruth M. Ogiony, Docket No. 1047-76; and Peter and Enis Santin, Docket No. 1072-76.↩2. Stangl was bought out of the Garden Partnership in 1968; he is not a party to this case. The official name of the partnership was changed to "P. Santin, J. & E. Ogiony-- Joint Venture."↩3. N.Y. Gen. Oblig. Law, sec. 5-501↩ (McKinney 1964).4. Although Garden Corporation was inactive, minutes for annual meetings of the shareholders and directors of the corporation were prepared for 1965 through 1978. The minutes for 1970 and 1971 were not signed. ↩5. In fact, Stangl, Roxborough and Peter Santin Construction Company, Inc. were shareholders; Santin and the Ogionys were only indirect shareholders of Garden Corporation.↩6. The amount of this mortgage was increased to $ 650,000 at 7 3/4% interest by an instrument executed April 10, 1969. ↩7. The total was increased to $ 3,529,400 due to the increase explained in note 6 supra.↩8. In addition, the Partners loaned their personal funds to Garden Partnership; Partners' loans outstanding as of December 31, 1971, totaled $ 166,411.94.↩9. The parties set forth in the Stipulation of Facts an exhaustive catalog of the expenses incurred by Garden Partnership. All↩ expenses connected with this real estate project, as well as any other expenses of Garden Partnership on its own behalf, were paid by the partnership. Expenses incurred by the partnership on its own behalf included legal and accounting fees, telephone charges, bank service charges, office supplies, travel expense, contributions and postage.10. Real estate taxes paid of $ 1,744.24 represent tax on 20 acres of undeveloped land for the entire year and 12 acres for 5/6 of the year. This equals a tax rate of approximately 58.14 per acre of undeveloped land per year. Accordingly, the real estate taxes for 48.6 acres of undeveloped land would have been $ 2,825.67. There is no evidence in the record that taxes on unimproved real estate increased during the years in issue. ↩11. Garden Partnership filed partnership information returns for the period 1/1/68 thru 9/30/68 and 10/1/68 thru 12/31/68 because Stangl left the Partnership on September 30, 1968. ↩12. An office was maintained by Garden Partnership at the apartment complex. ↩13. Although Garden Partnership reported income with respect to its washers and dryers, there is no evidence in the record as to costs associated with, or the basis of, such machines. ↩14. Of this interest, $ 916.65 was paid to Peter Santin Construction Company, Inc., $ 916.65 was paid to Roxborough Homes, Inc., and $ 568.75 was paid to Manufacturers' and Traders' Trust Company ("Manufacturers'"). Garden Partnership had borrowed from Peter Santin Construction Company, Inc. and Roxborough. Garden Corporation had borrowed $ 30,000 from Manufacturers' as part of its townhouse project.↩15. The truck was used for maintenance of the apartment complex grounds.↩16. The sole year at issue here is the fiscal year ended September 30, 1971.↩17. Losson Partnership's expenses were the same as expenses of Garden Partnership.↩18. Neither party emphasized that Santin and the Ogionys, not Garden Partnership, acquired the tract from Sereth. For the purpose of determining Garden Partnership's net operating losses during the years in issue, we have treated the partnership as the owner of the property not transferred to Garden Corporation. ↩19. In fact petitioners John Ogiony, Edward Ogiony and Peter Santin were not↩ partners in Losson Partnership; their wholly-owned corporations were partners. Respondent, however, did not base his determination on this fact, and respondent presented no argument that these individuals were not entitled to the claimed deductions on these grounds. Accordingly, for purposes of this opinion we have treated these individuals as partners in the Losson Partnership.20. See Jones v. Commissioner,T.C. Memo. 1978-446↩ (November 7, 1978), 37 T.C.M. , 47 P-H Memo. T.C. par. 78,446 (1978).21. Although respondent did not make such a determination here, the same result would occur, since both corporations herein have always operated at a loss.↩22. For example, if 5 percent of a given piece of land was transferred on July 1 of a given year, the corporation would own 5 percent of the land for 50 percent of the year, or 2.5 percent of the land for the entire year.↩23. We lack any means to allocate interest deductions to petitioners for the periods in 1968 and 1969 in which they owned some of the developed property. ↩24. In 1968 the Partners paid Sereth interest of $ 9,006.42 in connection with the purchase of 16 acres of land. This interest, at 5 percent from the date the option was obtained to the date of closing, was part of the cost of acquisition of the property. Such interest is not deductible but, rather, is added to their basis in the property. Joell Company v. Commissioner,41 B.T.A. 825">41 B.T.A. 825, 41 B.T.A. 825">827 (1940); Goddard v. Commissioner,21 T.C.M. 419↩, 31 P-H Memo. T.C. par. 62,083 (1962).25. This does not include interest of $ 4,505.47 paid in connection with the acquisition of 12 acres from Sereth in 1967 which must be added to the Partners' basis in the property. See note 24 supra.↩26. When Garden Corporation attempted to construct townhouses in 1965-1966, it borrowed $ 30,000 from Manufacturers. ↩27. We note, again, that respondent presented no reason for disallowing this interest deduction other than the argument that Garden Corporation was liable on the indebtedness. We found as a fact that Garden Partnership borrowed from Peter Santin Construction Company, Inc. and Roxborough Homes, Inc.↩28. Losson Partnership claimed a depreciation deduction for "furniture and fixtures" in 1971. This deduction is disallowed in its entirety, since petitioners have not proved what portion, if any, of the claimed deduction was allocable to furniture.↩29. Under New York law, fixtures "are articles which were personalty but which by being annexed to realty are regarded as a part thereof." In re Lido Beach Sewage Collection District,40 Misc. 2d 384">40 Misc. 2d 384, 243 N.Y.S.2d 223, 225↩ (Nassau County Ct. 1963). Petitioners have failed to prove that these assets--rugs, appliances, hot water tanks--were not annexed to the buildings. 30. We lack any means to allocate depreciation deductions to petitioners for the periods in 1968 and 1969 in which they owned some of the developed property. ↩31. Again, we note that respondent disallowed the claimed depreciation deductions only on grounds of ownership--we have considered no other reasons for disallowing the claimed deductions.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623042/ | THE HOOVEN, OWENS, RENTSCHLER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hooven, Owens, Rentschler Co. v. CommissionerDocket No. 8820.United States Board of Tax Appeals9 B.T.A. 1376; 1928 BTA LEXIS 4236; January 17, 1928, Promulgated 1928 BTA LEXIS 4236">*4236 1. GOOD WILL. - The cash value of the good will of the petitioner's predecessor company acquired for stock in the year 1901 determined for the purposes of invested capital. 2. INCOME TAXES OF PRIOR YEARS. - In determining the petitioner's invested capital for the year 1920 the amount of the income and profits taxes for the year 1918, when the same shall have been finally determined, should be deducted from invested capital for the year 1920 in the full amount of such taxes. The income and profits taxes for the year 1919, when the same shall have been finally determined, should be deducted from invested capital for the year 1920 in such amount as is authorized by the then existing Treasury regulations and in accord with the provisions of section 1207 of the Revenue Act of 1926. W. W. Spalding, Esq., for the petitioner. John D. Foley, Esq., for the respondent. TRUSSELL 9 B.T.A. 1376">*1377 In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar year 1920, for which the respondent has determined a deficiency of $5,804.61. The petitioner alleges error on the part of the respondent (1) in excluding1928 BTA LEXIS 4236">*4237 from invested capital a value for good will paid in to the taxpayer for capital stock, and (2) in reducing invested capital for 1920 by additional income and profits taxes alleged to be due for 1918 and 1919. FINDINGS OF FACT. The petitioner's predecessor company, having the same name, was organized in the year 1880 and had its principal office and place of business at Hamilton, Ohio. It then took over the assets and going business of an older organization which had for some time been engaged in the manufacture of sawmills and stationary engines. To this business it added that of the manufacture of threshing machines and portable engines, and continued thus for about three years with little success. About the year 1883 it began the manufacture of the Corliss Engine, selling the same under its adopted trade mark of Hamilton-Corliss Engine. This business proved successful and in March, 1891, this predecessor company had an authorized capital of $1,000,000 fully subscribed for. Its business continued growing and expanding, and its sales of the Corliss Engine reached as high as $700,000 a year, and in the year immediately preceding 1901 the gains and profits of the predecessor1928 BTA LEXIS 4236">*4238 company were in round figures $237,000. Preliminary to the reorganization the assets and liabilities of the predecessor company were appraised by three disinterested appraisers, who found that the tangible assets, including cash and bills and accounts receivable, had a then value of $1,273,937.95 and that the current liabilities were $23,937.95. Prior to the making of this appraisal a group of bankers had agreed to underwrite the issue of preferred stock of the proposed successor company and had agreed 9 B.T.A. 1376">*1378 that in the capitalization of the proposed successor company the good will of the predecessor might be taken to have the value of $583,121. The appraisers accepted this estimate of the good will value. The books of account of the predecessor company were all destroyed as a result of a flood which occurred in the year 1913 and no records of that company are now available. The petitioner was organized as a new corporation under the laws of the State of Ohio on or about April 1, 1901, with an authorized capital of common stock, $1,000,000, and preferred stock, $1,000,000, each represented by shares of the par value of $100 per share. All of the common stock and1928 BTA LEXIS 4236">*4239 $750,000 par value of preferred stock were issued in exchange for all the properties and the going business of the predecessor company, the intangibles being included in the amount of $500,000. Five men who had been and were stockholders and directors of the predecessor company received common stock of the new company as follows: SharesPar valueJ. C. Hooven4,377$437,700G. H. Helvey1,296129,600C. O. Richter34434,400G. A. Renschler1,989198,900Henry Sohn1,994199,400Total10,0001,000,000and the 7,500 shares of the preferred stock were, under the direction of the above named stockholders, issued to the Bankers Syndicate for distribution or sale. The opening book entries of the petitioner condensed show its acquired assets and liabilities as follows: Tangible assets$1,273,937.95Good will500,000.00Total1,773,937.95Capital stock:Common1,000,000.00Preferred750,000.00Accounts payable23,937.95Total1,773,937.95The valuation of the tangible properties as above stated is not here challenged. During the nine months from April 1 to December 31, 1901, and the calendar years 1902 and 1903, 1928 BTA LEXIS 4236">*4240 the net earnings and the average tangible assets of the petitioner were as follows: YearNet earningsCapital invested in tangible assets1901 (9 months)$151,676.58$1,250,000.001902232,215.471,367,925.581903214,080.801,555,142.059 B.T.A. 1376">*1379 The petitioner's capital stock outstanding on March 3, 1917, was - Preferred stock$797,600Common stock1,000,000Total1,797,600and the same amounts of preferred and common stock were outstanding on January 1, 1920. In making his adjustments of invested capital for the calendar year 1920 the respondent eliminated the full amount of good will, $500,000. He also eliminated the full amount of income and profits taxes paid by the petitioner for the calendar year 1918, and also $92,948.25 of a proposed additional income and profits tax for the calendar year 1918, and he further eliminated from invested capital for the year 1920 the amount of $803,556.38, computed upon the basis of a tax liability for that year of $1,906,656.06, prorated to installments in accordance with the then existing regulations. The petitioner's income and profits-tax liability for both the years 1918 and1928 BTA LEXIS 4236">*4241 1919 was at the time of the trial of this action being given consideration by the Commissioner under the provisions of sections 327 and 328 of the Revenue Act of 1918 and a final determination of the tax liability for those years had not then been made. The figures eliminated are tentative computations. On September 26, 1925, the Commissioner issued his deficiency letter in which are recited a deficiency for the year 1920 in the amount of $5,804.61 and an overassessment for the year 1921 in the amount of $1,048.13. The deficiency letter contains no exhibit or tabulation showing how these amounts were arrived at but reference is made to a letter sent to the petitioner under date of April 8, 1925, as the basis upon which the deficiency here under review is computed. The said letter of April 8, 1925, is in the record. The good will of the predecessor company had, at the time acquired by the petitioner for stock, a cash value of $328,000. OPINION. TRUSSELL: The business acquired and now owned by this petitioner was started in the year 1880. The record does not show the amount of capitalization of the original organization, but one of 9 B.T.A. 1376">*1380 the witnesses, who had1928 BTA LEXIS 4236">*4242 been with the company continuously since 1880, testified that it began with comparatively small capital and that the increase in its capital and tangible assets was due chiefly to the accumulation of earnings and profits. It is thus seen that from small beginnings in 1880 the business grew until in April, 1901, it had tangible properties of a net value of a million and a quarter dollars, that one of its chief products sold under its trademark reached a figure of annual sales of $700,000 per year and went into every part of this country, together with many sales for export. The petitioner having taken over this business and continued it along the same lines, with other additions, apparently has had an uninterrupted period of prosperity down to and including the year here under review, at the beginning of which the Commissioner found, as shown by his deficiency letter, that the company had accumulated a surplus of $3,697,402.36. The respondent's argument that the predecessor company did not have in 1901 a valuable good will does not make a very strong appeal. Although we do not have the book records of years prior to the reorganization, one of the stockholders of the predecessor1928 BTA LEXIS 4236">*4243 company testified that in the year immediately preceding the reorganization the predecessor company's profits were approximately $237,000 and that for some years prior thereto, he thought they were in the neighborhood of $200,000. The present owners took over this business in April, 1901, and continued it without much modification either as to the character of the business or its capitalization, and during the two years and nine months immediately following the reorganization, the average earnings were at the rate of $216,177, per year upon a capital investment in tangible properties averaging $1,391,022. Analyzing these figures and having given consideration to the history of this business prior to 1901 and the continued prosperity of the business since that date, we have arrived at the conclusion that the good will of the predecessor company acquired by this taxpayer for stock had on the date acquired a cash value of $328,000. The instant case involves income and profits-tax liability for the calendar year 1920 and has been tried when the tax liability for the years 1918 and 1919 are still undetermined. Final determination of deficiency herein for the year under review will1928 BTA LEXIS 4236">*4244 be held to be made in accordance with the findings of fact hereinabove set forth, after the liability for the years 1918 and 1919 has been settled, at which time the taxes for the years 1918 and 1919 will be reflected in the adjustment of invested capital in accordance with the existing regulations and section 1207 of the Revenue Act of 1926. Judgment will be entered upon 15 days' notice, pursuant to Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623043/ | Allan S. Vinnell and Pauline Vinnell, Petitioners v. Commissioner of Internal Revenue, RespondentVinnell v. CommissionerDocket No. 1497-66United States Tax Court52 T.C. 934; 1969 U.S. Tax Ct. LEXIS 59; September 11, 1969, Filed 1969 U.S. Tax Ct. LEXIS 59">*59 Decision will be entered for the respondent. Petitioners owned the stock of two corporations. In 1959, petitioners sold the stock of one to the other corporation under a contract in which the acquiring corporation agreed to pay petitioners $ 1,500,000, without interest, over a period of 10 years. Petitioners reported the 1961 payment of $ 150,000 as an amount realized in exchange for a capital asset. Respondent determined that the 1961 payment was a dividend and should receive ordinary-income treatment instead. The parties agreed that the sale should be treated as a distribution in redemption of the stock of the acquiring corporation. Held:1. The distribution in redemption was essentially equivalent to a dividend, and should therefore be treated as a distribution of property to which sec. 301 applies. Sec. 302(d), I.R.C. 1954; and2. The payment received by petitioners in 1961 was taxable dividend income as determined by respondent, and not capital gain as reported by them. Secs. 301 and 316, I.R.C. 1954. Max Thelen, Jr., and David M. Bridges, for the petitioners.Charles W. Nyquist, for the respondent. Hoyt, Judge. HOYT52 T.C. 934">*934 Respondent determined a deficiency in petitioners' individual income tax for 1961 in the amount of $ 71,903.38. The following two issues must be decided: (1) Whether payments received1969 U.S. Tax Ct. LEXIS 59">*63 by petitioners from the sale of stock in one of their controlled corporations to another of their controlled corporations, treated here as a distribution in redemption of the stock of the acquiring corporation, were essentially equivalent to a dividend; and if so, (2) whether the acquiring corporation's contractual obligation to pay petitioners $ 1,500,000 over a period of 10 years represented a distribution of money or other property in the year of the obligation within the meaning of section 301(b)(1)(A). 1FINDINGS OF FACTThose facts which were stipulated are found accordingly and incorporated herein by this reference.Petitioners are husband and wife. They filed their joint Federal income tax return for the year 1961 with the district director of internal revenue at Los Angeles, Calif. Pauline Vinnell is a party hereto solely because she filed a joint income tax return with her husband for the year 1961. Therefore, Allan S. Vinnell will hereafter 1969 U.S. Tax Ct. LEXIS 59">*64 be referred to as petitioner.Petitioner had been engaged in the contracting business for many years prior to 1944 in southern California and elsewhere. His operations began as a sole proprietorship doing business under the name of 52 T.C. 934">*935 A. S. Vinnell Co. On May 26, 1944, petitioner caused a Mexican company to be incorporated under the name Cia. Vinnell de Mexico, S. A. (hereinafter referred to as CVM). All of the stock in CVM was owned by petitioner at all times prior to December 30, 1959.On August 25, 1944, La Victoria y Asociados, S. A. (hereinafter referred to as LVA) was incorporated in Mexico. Petitioner participated in this venture with Ortiz Rubio, a Mexican national. The stock ownership of LVA upon its incorporation was as follows: CVM, 125 shares; Ortiz Rubio, 125 shares. LVA has been engaged in the construction business in Mexico at all times since its incorporation. In 1954, LVA's field manager purchased a total of 10 percent of the outstanding stock, 5 percent each from CVM and Ortiz Rubio. Upon the field manager's death in 1955, CVM acquired his interest. On January 1, 1956, after the payment of stock dividends, the stock ownership of LVA was as follows: 1969 U.S. Tax Ct. LEXIS 59">*65 CVM, 1,375 shares; Ortiz Rubio, 1,125 shares.On October 5, 1945, petitioner incorporated his domestic contracting business as Vinnell Construction Co., a California corporation. The name was changed to Vinnell Co., Inc., on March 29, 1946, and to Vinnell Corp. by resolution adopted on January 4, 1960, and filed with the secretary of state of California on January 11, 1960. That corporation will hereinafter be referred to as Vinnell Corp. Petitioners were the sole stockholders of Vinnell Corp. at all times prior to December 1959. Allan owned 55 percent of the common stock, and Pauline the other 45 percent.During the years from 1950 to 1960, the corporations under petitioner's control generally were in need of working capital. The only cash which they had available was either that which petitioners supplied, or that which was borrowed and guaranteed by them personally. The receivables of Vinnell Corp., CVM, and various subsidiaries were all pledged as a part of Vinnell Corp.'s revolving line of credit with the Bank of America which was established in 1956 for all operations. The petitioners also personally guaranteed that line of credit. Overall, the one master line of credit1969 U.S. Tax Ct. LEXIS 59">*66 was used for all petitioner's corporations, and all operating loans came through that line. This financing arrangement continued through the year in issue and at least up until the time of trial.The practice in the construction business required the contractor to furnish payment and performance bonds for its jobs. The bonding company's willingness to provide such bonds was directly related to the contractor's "quick assets," that is, the cash and receivables which would be satisfied within 1 year. Thus Vinnell Corp.'s lack of capital and working capital was a limitation on the amount of work it could undertake.In the late 1950's, the companies under petitioner's control were borrowing increasingly larger sums of money from the bank and obtaining 52 T.C. 934">*936 larger bonds from the bonding company. The construction business, unlike many other businesses, depends heavily upon a single personality as the driving force of the business. The bank and bonding company became interested in what would happen to the organization if anything should happen to petitioner. As the liabilities grew, the question became more important. They were therefore anxious to create an arrangement which1969 U.S. Tax Ct. LEXIS 59">*67 would guarantee the continuity of management within the organization. The program which was planned would take care of Pauline Vinnell, who owned approximately half the stock, but simultaneously keep the management in the hands of the company's key employees.In 1956, L. E. Howard was employed by petitioner to supervise the financial aspects of the business in its entirety. He determined that the disconnected situation under which the various companies held their assets should be consolidated in order to give them greater strength with the bank and an increased bonding capacity. He therefore brought changes which satisfied the bank that "all the eggs were in one basket," and thus strengthened the credit position. When Howard was offered his position in Vinnell Corp. by petitioner, he was assured that eventually employees such as himself would be given an opportunity to acquire an equity interest in that corporation. He was also assured of a bonus based upon net profits of the business operation. That figure was to include the net profits of CVM as well as Vinnell Corp.On June 30, 1959, the Vinnell Foundation, a nonprofit corporation, was incorporated under the laws of California. 1969 U.S. Tax Ct. LEXIS 59">*68 The petitioners were among its first directors along with others engaged in the petitioner's construction operation and two of their lawyers. Having no descendants, or close relatives to whom they wished to leave their considerable estates, the petitioners' motive for establishment of the foundation was to carry out various charitable wishes after their deaths, such as to provide for schools and the protection of the health of youngsters.On or about December 21, 1959, Vinnell Corp. liquidated its wholly owned subsidiary Vinnell Corp. of California. The sum of $ 2,774,242.06 was added to the earned surplus account of Vinnell Corp. because of the liquidation. Vinnell Corp. transferred $ 1,743,750 from the earned surplus account to the capital stock account in connection with a subsequent recapitalization. On December 31, 1959, the balance in the earned surplus account was $ 562,485.31.On September 21, 1959, Vinnell Corp. presented a plan for recapitalization to the Commissioner of Internal Revenue. Under the plan, Pauline Vinnell would exchange her common stock representing 45-percent interest in Vinnell Corp. for preferred stock and possibly some common stock, with a total 1969 U.S. Tax Ct. LEXIS 59">*69 par value of $ 580,000. In addition, 250,000 shares of $ 10 par value common stock were to be sold to key management 52 T.C. 934">*937 personnel. On December 14, 1959, the Internal Revenue Service issued a ruling which approved the proposed recapitalization. At no place in either the request for a ruling, in the submitted stockholders' agreement, or in the correspondence with respect thereto was it mentioned that Allan proposed to sell his CVM stock to Vinnell Corp.On November 6, 1959, an application for a permit authorizing the issue and sale of securities under a plan of reorganization, and proposing to sell not more than 40,000 shares of common stock of Vinnell Corp. to named key executives was filed by Vinnell Corp. with the Department of Investment, Division of Corporations, State of California. The application also sought permission to issue 12,375 shares of 6-percent cumulative nonparticipating $ 100 par value preferred stock to Pauline Vinnell in return for her 450 shares of $ 100 par value common stock. No mention of a proposed purchase of petitioner's CVM stock was made in this application. The reasons given in the application for the proposed recapitalization were as follows: 1969 U.S. Tax Ct. LEXIS 59">*70 (a) to provide the management officers and employees of Applicant an opportunity for substantial stock ownership in Applicant; and(b) to provide that, in the event of the death of Mr. Vinnell, control of the corporation should not be in the hands of Mrs. Vinnell.On December 30, 1959, the commissioner of corporations of the State of California issued the permit to grant Vinnell Corp.'s request in the application to recapitalize.On December 30, 1959, the board of directors of Vinnell Corp. adopted a resolution to purchase petitioner's interest in CVM for $ 1,500,000, payable in equal installments over a 10-year period. As of December 31, 1959, the book value of CVM was $ 1,580,918.66, stipulated by the parties as follows:ASSETSCash$ 5,022.93Note receivable -- Vinnell Corp500,323.32Account receivable -- Vinnell Corp179,302.20Account receivable -- La Victoria340,813.72Machinery332,971.49Reserve(332,971.49).00Investment -- La Victoria stock552,000.00Other assets3,456.49Total assets$ 1,580,918.66LIABILITIESAccount payable -- A. S. Vinnell$ 229,564.06Taxes payable731.66Total liabilities$ 230,295.72Capital stock46,391.75Retained earnings1,304,231.19Total liabilities and capital1,580,918.661969 U.S. Tax Ct. LEXIS 59">*71 52 T.C. 934">*938 The purchase price agreed to by petitioner and Vinnell Corp. was an approximation of the book value of CVM. The resolution adopted by the corporation's board of directors, consisting of the two petitioners, L. E. Howard, Jr., and Samuel S. Gill, authorized the purchase and stated that Vinnell Corp. had sufficient earned surplus to make the purchase, and that the installment payments would not impair its credit or cause it to be unable to meet its debts as they became payable.On that same date, an agreement for purchase and sale of the CVM stock by petitioner to Vinnell Corp. for $ 1,500,000 was executed and consummated. The agreement obligated Vinnell Corp. to pay petitioner $ 1,500,000 for the CVM stock in equal installments of $ 150,000 each for 10 years. The first payment was made at the time of the sale. Vinnell Corp. agreed to make the payments annually unless one of them were prohibited by a loan agreement with an obligee of the corporation, in which case that payment would be deferred until succeeding anniversary dates of the sales agreement following the 10th anniversary date thereof. The payments were also to be subordinate to any claims of the Bank of America. 1969 U.S. Tax Ct. LEXIS 59">*72 The corporation was not in a position to pay cash at the time of the sale, but petitioner fully expected to be paid off within the 10-year period. By December 31, 1961, three payments of $ 150,000 each had been made to petitioner pursuant to the agreement.On October 31, 1960, CVM was liquidated into Vinnell Corp. Its net worth at that time was $ 1,562,855. Petitioner and his advisers had discussed such a move as early as mid-December 1959. Even before the sale of CVM to Vinnell Corp., CVM's spare cash was available for the credit of the group to provide additional operating funds for the entire group. CVM had no direct banking relations as such; its financing arrangements had always been handled as a part of those of Vinnell Corp.On July 11, 1960, CVM sold its stock in LVA to Vinnell International Corp., a wholly owned Panamanian subsidiary of Vinnell Corp. for $ 522,000. The LVA stock was first sold to petitioner as a strawman, and then by him to Vinnell International Corp.On December 30, 1959, petitioner executed a stockholders' agreement which imposed certain restrictions upon the sale of stock in Vinnell Corp. This agreement was executed at the same time the sales agreement1969 U.S. Tax Ct. LEXIS 59">*73 for the CVM stock was executed and consummated. Part of the agreement provided that the petitioner herein would not carry on a contracting business in his individual capacity or through the medium of any other corporation besides Vinnell Corp. He agreed to sell all his stock in CVM to Vinnell Corp. on mutually agreeable terms. As already mentioned, the plan of recapitalization which Vinnell Corp. had submitted to the Commissioner of Internal Revenue52 T.C. 934">*939 on September 21, 1959, with a request for a ruling on taxability of the transaction, made no mention of the proposed sale by petitioner of his CVM stock. The paragraph appearing in the stockholders' agreement of December 30, 1959, was omitted from the proposed agreement submitted to the Internal Revenue Service on September 21, 1959,On April 11, 1963, petitioner and the other shareholders of Vinnell Corp. executed a stockholders' agreement which superseded the agreement of December 30, 1959. Petitioner also agreed in the later agreement not to carry on a contracting business in his individual capacity or through any corporation but Vinnell Corp. or one of its subsidiaries.On December 30, 1959, Pauline Vinnell surrendered1969 U.S. Tax Ct. LEXIS 59">*74 her 450 shares of common stock in Vinnell Corp. and received in return 12,375 shares of its preferred stock. On that same day, petitioner surrendered his 550 shares of common stock and received in return 151,250 shares of common stock.No dividends were declared on common stock by Vinnell Corp. in 1961 or prior years. As of December 31, 1961, the earned surplus account of the corporation showed a balance of $ 878,323.35.On or about June 1, 1960, 10 of the executives of Vinnell Corp. purchased common stock of Vinnell Corp. at $ 10 per share, pursuant to the permit referred to above. The purchases were for cash, and were financed in part by funds advanced to the executives by petitioner through a special bank account with the Bank of America opened by him for that purpose. The 10 executives executed notes in his favor and received checks drawn on the special bank account which were used to purchase the stock in Vinnell Corp. from petitioner. On June 15, 1960, the stock certificates were delivered to the executives and they executed the stockholders' agreement referred to above. The corporation received $ 385,000 in cash as paid-in capital as a result of these sales of stock. 1969 U.S. Tax Ct. LEXIS 59">*75 The common stock of Vinnell Corp. after issuance of stock on June 15, 1960, was as follows:Number ofNamesharesA. S. Vinnell151,250McNamara7,500Hayes2,500Howard6,000Norwood2,500Griffith2,000Griggs5,000Buckley2,500Hilger2,000Pope3,500Hodgson5,000189,750Prior to the recapitalization, the petitioners owned 100 percent of the stock in Vinnell Corp. On June 15, 1960, petitioner owned 79.7 percent of the common stock and Pauline owned the issued preferred stock.In December of 1959, 1960, and 1961, Vinnell Corp. made payments to petitioner of $ 150,000 each, pursuant to the agreement for sale of 52 T.C. 934">*940 the CVM stock. Petitioners reported income each year in the amount of $ 145,360.80 as capital gains on the installment basis. It is stipulated that no adjustment was made with respect to these gains and the income tax liability for petitioners for the years 1959 and 1960 are not at issue herein, the statute of limitations having expired. Respondent determined that the entire $ 150,000 payment made in 1961 was a dividend taxable at ordinary income tax rates and increased petitioner's dividend income accordingly "by $ 149,950.00 (Dividend1969 U.S. Tax Ct. LEXIS 59">*76 of $ 150,000.00 less dividend exclusion of $ 50.00)" for that year. Reported capital gains were adjusted to eliminate therefrom the $ 145,360.80 returned.OPINIONThe sale of the CVM stock by petitioner to Vinnell Corp. falls within the purview of section 304(a)(1), 2 and the parties so agree. That section requires that property received by petitioner in return for the CVM stock be treated as a distribution in redemption of the stock of the acquiring corporation (Vinnell Corp.). For the purposes of the present case, the term "property" is defined by section 317 as money, securities, or other property.1969 U.S. Tax Ct. LEXIS 59">*77 We are thus required to treat this sale of stock as a redemption by petitioner of his stock in Vinnell Corp.Section 302(a)31969 U.S. Tax Ct. LEXIS 59">*78 requires us to treat the redemption as a distribution in exchange for the stock so long as the transaction meets one of the four tests of section 302(b). Petitioner contends that he meets the test of section 302(b)(1)4 in that the redemption was not essentially equivalent to a dividend. On the other hand, respondent contends that the redemption fails to meet the test, and that therefore section 302(a) cannot apply. Instead, respondent contends that section 302(d)5 requires us to treat the redemption as 52 T.C. 934">*941 a distribution of property to which section 301 applies. The issue as presented by the parties and submitted for decision therefore deals with whether the redemption was essentially equivalent to a dividend. Sec. 302(b)(1). Respondent contends that it was, and so the 1961 installment payment should be treated as a distribution taxable as ordinary income. Petitioner argues that it was not essentially equivalent to a dividend, and asks us to preserve capital gains treatment for the 1961 installment payment.Essentially, petitioners contend that the sale of the CVM stock to Vinnell Corp. was born of business necessity, and therefore cannot be essentially equivalent to a dividend. They have argued that business purposes made it necessary to contract the various entities which comprised petitioner's construction empire into one operating corporation so as to increase the business "quick assets," thereby improving its credit position and bonding capacity. They aver that another purpose of the1969 U.S. Tax Ct. LEXIS 59">*79 sale was to make the offer to sell stock in Vinnell Corp. more attractive to its key executives, "to the end that the prosperity, further expansion and perpetuity of the business could be assured." Thus petitioner contends that the sale of CVM to Vinnell Corp. was designed to go hand-in-hand with the idea of permitting the key executives to acquire an equity interest in the business and was a part of the planned recapitalization.Section 304(a)(1) was enacted in order to prevent a taxpayer from using brother-sister corporations which he controls as an instrumentality for "bailing out" corporate earnings at capital gains rates. It requires the transaction to be viewed through the section 302 glass with its accompanying safeguards against dividend equivalency, rather than as a sale of stock to an unrelated third party. We therefore will examine each of the motives for the sale put forth by petitioners with a view towards discerning whether a bailout of corporate earnings, such as would give rise to the dividend equivalence result, was being attempted.Petitioners first contend that the combining of Vinnell Corp. and CVM increased the "quick assets" which improved the acquiring corporation's1969 U.S. Tax Ct. LEXIS 59">*80 credit position and bonding capacity. This argument finds little support in the record. During the years while petitioner owned both CVM and Vinnell Corp., CVM had no direct banking relations as such, but rather its finances were handled as if it were a part of Vinnell Corp. Before the sale, CVM's spare cash was combined with the operating funds of Vinnell Corp. to provide additional operating funds for the entire group. As reflected in our findings, at the time of sale CVM had only $ 5,000 in cash on hand and held over $ 500,000 in notes receivable and $ 179,000 in accounts receivable of Vinnell Corp. It also held $ 340,000 in accounts receivable of LVA. 52 T.C. 934">*942 When these notes or accounts were due does not appear of record. We conclude that contrary to petitioners' contentions, CVM had almost no quick assets even though it might be regarded from the accounting point of view that some working capital as such was brought into the Vinnell picture by the stock transfer. However, all the corporate loans and bonds had always been personally guaranteed by petitioners, so that in effect petitioner's stock in CVM stood back of all Vinnell Corp.'s obligations as assets of the guarantor. 1969 U.S. Tax Ct. LEXIS 59">*81 No additional security therefore actually resulted from the transfer of the CVM stock to Vinnell Corp.There was no evidence offered that the Bank of America demanded or requested the purchase of petitioner's CVM stock, it being merely stated by Vinnell himself on the witness stand that the stock "was to be sold or included in the reorganization" and that the sale transaction was set up and arranged because of the decision of his financial and legal advisers. The evidence of record does not convince us that the motivating force for the sale arose from corporate business purposes to obtain credit or to improve bonding arrangements; we conclude that Vinnell Corp.'s credit position and bonding capacity were not materially aided by the sale. Petitioners continued to guarantee corporate borrowings and obligations after the sale up to time of trial as they had always done. Thus while the acquisition of the CVM stock might have resulted in the improvement of Vinnell Corp.'s financial position to some extent, it cannot be regarded as the reason for the purchase.If Vinnell Corp. was concerned about its credit situation and its capacity to obtain performance bonds, why did it pay out $ 1969 U.S. Tax Ct. LEXIS 59">*82 150,000 in cash and obligate itself to pay an additional $ 1,350,000 over a 9-year period? A further issuance of stock, common or preferred, in lieu of such an obligation would have obviously been a more satisfactory device to enhance its financial attractiveness to banks and bonding companies. Kerr v. Commissioner, 326 F.2d 225, 232 (C.A. 9, 1964), affirming 38 T.C. 723">38 T.C. 723 (1962), certiorari denied 377 U.S. 963">377 U.S. 963 (1964).The next contention as to corporate business purpose put forth by petitioners appears to be similarly unsupported by the facts of record. It is argued that petitioner had intended for years to combine CVM with Vinnell Corp. as a part of the recapitalization and sale of stock to key employees. Petitioner discussed the sale of stock to certain key employees at the time of their employment and thereafter, with the understanding that petitioner would allow them to acquire an equity interest in Vinnell Corp. when conditions permitted. No mention was made at the time such discussions were held of making CVM a subsidiary of Vinnell Corp. or of a sale by petitioner of his stock. Petitioner1969 U.S. Tax Ct. LEXIS 59">*83 has alleged that the sale of the CVM stock was an integral part of 52 T.C. 934">*943 the recapitalization under which petitioners received different stock and key employees acquired stock interests, yet no mention was made of the CVM sale either to the affected employees, to the State of California in the application to recapitalize, in the plan for recapitalization submitted to the Internal Revenue Service on September 21, 1959, or in the stockholders' agreement attached thereto.In light of the lack of evidence indicating that the sale was a part of the recapitalization, we are inclined to agree with respondent that it was an afterthought by petitioner rather than a part of his long-range plans. Although petitioner stressed at trial that he had always wanted to bring CVM into Vinnell Corp., he did not know why a sale of his CVM stock was necessary to accomplish that objective.We conclude that the initiative for the sale originated, at a late date in 1959, with petitioner who was advised by his financial and legal advisers that the transaction, which had not theretofore been contemplated as a part of the recapitalization or plan to permit key employees to become stockholders, be cast as1969 U.S. Tax Ct. LEXIS 59">*84 a purchase and sale. As the sole stockholder of CVM and as owner of 55 percent of Vinnell Corp.'s stock and with his wife (who owned the other 45 percent of that stock), the owner of 100 percent of Vinnell Corp. also, 6 it would strain credibility to believe that initiative to obligate itself to pay petitioner $ 1,500,000 came from the corporation and not from petitioner. Kerr v. Commissioner, supra.Applying the constructive-ownership rules of section 318(a)(2) (C), 7 there was no change in the stock ownership caused by the sale of CVM to Vinnell Corp. Although subsequently petitioner's constructive ownership of Vinnell Corp., and thus CVM as well, was reduced from 100 percent to 79 percent in June of 1960 when the key employees acquired their stock interests, we have found that the CVM sale was not a part of the recapitalization and sale thereafter of some common stock to employees. Therefore, the distribution in redemption, 1969 U.S. Tax Ct. LEXIS 59">*85 by itself, did not result in any change in the proportionate ownership of stock by the shareholders.The parties have stipulated that Vinnell Corp. had never paid a dividend. There are no other corporate distributions with which we may compare the one in question in order to find that it was anything but an attempted bailout of corporate earnings at capital gains rates.We have already discussed petitioner's allegations regarding a business purpose for the CVM sale above, and found them to be without 52 T.C. 934">*944 support in the record. Even if we were to give credence to petitioner's "business purpose" argument that the 1969 U.S. Tax Ct. LEXIS 59">*86 CVM sale took petitioner out of competition with Vinnell Corp. and was part of the long-range recapitalization plan, thereby making the Vinnell Corp. stock more attractive to the key employees, it has been held many times that the existence of a single business purpose will not of itself conclusively prevent a determination of dividend equivalence. Kerr v. Commissioner, supra;United States v. Fewell, 255 F.2d 496 (C.A. 5, 1958); Bradbury v. Commissioner, 298 F.2d 111 (C.A. 1, 1962), affirming a Memorandum Opinion of this Court; Kessner v. Commissioner, 248 F.2d 943 (C.A. 3, 1957), affirming per curiam 26 T.C. 1046">26 T.C. 1046 (1956); Genevra Heman, 32 T.C. 479">32 T.C. 479 (1959); and Neff v. United States, 305 F.2d 455 (Ct. Cl. 1962).We conclude and hold that here there was no real or meaningful shift in the position of the petitioner, qua stockholder, in relation to the corporation and the other shareholders occasioned by the distribution. Immediately thereafter petitioner1969 U.S. Tax Ct. LEXIS 59">*87 owned precisely the same stock interest and yet he had received $ 150,000 and would receive $ 1,350,000 more by virtue of the sale agreement. Inasmuch as the distribution was initiated by the petitioner for a stockholder purpose, not a corporate business purpose, and in light of the dividend history, we are of the opinion that it was essentially equivalent to a dividend. We so hold.After the case was submitted and the parties had filed their briefs, it occurred to us that there was a further issue, not discussed by the parties or presented on brief. This was whether or not the contractual obligation of the 1959 contract itself might not properly be regarded as the distribution of property in that year so that if dividend equivalence were determined, the taxable event took place at that time. In Kerr v. Commissioner, supra, involving issues similar to those presented here, the issuance of a promissory note by the acquiring corporation was held to be essentially equivalent to a dividend in the face amount of the note in the year of issuance even though it was by express terms payable in equal yearly installments thereafter over a period of 5 years. 1969 U.S. Tax Ct. LEXIS 59">*88 It is clearly contemplated and suggested by section 312(a)(2), by the regulations, 8 and by leading tax treatises 9 that in lieu of distributing cash or property, a corporation may distribute its own obligations with the identical tax consequences.The petitioner declined to take a position on this issue or to file a supplemental brief, but respondent filed a brief. He suggested that 52 T.C. 934">*945 assuming arguendo that the distribution here involved was essentially equivalent to a dividend, there were here a series of distributions pursuant to the acquiring corporation's contractual obligation to petitioner, which was not itself a distribution of money or property within the meaning of section 301(b)(1)(A) in the year of execution, 1959; the payments themselves in the various years, including 1961, constituted dividends at the times they were made. 1969 U.S. Tax Ct. LEXIS 59">*89 We agree with respondent and on the record before us conclude and hold that the contractual obligation here involved did not constitute the distribution of an obligation of the acquiring corporation in 1959 so as to subject it to taxation as a money or property distribution in that year. The contract itself was merely written evidence of the obligation of Vinnell Corp. to pay petitioner $ 1,500,000 over a period of years for his stock of Cia. Vinnell and not intended by the parties to be in payment of that obligation. The contract contained no provision for the payment of interest. The petitioner's rights to payments were subject to various contingencies; they were subject to deferral beyond the 10-year term specified because of prohibitions in any loan agreements with lending institutions or "any similar prohibition." Furthermore, petitioners specifically agreed that his rights to payments under the contract "shall be subordinate to any claims of the Bank of America" arising under or out of its present lending agreement with Vinnell Corp. and he further agreed to execute any subordination agreement which the bank might require.Under all of the facts and circumstances here present, 1969 U.S. Tax Ct. LEXIS 59">*90 the contractual obligation created in 1959 cannot properly be regarded as a distribution in that year of money or property within the meaning of section 301(b)(1)(A). Cf. Nina J. Ennis, 17 T.C. 465">17 T.C. 465 (1951); Dudley T. Humphrey, 32 B.T.A. 280">32 B.T.A. 280 (1935).We agree with respondent that the annual payments made by Vinnell Corp. to petitioner under its contract of December 31, 1959, were a series of distributions within the purview of sections 301 and 316 in the years in which they were made. In view of the fact that Vinnell Corp., the acquiring corporation, had accumulated earned surplus of $ 878,323.35 as of December 31, 1961, and petitioners have not established that accumulated earnings and profits did not equal at least the amount determined by respondent as a taxable dividend, the 1961 payment of $ 150,000, here involved, is taxable to petitioners as ordinary income. The respondent's determination must be sustained.Decision will be entered for the respondent. Footnotes1. All references are to the Internal Revenue Code of 1954.↩2. SEC. 304. REDEMPTION THROUGH USE OF RELATED CORPORATIONS.(a) Treatment of Certain Stock Purchases. -- (1) Acquisition by related corporation (other than subsidiary). -- For purposes of sections 302 and 303, if -- (A) one or more persons are in control of each of two corporations, and(B) in return for property, one of the corporations acquires stock in the other corporation from the person (or persons) so in control,then (unless paragraph (2) applies) such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock. In any such case, the stock so acquired shall be treated as having been transferred by the person from whom acquired, and as having been received by the corporation acquiring it, as a contribution to the capital of such corporation.↩3. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.(a) General Rule. -- If a corporation redeems its stock (within the meaning of section 317(b)↩), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.4. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.(b) Redemptions Treated as Exchanges. -- (1) Redemptions not equivalent to dividends. -- Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.↩5. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.(d) Redemptions Treated as Distributions of Property. -- Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301↩ applies.6. Secs. 302(c)(1) and 318(a)(1)(A)(i), I.R.C. 1954↩.7. SEC. 318(a)(2)(C)↩. From Corporations. -- If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.8. Secs. 1.301-1(d) and 1.301(h)(2)(i), Income Tax Regs.↩9. Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, sec. 5.40 (2d ed. 1966).↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623044/ | Estate of John B. Sharpe, The Union Trust Company of Pittsburgh, Executor, Petitioner, v. Commissioner of Internal Revenue, RespondentSharpe v. CommissionerDocket No. 112179United States Tax Court3 T.C. 612; 1944 U.S. Tax Ct. LEXIS 147; April 14, 1944, Promulgated 1944 U.S. Tax Ct. LEXIS 147">*147 Decision will be entered for the respondent. 1. Shortly before his death an individual transferred a substantial portion of his property to a trustee with instructions to distribute the corpus ratably, during the 25 years immediately following his death, to an English corporation organized for the general purpose of advocating, espousing, and maintaining the principle of the "Single Tax." The value of the property on the date of death was deducted by the executor from gross estate on the theory that such deduction was proper under section 303 (a) (3) of the Revenue Act of 1926 as amended. Under the facts it is held:(1) Petitioner has failed to show that the named beneficiary under the trust was, in fact, the trustee of a trust and required to use the funds exclusively for charitable or educational purposes.(2) The corporate beneficiary has not been shown to have been organized and operated exclusively for charitable or educational purposes and a substantial part of its activities consisted of carrying on propaganda or otherwise attempting to influence legislation.2. The discounted value of the right of a trustee to collect, during the 25 years immediately following the1944 U.S. Tax Ct. LEXIS 147">*148 death of the settlor, a percentage of the corpus of the trust as distribution is made, can not be allowed as a deduction from gross estate under section 303 (a) (1) (B) of the Revenue Act of 1926 as amended, nor may it be excluded from the value of the property which is to be included in gross estate. Central Hanover Bank & Trust Co. v. Commissioner, 118 Fed. (2d) 270, followed. John Lloyd, Jr., Esq., for the petitioner.Paul A. Waring, Esq., for the respondent. Mellott, Judge. MELLOTT3 T.C. 612">*613 The Commissioner determined a deficiency in estate tax in the amount of $ 39,004.43. The principal issue is whether the value of the corpus of a trust established by the decedent, for the benefit of a corporation organized for the purpose of advocating and furthering the "Single Tax" as expounded by Henry George, is deductible from gross estate as a transfer for charitable or educational purposes. A subsidiary issue is whether the value, as of the date of death, of executor's commissions on corpus payable to the beneficiary in the future may be deducted from gross estate.Most of the basic facts have been stipulated and are found accordingly. 1944 U.S. Tax Ct. LEXIS 147">*149 We summarize the stipulated facts. Others shown in our findings are based upon evidence adduced at the hearing.FINDINGS OF FACT.John B. Sharpe, hereinafter sometimes referred to as the decedent, died testate in the eightieth year of his life at Atlantic City, New Jersey, on September 18, 1938. His only heirs at law and next of kin were two cousins. His will was executed July 23, 1938. The Union Trust Co. of Pittsburgh, Pennsylvania, was duly appointed executor of his estate.Under item third of decedent's will his residuary estate was bequeathed to the Union Trust Co. of Pittsburgh, Pennsylvania, with instructions that it be added to and be made a part of the trust hereinafter referred to.On July 18, 1938, the decedent executed a deed of trust, naming the Union Trust Co. of Pittsburgh as trustee. He transferred to the trustee stocks and bonds having a stated value of $ 297,316.58, ordering that the property be held and managed in accordance with his directions. Briefly, the directions were that the income be paid over to the settlor during the term of his natural life; but if he should become ill or incapacitated the trustee was authorized to use so much of the principal1944 U.S. Tax Ct. LEXIS 147">*150 of the trust estate as it should deem necessary and advisable for his proper and comfortable maintenance and support. After his death the trustee was to pay from corpus and accumulated income all of the donor's just debts, expenses of his last illness, inheritance and estate taxes, expense of erecting a headstone at his grave (provided the personal estate should not be sufficient to pay them, the same provisions also being contained in his will), and the balance of the property was to "continue in trust and the net income therefrom [be] paid over in convenient installments to The United Committee for the Taxation of Land Values, Limited" of London, England.The trust is to continue for 25 years. Beginning one year after the date of the donor's death the trustee is to pay over to the committee 13 T.C. 612">*614 one twenty-fifth of the trust corpus, free and discharged of the trust, the provision of the trust instrument being so phrased that at the end of 25 years the total trust corpus and income will have been paid over to the committee in substantially equal annual amounts.1944 U.S. Tax Ct. LEXIS 147">*151 The decedent, for many years, had been interested in political economy, especially in the theory advocated and espoused by Henry George known as the "Single Tax," or tax only upon land. He had written at least one pamphlet upon the subject himself. 2 He wrote, or in any event furnished to the draftsman of his trust, the language which became paragraph (f) of article I, reading as follows:(f) The Donor wishing to continue the support he has long given the United Committee for the Taxation of Land Values, Limited, and to assist it in maintaining its future activities, directs that the payments hereinabove directed to be made to the said the United Committee for the taxation of Land Values, Limited, be used and expended by the said the United Committee for the Taxation of Land Values, Limited, primarily for the distribution of literature advocating the justice and expediency of taxing land values and exempting from taxation the improvements, industries, and the processes of exchange, and in such other ways of expenditures as the said the United Committee for the Taxation of Land Values, Limited, shall from time to time deem wise and expedient, provided, however, that all such expenditures1944 U.S. Tax Ct. LEXIS 147">*152 shall be in accord and consistent with the aim and purpose of this gift, which is to promote a wider knowledge and a greater appreciation of the moral basis and economic principle of what has come to be known as the Single Tax as developed and set forth by Henry George in his book entitled "Progress and Poverty." Any such payments so made by the Trustee, however, shall be without liability on the Trustee to see to the proper application of the expenditure of the same.The United Committee for the Taxation of Land Values, Limited, is a company limited by guarantee and not having a share capital, incorporated on January 23, 1929, under The Companies Acts 1908 to 1917 of England. A copy of the memorandum and articles of association is made a part of the stipulation.The memorandum provides, inter alia.3. The objects for which 1944 U.S. Tax Ct. LEXIS 147">*153 the Association is established are --(A) To promote economic freedom and social justice by publishing, advocating and maintaining the principles and policy of Land-Value Taxation and Free Trade as expounded by Henry George.(B) To secure discussion and consideration of the said principles and their probable effect upon social welfare; to assist in all proper ways to establish the same in practical operation of law; to aid in the education of the public in the science of political economy and sound principles of taxation (according to the published works of Henry George); and for these purposes to establish and maintain such facilities as may be necessary for publishing, 3 T.C. 612">*615 lecturing and educational activities, and/or to give aid to individuals or other organizations with similar objects and to do all other acts that may tend to further the objects named. * * *(E) To undertake and execute any trusts which may lawfully be undertaken by the Association and may be conducive to its objects. * * ** * * *4. The income and property of the Association, whencesoever derived, shall be applied solely towards the promotion of the objects of the Association as set forth in this Memorandum1944 U.S. Tax Ct. LEXIS 147">*154 of Association, and no portion thereof shall be paid or transferred, directly or indirectly, by way of dividend, bonus or otherwise howsoever by way of profit, to the Members of the Association.Provided that nothing herein shall prevent the payment, in good faith, of reasonable and proper remuneration to any officer or servant of the Association, or to any Member of the Association, in return for any services actually rendered to the Association.* * * *7. If upon the winding up or dissolution of the Association there remains, after the satisfaction of all its debts and liabilities, any property whatsoever, the same shall not be paid to or distributed among the Members of the Association, but shall be given or transferred to some other institution or institutions having objects similar to the objects of the Association, such institution or institutions to be determined by the Members of the Association at or before the time of dissolution, or in default thereof by such judge of the High Court of Justice as may have or acquire jurisdiction in the matter.According to the report of the committee for the year 1935 it made total expenditures during that year of £ 2,369, of which £ 1521944 U.S. Tax Ct. LEXIS 147">*155 were expended in connection with "municipal campaign" and £ 118 for "general election." The expenditures are not shown in detail, but appear to have been for pamphlets, memoranda leaflets, press communications, circulars, etc. The total expenditures for the year 1936 were £ 2,181, of which £ 271 appear to have been made for "general propaganda, meetings, Etc."Article 5 of the deed of trust signed by the decedent under date of July 18, 1938, provides:The Trustee shall receive reasonable compensation on the gross income collected, payable at the time or times the income is distributed hereunder.The Trustee shall receive no compensation on the principal of the trust covering withdrawals therefrom made by the Donor for his benefit during his lifetime either by revocation of the trust in part or in its entirety, or by expenditure from the principal by the Trustee for the benefit of the Donor should he become incapacitated.The Trustee, however, shall receive additional reasonable compensation on the principal of the trust estate remaining in its hands after the death of the Donor, excepting that the Trustee shall not be entitled to receive such additional compensation on any amounts1944 U.S. Tax Ct. LEXIS 147">*156 on which the Trustee has received compensation as Executor of the Will of the Donor.The yearly payments from the trust, which have been made since the death of the decedent, have been sent by the trustee to the Bankers Trust Co. of New York for the credit of the committee. The record 3 T.C. 612">*616 does not show how any portion of the amount has been expended by the committee.In the Federal estate tax return filed by the executor on October 11, 1939, the total gross estate is shown to be $ 308,105.97. The Commissioner determined it to be $ 308,162.22. The deductions claimed for funeral expenses, debts, attorney's fees, and miscellaneous administration expenses have been allowed. In schedule G of the return stocks and bonds aggregating $ 297,260.33 are listed, together with a notation to the effect that they comprised the corpus of a revocable trust created by the decedent on July 18, 1938, with the Union Trust Co. of Pittsburgh as the trustee. The value of the securities at the date of decedent's death is shown to be $ 279,065.19 and the value is not now in issue. The executor deducted the entire amount from gross estate, explaining, in schedule N, that decedent had made a gift1944 U.S. Tax Ct. LEXIS 147">*157 of the entire net residuary estate (including trust) to the United Committee for Taxation of Land Values, London, England. The Commissioner determined that the amount "is not deductible from the value of the gross estate under Section 303 (a) (3) of the Revenue Act of 1926 as amended."In schedule O of the estate tax return the executor deducted "Executor's Commissions $ 8,890.95." The Commissioner allowed $ 542.35, this being the amount of commissions paid and applicable to the personal estate of the decedent, exclusive of the trust. The remainder, $ 8,348.60, 3 was disallowed. This amount is approximately the present value on the date the return was filed of the right to collect during the ensuing 25 years 5 percent of the value of the property held in trust (5 percent of $ 279,065.19 or $ 14,863.02) discounted yearly over the life of the trust. 3A reasonable fee or charge in connection with paying over the corpus of1944 U.S. Tax Ct. LEXIS 147">*158 the trust to the beneficiary and preparing the necessary accounts is 5 percent of the amount paid over, and the trustee, since the death of the decedent, has followed the practice of paying such amount over to itself at each installment payment of principal to, or for the credit of, the committee.OPINION.The provisions of the revenue act and of the regulations applicable to the first issue are shown in the margin. 41944 U.S. Tax Ct. LEXIS 147">*159 3 T.C. 612">*617 Petitioner, pointing out that the statute recognizes a transfer may be made either to a corporation meeting the specified tests or to a trustee meeting somewhat the same but neverthless different tests, divides its argument into two parts. Its major contention, or in any event the one discussed at greater length upon brief, is that the decedent, in effect, created two successive trusteeships -- one (Union Trust Co.) being "an investing trustee" and the other (the committee) being "a spending trustee." In this view it contends it is entitled to the claimed deduction, regardless of what might be the nature of the activities of the United Committee. It argues, however, that the evidence establishes the corporation named as beneficiary of the trust possesses all of the characteristics specified in the first subdivision of the statute and that the deduction should be allowed even if its theory that the committee was a mere spending trustee be found to be untenable.Respondent insists that his determination should be upheld. He argues that the evidence conclusively shows the committee was not organized and operated exclusively for charitable or educational purposes and that1944 U.S. Tax Ct. LEXIS 147">*160 a substantial part of its activities consisted of carrying on propaganda or otherwise attempting to influence legislation; that it was the beneficiary of the gift made by decedent and could expend the funds in any way it saw fit; that its purpose was "to assist in all proper ways to establish * * * [the principles espoused by Henry George] in practical operation of law;" that some of the ways determined by it to be proper included propaganda, attempts to influence legislation, and the carrying on of political activities in an effort "to effect a change in the existing tax system"; and that the gift was clearly outside of the purview and intent of the statute.The parties base a substantial part of their argument upon evidence of doubtful pertinency or value -- reports of the committee for the years 1935 and 1936. Respondent quotes at length from one of them to 3 T.C. 612">*618 show that the committee, by its own statement, had been enabled to carry out "with the revenue from donations and contributions to the Land & Liberty [magazine published by the committee] Sustentation Fund * * * the special propaganda, notably on the municipal campaign and the General Election, as explained in this1944 U.S. Tax Ct. LEXIS 147">*161 report." Petitioner points out that the same report shows it has carried on its work "as a purely non-party educational association, making opinion as it can through the financial means placed at its disposition by voluntary contribution"; that it has been appointed as trustee of the "Henry George Foundation of Great Britain" and as such has, as required by the deed of trust of a named contributor (not this decedent), complied with the provisions requiring that the fund "be used only for the publication, advertizing and circulating of the works of Henry George and kindred literature offered for sale and not * * * for subsidizing any other form of work"; and that the funds of the foundation "are kept entirely distinct from those of the United Committee." This, it insists, supports its contention it was merely "a spending trustee," supervising and administering the charitable trust, represented by the funds being and to be turned over to it by the "investing trustee." Respondent also points out that at least in 1935 and 1936 substantial amounts, as shown in our findings, were expended by the committee for "general propaganda" and in connection with "municipal campaign" and "general 1944 U.S. Tax Ct. LEXIS 147">*162 election."In our judgment the statements contained in the reports, even though brought onto the record by the stipulation of the parties, can not be made the basis of decision in the instant case. Even if we ignore the hearsay feature, the action of the committee in years prior to the transfer by the decedent is not determinative of the use to which the funds contributed by the decedent will be put. Nor can we find anything in the present record which would justify us in concluding that the settlor intended that the gift, when received by the committee, would be held by it in trust for the foundation referred to in the reports or for any other limited use. In reaching this conclusion we have not failed to take into consideration the well established principles applicable to charitable trusts, as carefully and, on the whole, accurately set out in petitioner's brief. Briefly they are -- whether tested by the laws of New Jersey, decedent's domicile, by the laws of Pennsylvania, where the trust was accepted, 5 or by the laws of England, where the committee has it principal office and conducts its activities -- that charitable trusts are favored by the law and by the courts, will 1944 U.S. Tax Ct. LEXIS 147">*163 not be permitted to fail for want of a trustee, will be construed to effectuate the will of the 3 T.C. 612">*619 settlor no matter how ineptly expressed, and will be enforced by the courts in an action prosecuted by the proper officer in the name of the sovereign. To these may be added, as suggested by petitioner, it is not necessary for the creation of a charitable trust that the donee be specifically described as a trustee or that the gift be specifically characterized a trust, if from the whole instrument it clearly appears that a charitable trust was intended to be created, and the trustee may be either a private person or a corporation.Most of the cases cited by petitioner from the three jurisdictions merely exemplify one or more of the general principles briefly alluded to. The1944 U.S. Tax Ct. LEXIS 147">*164 differences, if any, in the law of the three jurisdictions seem to be so few and insignificant that we need not pause to determine which is applicable. On this phase of the case it should be kept in mind that we are not now considering the question presented to the courts in most of the cases cited by petitioner. Thus, in ; , it was perfectly clear from the language of the will that the property had been bequeathed in trust -- "in sacred trust," said the proviso -- for the express purpose of "spreading the light" on social and political liberty as taught by Henry George. The vice-chancellor held that the trust should not be enforced as a charitable trust because the doctrine was "antagonistic to the purpose" for which courts had been created. The Court of Errors and Appeals characterized the holding as one declaring that a court will not lend its aid "to the agitation of the question whether the laws which it is in the habit of executing have or have not any better foundation than wrong and injustice." It held the true test to be whether the writings to be circulated, "when1944 U.S. Tax Ct. LEXIS 147">*165 considered with respect to their purpose and general tendency, [were] hostile to religion, to law, or to morals" and, applying that test, upheld the trust as a valid charitable one.In ; , a bequest had been made to Harvard University to be used in teaching eugenics. Harvard refused to accept the bequest and the question presented to the Supreme Court was whether its declination effected a nullification of the wishes of the testator and ended the trust. Pointing out that the settlor had been "definite as to the means by which his charitable purposes may be carried out, and equally plain as to the objects of the charity," the court applied the principle that "if one trust agency fails the courts will supply another."The cases and others cited by petitioner would be more nearly apposite if the issue were whether a valid trust had been created by the settlor; but no such question is being raised. The trustee has accepted the trust and, for aught that appears in this record, is enforcing it according to its terms. Petitioner's argument that two 3 T.C. 612">*620 separate trusts were established, 1944 U.S. Tax Ct. LEXIS 147">*166 the nominal beneficiary being a trustee, seems to be based very largely upon the following quotation from Restatement of the Law of Trusts (p. 1101):If * * * the transferor manifested an intention to restrict the transferee in the use of the property transferred, the transfree does not take the property for his own benefit. A charitable trust is created if the transferee was restricted in the use of the property to charitable purposes.The rule may be accepted as sound; but it does not justify the conclusion sought by petitioner. The remainder of the paragraph of comment, in which the quoted portion appears, recognizes the rule that, if a transferee is restricted in the use of the property to purposes not limited to charitable purposes but including noncharitable purposes for which a trust can not validly be created, the transferee holds the property upon a resulting trust for the transferor or his estate. Moreover, the rule upon which petitioner relies requires a "manifestation of intention," which the same treatise says "means the external expression of intention as distinguished from undisclosed intention." , from1944 U.S. Tax Ct. LEXIS 147">*167 which petitioner quotes at length, furnishes but slight support for his contention; for it lays down the tripartite requirement that the donor's words of limitation be imperative, the subject of his gift certain, and "the objects or persons intended to have the benefit of the recommendation or wish be also certain." In our judgment no such showing has been made in the instant case. We are therefore of the opinion petitioner can not prevail upon the theory urged.Since we have concluded that the transfer was made for the use of the committee rather than to be held by it as "a spending trustee," we must now determine whether the corporation meets the tests laid down by the statute and the regulations.The purposes for which the committee was organized are shown by the memorandum and articles of association attached to the stipulation, pertinent excerpts from which are shown in our findings. Evidence as to its operation is quite meager, consisting in the main of published reports for 1935 and 1936 and copies of pamphlets published by it. 6 The dearth of evidence is attributed by petitioner, upon brief, to the difficulty of transporting witnesses because of present war conditions. 1944 U.S. Tax Ct. LEXIS 147">*168 Enough is shown, however, to enable us to get a reasonably clear view of the committee's activities.The best evidence of whether the committee was organized and 3 T.C. 612">*621 operated exclusively for charitable or educational purposes, as contended by petitioner, and whether any substantial part of its activities1944 U.S. Tax Ct. LEXIS 147">*169 consisted of carrying on propaganda or otherwise attempting to influence legislation, may be found in its articles of incorporation. They show its objects to be, among others, "advocating and maintaining the principles" of the single tax, assisting "in all proper ways to establish the same in practical operation of law," giving "aid to individuals or other organizations with similar objects," and doing "all other acts that may tend to further the objects named." The income and property of the association, whencesoever derived, is to be "applied solely towards the promotion of the objects of the Association" as set forth in the memorandum.The objects and purposes set out above, in our judgment, support the respondent's determination that the committee was not organized and operated exclusively for charitable or educational purposes. "To advocate the abolition of all taxes upon industry and the products of industry and their replacement by a single tax upon land," as the Circuit Court of Appeals for the Second Circuit pointed out in , is not "an educational purpose, although it may be educational in some1944 U.S. Tax Ct. LEXIS 147">*170 degree to those who listen to or read the theories urged. It has for its purposes the dissemination of controversial propaganda, which means a plan for the publication of a doctrine or system of principles." "A legislative program is outside the intendment of the statute, and, having it, a corporation cannot claim an exclusively educational or charitable purpose. ." . Cf. . "To assist in all proper ways to establish the [principles] in practical operation of law" certainly connotes a legislative program; but any doubt that this is true seems to be dispelled completely by the broader language "to do all other acts that may tend to further the objects named." Moreover, the copies of the monthly journal "Land & Liberty," published by the committee and attached to the stipulation, indicate that a substantial part of the activities of the committee was "carrying on propaganda or otherwise attempting to influence legislation." A few illustrations will suffice. 1944 U.S. Tax Ct. LEXIS 147">*171 Thus in the September 1938 issue a communication of the assistant editor to "The Times" is printed, in which it is said:The London County Council is entitled to expect that its proposal for a rate on site values in London will be considered by Parliament on its merits, and Mr. Herbert Morrison's Bank Holiday speech was no more than a perfectly proper plea that this should be so. Sir Harold Webbe's letter to you confirms the impression that an attempt will be made to avoid that consideration by raising the side issue that such legislation should apply to the whole country and should not be introduced by private legislation. If the proposal is a beneficial one, the onus rests upon its opponents of demonstrating why it 3 T.C. 612">*622 should not be applied to London whether or not the rest of the country enjoys its advantages and no one has yet attempted that task.In the same issue, under the heading "Education's Toll to Landlordism," it is said:Arising out of a question in the House of Commons, 27th July, 1938, the Rt. Hon. Col. Josiah C. Wedgwood has been supplied with particulars of 105 sites compulsorily acquired under authority of the Board during the years 1934, 1935, 1936, and1944 U.S. Tax Ct. LEXIS 147">*172 1937. Not all the prices can yet be stated as a number await approval. Eliminating these and also cases where acquisition included buildings, we have compiled the following table: [Then follows a table listing 290 acres stated to be "agricultural land or vacant land which despite its value was exempt from contributions to local taxation -- landowners received the gift out of the public purse of not less than £ 212,477."]In "News of the Movement," in the September 1938 issue -- a subdivision or title appearing in each journal -- is a suggestion that contributions be made for the purpose of reprinting some of the pages of the August issue:* * * as a pamphlet and thus give the widest possible publicity to the action of the London County Council and its importance for everyone interested in permitting the rating of land values. That is what should be sent far and wide to councillors and others. The inclusive cost of such an enterprise along with necessary circulars and postage would be in the neighborhood of £ 100. The opportunity is so inviting and the occasion so vital that we have no hesitation in appealing to our supporters for special donations that will be earmarked for this1944 U.S. Tax Ct. LEXIS 147">*173 purpose.In the October 1938 issue, in a signed editorial by the assistant editor, it is said:What is most needed to secure the peace of the world is throwing down of all barriers between nations which prevent the free movement of goods and all people, together with the abolition of the barriers which prevent the denizens of each country from making use of its national resources and which require them to make payment to a few among them for this essential and national right. If such conditions were established, every man would be in effect a citizen of the world with liberty to produce wealth wherever opportunity offered and freedom to transport himself and his possessions where he chose.A statement of the leader of the London County Council for Site Value Rating is set out, in which it is said:The general body of ratepayers have every interest in the Councillors' proposal and they should write to their Members of Parliament asking them to support the bill. Those Members of Parliament who oppose this bill are thereby insisting that the occupiers shall continue to carry the full burden in order that the owner of the land shall escape.Under the heading "Wanted -- More and More1944 U.S. Tax Ct. LEXIS 147">*174 Publicity," it is stated:By arrangement (Land & Liberty offices) "The Bradford Citizen" is getting an article every month. A syndicated article by F. C. R. Douglas [assistant editor of the Journal] issued some months past and published widely came to light again in "The Rotherham Express" on 17th September -- indicating how 3 T.C. 612">*623 editors have material on file ready to be used when a question comes to the front * * *. Turning again to special articles, "The Labour Press" service of 7th September, produced the facts and figures (Land & Liberty has given them) of "Expensive Playgrounds -- or None at all", how land speculation hinders the "Keep Fit" campaign.In "News of the Movement," in the October issue, speakers are urged to secure the handbook printed by the committee, and it is said:Leaflet literature for the municipal elections will be immediately in demand and we ask our supporters to help us in meeting it. Two of the leaflets (octavo size) most in request are "Tax Land Values" and "Who Should Pay."In a 222-page Handbook for Speakers and Writers published by the committee and bearing the title "Why Rents and Rates Are High -- Land Monopoly in Town and Country -- 600 1944 U.S. Tax Ct. LEXIS 147">*175 Examples," forewords by members of Parliament appear in which is is said:In this book the author sets out with great clarity the facts of the land ramp. He shows how in instance after instance the values created by the community are taken by individuals who have done no service whatever. It is easy to condemn the people who make extravagant profit by holding the owner to ransom but the real condemnation should be on the people of this country who allow exploitation to go on. I hope that this book will be widely read and that the striking examples will be brought before the electors. * * * To obtain the driving force necessary to remedy this injustice it is essential that the facts should be brought home to the electorate.In the subdivision "News of the Movement" in the November 1938 issue it is said:The English provincial papers * * * are much more willing to give publicity to our views than are the "national" papers. It is already known that many of the 340 papers, to which the general secretary had sent a letter on the Borough Elections, have printed it and applications are being received from readers who wish for further information. Thanks are due and are hereby tendered1944 U.S. Tax Ct. LEXIS 147">*176 to members who sent to the office lists of candidates for their Borough Councils. All candidates whose names and addresses were obtained, in this or other ways, have been communicated with.Petitioner insists that ; ; ; and , directly or impliedly hold that the political activity inhibited by the phrase "carrying on propaganda or otherwise attempting to influence legislation" is "that kind of political effort which is directly aimed at procuring the enactment or repeal of specific laws." We do not so construe the cases. In the Slee case the only activities touching upon legislation consisted "in directing persons how best to prepare proposals for changes in the law and in distributing leaflets to legislators and others recommending such changes * * *." In the Leubuscher case, as pointed out above, the advocacy of the single tax was held not to be exclusively 1944 U.S. Tax Ct. LEXIS 147">*177 educational; 3 T.C. 612">*624 but a corporation to be formed only for the purpose of teaching and propounding the ideas of Henry George and not for seeking the passage of legislation met the test. In the Cochran case the court was of the opinion that the evidentiary findings of the Board of Tax Appeals did not support its conclusion that the World League Against Alcoholism was organized for legislative purposes. The Girard Trust Co. case possibly comes closer to suggesting the rule urged upon us by petitioner. In that case the court reversed our holding in , that the Board of Temperance, Prohibition and Public Morals of the Methodist Episcopal Church was not engaged exclusively in religious, charitable, or educational purposes because it advocated the enactment of laws to suppress the liquor traffic, extensively carried on propaganda, and had for one of its objects "the speedy enactment of * * * legislation [to suppress the liquor traffic] throughout the world."With all due deference to the court, we adhere to the views expressed by us in the Simpson case; but the point need not be pressed. The reasonable1944 U.S. Tax Ct. LEXIS 147">*178 inference from the meager evidence before us is that the committee was, during the four months immediately following the death of the decedent, engaged in political activities directly aimed at procuring the enactment of the London County Council Bill for Site Value Rating; that it was backing the Parliamentary Labour Party in the promotion of "legislation * * * which would enable all local authorities to take rates off houses and industry and put them on site values"; and that it aided and intended to aid, both by its publications and through its officers, in making "the L. C. C.'s proposal a national issue." 7 Thus even under the rule urged by petitioner -- which, however, we do not approve -- it has been shown that the deduction may not be allowed.The reference in the preceding paragraph to specific political activities is not to be construed as an intimation that they constituted all of the activities which we believe should be construed1944 U.S. Tax Ct. LEXIS 147">*179 as "carrying on propaganda or otherwise attempting to influence legislation." The monthly journals of the committee, and particularly the excerpts set out above, indicate it was engaged in political agitation, that it was set up for that purpose, and that it did not limit its activities purely to education -- teaching and expounding. Thus it can not be said that the corporation was organized and operated exclusively for charitable or educational purposes. Whether any substantial sums were expended in espousing or opposing the election of public officers is, on this record, difficult to determine. As stated above, we prefer not to accept the reports of 1935 and 1936 as proof that similar expenditures were made by the committee at about the time of the death of the decedent. The important circumstance is that the committee, under 3 T.C. 612">*625 its articles of association, was free to make such expenditures if it chose to do so. That, in our judgment, prevents the allowance of the claimed deduction under section 303 (a) (3), supra.The remaining issue is whether the estimated present value of trustees' commissions, payable in substantially equal annual installments during the 251944 U.S. Tax Ct. LEXIS 147">*180 years following the decedent's death, denominated "termination fee" or charges for paying out the trust property, may be taken into account in determining the amount of estate tax due. As shown in our findings, deduction was claimed in the estate tax return in the amount of $ 8,890.95, of which $ 542.35 has been allowed, this being the amount actually paid. Petitioner concedes that the amount claimed is not deductible under section 303 (a) (1) (B) of the Revenue Act of 1926 as amended, but claims that the amount in its hands for transfer to the committee "was inevitably diminished and the value of the transfer * * * was certainly, in fact, lessened" by the obligation to pay the termination fee. It therefore urges that there should be a reduction, apparently under section 303 (a) (1) (D) of the Revenue Act of 1926 as amended, 81944 U.S. Tax Ct. LEXIS 147">*181 in the value of the property transferred to the trust. The applicable regulation is shown in the margin. 9In ; affirmed sub nom. , it was held that a termination charge, payable by the trustee of an inter vivos trust to itself as "compensation for services * * * in the conservation of the trust fund for the entire period of its existence up to the time of its transfer to the executors under the will [1903 to 1936]," was excludible from the value of the gross estate. Petitioner insists this case supports its claim 1944 U.S. Tax Ct. LEXIS 147">*182 that the value of the property in the trust at the date of the death of the decedent should be reduced by $ 8,379.12. We do not agree.The same question was before us in . We held it was "too obvious for comment that such future commissions are not measurable by applying the statutory rates of percentage to the value of the property at the time of decedent's death, but only by applying such rates to the value of the property when distributed or paid out." Opinion was expressed that it was doubtful if any evidence could be produced by which the amount of future commissions could be determined. This was the view hinted by the Circuit Court of Appeals for the Second Circuit in , and in , and taken definitely in affirming our decision in the Central Hanover Bank & Trust Co. case. See . The fundamental distinction between1944 U.S. Tax Ct. LEXIS 147">*183 this line of cases and the Fiske case, supra, as well as , upon which petitioner also relies, is that in the latter group the trustees' commissions were payable before the property was to be turned over to the estate, while in the other group and in the instant case the commissions will become due and payable, almost in their entirety, for services to be rendered after the death of the decedent.The Commissioner, in our judgment, committed no error in determining the deficiency in tax.Decision will be entered for the respondent. Footnotes1. All references herein to the "committee" mean the company incorporated January 23, 1929 under the name "The United Committee for the Taxation of Land Values, Limited."↩2. One of the exhibits introduced in evidence is a 30-page pamphlet entitled "The New Political Economy," by John B. Sharpe, published by the Robert Schalkenbach Foundation, New York, N. Y.↩3. The only witness who testified upon the subject fixed the discounted value at $ 8,379.12.↩4. Section 303 (a) (3), Revenue Act of 1926, as amended by section 807, Revenue Act of 1932 and section 406 Revenue Act of 1934 --Sec. 303. For the purpose of the tax the value of the net estate shall be determined --(a) In the case of a citizen or resident of the United States, by deducting from the value of the gross estate --* * * *(3) The amount of all bequests, legacies, devices, or transfers. * * * to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation, or to a trustee or trustees, or a fraternal society, order, or association operating under the lodge system, but only if such contributions or gifts are to be used by such trustee or trustees, or by such fraternal society, order, or association, exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.Article 45, Regulations 80 --Art. 45. Religious, charitable, scientific, and educational corporations. -- A corporation or association to which such a transfer was made must meet four tests: (1) It must be organized and operated for one or more of the specified purposes; (2) it must be organized and operated exclusively for such purpose or purposes; (3) no part of its net earnings shall inure to the benefit of private stockholders or individuals; and (4) no substantial part of its activities shall be carrying on propaganda, or otherwise attempting, to influence legislation.* * * *↩5. The trust instrument recites the trust has been accepted in Pennsylvania "and all questions pertaining to the validity and construction of this indenture shall be determined in accordance with the laws of the commonwealth of Pennsylvania."↩6. The Study of Political Economy by Henry George, being a reprint from the Popular Science Monthly, March 1880; The London County Council and the Rating of Site Values; September, October, November, and December 1938 issues of Land & Liberty, Monthly Journal for Land Value Taxation and Free Trade, including articles upon such subjects as "What is Labour's Agricultural Policy?" "Education's Toll to Landlordism," "Economic Background of the Crisis," "Social Justice the Way to Peace," "The Municipal Elections," "Condition of the English Peasantry," "Why Rents and Rates are High -- New York," "Food Taxation and Landlord's Rents," "Town Planning and Taxation," "The London County Council Bill for Rating Site Values."↩7. The quotations are from the September issue of Land & Liberty, p. 148.↩8. Sec. 303 [as amended by § 805 of the Revenue Act of 1932, 47 Stat. 169, 280]. For the purpose of the tax the value of the net estate shall be determined --(a) In the case of a resident, by deducting from the value of the gross estate --(1) Such amounts -- (A) for funeral expenses,(B) for administration expenses,(C) for claims against the estate,(D) for unpaid mortgages upon, or any indebtedness in respect to, property where the value of decedent's interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate * * *↩as are allowed by the laws of the jurisdiction * * * under which the estate is being administered * * *. [26 U.S. C. A., Int. Rev. Acts, p. 232.]9. Art. 33 [Regulations 80 (1937 Ed.)]. Executor's commissions. -- The executor or administrator, in filing the return, may deduct his commissions in such an amount as has actually been paid or which at that time it is reasonably expected will be paid, but no deduction may be taken if no commissions are to be collected. * * ** * * *Amounts paid as trustees' commissions do not constitute expenses of administration and are not deductible, whether received by the executor acting in the capacity of a trustee or by a separate trustee as such.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623045/ | LILLIAN MCDONALD BRINTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. IRENE STROMEYER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. WILLIAM A. STROMEYER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brinton v. CommissionerDocket Nos. 53715, 55341, 55342.United States Board of Tax Appeals28 B.T.A. 472; 1933 BTA LEXIS 1127; June 20, 1933, Promulgated 1933 BTA LEXIS 1127">*1127 1. Where a widow entitled to survivor's share of community property elects to relinquish her right therein and take under the will, she becomes a beneficiary under the will and may take after administration, only that part of the estate which was devised to her. 2. Where facts show that estate was in process of administration by independent executors up to time of distribution, the value of property as of date of distribution is the basis for determining gain upon subsequent sale thereof by beneficiaries. Pierce Archer, Jr., Esq., for the petitioners. Otis J. Tall, Esq., for the respondent. GOODRICH 28 B.T.A. 472">*472 In these proceedings, which upon motion were consolidated, petitioners assail determinations of the following deficiencies in income tax for the year 1928: Lillian McDonald Brinton$21,175.42Irene Stromeyer10,608.42William A. Stromeyer10,559.76The controversy relates to the proper basis to be used in determining the amount of gain arising from the sale in 1928 of certain shares of stock of the West Texas Telephone Co. acquired by petitioners as beneficiaries under the will of William T. Stromeyer, deceased. 1933 BTA LEXIS 1127">*1128 28 B.T.A. 472">*473 FINDINGS OF FACT. Petitioners reside at West Chester, Pennsylvania. William T. Stromeyer, a resident of Brownwood, Texas, died November 15, 1911, leaving to survive him his widow (now Lillian McDonald Brinton) and two minor children, William A. and Irene Stromeyer. He left a will wherein he disposed of all his separate property and all the community property of himself and wife. His widow chose to waive her rights as survivor of the community and take as devisee under the will. The estate disposed of by the will consisted of life insurance, real estate, an interest in the undistributed estate of decedent's father, and 180 shares of stock in the West Texas Telephone Co., of which decedent had been an officer. By the will, which is included herein by reference, the widow was given "the equal undivided one-half of the property and estate, whether real, personal or mixed, community or separate" of which the testator died seized or possessed, together with the use of the homestead and certain appurtenances thereto. All the rest and residue of the estate of every character was, "subject to the trusts and powers hereinafter conferred upon those named as executrix, 1933 BTA LEXIS 1127">*1129 executors and trustees herein" to go to the two children "share and share alike", and to the survivor of them should either die single and unmarried, but if either or both died leaving a child or children, then its, or their share to such child or children as may survive. The widow, her father, and another were named as executors of the will and trustees of the estate to serve without bond, and it was provided that no action should be had in the county court in connection with the administration except the proof of the will, the filing of the necessary inventories, and similar formal acts. The executors-trustees were directed to control and invested the estate property and proceeds thereof devised to the children until they attained the age of 21, or, in the case of the daughter, until her marriage, and then to make distribution. The general power granted by the will is illustrated by the following excerpt: It is my will that the executors and trustees herein named shall have full power under this will to collect, preserve, sell, or otherwise dispose of, all property upon which this will is operative; and all three concurring, to divide and partition the same between my beloved1933 BTA LEXIS 1127">*1130 wife and children: to re-invest the proceeds of sales and collections, and to re-sell and to mortgage, or otherwise encumber, any and all such property, it being my desire to facilitate the handling of said estate, and my purpose to confer upon the executors and trustees, herein named, such power and authority as will enable them to handle and dispose of the property, and handle and re-invest proceeds, as if it were their own, they being liable, however, at all times, to the proper beneficiaries, 28 B.T.A. 472">*474 and for the faithful exercise of all the powers herein vested in them, and for the exercise of good faith in the performance of the trusts herein reposed in them. The will provided for appointment of a substitute executor-trustee in event of death of one of those originally named, and also permitted the application of the corpus of the estate toward the education of the children if necessary. A copy of the inventory and appraisement (which is stipulated and included herein by reference) was filed by the executors February 3, 1912. It showed certain properties, in which the decedent had an undivided one-fifth interest, held by trustees under the will of the decedent's father, 1933 BTA LEXIS 1127">*1131 probated in New York City, and not subject to the possession and control of the executors and trustees here named for several years to come, and community property valued at approximately $60,000, including 180 shares of the capital stock of the West Texas Telephone Co., valued at $36,000. It also showed debts of approximately $34,000. The shares of stock of the West Texas Telephone Co. were transferred into the name of the estate in 1916, when a 300 percent stock dividend was declared. Another stock dividend was issued in 1924. At the time of distribution in 1928 the number of shares had been increased by stock dividends to 870. The book value of this stock at March 1, 1913, was $299.82 per share. No final account was filed with the probate court as authorized by the will. The law of Texas did not require such account. In 1928, however, on instructions of the executors an audit and report was made from the records of the executors, such as receipts, checks, etc., and, on the basis of this audit, distribution of the estate was made by the executors-trustees. The receipts and disbursements as set out in this report are stipulated and included herein by reference. The receipts1933 BTA LEXIS 1127">*1132 were deposited in the Brownwood National Bank to the credit of the executors of the estate and disbursements were made by checks signed by them as executors of W. T. Stromeyer, deceased. In 1925 upon petition made to the County Court of Brown County, Texas, in probate, A. N. Rodgers was appointed coexecutor and cotrustee of the will and estate of William T. Stromeyer to succeed McDonald, who died in 1925, and letters testamentary were issued to him. The executors-trustees continued to hold and manage the estate from the death of the decedent until 1928, when distribution was made. Disbursements during this time were made on account of debts, expenses, and to the beneficiaries. The greater part of the debts was paid by the end of 1917, but the indebtedness was not completely discharged until ten years later. The income of the 28 B.T.A. 472">*475 estate during this whole period consisted largely of dividends from the stock of the West Texas Telephone Co., which began paying dividends in 1912. A piece of real estate was sold in 1921 and the homestead in 1922. William A. Stromeyer became of age April 7, 1928, and under the terms of the will one fourth of the decedent's stock of the1933 BTA LEXIS 1127">*1133 West Texas Telephone Co. (amounting to 217 shares) was transferred to him. At this time also 435 shares were transferred to Lillian McDonald Brinton, and 218 shares were placed in the names of Lillian Brinton and A. N. Rodgers, independent trustees for Irene Stromeyer. The certificates representing the stock so transferred were endorsed by "Lillian S. Brinton and A. N. Rodgers, Executors." On July 2, 1928, William A. Stromeyer, Lillian Brinton and the trustees for Irene Stromeyer deposited their stock with the secretary of the West Texas Telephone Co., to be held pending the acceptance or rejection of the offer to purchase on September 18, 1928. A committee of the Telephone Co., authorized by the stockholders to act for them, consummated the sale. The amount received by the three petitioners for their 870 shares was $373,491, which was distributed as follows: Lillian McDonald Brinton$186,745.50William A. Stromeyer93,372.75Lillian McDonald Brinton and A. N.93,372.75Rodgers, independent trustees for Irene StromeyerTotal373,491.00In finding the deficiencies here in question the Commissioner determined the basis for computing gain or loss to1933 BTA LEXIS 1127">*1134 be $40 per share as at March 1, 1913, for all the shares of stock distributed and later sold. OPINION. GOODRICH: Petitioners contend that the basis for determining the profit on the sale of the stock is the fair market value at the date of its distribution to them in 1928. Respondent has determined and maintains that the basis is the fair market value of the stock on March 1, 1913. In the case of the decedent's widow, now Lillian McDonald Brinton, he argues that she acquired the stock in question as her share of the community property, and that her election to take under the will was a nullity. We cannot agree with this argument. Clearly by his will the decedent disposed of his separate estate, consisting of an undivided interest in his father's estate, and all the community property. By her election to take under the will decedent's 28 B.T.A. 472">*476 widow relinquished her statutory interest in the community property in exchange for the rights accruing to her under the terms of the will. Thereafter her rights in all the property disposed of by the will, including all the property of the marital community, were limited and determined by the will, 1933 BTA LEXIS 1127">*1135 Smith v. Butler,19 S.W. 1083">19 S.W. 1083; Prior v. Pendleton,47 S.W. 706">47 S.W. 706; 49 S.W. 212">49 S.W. 212. She became a beneficiary of the will and could not thereafter claim any interest in the community property as the survivor of the community. Cf. Farmer v. Zinn,261 S.W. 1073">261 S.W. 1073; Heller v. Heller,233 S.W. 870">233 S.W. 870; Scaggs v. Deskin,66 S.W. 793">66 S.W. 793; 19 S.W. 1083">Smith v. Butler, supra.Thereafter her survivor's share of the community property undoubtedly became liable for the debts of the estate, including the personal debts of the decedent. Cf. Shiner v. Shiner,40 S.W. 439">40 S.W. 439. While it may be suggested that her rights under the will were acquired by purchase, cf. Allen v. Brandeis, 29 Fed.(2d) 363; Irwin v. Gavit,268 U.S. 161">268 U.S. 161; Mary W. B. Curtis,26 B.T.A. 1103">26 B.T.A. 1103, nevertheless this did not change her character as a beneficiary of the will. She was subject to the same administration as other beneficiaries in accordance with the terms of the will. Cf. 1933 BTA LEXIS 1127">*1136 Butterworth v. Commissioner, 63 Fed.(2d) 944. The interest which she acquired was not that of a beneficiary of a trust or a life tenant, but was a one-half interest in all the net estate disposed of by the will, which, after the payment of debts and the expenses of administration, would be subject to distribution by the executors under the terms of the will. Just what property would be so distributed or whether or not there would be any property to distribute could not be determined before the debts and expenses were paid. The respondent urges that administration ended when the executors filed an inventory and appraisal of the estate on February 22, 1912, and that distribution was then made to trustees for the beneficiaries. Under the laws of Texas (art. 3436, Vernon's Ann. Texas Stats.) where, as here, a testator has provided in his will that no other action may be had in the county court than the probating and recording of his will and the filing of an inventory and appraisement and list of claims of his estate, the executors of the will are in legal phraseology termed independent executors, cf. 1933 BTA LEXIS 1127">*1137 Ellis v. Mabry,60 S.W. 572">60 S.W. 572. Such independent executors have much broader powers in the management and control of the estate than ordinary executors or administrators. And where power is given them by the will to control, sell, invest and reinvest the property coming into their hands such power may be exercised by them as independent executors and not as trustees. Cf. Beckham v. Beckham,227 S.W. 940">227 S.W. 940; Yeager v. Bradley,246 S.W. 688">246 S.W. 688. This management of the estate by the 28 B.T.A. 472">*477 independent executors is an administration under the law. They may manage the estate and pay the debts as though they were their own. Cf. Ewing v. Schultz,220 S.W. 625">220 S.W. 625; Fernandez v. Holland-Texas Hypoteck Bank of Amsterdam, Holland,221 S.W. 1004">221 S.W. 1004; Todd v. Willis, 66 T. 704; 1 S.W. 803">1 S.W. 803. It appears that at the time of decedent's death he was deeply in debt and practically all of his property was mortgaged or hypothecated. Shortly thereafter the telephone stock began paying dividends. The executors managed the estate so as to provide a living for the widow and children and to1933 BTA LEXIS 1127">*1138 pay off the debts which were largely liquidated by 1917, but not finally paid before ten years later. The real estate was not finally disposed of until 1922 and distribution was not made until the oldest child became of age in 1928. Moreover, the moneys belonging to the estate were deposited in the bank to the credit of the "executors" and disbursements made upon checks signed by the "executors" and upon the death of one of the executors the probate court appointed a successor to him in 1925. Under such circumstances we think that the independent executors continued to administer the estate until it was distributed in 1928. But even if respondent's theory were correct and the independent executors became testamentary trustees at some point in their administration prior to the distribution in 1928, that fact would not be controlling. In Ralph W. Harbison,26 B.T.A. 896">26 B.T.A. 896, the Board considered a question substantially the same as that here raised by respondent - whether distribution to the trustee (when there is a substantial equitable interest in the beneficiary) is distribution to the beneficiary - and held that distribution to the beneficiary does not occur until1933 BTA LEXIS 1127">*1139 the termination of the trust. The Commissioner acquiesced in this decision. See G.C.M. 11309, XII-12-6080, p. 5 (modifying G.C.M. 6195, cited by respondent in his brief), holding that the value at the date of distribution to the taxpayer is the basis for determining gain upon the sale of personal property received from a testamentary trust. The property here in question is personal property, acquired by will but not by specific bequest, and the case falls within section 113(a)(5), Revenue Act of 1928, which provides that "the basis shall be the fair market value of the property at the time of the distribution to the taxpayer." Cf. Finance Committee Report No. 960, p. 28, 70th Cong., 1st Sess. Since there was no increase in value of the stock between the date of distribution to petitioners and the date of its sale by them, no profit arose therefrom. Judgment will be entered for the petitioners. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623046/ | Kathleen Marie Emmons v. Commissioner.Emmons v. CommissionerDocket No. 86449.United States Tax CourtT.C. Memo 1961-290; 1961 Tax Ct. Memo LEXIS 60; 20 T.C.M. 1513; T.C.M. (RIA) 61290; October 23, 1961Henry J. Burt, Jr., Esq., 1910 Kentucky Home Life Bldg., Louisville, Ky., for the petitioner. Vernon R. Balmes, Esq., for the respondent. MULRONEY Memorandum Findings of Fact and Opinion MULRONEY, Judge: The respondent determined a deficiency of $360.68 in petitioner's income tax for 1958. The questions1961 Tax Ct. Memo LEXIS 60">*61 for decision are whether petitioner provided over one-half of her mother's support in 1958 and whether petitioner is entitled to deductions for medical expenses and interest paid on behalf of her mother in 1958. Findings of Fact Petitioner Kathleen Marie Emmons is an individual who lives in Louisville, Kentucky. She filed her 1958 individual income tax return with the district director of internal revenue at Louisville. Petitioner is a secretary. Her 1958 income was $3,300 from salary. Her takehome pay, after deductions for Federal and state taxes and hospitalization insurance, was $2,209.83. She has been severely physically crippled since childhood as the result of polio and she can only walk with the aid of crutches. Petitioner's father died in 1957. His estate was small and did not include sufficient liquid assets to pay debts and costs of administration. It included an automobile and a house, subject to a mortgage, both of which went to petitioner's mother. In 1958 petitioner and her mother lived in the house. Her mother's only source of income was $50.40 a month from a pension of the Veteran's Administration. Petitioner and her mother maintained a joint checking account. 1961 Tax Ct. Memo LEXIS 60">*62 Petitioner's salary and her mother's pension were deposited in that account. From time to time petitioner's mother made some of the deposits to the account and wrote checks on it because it was easier for her to get around than it was for petitioner. In addition, during 1958 petitioner and her mother maintained a joint savings account. The account had been opened in 1957 with a deposit of $2,500. Of this amount, $1,000 was petitioner's and the balance her mother's. Petitioner made payments of $86 per month on the mortgage on the house. Of the $1,032 so paid, $355.95 represented interest. Petitioner and her mother withdrew $925 from their savings account in 1958. Petitioner's mother was not well when her husband died in 1957. In 1958 she underwent surgery for the removal of a portion of her left lung. After the operation she lost her hearing and had to have a hearing aid. Her medical expenses in 1958 were $783.63. Petitioner has a brother. In 1958 he was married and had four children. Petitioner's brother did not provide any support for petitioner's mother in 1958. On her 1958 income tax return petitioner claimed her mother as a dependent. In addition, she deducted interest1961 Tax Ct. Memo LEXIS 60">*63 paid on the mortgage of $355.95, city personalty tax of $37.39, state personalty tax of $7.94, and medical expenses of $1,188.17. In the statutory notice respondent determined that petitioner had additional income from interest on the savings account of $17.99; that the deductions for interest and personalty taxes were not allowable under sections 163 and 164 of the Internal Revenue Code of 1954; 1 that her mother was not her dependent under section 151 (e) and so the $600 dependency exemption was not allowable; and that $783.63, "medical expenses applicable to [her] mother" were not allowable "as she was not your dependent." Petitioner provided over one-half of her mother's support in 1958. Opinion The evidence proves conclusively and we have found as a fact, that petitioner provided over one-half of her mother's support in 1958. The only sources of support for petitioner and her mother were petitioner's salary, her mother's pension and their joint savings account. If it be true, as respondent argues on the interest issue below, that the house in question belonged1961 Tax Ct. Memo LEXIS 60">*64 to petitioner's mother, then the payments on the mortgage of $1,032 plus the amount spent for her mother's clothes, $403.77, plus the $783.63 which respondent admits in the statutory notice was spent for her mother's medical care, amount to considerably more than the mother's contribution to the family (pension payment receipts of $604.80) even without taking into account amounts expended for food and other items. We are singularly unimpressed with respondent's argument that because most deposits, checks and withdrawals from the savings account were in petitioner's mother's name, her mother "actually paid most of petitioner's, as well as her own, expenses." The mother adequately explained the reason for this when she testified that petitioner "is unable to get around and take care of business and I have to do a lot of things * * *." Kathleen's severe disability was observed by the Court. Respondent's only basis for disallowance of $783.63 of the deduction claimed for medical expenses was that petitioner's mother was not her dependent. We have above decided contrary to respondent on the dependency issue. We therefore hold petitioner is entitled to deduct the full amount claimed for1961 Tax Ct. Memo LEXIS 60">*65 medical expenses under section 213(a). Respondent disallowed the interest deduction of $355.95 and on brief argues that petitioner is not entitled to it because the indebtedness was not hers. We agree with respondent. Petitioner, her mother and her brother testified that they had agreed in 1957 that the house should belong to petitioner, even though her mother then held record title to it. In support of this testimony, there is evidence that her mother deeded the house to her in December 1959. However, petitioner has not shown that she assumed the mortgage during 1958 and it is upon the debt that the interest was paid. The debt was not hers. We hold respondent correctly disallowed the interest deduction. Respondent disallowed personalty taxes of $45.33 claimed by petitioner as a deduction. On brief petitioner admits the taxes were not hers, but were her mother's. We hold respondent correctly disallowed this deduction. Respondent increased petitioner's income for 1958 by $17.99 to report interest income from the joint savings account. Only two-fifths of this amount is taxable income to petitioner. Her original contribution to the savings account was two-fifths of the total opening1961 Tax Ct. Memo LEXIS 60">*66 deposit, which was the only deposit ever made in this savings account. Decision will be entered under Rule 50. Footnotes1. All section references herein are to the Internal Revenue Code of 1954, as amended.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623048/ | GERALD D. ROBERTS CONSULTANTS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; GERALD D. ROBERTS AND JUDY A. ROBERTS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGerald D. Roberts Consultants, Inc. v. CommissionerDocket Nos. 19849-89, 19850-891United States Tax CourtT.C. Memo 1991-490; 1991 Tax Ct. Memo LEXIS 539; 62 T.C.M. 890; T.C.M. (RIA) 91490; September 30, 1991, Filed 1991 Tax Ct. Memo LEXIS 539">*539 Decisions will be entered under Rule 155. Robert C. Anderson, for the petitioners. Terry L. Zabel, for the respondent. JACOBS, Judge. JACOBSMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined the following deficiencies in and additions to petitioner Gerald D. Roberts Consultants, Inc.'s Federal income tax: Additions to TaxSec. 6653(a)(1) 2Sec. 6653(a)(2)Taxablefor 1985 andfor 1985 andYearSec. 6653(a)(1)(A)Sec. 6653(a)(1)(B)Sec.Ending 3Deficiencyfor 1986for 198666619/30/85$ 12,390$ 62050% of interest$ 3,098on $ 12,3909/30/86$ 19,454$ 97350% of interest$ 4,864on $ 19,4541991 Tax Ct. Memo LEXIS 539">*540 Respondent determined the following deficiencies in and additions to petitioners Gerald D. and Judy A. Roberts' Federal income tax: Additions to TaxSec. 6653(a)(1)Sec. 6653(a)(2)for 1985 andfor 1985 andSec. 6653(a)(1)(A)Sec. 6653(a)(1)(B)Sec.YearDeficiencyfor 1986for 198666611985$ 9,098$ 45550% of interest$ 2,275on $ 9,0981986$ 14,857$ 74350% of interest$ 3,714on $ 14,857After concessions, the issues for decision are: 1. Whether Gerald D. Roberts Consultants, Inc. was a personal holding company during both years in issue and therefore subject to the personal holding company tax. We hold that it was. 2. Whether certain payments made by Gerald D. Roberts Consultants, Inc. to or for the benefit of its sole stockholder, Gerald Roberts, and members of his immediate family, constitute deductible corporate business expenses. We hold that they do not. 3. Whether said corporate payments are taxable to Gerald Roberts as constructive dividends, or alternatively, whether pursuant to section 269A, respondent may attribute the income received by Gerald D. Roberts Consultants, Inc. to Gerald Roberts personally. We hold that the1991 Tax Ct. Memo LEXIS 539">*541 corporate payments constitute constructive dividends to Gerald Roberts. 4. Whether the corporate and individual petitioners herein are liable for additions to tax for negligence or intentional disregard of rules and regulations. We hold that they are. 5. Whether the corporate and individual petitioners herein are liable for additions to tax for substantial understatements of income tax. We hold that they are. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of fact and accompanying exhibits are incorporated herein by this reference. Gerald D. Roberts Consultants, Inc. (Roberts Consultants) was incorporated in Mississippi in October 1981. Its principal place of business was located in Marquette, Michigan, at the time it filed its petition. Its sole stockholder was Gerald Roberts. Gerald and Judy Roberts, husband and wife, resided in Southport, North Carolina, at the time they filed their petition. They filed joint Federal income tax returns for both years in issue. BackgroundFrom 1973 to 1980, Gerald Roberts was employed by the Tennessee Valley Authority (TVA) as a generating power plant operator. During the first several1991 Tax Ct. Memo LEXIS 539">*542 years of his employment with TVA, he worked at a fossil fuel electrical power generating plant. Beginning in 1976, he worked at the Brown's Ferry Nuclear Facility in Decatur, Alabama. As a result of his experience with nuclear power, he received (in April 1978) an operator's license from the U.S. Nuclear Regulatory Commission. In 1980, he left the employ of TVA to work for United Engineers and Constructors (United). Roberts ConsultantsShortly after the commencement of his employment at United, Mr. Roberts was contacted by Jim Church, of Power Management Consultants Corporation (PMC). PMC was a general contractor which provided management and consulting services to utility companies for the construction and startup of new nuclear power plants. PMC entered into subcontracts with others, such as Mr. Roberts, who were familiar with the various phases of the construction and startup of nuclear power plants. In October 1981, PMC offered to hire Mr. Roberts as a subcontractor to perform work at the Grand Gulf Nuclear Power Plant in Grand Gulf, Mississippi. Before commencing work at the Grand Gulf Nuclear Power Plant, but subsequent to accepting work under the subcontract, 1991 Tax Ct. Memo LEXIS 539">*543 Mr. Roberts caused Roberts Consultants to be organized. The stated purpose of Roberts Consultants was "to carry on a general engineering and consulting business relating to power plants." During the latter part of 1982, PMC offered to hire Roberts Consultants as a subcontractor to perform work at the Clinton Nuclear Power Plant in Clinton, Illinois. This offer was accepted; and at the end of November 1982, Mr. Roberts left the Grand Gulf Nuclear Power Plant to work at the Clinton Nuclear Power Plant. Ostensibly, the party contracting with PMC (for services to be rendered at both the Grand Gulf and Clinton Nuclear Power Plants) was Roberts Consultants. However, at all relevant times, Gerald Roberts was the sole service provider under the contracts. PMC paid Roberts Consultants for the services rendered by Gerald Roberts at the Grand Gulf and Clinton Nuclear Power Plants. Roberts Consultants, in turn, paid Gerald Roberts. Initially, the arrangement between PMC and Gerald Roberts was verbal. In June 1984, Jim Church, on behalf of PMC, and Gerald Roberts, purportedly on behalf of Roberts Consultants, formalized their prior arrangements by executing five contracts. These written1991 Tax Ct. Memo LEXIS 539">*544 agreements purported to cover five periods commencing October 1981, April 1982, August 1982, July 1983, and November 1983. All five contracts contain the following: Description of Second Party's [Roberts Consultants'] Duties PMC Corp. has entered into this agreement based on a given consultant's resume, experience and potential and that individual shall put forth 100% effort in return for the subject compensation at all times, without regards to assignments or changes to those assignments * * *.All income received by Roberts Consultants from PMC was generated by Mr. Roberts' services. Gerald Roberts' and Roberts Consultants' affiliation with PMC ended in June 1985. Walker Training Services, Inc.In October 1985, Mr. Roberts met Danny Walker, of Walker Training Services, Inc. (Walker Training). Walker Training developed operator training programs for power plants. Roberts Consultants entered into a consulting contract with Walker Training, pursuant to which Roberts Consultants agreed to establish a training program for nuclear operators at the Hatch Nuclear Power Plant in Savannah, Georgia. Gerald Roberts was the only service provider supplied by Roberts Consultants1991 Tax Ct. Memo LEXIS 539">*545 under its agreement with Walker Training. The only income Roberts Consultants received from October 26, 1985, through February 28, 1986, came from its contract with Walker Training for Mr. Roberts' services. While working at the Hatch Nuclear Power Plant, Gerald Roberts lived in rented quarters in Savannah; his wife and two children lived in Supply, North Carolina. Resource Technical Services, Inc.On February 5, 1986, Roberts Consultants entered into an agreement with Resource Technical Services, Inc. (Resource Technical), pursuant to which Roberts Consultants agreed to develop a written alternative safe plant shutdown procedure in the event of a fire at the Brunswick Steam Electric Station in Southport, North Carolina. The agreement, in pertinent part, provided: "The CONTRACTOR [Roberts Consultants] shall submit a list of its employees who will be providing services under this contract, and the COMPANY [Resource Technical] reserves the right to reject any person." Mr. Roberts submitted a list containing the names of persons who might be potential corporate employees of Roberts Consultants; however, at the time the list was submitted to Resource Technical, Roberts Consultants1991 Tax Ct. Memo LEXIS 539">*546 had no relationship or arrangement with the persons whose names were submitted. All income received by Roberts Consultants from March 21, 1986, to December 31, 1986, came from Resource Technical with regard to the services rendered by Gerald Roberts at the Brunswick Steam Electric Station. Payments by Roberts Consultants to Gerald RobertsRoberts Consultants deducted as business expenses the following payments made to or for the benefit of Gerald Roberts, and members of his immediate family, which respondent disallowed: Taxable Year Ended9/30/859/30/86Auto Expense$ 3,005$ 1,562Cost of Goods Sold Expense *--9,185Depreciation Expense5,0053,200Insurance Expense1,143899Interest Expense899764License Expense23396Meetings Expense1,617284Miscellaneous Expense880553Per Diem Expense--11,460Rent Expense2,400200Supplies Expense1,208356Telephone Expense150260Total$ 16,540$ 28,8191991 Tax Ct. Memo LEXIS 539">*547 Roberts Consultants concedes the disallowance of the following claimed corporate deductions: Taxable Year Ended9/30/859/30/86Auto Expense$ 2,254$ 781Insurance487200Depreciation4,0001,600Interest Paid674382Auto License17548Total7,5903,011Less: Amount paid to Corp. *-900-900Amount Conceded$ 6,690$ 2,111In the notice of deficiency issued to Gerald and Judy Roberts, respondent determined that Gerald Roberts received constructive dividends with respect to the following corporate payments: 19851986Auto Expense Reimbursement$ 3,005$ 1,563to Gerald RobertsAuto Insurance649399Auto License23396Auto Loan Payments to GMAC4,3034,590Insurance Premiums494701Telephone Bills Reimbursed150260to Gerald RobertsPayments to Children800800Repairs to VCR80253Computer Purchase1,007--Prentice Hall Books102--Post Office Box Rent--27Unsubstantiated Travel Reimbursement1,617284to Gerald RobertsUnsubstantiated Supplies Reimbursement201426to Gerald RobertsMoving Expenses Reimbursement--300to Gerald RobertsLoans to Gerald Roberts16,000--Per Diem to Gerald Roberts--19,845Total$ 28,641$ 29,5441991 Tax Ct. Memo LEXIS 539">*548 Automobile ExpensesIn 1984, 1985, and 1986, Roberts Consultants owned a 1984 Blazer station wagon (with a five-passenger capacity) and a 1982 Oldsmobile 98 (with a six-passenger capacity). During this time, Mr. and Mrs. Roberts personally owned a 1969 restored Corvette, which was a two-passenger vehicle. The named insureds with regard to the corporate-owned vehicles were Gerald and Judy Roberts. Mr. Roberts used the corporate vehicles for commuting purposes; Mrs. Roberts used the corporate vehicles for family purposes. Respondent determined that Mr. Roberts received a constructive dividend as a result of the individual petitioners' use of the corporate vehicles for personal and family purposes. The individual petitioners concede the correctness of respondent's determination to the extent of $ 6,690 for 1985 and $ 2,111 for 1986. Meetings ExpensesRoberts Consultants claimed a deduction for meetings and convention expenses, which respondent disallowed. Respondent concedes $ 1,385 of the claimed meeting expenses for 1985. The deduction claimed by Roberts Consultants for 1986 (in the amount of $ 284) relates to a trip taken by Mr. and Mrs. Roberts and their two1991 Tax Ct. Memo LEXIS 539">*549 children from Supply, North Carolina, to Tupelo, Mississippi, in August 1986. The purpose of the trip was to visit Rita and Richard Sinervo. The Sinervos were longtime friends of the Roberts. In addition, Mrs. Sinervo prepared the Roberts' personal tax returns. In petitioners' post-trial briefs, Roberts Consultants concedes 75 percent (or $ 213) of the amount of the deduction claimed for the trip to Tupelo, and the individual petitioners concede that 50 percent (or $ 142) constitutes a constructive dividend. Miscellaneous DeductionsRoberts Consultants claimed deductions in 1985 for payments aggregating $ 800 to his two minor children (the Roberts have two sons, one born in 1973 and the other in 1976) for cleaning and other tasks. Similar deductions were claimed in 1986 as "cost of goods sold." Roberts Consultants also claimed deductions of $ 80 in 1985 and $ 253 in 1986 with regard to repairs made to a VCR which ostensibly Mr. Roberts needed in the performance of services rendered at various power plants. In petitioners' post-trial briefs, they concede 10 percent (or $ 33) of the aggregate amount ($ 80 + $ 253 = $ 333) claimed for repairs to the VCR. Correspondingly, 1991 Tax Ct. Memo LEXIS 539">*550 the individual petitioners concede that 10 percent of the VCR repairs (or $ 33) constitutes a constructive dividend. Finally, Roberts Consultants deducted $ 300 in 1986 for an unexplained miscellaneous expense. Per Diem ExpensesRoberts Consultants paid Gerald Roberts a per diem consisting of two types of items, a daily $ 40 subsistence expense, and Mr. Roberts' out-of-pocket expenses. Respondent disallowed the claimed corporation deduction and posits that such payment constituted income dividends to Mr. Roberts. The individual petitioners concede that their income should be increased by $ 7,300 for per diem payments to Mr. Roberts from April 1, 1986, to September 30, 1986. Rent ExpenseRoberts Consultants claimed rental deductions for payments made to Mr. Roberts for use of office space in the individual petitioners' home. No testimony or evidence was introduced indicating that a written rental agreement existed between Roberts Consultants and the individual petitioners. During these periods, Mr. Roberts was provided with office space at the Clinton Nuclear Power Plant, the Hatch Nuclear Power Plant, and the Brunswick Steam Electric Station. Supplies Expenses1991 Tax Ct. Memo LEXIS 539">*551 Roberts Consultants claimed a $ 1,543 deduction for supplies in 1985, of which $ 1,208 was disallowed. Of the $ 1,208 disallowed amount, $ 1,007 was a reimbursement to Gerald Roberts for the purchase of a Commodore computer. The computer was never used by Roberts Consultants or the individual petitioners. Roberts Consultants provided no substantiation for the remaining $ 201 ($ 1,208 - $ 1,007) disallowed amount. Roberts Consultants also claimed a $ 520 deduction for supplies in 1986, of which $ 356 was disallowed by respondent. No explanation or substantiation regarding this expenditure was provided. Telephone ExpensesRoberts Consultants did not have its own telephone. It claimed deductions for payments made to Gerald Roberts as reimbursement for alleged corporate usage of the Roberts' phone. Life Insurance PremiumsRoberts Consultants paid (and deducted) premiums on two insurance policies: one policy on the life of Mr. Roberts, with Mrs. Roberts and the children as beneficiaries, and the other on the life of Mrs. Roberts, with Mr. Roberts and the children as beneficiaries. Respondent determined that payment of these premiums constituted constructive dividends1991 Tax Ct. Memo LEXIS 539">*552 to Mr. Roberts. The individual petitioners concede that they had unreported income in 1985 and 1986 in the amounts of $ 202 and $ 208, respectively, arising from the payment of the insurance premiums by Roberts Consultants. The conceded amounts represent but a portion of the total premiums paid. LoansMr. Roberts received payments (ostensibly as loans) totaling $ 16,000 from Roberts Consultants on February 8, 1985, March 6, 1985, April 10, 1985, May 1, 1985, and May 6, 1985. Respondent determined that these payments constituted constructive dividends to Mr. Roberts. A reduction in the amount of "loans to stockholders account," as set forth on the 1986 corporate tax return, indicates that Mr. Roberts repaid Roberts Consultants a portion of these "loans" between October 1, 1985, and September 30, 1986. However, no direct evidence was introduced to corroborate the repayment. OPINION Issue 1. Personal Holding CompanyRespondent determined that Roberts Consultants was a personal holding company within the meaning of section 542(a), and thus subject to the personal holding company tax imposed by section 541 for its 1985 and 1986 taxable years. Section 541 imposes1991 Tax Ct. Memo LEXIS 539">*553 a tax on every "personal holding company" equal to 50 (now 28) percent of its undistributed "personal holding company income." A corporation is a personal holding company if it meets both a stock ownership test and a tainted income test, as specified in section 542(a). A corporation satisfies the stock ownership test if, at any time during the last half of the taxable year, more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals. Sec. 542(a)(2). A corporation satisfies the tainted income test if at least 60 percent of its adjusted ordinary gross income for the taxable year constitutes personal holding company income. Sec. 542(a)(1). Section 543 defines personal holding company income. It provides, in pertinent part, as follows: (a) GENERAL RULE. - For purposes of this subtitle, the term "personal holding company income" means the portion of the adjusted ordinary gross income which consists of: * * * (7) PERSONAL SERVICE CONTRACTS. -- (A) Amounts received under a contract under which the corporation is to furnish personal services; if some person other than the corporation has the right to designate1991 Tax Ct. Memo LEXIS 539">*554 (by name or by description) the individual who is to perform the services, or if the individual who is to perform the services is designated (by name or by description) in the contract; and (B) amounts received from the sale or other disposition of such a contract. This paragraph shall apply with respect to amounts received for services under a particular contract only if at some time during the taxable year 25 percent or more in value of the outstanding stock of the corporation is owned, directly or indirectly, by or for the individual who has performed, is to perform, or may be designated (by name or by description) as the one to perform, such services. 4Two statutory tests -- a designation test and a stock ownership test -- must be met in order for a contract to be considered a "personal service contract" within the meaning of section 543(a)(7). Kenyatta Corp. v. Commissioner, 86 T.C. 171">86 T.C. 171, 86 T.C. 171">183 (1986), affd. 812 F.2d 577">812 F.2d 577 (9th Cir. 1987). The designation test requires that the individual who is to perform the services be designated, by name or by description, in the contract or that such individual can be so designated by some person other than the corporation. 1991 Tax Ct. Memo LEXIS 539">*555 Sec. 543(a)(7)(A). The stock ownership test requires that the person designated to perform services own at least 25 percent of the corporation's stock at some time during the taxable year. The 25-percent stock ownership test is set forth in the flush language of section 543(a)(7). Roberts Consultants concedes that Gerald Roberts, its primary service provider, owned 100 percent of its stock; thus, the stock ownership tests set forth in sections 542(a)(2) and 1991 Tax Ct. Memo LEXIS 539">*556 543(a)(7) have been satisfied. Accordingly, we need only determine whether the designation test has been satisfied. Roberts Consultants argues that it was not a personal service corporation since its contracts with PMC, Walker Training, and Resource Technical did not designate Gerald Roberts, by name or description, as the individual who would perform the services required under the contract. We reject this argument. The facts in this case are similar to those in RAS of Sand River v. Commissioner, 935 F.2d 270">935 F.2d 270 (6th Cir. 1991), affg. per curiam a Memorandum Opinion of this Court. There, Richard A. Sinervo performed services for the Clinton Nuclear Power Plant through a contract between his wholly owned corporation and PMC. 5 The disallowed deductions which RAS of Sand River claimed consisted of personal living expenses of the corporation's owners. Mr. Sinervo was the only service provider for RAS of Sand River. The corporate petitioner failed to prove that Mr. Sinervo was not designated by name or description in the contract with PMC. RAS of Sand River failed to establish a base of potential employees and relied only upon Mr. Sinervo to perform said work. Also, the utility1991 Tax Ct. Memo LEXIS 539">*557 company which contracted with PMC for the construction of the Clinton Nuclear Power Plant designated Mr. Sinervo by accepting him on the basis of his resume. We found that RAS of Sand River failed to meet its burden of proof with respect to the designation test and concluded that RAS of Sand River was a personal service company. In the case before us, Gerald Roberts was president, sole shareholder, and sole employee of Roberts Consultants. He performed all of Roberts Consultants' services at the Clinton Nuclear Power Plant, the Hatch Power Plant, and the Brunswick Steam Electric Station. Although his services were not so valuable1991 Tax Ct. Memo LEXIS 539">*558 and unique as to be irreplaceable, 86 T.C. 171">Kenyatta Corp. v. Commissioner, supra at 188, he provided the only services which generated gross receipts for Roberts Consultants during both years in issue. The parties which contracted with Roberts Consultants (PMC, Walker Training, and Resource Technical) knew that Gerald Roberts and Roberts Consultants were in reality one and the same, and that Gerald Roberts would provide all work under the service contracts. Gerald Roberts provided services for PMC at the Clinton Nuclear Power Plant for 4 years before signing service contracts with PMC. These contracts were backdated to the date when services were first performed by him. Although Mr. Roberts is not designated by name, the backdated PMC contracts do not foreclose the possibility that he was designated by description as the person to perform services thereunder. 6 In pertinent part the written contracts provide: PMC Corp. has entered into this agreement based on a given consultants resume, experience and potential and that individual shall put forth 100% effort in return for the subject compensation at all times * * *.We are convinced that the PMC contracts, in addition1991 Tax Ct. Memo LEXIS 539">*559 to the others Roberts Consultants entered into, were contracts for the services of Gerald Roberts and Gerald Roberts alone. He was the only service provider for Roberts Consultants, and PMC knew that it was contracting for Gerald Roberts' services. 7 We likewise are convinced that Walker Training and Resource Technical knew that they were contracting for Gerald Roberts' services. PMC, Walker Training, and Resource Technical entered into the contracts with Roberts Consultants based on Gerald Roberts' reputation and qualifications. Roberts Consultants did not attempt to supply any service provider other than Mr. Roberts. And there is no indication that anyone other than Gerald Roberts was even considered as a service provider under the contracts. (We note that Resource Technical reserved the right to reject any substitute service provider and exercised that right by only accepting Mr. Roberts to perform work under the contract.) Control over the earning of all of the income in question remained with him. The reality of the situation involved herein is that Gerald Roberts was the designated individual who was required to perform services for PMC, Walker Training, and Resource 1991 Tax Ct. Memo LEXIS 539">*560 Technical. Thus, we find and hold that Gerald Roberts was the person designated as the person to furnish services under Roberts Consultants' service contracts with PMC, Walker Training, and Resource Technical. In sum, since both the stock ownership and the designation tests have been met, the total income Roberts Consultants received during the years in issue was personal holding company income pursuant to section 543(a). Roberts Consultants neither argued nor attempted to prove that its personal holding company income was less than 60 percent of its adjusted1991 Tax Ct. Memo LEXIS 539">*561 ordinary gross income. See sec. 542(a)(1). Accordingly, during both years in issue, Roberts Consultants was a personal holding company, and thus subject to the personal holding company tax. Issue 2. Section 162(a) DeductionsThe next issue for decision is whether certain payments made by Roberts Consultants to or for the benefit of Gerald Roberts and members of his immediate family constitute deductible corporate business expenses. At the outset, we note that deductions are a matter of legislative grace, and taxpayers are required to prove their entitlement to deductions by a preponderance of the evidence. Rule 142(a); 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). Section 162(a) permits the deduction of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Whether expenditures are for ordinary and necessary business expenses is a question of fact. Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467, 320 U.S. 467">473-475, 88 L. Ed. 171">88 L. Ed. 171, 64 S. Ct. 249">64 S. Ct. 249 (1943). Personal, living, or family expenses are generally not deductible. Sec. 262. Automobile ExpensesGerald Roberts used the corporate-owned vehicles to commute to work. Mrs. Roberts used the vehicles1991 Tax Ct. Memo LEXIS 539">*562 for family purposes. There is no evidence in the record which indicates that they were used for any purpose other than commuting and family activities; expenses arising from commuting and family activities are personal, nondeductible expenses. Respondent's disallowance of the deductions claimed by Roberts Consultants totaling $ 9,790 for 1985 and $ 6,021 for 1986, and labeled as auto expenses, depreciation expense, insurance expense, interest expense, and license expense, is sustained. Meetings ExpensesBoth parties concede portions of the corporate deductions claimed for meetings expenses. Even though we are mindful that one of the persons the Roberts family visited during their trip to Tupelo, Mississippi, was Rita Sinervo, their tax preparer, petitioners failed to show that such trip was other than for pleasure. Accordingly, none of the expenses of such trip are deductible, and respondent's determination in this regard is sustained. Miscellaneous ExpensesIn 1985, Roberts Consultants deducted payments made to the Roberts' minor children as a miscellaneous expense. These payments were for services rendered in helping Mrs. Roberts perform cleaning tasks and going1991 Tax Ct. Memo LEXIS 539">*563 to the mailbox. Such payments were rewards for performing family chores. As such, they are nondeductible personal expenses. Sec. 262. Roberts Consultants deducted payments made to repair the Roberts' VCR. Despite Mr. Roberts' testimony, we believe the VCR was used for personal purposes. (We did not find his testimony on this point to be credible.) Accordingly, the deductions for repairs to the VCR were properly disallowed. Finally, a $ 300 miscellaneous expense for 1986 was also properly disallowed, since Roberts Consultants did not substantiate this deduction. Per Diem ExpensesRoberts Consultants claimed a per diem expense deduction for payments made to Gerald Roberts. For 1985, the per diem expenses were included as part of "cost of goods sold." For 1986, the per diem expenses were listed separately. Notwithstanding the business characterization of the per diem expenses, we hold that such payments to Gerald Roberts for both years are not deductible. Had Gerald Roberts not utilized Roberts Consultants to receive payments from Walker Training and Resource Technical, he would not have been entitled to a deduction for travel and other expenses while working at the1991 Tax Ct. Memo LEXIS 539">*564 Hatch Nuclear Power Plant in Savannah, Georgia, and the Brunswick Steam Electric Station in Southport, North Carolina, and maintaining a family home in Supply, North Carolina. Accordingly, respondent's disallowance of the corporate deduction for these expenses is sustained. Rent ExpenseRoberts Consultants claimed deductions for 1985 and 1986 with regard to rent paid to Mr. Roberts for the use of space in the Roberts' home. Mr. Roberts was provided with office space at each power plant where he performed services; thus, it was not necessary for Roberts Consultants to rent a portion of the Roberts' home. Accordingly, respondent's disallowance of the claimed rent expense is sustained. Supplies ExpensesWe sustain respondent's disallowance of a portion of the deduction claimed for supplies for failure to substantiate. Sec. 162(a). Telephone ExpensesRoberts Consultants failed to substantiate its claim for telephone expenses for 1985; thus, respondent's disallowance of the claimed telephone expenses for 1985 is sustained. The expenses for 1986 were for a telephone installation charge and flat monthly service charges incurred by Mr. Roberts. There is no evidence1991 Tax Ct. Memo LEXIS 539">*565 that these expenses related to any business usage of Mr. Roberts' telephone. Accordingly, respondent's disallowance of the claimed telephone expenses for 1986 is sustained. Issue 3. Constructive DividendsRespondent determined that payments made by Roberts Consultants to or for the benefit of Gerald Roberts and members of his immediate family constitute constructive dividend income. Dividend income is included in the gross income of the recipient. Sec. 61(a). The term "dividend" is defined as any distribution of property by a corporation to its shareholders out of post-1913 accumulated and current earnings and profits. Sec. 316(a). A distribution under section 301 may be found even though the corporation has not formally declared a dividend. Crosby v. United States, 496 F.2d 1384">496 F.2d 1384, 496 F.2d 1384">1388 (5th Cir. 1974). Gerald Roberts caused Roberts Consultants to be organized in order to convert personal living and family expenses into business expenses. 8 Where payments are made for the personal benefit of a shareholder by a corporation and such payments are not proximately related to the corporate business, the corporation is not entitled to deductions to the extent that they1991 Tax Ct. Memo LEXIS 539">*566 relate to such personal use, and the payments are includable in the shareholder's income as constructive dividends to the extent of the corporation's earnings and profits. Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332, 85 T.C. 332">356 (1985). Our holding that the Roberts Consultants business expenses1991 Tax Ct. Memo LEXIS 539">*567 in issue are not deductible does not automatically result in constructive dividends to Mr. and Mrs. Roberts. The test for constructive dividends in such circumstances is not only that the expenses be nondeductible to the corporation, but that the expenses also represent some economic gain or benefit to the shareholder. Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 356-357. Gerald Roberts received an economic benefit with respect to the corporation's payment of automobile expenses, as well as reimbursements to him for telephone expenses, VCR repairs, computer purchase, supplies, travel expenses, moving expenses, and post office box rent. Such expenses were neither ordinary nor necessary business expenses, but rather reimbursement of Gerald Roberts' personal expenses. Accordingly, respondent's determination that the aforementioned corporate payments constitute income to the Roberts is sustained. Respondent determined the corporate purchase of Prentice Hall tax publications constituted constructive dividend income to Gerald Roberts. While we agree with said determination, we hasten to add that Gerald Roberts is entitled to a Schedule A deduction in an amount equal to the constructive1991 Tax Ct. Memo LEXIS 539">*568 dividend. Insurance Premium PaymentsRoberts Consultants also paid the insurance premiums on two life insurance policies: (1) One in which Mr. Roberts was the insured and the beneficiaries were Mrs. Roberts and the children; (2) the second in which Mrs. Roberts was the insured and Mr. Roberts and the children were the beneficiaries. The payment of premiums by a corporation on an insurance policy owned by a shareholder results in a constructive dividend to the shareholder. Paramount-Richards Theatres, Inc. v. Commissioner, 153 F.2d 602">153 F.2d 602 (5th Cir. 1946); Canaday v. Guitteau, 86 F.2d 303">86 F.2d 303 (6th Cir. 1936); Lynch v. Commissioner, T.C. Memo 1983-173. Thus, the insurance premiums paid by the corporation on behalf of the Roberts constitute constructive dividends. Payments to the Roberts' ChildrenIt is well established that a payment made to a family member of a shareholder can constitute a section 301 distribution by the corporation with respect to the stock of the shareholder. Green v. United States, 460 F.2d 412">460 F.2d 412, 460 F.2d 412">419 (5th Cir. 1972); Epstein v. Commissioner, 53 T.C. 459">53 T.C. 459, 53 T.C. 459">474-475 (1969). Under proper circumstances, it is appropriate to hold that a 1991 Tax Ct. Memo LEXIS 539">*569 payment to a family member represents a distribution by the corporation to the shareholder. 53 T.C. 459">Epstein v. Commissioner, supra.Roberts Consultants paid annual allowances to the Roberts' children in the amounts of $ 400 per child during 1985 and 1986. There is no indication that the activities of the children produced any benefit to the corporation. On the contrary, the childrens' activities benefited their parents. Thus, we sustain respondent's determination that the payments to the Roberts' children by Roberts Consultants constituted income to Gerald Roberts. LoansMr. Roberts also received loans from Roberts Consultants during 1985. The loans to shareholder account, as set forth on Roberts Consultants' 1986 tax return, indicates that the balance of said account was reduced by approximately $ 16,000 during the period commencing October 1985. No evidence was introduced that Mr. Roberts actually repaid the corporate loan. The forgiveness of a loan owed to a corporation by its sole shareholder is a constructive dividend to the shareholder. Accordingly, respondent's determination that the $ 16,000 reduction constitutes income to Gerald Roberts is sustained. 1991 Tax Ct. Memo LEXIS 539">*570 Per DiemFinally, Mr. Roberts received payments totaling $ 19,845 from Roberts Consultants during 1986 as per diem expenses. We have found that these expenses were not ordinary and necessary corporate business expenses. Instead, they were expended for Gerald Roberts' rent, telephone charges, and gasoline. Gerald Roberts received an economic benefit as a result of these payments; accordingly, the payments are constructive dividends to him. Since we have decided that the Roberts received constructive dividends from Roberts Consultants, we need not address the section 269A issue. Issue 4. Section 6653(a) Addition To TaxThe next issue for decision is whether Roberts Consultants and Mr. and Mrs. Roberts are liable for the additions to tax provided by section 6653(a)(1) and (2) in 1985, and section 6653(a)(1)(A) and (B) in 1986. Section 6653(a)(1), which was redesignated 6653(a)(1)(A) for taxable years in which a return is due after December 31, 1986, provides that if any part of an underpayment of tax is due to negligence or intentional disregard of rules and regulations, there shall be added to the tax an amount equal to 5 percent of the underpayment. Section 6653(a)(2), 1991 Tax Ct. Memo LEXIS 539">*571 which was redesignated 6653(a)(1)(B) for taxable periods for which a return is due after December 31, 1986, provides that if any part of an underpayment of tax is due to negligence or intentional disregard of rules and regulations, there shall be added to the tax, in addition to the 5-percent addition provided by section 6653(a)(1), an amount equal to 50 percent of the interest payable under section 6601 with respect to the portion of such underpayment which is attributable to negligence. The addition to tax under section 6653(a)(2) is imposed for the period beginning on the last day prescribed by law for payment of such underpayment. Sec. 6653(a)(2)(B). Within the meaning of section 6653(a), negligence has been defined as the "lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985), quoting Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 380 F.2d 499">506 (5th Cir. 1967). Petitioner bears the burden of proving that its underpayment of tax was not due to negligence. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791 (1972); Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 57 T.C. 781">802-803 (1972). Roberts Consultants1991 Tax Ct. Memo LEXIS 539">*572 claimed deductions for its 1985 and 1986 taxable years in the amounts of $ 16,540 and $ 28,819, 9 respectively, which we have found to be payments made to or for the benefit of the Roberts, and thus not ordinary and necessary business expenses. Roberts Consultants was formed and operated by Mr. Roberts for the purpose of converting personal expenses into tax deductions. Thus, Roberts Consultants is subject to additions to tax pursuant to section 6653(a)(1) and (2) for its 1985 taxable year, and subject to additions pursuant to section 6653(a)(1)(A) and (B) for its 1986 taxable year. Mr. and Mrs. Roberts failed to report constructive dividends received from the personal service corporation, Roberts Consultants, owned by Mr. Roberts during 1985 and 1986. Mr. Roberts formed and operated Roberts Consultants with the intent of reducing the Roberts' 1991 Tax Ct. Memo LEXIS 539">*573 personal income tax liability. Thus, the Roberts clearly did not exercise ordinarily prudent behavior. See 85 T.C. 934">Neely v. Commissioner, supra.Accordingly, they are subject to the additions to tax pursuant to section 6653(a)(1) and (2) for 1985 and the addition pursuant to section 6653(a)(1)(A) and 6653(A)(1)(B) for 1986. 10Issue 5. Section 6661 Addition To TaxSection 6661(a) imposes an addition to tax when there is a "substantial understatement of income tax for any taxable year." 11 The amount of this addition to tax is equal to 25 percent of any underpayment 1991 Tax Ct. Memo LEXIS 539">*574 attributable to the substantial understatement. See Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988). With respect to a personal holding company, an understatement is substantial if it exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6661(a)(1) and (2). Roberts Consultants reported tax liabilities for its 1985 and 1986 tax years in the amounts of $ 3,497 and $ 5,593, respectively. Respondent determined a deficiency in tax for those years in the amounts of $ 12,390 and $ 19,454, respectively. Mr. and Mrs. Roberts reported income tax liabilities for 1985 and 1986 in the amounts of $ 3,878 and $ 6,319, respectively. Respondent determined that the Roberts have a deficiency in income tax arising from unreported constructive dividends for the taxable1991 Tax Ct. Memo LEXIS 539">*575 years in issue in the amounts of $ 9,098 and $ 14,857, respectively. Petitioners have the burden of proof on this issue. Rule 142(a). Neither Roberts Consultants nor the Roberts presented proof relating specifically to such determinations. Accordingly, respondent's determination is sustained. To reflect the foregoing and concessions of the parties, Decisions will be entered under Rule 155. Footnotes1. Consolidated for trial, briefing, and opinion.↩2. All section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩3. Petitioner Gerald D. Roberts Consultants, Inc.'s taxable year ending September 30, 1985, will hereinafter be referred to as its 1985 taxable year, and its taxable year ending September 30, 1986, will hereinafter be referred to as its 1986 taxable year.↩*. The disallowed portion of cost of goods sold expense represents corporate payments aggregating $ 8,385 to Gerald Roberts for reimbursement of his travel and living expenses from October 13, 1985, to February 28, 1986, while living in Savannah, and payments aggregating $ 800 to his two minor children.↩*. It is not clear why the concession was reduced by the amount of Gerald Roberts' payment to Roberts Consultants.↩4. The statutory provisions concerning personal service contracts were enacted to close the so-called incorporated talent loophole. Absent this provision, individuals receiving large amounts of personal service income could avoid the effect of the progressive income tax rates by arranging for wholly owned corporations to contract and receive compensation for their services. S. Rept. 1242, 75th Cong., 1st Sess. (1937), 1937-2 C.B. 609, 613; Kurt Frings Agency, Inc. v. Commissioner, 42 T.C. 472">42 T.C. 472, 42 T.C. 472">477 (1964), affd. per curiam 351 F.2d 951">351 F.2d 951↩ (9th Cir. 1965).5. We note that the Richard Sinervo in RAS of Sand River v. Commissioner, 935 F.2d 270">935 F.2d 270↩ (6th Cir. 1991), affg. per curiam a Memorandum Opinion of this Court, is the brother of Vincent Sinervo, the accountant who prepared Roberts Consultants' tax returns as well as those of RAS of Sand River, and is the husband of Rita Sinervo, who prepared Gerald and Judy Roberts' personal tax returns.6. See 935 F.2d 270">RAS of Sand River, Inc. v. Commissioner, supra↩, where we disregarded a similar written contract between PMC and the taxpayer involved therein. 7. We note that Mr. Roberts did not sign the November 8, 1983, contract on behalf of Roberts Consultants; however, the compensation package portion of the contract was signed personally by him on August 24, 1984. We consider this to be a further indication that PMC contracted for Mr. Roberts' services.↩8. Mr. Roberts claims Roberts Consultants was formed as a result of Jim Church's insistence that PMC would do business only with a corporate subcontractor. We closely observed Mr. Roberts while he was testifying. For the most part, we found his testimony unconvincing; he was not a credible witness. We are not bound to accept uncontroverted testimony at face value if such testimony seems improbable, unreasonable, or questionable, Lovell and Hart, Inc. v. Commissioner, 456 F.2d 145">456 F.2d 145, 456 F.2d 145">148 (6th Cir. 1972), affg. per curiam a Memorandum Opinion of this Court, or if the facts in their totality convey a different impression, Diamond Bros. Co. v. Commissioner, 322 F.2d 725">322 F.2d 725, 322 F.2d 725">731↩ (3d Cir. 1963), affg. a Memorandum Opinion of this Court.9. Roberts Consultants conceded at trial that it was not entitled to $ 6,690 and $ 9,411 of the expense deductions claimed for its 1985 and 1986 taxable years, respectively.↩10. Both the corporate and individual petitioners argue that they relied on expert advice in filing their returns, and thus should not be liable for the additions to tax for negligence. However, as we stated in 935 F.2d 270">RAS of Sand River, Inc. v. Commissioner, supra, the reliance upon expert advice does not necessarily insulate the taxpayer from liability for negligence additions to tax. Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 57 T.C. 781">802↩ (1972).11. An understatement occurs when the amount of tax shown on the return, less any rebate (within the meaning of sec. 6211(b)(2)), is less than the amount of tax required to be shown on the return. See sec. 6661(b)(2)(A).↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623049/ | FLAHERTYS ARDEN BOWL, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFlahertys Arden Bowl, Inc. v. CommissionerNo. 15223-98United States Tax Court115 T.C. 269; 2000 U.S. Tax Ct. LEXIS 65; 115 T.C. No. 19; September 25, 2000, Filed 2000 U.S. Tax Ct. LEXIS 65">*65 Decision will be entered for respondent with respect to the deficiencies, and for petitioner with respect to the additions to tax under section 6651(a)(1). F owns more than 50 percent of the stock of P. F is a beneficiary of two retirement plans held by T. Under the terms of the plans F is authorized to direct the investments of the assets in his accounts in the plans. F is a fiduciary under sec. 4975, I.R.C., and, under that section, P is a "disqualified person". Sec. 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, 877, provides that if a plan beneficiary exercises control over the plan's assets in his account, the beneficiary is not a fiduciary. HELD: ERISA sec. 404(c) does not modify the definition of a fiduciary under sec. 4975, I.R.C., and P is liable for the tax imposed by that section. Nick Hay, for petitioner.James S. Stanis, for respondent. Dawson, Howard A., Jr.;Powell, Carleton D.DAWSON; POWELL115 T.C. 269">*270 OPINION2000 U.S. Tax Ct. LEXIS 65">*66 DAWSON, JUDGE: This case was assigned to Special Trial Judge Carleton D. Powell pursuant to Rules 180, 181, and 183. All Rule references are to the Tax Court Rules of Practice and Procedure. The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below.OPINION OF THE SPECIAL TRIAL JUDGEPOWELL, SPECIAL TRIAL JUDGE: Respondent determined deficiencies in petitioner's 1993 and 1994 Federal excise taxes under section 4975(a)1 of $ 800 and $ 1,303, respectively. Respondent also determined additions to tax under section 6651(a)(1) for 1993 and 1994 of $ 200 and $ 326, respectively. The issues are (1) whether petitioner is a disqualified person under section 4975(e), and, if so, (2) whether petitioner is liable for the section 6651(a)(1) additions to tax.At the time the petition was filed petitioner's principal place of business was located in Arden Hills, Minnesota. 2000 U.S. Tax Ct. LEXIS 65">*67 BACKGROUNDThe facts may be summarized as follows. Flahertys Arden Bowl, Inc. (petitioner), is a corporation organized under the laws of Minnesota. Patrick F. Flaherty (Mr. Flaherty) owns 57 percent of the common stock of petitioner and is the secretary of petitioner.Mr. Flaherty is an attorney licensed to practice law in the State of Minnesota. Beginning in 1968, Mr. Flaherty's employer, Moss & Barnett, P.A., maintained a qualified profit sharing plan. Moss & Barnett, P.A., also maintained a qualified pension plan. Both plans were trusts as defined in section 401(a) and were exempt from tax under section 501(a). Mr. Flaherty participated in both plans. 115 T.C. 269">*271 U.S. Bank, National Association, is the successor trustee of both plans. 2 Both plans were defined contribution plans and provided segregated account balances for each participant. Both plans permitted the participant to direct up to 100 percent of the account assets.2000 U.S. Tax Ct. LEXIS 65">*68 During the period January 29, 1981, through June 15, 1982, Mr. Flaherty directed the trustee of his profit sharing plan account to lend $ 200,100 to petitioner. Mr. Flaherty also directed the trustee of his pension plan account to lend petitioner an additional $ 25,900. Mr. Flaherty, as an officer of petitioner, executed notes payable to the plans in exchange for the loans. The loans were payable upon demand and provided for interest at a market rate plus 1 percent. Petitioner timely paid interest on the loans. While the loans were outstanding, each plan listed the notes as assets on its books and records. The principal of both loans was repaid on April 5, 1994.Before his direction to the plans, Mr. Flaherty contacted Marvin Braun (Mr. Braun) at U.S. Bank, National Association, and discussed the loans. Mr. Braun is a lawyer and has provided services for qualified retirement plans since 1971. Mr. Flaherty asked whether, under the plan agreements, he could direct that the loans be made and whether section 4975 would apply to petitioner. Mr. Braun advised him that the loans could be made and that section 4975 would not apply. Mr. Braun was aware of the relationship between Mr. Flaherty2000 U.S. Tax Ct. LEXIS 65">*69 and petitioner. In directing that the loans be made, Mr. Flaherty relied on Mr. Braun's advice.Petitioner did not file a Form 5330, Excise Tax Return, for either of the years in issue. Respondent determined that petitioner was a disqualified person within the meaning of section 4975(a), that the loans were prohibited transactions under section 4975(c)(1)(B), and that excise taxes were due under section 4975(a). Respondent also determined that petitioner failed to file Forms 5330 to report its liability for the excise taxes and that petitioner was liable for the additions to tax under section 6651(a)(1). 115 T.C. 269">*272 DISCUSSIONI. LIABILITY UNDER SECTION 4975A. THE STATUTESSection 4975 was added to the Internal Revenue Code by title II of the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, sec. 2003, 88 Stat. 829, 971. ERISA was enacted to protect * * * the interests of participants in employee benefit plans and their beneficiaries, by requiring the disclosure and reporting to participants and beneficiaries of financial and other information with respect thereto, by establishing standards of conduct, responsibility, and2000 U.S. Tax Ct. LEXIS 65">*70 obligation for fiduciaries of employee benefit plans, and by providing for appropriate remedies, sanctions, and ready access to the Federal courts. [ERISA sec. 2(b), 29 U.S.C. sec. 1001(b) (1988).]The statutory framework of ERISA contains four separate titles. We deal with Titles I and II. Title I of ERISA contains the "labor provisions" codified as amended in 29 U.S.C. secs. 1001-1461 (1988). The labor provisions were designed to give the Department of Labor broad remedial powers over employee benefit plans. Title II of ERISA contains the "tax provisions" including section 4975. The tax provisions, contained in the Internal Revenue Code, provide the statutory framework for the tax laws governing employee benefit plans and generally are administered by the Department of the Treasury. See Rutland v. Commissioner, 89 T.C. 1137">89 T.C. 1137, 89 T.C. 1137">1143 n.4 (1987).There are many areas where the labor provisions coincide with or overlap the tax provisions. While much of the statutory terminology is similar, there are instances in which the statutes are different. At issue in this case is one of those inconsistencies. 2000 U.S. Tax Ct. LEXIS 65">*71 Section 4975(a) provides: SEC. 4975(a). Initial Taxes on Disqualified Person. -- There is hereby imposed a tax on each prohibited transaction. The rate of tax shall be equal to 5 percent of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the taxable period. The tax imposed by this subsection shall be paid by any disqualified person who participates in the prohibited transaction (other than a fiduciary acting only as such). 115 T.C. 269">*273 The definition of a prohibited transaction includes "any direct or indirect lending of money or other extension of credit between a plan and a disqualified person". Sec. 4975(c)(1)(B). For our purposes, section 4975(c) is similar to ERISA section 406, 29 U.S.C. section 1106(a)(1)(B), except that the term "disqualified person" is changed to "a party in interest". A disqualified person and a party in interest are defined as, inter alia, a "fiduciary". Sec. 4975(e)(2)(A); ERISA sec. 3(14)(A), 29 U.S.C. sec. 1002(14)(A). Section 4975(e)(2)(G) and ERISA section 3(14)(G), 29 U.S.C. 10022000 U.S. Tax Ct. LEXIS 65">*72 (14)(G), further provide that a corporation in which a fiduciary owns 50 percent or more of the stock is also a disqualified person or party in interest.Section 4975(e)(3) provides: For purposes of this section, the term "fiduciary" means any person who -- (A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assetsERISA section 3(21)(A)(i), 29 U.S.C. section 1002(21)(A)(i), contains virtually the same language.If this were the end of the statutory framework, petitioner would clearly be a "disqualified person" and liable for the excise tax imposed by section 4975(a). Mr. Flaherty is a fiduciary because he directs the management of the plans' assets, more than 50 percent of petitioner's stock is owned by Mr. Flaherty, and the plans lent money to petitioner.The labor provisions of ERISA, however, provide an exception to the definition of fiduciary: In the case of a pension plan which provides for individual accounts and permits a participant2000 U.S. Tax Ct. LEXIS 65">*73 or beneficiary to exercise control over the assets in his account, if a participant or beneficiary exercises control over the assets in his account (as determined under regulations of the Secretary) -- (A) such participant or beneficiary shall not be deemed to be a fiduciary by reason of such exercise, and (B) no person who is otherwise a fiduciary shall be liable under this part for any loss, or by reason of any breach, which results from such participant's or beneficiary's exercise of control. [ERISA sec. 404(c)(1), 29 U.S.C. sec. 1104(c)(1).]The plans permitted Mr. Flaherty to exercise control over the assets in the accounts, and petitioner maintains that, since Mr. Flaherty is not a fiduciary under the provisions of 115 T.C. 269">*274 ERISA section 404, 29 U.S.C. section 1104, he is not a fiduciary under section 4975. On the other hand, respondent argues that Mr. Flaherty is a fiduciary for purposes of section 4975 even though he may not be a fiduciary under ERISA section 404. We, therefore, 2000 U.S. Tax Ct. LEXIS 65">*74 must decide whether ERISA section 404(c)(1) is incorporated into section 4975(e). B. PRINCIPLES OF STATUTORY CONSTRUCTION AND THE LEGISLATIVE HISTORYThe starting point for the interpretation of a statute is the language itself. See Consumer Prod. Safety Commn. v. GTE Sylvania, Inc., 447 U.S. 102">447 U.S. 102, 447 U.S. 102">108, 64 L. Ed. 2d 766">64 L. Ed. 2d 766, 100 S. Ct. 2051">100 S. Ct. 2051 (1980). If the language of the statute is plain, the function of the court is to enforce the statute according to its terms. See United States v. Ron Pair Enters., Inc., 489 U.S. 235">489 U.S. 235, 489 U.S. 235">240-241, 103 L. Ed. 2d 290">103 L. Ed. 2d 290, 109 S. Ct. 1026">109 S. Ct. 1026 (1989). All parts of a statute must be read together, and each part should be given its full effect. See McNutt-Boyce Co. v. Commissioner, 38 T.C. 462">38 T.C. 462, 38 T.C. 462">469 (1962), affd. per curiam 324 F.2d 957">324 F.2d 957 (5th Cir. 1963). When identical words are used in different parts of the same act, they are intended to have the same meaning. See Commissioner v. Keystone Consol. Indus., Inc., 508 U.S. 152">508 U.S. 152, 508 U.S. 152">159, 124 L. Ed. 2d 71">124 L. Ed. 2d 71, 113 S. Ct. 2006">113 S. Ct. 2006 (1993). On the other hand, "Where language is included in one section of a statute but omitted in another section of the same statute, it is generally presumed that the disparate inclusion and exclusion was done intentionally2000 U.S. Tax Ct. LEXIS 65">*75 and purposely." United States v. Lamere, 980 F.2d 506">980 F.2d 506, 980 F.2d 506">513 (8th Cir. 1992); see also 2B Singer, Sutherland Statutory Construction, sec. 51.02, at 122-123 (5th ed. 1992) ("where a statute, with reference to one subject contains a given provision, the omission of such provision from a similar statute concerning a related subject is significant to show that a different intention existed").ERISA section 404 pertains to fiduciary duties. Under ERISA section 404(a) a fiduciary shall discharge his duties with the care of a prudent man and diversify the investments. It is against this background that we must read ERISA section 404(c)(1), which provides that (1) the participant, who exercises control of the assets, is not deemed to be a fiduciary and, therefore, is not subject to ERISA section 404(a), and (2) any other fiduciary is not liable "under this part for any loss 115 T.C. 269">*275 * * * which results" from the participant's exercise of control of the assets."[T]his part" refers to part 4, Fiduciary Responsibility, subchapter I, subtitle B, Regulatory Provisions, encompassing ERISA sections 401 through 414, 29 U.S.C. sections 1101 through 1114, and includes provisions2000 U.S. Tax Ct. LEXIS 65">*76 for fiduciary liability contained in ERISA section 409, 29 U.S.C. section 1109. It would appear that in a participant-directed plan ERISA section 404(c)(1) exculpates from part 4 potential liability a participant exercising control over the account assets, and any person who would otherwise be considered a fiduciary is relieved from the liability under part 4 of ERISA for any loss resulting from the participant's exercise of control. In the context of this case, ERISA section 404(c)(1) serves to insulate the participant (Mr. Flaherty) and the U.S. Bank, National Association, from the potential liability arising from any violation of the prudent man standard of care contained in ERISA section 404(a), 29 U.S.C. section 1104(a). See H. Conf. Rept. 93-1280, at 305 (1974), 1974-3 C.B. 415, 466.To the contrary, section 4975(e)(3) contains the definition of a fiduciary "For purposes of this section". There is no exception in the language of section 4975(e)(3) similar to that of ERISA section 404(c)(1) for the section 4975 liability of a disqualified person. Applying the rules of statutory construction discussed supra p. 8, we, therefore, 2000 U.S. Tax Ct. LEXIS 65">*77 assume that Congress intended a different result with respect to the section 4975 liability.Petitioner contends, however, that the legislative history indicates a clear intent of Congress not only that the definitions of part 4 of ERISA and of the Internal Revenue Code should be as similar as possible, but also that they should operate together. Petitioner relies on various statements from the report of the conference committee. See H. Conf. Rept. 93-1280, 469 U.S. 241">supra at 295, 1974-3 C.B. at 456-457 ("To the maximum extent possible, the prohibited transaction rules are identical in the labor and tax provisions, so they will apply in the same manner to the same transaction."); 469 U.S. 241">id. at 308, 1974-3 C.B. at 469 ("The conferees intend that the labor and tax provisions are to be interpreted in the same way and both are to apply to income and assets. The different wordings are used merely because of different usages in the labor and tax laws."). 115 T.C. 269">*276 We agree with petitioner that the legislative history indicates a general intent of Congress that the language of the provisions be read together. The legislative history does not, however, preclude the existence of separate definitions or separate scopes2000 U.S. Tax Ct. LEXIS 65">*78 in the two provisions. As we noted in O'Malley v. Commissioner, 96 T.C. 644">96 T.C. 644, 96 T.C. 644">650-651 (1991), affd. 972 F.2d 150">972 F.2d 150 (7th Cir. 1992): The basis for the liability of a disqualified person for the excise tax under section 4975(a) * * * is not the same as the basis for liability of a fiduciary under section 406(a), ERISA. See, e.g., H. Rept 93-1280 (Conf.) at 306-307 (1974),1974-3 C.B. 415, 467-468. A fiduciary is liable under section 406(a), ERISA, if he or she knowingly caused the plan to engage in a transaction which is described in section 406(a)(1), ERISA. * * * Under section 4975(a) and (b), a disqualified person is liable for the excise tax if he or she participates in the transaction. Participation in section 4975 occurs any time a disqualified person is involved in a transaction in a capacity OTHER THAN as a fiduciary acting only as such. * * *Furthermore, the conference report indicates that Congress intended that the definition of "party-in-interest" in the labor provisions not coincide in every respect with the definition2000 U.S. Tax Ct. LEXIS 65">*79 of a "disqualified person" in the tax provisions. It states: Under the tax provisions, the same general categories of persons are disqualified persons, with some differences. Although fiduciaries are disqualified persons under the tax provisions, they are to be subject to the excise tax only if they act in a prohibited transaction in a capacity other than that of a fiduciary. Also, only highly-compensated employees are to be treated as disqualified persons, not all employees of an employer, etc. [H. Conf. Rept. 93-1280, 489 U.S. 235">supra at 323, 1974-3 C.B. at 484.]Under the labor provisions the potential liability runs directly to the fiduciary for breaches of his or her duties. Under section 4975, however, the liability runs not to a fiduciary as such but to disqualified persons and applies whether or not a fiduciary breached his duties under ERISA section 404(a). See Westoak Realty and Inv. Co., Inc. v. Commissioner, 999 F.2d 308">999 F.2d 308, 999 F.2d 308">311 (8th Cir. 1993), affg. T.C. Memo 1992-171; Leib v. Commissioner, 88 T.C. 1474">88 T.C. 1474, 88 T.C. 1474">1481 (1987). We do not find, therefore, that the legislative2000 U.S. Tax Ct. LEXIS 65">*80 history alters our conclusion that the exception contained in ERISA section 404(c)(1) is not incorporated into the section 4975 definition of a fiduciary.115 T.C. 269">*277 C. REGULATIONSAs pointed out above, Congress intended a bifurcated enforcement of ERISA. President Carter issued Reorganization Plan No. 4 of 1978 (the 1978 Plan), 3 C.F.R. 332 (1979), 92 Stat. 3790. The 1978 Plan allocates the responsibility of administering the provisions of ERISA between the Secretary of the Treasury and the Secretary of Labor. Section 102 of the 1978 Plan gives the Secretary of Labor authority with respect to regulations, rulings, opinions, and exemptions under section 4975 * * * EXCEPT for (i) subsections 4975(a), (b), (c)(3), * * * (e)(1), and (e)(7) of the Code; (ii) to the extent necessary for the continued enforcement of subsections 4975(a) and (b) * * *; and (iii) exemptions with respect to transactions that are exempted by subsection 404(c) of ERISA from the provisions of part 4 of Subtitle B of Title I of ERISA * * *Section 102 of the 1978 Plan also provides that the Secretary of the Treasury shall still have responsibility2000 U.S. Tax Ct. LEXIS 65">*81 to audit qualified retirement plans and to enforce the section 4975 excise tax as provided in section 105 of the 1978 Plan. Section 105 of the 1978 Plan binds the Secretary of Treasury to the "regulations, rulings, opinions, and exemptions issued by the Secretary of Labor".In October of 1992 the Department of Labor issued final regulations that provide: Prohibited Transactions. The relief provided by section 404(c) of the Act and this section applies only to the provisions of part 4 of title I of the Act. Therefore, nothing in this section relieves a disqualified person from the taxes imposed by sections 4975(a) and (b) of the Internal Revenue Code with respect to the transactions prohibited by section 4975(c)(1) of the Code. [29 C.F.R. sec. 2550.404c-1(d)(3) (1993).]The regulations are effective "with respect to transactions occurring on or after the first day of the second plan year beginning on or after October 13, 1992." Id. sec. 2550.404c-1(g)(1). Both parties agree that the loans at issue were repaid before the effective date of the regulations and the regulations do not apply to2000 U.S. Tax Ct. LEXIS 65">*82 the transactions in this case. Nonetheless, it should be noted that the result attained by the regulations coincides with our reasoning.Furthermore, this provision of the regulations has its genesis in proposed regulations issued in 1987 and 1991. In 115 T.C. 269">*278 1987, the Department of Labor issued proposed regulations regarding participant-directed plans. See 52 Fed. Reg. 33508 (Sept. 3, 1987). The preamble to the proposed regulations provided, in part: Prohibited transactions. Finally, the proposed regulation makes it clear that * * * the relief provided by section 404(c)(2) extends only to the provisions of part 4 of Title I of ERISA (relating to fiduciary responsibility). Therefore, even if a prohibited transaction is a direct and necessary consequence of a participant's exercise of control, nothing in section 404(c) of ERISA would relieve a "disqualified person" described in section 4975(e)(2) of the Code (including a fiduciary) from liability for the taxes imposed by sections 4975 (a) and (b) of the Code with respect to such prohibited transaction. [Id. at 33513.]In 1991, the Department2000 U.S. Tax Ct. LEXIS 65">*83 of Labor issued new proposed regulations regarding participant-directed plans. See id. at 10734. The 1991 proposed regulations took the same position with respect to ERISA section 404(c). The 1991 proposed regulations noted that "There is no provision in the Internal Revenue Code corresponding to section 404". Id. at 10734. Proposed regulations are not authoritative. On the other hand, "proposed regulations can be useful as guidelines where they closely follow the legislative history of the act." Van Wyk v. Commissioner, 113 T.C. 440">113 T.C. 440, 113 T.C. 440">444 (1999).Petitioner contends that since the Department of Labor failed to issue final regulations until 1992, the exception to the definition of a fiduciary provided by ERISA section 404(c), 29 U.S.C. section 1104(c), should apply throughout ERISA including the tax provisions. Because the Department of Labor failed to issue final regulations on this point until 1992, petitioner contends that respondent is not in a position to argue that separate definitions of a fiduciary apply for the two titles. However, the absence of final regulations does not render the provisions of section 4975 inoperative. Cf. Occidental Petroleum Corp. v. Commissioner, 82 T.C. 819">82 T.C. 819, 82 T.C. 819">829 (1984).2000 U.S. Tax Ct. LEXIS 65">*84 II. ADDITIONS TO TAX UNDER SECTION 6651(A)(1)The parties agree that, if petitioner is liable for the excise taxes under section 4975, excise tax returns should have been filed. Section 6651(a) imposes an addition to tax for failing to file a timely income tax return, unless such failure to 115 T.C. 269">*279 file is due to reasonable cause and not due to willful neglect. The addition to tax is 5 percent of the amount required to be reported on the return for each month or fraction thereof during which such failure to file continues, not to exceed 25 percent in the aggregate. See sec. 6651(a)(1); United States v. Boyle, 469 U.S. 241">469 U.S. 241, 83 L. Ed. 2d 622">83 L. Ed. 2d 622, 105 S. Ct. 687">105 S. Ct. 687 (1985).There is, and we do not understand respondent to argue otherwise, no evidence indicating that petitioner's failure to file was the result of willful neglect. Thus, the question is whether petitioner has demonstrated reasonable cause for the failure. The failure to file flows directly from Mr. Braun's advice that petitioner incurred no liability from the loan transactions.Petitioner argues that its reliance on that advice constituted reasonable cause. We have held in various situations that reliance on expert advice constitutes reasonable cause. See, 2000 U.S. Tax Ct. LEXIS 65">*85 e.g., Citrus Valley Estates, Inc. v. Commissioner, 99 T.C. 379">99 T.C. 379, 99 T.C. 379">463 (1992); see also United States v. Boyle, supra 469 U.S. 241">469 U.S. at 250-251. Mr. Braun is a lawyer with extensive experience in the area of retirement plans. He was fully aware of all of the relevant facts. He researched the issue and advised petitioner that he believed the loans would not violate any of the provisions of ERISA or cause any tax liability under section 4975. The ERISA provisions involved are highly complex, and the fact that his conclusion was erroneous does not mean that petitioner's reliance was not reasonable. Consequently, we conclude that petitioner has established reasonable cause for not filing the returns and, therefore, the additions to tax under section 6651(a)(1) are inappropriate.Decision will be entered for respondent with respect to the deficiencies, and for petitioner with respect to the additions to tax under section 6651(a)(1). Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the years in issue.↩2. First National Bank of Minneapolis was the original trustee of both plans. In 1986, the trust department of First National Bank of Minneapolis merged with First Trust Company of St. Paul. First Trust Company of St. Paul became First Trust National Association, which is now known as U.S. Bank, National Association.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623050/ | Seven Canal Place Corporation v. Commissioner.Seven Canal Place Corp. v. CommissionerDocket No. 1162-62.United States Tax CourtT.C. Memo 1964-270; 1964 Tax Ct. Memo LEXIS 69; 23 T.C.M. 1643; T.C.M. (RIA) 64270; October 15, 19641964 Tax Ct. Memo LEXIS 69">*69 Held, reasonable compensation for the year 1956 for petitioner's officers, determined. Robert P. Beshar, for the petitioner. Warren Shine, for the respondent. PIERCE Memorandum Findings of Fact and Opinion PIERCE, Judge: Respondent determined a deficiency in the income tax of the petitioner corporation for its taxable calendar year 1956 in the amount of $2,758.26. The sole issue for decision is the amount of the deduction for reasonable compensation to its officers, to which it is entitled for said year. Findings of Fact Some of the facts have been stipulated. The stipulation of facts and the exhibits identified therein are incorporated herein by reference. 1964 Tax Ct. Memo LEXIS 69">*70 The petitioner, Seven Canal Place Corporation, was organized in 1941 under the laws of the State of New York. It filed its Federal income tax return for the calendar year 1956 with the district director of internal revenue, Upper Manhattan District, in New York City. Petitioner's issued and outstanding capital stock at all times here material consisted of 80 shares of common stock, 69 shares of which were held by its president and treasurer, Herbert K. Beshar, and 11 shares by Herbert's brother, Edward H. Beshar, the vice president of petitioner. Petitioner's secretary was Ella A. Beshar, the wife of Herbert. These three officers had held the same offices for several years prior to 1956; and they were petitioner's only employees during 1956. During the taxable year here involved, Herbert was also the president and majority shareholder of a related corporation, A. Beshar & Co. Inc. (hereinafter called the "Beshar Company"), which was engaged in a business of cleaning, repairing, and selling at retail, oriental rugs and other carpeting. Beshar, Inc. was in turn the parent and sole stockholder of a subsidiary corporation, Carpet Servicing Co. Inc. (hereinafter called the "Carpet1964 Tax Ct. Memo LEXIS 69">*71 Company"), which engaged in a wholesale business of cleaning and repairing rugs and carpets for large department stores, banks, office buildings, and the like. The three Beshar corporations (Beshar, Inc., Carpet Company, and the petitioner) shared common executive offices in a building in mid-town Manhattan, where Beshar, Inc. carried on its retail sales operations. During the taxable year involved, petitioner's business was that of a real estate holding company; and it owned two parcels of improved real property in an industrial district of the Bronx, one at 5 Canal Place and the other at 2564-6 Park Avenue. The Canal Place property was improved with a 5-story brick commercial building, which petitioner had acquired in 1941. The Canal Place building contained approximately 45,000 square feet of floor space and it was equipped with a large freight elevator capable of handling a fully loaded 2 1/2 ton delivery truck. Ever since its acquisition by petitioner in 1941, the Canal Place building has been fully occupied by the other Beshar corporations, Beshar, Inc., and the Carpet Company. During 1956, the rent charged to Beshar, Inc. was $6,900; while that carged to the Carpet Company1964 Tax Ct. Memo LEXIS 69">*72 was $12,000. These amounts were reported as income by petitioner on its return for the taxable year involved; although the rents were not actually paid over to it, but were instead credited to petitioner in inter-company accounts on the tenants' books and picked up as receivables in an inter-company account on the petitioner's books. Rentals in the same amounts had been charged for each year since 1952. In addition to carrying on their respective rug-cleaning operations in the Canal Place building, Beshar, Inc. and the Carpet Company also stored large quantities of rugs, as well as art objects, which belonged to their customers; and Beshar, Inc. also stored there a large portion of its inventories of rugs. Insurance underwriters were unwilling to insure the contents of the building at their full value. At the rear of the Canal Place building stood the Park Avenue building, the two being separated only by a heating plant which serves both buildings. The Park Avenue building was likewise acquired by petitioner in 1941, at the same time as the Canal Place building. The Park Avenue building is a 3-story, concrete commercial structure, containing 23,000 square feet of floor space. Petitioner1964 Tax Ct. Memo LEXIS 69">*73 has at all times leased this building to tenants unrelated to it. During 1956, the tenant was L. A. Sales Company, a corporation engaged in the distribution of high-priced miniature trains, planes, and the like. Petitioner reported taxable income of $9,415.86 for the year 1956 and paid Federal income tax thereon of $2,824.76. In addition to its expenses for Federal taxes and the disputed salaries paid its officers, petitioner incurred other expenses during 1956 totaling $17,084.16 for: Repairs and capital improvements to its buildings; various state and local property, franchise and unemployment taxes; social security; accounting and legal fees; real estate commissions; insurance; fuel and other supplies; interest and electric protection service (burglar alarm). Included in the total expenses so incurred was depreciation in the amount of $1,894.37. Petitioner has never paid any dividends. Its earned surplus on December 31, 1956, was $89,501.56. Herbert, Edward and Ella received salaries from Beshar, Inc. and Carpet Company, in addition to their salaries from petitioner, in the following amounts: Car-Beshar, Inc.pet companyHerbert$25,200$7,000Edward3,4655,100Ella3,1501,7001964 Tax Ct. Memo LEXIS 69">*74 Herbert performed a considerable amount of work on behalf of petitioner during the year 1956. Because of the valuable rugs and art objects stored in the Canal Place building, which (as above found as a fact) were not able to be completely covered by insurance, it was necessary for Herbert to keep a careful surveillance over the Canal Place building, as well as the Park Avenue building, to detect and eliminate potential hazards. He inspected both buildings at least twice each week. He supervised the making of repairs and capital improvements to the buildings; investigated claims for damages to goods of L. A. Sales Company because of defects in the Park Avenue buildings; conferred with petitioner's accountant regarding the salaries, taxes and tax returns of petitioner; discussed with an insurance broker the insurance deemed necessary for the buildings; and investigated attempted burglaries at the buildings. During the year petitioner eliminated watchman service at the buildings and Herbert supervised the installation of an electrical burglar alarm system known as Holmes Protection Service. The lease under which L. A. Sales Company occupied the Park Avenue building was for a term1964 Tax Ct. Memo LEXIS 69">*75 expiring in February 1957. The lease contained an option on the part of L. A. Sales Company to renew. Because of the indicated possibility that L. A. Sales Company might not exercise its option to renew the lease, Herbert spent a large amount of time during 1956 consulting with real estate brokers regarding prospective tenants, interviewing prospective tenants and inspecting their business operations. Negotiations with L. A. Sales Company were conducted periodically throughout the year until late December 1956 when L. A. Sales Company exercised its option and renewed its lease for an additional 3 years at an increased rental. As noted above petitioner had a large earned surplus during the year 1956. Part of this surplus had been accumulated with a view toward the petitioner corporation's acquiring additional real property. To this end, Herbert and Ella considered numerous parcels of real property in the New York City area and elsewhere as investment for petitioner. Many of the properties were personally inspected by them, although none proved satisfactory to them as an investment for petitioner. Ella assisted Herbert in conducting the affairs of petitioner by reviewing credit ratings1964 Tax Ct. Memo LEXIS 69">*76 for prospective tenants of the Park Avenue property, by reviewing legal documents, by searching for and inspecting prospective new investments, by preparing advertising and by consulting with Herbert regarding the rental negotiations with L. A. Sales Company and other matters. The only evidence of work performed by Edward for petitioner during 1956 is that during the rental negotiations with L. A. Sales Company, he screened and interviewed prospective tenants, referring those deemed desirable to Herbert. Edward severed his association with petitioner in 1957. During the years 1947 through 1956 petitioner paid salaries to its three officers as follows: GrossTotalHer-income ofYearsalariesbertEdwardEllapetitioner1947$ 9,200$5,000$2,400$1,800$30,252194810,2005,5002,7002,00032,168194910,2005,5002,7002,00037,281195012,0006,6003,0002,40040,351195112,0006,6003,0002,40037,866195212,0006,6003,0002,40030,615195312,0006,6003,0002,40020,849195412,0006,6003,0002,40024,41219559,4005,2002,4001,80028,81619569,4005,2002,4001,80035,9001964 Tax Ct. Memo LEXIS 69">*77 The salaries so paid and claimed as deductions on petitioner's income tax returns for the years 1951, 1952 and 1953 were challenged as excessive by respondent. After negotiations, the parties agreed to the allowance of total salaries of $9,400 for those three years. In a separate audit, the salaries paid and claimed as a deduction for the year 1954 were challenged and the parties likewise agreed to the allowance of total salaries of $9,400 in that year. Petitioner then deducted $9,400 in salaries on its returns for the years 1955 and 1956. Respondent, in his notice of deficiency, partially disallowed the deduction for officers' salaries claimed by petitioner in its 1956 return; and he explained his action as follows: [The] deduction of $9,400.00 claimed for officers' compensation for the calendar year 1956 was excessive and unreasonable to the extent of $7,900.00 and therefore to such extent is not deductible under the provisions of Section 162 of the Internal Revenue Code of 1954. Ultimate Finding of Fact The full amount of compensation paid by petitioner to both Herbert and to Ella during the year 1956 was reasonable in amount. A reasonable allowance1964 Tax Ct. Memo LEXIS 69">*78 for compensation for the services performed by Edward is $600 for the year 1956. Opinion Section 162(a)(1) of the 1954 Code grants a taxpayer a deduction for all the ordinary and necessary business expenses paid or incurred, including "a reasonable allowance for salaries or other compensation for personal services actually rendered." The issue in the instant case requires us to fix the "reasonable allowance," or reasonable compensation, for Herbert, for Ella, and for Edward Beshar, the officers and only employees of the petitioner corporation, for the year 1956. Respondent has determined, and here argues, that $1,500 is the aggregate amount of the reasonable allowance for all three - he does not say how this should be allocated among the three officer-employees. Petitioner deducted, and here argues, that the reasonable allowances are: $5,200 for Herbert, $2,400 for Edward, and $1,800 for Ella - or an aggregate of $9,400. What constitutes reasonable compensation is a question of fact to be decided under the circumstances of each individual case. Geiger & Peters, Inc., 27 T.C. 911">27 T.C. 911. We have given careful consideration to the testimony and all the other evidence in1964 Tax Ct. Memo LEXIS 69">*79 this case, and we have come to the firm conclusion that the respondent's $1,500 figure is much too low, and should not be permitted to stand. With regard to Herbert (petitioner's president-treasurer), the evidence establishes that in addition to routine administrative work performed for petitioner, he also conducted negotiations for renewal of the lease by L. A. Sales Company, the unrelated tenant who occupied the Park Avenue building; interviewed numerous prospective tenants for the Park Avenue building; inspected several properties as possible investments for petitioner (whose business was that of a real estate holding company); and supervised the installation of a new burglar alarm system, as well as the making of various repairs and capital improvements to petitioner's properties. For these services, petitioner paid Herbert $5,200 per year (or slightly over $430 per month). In the light of the foregoing, and other services performed by Herbert, we have found as an ultimate fact that the amount which petitioner paid him was reasonable. We hold that petitioner properly deducted the amount so paid to Herbert. Insofar as Ella (petitioner's secretary) is concerned, the evidence1964 Tax Ct. Memo LEXIS 69">*80 establishes that she served primarily as a valuable assistant to Herbert. She handled much of the administrative work of petitioner such as reviewing tax returns, leases, and carrying on correspondence. She also obtained and reviewed credit reports on prospective tenants of the Park Avenue building. In addition she accompanied Herbert on inspections of various pieces of real property as possible investments for petitioner. Petitioner paid Ella only $1,800 per year (or $150 per month). We have found as an ultimate fact that that amount was reasonable; and we hold that petitioner was entitled to a deduction therefor. Turning finally to Edward (petitioner's vice president), his services, viewed in the light of the evidence before us, were minimal. Petitioner paid him $2,400 per year. That amount was excessive. Doing the best we can with the scant evidence before us, we have found as an ultimate fact and here hold, that $600 was reasonable compensation for Edward for 1956. We recognize, of course, that petitioner and respondent, in working out a settlement of petitioner's tax liabilities for 1951, 1952, and 1953, agreed petitioner was entitled to an aggregate deduction of $9,400 per1964 Tax Ct. Memo LEXIS 69">*81 year for salaries for its officers in those years; and that this same amount was likewise utilized in settling petitioner's 1954 Federal income tax liabilities. We do not know how the $9,400 figure was arrived at, or what trading with respect to other issues may have gone into fixing it, or whether Edward may have been more active in those earlier years. In any event, that settlement figure concerning services for prior years is not controlling on the deductible compensation for the later year, 1956, which is here involved. Petitioner here is entitled to a deduction for the salary of each officer in 1956, in accordance with the proof it has made in the case here before us. We have endeavored to decide this case in accordance with that principle. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623052/ | HARRY O. JOHNSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Johnson v. CommissionerDocket No. 66991.United States Board of Tax Appeals33 B.T.A. 872; 1936 BTA LEXIS 813; January 7, 1936, Promulgated 1936 BTA LEXIS 813">*813 J. E. Marshall, Esq., for the respondent. MURDOCK 33 B.T.A. 872">*872 MURDOCK: The Commissioner determined a deficiency of $8,617.33 in the petitioner's income tax for 1925 and also determined that $4,308.67 was due as a penalty provided by section 275(b) of the Revenue Act of 1926. Although the petitioner filed a so-called petition, he did not appear at the hearing nor did anyone appear on his behalf. The Commissioner in his answer alleged facts to support the imposition of the fraud penalty. No reply to the Commissioner's answer was filed. The Commissioner, nevertheless, offered evidence to support the imposition of the fraud penalty. FINDINGS OF FACT. A part of the deficiency for 1925 was due to fraud with intent to evade tax. Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623071/ | LEWIS B. JUDD AND VIVIENNE JUDD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentJudd v. CommissionerDocket No. 23024-88United States Tax CourtT.C. Memo 1990-253; 1990 Tax Ct. Memo LEXIS 272; 59 T.C.M. (CCH) 663; T.C.M. (RIA) 90253; May 23, 1990, Filed William F. De Francis, for the petitioners. Robert W. Sadowski, for the respondent. GERBER, Judge. GERBER*916 MEMORANDUM FINDINGS OF FACT AND OPINION This matter is before us to consider petitioners' Motion to Dismiss For Untimely Receipt of Notice of Deficiency (Motion to Dismiss for Lack of Jurisdiction), filed November 6, 1989. The issues for consideration are: (1) Whether petitioners' receipt (other than by mail) of a notice of deficiency which had been mailed, but not addressed to their "last known address," at a time when the period for assessment would have expired, but for the issuance of said notice, would result in our jurisdiction; and (2) whether the petition herein was timely filed. FINDINGS OF FACT Petitioners, who at all times*274 pertinent to this proceeding were married, had their legal residence at Jupiter, Florida, at the time of the filing of their petition herein. Petitioners' 1984 Federal income tax return, which was received by respondent June 18, 1985, reflected "MAN O WAR CAY, ABACO, BAHAMAS" (Bahamas address) as their mailing address on a pre-printed label provided to petitioners by respondent. Petitioners had resided at the Bahamas address from about 1970 until sometime in 1986, when petitioners moved to Jupiter, Florida. Petitioners' 1987 Federal income tax return, reflected their address as "C/O GOLDING, 105 Eganfuskee Street, Jupiter, FL 33477" (Jupiter address) and also was printed on a pre-addressed label provided to petitioners by respondent. On June 3, 1988, subsequent to petitioners' filing of their 1987 return, respondent mailed a notice of deficiency for petitioners' 1984 taxable year to their Bahamas address. The notice was received by the Bahamian postal representative on Man O War Cay, a locality with a population approximately 265 people. On or about August 10, 1988, Jerry Tubbs (Tubbs), a friend of petitioners, was at Man O War Cay on business and the Bahamian postal representative*275 inquired whether Tubbs knew of the whereabouts of petitioners. The Bahamian postal representative gave the notice to Tubbs for delivery to petitioners. Tubbs delivered the notice to petitioners at Jupiter, Florida on or about August 12, 1988. The petition in this case was mailed on September 1, 1988, and filed on September 6, 1988. OPINION Petitioners assert that we do not have jurisdiction and that this case should be dismissed because the notice was not sent to their last known address and the 3-year statutory period within which the tax could be assessed had expired before August 12, 1988, when they actually received notice of respondent's determination. Respondent agrees that the notice had not been sent to petitioners's last known address, but that a notice had been mailed to petitioners, they received actual notice and they timely petitioned, providing this Court with jurisdiction. We agree with respondent. The parties agree that respondent determined a deficiency with respect to petitioners. It is also agreed that respondent did not mail a notice to petitioners' "last known address." Petitioners argue that respondent's failure to mail a notice to their last known*276 address raises the fundamental issue of whether respondent issued and mailed a notice or otherwise attempted to communicate a deficiency determination. More specifically, petitioners argue that respondent's failure to mail a notice to their last known address as required by section 6212, 1 may be tantamount to a complete failure by respondent *917 to mail a deficiency notice. They conclude that the 3-year period for assessing a deficiency had expired and that respondent is barred from assessing any tax deficiency. Respondent, under the standard of , was charged with knowledge that petitioners had established a new residence at the Jupiter address. Although respondent failed to comply with the last known address requirement of section 6212(b), he did comply with the more basic requirements of sections 6212(a), 6213(a), *277 and 6503(a)(1) by issuing, attempting to mail or otherwise communicate a deficiency determination to petitioners. Miller v. Commissioner, 94 T.C. , (March 8, 1990) (slip op. at 19-23). Simply stated, the notice was not mailed to petitioners' "last known address" but was nonetheless timely mailed and respondent's failure to comply with the last known address requirement of section 6212(b)(2) did not invalidate the notice. Respondent argues that he mailed a notice to petitioners; that they received actual notice; and that they timely petitioned this Court providing for our timely acquisition of jurisdiction. If the Commissioner determines that there is a deficiency in income tax, respondent must notify or attempt to notify the taxpayer(s) of the deficiency determination. Sec. 6212(a). 2 With some exceptions not applicable here, respondent is precluded from assessing and collecting any tax deficiency without first mailing a notice of deficiency under section 6212(a) or otherwise notifying the taxpayer of the deficiency. Sec. 6213(a). *278 Although rarely focused upon, it should be understood that respondent is not limited to the use of a mailing by certified or registered mail to effectuate notice of his deficiency determination. Respondent may use regular mail. See , affd. , and cases cited therein. If respondent uses certified or registered mail addressed to a taxpayer's "last known address," then he is protected and within a safe harbor as to the requirements of sections 6212 and 6213. However, actual or direct notice or delivery suffices to meet the requirements of section 6212. ; , affg. . Respondent may issue a valid notice even though he fails to meet the mailing requirements of section 6212(a). Section 6212(b) is to guide respondent in determining where to mail the notice of deficiency. Paragraph (1) of section 6212(b) provides, as follows:(1) Income and gift taxes and certain excise taxes. -- In the*279 absence of notice to the Secretary under section 6903 of the existence of a fiduciary relationship, notice of a deficiency in respect of a tax imposed by subtitle A, chapter 12, chapter 42, chapter 43, chapter 44, or chapter 45 if mailed to the taxpayer at his last known address, shall be sufficient for purposes of subtitle A, chapter 12, chapter 42, chapter 43, chapter 44, chapter 45, and this chapter even if such taxpayer is deceased, or is under a legal disability, or, in the case of a corporation, has terminated its existence. In the present case respondent was constructively charged with and had actual knowledge of petitioners' Jupiter address. Although respondent did not meet the last known address requirements, the joint deficiency notice was a notice of a deficiency determination within the meaning of section 6212(a). Further, it notified petitioners that a deficiency had been determined against them; and it gave petitioners the opportunity to petition this Court for a redetermination of the deficiency without having to first pay the deficiency. See ; ; .*280 We have held that the mailing of a notice of deficiency to a taxpayer's last known address under section 6212(b) is a safe harbor assuring respondent that the notice is valid for purposes of section 6212(a). Consequently, a notice that is mailed to the taxpayer's last known address will toll the period for assessment even if the notice is not received by the taxpayer. , affg. on other grounds ; , revg. and remanding a Memorandum Opinion of this Court; ; ; , affd. without published opinion ; . In certain relatively unique circumstances, however, the mailing of a deficiency notice which is not addressed to the taxpayer's*281 last *918 known address may result in our acquisition of jurisdiction. In a limited but established line of cases an incorrectly addressed notice has resulted in our jurisdiction where the taxpayer receives "actual notice [of the contents of the deficiency notice] without prejudicial delay * * *." , affg. ; see also ; ; ; ; ; see also , revg. a Memorandum Opinion of this Court. By providing the safe harbor of section 6212(b), Congress did not intend to invalidate actual rather than constructive methods of communicating respondent's determination. .; , contains a discussion of the "actual*282 notice"principle, as follows: The deficiency notices in those cases were held to be valid because they served the two functions of section 6212: (1) They notified the taxpayer that a deficiency had been determined against him; and (2) they gave the taxpayer the opportunity to petition this Court for redetermination of the proposed deficiency. Both elements are satisfied here. Petitioners received actual notice of the deficiency and were aware of respondent's determination of a deficiency. Moreover, the petition was timely mailed within 90 days after respondent mailed the notice of deficiency. Our holding here is in accord with the opinion of the Court of Appeals for the Ninth Circuit in , which held that a notice of deficiency is valid if its mailing results in actual notice without prejudicial delay, or if the notice is mailed to the taxpayer's last known address. 3 The Court of Appeals for the Ninth Circuit held that: in those cases where actual notice did not result or was not proved to have resulted from a mailing, or where delivery of mail was delayed to the prejudice of the petitioner in seeking redetermination,*283 mailing to suffice under [section] 6212(b) must be to the last known address. We conclude, however, that if mailing results in actual notice without prejudicial delay (as clearly was the case here), it meets the conditions of [section] 6212(a) no matter to what address the notice successfully was sent. [Fn. ref. omitted.] We, therefore, conclude that the notice of deficiency in the instant case is valid and that we have jurisdiction to consider the merits of this case. Petitioners also argue that the 3-year period within which respondent may assess under section 6501(a) expired with respect to their 1984 tax year. Petitioners rely upon the fact that they*284 did not receive the deficiency notice until August 12, 1988, more than 3 years after the return for 1984 was filed. This argument was squarely addressed and rejected by this Court in . There, respondent mailed the deficiency notice before the statute of limitations expired. However, the notice was not addressed to the taxpayers' last known address. Nonetheless, the taxpayers received the notice, but after 3 years from the date their returns were filed. The taxpayers argued that the notice did not become valid for any purpose until it was actually received by them, by which time the statute of limitations under section 6501(a) had expired. In dismissing this argument, we held as follows: Based on the express language of section 6503(a)(1), the Ninth Circuit's opinion in Clodfelter, and on the foregoing reasons, we hold that the mailing of the notice of deficiency, which complied with section 6212(a) [under the same reasoning we have applied here], which was received by petitioners, and in regard to which a timely petition was filed in this Court, tolled the period of limitations on the date the notice was mailed even*285 though the notice was not sent to their last known address. Therefore, since the mailing date of that notice was the last day of the 3-year period under section 6501(a), a valid notice of deficiency was issued. [; see also .] See also Miller v. Commissioner, supra (slip op. at 24-25). We, accordingly, hold here that respondent's determination (statutory notice of deficiency) was timely communicated and that the period for assessment was tolled and has not expired. Finally, petitioners argue that their petition was untimely because it was filed 95 days after the mailing of the notice of deficiency. Under section 6213 taxpayers with domestic addresses have 90 days and taxpayers with addresses *919 outside of the United States have 150 days within which to file a petition with this Court from a notice of deficiency. Petitioners argue that petitioner had only 90 days because they were not, and their last known address was not, outside of the United States on June 3, 1988, when the notice of deficiency was mailed. Respondent, on brief, disagrees*286 with petitioners' position that they were not entitled to the 150-day period within which to file a petition. Respondent, also argues that the petition was timely filed under the 90-day period because it was timely mailed. Although section 6213 refers to the filing of a petition in connection with the 90 and 150-day periods, a petition to this Court is deemed timely filed if it is timely mailed. See sec. 7502(a); sec. 301.7502-1(a) and (b)(i)(ii), Proced. & Admin. Regs.; . The petition in this case was mailed to this Court by certified mail. The postage fees for mailing and certification were satisfied by means of a private postage meter stamp bearing the date September 1, 1988. Respondent relies upon the postage meter date to argue timely mailing and petitioner did not offer contrary evidence or offer argument to the contrary. Accordingly, we hold that the timely mailed petition was timely filed. To reflect the foregoing, An appropriate order will be issued denying petitioners' motion.Footnotes1. Section references are to the Internal Revenue Code of 1954, as amended and in effect for the period under consideration.↩2. Sec. 6212(a) provides: If the Secretary determines that there is a deficiency in respect of any tax * * *, he is authorized to send notice of such deficiency to the taxpayer by certified or registered mail.↩3. The Court also acknowledged the existence of other methods of providing valid notice. , affg. ; see also , affd. .↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/1671887/ | 198 F. Supp. 256 (1961)
EASTERN EXPRESS, INC. et al.,
v.
UNITED STATES of America et al.
No. TH 59-C-50.
United States District Court S. D. Indiana, Terre Haute Division.
September 5, 1961.
*257 David E. Rosenfeld, Rosenfeld & Wolfe, Thomas J. Hogan, Terre Haute, Ind., Bryce Rea, Jr., Watkins & Rea, Roland Rice and Homer S. Carpenter, Rice, Carpenter & Carraway, Washington, D. C., for plaintiffs.
Robert W. Ginnane, Gen. Counsel, B. Franklin Taylor, Jr., Associate Gen. Counsel, Interstate Commerce Commission, Washington, D. C., Robert A. Bicks, Acting Asst. Atty. Gen., Don A. Tabbert, U. S. Atty., Indianapolis, Ind., for defendants.
Kenneth F. Burgess, D. Robert Thomas, Chicago, Ill., Frank M. McHale, McHale, Cook, Welch & McKinney, William E. Jenner, Jenner & Brown, Indianapolis, Ind., Harry C. Ames, James L. Givan, Washington, D. C., S. S. Eisen, George H. Leonard, New York City, Theodore R. Schneider, St. Louis, Mo., for intervening defendants.
Before CASTLE, Circuit Judge, and STECKLER and HOLDER, District Judges.
PER CURIAM.
This is an action to set aside and annul an order of the Interstate Commerce Commission approving certain freight forwarder volume commodity rates in connection with trailer-on-flatcar service.[1] The action was brought pursuant to 28 U.S.C. §§ 1336, 1398 and 2321 through 2325. The United States of America was made a party as required by Section 2322. The court's jurisdiction of the parties and the subject matter is not in issue. A three-judge court was convened pursuant to 28 U.S.C. § 2284, and the case was submitted upon the pleadings and a certified copy of the record of the proceedings before the Interstate Commerce Commission, including the evidence therein. Exhaustive briefs were filed, and the court has had the benefit of oral arguments of counsel.
For brevity, hereinafter the Interstate Commerce Commission will be referred to as "the Commission."
Plaintiffs were protestants before the Commission. Plaintiff Eastern Motor Express, Inc. is an Indiana corporation with its principal office in Terre Haute, *258 Indiana. It is a common carrier by motor of general commodities in interstate and foreign commerce from New York City, New York, and other eastern cities to Chicago, Illinois, and St. Louis, Missouri, serving all intermediate points on most of its routes. Plaintiff The Eastern Central Motor Carriers Association, Inc. is an Ohio corporation, the membership of which is comprised of common carriers by motor which provide transportation of property in interstate commerce between eastern points, including Chicago and St. Louis. Plaintiff The National Motor Freight Traffic Association, Incorporated is a membership corporation of the District of Columbia, its members being common carriers by motor which are in competition for traffic with the freight forwarders whose operations and rates are the subject of the report and order of the Commission in this proceeding. Plaintiff The Regular Common Carrier Conference of the American Trucking Association, Inc. is a District of Columbia corporation, the membership of which comprises common carriers by motor which perform transportation in interstate or foreign commerce over regular routes under the jurisdiction of the Commission.
By order of this court, the freight forwarders whose rates were approved by the Commission in the order which the plaintiffs seek to annul and the Freight Forwarders Institute, an association of freight forwarders, were permitted to intervene as defendants in this proceeding. The defendant freight forwarders are: A. B. C. Freight Forwarding Corporation; Acme Fast Freight, Inc.; Blue Ribbon Express, Inc.; Clipper Carloading Company, Inc.; International Forwarding Company, Inc.; Sidney B. Lifschultz, Bernice Brown, Rose Grossman, Nora Bergman and American National Bank and Trust Co. of Chicago, Trustee, a partnership, d/b/a Lifschultz Fast Freight; Midland Forwarding Corporation; National Carloading Corporation; Pacific and Atlantic Shippers, Inc.; Republic Carloading & Distributing Company, Inc.; Springmeier Shipping Company, Inc.; and Universal Carloading & Distributing Company, Inc. Each defendant freight forwarder is engaged in the transportation, or the providing of transportation, of property in interstate commerce subject to regulation by the Commission.
The four principal common carrier transportation agencies, namely the rail-roads, motor carriers, water carriers, and freight forwarders, are regulated in separate parts of the Interstate Commerce Act. The freight forwarders are regulated under Part IV of the act, which was adopted in 1942 (49 U.S.C.A. § 1001 et seq.) "Freight forwarder" is defined in Section 402(a) of the Act, as amended, 49 U.S.C.A. § 1002(a), which reads:
"(5) The term `freight forwarder' means any person which (otherwise than as a carrier subject to chapters 1, 8, or 12 of this title) holds itself out to the general public as a common carrier to transport or provide transportation of property, or any class or classes of property, for compensation, in interstate commerce, and which, in the ordinary and usual course of its undertaking, (A) assembles and consolidates or provides for assembling and consolidating shipments of such property, and performs or provides for the performance of break-bulk and distributing operations with respect to such consolidated shipments, and (B) assumes responsibility for the transportation of such property from point of receipt to point of destination, and (C) utilizes, for the whole or any part of the transportation of such shipments, the services of a carrier or carriers subject to chapters 1, 8, or 12 of this title."
In July, 1958, the railroads inaugurated a trailer-on-flatcar ("piggyback") service which requires the shipper to furnish the trailers and to transport them to and from the rail loading ramps. These rates, known as Plan III, to distinguish them from other types of "piggyback" *259 service offered,[2] provide for the transportation of not more than two trailers on one flatcar, the trailers to be empty or loaded with not more than 70,000 pounds of freight, no one commodity to exceed sixty per cent of the total carload weight.
By tariff schedules filed with the Commission to become effective on August 20, 1958, and later dates, the defendant freight forwarders published a number of volume rates for the transportation of specified commodities between Chicago and the New York City area in shipments of the respective minimum weights specified in the tariffs, ranging from 10,000 to 30,000 pounds. The proposed rates were published on the same level as the corresponding rates for similar shipments between Chicago and New York maintained by the principal motor common carriers. Under the proposed rates, a shipper desiring to ship between Chicago and New York by freight forwarder a shipment of one of the specified commodities at the weight of 10,000 to 30,000 pounds specified in the tariff item would be enabled to do so at the same rate as that available to him by motor carrier, such rate being lower per hundred pounds than the rate for smaller shipments.
Upon protest of the plaintiff motor carrier associations, plaintiff Eastern Express, Inc., and certain other motor common carriers operating within official territory,[3] the proposed forwarder rates reviewed by the Commission in its Investigation and Suspension Docket No. 6993, and supplements, were suspended until March 20, 1959, and later dates, when they became effective. Similar volume commodity rates of defendant International Forwarding Company, Inc. between Chicago and New York were not suspended and became effective prior to September 19, 1958, but were included in the Commission's investigation by order of the Commission on September 19, 1958, in Docket No. 32530.
Hearings were held before an examiner of the Commission, at which testimony and exhibits were received in evidence. An examiner's report was waived by the parties, briefs were submitted, and oral argument was heard by the entire Commission. On September 4, 1959, the Commission made and filed its report containing its findings and conclusions and entered its order,[4] in which report and order the Commission, among other things, made the ultimate finding that the rates in question are just and reasonable and not otherwise unlawful, and discontinued the proceedings. After the plaintiffs filed their complaint in this court, the Commission, on its own motion, reopened the proceedings for reconsideration on the record, and this court stayed the present action pending final administrative action on the reopening. On April 8, 1960, the Commission made and filed its report on reconsideration[5]*260 in which it made certain additional findings, adhered to the views which it had expressed in the prior report, and affirmed the findings therein.
Plaintiffs state there is not before the court an issue involving administrative expertise; that the issues before the court are those which are familiar to judges a question of statutory construction, and whether the administrative agency failed to perform the statutory obligation placed upon it by the statute. On the other hand, the defendants state that the general issue before the court is simply whether the Commission's conclusion that the rates at issue are just and reasonable, and not otherwise unlawful, is supported by adequate findings and is in accordance with statutory standards. In support, they say the rates in question are peculiarly for the decision of the Commission as the expert in the field; that the Commission, as the rate making body, is charged with determining the justness and reasonableness of rates and tariffs for interstate shipments under the Act, and if the conclusion of the Commission is in accordance with law, is not arbitrary, or an abuse of discretion, and is supported by adequate findings which reveal that the decision has a rational basis, and not against the public interest, then the decision may not be disturbed on review. We agree this is a general statement of the rule. As we understand our function, we are not permitted to prescribe or approve rates, nor are we at liberty to prescribe general attitudes the Commission must adopt towards the exercise of its discretion left to it rather than to the courts. We are to decide only whether the Commission has acted within the power delegated to it by law. I. C. C. v. Inland Waterways Corp., 1942, 319 U.S. 671, 691, 63 S. Ct. 1296, 87 L. Ed. 1655.
Though there are many subsidiary aspects of plaintiffs' argument, they fall generally under three principal headings. Plaintiffs contend the rates in issue are unlawful for the following reasons:
First, the assailed service the forwarders are enabled to render under the Commission's order is such that it goes far beyond the scope of lawful freight forwarder operation. They claim forwarder operations authorized by statute embrace only less-truckload or less-carload shipments, and that lawful forwarder operations require numerous services which will not be rendered in the course of the "new," "alien" forwarder activity.
Second, plaintiffs state the freight forwarder service made possible through their volume rates, and under Plan III of the rail carriers, will be in derogation of Section 418 of the Interstate Commerce Act, which prohibits forwarders from supplying "instrumentalities" of transportation, except as permitted in that section, 49 U.S.C.A. § 1018.[6]
And third, they say the Commission's order approving the volume commodity forwarder rates permits the entry of the forwarders into the field of truckload and volume transportation which will impair the abilities of the motor carriers to continue their services to the large and small points at equivalent rates without discrimination or prejudice, and that this would be destructive of the national transportation system by rail, highway, and water. Under this latter contention, plaintiffs also assert that the full reach of the Interstate Commerce *261 Act requires that the separate modes of transportation be kept separate, and that the volume commodity shipments by the forwarders will deprive the public of inherent advantages of separate modes of transport.
Counsel for the United States, and counsel for the Commission, counter by stating that the freight forwarder service offered under the challenged rates is well within the statutory area of forwarder activity, in that the volume basis of the challenged rates is no bar to their legality, and the service rendered under the challenged rates is true forwarder activity; that the Commission did not err in concluding that Section 418 does not prohibit the freight forwarder from rendering the service contemplated by the rates at issue, since the purpose of Section 418 is simply to require freight forwarders to use specified regulated and exempt common carriers, rather than contract carriers, for the performance of line-haul transportation, and that since the line-haul transportation is performed by the railroads, there is no violation of Section 418. And finally, they state that the Commission gave due and proper consideration to the relevant provisions of the national transportation policy in concluding that the rates in issue are just and reasonable.
The argument of the defendant freight forwarders is similar to that of the United States and the Commission. They say the Commission properly found that the handling of forwarder shipments in the 10,000 to 30,000 pound minima weight category and the publication of rates thereon are lawful; that the Commission properly found that under these rates the forwarders would perform the services contemplated in the statutory definition of freight forwarders; that the Commission properly found that the assailed service does not violate Section 418; and that the Commission correctly found that the rates at issue are proper under the national transportation policy, and that to deny forwarders their right to compete fairly with the motor carriers would be contrary to that policy.
With these arguments before us, we have examined the reports of the Commission and the record of evidence in these proceedings.
The Commission's reports contain statements of findings and conclusions in support of its ultimate finding. The Commission found that in recent years the freight forwarders operating in official territory generally have maintained rates the same as those of the principal motor common carriers on shipments weighing less than 10,000 pounds; that, apart from the rates in question, the freight forwarders have published rates on some commodities subject to weights exceeding 10,000 pounds on a lower basis than those applicable on smaller shipments; that this has not been true generally, because the spread between the freight forwarder rates and the rail carload rates used by the forwarders for rail movement of consolidated forwarder shipments was insufficient to permit the establishment by the forwarders of lower rates on a profitable basis; that in July, 1958, some rail carriers established trailer-on-flatcar ("piggyback") rates between Chicago and the New York City area of $451.50 which require the shipper to furnish the trailers and to transport them to and from the rail loading and unloading ramps; that these rates under Plan III TOFC, provide for the transportation of not more than two trailers on one flatcar, empty, or loaded with not more than 70,000 pounds of freight, with no one article to exceed a specified percentage of the total weight of the shipment, usually 60 per cent, and that if the weight of the lading exceeds 70,000 pounds, the excess weight is subject to a rate of 64.5 cents per hundred pounds; that after these rail rates were established, the forwarders, concluding that they could establish lower rates on volume shipments on a profitable basis, published the volume rates at issue with the avowed purpose of meeting motor-carrier competition.
The Commission further found that the forwarders generally maintain lower rates on shipments weighing 5,000 *262 pounds than on shipments of lesser weights, thereby giving effect to the lower cost for handling one large shipment as compared with several small shipments of the same aggregate weight, and that the plaintiffs do not object to this, although the plaintiffs urge that no weight break other than at 5,000 pounds should be permitted to the forwarders; the Commission also found and concluded that there is nothing in the provisions of Part IV of the Interstate Commerce Act, or the legislative history of those provisions which establishes that freight forwarders are, or were intended to be, limited in the weight of shipments which they may handle or which prohibits forwarders from establishing rates subject to minima ranging from 10,000 to 30,000 pounds; that the Commission in earlier decisions had approved freight forwarder rates at various volume minimum weights in excess of 10,000 pounds; that it is just and reasonable that the shipping public should receive the benefits flowing from any ability of a forwarder to handle a heavier shipment more economically than it can handle several small shipments of the same aggregate weight; and that in the absence of an applicable statutory limitation or prohibition, there is no justification for holding that freight forwarders may not publish lower rates on heavier weighted shipments based upon economies inherent in the lower costs to them of the underlying transportation service which they utilize.
The Commission found that under the forwarder rates at issue the forwarders generally would pick up a shipment, either in a pick-up truck or in a trailer used in line-haul service, and bring it to their terminals, where it would be held awaiting consolidation with a sufficient quantity of other shipments so as to constitute the necessary trailer-loads, or would load into a line-haul trailer containing a shipment other freight picked up at a shipper's place of business en route between the forwarder's terminal and the railhead; that when two trailers were loaded they would be moved to the rail ramp and the rail carrier would place them on a flatcar; that occasionally one of the trailers may be loaded with only one shipment from one consignor to one consignee; that in order to comply with the provisions of the rail Plan III tariffs at least two different commodities must be loaded on each flatcar; that although there is no evidence that the forwarders have done so in the past, it is possible under the Plan III rail rates for a flatcar to be loaded with two trailers each containing but a single shipment; and that where a forwarder contracts for two or more shipments (including the case of two shipments each occupying a single trailer), tenders them at the railhead to be shipped as a single carload shipment, and makes, or arranges for, distribution of each of the tendered shipments to its consignee, there is consolidation and distribution by the forwarder despite the fact that the railroad which provides the underlying transportation physically places the trailers on the flatcar and removes them from the flatcar at the termination of the line haul. The Commission concluded that in the ordinary and usual course of their business, the forwarders will perform the services contemplated by Section 402(a) of the Interstate Commerce Act, 49 U.S.C.A. § 1002(a).
Rejecting the contention of the plaintiffs that Section 418 of the Interstate Commerce Act, 49 U.S.C.A. § 1018,[7] prohibits the forwarders from providing the trailers which the rail carriers hold themselves out to transport under the rail Plan III rates, the Commission found that under the railroads' Plan III rates utilized by the forwarders for the linehaul transportation, there is no holding out by the railroads to furnish the trailers, and the rail rates apply on empty as well as loaded trailers; that the trailers are to be regarded as containers or articles of commerce rather than as instrumentalities of transportation; that in their relation with rail carriers forwarders are in most respects shippers, and, like ordinary shippers, they may furnish *263 trailers under the rail Plan III rates; and that the purpose of Section 418 is to prevent forwarders from utilizing contract carriers for line-haul transportation.
After reciting the pertinent provisions of the national transportation policy (49 U.S.C.A. preceding Sections 1, 301, 901 and 1001) and pointing out that this declaration of policy does not mean that one transportation agency may be required to refrain from establishing rates which are just and reasonable and otherwise lawful in order to protect the traffic of a competing mode, the Commission found that since the rates at issue are in no instance lower than the corresponding rates of the motor carrier protestants, any advantage which one agency of transportation may have over the other is the result of differences in service; that the evidence does not permit a finding that the forwarder rates under consideration will produce a diversion in traffic sufficient to imperil the abilities of the motor carriers to survive and serve the public; that the forwarder rates are compensatory and are no lower than necessary to meet the existing competition; and that to refuse to permit the forwarders to maintain rates on the same level as those of the motor carriers would be tantamount to an attempt by the Commission to apportion traffic artificially and thereby to prevent normal, healthy competition and deny forwarders an opportunity to compete fairly with motor carriers, contrary to the national transportation policy.
Plaintiffs' statements to this court on brief that the forwarders had not heretofore published rates applicable to volume shipments is contrary not only to the findings of the Commission but also to the evidence of both parties at the hearing before the Commission. Exhibit 20, offered by plaintiffs, consisted of fourteen pages setting forth existing volume rates of the defendant forwarders, prior to the rates here under consideration, which were applicable to shipments having minimum weights of 10,000 to 30,000 pounds between the points involved in this proceeding. The commodities covered by those pre-existing volume rates consisted of various kinds of freight, namely, bicycles NOI; bicycle parts, iron or steel; boots or shoes; floor coverings; freight, all kinds; pads or padding; traffic materials; radio receiving sets and television receiving sets, and related articles; electric razors; and soap ingredients. The tariff (Exhibit 4) filed with the Commission by one of the defendant forwarders in 1943, just after Part IV of the Interstate Commerce Act went into effect, published volume rates between Chicago and New York and other eastern points at progressively lower levels for higher minimum weights ranging up to a minimum weight of 20,000 pounds. Those volume rates remained in effect until 1947 when they were cancelled because the forwarder's costs had gone up to such a point, due to rail increases, that the forwarder no longer could continue to publish those rates. Thereafter, that forwarder lost the majority of its volume business because the truck rates were lower than the forwarder rates. The evidence showed that the forwarder rates for transcontinental shipments have for many years included large numbers of volume rates, that the forwarder Tariff 8 series which applies westbound is entitled "Volume Commodity Rates," that both it and the forwarder eastbound transcontinental tariff contained many rates with minimum weights of 30,000 pounds or more, that thousands of volume rates for transcontinental application have been published by the forwarders, and that the forwarders for many years have been handling large numbers of shipments under their transcontinental volume rates at the relatively high minimum weights.
The evidence before the Commission showed that the national annual volume of freight handled by Class I motor carriers increased from 83,576,122 tons in 1948 to 132,730,481 tons in 1956, the latest date of record, whereas the volume handled by freight forwarders in 1948 was only 4,074,984 tons and in 1956 only 4,598,349 tons (Exhibit 12); that the *264 majority of the shipments, both of motor carriers and of freight forwarders, were substantially less than the 10,000 to 30,000 pound weights which are the minimum weights here involved, the average shipment handled in 1956 by motor carriers being 1,253 pounds and by freight forwarders being 361 pounds (Exhibit 7); that the annual average shipment handled by one defendant freight forwarder in the period 1943 through 1946, when the forwarder maintained the volume rates between New York and Chicago shown in Exhibit 4, ranged from 908 pounds to 1,142 pounds (Exhibit 6); and that despite the general parity of rates of motor carriers and freight forwarders for shipments weighing less than 10,000 pounds, the competition for shipments at equal rates has not prevented survival and growth of the motor carriers.
One additional matter should be mentioned. Plaintiffs complain that they presented to the Commission on the record, certain questions which the Commission did not discuss or dispose of in its first report. They allege that the Commission's failure to do so was error under Section 8(b) of the Administrative Procedure Act, 5 U.S.C.A. § 1007. Plaintiffs state that upon the re-opening of the proceeding, they again asked the Commission to rule specifically on those matters by filing a petition which restated them in twelve separate questions. They insist that five of the questions were not answered by the Commission either directly or by implication in either report.
In its second report dated April 8, 1960, the Commission gave attention to the petition wherein the questions were asked, and stated "The contents of that petition have been given careful consideration, and to the extent that the questions propounded are important to the issues presented, the answers thereto will be found herein or in the prior report in these proceedings." Taking the reports together, we agree with the Commission that to the extent the questions propounded are important to the issues presented before the Commission, the answers are found in the two reports. The Commission made adequate subsidiary findings upon the material issues presented in the proceedings before it, and the ultimate findings which it was required to make are supported by substantial evidence. Minneapolis & St. Louis R. Co. v. United States, 1959, 361 U.S. 173, 192, 80 S. Ct. 229, 4 L. Ed. 2d 223.
From the foregoing, we conclude as a matter of law, that the defendant freight forwarders are not restricted by the Interstate Commerce Act, including the national transportation policy, to the handling of so-called small shipments or to the handling of shipments weighing less than 10,000 pounds or any other particular weight; nor are they so restricted to the publication of rates at minimum weights less than the minimum weights specified in the forwarder tariffs here involved. Nothing in that act and policy requires that freight rates of freight forwarders to the shipping public for shipments of more than 10,000 pounds shall be higher than the freight rates of the competing motor carriers for such shipments, or that they shall be no lower per hundred pounds than freight forwarder rates for smaller shipments. Nothing in that Act and policy gives, or was intended to give, to the motor carriers a right to exclude freight forwarders from competition with motor carriers for shipments of 10,000 pounds or more; nor does that Act and policy provide that competition of freight forwarders for such shipments shall be restrained by requiring freight forwarders to charge the public more for such shipments than is charged by motor carriers, or by requiring freight forwarders to charge for such shipments rates no lower per hundred pounds than the rates for smaller shipments. The legislative history of Part IV of the Interstate Commerce Act shows that Congress was well aware that freight forwarders handled shipments weighing in excess *265 of 10,000 pounds,[8] and further shows that Congress refused to restrict competition by adopting proposed provisions of Part IV[9] which, if adopted, would have made it unlawful for freight forwarders to publish rates lower than the contemporaneous rates of common carriers by railroad or motor vehicle for a like kind and quantity of property between the same points.
Under their operations described in the reports of the Commission in connection with the handling of shipments to which these freight forwarder rates apply, the freight forwarders, in the ordinary and usual course of their undertaking, would perform all of the services contemplated by Section 402(a) (5) of the Interstate Commerce Act.
With respect to the plaintiffs' argument that the assailed forwarder service is in derogation of Section 418 of the Interstate Commerce Act, in view of the reasons stated in the Commission's initial report in these proceedings, which have been stated heretofore, we concur in the conclusion of the Commission that rail shipments by the freight forwarders of their trailers, loaded or empty, under the rail Plan III piggyback rates published by the railroads and available for the use of the shipping public, are not unlawful under said section.
In reaching its conclusions in this matter, the Commission gave due and careful consideration to, and properly applied the provisions of, the national transportation policy, as well as the other provisions of the Interstate Commerce Act. The record before the Commission amply justifies its conclusion that "The evidence does not permit a finding that the forwarder rates under consideration will produce a diversion of traffic sufficient to imperil the abilities of the motor carriers to survive and serve the public"; and the Commission's conclusion that "to refuse to permit the forwarders to maintain rates on the same level as those of the protestants would be tantamount to an attempt by us to apportion traffic artificially, and thereby to prevent normal, healthy competition and deny forwarders an opportunity to compete fairly with motor carriers, contrary to the national transportation policy" is a rational, proper and permissible judgment.
The decision of the Commission in this proceeding is consistent with its previous decisions. The Commission in previous decisions has approved the publication by freight forwarders of rates for volume shipments at various minimum weights over 10,000 pounds. Consolidation of Shipments by Freight Forwarders, 256 I.C.C. 305 (1943); New England Motor Rate Bureau, Inc. v. Julius Bleich, doing business as New York-Philadelphia Dispatch, 272 I.C.C. 133 (1948); Prepared Flour from Los Angeles to Arizona, 283 I.C.C. 92 (1951); Barge Service Corporation Freight Forwarder Application, 285 I.C.C. 249, 285 I.C.C. 309 (1953); Freight Forwarder Commodity-Rates Westbound Transcontinental, 296 I.C.C. 445 (1955); Acme Fast Freight, Inc. v. Western Freight Association, 299 I.C.C. 315 (1956); Iron and Steel from Monaca, Pa. to Southern Points, 305 I.C.C. 110 (1958); Forwarder Volume Commodity Rates, Transcontinental, 306 I.C.C. 535 (1959); Radios, Boots, Etc. from the East to Texas, 306 I.C.C. 615 (1959). Prior to the enactment in 1942 of Part IV of the Interstate Commerce Act, the Commission approved rail rates for the transportation of trailers of freight forwarders and other shippers and considered such trailers to be containers or articles of commerce. Vehicle Container Rates in Southwest, 196 I.C.C. 127 *266 (1933); Trucks on Flat Cars between Chicago and Twin Cities, 216 I.C.C. 435 (1936). In New England Motor Rate Bureau, Inc. v. Julius Bleich, doing business as New York-Philadelphia Dispatch, 272 I.C.C. 133 (1948), the Commission, over the objections of competing motor carriers, approved rates of a freight forwarder at minimum weights up to 30,000 pounds, under which the freight forwarder shipped its loaded trailers by rail to the point from which delivery of the shipment was made direct to the consignee. In Movement of Highway Trailers by Rail, 293 I.C.C. 93 (1954), the Commission approved the use by freight forwarders of rail rates for the transportation of loaded trailers of the freight forwarders. As stated by the Commission in its reports herein, the Commission has held that the national transportation policy "does not mean that one transportation agency may be required to refrain from establishing rates which are reasonable and otherwise lawful in order to protect the traffic of a competing mode. E. g., Cigar-boxes from Newark, N. J. to Selma, Ala., 296 I.C.C. 68; Various Commodities, Mid-Atlantic and New England, 63 M.C. C. 584; see Mississippi Valley Barge Line Co. v. United States, 292 U.S. 282 [54 S. Ct. 692, 78 L. Ed. 1260]." The Commission also has previously held that in ruling upon competitive transportation rates, it should exercise extreme care to avoid an attempt "to apportion the traffic artificially and thereby eliminate normal, healthy competition contrary to the national transportation policy." Fabrics from Georgia and North Carolina to Okla. and Texas, 63 M.C.C. 430, 434 (1955). By its reports and order in this proceeding, the Commission has properly recognized the right of the defendant freight forwarders to make available to the shipping public reduced rates to meet motor carrier competition on volume shipments, such reduced rates having been made possible through the use by the forwarders of the economical Plan III rates and transportation service instituted by the rail carriers in 1958, and the action of the Commission was in no way arbitrary or capricious.
The Commission's order of September 4, 1959 was issued after full and fair hearing, is within the scope of the statutory jurisdiction and authority of the Commission, is supported by adequate findings based upon substantial evidence, has a rational basis, and is in all respects in accordance with law.
The injunction prayed for by the plaintiffs should be denied and the complaint should be dismissed.
It is therefore hereby ordered that an appropriate final judgment in accordance herewith be entered.
NOTES
[1] The initial report and order of the Commission is dated September 4, 1959, and was entered in Investigation and Suspension Docket 6993, which includes Supplemental Orders Nos. 1-7, Forwarders Volume Commodity Rates Between Chicago and New York, 308 I.C.C. 455; and its report on reconsideration is dated April 8, 1960, in Docket No. 32530, Forwarder Volume Commodity Rates Between Chicago and New York, 310 I.C.C. 199.
[2] Under Plan I TOFC service, the railroads provide motor carriers, in substitution for highway movement, flatcar transportation of their freight-laden trailers. The traffic moving in this service moves on motor carrier billing and at motor carrier published rates.
Plan II TOFC service is offered by the railroads directly to the shipping public and consists of transportation from the shipper's premises to the receiver's premises in highway trailers provided by the railroads, the movement between the railroads' terminals being accomplished on railroad flatcars.
Plan III TOFC service is offered directly to the shipping public but is restricted to the movement on railroad flatcars of traffic in shipper-provided trailers. It differs from Plan II in that the railroads provide neither the trailers nor their movement beyond their terminals.
Plan IV TOFC service is the same as Plan III service except that the shipper provides both the trailers and the flatcars.
[3] Official territory consists generally of that part of the United States lying east of the Mississippi River and north of the Ohio River and a line drawn roughly from Cincinnati, Ohio, to Norfolk, Virginia; hence it includes the territory between Chicago and New York involved here. See New York v. United States, 1947, 331 U.S. 284, 291, 67 S. Ct. 1207, 91 L. Ed. 1492; Class Rate Investigation, 1939, 262 I.C.C. 447, 457, 516 (1945).
[4] Footnote 1, supra.
[5] Footnote 1, supra.
[6] Section 418 provides:
"It shall be unlawful, except in the performance within terminal areas of transfer, collection, or delivery services, for freight forwarders to employ or utilize the instrumentalities or services of any carriers other than common carriers by railroad, motor vehicle, or water, subject to this Act; express companies subject to this Act; air carriers subject to the Civil Aeronautics Act of 1938, as amended; common carriers by motor vehicle engaged in transportation exempted under the provisions of section 203(b) (7a) of this Act; common carriers by motor vehicle exempted under the provisions of section 204(a) (4a) of this Act; or common carriers by water engaged in transportation exempted under the provisions of section 303(b) of this Act."
[7] Footnote 6, supra.
[8] Hearings before a Subcommittee of the Senate Committee on Interstate and Foreign Commerce on S.Res. 146, 76th Cong., 3rd Sess., June, 1940, pp. 31, 175-176, 298, 302, 429.
[9] Hearings before the House Committee on Interstate and Foreign Commerce on H.R. 3684 A Bill to Amend the Interstate Commerce Act, as Amended, to Provide for the Regulation of Freight Forwarders, 77th Cong., 1st Sess., March, 1941, pp. 3-4. | 01-04-2023 | 10-30-2013 |
https://www.courtlistener.com/api/rest/v3/opinions/4537787/ | NOT PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
_____________
No. 19-3680
_____________
LORENZO RUFINO-SILVA,
Petitioner,
v.
ATTORNEY GENERAL UNITED STATES OF AMERICA
______________
On Petition for Review from a Final Order
of the Board of Immigration Appeals
Agency No. A088-231-993
Immigration Judge: Annie S. Garcy
______________
Submitted Pursuant to Third Circuit L.A.R. 34.1(a):
May 26, 2020
______________
Before: AMBRO, HARDIMAN, and RESTREPO, Circuit Judges.
(Filed: May 29, 2020)
_____________
OPINION *
______________
*
This disposition is not an opinion of the full Court and pursuant to I.O.P. 5.7 does not
constitute binding precedent.
RESTREPO, Circuit Judge.
Lorenzo Rufino-Silva, a non-citizen and national of Mexico, petitions for review
of a final decision issued by the Board of Immigration Appeals (BIA) denying his second
motion to reopen or reconsider his application for cancellation of removal. He contends
that a defective notice to appear (NTA) deprived the Immigration Court of jurisdiction,
and therefore, his removal proceedings should be terminated. Because our precedential
decision in Nkomo v. Att’y Gen., 930 F.3d 129 (3d Cir. 2019), forecloses his jurisdictional
argument, we will deny the petition.
I
After being in the United States for more than twenty years, Rufino-Silva received
an NTA charging him as removable for having entered the country without authorization.
The NTA did not state the date or time of his hearing. Shortly thereafter, he received a
second notice setting his hearing for May 13, 2010, at 9:00 a.m.
Rufino-Silva appeared before the Immigration Judge (IJ), conceded removability,
and applied for cancellation of removal on the ground that his removal would pose an
exceptional hardship for his minor son who is a U.S. citizen. The IJ denied his
application but granted the alternative relief of voluntary departure. The BIA affirmed
that decision.
Rufino-Silva did not leave the country. Years later, he moved the BIA to reopen
his removal proceedings to consider new evidence of hardship to his son. In February
2019, the BIA denied the motion.
2
Rufino-Silva petitioned this Court to review the BIA’s February 2019 decision.
He asserted for the first time that his removal proceedings should be terminated for lack
of jurisdiction because the NTA he received did not contain the date and time of his
hearing as required under Pereira v. Sessions, 138 S. Ct. 2105 (2018). In July 2019, this
Court dismissed the petition insofar as it presented an issue that had not been raised
before the BIA. Rufino-Silva v. Att’y Gen., 781 F. App’x 54, 56 (3d Cir. 2019). The
panel noted that, mere days before, this Court had rejected his jurisdictional argument in
Nkomo. Id. at 56 n.2.
While that prior appeal was pending before this Court, Rufino-Silva filed a second
motion before the BIA in which he argued that his case should be terminated for lack of
jurisdiction under Pereira. The BIA denied the motion in November 2019, holding that
this jurisdictional argument had already been rejected in Matter of Bermudez-Cota, 27 I.
& N. Dec. 441 (BIA 2018), and that it would not “revisit that decision here.” A.R. 3.
Rufino-Silva returns to this Court, seeking review of the BIA’s latest decision.1
II
In Nkomo, we held that an NTA that fails to specify the time and date of an initial
removal hearing does not deprive an immigration court of jurisdiction. 930 F.3d at 131.
Here, Rufino-Silva received an NTA without the date and time for the initial hearing but
1
The BIA had jurisdiction under 8 C.F.R. § 1003.2(b) and (c). We have jurisdiction to
review a timely petition under 8 U.S.C. § 1252. When a petition presents a purely legal
question, our review is de novo. Yusupov v. Att’y Gen., 518 F.3d 185, 197-98 (3d Cir.
2008).
3
later received a second notice specifying that information. Under Nkomo, the IJ had
jurisdiction over Rufino-Silva’s removal proceedings.
Rufino-Silva argues that Pereira compels a different result. But Nkomo already
considered and rejected that argument. The Nkomo court held that Pereira is inapposite,
because that case addressed the NTA requirements under 8 U.S.C. § 1229(a) for purposes
of triggering the stop-time rule under 8 U.S.C. § 1229b(d)(1)—statutes that are not
referenced in the “jurisdiction-vesting” regulations at issue here. See Nkomo, 930 F.3d at
133-34; accord Guadalupe v. Att’y Gen., 951 F.3d 161, 163 n.6 (3d Cir. 2020) (“Pereira
does not implicate the IJ’s authority to adjudicate.” (citing Nkomo)). Therefore, Nkomo
controls.
Recognizing as much, Rufino-Silva argues that the BIA exceeded its power in
Bermudez-Cota and that Nkomo’s reliance on that decision was misplaced. He also urges
us to reexamine Nkomo and find that it is no longer good law because it conflicts with
Pereira as interpreted by other circuits. These arguments are unavailing. First, we note
that Nkomo did not rely on Bermudez-Cota in reaching its holding. See Nkomo, 940 F.3d
at 132, 133 (indicating only that the BIA below cited to Bermudez-Cota and that the
BIA’s decision in Bermudez-Cota was in line with seven of our sister circuits). Second,
and more fundamentally, these arguments do not present a basis for a panel of this Court
to revisit a precedential decision of another panel of this Court. See Jutrowski v. Twp. of
Riverdale, 904 F.3d 280, 293 n.13 (3d Cir. 2018); cf. Guadalupe, 951 F.3d at 162
(holding, in the first instance, that Pereira abrogated our earlier decision in Orozco-
4
Velasquez v. Att’y Gen., 817 F.3d 78 (3d Cir. 2016), because the NTA in both cases
involved the stop-time rule). 2
III
For these reasons, we will deny the petition.
2
We note that the supposedly conflicting out-of-circuits cases cited by Rufino-Silva are
not necessarily contrary to our holding in Nkomo. Those cases treat the regulations at
issue as “claim-processing” rules, rather than “jurisdiction-vesting” rules, but they reach
the same conclusion: the alleged defects in the NTA do not deprive the immigration court
of jurisdiction. See, e.g., Perez-Sanchez v. Att’y Gen., 935 F.3d 1148, 1155, 1156-57
(11th Cir. 2019). While the difference in reasoning might matter in a different case, it
does not matter here. Even if we were to interpret Nkomo as being consistent with the
“claim-processing” approach, Rufino-Silva’s petition would still fail. By not raising the
alleged defects in the NTA in a timely manner, he forfeited that defense under the “claim-
processing” approach. See Ortiz-Santiago v. Barr, 924 F.3d 956, 964 (7th Cir. 2019). He
has also failed to exhaust that issue. See Perez-Sanchez, 935 F.3d at 1157.
5 | 01-04-2023 | 05-29-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623074/ | ARTHUR C. FRASER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Fraser v. CommissionerDocket No. 6495.United States Board of Tax Appeals6 B.T.A. 346; 1927 BTA LEXIS 3537; February 28, 1927, Promulgated *3537 1. Carrying charges for a period prior to March 1, 1913, may not be added to cost of property acquired prior thereto in determining cost or other basis for computing gain or loss on sale of the property. 2. The depreciated March 1, 1913, value of property acquired prior thereto, determined, and, being in excess of cost, held, basis for determining gain on sale. Arthur C. Fraser pro se. Harold Allen, Esq., for the respondent. MILLIKEN *346 This proceeding results from the determination by the Commissioner of deficiencies in income tax for the years 1920 and 1921, in the amounts of $266.49 and $367.97, respectively. The issue involved is the gain or loss resulting from the sale of real property in the year 1920. The Commissioner determined a gain and computed it upon the installment sales basis. FINDINGS OF FACT. Petitioner resides at 98 Montague Street, Brooklyn, N.Y. In 1905 he purchased lots comprising 66 2/3 front footage on Ocean Avenue, Brooklyn, N.Y., for the sum of $11,000, and Incident to such pruchase, paid legal expenses and commissions totaling $431.01. From 1905 to 1909, he paid taxes on the property in question, *3538 totaling $565.09, and interest on deferred payments due on the purchase price of $2,805. In december, 1909, he sold 16 2/3 feet of the property purchased in 1905 to G. M. Boardman, leaving a front footage of 50 feet. In 1910 he constructed a house on the lot at a cost of $8,600. For the period 1910 to 1913, petitioner paid the following amounts by reason of his ownership of the property: Legal services, surveyors' fees and assessments$555.82Taxes761.82Water charges or assessments51.00Insurance40.00Interest3,727.29In his Federal income-tax returns, petitioner claimed and was allowed depreciation for the period 1913 to 1920 on the property, in the total sum of $1,507.50. The fair market price or value of the property situated on Ocean Avenue, Brooklyn N.Y., on March 1, 1913, was $19,500. *347 Petitioner sold the property in 1920 for $22,000, the sale being consummated upon the following terms: $4,000 cash at time of sale and the remainder of purchase price was secured by bond and mortgage, payable in installments of $2,000 in 1921, $1,000 in 1922, $2,000 in 1923, $1,000 in 1924, and the remainder of the purchase price due and payable*3539 in 1928. Fees for commissions due on the sale of the property, and legal services paid incident to the sale, amounted to $620, leaving a net sale price of the property of $21,380. OPINION. MILLIKEN: Petitioner seeks to add carrying charges, such as interest and taxes, paid prior to March 1, 1913, to the cost of the property, for the purposes of determining gain or loss on the sale. We have heretofore ruled on this question adversely to his contention. . The deficiencies in question should be recomputed. The fair market price or value of the property on March 1, 1913, was $19,500 and depreciation on the building value of $1,507.50 should be subtracted from such value for purpose of determining gain resulting from the sale of the property for $21,380. 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/4623075/ | ACKERMAN BUICK, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAckerman Buick, Inc. v. CommissionerDocket No. 5132-70United States Tax CourtT.C. Memo 1973-224; 1973 Tax Ct. Memo LEXIS 64; 32 T.C.M. (CCH) 1061; T.C.M. (RIA) 73224; October 10, 1973, Filed Earle J. Niederluecke, for the petitioner. John B. Turner, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a deficiency of $8,538.86 in petitioner's 1967 Federal income tax. The sole issue to be decided 1 is whether petitioner is entitled to deduct the cost ($10,758) of a roadway it dedicated to the City of Ferguson, Missouri, either as a charitable contribution or as a business expense. FINDINGS OF FACT Some of the facts have been stipulated, and are found accordingly. 2 Petitioner, Ackerman Buick, Inc., is a Delaware corporation with its*65 principal place of business in St. Louis, Missouri. Petitioner filed its 1967 Federal income tax return with the district director of internal revenue at St. Louis, Missouri. Petitioner entered into a Buick automobile franchise agreement with General Motors in 1964. It thereafter acquired the assets of Kuhs Buick, Inc., located in the City of St. Louis, and carried on business at that location for approximately 18 months, after which it moved to its present location in the City of Ferguson, Missouri. At the time of entering into the 1964 franchise agreement, General Motors and petitioner understood that petitioner would acquire a new location in northwest St. Louis County, Missouri. Pursuant to this understanding, J. W. Ackerman, petitioner's president, viewed various sites for a possible location of the agency. Ackerman's attention focused on an 8.766 acre tract of land located on Pershall Road in the City of Ferguson. At the time of his initial investigation in 1964, this land was zoned by the City of Ferguson for single family residential use. In order for petitioner to locate its automobile agency there, it had to have the land rezoned to permit commercial use. On*66 April 7, 1964, petitioner entered into an Option Contract with the owner of the 8.766 acre parcel which 3 granted petitioner the right to purchase the land, subject to approval by General Motors, and subject to rezoning of the property to commercial use by the City of Ferguson. The Option Contract provided in part: It is further understood and agreed that this contract is subject to rezoning by City of Ferguson and County of St. Louis, Missouri in order to permit Ackerman Buick, Inc. to make commercial use of the property as an automotive sales and service agency. However, if one of the aforementioned municipalities refuses to consider or grant a petition for rezoning then it shall be sufficient if that municipality will irrevocably bind itself by agreement to accept a rezoning determination by the other. In the event said rezoning is not granted, this contract shall be null and void and total $8000.00 earnest deposit refunded to Ackerman Buick, Inc. All costs in connection with said rezoning shall be paid by Ackerman Buick, Inc. and seller shall not be responsible for any of said costs. On April 13, 1964, petitioner filed a petition for rezoning the property from residential*67 to commercial use with the City of Ferguson, and the matter was referred to the City's Planning Commission. There followed a series of communications and negotiations between petitioner's attorney and various City officials. During these negotiations, representatives of the City indicated they wanted petitioner to dedicate to the City a road across the parcel and to pave it, in order to extend Trask Drive from its existing dead end through to Pershall Road. 4 Petitioner's attorney wrote a letter to the Ferguson Planning Commission, dated June 16, 1964, which stated: In connection with the pending Petition for Rezoning by Ackerman Buick, Inc., please be advised that the corporation represents that it will dedicate to the City of Ferguson a certain tract of land across the subject property as a roadway, and will improve said roadway, in accordance with the specification of the ordinances of the City, across its property and to Pershall Road across other property which may be made available to the City. This representation is made on the expectancy of the corporation that it will be able to develop the property for its commercial purposes after, and in the event of, re-zoning*68 as requested in its petition.Petitioner's attorney further defined petitioner's position in a letter, dated July 9, 1964, to an official of the City of Ferguson. Therein he stated the following: Because there have been misunderstandings which, although resolved, are never desirable, I deem it advisable to set out the present posture of our development, and our commitment to the City of Ferguson, so that no future doubt can arise as we proceed. * * * [The Option Contract] is contingent on a rezoning of the 8.766 acres as commercial, and thus we can not and will not acquire legal title until and, unless the City Council sees fit to grant our rezoning. At my initial appearance before the Planning Commission, the access problem to Pershall Road was noted, and a meeting ensued at the site, at which I understood that the City would require not only a dedication of a roadway, but we would have to assume the burden of paving across our property. * * * 5 In addition, if the Council is inclined to accept the recommendation of the Planning Commission, that the area west of the roadway not be rezoned commercial, we must consider a road course which will be economically advantageous.*69 * * * Notwithstanding, this is to reaffirm that, if Ackerman Buick, Inc., acquires the property for development as an automotive sales agency, it is committed to dedicate a road course across its property to continue Trask Drive, to join the private road leading to Pershall Road, and will determine the exact course at the earliest possible time, which I presently hope can be before July 14, 1964. In another letter to the same City official, dated October 6, 1964, petitioner's attorney wrote: The purpose for submitting these alternative courses is to request that the rezoning ordinance be amended, since there have been significant changes in our grading and general plan of development since my letter of July 9, 1964 in which I suggested a different road course. In that letter, I states [sic] the road course was tentative and might be changed as our plans developed. However, this in no way changes our stated representation that we will dedicate a road course over our property as a part of the extension of Trask Avenue to Pershall Road. On February 9, 1965, the City of Ferguson rezoned the property in question from residential to commercial use. In the meantime, General*70 Motors had approved petitioner's plans for the land. Upon exercise of the Option Contract, the property was conveyed to petitioner on February 23, 1965. In 1965 petitioner paved the road. Subsequent to the 6 rezoning and its acquisition of the tract, petitioner, on June 27, 1967, dedicated to the City of Ferguson its part of the roadway designated as the Trask Drive Extension. Upon completion, the City took over full maintenance of the road and it became part of the City's public street system. The cost of the dedicated roadway on June 27, 1967, was $10,758. On its 1967 return petitioner deducted the cost of this dedicated property as a business expense. Respondent disallowed this deduction and determined that the $10,758 was a capital expenditure. ULTIMATE FINDING OF FACT The primary motivation for the dedication of part of petitioner's property to the City of Ferguson was to secure the rezoning of the property. OPINION Petitioner first argues that is is entitled to deduct as a charitable contribution the cost ($10,758) of that portion of Trask Drive that it dedicated to the City of Ferguson. Respondent does not dispute the cost of the dedicated roadway, but*71 counters that the dedication was not a "contribution or gift" within the meaning of section 170(c), 2 because made in the expectation of the receipt of 7 certain direct economic benefits within the power of the City to bestow, which otherwise might not be forthcoming. The cases have consistently held that if a donor seeks to secure a direct economic benefit as a result of dedicating property to a qualified charity, the contribution is not charitable in nature. Stubbs v. United States, 428 F.2d 885">428 F.2d 885 (C.A. 9, 1970), certiorari denied 400 U.S. 1009">400 U.S. 1009 (1971); United States v. Transamerica Corp., 392 F.2d 522">392 F.2d 522 (C.A. 9, 1968); DeJong v. Commissioner, 309 F.2d 373">309 F.2d 373 (C.A. 9, 1962), affirming 36 T.C. 896">36 T.C. 896 (1961); Singer Co. v. United States, 449 F.2d 413">449 F.2d 413 (Ct. Cl., 1971); Charles O. Grinslade, 59 T.C. 566">59 T.C. 566 (1973); Larry G. Sutton, 57 T.C. 239">57 T.C. 239 (1971); and Jordon Perlmutter, 45 T.C. 311">45 T.C. 311 (1965). On the other hand, a contribution is charitable in nature if the benefits*72 accruing to the donor are only incidental to the benefits accruing to the public. Citizens & Southern National Bank of S.C. v. United States, 243 F. Supp. 900">243 F. Supp. 900 (W.D.S.C., 1965); Toole v. Tomlinson, an unreported case ( M.D. Fla., 1963, 11 A.F.T.R.2d (RIA) 847">11 A.F.T.R. 2d 847, 63-1U.S.T.C. par. 9267); Rev. Rul. 69-90, 1 C.B. 63">1969-1 C.B. 63; and Rev. Rul. 67-446, 2 C.B. 119">1967-2 C.B. 119. Receipt of a desired zoning variance from a city which would or might not be available without making a dedication of land to the city has been held to be a direct economic 8 benefit which would preclude a charitable deduction. Stubbs v. United States, supra; Charles O. Grinslade, supra.In this case petitioner's attorney testified that his letters to the Planning Commission are an accurate representation of the facts. In his letter of June 16, 1964 to the Ferguson Planning Commission he wrote: In connection with the pending Petition for Rezoning by Ackerman Buick, Inc., please be advised that the corporation represents that it will dedicate to the City of Ferguson a certain tract of land across the subject property as a roadway * * *. In addition, *73 in his letter of July 9, 1964, he wrote of selecting a roadway that would be "economically advantageous" to petitioner. Moreover, in the same letter, petitioner's attorney wrote that petitioner had a "commitment" to the City, i.e., to pave and dedicate Trask Drive Extension in return for the necessary zoning. The substance of the transaction is clear. If, and only if, the City Planning Commissioner would rezone the subject property, petitioner would dedicate a roadway to the City. An "economically advantageous" result was anticipated. We find that petitioner obligated itself to dedicate the roadway to the City in order to facilitate the rezoning of the property on which it hoped to establish its business. Petitioner thereby sought to insure that advantageous zoning would take place with minimum difficulty.Petitioner thus sought and received a quid pro quo for its 9 dedication, and, accordingly, such contribution did not have the requisite charitable nature. Petitioner next argues that if the dedication of the roadway does not constitute a charitable contribution, the cost of the dedicated roadway ($10,758) is deductible as an ordinary and necessary business expense. Respondent*74 again does not dispute the cost allocated to the dedicated roadway, but contends that the cost of the dedicated roadway represents part of the cost of acquiring and rezoning the 8.766-acre tract and is a capital expense, and we agree. We have previously held that the dedication of Trask Road was done in anticipation of acquiring rezoning which was to petitioner a condition precedent to purchasing the land. Zoning costs are "capital expenses, not amortizable because indefinite and undeterminable in the duration of their consequence, and recoverable through addition to the basis of the property rather than through periodic deduction." Arthur T. Galt, 19 T.C. 892">19 T.C. 892, 910 (1953), reversed in part and affirmed in part on other issues, 216 F.2d 41">216 F.2d 41 (C.A. 7, 1954), certiorari denied 348 U.S. 951">348 U.S. 951 (1955). The benefits of the rezoning increased the value of the remaining land. Petitioner has no depreciable interest in the dedicated street which belongs to and is maintained by the City of Ferguson. Algernon Blair, Inc., 29 T.C. 1205">29 T.C. 1205, 1221-1222 (1958). Therefore, we hold that the cost of the dedicated 10 roadway is added to the basis of*75 petitioner's remaining land. Decision will be entered for respondent. Footnotes1. The parties agree that another deduction which was disallowed by respondent is deductible, if at all, in another year. ↩2. All Code references are to the Internal Revenue Code of 1954, as in effect during the year in issue. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623079/ | Carboloy Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentCarboloy Co. v. CommissionerDocket No. 29366United States Tax Court18 T.C. 1028; 1952 U.S. Tax Ct. LEXIS 102; September 18, 1952, Promulgated *102 Decision will be entered for the respondent. Intercompany profits restored to petitioner's opening inventory for 1943, first taxable year after it discontinued filing consolidated returns with affiliated corporate group held properly restricted under Treasury Regulations 110, section 39.33 (c), as amended, to intercompany profits eliminated from petitioner's inventory at beginning of consolidated period. John P. Lipscomb, Jr., Esq., and C. Rudolf Peterson, Esq., for *103 the petitioner.E. M. Woolf, Esq., for the respondent. Opper, Judge. OPPER*1028 OPINION.A deficiency in excess profits taxes for the calendar year 1943 determined in the amount of $ 13,985.79 constitutes the occasion for the present controversy. An overpayment is also claimed. All of the facts have been stipulated and are hereby found accordingly.The sole issue is the correct amount of petitioner's opening inventory on the first day of the tax year. Prior thereto petitioner had been one of a number of corporations participating in a consolidated return. In 1943, however, it returned to the separate return method, and in computing its opening inventory for that year it added back $ 61,008 of previously excluded intercompany profit. Respondent accepted this figure as correct and continues to maintain that position. Petitioner, however, now contends that a total of $ 331,571 of intercompany profits or $ 270,563 in excess of the amount originally included should be added to its opening inventory. The larger amount constitutes the intercompany profits in petitioner's inventory at the end of the consolidated return period. The smaller figure is that which was, pursuant*104 to accepted procedure, 1 excluded for consolidated return purposes at the beginning of the consolidated return period. There appears to be no question about adjustments to inventory during the consolidated period.There is hence presented*105 a narrow, technical, and specific problem involving the interplay of inventory accounting with consolidated *1029 returns. Petitioner apparently makes no contention that respondent has not applied to its situation the letter of the applicable regulation. 2*106 Its position appears to be alternatively that the regulation should be applied discriminately so that only specific situations representing potential failure to reflect income would be covered; or that the regulation is invalid since it goes beyond any necessary protection of the revenue against distortions of income. 3We are unable to accept either approach. Assuming that the regulation is valid, we think it must be applied to all taxpayers whether the effect is beneficial or the reverse. It may be, as petitioner argues that the consolidated group as a whole will suffer a detriment as a result of its adventure into consolidated reporting. Unfortunate as that may be, it provides no occasion for a less than uniform application of regulations as specific and detailed as those under consideration. 4*107 Nor can we agree that the regulation itself is invalid. It is urged upon us that the condition of a taxpayer's inventory at the end of the first separate return year is of no consequence in its relation to the prior consolidated period. 5 Respondent's explanation for the provision in question is that it assists in preventing intercompany manipulations for tax avoidance comparable to those inhibited by Internal Revenue Code section 45. The field is too complicated and the possible situations too numerous for us to say, as it would be necessary to do, that this phase of the regulation is so unreasonable as to be clearly invalid. Even though as*108 petitioner contends, section 45 might furnish some assistance in accomplishing the result for which the regulations are designed, it is too clear for the effectiveness of this argument, first, *1030 that the relationship of section 45 with consolidated returns 6 has been frequently announced, see e. g. Seminole Flavor Co., 4 T. C. 1215, and second, that the limitation on the operation of section 45 is so severe that other means of effectuating the present purpose seem clearly permissible. Cf. Chelsea Products, Inc., 16 T. C. 840, affd. (C. A. 3) 197 F.2d 620">197 F. 2d 620.Be that as it may, it is the confinement to the amount originally excluded from inventory which really pinches petitioner. The difference between that figure and the amount now claimed, that is, the whole of the intercompany profit in the inventory at the close of consolidated reporting, is necessarily*109 profits of petitioner's affiliates secured during the consolidated period but, due to the consolidation, not taken up as income by them. See Singer Sewing Machine Co., 5 T. C. 851, affd. (C. A. 3) 158 F.2d 982">158 F. 2d 982.Petitioner's only approach to that really effective restriction 7*110 is that it should be applied, at least in this instance, not by individual corporations but to the consolidated group. 8 This seems to be the equivalent of resisting its application entirely since it seems obvious that, on a return to separate reporting, each corporation's adjustment of its accounting system must be complete and self-sufficient. See Bostonian National Shoe Stores, Inc., 39 B. T. A. 444. At least it amounts to disregarding the regulation and to employing petitioner's method, not that formulated by respondent.Consolidated returns are optional. The privilege of employing them is carefully conditioned upon the acceptance by all participating *1031 taxpayers of the applicable regulations. Section 141, Internal Revenue Code as amended 9 by Revenue Act of 1942, section 159. Because of the technical and complicated nature of the problem, Congress placed in the respondent more than ordinary discretion and imposed upon him a heavier responsibility than usual, see Bostonian National Shoe Stores, Inc., supra, 448,*111 to employ his regulatory power in order for the overriding purpose of the legislation to be achieved, 10 while at the same time eliminating any possibility of such distortion of income as to result in inadequate taxation of the taxpayers concerned. *112 11It may well be that respondent cannot by regulation deprive a consolidated group of a privilege conferred upon it by some other statutory provision. See General Machinery Corporation, 33 B. T. A. 1215, affd. (C. A. 6) 95 F.2d 759">95 F. 2d 759. But only the adoption and relinquishment of consolidated returns*113 is involved here. And bearing in mind petitioner's agreement to abide by the regulations; that it is but one of a number of separate enterprises included in the consolidation; that the regulations are designed to be of general applicability; and in particular, that the regulation in question has not been shown to be so clearly arbitrary or unreasonable on its face as to be treated as invalid, we conclude that the action originally taken by petitioner and concurred in by respondent was correct and the deficiency properly determined.Decision will be entered for the respondent. Footnotes1. Regulations 110.Sec. 33.39. Inventories.(b) Consolidated Return After Separate Return by Affiliates↩. If a corporation which is a member of the affiliated group for the first consolidated return period was a member of the group in the preceding taxable year, the value of its opening inventory to be used in computing the consolidated net income for the first consolidated return period shall be the proper value of the closing inventory used in computing its net income for the preceding taxable year decreased in the amount of profits or increased in the amount of losses reflected in such inventory which arose in transactions between members of the affiliated group and which have not been realized by the group through final transactions with persons other than members of the group.2. Regulations 110.Sec. 33.39. Inventories.(c) If a corporation which was a member of an affiliated group in a consolidated return period makes or is required to make a separate return for the succeeding taxable year, the value of its opening inventory to be used in computing its net income for such succeeding taxable year shall be the proper value of its closing inventory used in computing consolidated net income for the last consolidated return period increased in the amount of profits or decreased in the amount of losses eliminated in the computation of such inventory as profits or losses arising in transactions between members of the affiliated group, but in an amount not exceeding, in the case of profits, either the amount of profits arising from such intercompany transactions reflected in the closing inventory of such corporation for such succeeding taxable year or the amount of such intercompany profits eliminated from its opening inventory for its first consolidated return period pursuant to the provisions of subparagraph (2) of this subsection, * * *. [As amended by T. D. 5245↩, Mar. 13, 1943.]3. It complains particularly of the provision that the intercompany profits added to the opening inventory of the first separate return year shall be "in an amount not exceeding * * * the amount of profits arising from such intercompany transactions reflected in the closing inventory of such corporation for such succeeding↩ taxable year * * *." [Emphasis added.] But it is not easy to see what bearing this provision can have on petitioner's difficulty, since the limitation from which it suffered was the alternative one relating to the intercompany profits eliminated at the inception of consolidated reporting.4. Singer Sewing Machine Co., 5 T.C. 851">5 T. C. 851, affd. on Judge Murdock's opinion below (C. A. 3) 158 F. 2d 982↩, dealt with the predecessor regulation and has no bearing on the construction of the regulations applicable here. Certainly it is no authority for applying the same regulation differently to different taxpayers.5. See footnote 3.↩6. Internal Revenue Code, section 141 (i)↩.7. It is true that the other restriction, but less confining under the present facts, would otherwise come into play as shown by the following table:Intercompany profitsName of subsidiaryEnd lastBeginningconsolidatedfirst consolidatedDec.31,yearYear Jan.1943Dec. 31,1,19411942General Electric Supply Corp$ 1,106,992$ 1,149,783$ 1,983,215General Electric X-Ray Corp53,12086,92219,440Locke Insulator Corporation7601,0910Petitioner156,062331,57161,008The Monowatt Electric Corp29,09533,972102,202Edison General ElectricApplicance Co., Inc116,952149,725218,145International General ElectricCo., Inc152,785290,46730,988International General ElectricS. A., Inc191,940148,5380$ 1,807,706$ 2,192,070$ 2,414,998↩Permittedrestorations,Name of subsidiaryJan.1, 1943,excessprofits taxGeneral Electric Supply Corp$ 1,106,992General Electric X-Ray Corp19,440Locke Insulator Corporation0Petitioner61,008The Monowatt Electric Corp29,095Edison General ElectricApplicance Co., Inc116,952International General ElectricCo., Inc30,988International General ElectricS. A., Inc148,538$ 1,513,0138. "Petitioner's position is that in determining the amount of the restoration of intercompany profits to petitioner's opening inventory, regard must be had to the inventories of the entire affiliated group in order to determine how many of such profits previously have escaped tax. When that amount is ascertained, a full restoration of profits as they existed at the close of the consolidated period is allowable provided the restoration to all members of the group does not exceed the previously taxed profits eliminated at the beginning of the consolidated period." (Petitioner's reply brief.)↩9. (a) * * * The making of consolidated returns shall be upon the condition that * * * all corporations which at any time during the taxable year have been members of the affiliated group making a consolidated income-tax return consent to all the consolidated income -- and excess-profits-tax regulations prescribed under subsection (b) prior to the last day prescribed by law for the filing of such return. The making of a consolidated income-tax return shall be considered as such consent. * * *↩10. "Many difficult and complicated problems, however, have arisen in the administration of the provisions permitting the filing of consolidated returns. It is, obviously, of utmost importance that these questions be answered with certainty and a definite rule be prescribed. Frequently, the particular policy is comparatively immaterial, so long as the rule to be applied is known. The committee believes it to be impracticable to attempt by legislation to prescribe the various detailed and complicated rules necessary to meet the many differing and complicated situations. Accordingly, it has found it necessary to delegate power to the Commissioner to prescribe regulations legislative in character covering them. * * *" [S. Rept. 960, 70th Cong., 1st Sess., p. 15.]↩11. SEC. 141. CONSOLIDATED RETURNS.(b) Regulations. -- The Commissioner, with the approval of the Secretary, shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making consolidated income - and excess-profits-tax returns and of each corporation in the group, both during and after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such manner as clearly to reflect the income- and excess-profits-tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such tax liability. * * * [I. R. C., sec. 141 (b)↩, as amended by Revenue Act of 1942, sec. 159 (a).] | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623080/ | Joseph Anastasio, Petitioner v. Commissioner of Internal Revenue, RespondentAnastasio v. CommissionerDocket No. 7134-74United States Tax Court67 T.C. 814; 1977 U.S. Tax Ct. LEXIS 153; February 16, 1977, Filed *153 Decision will be entered for the respondent. In 1970, petitioner won $ 100,000 in a lottery. Because petitioner was a minor at that time, under the applicable State law, the prize money was paid in 1970 to petitioner's parents as custodians under the State's Uniform Gifts to Minors Act. The prize proceeds, and interest earned in 1970 thereon, were turned over to petitioner in 1971. Held, the prize money was income to petitioner in 1970. Held, further, the prize money, held by petitioner's parents as custodians under the Uniform Gifts to Minors Act, did not constitute the corpus of a trust. Held, further, interest earned on the prize money was taxable to petitioner in the year earned, not the year it was turned over to him by his parents. Stanley Pressment, for the petitioner.Michael A. Zimmerman and Richard M. Campbell, for the respondent. Tannenwald, Judge. TANNENWALD*814 OPINIONRespondent determined a deficiency in petitioner's Federal income tax for the year 1970 in the amount of $ 61,086.39. The sole issue is whether a lottery prize won by a minor, together with income earned thereon, which is made payable under the applicable State law to his parents as custodians, constitutes income in the year the prize is awarded or in the year the money is actually turned over to him by his parents.All of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.Petitioner resided in New York, N.Y., at the time the petition herein was filed. His Federal income tax return for *815 the year 1970 was filed with the Internal Revenue Service Center at Andover, Mass.In February 1970, petitioner, who was born on September 1, 1950, purchased in his own name a New York State lottery ticket for $ 1 and won $ 100,000. Since petitioner was a minor, the*155 State of New York, pursuant to sec. 9553, N.Y. Unconsol. Laws (McKinney 1974), issued a check dated April 13, 1970, in that amount to Carmine and Rafaela Anastasio, who were petitioner's parents.The $ 100,000 was used to purchase an interest-bearing note and a savings bond in the names of Carmine and Rafaela Anastasio as custodians for Joseph Anastasio, under the New York Uniform Gifts to Minors Act. The total interest earned by the note and bond in 1970 was $ 4,581.At no time during 1970 did petitioner or his parents execute, or have executed on their behalf, any trust indenture for the benefit of petitioner. Petitioner's parents filed a United States Fiduciary Income Tax Return, as custodians for petitioner, for the taxable year ending March 31, 1971. In this return, $ 104,581 was included in gross income, but was shown as having been distributed to petitioner within 65 days of the close of the taxable year, with the result that the return showed no income tax due. The distribution was made because petitioner's parents, pursuant to New York Estates, Powers and Trusts Law (hereinafter EPTL) sec. 7-4.3(b) (McKinney 1967), determined that the distribution would economically benefit*156 petitioner by enabling him to average his income for tax purposes. Joseph reported the $ 104,581 on his Federal income tax return for 1971, the first year in which he was considered eligible to average his income under section 1301 et seq. 1The basic issue involved herein is whether, as respondent contends, petitioner received sufficient economic and financial benefits in 1970 to cause the lottery prize and the interest thereon to be taxable to him in that year, or whether, as petitioner argues, he was precluded from possessing the attributes of ownership and enjoyment in 1970, to such an *816 extent that he should not be taxed until he received the money in 1971 because the prize was paid to his parents as custodians. For the reasons hereinafter stated, we hold for respondent. *157 The applicable New York State Lottery for Education Law provided that if the winner of the lottery was a minor and the prize was $ 5,000 or more, payment would be made to the minor by depositing the funds to the credit of an adult member of the minor's family as custodian for the minor. N.Y. Unconsol. Laws. sec. 9553(b) (McKinney 1974). The powers and duties of such a custodian are set forth in part four of article seven of the Estates, Powers and Trusts Law. Under those provisions, the custodian can use the funds, in his complete discretion, "for the support, maintenance, education, and benefit of the minor," EPTL sec. 7-4.3(b); the minor, if he has attained the age of 14 years, can petition the court to order the custodian to expend the funds held by him for his support, maintenance, or education, EPTL sec. 7-4.3(c); and the custodian must pay whatever amount is not expended to the minor upon his reaching 21 years, EPTL sec. 7-4.3(d).The State of New York issued its check for $ 100,000 on April 13, 1970, less than 17 months prior to Joseph's 21st birthday. The only limitations on his total enjoyment of the prize money were the powers of his parents as custodians to invest*158 the funds as they saw fit and to distribute the funds to Joseph or to hold them for him during that 17-month period.In Stephen W. Pulsifer, 64 T.C. 245 (1975), winnings from the Irish Sweepstakes were deposited in a bank account for the benefit of a minor until he reached 21 years of age or until application for release of the funds was made on his behalf by his legal representative. We held that the minor was taxable in the year the amounts were deposited for his benefit and not in the year of actual receipt by him. Cf. Candido Jacuzzi, 61 T.C. 262">61 T.C. 262 (1973); E. T. Sproull, 16 T.C. 244">16 T.C. 244 (1951), affd. per curiam 194 F.2d 541">194 F.2d 541 (6th Cir. 1952). See also Rev. Rul. 67-203, 1 C.B. 105">1967-1 C.B. 105.Petitioner seeks to distinguish Pulsifer on the ground that it was not clear in that case whether the minor's rights were assignable and that in the instant case Joseph could not assign his right to the prize money but could only petition to a court for its release to him or expenditure for his support, *817 maintenance, or education. *159 Putting aside the fact that the applicable New York law does not specifically prohibit an assignment by Joseph and assuming without deciding for purposes of decision herein that petitioner was so prohibited, we are satisfied, as we were in Pulsifer (see 64 T.C. at 247), that petitioner's position is without merit. The mere absence of a right to assign has long been held not to constitute a valid reason for reaching a different result. United States v. Drescher, 179 F.2d 863 (2d Cir. 1950); Renton K. Brodie, 1 T.C. 275 (1942). Nor were the short-term management powers vested in petitioner's parents sufficient limitations upon his enjoyment of the funds to justify postponement of taxation until their removal. See City Nat. Bank & Trust Co. v. United States, 191">109 F.2d 191 (7th Cir. 1940).We hold that Stephen W. Pulsifer, supra, controls and that petitioner received sufficient benefit to be subject to tax on the prize money in 1970.Nannie Carr Harris, 56 T.C. 1165 (1971), revd. 477 F.2d 812">477 F.2d 812 (4th Cir. 1973),*160 relied upon by petitioner, is distinguishable both on its facts and on its legal theory. Our decision in that case was based upon the doctrine of constructive receipt, a concept that significantly differs from the theory of economic benefit (see E. T. Sproull, 16 T.C. at 246-247), 2 although admittedly the decided cases have not always been models of clarity in respect of the distinction. See 2 Mertens, Law of Federal Income Taxation, sec. 10.13 (1974 rev.). Since we rest our decision herein on the economic benefit theory, we have no need to consider whether we will follow the reversal of our decision in Harris.We think that the foregoing*161 rationale in respect of the prize money is equally applicable to the interest earned in 1970. Joseph argues that for tax purposes the lottery award constituted the corpus of a trust and interest earned from the award should be taxed in accordance with the provisions taxing trusts and beneficiaries. Sec. 641 et seq.In enacting the Model Gifts of Securities to Minors Act, upon which the present New York Uniform Gifts to Minors *818 Act is based, the legislature "intended to provide a single and inexpensive method for making gifts of securities to minors without the necessity of resorting to trusts and formal guardianships." In re Bushing's Custodian, 8 Misc. 2d 755">8 Misc. 2d 755, 167 N.Y.S.2d 132">167 N.Y.S.2d 132, 134 (Nassau County Surr. Ct. 1957). To effectuate this purpose, custodians under the New York Gifts to Minors Act were given broader powers and subjected to fewer restrictions than were trustees. Compare EPTL secs. 7-4.3 and 7-4.4 with EPTL sec. 11-1.1 et seq.We see no need to elaborate on the distinctions between the powers of a trustee and those of a custodian under the New York Uniform Gifts to Minors Act. We are satisfied that that Act does no*162 more than create a statutory framework, within the specified area, for the exercise of the powers of a guardian to manage the property of minors. Where income-producing property was held by a parent as a natural guardian for a minor child, we have held that no trust was in existence for tax purposes, and that the income was taxable to the minor child directly. Prudence Miller Trust, 7 T.C. 1245">7 T.C. 1245 (1946); James T. Pettus, 45 B.T.A. 855">45 B.T.A. 855 (1941). 3 Property held by a parent as custodian under the New York Uniform Gifts to Minors Act should be taxed in the same manner. Cf. Estate of Chrysler v. Commissioner, 361 F.2d 508">361 F.2d 508, 511 (2d Cir. 1966), revg. on another issue 44 T.C. 55">44 T.C. 55 (1965).*163 We hold that petitioner is taxable on the interest earned in 1970.Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question. The question of petitioner's right to average in 1971 is not before us and we express no opinion thereon.↩2. The cases of Drysdale v. Commissioner, 277 F.2d 413">277 F.2d 413 (6th Cir. 1960), revg. 32 T.C. 378">32 T.C. 378 (1959), and Aaron Watson, T.C. Memo. 1974-63↩, also relied upon by petitioner, similarly involved the doctrine of constructive receipt and are, therefore, distinguishable.3. See also Dorothy Stuit, 54 T.C. 580">54 T.C. 580, 582 (1970), affd. 452 F.2d 190">452 F.2d 190↩ (7th Cir. 1971), where we indicated that a custodian was not a "trustee" in the usual sense of that term; Peirsol, "Gifts to Minors: How Effectively Has the Uniform Act Functioned?", 25th Ann. N.Y.U. Tax Inst. 1099, 1111 (1967); "Uniform Gifts to Minors Act," 103 Trusts and Estates 983, 993 (1964). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623081/ | BAIRD MACHINE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Baird Machine Co. v. CommissionerDocket No. 21459.United States Board of Tax Appeals19 B.T.A. 801; 1930 BTA LEXIS 2324; April 30, 1930, Promulgated *2324 CHANGING BASES OF MAKING RETURNS. - Where, after the enactment of 1921 Revenue Act, a taxpayer, with knowledge of its right of election, makes a return on either the separate or the consolidated basis, it may not thereafter change without first obtaining permission from the Commissioner. Albert Mannheimer, Esq., for the petitioner. John D. Foley, Esq., for Lloyd W. Creason, Esq., for the respondent. LOVE *801 The Commissioner determined a deficiency of $4,398.17 in income tax for the year 1923. The amount in controversy is $2,108.99. Petitioner alleges that the determination of the tax set forth in the notice of deficiency is based upon the following errors: 1. Section 274(a) of the Revenue Act of 1924 has not been complied with by the Commissioner. 2. The Baird Machine Co. and the Portland Foundry Co. should be permitted to file a consolidated return for 1923. FINDINGS OF FACT. Petitioner is a Connecticut corporation with its principal office at Stratford. The Portland Foundry Co. is a Maine corporation, organized in 1920. For 1922 these corporations filed separate returns. For 1923 a consolidated return was filed, *2325 but as separate returns had been filed by each company for 1922, the Commissioner held that an election had been made in that year and that, therefore, the returns for 1923 should have been filed on the same basis, as permission to change to a consolidated basis had not been granted. The common stock certificate book of the Portland Foundry Co., together with all the common stock certificates issued to September *802 10, 1923, were placed in evidence by the petitioner. For convenience of reference, we list these certificates below: CertificateDateIssued in name of - Number Transfer to BairdNo.sharesMach. Co., datesdates as of -1Aug. 3, 1920Charles L. Warner1,794Aug. 3, 1920.2Aug. 4, 1920Horace C. Finkle213Jan. 1, 1923.3doBenton J. Calkins86Do.4doPauline C. Warner6Do.5doCharlotte P. Meserve6Do.6doBertha M. Platt3Do.7doLeslie W. Barnes3Do.8doF. R. Goodrich3Do.9doEarl Ray Carter3Do.10Aug. 18, 1920Thomas H. Sellow3Do.11doArthur J. Lewis15Do.12Aug. 19, 1920Helen S. Warner151 Ctf. canceled.13Sept. 4, 1920John T. Chidsey3No date shown.14Dec. 31, 1920Albert Pott6Jan. 1, 1923.15doB. C. Warner15Do.16Jan. 28, 1921Leon A. Warner3Do. (?).17Jan. 3, 1923Emma P. Clark 3No date shown.(tf'd from)18doHelen S. Warner 12Do.(ctf. 12)19Sept. 10, 1923Theodore Tesslo3July 7, 1924.*2326 The stock issued and outstanding on December 31, 1920, December 31, 1921, and December 31, 1922, was 2,087 shares, of which the ownership was as follows: Baird Machine Co., 81.7 per cent; Horace C. Finkle, 10.2 per cent; Benton J. Calkins, 4.1 per cent; and all others 4 per cent. On November 22, 1926, petitioner received the following letter, dated November 20, 1926, from respondent: The BAIRD MACHINE COMPANY, Bridgeport, Connecticut.SIRS: Reference is made to your letter dated November 10, 1926, in reply to office letter dated November 6, 1926, in which permission was denied to file amended consolidated return for the years 1922 and 1923. It is noted that a consolidated return was filed by your company for the year 1923 but as separate returns were filed by each company in 1922, it is held that an election was made in that year. Therefore the returns for 1923 should have been filed on the same basis as permission to change to a consolidated basis was not requested prior to the due date of the 1923 returns. The ruling shown in office letter dated November 6, 1926, is therefore sustained. OPINION. LOVE: The petitioner's*2327 first assignment of error does not appear to be supported by either the facts or the law. The petitioner asserts in its pleadings that "no reason has been given in writing for the assessment of the additional tax in controversy;" but the Commissioner accompanied his deficiency notice with a statement (an alleged copy of which is included in the petition) in which it is said that "the revenue agent's reports dated March 24, 1926, and June 7, 1926, *803 have been examined and the report of June 7, 1926, showing the above tax liability has been accepted as rendered." The Board has recognized the right of both the petitioner and the respondent to move for more specific allegations in their respective pleadings, and no motion to that effect was made by petitioner. If there be no deficiency, or if the deficiency asserted by the Commissioner is not correct in amount, the petitioner may show such a situation, but the burden rests upon it to prove to this Board the correct amount of the deficiency, or that there is none. In ordinary cases this may be done wholly independent of, and without regard to, the processes or computations through which the Commissioner arrived at his determination, *2328 as well as by breaking down the contention of the Commissioner, if his bases or methods of computation are disclosed and challenged. In the absence of such proof, the computation of the Commissioner will be sustained. See Rule 30 of the Board's rules of practice. The Board will not sustain this petitioner in its contention here; there is no real issue. Petitioner's second allegation of error is founded upon its assertion that it is entitled to affiliation in 1923 with the Portland Foundry Co., and that it should be required to file a consolidated return for that year. The Revenue Act of 1921, under which these returns were filed, provides in section 240: (a) That corporations which are affiliated within the meaning of this section may, for any taxable year beginning on or after January 1, 1922, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission*2329 to change the basis is granted by the Commissioner. * * * (c) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. This issue concerning the right of affiliation in 1923 resolves itself into two considerations under the above provisions of the law: First: Was the petitioner entitled to file a consolidated return for 1922? Second: If it were so entitled, and notwithstanding, filed separate returns, with full knowledge of its right to file consolidated return, must it be held to have made an election at that time that would thereafter prevent it from filing consolidated returns unless permission to change the basis is granted by the Commissioner? *804 The testimony of the sole witness, B. J. Calkins, assistant secretary and accountant of the Baird Machine Co., who had been connected with it for about 25 years, varies slightly but not materially*2330 from the documentary evidence introduced. Only the common stock of the Portland Foundry Co. was entitled to vote. Calkins testified that in the period under review the total amount of common stock issued and outstanding was 2,093 shares. According to the certificates actually issued and the corresponding stubs in the certificate book from which they were detached, we find the number of shares on August 3, 1920, to have been 2,087, of which 1,794 were held by Charles L. Warner as agent or trustee for the Baird Machine Co.; 210 by Horace C. Finkle; and 83 by Burton J. Calkins. On various dates between August 4, 1920, and December 31, 1920, 87 shares were transferred from the 1,794 shares held by Warner as above; 3 shares to Finkle, 3 shares to Calkins, and 81 shares in all to twelve other persons, each of whom was, according to the witness, an official of the Baird Machine Co., a friend, or an employee. Thus, on December 31, 1920, the voting stock of the Portland Foundry Co. was held as follows: SharesPer centBaird Machine Co. (Charles L. Warner, as trustee)1,70781.7Horace C. Finkle (Baird Machine Co. employee and officer of Portland Foundry Co.)21310.2Burton J. Calkins (officer of Baird Machine Co. and of Portland Foundry Co.)864.1Eleven other persons (officials and employees of Baird Machine Co. and their friends)814.0Total outstanding common (voting) stock2,087100.0*2331 In the earlier appeal of the Baird Machine Co., decided October 28, 1925 (see ), we found that that company in the year 1920 owned directly or controlled through closely affiliated interests substantially all the stock of the Portland Foundry Co., and that the two companies were affiliated. Counsel for petitioner urges that the Portland Foundry Co. here under consideration is a Maine corporation, and that the one considered in the earlier decision was incorporated in Connecticut; but it can not be that the latter corporation only was considered in that opinion. The Maine corporation came into existence on or before August 3, 1920, and we quote from our findings of fact in the earlier case that "Finkel's stock was at all times during the years 1919 and 1920, in the possession of the [Baird] Machine Company and held by it as collateral security, as above recited, and was voted by the Machine Company until it was purchased from Finkel in the year 1923 * * *." (Italics supplied.) From this it is evident that we were then considering the circumstances in connection with the Maine corporation as the successor *805 of the Connecticut*2332 corporation which, upon the admission of counsel, was dissolved in 1920. During the period from December 31, 1920, to January 1, 1923, there was only one transfer of stock; that occurring on January 28, 1921, when three shares were transferred from Charles L. Warner, as agent or trustee for the Baird Machine Co., to Leon A. Warner, presumably a relative of Charles L. Warner, so that at all times from January 28, 1921, to December 31, 1922, the ownership of the stock of the Portland Foundry Co. was as follows: SharesBaird Machine Co1,704Horace C. Finkle213Burton J. Calkins86Twelve other persons84Total2,087Within a negligible fraction of one per cent, the percentages of ownership remained the same as at December 31, 1920. During both of the years 1921 and 1922 the Baird Machine Company owned or controlled through closely affiliated interests 96 per cent of the stock of the Portland Foundry Co., and since it was not shown nor contended that there had been any change in the business relations, management, or method of operation, we hold that in 1921 and 1922 they were affiliated corporations, as they were in 1920. *2333 In 1922 petitioner had the option to file separate returns for each corporation or a consolidated return for both of them, irrespective of its practice in earlier years. It elected to file separate returns for that year and since permission to change the basis was not granted by the Commissioner, we hold that petitioner is bound by that election to file separate returns for 1923, even though on January 1, 1923, or shortly thereafter, it came into actual possession of all of the stock of the Portland Foundry Co. ; ; ; ; ; . Also see . Reviewed by the Board. Judgment will be entered for the respondent.Footnotes1. See certificates 17 and 18. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623082/ | Kerr-Cochran, Incorporated, a Nebraska Corporation v. Commissioner.Kerr-Cochran, Inc. v. CommissionerDocket No. 48271.United States Tax CourtT.C. Memo 1955-90; 1955 Tax Ct. Memo LEXIS 249; 14 T.C.M. (CCH) 304; T.C.M. (RIA) 55090; April 15, 1955*249 Petitioner was principally engaged in buying, selling and renting automobiles, trucks, farm machinery, automotive parts, and equipment. In addition, it invested funds in commercial real estate, stocks, oil leases, and made loans to its president and his relatives. The president of the company owned over 97 per cent of the company's stock. During 1949 and 1950, petitioner had substantial earned surplus and net income after taxes, but no dividends were paid to stockholders.1. Held, on the facts, that earnings or profits were permitted to accumulate during 1949 and 1950 beyond the reasonable needs of the business within the meaning of section 102(c), Internal Revenue Code, 1939. 2. Held further, that petitioner was availed of during the years in question for the purpose of avoiding surtax upon its shareholders within the meaning of section 102, Internal Revenue Code, 1939. James D. Conway, Esq., for the petitioner. Richard C. McLaughlin, Esq., for the respondent. FISHERMemorandum Findings of Fact and Opinion Respondent determined a deficiency in petitioner's income tax for 1949 and 1950 of $35,621.01 and $25,727.93, respectively. The only issue involved herein is whether petitioner *250 was availed of during the years in question for the purpose of preventing the imposition of surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being divided or distributed. Findings of Fact Some of the facts were stipulated. Those so stipulated are found accordingly and incorporated herein by reference. Petitioner is a corporation which was organized under the laws of the State of Nebraska on August 10, 1939, with its principal place of business in Hastings, Nebraska. Petitioner's income tax returns for the calendar years 1949 and 1950 were filed with the then collector of internal revenue for the district of Nebraska. Since its incorporation, petitioner has employed a calendar year and accrual method of accounting and its tax returns have been prepared and filed on that basis. The Articles of Incorporation of the company provide in part that its objects and purposes are to manufacture, buy and sell motor vehicles, merchandise relating to the automotive industry, and other merchandise; and to maintain a shop for the repair of motors. It also provides that, among other powers, the corporation has the right to acquire and dispose *251 of personal and real property as may be necessary or convenient for the proper conduct of the affairs of the corporation. Petitioner was organized by Claren R. Kerr, Hastings, Nebraska, H. Max Cochran, Creston, Iowa, and Homer N. Harsh, Creston, Iowa. Authorized capital stock was two hundred and fifty (250) shares of common stock with a par value of One Hundred Dollars ($100.00). Two hundred (200) shares were issued on September 2, 1939, to the following persons and in the following amounts: SharesClaren Kerr, Hastings, Nebraska72H. Max Cochran, Creston, Iowa72Andrew J. Harsh, Hastings, Nebraska20Harry Blosser, Creston, Iowa16Homer Harsh, Creston, Iowa20200 A total amount of $25,000 was paid in at this time which was credited to the capital accounts, as follows: Capital Stock (Common)$20,000Paid-in or Capital Surplus5,000The corporation had a nonexclusive franchise confined to the Hastings, Nebraska, area for the sale of Chevrolet automobiles. It was also authorized to sell Chevrolet trucks on a fleet basis (five or more) anywhere in the United States. In addition to these activities, the company engaged in numerous other activities including the sale of farm machinery, hydraulic hoists *252 and truck bodies, the rental of trucks to the United States through contractors, the raising of wheat in a joint venture, and the financing of some of its sales. On August 30, 1946, the stockholders of petitioner voted to retire 127 shares of its common stock at the then book value of $281.28 per share. On or about the same date, Claren Kerr sold one share of common stock to his brother, Lyle Kerr. Thereafter, the stockholders of record were as follows: SharesClaren Kerr71Lyle Kerr1Andrew J. Harsh1 These three individuals were elected directors at a stockholders meeting held on August 30, 1946, and have continued to act in that capacity. Also on August 30, 1946, Claren Kerr was elected President, Lyle Kerr, Vice-President, and Andrew J. Harsh, Secretary-Treasurer. They have continued to hold their respective offices to the date of the hearing herein. At a special stockholders meeting held on December 20, 1947, the shareholders authorized the directors of the corporation to issue to the stockholders of record on that date two shares of common stock for each share outstanding. From that date to the date of hearing, the capital stock of the petitioner has been held as follows: SharesClaren Kerr213Lyle Kerr3Andrew J. Harsh3Total219Petitioner's *253 gross income, net income, and net income after taxes as reported on its tax returns for each of the years 1946-1951, inclusive, were as follows: GrossNetNet IncomeYearIncomeIncomeAfter Taxes1946$102,496.78$ 54,192.55$ 33,599.381947341,377.89171,787.59106,652.461948338,735.72180,164.70111,702.111949361,436.36195,312.17121,093.541950350,245.58149,388.8891,633.041951425,142.87166,140.8177,924.84Petitioner's earned surplus and undivided profits, and the ratio of current assets to current liabilities, as of December 31 of each of the years 1946-1951, inclusive, were as follows: Earned SurplusRatio of Currentand UndividedAssets to CurrentYearProfitsLiabilities1946$ 44,569.401.2061947136,621.862,5801948248,323.973,5851949369,417.514,3131950460,850.554,2031951544,985.373,577Petitioner's balance sheets as of December 31, 1949 and December 31, 1950 were as follows: ASSETS19491950Cash$152,272.35$121,991.87Notes and Accounts Re-ceivable (Less Reservefor bad debts)156,013.04144,468.27Inventory (Finishedgoods)90,234.18149,981.35Other Investments (Se-curities)40,102.2045,338.21Building under construc-tion59,193.99Building50,000.0050,000.00Service and Companycars$ 2,146.32$ 7,779.74Machinery and Equipm't10,385.6110,385.61Furniture and Fixtures2,270.142,270.14Land20,000.0021,906.41Prepaid insurance, ad-vertising deposits2,843.662,911.32Leasehold improvements3,559.788,729.08Total - Before Reservefor Depreciation$529,827.28$624,955.99Less Reserve for De-preciation on Depre-ciable Assets12,679.4516,780.96Total Assets$517,147.83$608,175.03LIABILITIESAccounts Payable$ 23,457.36$ 39,084.10Accrued Taxes2,434.4210,212.91Accrued Wages1,000.00Provision for FederalIncome Taxes74,218.6357,955.84Surplus Reserves23,894.9115,346.63Capital Stock21,900.0021,900.00Paid-in or Capital Sur-plus1,825.001,825.00Earned Surplus and Un-divided Profits369,417.51460,850.55Total Liabilities$517,147.83$608,175.03*254 In 1948, petitioner entered into a joint venture with A. L. Lintner of Tucson, Arizona, and the Pioneer Automobile Company of Denver, Colorado, for the sale of parts to the Chinese Nationalist Government. The American National Bank of Denver, Colorado, acted as the intermediary in this venture. To insure the joint venture's credit and to guarantee payment for the parts purchased, petitioner deposited $100,000 of its funds with the bank and Claren Kerr deposited $50,000 of his personal funds on behalf of the petitioner. This money was deposited on or about December 6, 1948, and remained on deposit with that bank during 1949 and 1950. Petitioner's profit on the parts transaction, which was completed in 1950, was about $60,000. Claren Kerr did not directly receive any profit from the transaction. On June 24, 1949, petitioner purchased a commercial building in Grand Island, Nebraska, at a total cost of $70,000. This building was held by the petitioner as rental property during the years 1949 and 1950. During 1950 petitioner's officers and several other merchants in Hastings, Nebraska, discussed the possibility of building a warehouse for their individual uses and for rental to other people. *255 Prior to beginning construction, the other interested parties were financially unable to continue with this venture and petitioner then proceeded on its own to build the Hastings warehouse. The building was completed in June 1951, at a cost of $146,404.23 of which $59,193.99 was expended during 1950. Subsequent to the completion of the warehouse in 1951, it was leased to the Federal Government for the storage of crude rubber and to a truck operator for use as a truck terminal. Donald Johnson is Claren Kerr's brother-in-law. During 1951, Donald Johnson and Lyle Kerr, vice-president of petitioner, entered the automobile business in Auburn, Nebraska. Petitioner loaned Donald Johnson, without interest, $30,000 on or about January 26, 1951, and an additional $4,000 on or about March 6, 1951, for the purpose of enabling Donald Johnson to purchase the Chevrolet business at Auburn, Nebraska. During 1951, Donald Johnson made payments in the total amount of $4,070.25 to be applied against this loan and a prior indebtedness. The balance in this account, which was carried on petitioner's books as an account receivable, as of December 31, 1951, was $37,429.75. During January 1951, petitioner purchased *256 a garage building in Auburn, Nebraska, at a cost of $34,500, which it then leased at a net rental of $250 per month to Donald Johnson. Petitioner also had invested some of its funds in securities and oil leases. Its total of such investments as of December 31 of each year is as follows: Total Oil and SecurityYearInvestments1948$34,057.26194934,157.26195038,538.21195136,248.21Peter Kiewit Sons Company is engaged in the general contracting business, which includes building dams, airports, highways and office buildings. Petitioner sold Peter Kiewit Sons Company new trucks and bought some of their used trucks. The account of Peter Kiewit Sons Company, carried on petitioner's books as an account receivable, was paid promptly during the years 1949-1951, inclusive, and several times during 1949 and 1950 the account showed a credit balance. Beginning on or about April 10, 1951, petitioner began selling trucks installed with special equipment for operation in a cold climate to Peter Kiewit Sons Company. This account was carried on petitioner's books under the name of North Atlantic Constructors. The account of North Atlantic Constructors, which was financed by the petitioner, was paid promptly *257 during its existence, usually within two or three weeks after a charge was made to the account. In order to carry this account (which had a debit balance of $473,699.13 on April 26, 1951) and that of Peter Kiewit Sons Company, on April 25, 1951, petitioner borrowed $190,000 from The Hastings National Bank, Hastings, Nebraska, and the Omaha National Bank, Omaha, Nebraska. Claren Kerr personally guaranteed these loans. They were repaid shortly thereafter as follows: $100,000 on May 1, 1951, $50,000 on May 7, 1951, and $40,000 on May 14, 1951. Also during 1951, petitioner borrowed the following additional funds from sources other than Claren Kerr (discussed infra) and the banks: $25,000 from Leona Cochran on January 24, 1951; and $40,000 from Kerr-Cochran Sales Company on or about April 11, 1951. These amounts were repaid subsequently during 1951. At the time all the above loans were made, petitioner had exhausted its line of credit with normal lending institutions. Petitioner and Claren Kerr advanced funds to each other during each of the years 1949 through 1951. His account with the company fluctuated during 1949 between a credit balance of $3,305.77 and a debit balance of $19,149.91. *258 During 1950, it fluctuated between a debits balance of $1,208.02 and a credit balance of $9,244.49. During 1951, it fluctuated between a credit balance of $119,776.05 on April 17, 1951, and a debit balance of $15,678.48 on November 31, 1951. During the first four months of 1951, Claren Kerr advanced over $115,000 to the corporation which was entirely repaid by May 26, 1951. Of this amount, he had personally borrowed $40,000 on April 17, 1951, from the Hastings National Bank. During the years in question, Claren Kerr was paid a salary of $300 per month by petitioner. He was also entitled to a bonus of 15 per cent of the company's net profit before taxes each year but the bonus was waived for 1949. The total compensation paid to him by petitioner during 1949, 1950 and 1951, was $3,650, $28,650, and $32,180, respectively. Claren Kerr purchased a farm located near Lexington, Missouri, in 1946, on which he proceeded to develop apple orchards. From the date of his purchase he suffered large losses in the operation of the farm. Petitioner advanced money, without interest, for the operation of the farm during the years 1948-1951, inclusive. These advances were carried on petitioner's books *259 during the years 1948-1951, inclusive, as an account receivable. The following schedule shows the amounts advanced, amounts repaid, and balances in this account as of December 31 of each of the years 1948-1951, inclusive: AmountDecember 31YearAdvancedBalance1948$ 2,096.21$ 2,096.2119493,500.005,596.2119509,476.7615,072.97195112,934.0028,006.97During 1951, petitioner advanced $32,518.27, of which $2,620.66 was repaid during that year, to commence construction of a personal residence for Claren Kerr. The unpaid balance in this account receivable at the end of 1951 was $29,897.61. During 1951, petitioner advanced funds to Claren Kerr and R. J. McKenzie for the purpose of buying lots and erecting several houses. After construction these houses were to be sold and the profits divided equally between Claren Kerr and R. J. McKenzie. As of September 22, 1951, petitioner had advanced $28,009.27 for this purpose. Beginning on September 30, 1946, and continuing through 1950, petitioner advanced money to Gladys Kerr, wife of Claren Kerr. These advances were carried on petitioner's books as an account receivable. No interest was paid on any of these advances. The following schedule reflects the *260 total amounts advanced and repaid in each of the years 1946-1951, inclusive, and the balance in the account as of December 31 of each year: AmountAmountDecember 31YearAdvancedRepaidBalance1946$15,000.00$15,000.00194725,739.32$28,700.0012,039.32194812,039.3219495,264.8017,304.12195015,000.0032,304.12195132,304.12On December 31, 1951, Gladys Kerr repaid the entire balance due, and the account was reduced to zero. There had been no advances to her during 1951. During the years in question, petitioner had a line of credit up to $40,000 with The Hastings National Bank. This was the maximum amount that bank would loan to any one borrower. Petitioner was also able to borrow larger amounts from other banks upon Claren Kerr's guarantee. No cash dividends have ever been paid by petitioner. For each of the years 1949 and 1950, Claren Kerr reported net taxable income of $35,930.81 and $29,515.27, respectively, upon which he incurred income tax liability of $10,841.56 and $8,369.28, respectively. Had petitioner distributed as a dividend the entire amount of its net income after taxes in each year, Claren Kerr's liability for income tax would have been increased by $72,143.98 and $52,998.68, respectively. *261 During each of the years 1949 and 1950, petitioner's earnings or profits were permitted to accumulate beyond the reasonable needs of its business, and the corporation was availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being divided or distributed. Opinion FISHER, Judge: Respondent determined that petitioner was availed of for the purpose of preventing the imposition of surtax upon its shareholders during the taxable years 1949 and 1950, and that it is therefore subject to tax under section 102 of the Internal Revenue Code of 1939. He contends that the earnings or profits of the corporation were permitted to accumulate beyond the reasonable needs of the business during those years which is determinative of the purpose to avoid surtax upon shareholders within the meaning of section 102 unless "the corporation by the clear preponderance of the evidence shall prove to the contrary." Section 102(c), Internal Revenue Code, 1939. We have determined as ultimate findings of fact, supra, that there were such accumulations of earnings or profits and that petitioner was *262 availed of during the years in question for the prohibited purpose. In our analysis, we turn first to the question of whether earnings or profits were permitted to accumulate during the taxable years beyond the reasonable needs of the business within the meaning of section 102 (c). At the outset, it should be noted that the company's earned surplus and undivided profits rose from about $44,000 at the end of 1946 to over $460,000 at the end of 1950, and that during this entire period no dividends were paid to its stockholders. Petitioner's net income after taxes for 1949 and 1950, the years involved herein, was $121,093.54 and $91,633.04, respectively. The principal activities of the company were buying, selling, renting and repairing automotive vehicles (including trucks and farm machinery), parts, and equipment. In addition, however, the corporation engaged in activities which were not directly related to its automotive business. Such activities included investments in commercial real estate, corporate stocks, oil and gas leases, and loans to individuals. The recent case of Jacob Sincoff, Inc., 20 T.C. 288">20 T.C. 288 (1953), affirmed 209 Fed. (2d) 569, involved a related factual situation. *263 In that case we said at page 292: "[Petitioner] argues that it had two businesses, one, the paper, paperboard, and twine business, which was becoming less important, and the other, called the primary one, the securities business. The petitioner was not a mere holding or investment company during 1945 because it operated as a jobber in the paper business. One of the arguments advanced to justify its accumulated earnings is its large indebtedness in order to buy securities as a part of its distinct and separate securities business. If its sole business had been the purchase, sale, and rention of securities it would have been a mere holding or investment company within the meaning of section 102(b). Investment of surplus funds of a closely owned business instead of distributing them is one way of avoiding surtax on the stockholders. Obviously, the petitioner can not plead an investment business, distinct from its paper, paperboard, and twine business, as an excuse for the accumulation of any of its earnings in order to avoid the application of section 102. Therefore, the only business needs which may properly be considered are the needs of the paper, paperboard, and twine business." In *264 the instant case, were petitioner a mere holding or investment company, that fact alone would be prima facie evidence of a purpose to avoid surtax upon shareholders. Section 102(b), Internal Revenue Code of 1939. Petitioner, however, is engaged principally in operating an automotive business. It is our view that the need for funds in the operating business, as distinguished from petitioner's investment activities, is the fundamental factor to be considered in determining the reasonableness of accumulated earnings and profits. In this respect, petitioner's use of funds for investments and certain other purposes (discussed infra) during the years in question indicates that its earnings or profits to this extent, at least, were not needed in its operating functions, and that such funds were therefore accumulated beyond its reasonable needs within the meaning of section 102(c). Helvering v. National Grocery Co. (1938) 304 U.S. 282">304 U.S. 282, reversing 92 Fed. (2d) 931, reversing 35 B.T.A. 163">35 B.T.A. 163; J. M. Perry & Co. v. Commissioner (C.A. 9, 1941), 120 Fed. (2d) 123, affirming a Memorandum Opinion of the Board of Tax Appeals; and Jacob Sincoff, Inc., supra. During 1949, petitioner expended $70,000 *265 for the acquisition of a commercial building in Grand Island, Nebraska, which it thereafter held as rental property. It also loaned over $5,000 to Gladys Kerr, the wife of its principal stockholder, and it advanced over $3,000 for the operation of a farm owned by Claren Kerr, the principal stockholder. Thus, during 1949, the company used about $80,000 for purposes not related to its normal business operations. Similarly during 1950, petitioner expended about $60,000 for the construction of a warehouse in Hastings, Nebraska, which was leased to others after its completion in 1951. It also increased its investment in securities and oil and gas leases by over $4,000, and it loaned an additional $15,000 to Gladys Kerr. Further advances of over $9,000 were made that year for the operation of Claren Kerr's farm. Thus, during 1950, over $88,000 was expended for purposes extraneous to the normal operations of petitioner's business. The year 1951 is not at issue herein but the use of funds in that year for purposes unrelated to the basic functions of the corporation gives some further indication, if any were needed, that the prior accumulation of earnings or profits was beyond the reasonable *266 needs of petitioner's operating business. During 1951, petitioner expended an additional $87,000 for the construction of the Hastings warehouse. It spent $34,500 for the acquisition of a garage building in Auburn, Nebraska, which it leased to Donald Johnson, Claren Kerr's brother-in-law. It also loaned Johnson $34,000 to enable him to purchase a Chevrolet business in Auburn, and over $28,000 was advanced to Claren Kerr and R. J. McKenzie who were partners in a home construction venture. In addition, over $32,000 was advanced to pay for the construction of a personal residence for Claren Kerr, and over $12,000 was advanced for the operation of his farm that year. Thus during 1951, petitioner expended over $225,000 for purposes alien to its normal business operations. Petitioner contends that accumulations of earnings or profits in 1949 and 1950 were necessary in order to increase the financial strength of the corporation. In this respect, however, it should be noted that petitioner's working capital position, as disclosed by its balance sheets, was most favorable at the end of each year involved herein despite large expenditures of cash for purposes unrelated to its operating business. *267 The ratio of current assets to current liabilities at the end of each of these years was well over four to one. Under these circumstances, it is apparent that the financial needs of petitioner were adequately provided for and that additions to working capital of the above-mentioned investment items (i.e., those which were not already reflected in working capital by reason of having been carried on the books as accounts receivable) would have resulted in the accumulation of quick assets far in excess of the reasonable demands of the business. See McCutchin Drilling Co. v. Commissioner (C.A. 5, 1944) 143 Fed. (2d) 480, affirming 45 B.T.A. 1146">45 B.T.A. 1146 [2 TCM 554]. Our view in this respect apparently concurs with that of the petitioner's officers who authorized the expenditures for investment purposes. Moreover, there is no evidence that such investments endangered the company's ability to meet current obligations as they might arise. On the contrary, the record discloses that, in addition to its working capital to meet its obligations, petitioner had the maximum allowable line of credit with The Hastings National Bank ($40,000), and additional sums could be borrowed by petitioner elsewhere *268 either from other banks upon Claren Kerr's guarantee or from Claren Kerr and other persons directly. We have noted that during 1949 and 1950 petitioner maintained intact a deposit of $100,000 with The American National Bank of Denver in Denver, Colorado, to guarantee payment for parts purchased by a joint venture in which petitioner participated for resale to the Chinese Nationalists. Despite the restriction on this large amount of cash, however, petitioner had other funds in sufficient quantity during those years to meet the needs of its current business operations and to use for the other purposes set out above. Accordingly, it is apparent that the Chinese transaction did not necessitate the accumulation of earnings or profits to any material extent. Petitioner also points out that $190,000 was borrowed from banks in addition to advances and other borrowings during 1951 to finance the accounts of North Atlantic Constructors and Peter Kiewit Sons Company. The bank loans were completely repaid, however, within three weeks, and large advances to petitioner by Claren Kerr were repaid within two months. These factors indicate that the need for funds was only temporary in nature. There *269 is no evidence that petitioner accumulated earnings or profits in 1949 or 1950 in anticipation of a need for funds to carry these two large accounts in 1951. Furthermore, the use of over $225,000 of corporate funds for other purposes during that year, as set out above, is inconsistent with petitioner's contention. Petitioner also contends that the accumulation of earnings or profits was necessary in order to augment the corporation's growth and expansion. It is our view, however, that the use of corporate funds in various enterprises of its principal stockholder and his relatives and in other investments during the years in question is manifestly incompatible with this contention. Moreover, there is no evidence of any plans or commitments for the expansion of petitioner's business operations which would require capital outlays commensurate with the accumulations during the years in question. Accordingly, for the reasons expressed above, it is our view that earnings or profits were permitted to accumulate during the years involved herein beyond the reasonable needs of petitioner's business within the meaning of section 102(c). Our finding that an unnecessary accumulation of earnings *270 or profits was permitted during the years in question is according to section 102(c), determinative of the further fact that the corporation was availed of for the purpose of avoiding surtax upon shareholders within the meaning of section 102 unless petitioner proves to the contrary by a clear preponderance of the evidence. We hold that petitioner has not met its burden of proof in this respect. Whitney Chain & Mfg. Co., 3 T.C. 1109">3 T.C. 1109 (1944), affirmed 149 Fed. (2d) 936. Moreover, we believe that the record affirmatively establishes that petitioner was availed of during the years in question for the prohibited purpose. After August 30, 1946, over 97 per cent of the petitioner's stock was owned by its president, Claren Kerr. His use of petitioner's corporate entity thereafter indicates clearly that he considered it much in the light of an incorporated pocketbook. The balance in his personal account with the company varied considerably during the years in question as the need for funds by himself or the corporation arose. Moreover, as set out fully above, large amounts were advanced by the corporation for the operation of his farm and for the construction of his personal residence. Similarly, *271 the corporation advanced funds for the use of his wife and for a home construction venture in which he was a partner. Furthermore, as already stated, the corporation invested funds in numerous enterprises which were not related to its operating business. Among such investments were securities, oil and gas leases, commercial real estate, and the automobile business of his brother-in-law. We think that these investments were made largely to satisfy the personal wishes of Claren Kerr rather than for corporate purposes. It appears clear from the record that, for all practical purposes, Claren Kerr used corporate funds as his own during the years in issue. Although no dividends were ever paid to him and he waived a substantial bonus due him in 1949, he received the equivalent of the corporate earnings to the extent that he wanted to make personal use of them during this period under other guises. See United Business Corporation v. Commissioner (C.A. 2, 1933), 62 Fed. (2d) 754, affirming 19 B.T.A. 809">19 B.T.A. 809. The failure to pay dividends resulted in extensive savings of income taxes on Kerr's part for the years in question. For 1949 and 1950 he reported a net taxable income of $35,930.81 and *272 $29,515.27, respectively. Had his share of petitioner's net income after taxes been distributed to him in each of those years, his tax liability would have been increased by $72,143.98 and $52,998.68, respectively. Thus, by leaving the money in the corporation, Kerr was able to use the full amount, unreduced by personal income taxes, for investments and other activities unrelated to the normal activities of the business which inured to his own personal benefit as substantially the sole owner. In this way, his personal assets, as reflected in his equity in the corporation, increased in value each year without the increment having been subjected to personal income tax liability. This means of at least deferring the tax was without any material inconvenience to Kerr since he at all times had access to corporate funds for his personal use when and if needed through the medium of either salary, or loans. It should not be overlooked that much of the impact of progressive income tax rates on such undistributed corporate earnings might later be avoided by the subsequent sale of Kerr's corporate stock (in which event his gain would be taxed at capital gains rates), or by the subsequent gift *273 or bequest of the stock (in which event gift or estate tax rates would apply). Under the circumstances, we draw the affirmative inference that independent of the presumption created under section 102(c) by our finding that earnings and profits were permitted to accumulate beyond the reasonable needs of petitioner's business, the petitioner was availed of during the taxable years for the purpose of preventing the imposition of surtax upon its shareholders. Helvering v. National Grocery Co., supra. During the course of the hearing in the instant case, respondent offered testimony and documentary evidence concerning the years 1952 and 1953 which are subsequent to those in question. Petitioner objected to the introduction of these items and the objections were taken under advisement. We are of the opinion that such evidence should not be considered in relation to any of the issues before us, and we sustain petitioner's objections. No like objection was raised with respect to evidence of circumstances arising in 1951. Other adjustments determined by respondent have not been assigned as error in the instant case. Decision will be entered for the respondent. **274 Footnotes*. Before changed by an official order of the Tax Court dated June 6, 1955, this sentence read: "Decision will be entered under Rule 50." | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623083/ | HAYSTONE SECURITIES CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Haystone Sec. Corp. v. CommissionerDocket No. 23160.United States Board of Tax Appeals19 B.T.A. 954; 1930 BTA LEXIS 2293; May 14, 1930, Promulgated *2293 A portion of a dividend declared and distributed in 1923 which represented earnings accumulated since February 28, 1913, held taxable as an ordinary dividend, regardless of whether or not it was part of a distribution in liquidation. George E. Cleary, Esq., for the petitioner. R. Wilson, Esq., for the respondent. MURDOCK *954 The Commissioner determined a deficiency in income tax for the year 1923 of $24,107.99. The petitioner alleges that "The respondent erroneously held that the petitioner was not entitled to deduct from gross income for the calendar year 1923 a loss of $191,401.42 sustained by the petitioner upon the disposition of 10,520 shares of stock of Pond Creek Coal Company." The parties entered into a stipulation which is incorporated in the findings of fact, and, in addition, the respondent introduced certain documents in evidence. FINDINGS OF FACT. (1) Haystone Securities Corporation, the petitioner herein, was throughout the calendar year 1923, at all times thereafter has continued to be, and still is, a New York corporation. *955 (2) Pond Creek Coal Company (hereinafter called Pond Creek) was a Maine corporation*2294 throughout the calendar year 1923, and continued to be such until its dissolution on November 20, 1924. Throughout the calendar year 1923 and at all times thereafter until its dissolution, the capital stock of Pond Creek was all of one class, and was represented by 212,920 outstanding shares of the par value of $10 each. (3) Early in 1923 and prior to February 23, 1923, the petitioner purchased 10,520 shares of the capital stock of Pond Creek and paid therefor $457,818. (4) At a meeting regularly held on February 15, 1923, the Board of Directors of Pond Creek duly passed the following resolution: VOTED: That a dividend of Thirty-Five Dollars ( $35) per share upon the outstanding Capital Stock of this Company be, and it hereby is, declared payable March 1st, 1923, out of earned surplus and paid-in surplus, to stockholders of record at the close of business February 23, 1923. (5) Subsequently at the aforesaid meeting held on February 15, 1923, the Board of Directors of Pond Creek duly passed the following resolution: VOTED: That the President be, and he hereby is, authorized to call a Special Meeting of the Stockholders of this Company at such time as may be fixed by the*2295 President to take such action as the stockholders may determine upon with reference to the liquidation of the affairs of the corporation and with reference to the dissolution of the Corporation. Prior to the passage of said resolutions no formal action had been taken by either the directors or stockholders of Pond Creek looking to the liquidation or dissolution of Pond Creek. (6) On March 1, 1923, pursuant to the resolution of its Board of Directors set out at paragraph (4) supra, Pond Creek paid to its shareholders of record as of February 23, 1923, including petitioner, a distribution of $35 a share. The total amount of said distribution was $7,452,200, of which amount $368,200 was paid to petitioner as owner of 10,520 shares of the capital stock of Pond Creek. (7) The surplus of Pond Creek on March 1, 1923, just prior to said distribution of $7,452,200, was $7,452,200, of which amount $4,189,249.90 consisted of earnings or profits (less reserves for contingencies, liquidating expenses, and Federal income and profits taxes applied to the proper years) accumulated after February 28, 1913, and $3,262,950.10 represented paid-in surplus. (8) At a special meeting regularly*2296 held on March 1, 1923, the stockholders of Pond Creek duly passed the following resolutions: VOTED: That the Directors be, and they hereby are, authorized to liquidate the affairs of the company, and at such time as they may determine upon, or from time to time, to distribute the assets available for distribution to the persons entitled thereto. VOTED: That upon the liquidation of the affairs of this company in accordance with the full intent of the foregoing vote, the President or other officer of this company be, and he hereby is, authorized to file a bill in equity for the dissolution of the corporation without the appointment of a trustee, and that an answer to said bill be filed by the Clerk or Secretary admitting all the allegations thereof. Said resolutions were the first corporate action authorizing or directing the liquidation and/or dissolution of Pond Creek. (9) Thereafter in 1923 Pond Creek, pursuant to action taken by its Board of Directors under authority of the resolutions of its stockholders set out at paragraph (8) supra, distributed to each of its shareholders, in exchange for their certificates of stock of Pond Creek, $10 per share. After this distribution*2297 *956 Pond Creek retained only sufficient assets to meet its outstanding liabilities, and its Board of Directors thereupon proceeded to take the necessary steps to secure its formal dissolution, which was accomplished on November 20, 1924. (10) As its proportion of said distribution of $10 per share, the petitioner received from Pond Creek on May 9, 1923, the sum of $105,200, and turned over to Pond Creek for cancellation the certificates representing petitioner's 10,520 shares of stock of Pond Creek. (11) In making its Federal income tax return for the calendar year 1923, which was filed on or about March 15, 1924, the petitioner reported as ordinary dividend income the same proportion, to wit, $206,983.42, of the total distribution of $368,200, received by it from Pond Creek on March 1, 1923, as the earnings or profits of Pond Creek accumulated since February 28, 1913, and available for distribution on March 1, 1923, to wit, $4,189,249.90, bore to the entire distribution of $7,452,200, made by Pond Creek on March 1, 1923, as aforesaid. In its said return the petitioner reported the balance of the distribution of $368,200, received by it from Pond Creek on March 1, 1923, to*2298 wit, $161,216.58, and the entire distribution received by it from Pond Creek on May 9, 1923, to wit, $105,200, as payment in full for its 10,520 shares of Pond Creek stock. Since the total of the amounts so treated as received in payment for its shares of Pond Creek stock, it with $266,416.58, was less by $191,401.42 than the cost to petitioner of said shares, to wit, $457,818, the petitioner in its said return reported a loss of $191,401.42 on the disposition of said shares. (12) In his notice of deficiency from which this appeal is taken the Commissioner of Internal Revenue has disallowed as a deduction from petitioner's gross income for the calendar year 1923, the entire amount of $191,401.42 claimed as a loss on the disposition of petitioner's shares of stock of Pond Creek. In said notice of deficiency the Commissioner has determined that to the extent of the cost to petitioner of its shares of Pond Creek, to wit, $457,818, the entire amount of the distributions received by petitioner from Pond Creek on March 1, 1923, and May 9, 1923, to wit, $473,400, represented payment for said shares, and that the excess, to wit, $15,582, of the amount of said distributions over the cost*2299 to petitioner of said shares constituted ordinary dividend income to the petitioner. (13) The Commissioner's said notice of deficiency shows petitioner's taxable net income for the calendar year 1923 to be $1,246,172.25, and computes the tax and deficiency as follows: Computation of taxNet income$1,246,172.25Less: ExemptionNone.Subject to tax at 12 1/2%1,246,172.25Tax at 12 1/2%155,771.53Tax previously assessed131,663.54Deficiency24,107.99(14) If, as a matter of law, petitioner is entitled to the deduction of $191,401.42 claimed by it as a loss on the disposition of its 10,520 shares of stock of Pond Creek, petitioner's true net income for the calendar year 1923 was $1,054,769.83, and the correct amount of its deficiency in income tax for said year is $182.69, computed as follows: *957 Net income$ 1,054,769.83Less: ExemptionNone.Subject to tax at 12 1/2%1,054,769.83Tax at 12 1/2%131,846.23Tax previously assessed131,663.54Deficiency182.69(15) The notice of deficiency against which this appeal is taken was mailed to the petitioner on November 30, 1926, and this proceeding was duly commenced*2300 by the filing, on January 27, 1927, of a petition for a redetermination of the deficiency found by the Commissioner. With the check for the dividend of $35 declared on February 15, 1923, a slip of paper was enclosed, on which the following appeared above the name of the treasurer of Pond Creek Coal Co.: On February 15, 1923, the directors of the Pond Creek Coal Comapny declared a dividend of thirty-five dollars per share upon the capital stock, payable March 1, 1923, to stockholders of record February 23, 1923. The exact proportion of this dividend that is paid out of earned surplus can not be determined until the final settlement of all the accounts and debts of the company. Stockholders will be notified relative thereto hereafter. Under date of March 22, 1923, the treasurer of the Pond Creek Coal Co. addressed a statement to the stockholders in which the following appears: The Directors of the Pond Creek Coal Company have declared a final dividend, in liquidation, of $10.00 per share, payable on or after April 2, 1923, at The First National Bank of Boston and The Chase National Bank of New York, upon surrender of the outstanding stock certificates representing the said*2301 shares. Under date of May 15, 1923, the treasurer of the Pond Creek Coal Co. addressed a statement to the stockholders which was as follows: According to our interpretation of the provisions of the United States Income Tax Law effecting distributions in liquidation, the dividend of $35.00 per share paid March 1, 1923, represented: Per shareDividend from Earnings Accumulated since March 1, 1913$19.675230Payment in Partial Liquidation of Capital15.324770Total payment35.000000and dividend of $10.00 per share payable on or after April 2, 1923, represented final payment in liquidation of Capital. OPINION. MURDOCK: The petitioner maintains that a distribution received by it in the amount of $368,200 on March 1, 1923, under the resolution of February 15, 1923, declaring a dividend of which its share was that amount, was an ordinary dividend to the extent of $206,983.42, *958 the amount of earnings of the Pond Creek Coal Co. accumulated since February 28, 1913, included in such distribution; that the balance of such distribution, amounting to $161,216.58, representing a distribution of paid-in surplus, should be applied against and reduce*2302 the cost of the stock to the petitioner; and that the distribution to the petitioner of $105,200 on May 9, 1923, in liquidation of the Pond Creek Coal Co., resulted in a loss of $191,401.42, this being the amount by which the cost of the stock, $457,818, exceeded the sum of the above mentioned $161,216.58, and the above mentioned $105,200. Counsel for the respondent made no oral argument and filed no brief, so the only justification for the Commissioner's action we find in the explanation of the deficiency notice, which was in part as follows: Article 1545, Regulations 62 provides that "where a corporation distributes all its property in complete liquidation or dissolution, the gain realized by the stockholder from this transaction, computed under section 202, is taxable as a dividend to the extent that it is paid out of earnings or profits of the corporation accumulated since February 28, 1913." Accordingly the difference between the $473,400.00 received in liquidation and the cost of the stock $457,818.00 or $15,582.00 is held to be profit taxable as dividends. Following the principles laid down in our previous decisions, our judgment in this case must be for the petitioner, *2303 regardless of whether the portion of the dividend in question was an ordinary dividend or a distribution in liquidation. ; ; ; ; . Cf. ; . Judgment will be entered for the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623084/ | HARRY J. BROWN, RALPH SKIDMORE AND C. W. SKOWLUND, AS EXECUTORS OF THE WILL OF MAGGIE HODGINS, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brown v. CommissionerDocket No. 91233.United States Board of Tax Appeals38 B.T.A. 298; 1938 BTA LEXIS 884; August 10, 1938, Promulgated *884 One Isaac Stephenson created a trust in 1917, by the terms of which petitioners' decedent was entitled to the income from a part of the trust estate and ultimately to the principal of that part. She was also given a power of appointment as to her interests in the trust estate. The trust instrument provided that under certain circumstances, similar to those recited in "spendthrift" trusts, the trustees might make the payments due under the trust not to the beneficiaries directly, but for their benefit. Petitioners' decedent died in 1935, having, by will exercised her power of appointment. Held, on authority of J. Earl Morgan, Executor,36 B.T.A. 588">36 B.T.A. 588, the power of appointment exercised by petitioners' decedent was general, and the value of property passing pursuant to the power was properly included by respondent in the value of decedent's gross estate. Perry J. Stearns, Esq., for the petitioners. R. F. Staubly, Esq., for the respondent. KERN *298 This proceeding involves a deficiency in Federal estate taxes determined by respondent in the matter of the estate of Maggie Hodgins, deceased, in the sum of $41,524.51, arising*885 by reason of the inclusion by respondent, in the value of decedent's estate subject to such tax, of the value of certain property passing pursuant to a power of appointment exercised by decedent by will. FINDINGS OF FACT. The parties have filed a stipulation of facts, which we incorporate herin by reference. Those facts which are material to an understanding of the issues may be summarized as follows: The decedent, Maggie Hodgins, was a daughter of the late Isaac Stephenson of Marinette, Wisconsin. At the time of her death she resided at Marinette, and her will was admitted to probate May 7, 1935. Her estate is being administered in the County Court of Marinette County. By deed of trust dated May 12, 1917, Isaac Stephenson transferred certain property listed therein to five trustees, and named the trust the "Isaac Stephenson Trust." He required the trustees to divide the trust property into eight numbered parts, and provided as to part 2 that the trustees should pay annually to his daughter Maggie Hodgins the net income from that part, and if she should be living at the time of the termination of the trust, should transfer to her all the property then constituting said*886 part 2. *299 The trust further provided that, if Maggie Hodgins should die prior to the termination of the trust, the trustees should pay the net annual income from part 2 to such person or persons as she might appoint by will, and, at the termination of the trust, should transfer the property then constituting part 2 to such person or persons as she might appoint by will. The pertinent provisions of the trust instrument are as follows: * * * 10. After my death and during the continuance of the trust hereby created, said trustees shall pay annually to my daughter MAGGIE HODGINS the net annual income from said part numbered two (2): If my daughter Maggie Hodgins shall be living at the time of the termination of this trust, said Trustees shall transfer to her all property then in their possession constituting said part two (2). If my daughter Maggie Hodgins should did prior to the termination of said trust, then said Trustees shall pay annually the net annual income from said part two (2) to such person or persons as she may appoint by her last will and testament duly admitted to probate, and at the termination of this trust said Trustees shall transfer the property*887 then in their possession constituting said part two (2) to such person or persons as she may appoint in the manner aforesaid. * * * The term of the trust was limited by the lives of the creator, Isaac Stephenson, and his wife, Martha E. Stephenson, and twenty-one years thereafter. The trust indenture provides at item 15: * * * 15. Whenever, in the judgment of said Trustees, there shall be danger that any portion or portions of the trust property coming to any beneficiary under this trust, whether income or corpus, as hereinbefore provided, will be dissipated or improvidently handled through intemperate or spendthrift habits, lack of business capacity, or subjection to the injurious influences of others affecting business capacity, or for any other reason or reasons, said Trustees shall withhold, if they deem it best, from every such beneficiary the whole or any and each portion of the trust property, whether of income or corpus, coming to such beneficiary as unworthy to receive the same, and said Trustee shall pay and transfer to every such beneficiary only so much of said trust property, whether of income or corpus, otherwise coming to such beneficiary, as said Trustees*888 shall deem advisable. Said Trustees shall, if they deem it best, instead of paying and transferring to any such beneficiary or beneficiaries any portion of said trust property, whether of income or corpus, expend the same, or any portion thereof, for the welfare and support of such unworthy beneficiary or beneficiaries. Whatever shall have been once withheld, as above provided, from any such unworthy beneficiary under this trust and shall not have been expended by such Trustees for the benefit and support of such unworthy beneficiary, shall be paid and transferred by said Trustees to such of his or her issue as would have taken the property so withheld, both income and corpus, in case such unworthy beneficiary had died intestate at the time of such withholding; and in the event of there being no such issue at the time any such trust property *300 shall be payable or transferable, then said Trustees shall pay and transfer and distribute such property so withheld to and among the then other existing remaining parts. Whenever, and while in the judgment of said Trustees the reason or reasons for withholding the portion or portions thereof of any beneficiary, as above provided, *889 shall have ceased to exist, then during such cessation said Trustees may pay and transfer to such beneficiary any portion or portions of said Trust property, whether income or corpus, that shall thereafter be coming to such beneficiary under any of the provisions of this trust, or said Trustees shall expend the same for the benefit or support of such beneficiary. Maggie Hodgins, by her will, appointed her cousin Bertha M. Baker of Marinette, Wisconsin, to receive $100 per month during her lifetime out of the net annual income which might become payable from said part 2, and any additions thereto, of the trust created by the trust deed. She appointed her niece Alice W. Keerl, daughter of a sister of her late husband, Joshua Hodgins, if she should survive her, to receive the sum of $25 per month so long as she might be unmarried, out of the net annual income which might become payable from part 2 and any additions thereto; and she appointed her sisters Mary S. Brown, Georgiana S. Ludington, and Harriet S. Skidmore to receive and have in equal shares after her death the remainder of the net annual income which might become payable to her appointed her three sisters last named to receive*890 and She further appointed her three sisters last named to receive and have all the property in the possession of the trustees of said trust at the termination thereof constituting part 2 and any additions thereto. Such appointment further provided that if any of her said sisters should not survive her, or, surviving her, should not survive the termination of the trust, then she appointed Howard S. George, Isaac Watson Stephenson, Mary Stephenson Whitehill, and Jane Stephenson Skidmore, nephews and nieces, respectively, of the decedent, to receive and have, in equal shares, after the death of any of said sisters the share of net income from part 2 which any such deceased sister would have received if living, and at the termination of the trust to receive and have absolutely the share of the principal of part 2 of the trust which any such deceased sister would have received had she survived the termination of the trust; provided, that if any one of the four persons last named should die before the termination of the trust, leaving issue him or her surviving, then she appointed such issue to receive the same share, by right of representation, both of income and principal of the trust, *891 which the parent of such issue would have received if living. The will of Maggie Hodgins was admitted to probate by the County Court of Marinette County on the 7th day of May 1935, and petitioners were appointed executors of the will. *301 OPINION. KERN: The principal question presented in this proceeding is whether the power of appointment which was received by petitioners' decedent under the trust created by Isaac Stephenson in 1917 and was exercised by her in her will, was a general power of appointment within the meaning of section 302(f) of the Revenue Act of 1926, set out in the margin. 1 This question was considered in the case of J. Earl Morgan, Executor,36 B.T.A. 588">36 B.T.A. 588, which involved a similar power of appointment arising under the same trust. Upon the authority of that decision, we hold that the power of appointment exercised by petitioners' decedent was a general power. The opinion in the case cited did not discuss the effect upon the character of the power of appointment of the "spendthrift" provisions contained in paragraph 15 of the trust instrument executed by Isaac Stephenson in 1917, which are set out above. These provisions do*892 not make the power of appointment special rather than general. By the terms of the trust instrument, they apply only to the portions of the trust property going to any beneficiaries under the trust, which might well be construed as meaning those beneficiaries expressly named therein. However, assuming that these provisions might apply to payments made to persons not expressly named as beneficiaries under the trust, but who were merely those designated by the beneficiaries pursuant to the power of appointment of which they were donees, we are still of the opinion that they do not render special a power of appointment otherwise general, since they are concerned only with the method of payment of income and principal, and do not withdraw or alter in substance the beneficial enjoyment of the income or principal by the person or persons designated pursuant to the power of appointment. *893 Also, there is nothing in the record to indicate that these "spendthrift" provisions were ever availed of by the trustees with reference to any payments to petitioners' decedent or her appointee. Petitioners contend further that, since the Isaac Stephenson trust took effect by trust indenture dated May 12, 1917, before the Revenue Act of 1926 was enacted, no part of this trust estate should be included in decedent's gross estate in computing the estate tax thereon. They also contend that, should a part of such trust estate be thus included in decedent's gross estate pursuant to section 302(f) of the *302 Revenue Act of 1926, this section would be contrary to the Fifth Amendment to the Constitution of the United States. Both of these arguments seem to be predicated on a contention that the person taking property pursuant to the exercise of a power of appointment by a donee of such power takes such property as from the donor of the power rather than from the donee. The only case cited by petitioner which is relevant to this contention is *894 United States v. Field,255 U.S. 257">255 U.S. 257. That case arose under the Revenue Act of 1916, which did not have any section therein similar to section 302(f) of the Revenue Act of 1926. The Court, in that case, indicated clearly that if there had been a section in the Revenue Act of 1916 which specifically provided, as section 302(f) of the Act of 1926 does, that property passing under a general power of appointment exercised by the decedent should be included in decedent's estate for Federal estate tax purposes, such a tax would be upheld. This inference may be justifiably made by reason of the fact that the Court, in holding in that case that property passing under a general power of appointment exercised by a decedent should not be included in decedent's estate, gave as one of the reasons for the decision the failure of the Revenue Act of 1916 to specifically provide for such inclusion, whereas the Revenue Act of 1918 did provide for its inclusion. This case and the case of Helvering v. Grinnell,294 U.S. 153">294 U.S. 153, in which the Court assumed the validity of this section in holding that it did not apply to the facts of the case, would indicate that, *895 where the appointee under a general power of appointment takes property pursuant to the exercise of such power by the donee thereof by will, the value of the property thus taken is includable in the estate of the donee for estate tax purposes, pursuant to the provisions of section 302(f), regardless of the fact that the power was created by the donor thereof prior to the enactment of this section of the act, since the property was transmitted to the appointee by the donee by the exercise of the power of appointment, and such transmission is subject to the Federal estate tax. Stratton v. United States, 50 Fed.(2d) 48, decided by the Circuit Court of Appeals for the First Circuit some four years prior to the decision of Helvering v. Grinnel, supra, is squarely in point. In that case the court used the following language: The appellants' contention that, under the law of Massachusetts, the property passing under the decedent's exercised powers of appointment was no part of her estate, and therefore, not taxable, while possibly logically sound, is not practically tenable. Compare *896 United States v. Field,255 U.S. 257">255 U.S. 257, 41 S. Ct. 256">41 S.Ct. 256, 65 L. Ed. 617">65 L.Ed. 617, 18 A.L.R. 1461">18 A.L.R. 1461. The federal power to tax is not thus limited. The decedent had, to repeat, not only the income during her life, but full power to dispose of it at her death. She actually transmitted the property by exercising the granted powers. Congress might tax such transmission. Tyler v. United States,281 U.S. 497">281 U.S. 497, 50 S. Ct. 356">50 S.Ct. 356, 74 L. Ed. 991">74 L.Ed. 991, 69 A.L.R. *303 758. The fact that the decedent's appointees took, technically, from the donor of her power, is, for present purposes, immaterial. Compare Third Nat. Bank & Trust Co. v. White (D.C.) 45 F.(2d) 911. See Fidelity Philadelphia Trust Co. v. McCaughn, 34 Fed.(2d) 600; James C. Webster et al., Executors,38 B.T.A. 273">38 B.T.A. 273; Edward J. Hancy, Executor,17 B.T.A. 464">17 B.T.A. 464; cf. Saltonstall v. Saltonstall,276 U.S. 260">276 U.S. 260. Decision will be entered for the respondent.Footnotes1. 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 - * * * (f) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will, or (2) by deed executed in contemplation of, or intended to take effect in possession or enjoyment at or after, his death, except in case of a bona fide sale for an adequate and full consideration in money or money's worth. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623085/ | APPEAL OF EDMUND J. KARR.Karr v. CommissionerDocket No. 1525.United States Board of Tax Appeals2 B.T.A. 635; 1925 BTA LEXIS 2321; September 28, 1925, Decided Submitted May 4, 1925. *2321 The taxpayer was a stockholder in a corporation which claimed personal service classification for the years 1919 and 1920. This was first denied by the Commissioner and subsequently allowed and the deficiency asserted against the taxpayer on account of his distributive share of the profits and on account of salary accrued to him but not drawn. Held, that the corporation was not a personal service corporation and that the taxpayer was not in receipt of income in the years in question in excess of the actual salary withdrawals. Robert A. Littleton, Esq., for the Commissioner. JAMES*635 Before JAMES, LITTLETON, SMITH, and TRUSSELL. This is an appeal from the determination of deficiencies in income tax for the years 1919 and 1920 of $1,006.87, and an overassessment for the year 1921 of $79.20, being a net deficiency for the three years of $927.67. FINDINGS OF FACT. The taxpayer during the years 1919 and 1920 was a stockholder of a corporation known as Karr, Ellis & Co., Inc., doing business at 5 Beekman Street, New York City. For the years in question the said corporation filed returns as, and claimed to be, a personal service corporation, *2322 which claim was, up to and including August 30, 1923, denied by the Commissioner. On January 23, 1924, the Commissioner determined that the corporation Karr, Ellis & Co., Inc., was a personal service corporation and its income taxable in distributive shares to its stockholders. For the year 1919 the taxpayer received and reported a salary from Karr, Ellis & Co., Inc., in the sum of $5,000, Karr, Ellis & Co., Inc., crediting to the taxpayer a salary of $10,000 and claiming and being allowed the same as a deduction in determining its net income. In addition, for the year 1919, subsequent to the filing of the returns of the corporation for that year, the Commissioner determined that the taxpayer's distributive share of the profits of the said company, taxable to him, amounted to $6,669.72. *636 For the year 1920 the taxpayer received and returned as income on account of salary from Karr, Ellis & Co., Inc., $11,000, but the said corporation claimed as a deduction, on account of salary credited to the taxpayer, the sum of $12,000, and the Commissioner further determined that the taxpayer's distributive share of profits of the company for the year 1920 amounted to $2,694.26. *2323 The taxpayer severed his relations with Karr, Ellis & Co., Inc., on the 15th day of October, 1922, and drew no further salary from the said corporation, either on or about that time, nor at any time did he receive the sums claimed by the Commissioner to have been his share of the distributive income of the said corporation, nor any other sums equivalent thereto, nor amounts credited to him as salary on the books of the corporation, but not then actually received by him. The taxpayer kept his accounts and made his returns upon the basis of cash receipts and disbursements. The corporation Karr, Ellis & Co., Inc., was ordained in 1917 by the taxpayer, one Ellis, and one D'Alton, who were actively engaged in the conduct of its affairs, and Delos Cook and William Boyd. Cook and Boyd furnished all the cash capital - some $25,000 - in connection with the financing of the company and were not at any time active in the conduct of its affairs, the stock which they owned in the corporation not even appearing in their own names. The corporation carried on the business of freight forwarding or freight brokerage in connection with Atlantic Shipping. The taxpayer, Ellis and D'Alton*2324 were men experienced in this line, the taxpayer during the war having been associated with the British Ministry of Shipping. Cook and Boyd were associated with steamship companies and did not wish their connection with the corporation, Karr, Ellis & Co., Inc., to be known. The business of Karr, Ellis & Co., Inc., consisted in procuring such freights for clients, and in this connection the corporation itself chartered the space, paid the freight charges, and charged its clients upon its own books for the freights so advance as well as for its own fees in connection therewith. The entire amount of deficiency involved in this appeal arises out of the Commissioner's action in attributing to the taxpayer income (1) on account of salary credited and not drawn, and (2) on account of the distributive shares of the profits of the corporation. DECISION. The deficiency determined by the Commissioner is disallowed. OPINION. JAMES: The Commissioner alleges that the taxpayer was in constructive receipt of income on account of salaries credited to him *637 but not drawn. In this connection we have repeatedly held the contrary view. *2325 ; ; ; ; ; . It is also clear from the foregoing findings of fact that, notwithstanding the decision of the Commissioner in respect of the corporation, Karr, Ellis & Co., Inc., holding that that corporation was a personal service corporation, that corporation was not a personal service corporation in that it lacked two of the essential elements of such a corporation, viz, (1) that its principal stockholders should be actively engaged in the conduct of its affairs, and (2) that capital should not be a material income-producing factor. It appears here that the only stockholders investing any money in the corporation were not actively engaged in the conduct of its affairs, and from the method of doing business it is very clear that capital was a material income-producing factor in the business. In view of the foregoing the deficiency determined by the Commissioner must be disallowed. ARUNDELL not*2326 participating. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623087/ | Webb Export Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentWebb Export Corp. v. CommissionerDocket No. 5406-85United States Tax Court91 T.C. 131; 1988 U.S. Tax Ct. LEXIS 99; 91 T.C. No. 14; July 26, 1988; As amended August 17, 1988 July 26, 1988, Filed *99 Decision will be entered under Rule 155. P is an exporter of veneer, lumber, and veneer-quality logs. It was organized by its parent to be a DISC and made an election to be a DISC. P bought standing timber, had a normal size logging crew fell the trees, clean the branches off as necessary, and cut the trees into veneer logs. Held, P's harvesting activities were both substantial in nature and generally considered to constitute production of property and, thus, constituted "production" within the meaning of sec. 1.993-3(c)(2), Income Tax Regs.Held, further, the veneer logs produced by P and the assets used in their production do not qualify as "export property" within the meaning of sec. 993(c)(1), I.R.C. 1954. Held, further, P's standing timber does not constitute an export asset. Held, further, P's qualified export receipts for 1978 did not equal or exceed 95 percent of its gross receipts for that year. Sec. 992(a)(1)(A), I.R.C. 1954. Held, further, the adjusted bases of P's qualified export assets do not equal or exceed 95 percent of the adjusted bases of all of its assets for any of the years 1977, 1978, and 1979. Sec. 992(a)(1)(B), I.R.C. 1954. *100 Aydin S. Caginalp and Gregory F. Hauser, for the petitioner.Cynthia J. Mattson and Charles A. Ray, for the respondent. Scott, Judge. SCOTT *131 Respondent determined deficiencies in petitioner's income tax for the years and in the amounts as follows: *132 YearDeficiency1977$ 337,324 1978606,693 1979588,884 Some of the issues raised by the pleadings have been disposed of by agreement of the parties, leaving for decision whether the timber harvesting activities of Webb Export Corp. during the years 1977, 1978, and 1979 were such as to cause it to fail to qualify as a Domestic International Sales Corporation (DISC) for the years 1977, 1978, and 1979.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Webb Export Corp. (Webb Export or petitioner) was incorporated under the laws of the State of Delaware on February 8, 1974. Since its inception, all its stock (one class, par value $ 2,500) has been owned by David R. Webb Co., Inc. (David Webb). At the time of the filing of the petition in this case, petitioner's principal office was located in Edinburgh, Indiana, at David Webb's principal office.For*101 the years ending December 31, 1977, December 31, 1978, and December 31, 1979, petitioner, an accrual basis taxpayer, filed Domestic International Sales Corporation returns Forms 1120-DISC.Petitioner reported its taxable income, and deemed distribution to David Webb, as follows:197719781979Taxable income$ 733,737$ 1,247,156$ 1,280,183Deemed distribution429,222694,863718,439David Webb filed corporate income tax returns, Forms 1120, for the years ending December 31, 1977, 1978, and 1979, and included in income the deemed distributions from petitioner.Petitioner, being incorporated under the laws of Delaware, met the requirement of section 1.992-1(a)(1), Income Tax Regs.Petitioner met the capitalization requirements of section 992(a)(1)(C)1 and sections 1.992-1(a)(4) and 1.992-1(d), Income *133 Tax Regs.; had in effect an election pursuant to section 992(b) to be treated as a DISC in accordance with sections 1.992-1(a)(5) and 1.992-1(e), Income Tax Regs.; maintained its bank account on each day of the taxable year in accordance with sections 1.992-1(a)(6) and 1.992-1(i), Income Tax Regs.; and maintained separate books and records in accordance*102 with section 1.992-1(a)(7), Income Tax Regs.In accordance with section 1.992-1(a)(8), Income Tax Regs., petitioner did not constitute a type of corporation described in section 1.992-1(f), Income Tax Regs. In accordance with section 993(c)(1)(A), petitioner did not extract or grow in the U.S. property that it sold as a DISC. Petitioner did purchase 40 acres of real estate on October 11, 1976, at a price of $ 45,000, some of the standing timber from which was sold at a price of $ 17,025.18 in 1976; the real property was sold in 1979 at a price of $ 38,939.82.In accordance with section 993(c)(1)(B), petitioner was engaged primarily in the sale, in the ordinary course of trade or business, of property for direct use, consumption, or disposition outside the United States. In accordance with section 993(c)(1)(C), not more than*103 50 percent of the fair market value of the property exported by petitioner was attributable to articles imported into the United States. The property sold by petitioner was not sold to another DISC.Petitioner was engaged in sales to foreign customers of two principal items. One was veneer manufactured by David Webb and the other veneer-quality cut logs. The cut logs were either purchased as cut logs from third parties, or petitioner purchased standing timber that it cut, delimbed, bucked, and skidded itself for export as cut logs. On occasion, the grantor from whom petitioner acquired the standing timber was responsible for performing these activities.Petitioner began purchasing standing timber for export as cut logs in late 1976. Petitioner commenced this activity because the quality and quantity demands placed on petitioner by its European customers required it to obtain a large number of cut logs of uniform consistency. The consistency of logs was necessary in order to match large numbers of pieces on the basis of wood grain. Also, the cost to petitioner of logs it cut from standing timber, including *134 the timber costs and related costs, was less than the purchase*104 price of cut logs. By using its experienced buyers, petitioner successfully bore the risk of purchasing standing timber, the potential defects of which were not as easily detectable as were defects in cut and trimmed logs.During the years 1977, 1978, and 1979, the standing timber purchased by petitioner principally consisted of veneer-quality walnut, red oak, and white oak. The average age of each species was in the following range:SpeciesAgeWalnut60-120 YearsWhite Oak80-200 YearsRed Oak50- 90 YearsPetitioner did not plant or cultivate hardwoods.In 1977, 1978, and 1979, petitioner employed several buyers of standing timber and cut logs. In early 1978, Kenneth Hunter (Mr. Hunter) became one of the principal standing-timber buyers for petitioner.Petitioner had a logging crew that engaged in harvesting activities during the period from September through May of the years involved. The crew consisted of two to four men in the woods, and two men in petitioner's log yard, all of whose jobs were interchangeable. The logging crew was responsible for felling (cutting of timber); delimbing (removal of branches); bucking (cutting into logs of certain required lengths); *105 skidding (moving the logs from the felling point to a roadway); loading (loading the logs onto trucks); and hauling (transporting the logs to petitioner's log yard).In addition to chain saws used for felling, delimbing, and bucking, the cutting equipment used by petitioner's crews consisted of skidders and a crawler/loader. The skidders were moved between sites by either their being hauled with a low boy, or being driven if the distance was short.Once in the log yard, the cut logs (whether acquired as cut logs or derived from standing timber) were moved, cataloged, and then shipped.For a majority of the standing-timber parcels, petitioner used its own logging crew. If two men were at the site, the two men did the felling, delimbing, bucking, loading, and hauling. The time period for these activities could be expedited with four men at the site: one to operate a chain *135 saw for felling and delimbing; one to buck with a chain saw; one to operate the skidding equipment; and one to operate the loader.The season for cutting veneer-quality logs for export was from late September to the first of May. In order to preserve the logs, the timber had to be cut after the foliage*106 was off and the sap down, but before the sap began to run in the spring. The higher sap content caused deterioration of the logs. The logs had to arrive in Europe by June 1 to prevent their deterioration.It was harder to cut, delimb, buck, and skid standing timber during the winter months because of wet ground and inclement weather. The logging crew worked 5 days a week, weather permitting. Approximately one-quarter of the season was lost to bad weather, but sometimes the crew worked weekends to make deadlines. To cut, delimb, buck, skid, haul, and load 100 large trees would take a crew of four men in the woods between 2 and 5 days, depending on the conditions. Often, care had to be taken not to damage the surrounding property.Petitioner was interested in the veneer-quality, "butt" log, the first 12 to 16 feet of tree above the stump, of the standing timber which resulted from the bucking process. Firewood was usually left behind by the crew, but other portions of the tree were sometimes sold to third parties in de minimis amounts. Since the crew was working with valuable hardwood, improper felling and bucking could be costly.Decisions as to the movement of the crew from*107 one site to the next were ultimately subject to approval by John Grunwald (Mr. Grunwald).When petitioner purchased cut logs from third parties, it purchased the logs either: (1) f.o.b. Edinburgh, Indiana, in which case the transportation cost was borne by the seller; or (2) f.o.b. truck, in which case petitioner transported the logs within the vicinity of Edinburgh, or contracted with a third party for longer distance hauling.The average costs to petitioner for the various jobs associated with cutting its standing timber into logs constituted a small portion of the purchase price of the standing timber because the standing timber purchased was *136 valuable, veneer-quality hardwood. The following were representative costs:Felling$ 10/1,000 Board ft. (1"x12"x12")Skidding20/1,000 Board ft.Bucking5/1,000 Board ft.Loading5-10/1,000 Board ft.Hauling20-40/1,000 Board ft.Due to its high quality, the purchase price of the standing timber that petitioner sold as cut logs was in the range of $ 500 to $ 2,000 per 1,000 board ft.As previously noted, in late 1976, petitioner purchased land containing standing timber in order to remove the standing timber thereon because*108 the owner would not sell the standing timber without selling the land. The timber was cut and sold in late 1976. Petitioner cleaned up the property for resale, required as a result of the timber removal, and sold the land in 1979.Petitioner's purchases of cut logs and standing timber for 1977, 1978, and 1979 were as follows:197719781979Cut logs$ 2,564,075$ 4,421,315$ 6,468,066Standing timber442,083925,239563,368Total3,006,1585,346,5547,031,434Petitioner's inventories as of the end of 1977, 1978, and 1979, comprised of cut logs, standing timber, and a farm purchased for standing timber, were as follows:197719781979Cut logs$ 22,128$ 54,470$ 266,722Standing timber294,245379,061621,387Farm38,94038,940Total355,313472,471888,109Petitioner's total gross receipts for 1977, 1978, and 1979, and gross receipts pertaining to standing timber, were as follows:Gross receipts197719781979Pertaining to standing timber$ 205,749$ 1,257,949$ 305,988Total12,745,64520,553,41722,241,535Percent pertaining tostanding timber1.61% 6.12% 1.38% The total adjusted bases of petitioner's*109 assets as of the end of 1977, 1978, and 1979 were as follows: *137 197719781979InventoryStanding timber *$ 294,245 $ 379,061 $ 621,387 Farm *38,940 38,940 Logs22,128 54,470 266,722 Depreciable assetsCutting equipment *86,270 94,874 94,874 Other159,675 156,615 156,615 Accumulated depreciationCutting equipment *(2,621)(20,319)(21,347)Other(7,897)(44,802)(102,858)Prepaid interest19,150 15,134 10,089 Producer's loans565,793 1,118,086 1,679,830 Trade receivablesStanding timber *6,256 177,746 51,593 Veneer and logs382,698 2,726,603 3,687,006 Working capital60,444 (114,422)Receivables/deposit36,984 23,614 Total1,564,637 4,793,836 6,353,103 In the statutory notice of deficiency respondent determined that petitioner did not qualify as a DISC for the years in issue, 1977, 1978, and*110 1979, because --[Petitioner's] qualified receipts for the years ended December 31, 1977 2 and December 31, 1978 were less than 95% of [petitioner's] gross receipts for those years and because the adjusted basis of [petitioner's] qualified export assets were less than 95% of the sum of the adjusted basis of all [petitioner's] assets at December 31, 1977, December 31, 1978 and December 31, 1979. [Petitioner is] therefore a taxable entity during [its] taxable years ended December 31, 1977, December 31, 1978 and December 31, 1979. 3*111 *138 OPINIONIn order to qualify as a DISC, for any taxable year, a corporation must, inter alia, derive 95 percent or more of its gross receipts from qualified export receipts and the adjusted bases of the corporation's qualified export assets at the close of the taxable year must equal or exceed 95 percent of the total adjusted bases of all assets of the corporation at that time. Secs. 992(a)(1)(A) and 992(a)(1)(B). Insofar as pertinent to this case, qualified export receipts are defined as "gross receipts from the sale, exchange, or other disposition of export property." Sec. 993(a)(1)(A). Qualified export assets include export property and assets used primarily in connection with the sale, lease, rental, storage, handling, transportation, etc., of export property. Sec. 993(b)(1) and (b)(2).Subject to certain exclusions, "export property" is defined generally by section 993(c) as property --(A) manufactured, produced, grown, or extracted in the United States by a person other than a DISC,(B) held primarily for sale, lease, or rental, in the ordinary course of trade or business, by, or to, a DISC, for direct use, consumption, or disposition outside the United States, *112 and(C) not more than 50 percent of the fair market value of which is attributable to articles imported into the United States.Respondent contends petitioner's harvesting of standing timber constitutes the "production" of property so that the resulting veneer logs do not constitute "export property" and the assets used in connection with harvesting the logs do not constitute qualified export assets. If respondent is correct, petitioner cannot satisfy either the qualified export receipts test for taxable year 1978 or the qualified export assets test for taxable years 1977 or 1978 and cannot satisfy the qualified export assets test for 1979 if we conclude that petitioner is incorrect in its contention that in any event the standing timber is a qualified export asset. Resolution of the issue as to whether petitioner's timber harvesting constitutes "production" turns upon our interpretation of section 1.993-3(c)(2), Income Tax Regs., 4 dealing *139 with the manufacture or production of property.*113 Respondent does not argue that petitioner's activities constituted the manufacture of property. Consequently, our inquiry is confined to the question of whether those harvesting activities constituted "production" within the meaning of this regulation.To be considered "production" under the regulation, the property in question must have been "substantially transformed" by petitioner ( sec. 1.993-3(c)(2)(ii), Income Tax Regs.), or the harvesting activities performed by petitioner in connection with the standing timber must have been "substantial in nature" and "generally considered to constitute the * * * production of property." Sec. 1.993-3(a)(2)(iii), Income Tax Regs.Petitioner contends that its logging activities do not constitute the substantial transformation of property and that those activities are neither substantial in nature nor generally considered the manufacture or production of property. Petitioner further argues that the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, established standing timber as export property and therefore a qualified export asset. On this theory, petitioner contends that the adjusted bases of 95 percent or more of its assets do consist*114 of qualified export assets so that it satisfies the qualified export asset test for each of the years in issue. 5*140 Substantial in Nature and Generally Considered To Constitute ProductionPetitioner argues that its logging activities were neither substantial in nature nor generally considered the manufacture or production of property within the meaning of section 1.993-3(c)(2)(iii), Income Tax Regs.A. Substantial in NatureIt is petitioner's position that the activities were not substantial because the unrefuted expert testimony established that the hardwood products industry does not generally consider logging to be production and that petitioner's activities were a limited, rudimentary, small-scale*115 operation. Petitioner cites Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C. 338">59 T.C. 338 (1972) (Dave Fischbein), to support its position contending that here its activities unlike those in Dave Fischbein v. Commissioner, supra, were not substantial.Respondent contends the activities of petitioner were substantial in nature and that petitioner's quantitative argument is in direct conflict with the testimony and the facts, which show that petitioner's activities cannot be characterized as insignificant or insubstantial. Respondent argues that petitioner ignores the Court's interpretation of "substantial in nature" in Dave Fischbein v. Commissioner, supra.Section 1.954-3(a)(4), Income Tax Regs., dealing with manufacture or production by a controlled foreign corporation, which was discussed in Dave Fischbein v. Commissioner, supra, unlike regulations section 1.993-3(c)(2)(ii), gives examples of "substantial in nature." Petitioner contends the facts herein are so distinguishable from those in Dave Fischbein v. Commissioner, supra,*116 that the Court should conclude it did not "produce" the logs from the standing timber.Dave Fischbein v. Commissioner, supra, on which both parties rely, involved a different issue from the issue involved in the instant case. One of the issues in that case was whether Dave Fischbein Manufacturing Co. (DFM) was required to include in its income certain income earned by its foreign subsidiary, Compagnie Fischbein, S.A. (CFSA), on *141 the basis that it constituted "subpart F" income as defined in section 954(d)(1) as "foreign base company sales income." CFSA purchased component parts for its "product," a bag-closing machine (most of the major components), from DFM and from unrelated third parties in Europe (standard parts). Among CFSA's reasons for purchasing parts in this way were: (1) To obtain Belgian certificates of origin, for European Common Market considerations, which required that the machines be of Belgian origin; and (2) to lower labor and overhead costs by completing the assembly of the machines in Europe rather than in the United States. That assembly required 58 steps taking some 6 hours. Within the completed machine, certain components*117 such as the housing and handle remained recognizable.Under the statutory scheme, foreign base company sales income did not include income with respect to personal property, produced in the country under the laws of which the controlled corporation is created or organized, which is sold for use outside the country. See also sec. 1.954-3(a)(2), Income Tax Regs. DFM contended, and the Commissioner disagreed, that the machines were produced in Belgium so that the resultant income was not includable in its income.Under section 1.954-3(a)(4)(i), Income Tax Regs., a foreign corporation was considered to have manufactured, produced, or constructed personal property if what it sold was in effect not what it purchased. In that context, property would be considered to have been manufactured, produced, or constructed if section 1.954-3(a)(4)(ii) or section 1.954-3(a)(4)(iii), 6 Income Tax Regs., was satisfied.*118 *142 Section 1.954-3(a)(4)(ii), Income Tax Regs., treats property as having been manufactured, produced, or constructed if it was substantially transformed prior to sale and contains in somewhat expanded form the substantial transformation examples found in section 1.993-3(c)(2)(ii), Income Tax Regs.In Dave Fischbein v. Commissioner, supra, we found that the income with respect to the sale of the machines by CFSA was not, under the facts therein, foreign base company sales income includable by DFM. In reaching this conclusion we rejected respondent's contention that petitioner's operations required merely the assembly of nearly perfect components, over a short time period, by unskilled personnel. We found the facts to be otherwise, specifically that the parts often required tailoring and testing to complete assembly and that the personnel were trained and experienced, employing both skill and judgment in the performance of their duties.*143 Applying the regulations described above, we concluded there was no "substantial transformation" similar to the examples within section 1.954-3(a)(4)(ii), Income Tax Regs., because the resultant product*119 was not sufficiently distinguishable from its component parts. However, we found the activities of CFSA to be the manufacture of a product within section 1.954-3(a)(4)(iii), Income Tax Regs., because they were both substantial in nature and generally considered to constitute manufacture of a product similar to the automobile assembly operation in example (2) of the regulation. We reached this conclusion based upon several actions taken by CFSA including:(a) [tailoring] and [finishing] some of its purchased components in order to place these parts in usable condition; (b) [putting] these tailored components and others together in a 6-hour, 58-step process to form salable, quality bag-closing machines; and (c) [possessing] in its plant all of the tools and equipment necessary for these activities. As a result of CFSA's operations, the purchaser of one of these devices is guaranteed a carefully put together, well tested, and operable machine. [Dave Fischbein v. Commissioner, supra at 360.]Although Dave Fischbein v. Commissioner, supra, involved a different statute, the term "substantial in nature" as interpreted therein*120 supports the conclusion that on the facts here present petitioner's activities were "substantial in nature." Here the purchased standing timber was subjected to an extensive subtraction and selection process in which veneer-quality trees were identified by petitioner's purchasing agents and arrangements were made with the property owners for their purchase. The next steps in the process involved petitioner's crew, of standard size in the logging industry, felling, delimbing, bucking, skidding, and hauling the timber. Each of these steps required the exercise of skill and judgment on the part of petitioner's trained, experienced crew. This resulted in the maximum output of the valuable hardwood by incurring the least damage during the logging process. The end result of these steps was the production of individual veneer-quality logs identifiable by number and specifications. During the years in issue, petitioner purchased more than 100 parcels of standing timber repeating this process each time so as to be able to supply several European mills with sufficient quantities of *144 veneer logs to maintain their operations throughout the year.These various steps, a time-consuming, *121 yet time-constrained, process in which petitioner possessed all the necessary tools and equipment utilized in its logging operations, when combined, constitute a process substantial in nature. We agree with the statement of this Court in Dave Fischbein v. Commissioner, supra at 360, in finding nothing insignificant or insubstantial in petitioner's "utilization of proper equipment, by trained personnel, in a time-consuming process which has, as its result," a high quality, individually identifiable veneer-quality log satisfying the specifications of its purchaser.However, to be considered "production," the operations of petitioner must not only be substantial in nature but also generally considered to constitute production.B. Generally Considered To Constitute ProductionPetitioner contends the unrefuted testimony establishes that logging is not generally considered the manufacture or production of property. Respondent argues that petitioner misleads the Court with the above contention because the weight of the evidence indicates that the forest products industry generally considers harvesting to be production.Petitioner's experts included *122 John A. Grunwald (Mr. Grunwald), petitioner's president and the president and chief executive officer of David Webb; Albert DeBonis (Mr. DeBonis), president of Wood Advisory Services, Inc., a wood and wood-based-products consulting organization; and George Kelly (Mr. Kelly), retired president of the Hardwood Manufacturer's Association.Mr. Grunwald testified that, from the viewpoint of a manufacturer, the severance of standing timber was not equal to production because it was merely a means for making a raw material transportable. Mr. Grunwald acknowledged that loggers refer to logging as production and that a log is a distinct element of a tree, and agreed that a conversion took place between standing timber and a log. He also agreed that standing timber cannot be exported, and that veneer cannot be manufactured from standing timber. However, Mr. Grunwald testified that petitioner *145 was not engaged in "production" because logs and standing timber were both considered raw materials for the production of decorative veneer and lumber by those in the veneer industry.Mr. Grunwald further acknowledged that he, as a veneer manufacturer, was unconcerned with the harvesting industry, *123 viewing raw materials merely as something he had to purchase to be able to manufacture a product, and admitted that a furniture manufacturer would consider the veneer produced by David Webb to be its raw material, although David Webb would still consider itself a producer of veneer.Mr. DeBonis testified that a log is nothing more than the stem of a tree and, thus, is not the result of any manufacturing or production process. He acknowledged, however, that a standing tree was of little use until certain processing functions had been performed and that those functions involved substantial activities.Mr. DeBonis stated that in the forest products industry as a whole, logging was not considered production because there was no transformation of the material, i.e. -- the log is not different from the tree, and because manufacturers consider logs to be the starting point of manufacturing. Mr. DeBonis, however, acknowledged that harvesters refer to logging as production, that standing timber is functionally different from logs, that in its standing form it is not useful to veneer manufacturers, and that the authorities he relied upon to support his position that logs are raw materials*124 also refer to logs as products.Mr. Kelly was asked to testify with respect to his opinion of whether petitioner's activities constituted manufacturing. He concluded petitioner's activities were not generally considered the manufacture or production of property, but were merely log harvesting. He admitted that loggers refer to logging as production and that hardwood manufacturers prefer logs to standing timber. Mr. Kelly concluded that even though harvesting is a necessary step toward the manufacturing process, the conversion of standing timber into logs was not production because the logger has not produced anything that was not already there.Respondent's experts were William R. Sizemore (Mr. Sizemore), a forester and appraiser specializing in forest *146 land management; Kenneth Hunter (Mr. Hunter), a former procurement buyer for petitioner; and Harold E. Burghart (Mr. Burghart), an IRS forester.Mr. Sizemore testified that he had worked with many integrated companies which referred to harvesting as production and to logs as products. While veneer harvesting required more care than pine or softwood harvesting, the same fundamental steps were required. Mr. Sizemore disagreed*125 with petitioner's experts' inference that severance of standing timber was merely a means of making raw materials transportable because there is no way to use the standing timber without severance. In his opinion, hardwood veneer logs are the result of a subtraction and selection process, and their resultant value far exceeds the value of the stumpage price and harvesting costs. Agreeing that conversion added nothing that was not already there, he concluded the goal of the harvesting process, the production of veneer logs, was achieved by a subtraction process. Mr. Sizemore also cited examples in which logging was considered production by the U.S. Departments of Commerce and Agriculture, the Cooperative Extension Service of the State of Indiana, the Society of American Foresters, and several international agencies. Based upon his experience in the forest products industry and the various authorities he relied upon, Mr. Sizemore concluded that logging is generally considered to constitute production in the forest products industry.Mr. Hunter testified that he considered the purchase of standing timber and the harvesting of it into logs to be production in the sense of making a*126 commodity from a tree. He acknowledged, however, that there is some degree of self-aggrandizement in loggers considering themselves to be producers.Mr. Burghart, relying upon his experience as a forester and various authorities such as the U.S. Forest Service, the Canadian Forest Service, the Indiana Directory of Loggers, the Society of American Foresters, and various university publications, testified that, in his opinion, petitioner's activities were generally considered production within the forest products industry. He disagreed with Mr. DeBonis' statement that a log is nothing more than a tree. To the *147 contrary, he concluded that a log exists only through the activities, such as those undertaken by petitioner, of man. He also disagreed with Mr. Grunwald's statement that standing timber is a raw material, instead considering it to be a natural resource used in the production of logs. He concluded that petitioner's operations require the "use of trained loggers knowledgeable about log specifications, use of chain saws and other specialized equipment, and considerable coordination of men and equipment under all kinds of operating conditions. In the forest products*127 industry, harvesting of standing timber is considered to constitute a production activity in which logs or other timber products are produced."We disagree with petitioner's contention that the unrefuted testimony establishes that petitioner's activities are not generally considered production. Rather, the experts were divided between those who had a manufacturer's viewpoint, that logging was not production -- and those with a broader forest products industry viewpoint -- that logging activities are generally considered production.Petitioner argues that although respondent and his experts rely upon materials which refer to logs as products, log output as production, and logging as productivity, respondent has failed to show that those references necessarily mean that logging is generally considered to constitute the production of property within the meaning of the regulation.Petitioner further argues that respondent's expert Mr. Burghart relied, inter alia, upon a Forest Service Handbook excerpt in which items such as nuts and fruits are referred to as "products." Petitioner thus contends that respondent's position includes within the definition of "product," "anything that is *128 sold and not necessarily property that is first produced by human hand, otherwise, nuts, fruits, and growing trees could not be products. Respondent's evidence referring to logs as products is therefore of no conclusive value."Petitioner misconstrues the excerpt which refers in fact not only to "products derived from harvested trees, such as logs, lumber, pulpwood, * * * but also of products derived from standing trees, such as gum naval stores, * * * *148 fruits, nuts, bark and Christmas greens." (Emphasis added.) We conclude that the harvesting of timber of the type done by petitioner is "production" resulting in a veneer log "product." The record shows that substantial activity and workmen's skill is necessary to obtain a log from a standing tree and that this activity is of a type which would generally be considered production. We accept and agree with the testimony of respondent's experts that the activities engaged in by petitioner are generally considered as production in the forest products industry. Petitioner argues that the conclusory testimony of respondent's experts, that logging is generally considered production, is not helpful because the testimony *129 of these witnesses is premised on a harvester's viewpoint.We consider it appropriate under the regulations to determine how harvesting or logging is generally perceived in the forest products industry and not appropriate to limit our consideration to how logging is perceived from a hardwood manufacturer's point of view. We conclude that the weight of the evidence indicates that logging is generally viewed as production. In arriving at this conclusion, we have not only considered the testimony of respondent's experts but also the fact that petitioner's experts acknowledged that: (1) Loggers consider themselves to be producers; (2) standing timber is not particularly useful to manufacturers; (3) substantial activities are required before such materials are useful to manufacturers; and (4) the items considered to be raw materials and who is perceived to be a producer, varies depending upon one's position in the manufacturing and/or production process.In accordance with our conclusion that petitioner's activities were substantial in nature and that these activities are generally considered production, we hold that the veneer logs sold by petitioner have been produced by petitioner *130 within the meaning of section 1.993-3(c)(2)(iii), Income Tax Regs. Accordingly, it is unnecessary to consider whether petitioner's activities constituted a substantial transformation under section 1.993-3(c)(2)(ii), Income Tax Regs.Because the veneer logs sold by petitioner were also "produced" by petitioner, they do not qualify as "export property," and thus cannot generate "qualified export *149 receipts." Sec. 993(a)(1)(A). Also, since these logs are not export property they are not qualified export assets. Secs. 993(b)(1) and 993(c)(1)(A). Also, the assets attributable to the production of these products which are not export property are not qualified export assets. Sec. 993(b)(2).We have found that the percentage of petitioner's gross receipts from the sale of logs it harvested from standing timber in 1978 was 6.12 percent. We thus hold that for 1978, petitioner does not qualify as a DISC since it fails to satisfy the qualified export receipts test of section 992(a)(1)(A) because its qualified export receipts do not equal or exceed 95 percent of its gross receipts.Petitioner does satisfy the qualified export receipts test of section 992(a)(1)(A) for the years 1977*131 and 1979. However, petitioner is disqualified as a DISC for those years if it fails to satisfy the qualified export asset test of section 992(a)(1)(B). As noted, the qualified export asset test requires that the adjusted bases of petitioner's qualified export assets equal or exceed 95 percent of the adjusted bases of all petitioner's assets at the close of the taxable year. Sec. 992(a)(1)(B).Section 993(b) includes within qualified export assets (1) export property and (2) assets used primarily in connection with the sale, lease, etc. of export property. Sec. 1.993-2(a), Income Tax Regs., also includes within qualified export assets, business assets. However, section 1.993-2(c), Income Tax Regs., states:Assets used primarily in the manufacture, production, growth, or extraction (within the meaning of sec. 1.993-3(c)) of property are not business assets.Petitioner contends that its standing timber is export property and therefore a qualified export asset. Petitioner further argues that the assets used in connection with its activities were also qualified export assets because the logging activities were not production. Since we have previously held that petitioner's logging*132 activities constitute production, those assets used in such production do not constitute qualified export assets.Petitioner contends that regardless of our conclusion as to whether its logging operations constitute production, its *150 standing timber is an "export asset." Petitioner contends that the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, specifically makes "timber" an export asset. It is petitioner's position that since the Tax Reform Act of 1976 removed timber products from the specific exclusion from "export property" provided for in section 993(c)(2)(C), this act made standing timber "export property." Prior to its amendment by the Tax Reform Act of 1976, section 993 (c)(2)(C) excluded from export property "products of a character with respect to which a deduction for depletion is allowable * * * under section 611." Section 611 provided for the allowance of a depletion deduction "in case of mines, oil and gas wells, other natural deposits, and timber." The provision of the Tax Reform Act of 1976 amending section 993(c)(2)(C) deleted the words "under section 611" and substituted therefor "under section 613 or 613A." Since a provision for depletion of timber*133 is not included in section 613 or 613A, products from timber were no longer specifically excluded from the definition of "export property." For this reason the veneer, lumber, and logs purchased by petitioner for export were entitled to be considered "export property." However, the amendment to section 993(c)(2)(C) did not change the provision of section 993(c)(1) that export property means property "manufactured, produced, grown or extracted in the United States by a person other than a DISC * * * held primarily for sale * * * in the ordinary course of trade or business * * * for direct use * * * outside the United States." The record here shows and we have found that petitioner's standing timber was not held for sale by petitioner in the ordinary course of its trade or business for direct use outside the United States. This standing timber was held by petitioner for production into veneer logs to be sold by it. Since the standing timber was not held for sale prior to its production into veneer logs, it was not "export property."Because petitioner's activities constituted the production of property in the form of veneer logs, we conclude that the logs produced by petitioner are*134 not export property. As previously stated petitioner's standing timber does not constitute export property. Also, this timber was an asset used in connection with the logs produced by petitioner. *151 Therefore under section 1.993-2(c), Income Tax Regs., we exclude from export property those assets, including the standing timber, used in connection with the production of veneer logs by petitioner. Based upon our previous finding that the percentage of petitioner's assets attributable to standing timber equaled 27.04, 13.98, and 11.75 percent for 1977, 1978, and 1979, respectively, we hold that petitioner did not satisfy the qualified export asset test of section 992(a)(1)(B) for any of the years in issue. Accordingly, we hold that petitioner did not qualify as a DISC for any of the years 1977, 1978, or 1979.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, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩*. The assets pertaining to standing timber are designated with an asterisk (*) and were 27.04 percent, 13.98 percent, and 11.75 percent of the total gross assets for the years 1977, 1978, and 1979, respectively. The "Producer's loans" constitute qualified export assets.↩2. As noted previously, the parties subsequently stipulated that the percentage of gross receipts from standing timber (i.e., nonqualified receipts) for the years ending Dec. 31, 1977, was only 1.61 percent.↩3. Petitioner's costs with respect to the cutting, delimbing, bucking, and skidding of its standing timber did not exceed 20 percent of the cost of the standing timber and respondent concedes that the 20-percent test of sec. 1.993-3(c)(2)(iv), Income Tax Regs., has been satisfied by petitioner for each of the 3 years in issue.The parties stipulated that petitioner is entitled to make a deficiency distribution as allowed by sec. 1.992-3, Income Tax Regs.↩, in an amount computed on the basis of the facts in the returns in the event that it is determined that the standing timber and related assets did not constitute qualified export assets or the receipts therefrom did not constitute qualified export receipts.4. Sec. 1.993-3(c)(2), Income Tax Regs., reads in part as follows:(c) Manufacture, production, growth, or extraction of property -- * * *(2) Manufactured or produced. -- (i) In general. For purposes of this section, property which is sold or leased by a person is considered to be manufactured or produced by such person if such property is manufactured or produced (within the meaning of either subdivision (ii), (iii), or (iv) of this subparagraph) by such person or by another person pursuant to a contract with such person. Except as provided in subdivision (iv) of this subparagraph, manufacture or production of property does not include assembly or packaging operations with respect to property.(ii) Substantial transformation. Property is manufactured or produced by a person if such property is substantially transformed by such person. Examples of substantial transformation of property would include the conversion of woodpulp to paper, steel rods to screws and bolts, and the canning of fish.(iii) Operations generally considered to constitute manufacturing↩. Property is manufactured or produced by a person if the operations performed by such person in connection with such property are substantial in nature and are generally considered to constitute the manufacture or production of property.5. It is respondent's position that only in the year 1979 would considering petitioner's standing timber to be an export assets, but the assets connected with the harvesting of the timber not to be export assets, result in less than 5 percent of petitioner's assets not being qualified export assets.↩6. Sec. 1.954-3(a)(4)(iii), Income Tax Regs., provided in pertinent part as follows:(iii) Manufacture of a product when purchased components constitute part of the property sold. If purchased property is used as a component part of personal property which is sold, the sale of the property will be treated as the sale of a manufactured product, rather than the sale of component parts, if the operations conducted by the selling corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture, production, or construction of property. Without limiting this substantive test, which is dependent on the facts and circumstances of each case, the operations of the selling corporation in connection with the use of the purchased property as a component part of the personal property which is sold will be considered to constitute the manufacture of a product if in connection with such property conversion costs (direct labor and factory burden) of such corporation account for 20 percent or more of the total cost of goods sold. In no event, however, will packaging, repackaging, labeling, or minor assembly operations constitute the manufacture, production, or construction of property for purposes of section 954(d)(1). The application of this subdivision may be illustrated by the following examples:* * * *Example (2). Controlled foreign corporation B, incorporated under the laws of foreign country X, operates an automobile assembly plant. In connection with such activity, B Corporation purchases from related persons assembled engines, transmissions, and certain other components, all of which are manufactured outside of country X; purchases additional components from unrelated persons; conducts stamping, machining, and subassembly operations; and has a substantial investment in tools, jigs, welding equipment, and other machinery and equipment used in the assembly of an automobile. On a per unit basis, B Corporation's selling price and costs of such automobiles are as follows:Selling price$ 2,500Cost of goods sold:Material --Acquired from related persons$ 1,200Acquired from others275Total material1,475Conversion costs (direct labor and factory burden)325Total cost of goods sold1,800Gross profit700Administrative and selling expenses300Taxable income400The product sold, an automobile, is not sufficiently distinguishable from the components purchased (the engine, transmission, etc.) to constitute a substantial transformation of purchased parts within the meaning of subdivision (ii) of this subparagraph. Although conversion costs of B Corporation are less than 20 percent of total cost of goods sold ($ 325/$ 1800 or 18 percent), the operations conducted by B Corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture of a product. Corporation B will be considered under this subdivision to have manufactured the product it sells.Example (3)↩. Controlled foreign corporation C, incorporated under the laws of foreign country X, purchases from related persons radio parts manufactured in foreign country Y. Corporation C designs radio kits, packages component parts required for assembly of such kits, and sells the parts in a knocked-down condition to unrelated persons for use outside country X. These packaging operations of C Corporation do not constitute the manufacture, production, or construction of personal property for purposes of section 954(d)(1). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623089/ | Herman Roberson and Doris B. Roberson, Petitioners, v. Commissioner of Internal Revenue, Respondent; Roberson Motor Co., Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentRoberson v. CommissionerDocket Nos. 45406, 70107, 45407United States Tax Court41 T.C. 577; 1964 U.S. Tax Ct. LEXIS 159; January 27, 1964, Filed *159 Respondent's motions will be granted and decisions will be entered in accordance therewith. In collateral proceedings in the United States District Court, brought by the United States of America against the taxpayers herein to protect the lien of its jeopardy assessment for deficiencies in taxes for the same taxable years here involved, the taxpayers submitted an offer in settlement of all their tax liabilities for those years. The offer was accepted by the Attorney General of the United States and, pursuant to stipulation of the parties, the District Court entered judgment in accordance therewith, the amount of which taxpayers have paid in full. Held, the settlement agreement is conclusive of the amount of the deficiencies owed by taxpayers for the years here involved and, taxpayers having paid that amount, respondent's motions to enter decisions of no deficiencies in these proceedings are granted. Herman Roberson, pro se.Frederick T. Carney, for the respondent. Drennen, Judge. DRENNEN*577 In these consolidated proceedings respondent determined deficiencies and additions to tax as follows:Additions totax, I.R.C.DocketTaxpayerYearDeficiency1939, secs.No.293(b),294(d)(1)(A),and 294(d)(2)45406Herman and Doris Roberson1948$ 1,446.02$ 1,124.15194913,549.889,074.7819506,345.005,182.0270107Herman and Doris Roberson195141,014.1426,913.82FYE10/3145407Roberson Motor Co., Inc19487,634.914,411.93194920,919.5510,459.771950567.391,372.97*161 Petitioners Herman and Doris B. Roberson, hereinafter referred to collectively as Roberson, were residents of Montgomery County, Ala., during the years 1948-51, and filed joint income tax returns for those years with the collector of internal revenue for the district of Alabama.Petitioner Roberson Motor Co., Inc., hereinafter referred to as Motor Co., was an Alabama corporation with its principal place of business in Montgomery, Ala., during the years here involved. It filed corporate income tax returns for its fiscal years ending October 31, 1948, 1949, and 1950, with the collector of internal revenue for the district of Alabama.*578 These cases were called for trial in Birmingham, Ala., on October 7, 1963, at which time respondent filed a motion to enter decision in each of the docket numbers requesting the Court to enter decisions of no deficiencies. The basis for these motions was that the deficiencies in tax and additions to tax had been discharged by the acceptance by the Attorney General of the United States of a sum offered by petitioners in settlement thereof in connection with a proceeding in the United States District Court for the Middle District of Alabama involving*162 petitioners' tax liabilities for the same taxable years here involved, and by the entry of a judgment by the District Court in accordance therewith on March 4, 1963, which judgment has been paid by petitioners; by reason of which there are now no deficiencies in income tax or additions to tax due from petitioners for the years here involved. Respondent also asserts that by reason of the judgment order of the District Court the issues in these cases are res judicata.Petitioners were not represented by counsel at the hearing but Herman Roberson appeared in person and orally objected to respondent's motions on the ground that the settlement offer had been submitted and the judgment of the District Court had been agreed to under duress, and asked that this Court redetermine petitioners' tax liability for the years here involved and determine overpayments of tax for those years.Respondent offered evidence, consisting of certified copies of pertinent pleadings and orders of the court in the District Court proceeding heretofore referred to, including the correspondence submitting the offers in settlement and the acceptance thereof, and filed a written memorandum in support of his motions. *163 Petitioners offered no evidence, except certain statements made by Roberson not under oath, and have filed no written memorandum in support of their opposition to respondent's motions.The Court took respondent's motions under advisement and this opinion reflects our conclusions with respect thereto.Some background of the prior administrative and judicial proceedings is necessary to understand the issue here involved.Jeopardy assessments of the amounts set forth in the notices of deficiency in docket Nos. 45406 and 45407 were made against petitioners by respondent or his delegate in Alabama on June 23, 1952, under authority of section 273, I.R.C. 1939. The notices of deficiency covering the calendar years 1948, 1949, and 1950 for the individuals and for the fiscal years ending October 31, 1948, 1949, and 1950, of the corporation were thereafter issued on August 22, 1952. The notice of deficiency for the calendar year 1951 for the individuals was issued June 24, 1957. Subsequent thereto a jeopardy assessment for the taxes, additions to tax, and interest for the year 1951 was made by respondent.*579 The Robersons and Motor Co. each filed in this Court petitions for redetermination*164 of the deficiencies determined against them for the years 1948-50 on or about November 17, 1952, and the Robersons filed a petition for redetermination of the deficiency determined against them for 1951 on or about September 20, 1957.Petitioner Roberson, who was the principal officer and stockholder of Motor Co., was subsequently sentenced to the Federal penitentiary in Atlanta and was incarcerated there for a number of years, during which time the proceedings in this Court were not calendared for trial. The cases were calendared for trial by this Court at its next trial calendar set for Birmingham, Ala., after the Court was advised that Roberson had been released from prison, which was the above-mentioned trial calendar in October 1963.On June 20, 1958, 3 days prior to the expiration of 6 years after the first jeopardy assessments had been made, the United States of America, not having been able to obtain extension agreements from petitioners, see sec. 6502, I.R.C. 1954, and no bond to stay collection having been filed by petitioners, see sec. 6863, I.R.C. 1954, filed civil action No. 1445-N in the United States District Court for the Middle District of Alabama against Herman *165 and Doris Roberson for a judgment for unpaid income taxes and additions to tax due from the defendants for the calendar years 1949 and 1950 in the total amount of $ 35,733.17. On the same day a similar civil action No. 1446-N was filed against Roberson Motor Co., Inc., and Herman, Doris, and Walter H. Roberson, in their individual capacities, and as officers, directors, stockholders, and trustees of Roberson Motor Co., Inc., seeking judgment for taxes and additions to tax owing from "defendant" (apparently Motor Co.) for its fiscal years 1948, 1949, and 1950 in the amount of $ 50,051.72. An amended complaint was later filed in civil action No. 1446-N alleging transferee liability against the individuals.By letter dated March 30, 1962, written on a letterhead of Wampole and Capouano, a firm of attorneys in Montgomery, Ala. (who, incidentally, were not counsel of record in the Tax Court proceedings, which counsel of record withdrew in 1961 and has not been replaced), and signed by Herman Roberson, Doris Roberson, and Walter H. Roberson, individually, addressed to the United States Attorney General and an individual in the appellate division, Internal Revenue Service, Birmingham, Ala., *166 and referring to civil action Nos. 1445-N and 1446-N, Tax Court docket Nos. 45406, 45407, and 70107, an offer of settlement was made which read in part as follows:We do hereby offer the government the total of $ 62,500.00 in payment, for purposes of settlement, of all assessments and notices of deficiency which have been received by us for the years 1948, 1949, 1950 and 1951.By letter dated August 7, 1962, addressed to Leon M. Capouano, Montgomery, Ala., signed by John B. Jones, Jr., Acting Assistant Attorney *580 General, Tax Division, and referring to all the proceedings in the District Court and the Tax Court above mentioned, petitioners were advised that their offer dated March 30, 1962, to settle those cases for the years 1948, 1949, 1950, and 1951 by payment to the Government of $ 62,500 had been accepted, and the terms of payment were specified.On September 5, 1962, a stipulation was filed with the District Court in civil action Nos. 1445-N and 1446-N, signed by an assistant United States attorney as attorney for the plaintiff, and by Leon M. Capouano, as attorney for defendants, in which it was stipulated that "The amount of indebtedness in these matters is $ 62,500," *167 and defendants were given 120 days within which to pay the full amount of the agreed upon indebtedness. If the amount was not paid in full within the 120 days, plaintiff was given the right of immediate reinstatement of the causes on the docket of the court for trial.The defendants not having paid the full amount of the stipulated indebtedness within 120 days, on March 4, 1963, the United States moved to reinstate the cases on the docket for trial, and for judgment against defendants for the unpaid balance in the amount of $ 35,294.29. Also on March 4, 1963, stipulations were filed, signed by attorneys for both parties, that a judgment order may be entered by the court for the amount due plaintiff by the defendants under the terms of the "offer in compromise" agreed to by the parties, and giving defendants 120 days within which to pay the balance of the amount due.By judgment order entered March 4, 1963, in both civil actions, the District Court, having been advised that the parties had entered into a settlement agreement which had been incorporated in a stipulation filed in the causes and that there was presently due plaintiff the sum of $ 35,294.29 under the agreement, entered*168 "judgment against the Defendants, Herman Roberson, Doris Roberson, and Walter Herman Roberson, jointly and severally, in the sum of $ 35,294.29, plus interest as provided by law."This Court was advised by both parties at the calendar call that the above judgment had been paid in full at that time.OPINIONRespondent's argument in support of his motions to enter decisions of no deficiencies in these proceedings is primarily that the parties intended to settle petitioners' tax liabilities for the years here involved in the District Court proceedings, that petitioners' offer in settlement was accepted by the Attorney General in behalf of the United States pursuant to section 7122(a), I.R.C. 1954, and when it was filed with the District Court and that court entered judgment in accordance therewith, the judgment of the District Court is res judicata of the *581 amount of the tax liability of petitioners for the years here involved. The agreed upon amount and the judgment of the District Court having been paid in full, there are now no deficiencies in tax or additions to tax due from petitioners.Petitioners are apparently attempting to repudiate their settlement agreement and*169 collaterally attack the judgment of the District Court in the hope that this Court, upon trial of the cases, would determine that there is a lesser amount of tax due from them than they paid under the settlement agreement and thus entitle them to a refund of the overpayment.Were it not for the fact that petitioners claim to have been deprived of their right to have their tax liabilities redetermined by this Court by the proceedings filed by the Government in the District Court to reduce its assessments to judgment, we would have had no hesitancy in granting respondent's motions. However, inasmuch as had the parties gone to trial in the District Court and the District Court had determined the correct amount of petitioners' tax liabilities for those years on the merits, this would have resulted in permitting the Government to choose the forum for redetermination of petitioner's tax liabilities, we took the matter under advisement to assure ourselves that the taxpayers' statutory right to come into this Court for that purpose was not being thwarted without their consent. Upon consideration of the matter, we find such not to be the case.What happened here was that the parties voluntarily*170 entered into an agreement settling the amount of the taxpayers' tax liability for all of the years here involved, and submitted that agreement to the District Court for approval, in a matter then pending between the parties in that court. We think this settlement agreement is conclusive of the amount of petitioners' tax liabilities for the years here involved, see Walker v. Alamo Foods Co., 16 F. 2d 694 (C.A. 5, 1927), certiorari denied 274 U.S. 741">274 U.S. 741 (1927); Shaw & Truesdell Co. v. United States, 1 F. Supp. 834">1 F. Supp. 834 (E.D.N.Y. 1932); Lone Star Brewing Association v. United States, 61 Ct. Cl. 118">61 Ct. Cl. 118 (1925); Seattle-First Nat. Bank v. United States, 44 F. Supp. 603">44 F. Supp. 603 (E.D. Wash. 1942), affd. 136 F. 2d 676 (C.A. 9, 1943), affd. 321 U.S. 583">321 U.S. 583 (1944), and that nothing could be gained by calendaring these cases for trial on the merits in this Court.If petitioners claim duress caused them to enter into the settlement agreement they should not have asked the District Court to approve*171 it; or at least should have raised this claim in the District Court. If they claim duress in agreeing to the judgment entered by the District Court, this should have been raised on appeal from that judgment. We will not entertain a collateral attack on the proceedings of the District Court in these proceedings.*582 The full amount of the agreed upon deficiencies having been paid, there is nothing left for this Court to decide.There may be some question as to whether this Court should now enter decisions of no deficiencies or simply dismiss the cases. We think that under the circumstances we could do either. This Court acquired jurisdiction of the cases when the petitions were filed herein. There was no bankruptcy proceeding as in Comas, Inc., 23 T.C. 8 (1954); nor was a receiver appointed by the District Court, as in Leon I. Ross, 309">38 T.C. 309 (1962); in both of which cases this Court dismissed the proceedings. We know of nothing that would deprive this Court of jurisdiction in the matter. The fact that the amount of the deficiencies has been conclusively determined would not oust this Court of jurisdiction*172 although it would limit the scope of its authority.We have no motion to dismiss before us. The motions pending before us request that we enter decisions determining that the deficiencies in income tax and additions to tax due from petitioners have been discharged by the acceptance by the Attorney General of the United States of a sum offered in settlement thereof and by reason thereof there are now no deficiencies in income tax or additions to tax due from petitioners for those years. We continue to have jurisdiction to enter such decisions and such decisions would appear to be proper under the circumstances.Respondent's motions will be granted and decisions will be entered in accordance therewith. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623090/ | Michael Gaspar and Mary Gaspar v. Commissioner.Gaspar v. CommissionerDocket No. 6998-65.United States Tax CourtT.C. Memo 1968-131; 1968 Tax Ct. Memo LEXIS 159; 27 T.C.M. (CCH) 634; T.C.M. (RIA) 68131; June 27, 1968, Filed *159 Held: Respondent failed to prove fraud or that petitioner omitted from gross income an amount properly includable therein in excess of 25 percent of the amount of gross income stated in petitioners' return. Secs. 6501(c) and 6501(e) not applicable. Assessment and collection of tax is barred by statute of limitations. Howard R. Weil, 555 Cedar Lane, Teaneck, N.J., for the petitioners. Julius M. Jacobs, for the respondent. DRENNENMemorandum Findings of Fact and Opinion DRENNEN, Judge: Respondent determined a deficiency in petitioners' income tax for the year 1959 in the amount of $18,322.39 and an addition to tax under section 6653(b), I.R.C. 1954, 1 in the amount of $9,161.19. The issues are (1) whether respondent correctly computed petitioners' taxable income for 1959 under the bank deposits method; (2) whether any part of the underpayment of tax for 1959 was due to fraud within the meaning of section 6653(b); and (3) whether assessment and collection of tax for the year 1959 is barred by the statute of limitations. Findings of Fact Some of the facts were stipulated and they are so found. Michael Gaspar and Mary Gaspar, husband and wife, were residents of Arlington, N.J., at the time of the filing of their petition. *161 They filed a joint income tax return for 1959 with the district director of internal revenue, Newark, N.J., on April 15, 1960. Michael Gaspar will hereinafter be called petitioner. On December 1, 1958, petitioner and his wife purchased a tavern in Jersey City, N.J., together with the liquor license for the tavern and the real estate and improvements for $18,000. They paid $8,000 cash and gave a purchase money mortgage for the remaining $10,000. The building consisted of a ground floor, which was occupied by the tavern, and an upper floor occupied by petitioners and their son, Michael E. Gaspar, Jr., as their living quarters. During 1959 petitioner was employed by the Central Railroad of New Jersey as a car inspector and received wages in the total amount of $4,749.84. Petitioner had been employed by the Central Railroad of New Jersey since 1928. During 1959 petitioner's wife was employed on a part-time basis as a cleaning woman by Terminal Cleaning Contractors, Inc., and by 120 Broadway Management Corp., both in New York City, and received wages in the total amount of $812.04. During 1959 petitioner tended bar at his tavern in the morning from 6 a.m. until his son, Michael, relieved*162 him at about 7:40 a.m., when petitioner went to work in the railroad yards. Petitioner also tended bar in the afternoon and evening after returning from work for the railroad at 4 p.m. Petitioner also tended bar on the days he did not work for the railroad. Petitioner's wife and his son took care of the tavern business during petitioner's absence, with his wife preparing the food served at the tavern and his son tending bar. Petitioner's tavern was situated near the railroad yard where he worked. The terminals of the Lehigh Valley Railroad and the Railway Express Agency were located nearby, and there were also several small factories, stevedoring companies, and other business concerns in the immediate vicinity. 635 Prior to his purchase of the tavern in 1958, petitioner made an arrangement with the Commercial Trust Co. of New Jersey, in Jersey City, N.J., whereby he would be permitted to withdraw cash against deposited, but uncollected, checks. This arrangement, which was similar to the arrangement the bank had with the prior owner of the tavern, was made in order to enable the petitioner to cash the pay checks of many of the tavern customers who worked at the nearby railroad*163 yards, factories, and other business concerns. On November 5, 1958, prior to his purchase of the tavern, petitioner opened a regular checking account with the Commercial Trust Company of New Jersey. Withdrawals from this checking account were authorized to be made by either petitioner or his son. On February 9, 1959, a special account was opened with the bank in the name of petitioner's son, Michael. All withdrawals from this special account were made by Michael. Petitioner's arrangement with the bank concerning cash withdrawals by him against deposited, but uncollected, checks applied to both the regular checking account and the special account. The Central Railroad of New Jersey made salary payments to its employees on the 11th and 26th of each month, while the Lehigh Valley Railroad paid its employees on the 10th and 25th of each month. The stevedoring companies paid their employees every Wednesday, and some of the factories nearby paid their employees on Tuesday and Friday. On the four railroad paydays each month petitioner stayed at the tavern the entire day in order to handle the large checkcashing operation. Petitioner tried to anticipate the cash needed on those days by*164 making advance withdrawals from the bank. Some of the railroad employees brought in their checks and cashed them personally; others would send their checks to the tavern in the morning in groups ranging from 10 to 20 checks and would pick up the cash later in the day. At times, petitioner would deposit in the bank the checks which he had cashed for various customers and would withdraw cash against that deposit to meet the check-cashing needs later in the day. All checks received in the check-cashing operations were deposited in both the regular or special account and cash withdrawals were made from both accounts. Prior to December 1, 1958, when the tavern was purchased by petitioner, a total of $9,600 was deposited in the regular checking account. On November 13, 1958, a withdrawal of $2,375 was made from a savings account in the name of petitioner and his wife at the Provident Institution for Savings in Jersey City and on the same date a withdrawal of $1,225 was made from a savings account in the same bank in the name of Mary Gaspar, Trustee for Michael E. Gaspar, Jr. After these withdrawals, both savings accounts were left with minimal balances. Petitioner obtained additional funds*165 at about this time by cashing his U.S. bonds for about $2,000, by borrowing approximately $2,000 on his life insurance policies, and by borrowing from friends. Petitioner also obtained money from his wife. Petitioner's income tax return was prepared by Albert Obolsky, an accountant who had also done some accounting work for the prior owner of the tavern. In preparing petitioner's income tax return for 1959, Obolsky used a figure for total receipts from an adding machine tape which petitioner showed him at the end of the year. Obolsky added to the figures shown on the tape certain other cash amounts received by petitioner during the year for the use of the telephone, from the bowling alley, and from other small items. Obolsky used bills and invoices submitted to him by petitioner to compute the cost of merchandise purchased and other business expenses. Obolsky also prepared certain monthly alcoholic beverage reports on the basis of invoices he obtained from petitioner once a month. Obolsky never saw the checkbook used by petitioner and he never reconciled petitioner's bank statements. On February 8, 1960, petitioner's wife and his son were arrested at the tavern by local police*166 officers and were charged with violating section 2A:170-18 of the New Jersey Statutes Annotated, which states as follows: 2A:170-18. Possession of lottery or numbers slips. Any person who has in his possession or custody any lottery slips, books or records pertaining to a lottery, or any person who has in his possession or has in an automobile in his custody any ticket or tickets, slip or slips, paper, document or memoranda in any way pertaining to the business of a number game, is a disorderly person. "Number game" as used in this section means any betting on any number or numbers, or sets or arrangements of numbers, on or according to any plan or method whatsoever. Petitioner's wife, Mary, pleaded guilty to the charge and was fined $100; and the 636 charge against petitioner's son, Michael, was dismissed. As a result of a raid by agents of the U.S. Treasury Department on petitioner's tavern on July 28, 1960, the petitioner and his wife were charged with violating the Gaming Statutes of the State of New Jersey and maintaining a gambling establishment. They pleaded not guilty and, after a trial before a judge and jury in the Hudson County Court of New Jersey, the jury brought*167 in a verdict of not guilty. In a subsequent libel action tried before a jury in the U.S. District Court for the District of New Jersey on August 5, 1964, the jury found that certain items seized in the raid, including $10,641.53 in currency, were not subject to forfeiture and that petitioner had a valid claim to the property. In connection with the investigation of petitioner's income tax return for 1959 respondent obtained the bank statements for the petitioner's regular checking account at the Commercial Trust Co. of New Jersey covering the period from November 5, 1958, through January 29, 1960, as well as the bank statements for the special account at the same bank covering the period from February 9, 1959, through January 6, 1960. Respondent also obtained copies of the deposit slips for both accounts at the bank and examined the microfilm of the checks drawn to the accounts. Based upon his examination of the bank's records, the respondent prepared a schedule showing the payees of the checks drawn during 1959 on the regular checking account. All checks drawn on the special account during 1959 were made payable to cash. Using the above information, respondent computed petitioner's*168 business income for 1959 under the bank deposits method. Respondent treated the deposits made in the regular checking account and in the special account, with some exceptions, as business deposits. Withdrawals in cash and by check from both accounts, with some exceptions, were treated as business withdrawals which reduced business income. Respondent's computation of petitioner's business income for 1959 under the bank deposits method is as follows: Regular checking accountDeposits-check$ 193,717.49Deposits-cash 39,300.00Total Deposits$ 233,017.49Withdrawals and chargesChecks to specific payees42,587.04Checks to cash188,298.21Debit memos787.20Bank service charges 95.21Total withdrawals and charges$ 231,767.66Less: Personal and nondeductible itemsPrudential Insurance Co$ 948.85Internal Revenue Ser1,743.04N.J. Div. Motor Vehicles25.00Contributions2,660.00Payments to GMAC, less interest886.61Veterans Administration31.90Total payments on mortgage, less interest 2,316.20Total personal and nondeductible withdrawals 8,611.60Balance of withdrawals applicable to business expenses and costs 223,156.06Net business income - regular account$ 9,81.43Special accountDeposits - checks$1,000,198.85Deposits - cash 382,230.00Total deposits$1,382,428.85Exclusion from business deposits of net cash from wages of petitioner, Mary Gaspar, and Michael E. Gaspar, Jr. 6,676.31Total business deposits$1,375,752.54Withdrawals and chargesChecks (all drawn to cash)$1,333,500.00Debit memos4,152.54Bank service charges 128.09Total withdrawals and charges $1,337,780.63Net business income - special account37,971.91Net business income - regular account (above) 9,861.43Total net business income per bank deposits method$ 47,833.34*169 637 Respondent then computed the taxable income for 1959 of petitioner and his wife as follows: Net business income per bank deposits method$47,833.34Add: Inventory on hand for which deduction has already been allowed by withdrawals from banks$1,551.00Less: Business depreciation allowable and not taken into account under bank deposits method 485.73Net increase in sch. C income$ 1,065.27Wages - petitioner4,749.84Wages - Mary Gaspar 812.04Adjusted gross income$54,460.49Itemized personal deductionsContributions$2,660.00Automobile license plates25.00Gas and cigarette tax76.25Union dues68.00Interest paid to Credit Union 22.67Total itemized personal deductions $ 2,851.92Net income$51,608.57Exemptions 1,200.00Taxable income$50,408.57In the joint income tax return for the year 1959 filed by petitioner and his wife they reported a net profit from the operation of the tavern in the amount of $10,339.51 and combined wages in the amount of $5,561.88, or a total adjusted gross income of $15,901.39. Respondent in his statutory notice of deficiency determined that petitioner and his wife*170 had unreported business income in the amount of $39,480.25 in 1959, based upon respondent's computation that their correct business income for 1959 was $49,819.76 2 rather than the amount of $10,339.51 reported by them. The statutory notice of deficiency for the year 1959 was mailed on September 15, 1965. Ultimate Findings of Fact Respondent failed to prove that the joint income tax return filed by petitioner and his wife for the taxable year 1959 was false or fraudulent with intent to evade tax. Respondent failed to prove that petitioner and his wife omitted from gross income on their joint income tax return for 1959 an amount properly includable therein which is in excess of 25 percent of the amount of gross income stated in the return for that year. Opinion Since the statutory notice of deficiency for the year 1959 was not mailed to petitioner and his wife until September 15, 1965, more than 3 years from the due date of their income tax return for*171 1959, it is apparent that assessment and collection of tax for the taxable year 1959 is barred by the statute of limitations, section 6501(a), unless the exception prescribed in either 638 section 6501(c) or section 6501(e) is applicable to the facts of this case. Section 6501(c)(1) provides that "In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time." Section 6501(e)(1) provides that "If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 6 years after the return was filed." The burden of proof with respect to fraud is upon the respondent and he must establish fraud by clear and convincing evidence. Jack M. Chesbro, 21 T.C. 123">21 T.C. 123 (1953), affd. per curiam 225 F. 2d 674 (C.A. 2, 1955); Arlette Coat Co., 14 T.C. 751">14 T.C. 751 (1950). We have held that a mere understatement of*172 income does not establish fraud. L. Glenn Switzer, 20 T.C. 759">20 T.C. 759; James Nicholson, 32 B.T.A. 977">32 B.T.A. 977 (1935), affd. 90 F. 2d 978 (C.A. 8, 1937). The existence of fraud with intent to evade tax must be affirmatively established. Drieborg v. Commissioner, 225 F. 2d 216 (C.A. 6, 1955). We are here concerned with the operation of a tavern in its first year of operation. Petitioner had been for more than 30 years an employee of the Central Railroad of New Jersey and continued in such employment after he purchased the tavern on December 1, 1958, for $18,000. The tavern was a family operation, with petitioner tending bar before and after his normal working hours for the railroad and on his days off. Petitioner's working day began at 6 a.m. and did not end until very late in the evening when he closed the tavern. Petitioner's son worked at the tavern, and petitioner's wife prepared sandwiches for customers and did general cleaning work. The record does not show that petitioner had any prior experience in the operation of a business or any training in proper record-keeping. Petitioner testified that he followed the advice of his accountant*173 and recorded in a book his daily cash receipts as indicated by the cash register tape. He testified he made these entries in the cash receipts books "practically every day." However, petitioner explained that he did not have the record book, which he described with some explicitness, at the time of the trial because it had been seized, along with many other items, in the raid on the tavern conducted by agents of the U.S. Treasury Department on July 28, 1960, and never returned to him. The evidence on the disappearance of the record book is unclear. Special Agent Ronald P. Graziano was not assigned to petitioner's case until early in 1964 when, according to his testimony, a box of records seized in the raid between 3 and 4 years earlier was made available to him. He testified that, in addition to checkbooks, there was a blank ledger book, a second ledger book with entries on the first two pages, and two spiral notebooks for receipts, one for 1959 and one for 1960. The special agent testified that the book for 1959 was incomplete in that it did not cover a full year. 3 He also testified that in November 1964 he returned to petitioner "everything that was turned over to me that I had*174 received in that box, which would include the records that I have just described." In other words, the special agent merely accepted a box of records which he was told were seized in a raid more than 3 years earlier. With the record in this ambiguous state, we cannot say with certainty that the cash receipts book which petitioner testified that he kept in 1959 prior to the raid did not actually exist. Moreover, we gather from the special agent's testimony that some record of receipts in 1959 did exist although it did not cover a full year. It is evident that petitioner's bookkeeping practices were informal and far from adequate. Albert Obolsky, who advised petitioner as to the necessary records to be kept, was in 1959 employed in the New York City Post Office and only worked part time as an accountant. He prepared various alcoholic beverage returns from invoices he obtained in an envelope from petitioner once a month. He prepared petitioner's income tax return on the basis of information supplied to him by petitioner. *175 Obolsky testified that "I didn't know anything about his [petitioner's] business outside of what he gave me." There was no attempt by petitioner or his accountant to reconcile any of the bank 639 statements for the regular checking account and the special account during 1959. It appears that the extensive check-cashing operations by petitioner in 1959 involved both bank accounts and were indiscriminately intermingled with the tavern's receipts and expenditures. Some indication of the extent of the check-cashing operations may be gained from respondent's Exhibit J which shows total deposits of checks in the special account alone in the amount of $1,000,198.85 and withdrawals (by checks drawn to cash) also in excess of $1 million. At most, this record reveals ample proof of inadequate record-keeping by petitioner, and perhaps a penchant for unbusinesslike methods in his operation of the tavern, but it is clear that evidence of inefficiency and ignorance of accounting methods are not sufficient to establish fraud. Walter M. Ferguson, Jr., 14 T.C. 846">14 T.C. 846 (1950); W. F. Shawver Co., 20 B.T.A. 723">20 B.T.A. 723 (1930). Respondent has not shown any positive or affirmative*176 act by petitioner indicating clearly and convincingly that fraud was present. It should be emphasized that the understatement of petitioner's income, covering the single taxable year 1959, was computed by respondent under a method which is based upon the principle that unexplained bank deposits are evidence of taxable income. Lessmann v. Commissioner, 327 F. 2d 990 (C.A. 8, 1964), affirming a Memorandum Opinion of this Court. However, it is undisputed that petitioner engaged in a large check-cashing operation and that a large part of the deposits in both bank accounts was from the check-cashing operation, and there is no evidence that petitioner made a profit on that operation. In fact, under these circumstances it would seem that the bank deposits method of computing income would be inapt and unreliable. Petitioner has offered a reasonable explanation for the deposits. Respondent computed petitioner's business income as the difference between the deposits and the withdrawals in the bank accounts. This is more akin to relying on an increase in one item in a net worth statement. We have examined the entire record and are not persuaded that the evidence is sufficient to*177 establish fraud. It might strongly suggest a suspicion of fraud, but "Mere suspicion of fraud and mere doubts as to the intentions of the taxpayer are not sufficient proof of fraud." L. Glenn Switzer, supra, at 765. Accordingly, we find that respondent has failed to carry his burden of proving by clear and convincing evidence that petitioner's income tax return for the taxable year 1959 was false or fraudulent with intent to evade tax within the meaning of section 6501(c). Respondent also contends that the 6-year period of limitations provided for in section 6501(e) is applicable. Under this section, respondent has the burden of proving that the petitioner omitted from gross income an amount properly includable therein in excess of 25 percent of the amount of gross income stated in the return. C.A. Reis, 1 T.C. 9">1 T.C. 9 (1942). To show that section 6501(e) applies here, respondent contends that the correct gross income figure is $1,608,770.04 instead of the amount of $51,777.77 actually reported by petitioner in his income tax return for 1959 and that, as these figures show, the omission from gross income is clearly in excess of 25 percent of the amount of gross*178 income stated in the return. Respondent obtains the figure of $1,608,770.04 by totaling all check deposits and all cash deposits in both the regular and the special bank accounts throughout the year, or $1,615,446.35, and subtracting $6,676.31 which represents the total net wages earned by the Gaspars during 1959 and deemed by respondent as deposited by them in the bank accounts. Respondent relies on the $1,608,770.04 figure thus obtained as the gross receipts or gross income of petitioner's tavern business to carry his burden of proving that section 6501(e) is applicable. We believe that respondent has, under the facts of this case, misinterpreted the term "gross income." Section 6501(e)(1) (A)(i) provides that "In the case of a trade or business, the term 'gross income' means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to diminution by the cost of such sales or services." The record shows that petitioner regularly cashed the pay checks of his customers who worked in nearby railroad yards, factories, and other business establishments and that such check-cashing operations were extensive*179 in nature. In fact, petitioner made special arrangements with his bank permitting him to withdraw cash against deposited but uncollected checks to facilitate the check-cashing operation. It is evident that a substantial portion of the figure $1,608,770.04, which respondent puts forth as the correct amount of petitioner's gross income in 1959, represents nothing more than the myriad of payroll checks cashed by petitioner and 640 deposited in the bank for collection plus redeposits of cash withdrawn in excess of the amounts actually needed to cash the checks. We can perceive no justification for treating these checks, which merely cleared through petitioner's bank accounts, and cash redeposits, as "amounts received or accrued from the sale of goods or services" within the meaning of the statute. Moreover, the statutory definition in section 6501(e)(1) (A)(i) clearly limits gross income to those amounts which are "required to be shown on the return." Here, petitioner merely served as a conduit for these payroll checks cashed by him throughout the year. Certainly they do not represent amounts received by him from the sale of any goods or services, and we do not believe that he was*180 required to show the amounts of such cashed checks on his return. To prevail here, respondent must show that petitioner omitted from his return an amount of gross income properly includable therein and that such omitted gross income exceeded 25 percent of the gross income actually reported by him. It is apparent that respondent has failed to meet his burden. We cannot accept the figure of $1,608,770.04 as the correct gross income and, on this record, it would be an impossible task to determine with any semblance of accuracy what portion of this figure represents gross income from the sale of goods or services. We conclude that respondent has not met his burden of proving that the 6-year statute of limitations provided in section 6501 (e)(1) is applicable. Consequently, we hold that assessment and collection of any deficiency for 1959 is barred by the statute of limitations. Decision will be entered for the petitioner. Footnotes1. All section references will be to the 1954 Internal Revenue Code↩, as amended, unless otherwise noted.2. The discrepancy between this figure which was shown to be the net profit from the business in the notice of deficiency and the $47,833.34 shown as the net business income in the computation above is not explained.↩3. It should be noted that the special agent's description of the spiral notebook did not coincide with petitioner's description of the cash receipts book kept by him.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623092/ | Farmers State Bank v. Commissioner.Farmers State Bank v. CommissionerDocket No. 766.United States Tax Court1945 Tax Ct. Memo LEXIS 322; 4 T.C.M. (CCH) 94; T.C.M. (RIA) 45043; January 25, 1945*322 Henry C. Moeller, C.P.A., 1124 Omaha Nat. Bank Bldg., Omaha, Nebr., for the petitioner. Gene W. Reardon, Esq., for the respondent. MELLOTTMemorandum Opinion MELLOTT, Judge: The Commissioner determined deficiencies in petitioner's income and excess profits tax as follows: ExcessYearIncome TaxProfits Tax1940$1,010.8119411,273.88$788.49The proceeding was submitted upon a stipulation of facts and the facts are found to be as stipulated. The question is whether the assessment or collection of tax is prohibited by section 3798(b) I.R.C.1*323 [The Facts] Summarizing the facts petitioner, a reorganized state bank of Nebraska, keeping its books on a cash basis and filing its returns with the collector of internal revenue in that state, had found, early in 1932, that its capital and surplus "were greatly impaired." The appropriate state department "furnished it with a schedule showing the procedural requirements for the reorganization of state banking institutions." Briefly they were that the old stockholders should vote an assessment on their stock in an amount sufficient to restore impairment of capital structure and make the bank solvent, and, after or contemporaneous with recapitalization, that depositors sign an agreement and waiver of withdrawal rights to the extent of 100% of all deposits. The creation of a "pool" in an amount sufficient to protect the reorganized bank against "all depositors who have not signed * * * and who may demand their deposits in full upon the reopening of the bank" was indicated to be an acceptable substitute for the last-mentioned requirement. On February 1, 1932, a 100 percent assessment was made against the stockholders ( $100 per share or $25,000) and the business of the bank was*324 suspended for purposes of reorganization. "Thereupon the old outstanding capital stock, par value $25,000, was cancelled and new capital stock, par value $25,000 was issued by the reorganized bank. Pursuant to an examination by certain committees under the approval of the State Banking Department, certain assets of the bank were charged off as worthless and others were partially charged off. The old surplus of $12,500 was eliminated and new surplus of $5,000 was contributed by the stockholders." "5. Further and additional money was needed to place petitioner bank in a sound and solvent condition, and accordingly, certain of the depositors of petitioner bank agreed * * * to pay from their deposits, or otherwise, for the purpose of forming a pool to comply with the request of the State Banking Department, the total amount of $115,335.47. In consideration therefor, the stockholders of petitioner desired to repay such depositors contributing to petitioner bank and pursuant thereto, on March 15, 1932, the stockholders entered into an agreement, a copy of which is attached hereto as Exhibit 3." The agreement referred to recited the substance of the facts shown above and stated: *325 * * * * *"AND WHEREAS, although said money was contributed as an absolute donation, to the bank, yet it is the mutual desire of all of the stockholders of said bank to repay said persons so contributing to the bank. "IT IS, THEREFORE, AGREED by and between the undersigned stockholders of said bank in consideration of our mutual promises and agreements herein contained, that said stockholders shall not receive any dividends of any kind or nature upon their stock in said Farmers State Bank, at Sargent, Nebraska, until said sums of money are repaid to said depositors in full; and for the purpose of making effective this said agreement, the following assignment and order is hereby made a part hereof, to wit: "'We the undersigned stockholders, owning the entire capital stock of said Farmers State Bank, Sargent, Nebraska, do hereby sell, assign, transfer and set over, any and all dividends of any kind or nature, as they may be declared and paid by said bank, to the persons and depositors who have contributed to the pool aforesaid; and we do hereby direct said bank and its officers to pay said dividends as they may become due to each of said contributors ratably in proportion to*326 the amounts so contributed.' "This assignment and order upon the bank for said dividends is to be continuing and shall follow the stock of each of us in the hands of any transferee either by assignment, pledge, execution or other mesne processes. And to obviate misunderstanding or fraud, the officers of the Farmers State Bank, shall endorse on each and every outstanding stock certificate of said Farmers State Bank, a statement, as follows: 'Dividends payable by this bank are assigned and pledged in accordance with a specific contract original of which is on file with the Department of Trade and Commerce at Lincoln, Nebraska, and a true copy of same on file the Farmers State Bank, at Sargent, Nebraska.' "The foregoing agreement shall be binding upon heirs, executors, administrators and assignees forever. "IN WITNESS WHEREOF, we have and do set our hands this 15th day of March, 1932." Under date of September 1, 1932, it was mutually agreed between petitioner and substantially all of its depositors that withdrawals of deposits existing as of February 1, 1932, should be limited to one percent per month until the bank should be able to operate as a going concern without such restriction. *327 This agreement provided that no interest should be paid upon the deposits existing on February 1, 1932. "7. On September 3, 1932, the Department of Trade & Commerce, Lincoln, Nebraska, and George C. Whalen, Assistant to the Receiver in Charge of the Farmers State Bank of Sargent, Nebraska, turned over all the books and records, assets, business and properties of the old bank in reorganization to the offices of the reorganized bank, and the Farmers State Bank of Sargent, Nebraska, was reopened and business was resumed. The original charter granted by the State of Nebraska to the Farmers State Bank, Sargent, Nebraska, has never been cancelled and the reorganized bank has continued to operate thereunder. "8. The following is a statement of the petitioner bank on September 3, 1932, after reorganization and when it resumed business: AssetsLoans and discounts (face value$207,445.72 written down to)$ 91,044.69Bonds and securities5,400.00Cash3,218.94Balances with banks (totals)7,457.11Balance with Receivership Division,Dept. of Banking30,453.47Banking House2,500.00Furniture and fixtures800.00Special deposit to cover deposits ofparties refusing to waive with-drawal rights3,709.61Total assets144,583.82LiabilitiesCapital stock$ 25,000.00Paid-in surplus5,000.00Undivided profits745.66Drafts outstanding8,569.15Certified checks1,125.00Frozen deposits - to be paid at therate of 1% per month58,800.86Released deposits32,162.49Contingent reserve for DepositorsFinal Settlement Fund9,471.05Special deposit - Security State Bank,Broken Bow (reserve set up fornon-waivers)3,709.61Total liability and capital$144,583.82*328 "9. Under the reorganization, loans and discounts of the old bank were written down in the amount of $116,411.03, and real estate of $19,860.00 was completely charged off. The aforementioned sum of $115,335.47, referred to in paragraph 5 above, which was waived by certain depositors and eliminated as a liability of the reorganized bank, was reduced to $11,530.95 by January 2, 1942, through voluntary payments from collections made from the above said assets written down and charged off and by the application of the bank's earnings as follows: "Amounts of deposits waived at the time of reorganization$115,335.47Payments fromAssets ChargedPayments fromOff andBank's EarningsWritten DownAugust 23, 1935$ 2,904.17$ 8,631.68May 1, 19365,073.966,457.89January 8, 19376,338.545,195.31August 30, 19374,192.407,341.45August 8, 19384,221.937,311.92June 30, 19399,053.012,480.84July 9, 19406,657.134,876.72January 14, 19418,166.593,367.23January 2, 19428,854.242,679.51Totals$55,461.97$48,342.55$103,804.52Balance January 2, 1942$ 11,530.95"10. The petitioner has never formally*329 declared a dividend since its reorganization in 1932, and the payments of earnings and collections from assets charged off and written down under the said reorganization were made to the said waiving and contributing depositors pursuant to the agreement of stockholders of Farmers State Bank, Sargent, Nebraska (Exhibit 3)." In its return for 1940 petitioner deducted - listing the amount on Line 17 "Rent" followed by the notation "Paid to Depositors Trust Fund" - $7,591.57. On the same line petitioner listed in its 1941 return $7,658.24, which it admits is the same type of payment. The claimed deductions were denied. The disallowance of the claimed deductions is not charged as error; but petitioner contends it is immune from the payment of any tax by section 3798 (b), supra. The instant case cannot be distinguished upon its facts from Peoples Bank, 43 B.T.A. 589">43 B.T.A. 589. Here, as there, by express agreement, the release given by the depositors was unconditional. The money was contributed "as an absolute donation." The provision of the contract looking to reimbursement before the stockholders claimed any dividends was not binding on the petitioner. The contributing depositors*330 neither asked nor were they given "a lien upon subsequent earnings of the bank." Their claims for reimbursement were against the stockholders who signed the contract and not "against assets segregated by such bank." The bank, as such, made no contract, granted no lien upon its earnings and segregated none of its assets. As we stated in Peoples Bank, supra, "the contracting parties, the stockholders, are without power to bind the bank's future earnings, which become petitioner's property as they arise and remain so until the declaration of dividends." Upon brief petitioner says: Ever since 1932 earnings of the bank have been credited to The Depositors' Trust Fund, and the fact that every year since 1932, the Stockholders Agreement, on file with the State Banking Department, has been lived up to by the bank constitutes sufficient evidence that the bank is the real party granting the lien on subsequent earnings to its waiving depositors. It is an undisputed fact that regardless of the imperfections in drawing up the necessary instrument, the taxpayer has continuously, since 1932, applied its earnings on depositors' claims, and it constitutes the very best evidence of*331 what was intended to be done in the beginning. This, it contends, shows that there was an equitable lien. We do not agree. No extended discussion of equitable liens is required. Such a lien, it has been said, may arise * * * from a written contract which shows an intention to charge some particular property with a debt or obligation, or is implied and declared by a court of equity out of general considerations of right and justice as applied to the relations of the parties and the circumstances of their dealings. 10 R.C.L. 351. The written contract here shows no intention to charge some particular property of the bank. The purpose of the agreement was exactly the opposite. Nor has there been any fraud, duress, undue influence, overreaching, or unconscionable dealing by a fiduciary or any other circumstance requiring the intervention of a court of equity. Even if it be assumed that petitioner felt it was morally obligated to reimburse the depositors, no equitable lien existed; for such a lien cannot be based purely upon a moral obligation. Stansell v. Roach, 147 Tenn. 183">147 Tenn. 183, 246 S.W. 520">246 S.W. 520. It is fundamental that a taxpayer seeking immunity from tax must bring itself*332 strictly within the terms of the provisions of the statute granting it. Retailers Credit Association of Alameda County v. Commissioner, 90 Fed. (2d) 47; Producers Creamery Co. v. United States, 55 Fed. (2d) 104; Participation Holding Co., 1 T.C. 852">1 T.C. 852. Petitioner, in our judgment, has not sustained this burden. One other circumstance may be adverted to which tends to support the conclusion we have reached. The parties have stipulated that some of the reduction occurred "through voluntary payments from collections made from * * * assets written down and charged off * * *." The fact that the payments were voluntarily made is at least a circumstance indicating that no legal obligation to make them existed. We are of the opinion and accordingly hold that the Commissioner committed no error in determining the deficiencies in tax. Decision will be entered for the respondent. Footnotes1. SEC. 3798. EXEMPTION OF INSOLVENT BANKS FROM TAX. * * * * *(b) Whenever any bank or trust company, a substantial portion of the business of which consists of receiving deposits and making loans and discounts, has been released or discharged from its liability to its depositors for any part of their claims against it, and such depositors have accepted, in lieu thereof, a lien upon subsequent earnings of such bank or trust company, or claims against assets segregated by such bank or trust company or against assets transferred from it to an individual or corporate trustee or agent, no tax shall be assessed or collected, or paid into the Treasury of the United States on account of such bank, or trust company, such individual or corporate trustee or such agent, which shall diminish the assets thereof which are available for the payment of such depositor claims and which are necessary for the full payment thereof.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623093/ | Abraham Freitag and Eva Freitag, His Wife v. Commissioner.Freitag v. CommissionerDocket No. 9018.United States Tax Court1948 Tax Ct. Memo LEXIS 268; 7 T.C.M. (CCH) 26; T.C.M. (RIA) 48005; January 23, 1948Martin Schwaeber, Esq., for the petitioners. William F. Evans, Esq., for the respondent. HARRON Memorandum Findings of Fact and Opinion HARRON, Judge: The Commissioner determined deficiencies in income and victory tax and penalties as follows: YearDeficiencyPenalty1943$72,508.51$54,381.39194433,830.4218,606.73The deficiencies and penalties were assessed under the provisions of the Internal Revenue laws applicable to jeopardy assessments. In the statement attached to the notice of deficiency, the respondent stated as follows: "This determination of your income and victory tax liability is made upon the basis of information from the file in the Bureau. "The fifty per cent penalty is asserted in accordance with the provisions of section 293(b) of the Internal Revenue Code. "Inasmuch as you failed to file a return for the taxable year 1943 and since your return for the taxable year 1944 was not filed within the time prescribed by law, twenty-five and five per centum, respectively, of the tax has been added thereto in accordance with the provisions of*270 section 291(a) of the Internal Revenue Code. "The Deficiencies and penalties disclosed herein were assessed with interest under the provisions of section 273 of the Internal Revenue Code on First New York Special No. 3 List, dated March 31, 1945." The petitioners filed a petition appealing from the determinations of the respondent for the years 1943 and 1944 in which it is stated that the petitioners resided in Brooklyn, New York, and that the return for the year 1944 was filed with the collector for the second district of New York. The petitioners, in their petition, denied that they had received income in the years 1943 and 1944 in certain amounts; they alleged that no penalties should accrue for the year 1943 because petitioners had no taxable income for that year, and that no penalty should accrue against the petitioners for the year 1944 because the petitioners had no taxable income in addition to the income reported in the return which was filed for the year 1944, and that there should be no penalty for lateness in filing the return for 1944. The respondent, in his answer, made affirmative allegations in support of imposition*271 of the penalties under sections 293(b) and 291(a) of the Internal Revenue Code. The respondent alleged that the petitioners had received certain income during the taxable years 1943 and 1944 which they had willfully and fraudulently failed to report with intent to evade the payment of tax. This proceeding was placed upon the circuit calendar for New York City beginning October 6, 1947, and was called from the calendar for trial. Petitioners failed to appear. They advised the Court that they would default. The respondent offered evidence in support of his affirmative pleadings. The record in this proceeding includes testimony of witnesses for the respondent, and various exhibits which were received in evidence. Findings of Fact Petitioners are husband and wife. Petitioners filed a joint income tax return for the calendar year 1944 on April 16, 1945. The respondent, through a collector, granted petitioners extension of time to April 15, 1945, within which to file an income tax return for the year 1944. The return was filed one day late. The petitioner, Abraham Freitag, did business as an individual under the name of Bias Coaters Company. Also, he owned*272 all of the stock of a corporation known as Bias Coating Corporation. The address of Bias Coaters Company and Bias Coating Corporation was the same, 35 York Street, Brooklyn, where a plant was operated in the manufacture of bandages. Abraham Freitag also owned stock of Korex Company which was organized in 1943. Corporation income and declared value excess profits tax returns, Form 1120, were filed for Bias Coating Corporation for the years 1943 and 1944. The return for 1943 reported gross sales $104,393.93, gross income $9,456.14, total expenses $10,693.03, and net operating loss of $1,236.89. The return for the year 1944 gave a New York City address for the corporation and reported it as inactive. The return reported no profit and no taxes due. On March 28 and March 29, 1945, proceedings were instituted by the United States Attorney in the United States District Court for the Southern District of New York, by filing of information in the following causes: United States v. Abraham Freitag and Harry Washer, Defendants, Docket No. C120-84; United States v. Bias Coating Corporation, Abraham Freitag and Harry Washer, Defendants, Docket No. C120-85; and United States v. Bias Coating*273 Corporation and Abraham Freitag, Docket No. C120-111. The defendants were charged in the respective complaints with violation of certain Federal statutes relating to regulation of priorities and failure to keep records required by law in Title 50, Appendix Section 633, U.S. Code, and the rules, regulations, and orders issued pursuant thereto; and with making willful and unlawful sales of finished piece goods to various concerns for stated prices which constituted higher prices per yard than the maximum price per yard for finished piece goods set forth in Maximum Price Regulations under Title 50, Appendix Section 901 et seq., United States Code, and in Maximum Price Regulation No. 127 and amendments thereto. Respondent's Exhibits E, F, G, and H, copies of the complaints filed against the above-named defendants, and of the judgments of the court are incorporated herein by this reference. Abraham Freitag pleaded guilty on certain counts for himself and Bias Coating Corporation. In the proceeding against Freitag and Washer, defendants, Docket No. C120-84, Freitag pleaded guilty, on May 25, 1945, to 15 charges, including that of failure to keep complete records of sales, prices received, *274 and all matters necessary to verify maximum prices received. By his plea of guilty, Freitag admitted making sales of finished piece goods during 1943 in the aggregate of 191,553 yards for the total price of $54,244.63; and making sales in 1944 of 104,301 1/4 yards for $26,777.98. In the proceeding against Bias Coating Corporation, Freitag, and Washer, defendants, Docket No. C120-85, Bias Coating Corporation by Freitag, president, and Freitag pleaded guilty, on May 25, 1945, to ten charges, including failure to keep complete records. By the plea of guilty, the corporation and Freitag admitted making sales of finished piece goods in 1943 and 1944 as follows: 1943, 24,287 yards for $8,014.71; 1944, 229,435 yards for $48,185.55. In the proceeding against Bias Coating Corporation and Freitag, Docket No. C120-111, Bias Coating Corporation and Freitag, on May 25, 1945, pleaded guilty to 20 charges. By the plea of guilty, the corporation and Freitag admitted to making purchases of various goods such as sheeting, nainsook and muslin in violation of priorities regulations during 1942, 1943 and 1944 as follows: 194214,490yards of Gonic cloth370,538yards of Sheeting194350,307yards of Alwyn cloth58,280yards of Printed Percales102,408yards of Muslin302,872yards of Print cloth401,074yards of Nainsook750,836yards of Sheeting194450,093yards of Muslin642,664yards of Bleached Nainsook451,006yards of SheetingRecapitulation of Purchases for1942, 1943, 19441,572,380yards of Sheeting1,043,738yards of Nainsook302,872yards of Print cloth152,501yards of Muslin123,077yards of Gonic, Alwyn and Percales3,194,568yards of goods*275 Recapitulation of Sales of Goods and Receipts 1943191,553yards finished goods for$54,244.6324,287yards finished goods for8,014.71215,840yards finished goods for$62,259.341944104,301 1/4yards finished goods for$26,777.98229,435yards finished goods for48,185.55333,736yards finished goods for$74,963.53The United States District Court entered Judgments and Commitments on May 31, 1945 against Bias Coating Corporation and Freitag, co-defendants, imposing fines aggregating $70,000; and committing Freitag to imprisonment for one year on each charge, to run concurrently in C120-84, and in C120-85 to run consecutively after service of sentence in C120-84; and to imprisonment for one year on each charge in C120-111, to run concurrently. On June 18, 1945, Freitag was imprisoned at Danbury, Connecticut. Petitioner, Eva Freitag, had an account during the year 1943 with a branch of the Manufacturers Trust Company located at 209 Montague Street, Brooklyn. Deposits were made in this account, according to deposit slips, as follows: October 8, 1943$ 6,500October 14, 19435,000October 22, 19435,000October 25, 19438,000October 25, 1943300Total$24,800*276 During 1943 and 1944 two accounts were maintained with The Merchants Bank of New York in the names of Bias Coating Corporation (the corporation) and Bias Coaters Company (the sole proprietorship). Checks were drawn on each of these accounts which were signed for the corporation and for the sole proprietorship, respectively, either by Abraham Freitag or Eva Freitag. During 1943 and 1944, some of the checks which were drawn on the account of Bias Coaters Company, the sole proprietorship, were made payable to cash or to Abraham Freitag or Eva Freitag as follows: May 7, 1943 Mrs. Eva Freitag (endorsed by same)$ 100June 9, 1943 A. Freitag (endorsed by same)60Sept. 3, 1943 A. Freitag (endorsed by same)200Nov. 11, 1943 A. Freitag (endorsed by same)100April 27, 1944 Cash (endorsed by E. Freitag)4,000May 26, 1944 Cash (endorsed by A. Freitag)550June 15, 1944 Cash (endorsed by E. Freitag)2,000During 1943 checks were drawn on the account of Bias Coating Corporation, the corporation, which were made payable to cash or to Abraham Freitag as follows: June 20, 1943 Cash (endorsed A. Freitag)$ 930May 7, 1943 Abraham Freitag50May 14, 1943 A. Freitag75June 9, 1943 A. Freitag, Spec.1,000*277 Other withdrawals were made from each of the above-described bank accounts for the personal use of petitioners. Investigation was made of the business activities of Abraham Freitag, Eva Freitag, Julius Levine, the father of Eva Freitag, Bias Coaters Company, and Bias Coating Corporation for the years 1943 and 1944 by two agents of the Bureau of Internal Revenue. The investigation extended over a period of 90 working days. The activities of Harry Washer, an individual who disposed of materials for the above-named persons and concerns, were investigated also. The investigations showed that Abraham Freitag did business through Bias Coating Corporation and Bias Coaters Company, and that he did business under the name of Abraham Freitag. During 1943 and 1944 the activities of Abraham Freitag consisted of transactions with respect to the manufacture and sale of bandages and cotton goods and muslin. He purchased material which he was supposed to have manufactured into bandages for Government contracts, and he maintained a storage place where he stored materials which he acquired under priorities which were subsequently sold and from the sales of which income was derived during 1943*278 and 1944. At the time of the investigation, the records maintained by Abraham Freitag were in such state that it was impossible to determine accurately the income derived from the various transactions. Because of the state of the records, the revenue agents canvassed all of the cotton goods houses in New York City to determine the purchases of materials and where materials were sold, and they secured the records of various people. On the basis of such investigation the revenue agents reconstructed sales, cost of sales, and operating expenses for 1943 and 1944. They determined that the total sales made by Bias Coating Corporation, Bias Coaters Company, Abraham Freitag, Eva Freitag, and Julius Levine amounted to $459,826.52 for the year 1943, that the cost of the sales amounted to $327,763.87; that overhead and operating expenses amounted to $38,855.02, and that the resulting profit for 1943 was $93,207.63. The revenue agents found that the gross sales for 1944 amounted to $186,802.18, cost of sales amounted to $77,246.52, operating expenses amounted to $22,106.64, and profit amounted to $87,449.02. Some records were kept by Bias Coating Corporation and Bias Coaters Company, but*279 these records did not actually contain all of the transactions entered into by either concern or by Abraham and Eva Freitag, and Julius Levine. The revenue agents determined that no individual income tax returns were filed by either Abraham or Eva Freitag for the year 1943. They determined further that the joint income tax return for 1944 which was filed by the petitioners understated the income of the petitioners for the year 1944. The revenue agents determined that income for the years 1943 and 1944 as reported in the returns filed by Bias Coating Corporation did not reflect certain transactions entered into by Abraham and Eva Freitag, and others. The revenue agents found during their investigations that Harry Washer, an individual, carried on business transactions for Abraham Freitag, Bias Coating Corporation, Bias Coaters Company, Eva Freitag, and Julius Levine. The services performed by Harry Washer were disposing of goods. During 1943, Harry Washer disposed of goods from the sales of which he received the net amount, after his commissions, of $280,190.33; and he disposed of goods during 1944, from the sales of which he realized the net amount of $138,164.73. Washer turned*280 over the above sums either to Bias Coating Corporation, Bias Coaters Company, Abraham Freitag, Eva Freitag, or Julius Levine. The goods sold by Washer consisted of uncut yardage, cotton goods. The revenue agents found during the course of their investigations that Washer disposed of some materials for Freitag by making sales to Oxford Handkerchief Company, A. Rubio, and Dardebwan Trading Company; and that S. Woolman, Inc., and Elson Company sold goods to Freitag. The percentage of profit made on the sales of yardage goods by Washer ran from 33 1/3 per cent to 100 per cent. Harry Washer resided in Brooklyn and maintained a place of business at his residence. His business was that of salesman of cotton goods. He sold cotton goods for Abraham Freitag during 1943 and 1944. He sold a considerable amount of goods, receiving a commission for his sales of from one and one-half to two cents a yard. Washer made payment of the amount of sales, less commissions, by checks. At some time he gave his cancelled checks to the Bureau of Internal Revenue for examination. He paid large amounts to Freitag and his companies. He paid by customers' checks and his own checks $280,190.33 during the year*281 1943 and $138,164.73 during 1944. Washer was told by Freitag to make payments of proceeds of sales to Bias Coating Corporation in some instances, and in other instances to either Bias Coaters Company or to Abraham Freitag, Eva Freitag, or Julius Levine. The proceeds which Washer paid to Freitag and other individuals were paid in cash. Korex Coating Company, a corporation, was organized in 1943 by Abraham Freitag and an individual named Lawrence to carry on a business of converting fabrics for the slipper and shoe industry. At some time Freitag became the owner of all of the stock of this company. In June 1944, Freitag sold 75 per cent of the stock of Korex Company to Louis Plever, who paid $19,000 by check and by cash to Abraham Freitag. Korex Company paid Freitag a salary during 1943. According to the books of Korex Company, the salary paid to Freitag during 1943 and 1944 amounted to $800 and $2,629, respectively. For the year 1943, the respondent determined that the petitioners received net income in the total amount of $105,407.78, representing dividends from Bias Coating Corporation in the amount of $97,107.78, compensation for services to Bias Coating Corporation in the amount*282 of $7,500, and compensation from Korex Coating Company in the amount of $800. Respondent determined that the income and victory tax on the 1943 net income amounted to $72,508.51. Since no return was filed and no tax was paid for 1943 the amount of $72,508.51 represented a deficiency in income and victory tax. The penalties added to the tax deficiency for 1943 were as follows: Fifty per cent of the deficiency, $36,254.26; and 25 per cent of the deficiency, $18,127.13; total penalties, $54,381.39. The joint income tax return for 1944 which was filed by the petitioners reported the following: Long-term capital gain of $4,775 from the sale of stock in Korex Coating Company; net loss of $15,978.93 from the business done under the name of Bias Coaters Company; income from miscellaneous sources in the amount of $70,000; and income from Korex Coating Company in the amount of $2,629.31. The adjusted gross income was reported as $61,425.38. The amount of the income tax reported on the return was $34,364.80. In his audit of the joint return of the petitioners for 1944, the respondent made determination as follows: (a) That petitioners had received but failed to report for taxation $7,500*283 compensation and $16,796.48 dividends from Bias Coating Corporation, and $45 dividends from other sources, totalling $24,341.48 unreported income. (b) That petitioners had overstated in the return income from Korex Coating Corporation in the amount of $130.49, and gains from sales of securities in the amount of $155.83, the total overstatement of income amounting to $286.32.(c) That a deduction in the amount of $15,978.93, reported as a loss, was not allowable because it did not represent a loss sustained during the taxable year within the meaning of section 23(e) of the Internal Revenue Code. The determinations resulted in increasing the net income for 1944 by the net amount of $40,034.09, so that net income was determined to be $101,459.47, and the deficiency in income tax amounted to $33,830.42. The respondent added to the tax deficiency a 50 per cent penalty of $16,915.21, for failure to report income; and a 5 per cent penalty of $1,691.52 for the late filing of the 1944 return; total penalties, $18,606.73. Ultimate Findings of Fact Abraham Freitag individually and through Bias Coating Corporation and his other agencies and agents purchased goods under*284 priorities and resold them during 1943 and 1944 in violation of Federal statutes and regulations promulgated thereunder. The gross sales of Abraham Freitag, Bias Coaing Corporation and other agencies and agents of Abraham Freitag amounted to at least $459,826 in 1943, and $186,802 in 1944. The indictments of Abraham Freitag and Bias Coating Corporation in the United States District Court, and the convictions of Abraham Freitag on his pleas of guilty, were in respect to the operations from which the profits and income were derived for which deficiencies in tax and penalties were asserted by the respondent for 1943 and 1944. The selling operations of Harry Washer during 1943 and 1944 yielded income in 1943 and 1944 to Abraham Freitag and/or Bias Coating Corporation for which deficiencies in tax and penalties were asserted by the respondent for 1943 and 1944. Neither Abraham Freitag nor Bias Coating Corporation kept adequate records of transactions and of the income derived therefrom. The income tax returns of Bias Coating Corporation for 1943 and 1944 did not reflect income derived from operations for which the corporation was indicted in the United States District Court and to which*285 Freitag pleaded guilty for the corporation in District Court Docket Numbers C120-85 and C120-111, or from the selling operations of Harry Washer for the corporation. Bias Coating Corporation had net income in the amount of $97,107.78 in 1943, and $86,796.48 in 1944. Abraham Freitag received from Bias Coating Corporation distributions amounting to $97,107.78 in 1943, and $86,796.48 in 1944. He failed to report for income tax, $97,107.78 for 1943, and $16,796.48 for 1944 fraudulently with intent to evade Federal tax. He received, also, from Bias Coating Corporation as compensation for services rendered $7,500 in 1943, and $7,500 in 1944, which amounts he failed to report for income tax fraudulently with intent to evade Federal tax. Abraham Freitag received as compensation for personal services in 1943, $800 from Korex Coating Corporation. The income of Abraham Freitag for 1943, which he failed to report for income tax, amounted to $105,407.78. Part of the deficiency in income tax for the year 1943, $72,508.51, is due to fraud with intent to evade tax. The failure of Abraham Freitag to file an income tax return for 1943 was due to fraudulent intent to evade income tax. The income*286 of Abraham Freitag for 1944 which he received from Bias Coating Corporation, which he failed to report for tax, consisting of compensation for services and corporate distributions, aggregated $24,296.48. His understatement of income from this source was due to fraud with intent to evade tax. Part of the deficiency for 1944 is due to fraud with intent to evade tax. Petitioners received in 1944 dividends of $45 from other sources. Petitioners did not sustain a loss in 1944 in the amount of $15,978.93. Abraham Freitag received $2,629 from Korex Coating Company in 1944, which was reported in the joint return. Petitioners failed to make and to file income tax returns for the year 1943. The failure to make and to file returns was not due to reasonable cause but was due to willful neglect. Petitioners failed to file the joint return for the year 1944 within the time prescribed by the Commissioner in pursuance of law. The joint return was filed late, one day after the time prescribed by the Commissioner. The failure to file the return timely was not due to reasonable cause but was due to willful neglect. Opinion There are three general issues, and in two of them the burden of proof*287 fell upon the petitioners to introduce evidence to show that the respondent's determinations for 1943 and 1944 were incorrect. After due notice of trial, petitioners failed to appear and their counsel, who did appear, advised the Court that petitioners would not offer evidence. Respondent had the burden of proof under the third issue involving fraud penalties, and he offered evidence. No brief has been filed by petitioners. Petitioners made no appearance through counsel on the day when respondent presented evidence under his burden of proof. Petitioners filed a joint return for 1944 which was signed by both persons. The notice of deficiency was addressed to both petitioners by name and as "Husband and Wife." The petition in this proceeding was filed under the caption "Abraham Freitag and Eva Freitag, his wife, petitioners," and it was signed by Eva Freitag and Abraham Freitag. The petition does not raise any issue regarding the question of the joint and several liability of the petitioners for deficiencies and penalties for both years 1943 and 1944, and it does not raise any issue regarding the propriety of respondent's determination of joint and several liability for the year*288 1943, the year for which no return was filed. In the absence of the presentation of any issues by the pleadings on these matters, we do not consider any question of liability under such general issues. Cf. Joseph Calafato, 42 B.T.A. 881">42 B.T.A. 881; aff'd., 124 Fed. (2d) 187. Issue 1. - Deficiencies in income tax for 1943 and 1944 Petitioners having failed to offer any evidence to overcome the prima facie correctness of the respondent's determinations that income from various sources was received in each taxable year, it has been found as a fact upon failure of proof that Abraham Freitag received income in 1943 which aggregated $105,407.78, and that he received income in 1944 in addition to that which was reported in the joint return in the aggregated amount of $24,296.48, plus $45 dividends from "other sources." It has been found also, for failure of proof, that petitioners did not sustain a loss in 1944 of $15,978.93. It has been found as a fact that compensation in 1944 from Korex Corporation amounted to $2,629. Under this general issue, respondent's determinations for 1943 and 1944 which have resulted in deficiencies in income tax for each year in the respective*289 amounts of $72,508.51 and $33,830.42, are sustained. The decision under separate order will be that there are deficiencies in income tax for the taxable years in the above amounts. Adjustment of a small item of compensation from Korex Corporation in 1944 has not been brought into issue, and in this connection respondent has not asked for any increase in the deficiency for 1944. 1Issue 2. - Penalties for failure to make and file returns imposed under section 291 (a) of the Internal Revenue Code Petitioners failed to offer evidence, as it was their burden to do, to show that the respondent erred in imposing a penalty of 25 per cent of the 1943 deficiency for failure to make and file income tax returns for 1943; and in imposing a penalty of 5 per cent of the 1944 deficiency for the late filing of the joint return for 1944. The penalty is an addition to the deficiency in each year. Accordingly, respondent's determinations*290 in adding to the deficiencies for 1943 and 1944 the 25 per cent and 5 per cent penalties under the provisions of section 291 (a) of the Internal Revenue Code are sustained upon the finding, for failure of proof, that the failure to file returns for 1943 and the late filing of the joint return for 1944 were not due to reasonable cause but were due to willful neglect. Issue 3. - Fraud penalties imposed under Section 293 (b) of the Internal Revenue Code It has been found in the findings of fact that Bias Coating Corporation paid Abraham Freitag as compensation for services $7,500 in each year 1943 and 1944, and that the corporation had distributable income of $97,107.78 and $86,796.48 in the respective taxable years. These findings have been made upon the basis of failure of proof, as stated above under Issue 1. But they have been made upon consideration, also, of all of the evidence adduced by the respondent. Having found that Abraham Freitag received income as above stated in the taxable years, there remains the question whether his failure to report such income for 1943 and his understatement of income for 1944 was fraudulent with*291 intent to evade tax. Under section 1112 of the Internal Revenue Code respondent had the burden of proving that all or part of the deficiencies are due to fraud. Respondent's evidence relates to all of his determinations that Abraham Freitag had certain items of income in 1943. With respect to respondent's determinations for 1944, his evidence under the fraud issue relates only to income received from Bias Coating Corporation as compensation and dividends. Therefore, our consideration of fraud with respect to the understatement of 1944 income does not relate to three items which respondent adjusted and added to the income of petitioners for 1944, namely, the loss deduction, the item of $45 of dividends, and the adjustment of income received from Korex Corporation. These proceedings involve two petitioners, a joint return of husband and wife having been filed for the year 1944 by Abraham Freitag and Eva Freitag, his wife, and both having signed the return. Respondent does not concede that the issue involving the fraud penalties does not involve Eva Freitag. There is no issue presented regarding the joint and several liability of the petitioners for the total*292 taxes and penalties. It is pertinent to observe that this Court has no jurisdiction over the collection of taxes. The determinations made by the respondent for 1943 and 1944 that "dividends" were received, but not reported for tax, from Bias Coating Corporation necessarily relates only to Abraham Freitag because he was the sole stockholder of the corporation. Other determinations for 1943 and 1944 relating to compensation for services to Bias Coating Corporation appear to involve only Abraham Freitag. During the year 1943, petitioners apparently lived together as husband and wife. Neither filed a separate return. No return was filed for 1943. Cf. Joseph Calafato, supra.For the year 1944, a joint return was filed. Respondent's evidence under the fraud penalty issue does not cover clearly and convincingly any activities or receipts of separate income by Eva Freitag for the years 1943 and 1944. We consider it necessary to point out that respondent's evidence under this issue does not relate to Eva Freitag. The record does not show that any of the income in question belonged to her. We mention this point to make it clear that our considerations under this issue do not*293 relate to the wife of Abraham Freitag. We observe that respondent made some effort to prove that Eva Freitag received income by drawing checks on the accounts of Bias Coaters Company, and that deposits in her bank account showed that she had funds in 1943 and 1944. Some items were read into the record by respondent's counsel from bank deposit books. This detail is not evidence that bank deposits represented income of Eva Freitag. It was not offered properly. It has not been considered. The findings of fact show all that the record contains regarding any alleged income of Eva Freitag. Our considerations of the evidence under this issue, therefore, relate only to Abraham Freitag. Respondent has failed to meet his burden of proof under the fraud penalty issue with respect to petitioner, Eva Freitag. The returns of petitioners for 1943 would have been due in March of 1944. At that time Bias Coating Corporation and Abraham Freitag had not been indicted in the United States District Court. Pleas of guilty to certain charges were not filed until May 25, 1945, which was after the joint return for 1944 was filed. In this proceeding there has been made in silence, by default under the issues*294 relating to the receipts of income in 1943 and 1944, admission that petitioner had some income in 1943 which gave rise to liability for income tax, and more income in 1944 than was reported. The entry of pleas of guilty to the many charges made by the Government against Freitag and his corporation have established that they purchased large quantities of goods illegally and sold them at above - O.P.A. prices in 1943 and 1944, and that, thereby, income from unlawful business practices was received by either Freitag, individually, or by his corporation, or both. Income from unlawful activities is subject to income tax under the broad scope of section 23 (a) of the Internal Revenue Code. See United States v. Sullivan, 274 U.S. 259">274 U.S. 259. Since the income from unlawful operations was taxable, a return for 1943 was required, and complete disclosure of all taxable income for 1944 was required under statute. The fact that the income was acquired unlawfully did not relieve Freitag from the requirement of filing a return for 1943 and a complete disclosure of 1944 income, even though filing returns and revealing income would have brought Freitag before a Court for*295 violations of Federal laws. United States v. Sullivan, supra. Therefore, the dangers inherent in reporting to the Government all taxable income for the taxable years cannot be taken as raising any implications favorable to petitioner. Rather, it is reasonable to infer that petitioner willfully intended to conceal income received from his illegal business activities. Respondent has introduced evidence under his statutory burden of proof with respect to the fraud penalties, as he had to do. Petitioner's failure to appear did not relieve respondent of his burden of proof. See Miller-Pocahontas Coal Co., 21 B.T.A. 1360">21 B.T.A. 1360, 1362, where it was said, "It may be that the lack of opposition lightens the burden as a practical matter, but respondent is entitled to no more." Respondent relies upon the findings of his revenue agents made upon their investigations, the testimony of Harry Washer, and the complaints made by the Government in the three proceedings in the U.S. District Court to which pleas of guilty were entered. Because petitioner defaulted in the issues in which he had the burden of proof relating to the amounts of his income in the taxable years, and because respondent's*296 determinations that petitioner received certain items of income in 1943 and 1944 are prima facie correct, respondent has considered that his burden of proof did not extend to showing the amounts of petitioner's income for 1943 and 1944. Because of the prima facie correctness rule and petitioner's income for 1943 and 1944. Because of the prima facie correctness rule and petitioner's election not to overcome such by introduction of evidence, consideration of the fraud question starts with the conclusion that Freitag's income for 1943 was $105,407.78, and for 1944 was $101,459.47, and was understated for 1944 as respondent has determined. The only question is whether Freitags' failure to report income was fraudulent with intent to evade tax. Upon the evidence before us we must conclude that there was fraudulent intent to evade tax. Freitag and his corporation admitted to failing to keep records of transactions in violation of law. As respondent points out, failure of a business operator to keep books is indicative of intent to conceal assets in bankruptcy cases. See In re Weisberger, 41 Fed. (2d) 275. Taxpayers are required to keep records for tax purposes. Section 54 (a), Internal Revenue Code*297 ; Regulations 111, Sec. 29.54-1. No other conclusion can be drawn from the record before us, and particularly from testimony of Harry Washer, than that Freitag had the intent of arranging his affairs so that the Government would not easily discover his illegal business operations, and that the intent extended to concealing income from the reach of taxation. The question under this issue is controlled by Harry Feldman, 34 B.T.A. 517">34 B.T.A. 517, 520, where it was said, in part, as follows: "All the revenue acts have required taxpayers to submit under oath 'true and accurate' returns, 'setting forth specifically the gross amount of income from all separates sources.' The returns thus made constitute the basis upon which the Government relies for the collection of its revenues. It has a right to rely upon such returns being correctly made, and a wilful omission of income, or a deliberate and intentional failure to report substantial amounts actually received, if not actually constituting a fraud upon it, is at least substantial evidence tending to establish fraud. (Cf. Joseph Cararoro, 29 B.T.A. 646">29 B.T.A. 646; D.C. Clarke, 22 B.T.A. 314">22 B.T.A. 314; Tanner Oil Co., 20 B.T.A. 794">20 B.T.A. 794;*298 M. Rea Gano, 19 B.T.A. 518">19 B.T.A. 518; Charles F. Long, 12 B.T.A. 488">12 B.T.A. 488.)" It is held that petitioner, Abraham Freitag, willfully and intentionally omitted from his return for 1944 the substantial sum of $24,341.48, and willfully and intentionally failed to report substantial amounts of income which he actually received in 1943. The statutory provision, section 293 (b), Internal Revenue Code, provides for the penalty in question if any part of any deficiency is due to fraud. See Mauch v. Commissioner, 113 Fed. (2d) 555. Decision will be entered under Rule 50. Footnotes1. Petitioners reported compensation from Korex in the 1944 return in the amount of $2,629.31, which respondent reduced to $2,498.82. S. Klinger testified that Korex paid Freitag $2,629 in 1944. Respondent passes over this item on brief.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623095/ | DANIEL and MARGUERITE WALSH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; BRANDYWINE PRODUCTS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWalsh v. CommissionerDocket Nos. 3720-79 and 3721-79.United States Tax CourtT.C. Memo 1981-336; 1981 Tax Ct. Memo LEXIS 408; 42 T.C.M. (CCH) 267; T.C.M. (RIA) 81336; June 29, 1981*408 Amounts paid as reasonable compensation determined. Held these amounts are deductible under section 162(a)(1), I.R.C. 1954, and constitute "earned income" for purposes of the limitations on tax ("maxitax") provided by section 1348, I.R.C. 1954. John M. Bernard and Lewis M. Hendler, for the petitioners. Gordon F. Moore, II, for the respondent. CHABOTMEMORANDUM FINDINGS OF FACT AND OPINION CHABOT, Judge: Respondent determined deficiencies in Federal income taxes against the individual and corporate petitioners as follows: PetitionersDocket No.YearAmountDeniel and Marguerite Walsh3720-791974$ 32,980.88197510,709.48Brandywine Products, Inc.3721-791974$ 343,640.00197545,765.00 These cases have been consolidated for trial, briefs, and opinion. The issue for decision is the extent to which amounts paid to Daniel Walsh by Brandywine Products, Inc., were reasonable compensation (within the meaning of section 162(a)1*409 ), were deductible by Brandywine Products, Inc., and constituted "earned income" to Daniel Walsh for purposes of the limitations on tax ("maxitax") provided by section 1348. 2FINDINGS OF FACT Some of the facts have been stipulated; the stipulation and the stipulated exhibits are incorporated herein by this reference. Petitioner Brandywine Products, Inc. (hereinafter sometimes referred to as "Brandywine"), is a Pennsylvania corporation. When its petition in this case was filed, Brandywine's principal office and place of business was in North Wales, Pennsylvania. When their petition in this case was filed, petitioners Daniel Walsh (hereinafter sometimes referred to as "Daniel") and Marguerite Walsh, husband and wife, resided in Furlong, Pennsylvania. Brandywine was incorporated in 1952; it reported its income using the accrual method of accounting on a calendar-year basis. Since its incorporation, Brandywine was engaged in the business of fabricating precision metal parts for machinery. During the years in issue, it specialized in the production of large-scale *410 rotary components required by the electrical power generating industry for nuclear, steam, and gas turbines; this is a high-technology business. Brandywine undertook what may be described as production contract machining; that is, fabricating customized parts in accordance with the drawings and specifications of its customers. It had no standardized or proprietary parts. The parts which Brandywine fabricated vary in weight from ounces to 5,000 pounds and in diamester from inches to sixteen feet. Some parts could be fabricated to a tolerance of +-.0001 inch. The time required for Brandywine to fabricate a part could vary from thirty seconds to one hundred or more hours. From one to six or seven machines may be required to fabricate a part. The time needed for Brandywine to set up a machine to fabricate a part could take as long as two days to a week. There were ten to twelve machine shops and there may have been another one hundred "cellar" shops 3 in the Philadelphia area, all of which might compete with Brandywine for a given job. Brandywine made sales to some customers outside the Philadelphia area, making the number of competitors outside that area (as well as those located *411 in that area) of some concern to Brandywine. The only shareholders of Brandywine, and the number of shares owned by each from its incorporation through 1975 are shown in table 1. Table 1 1952 through 19641965 through 1975ShareholdersShares%Shares%Daniel8033-1/36828-1/3John Walsh8033-1/36828-1/3Stanley Karminski8033-1/36828-1/3Edward McBryan3615240240John Walsh is Daniel's brother. Stanley Karminski is the brother-in-law of Daniel and John Walsh. Edward McBryan is not related to Daniel, John Walsh, or Stanley Karminski, but was a college classmate of Daniel. (Daniel, John Walsh, Stanley Karminski, and Edward McBryan are hereinafter sometimes collectively referred to as "the principals".) From 1972 through the years in issue, the principals managed Brandywine's business operations and affairs. From the time they acquired their shares in Brandywine, the principals served as directors and officers of Brandywine. From 1965 through the years in issue, the principals held the offices in Brandywine indicated in table 2. Table 2 NameTitleDanielVice PresidentStanley KarminskiPresidentJohn WalshProduction SupervisorEdward McBryanSecretary-TreasurerThrough *412 1973, Brandywine compensated the principals equally. For 1969 through 1973, each of the principals received fixed cash compensation as indicated in table 3. Table 3 YearAmount1969$ 46,500197060,500197160,000197240,000197385,000On September 5, 1972, Brandywine's board of directors unanimously adopted resolutions in part decreasing each officer's salary for 1972 to $ 40,000 (from the $ 60,000 annual salaries paid for 1971) and committing Brandywine to make up this $ 20,000 salary reduction as soon as Brandywine would be able to do so. In 1973 and in 1974, Brandywine paid each of the principals $ 10,000 pursuant to unanimous resolutions of the board of directors (dated February 20, 1973, and March 1, 1974, respectively) directing that such payments be made in respect of the 1972 salary cut. During the fall of 1973 and the winter of 1973-1974, a change in the business relationship of the principals began to occur. Before 1974, the principals consulted with one another during daily management meetings and participated in major decisions (including making and princing bids to customers and expenditures of more than $ 2,000); however, each of the principals had the following major areas *413 of responsibility: (1) Stanley Karminski--general management, plus miscellaneous matters such as employee relations, legal arrangements, quality control, research and development, liquidating obsolete equipment, and seeking out and purchasing new equipment. (2) John Walsh--the production shop. (3) Edward McBryan--the office force and accounting and financial matters. (4) Daniel--sales and materials purchasing. In earlier years, all of the principals had done sales work. However, by about 1970 Daniel was the only one of the principals to continue in that phase of Brandywine's business. Before 1974, Brandywine's selling procedure was as follows: Daniel would make contact with the customer; the customer would draw its own specifications; Daniel would take the drawings or proposal back to Brandywine to present to the daily meeting of the principals; each of the principals would make an independent determination of whether the job should be accepted, what price should be charged, what equipment should be used, and which employee should do the work; the principals would meet and take an average of the four proposed prices, and this average price would then be submitted as Brandywine's *414 bid. Daniel would always propose relatively high bids. In comparison, John Walsh might propose low bids and the other two principals would recommend more middle-of-the-road bids. This process of bidding on jobs caused significant delays in submitting bids to customers; sometimes Brandywine did not meet bidding deadlines. Also, this process had a significant adverse impact on Brandywine's profit performance since it was not charging the highest price which it could get for each job. In the latter half of 1973, Daniel told the other principals that he needed more money, that the team concept they had been using for bidding did not work well in sales, and that he could make more money for Brandywine if he were given full authority over sales and an incentive compensation package. At this time, Daniel was under a very heavy personal financial load because of the manner in which he desired to support his wife and twelve children, the oldest of whom was about to enter college; and he had not seriously looked for other employment and had no firm offer to join another employer. Stanley Karminski and Edward McBryan were the same age as Daniel and had five and nine children, respectively. *415 John Walsh, who is five years younger than Daniel, had eight children. Brandywine's business success and profitability depended largely on the capacity of the person or persons responsible for selling and bidding, functions over which Daniel had sole responsibility for the years in issue. It took considerable knowledge, experience, and judgment to determine whether Brandywine could fabricate a part requested by a potential customer, to determine the price at which Brandywine could produce that part competitively and profitably, and to properly schedule work for customers. Careful scheduling of manufacturing steps (i.e., the best use of available equipment, personnel, and shop space) was also needed. Daniel was graduated from Villanova University in 1951 with a degree in mechanical engineering. He was employed by Brandywine on a full-time basis since joining the company in 1952. Daniel had not received any degrees nor had any formal instruction in sales or marketing, other than occasionally to listen to "motivation tapes" while driving his car. Of the principals, Daniel had the most experience and aggressiveness in the sales area; he also was very knowledgable about the complete *416 operation of the Brandywine shop. The principals discussed Daniel's proposals and reached agreements revising their decision-making processes and the method of compensating Daniel. After 1973, Daniel was given sole responsibility for making and princing bids to customers, and his responsibility for purchasing raw materials was reassigned to a middle-management employee. During the years in issue, Daniel had no responsibility for such purchasing. Apart from these changes, each of the principals retained the same responsibility as before. Except for decisions regarding bidding, all major managerial decisions continued to be made by the principals acting as a group, rather than individually. John Walsh, Stanley Karminski, and Edward McBryan reserved the right to make suggestions about bidding if Brandywine started to lose money. On March 1, 1974, Brandywine's board of directors, comprised of the principals, unanimously adopted a resolution providing that Brandywine enter into employment agreements with each of its officers for 1974, fixing annual salary for each of the officers other than Daniel at $ 85,000 and for Daniel at $ 115,000 plus a bonus (if earned pursuant to the terms *417 of Daniel's employment agreement). On the same date, a written employment agreement was entered into between Daniel and Brandywine for 1974. This agreement provides for a bonus above the $ 115,000 annual base salary equal to 1 percent of Brandywine's 1974 gross sales and 20 percent of its 1974 taxable income. This agreement also provides as follows: 7. Repayment Requirement. To the extent that any compensation paid to [Daniel] * * * under paragraph 4B hereof is determined to be excessive, unreasonable or otherwise unallowable, in whole or in part, as a deductible expense for federal income tax purposes, [Daniel] * * * shall have the obligation to reimburse [Brandywine] * * * to the extent of such non-deductible amount. At the close of 1973, Brandywine had experienced its best year thus far, in terms of profits and sales; orders by customers were strong and the principals expected sales to be as strong or stronger in 1974 than 1973. It is estimated that sales orders written by Brandywine in January and February of 1974 aggregated between $ 800,000 and $ 1,000,000. The general market for Brandywine's production contract machinery business was favorable in 1974. Some of the sales *418 orders written in 1974 by Brandywine carried over to 1975, in part causing 1975 to be a good year. On February 4, 1975, Brandywine's board of directors, comprised of the principals, unanimously adopted a resolution approving 1975 employment agreements, the terms of which were identical to those for 1974, except that salaries were raised $ 10,000 for each of them. On the same date, a written employment agreement was entered into between Daniel and Brandywine for 1975, with identical terms as the agreement for 1974, except that it provides a base salary of $ 125,000. The principals other than Daniel were paid fixed salaries for the years in issue. No incentive or bonus compensation feature was provided for them, nor were they paid any incentive or bonus compensation in or for either of these years. In 1974, Brandywine's two highest paid employees, other than the principals, were its foreman and its material controller; they received salaries of $ 27,980 and $ 22,980, respectively. Brandywine employed 40 employees in the years in issue. Brandywine paid its employees (other than the principals) wages and salaries totalling approximately $ 600,000 in 1974 and approximately $ 500,000 *419 in 1975. During each of the years in issue, more than 95 percent of Brandywine's sales were made to various divisions of Westinghouse Corporation (hereinafter referred to as "Westinghouse"). Brandywine had no fixed period contract with these Westinghouse divisions and they could have ceased doing business with Brandywine at any time. Demand for parts such as Brandywine fabricates would increase (or decrease) in relationship to the growth (or decline) of Westinghouse's power generating equipment business. At any given time during the years in issue, Brandywine had about $ 100,000 of raw materials on hand for anticipated orders from Westinghouse. Brandywine purchased $ 843,106.38 of merchandise in 1974 and $ 751,646.12 in 1975. Brandywine kept this $ 100,000 worth of raw materials on hand because (1) ability to make quick delivery often was important in securing sales and (2) it generally took a long time for Brandywine to receive raw materials ordered from suppliers. For 1969 through 1976, Brandywine's sales, gross profits, profits before the principals' compensation and Federal income tax, principals' total compensation, compensation paid to Daniel, after-tax profits, and dividends *420 are the amounts shown in table 4: Table 4 Profits BeforeTax andGrossPrincipals'YearSalesProfitsCompensation1969$ 1,163,032$ 587,272$ 251,21119701,470,812721,594361,95519711,265,591744,559362,7941972828,118459,378166,35519731,873,143898,111424,47119743,641,0182,078,0261,170,67219752,968,1271,597,230633,74919762,038,8041,312,549516,618Principals'TotalDaniel'sAfter-TaxYearCompensationCompensationProfitsDividends1969$ 186,000$ 46,500$ 40,2821970242,00060,50069,3081,2001971240,00060,00075,1711972160,00040,0006,2201973340,00085,00073,3081,2001974590,000305,000322,46324,0001975479,000194,000102,38618,0001976493,000160,00020,91318,000On its 1974 Federal income tax return, Brandywine claimed a deduction of $ 305,000 reflecting actual payments 4*421 to Daniel in that year which were characterized by Brandywine as follows: Base salary$ 115,000Incentive compensation180,000Payment of a prior year'ssalary reduction10,000Total$ 305,000The "incentive compensation" component of this 1974 payment to Daniel was calculated pursuant to his employment agreement as follows: 1% BonusSales of $ 3,641,018 X 1%$ 36,41020% BonusProfit before principals'compensation andFederal income tax$ 1,170,672Less: (1) Daniel's basesalary$ 115,000(2) Daniel's 1%bonus36,410(3) Compensationof the otherprincipals255,000(4) Payments tothe principalson account of1972 salaryreduction40,000446,410Profit before 20%bonus 5*422 $ 724,26220%144,852Incentive Compensation6 $ 181,262 On its 1975 Federal income tax return, Brandywine claimed a deduction of $ 194,000 reflecting actual payments 7 to Daniel in that year which were characterized by Brandywine as follows: Base salary$ 125,000Incentive compensation69,000Total$ 194,000The "incentive compensation" component of the above payments to Daniel for the tax year 1975 *423 was calculated pursuant to his employment agreement as follows: 1% BonusSales of $ 2,968,127 X 1%$ 29,68120% BonusProfit before principals'compensation andFederal income tax$ 633,749Less: (1) Daniel's basesalary$ 125,000(2) Daniel's 1%bonus29,681(3) Compensationof the otherprincipals285,000439,681Profit before 20% bonus 5194,06820%38,814Incentive Compensation8 $ 68,495The parties and their experts have taken the positions set forth in table 5 regarding Brandywine's payments to Daniel. Table 5 19741975Amounts deducted by Brandywine9*424 $ 305,000$ 194,000Amounts determined by respondentto be reasonable compensation 10115,000115,000Reasonable compensation, perpetitioners' expert325,800150,600Reasonable compensation, 11 perrespondent's expert120,690115,155Brandywine paid $ 250,000 of reasonable compensation to Daniel in 1974 for *425 services rendered by him in 1974; and paid $ 150,000 of reasonable compensation to Daniel in 1975 for services rendered by him in 1975. OPINION The parties' basic dispute is as to the proper treatment of Daniel's income from Brandywine. Petitioners maintain that the amounts claimed by Brandywine as compensation for Daniel were paid for services actually rendered and were reasonable in amount, within the meaning of section 162(a)(1). They argue that these amounts thus are deductible in full by Brandywine and that, as to Daniel, they constitute "earned income" for purposes of the limitations on tax provided by section 1348. Respondent contends that any amounts paid to Daniel in excess of $ 115,000 for each of the years in issue, were not intended as payments purely for personal services, and even if they were so intended, they were unreasonable in amount for the services he rendered. Respondent argues that these excess amounts are not deductible under section 162(a)(1), that they are not "earned income" under section 911(b), and that therefore they are not eligible for the limitations on tax provided by section 1348. We have found that $ 250,000 paid in 1974 by Brandywine was reasonable *426 compensation for services rendered by Daniel in 1974 and that $ 150,000 paid in 1975 by Brandywine was reasonable compensation for services rendered by Daniel in 1975. Section 162(a)(1)12 provides for deductions for amounts paid or incurred as reasonable compensation. Section 1348, enacted by section 801(a) of the Tax Reform Act of 1969 (Pub.L. 91-172, 83 Stat. 685), provides that the marginal tax rate applicable to an individual's earned income is not to exceed 50 percent. "Earned income" is defined in section 1348(b)(1) as "any income which is earned income within the meaning of * * * section 911(b) * * *." 13*427 The parties agree that, under section 911(b), 14*428 to the extent the amounts paid to Daniel are deductible by Brandywine under section 162(a)(1) as reasonable compensation for services actually rendered, these amounts constitute earned income within the meaning of section 1348(b)(1). See Kennedy v. Commissioner, 72 T.C. 793">72 T.C. 793, 805 (1979), on appeal (CA6 March 14, 1980). See also Home Interiors & Gifts v. Commissioner, 73 T.C. 1142">73 T.C. 1142, 1154 (1980). The initial task, then, is to determine how much of the amounts so paid are so deductible. 15The question of reasonableness is one of fact which must be resolved on the basis of all the facts and circumstances in the case. Pepsi-Cola Bottling Co. of Salina v. Commissioner, 528 F.2d 176">528 F.2d 176, 179 (CA10 1975), affg. 61 T.C. 564">61 T.C. 564 (1974); *429 Pacific Grains v. Commissioner, 399 F.2d 603">399 F.2d 603, 605 (CA9 1968), affg. a Memorandum Opinion of this Court; 16Home Interiors & Gifts v. Commissioner, 73 T.C. at 1155; Kennedy v. Commissioner, 793">72 T.C. at 801; Levenson & Klein v. Commissioner, 67 T.C. 694">67 T.C. 694, 711 (1977).Discerning the intent behind the payments also presents a factual question to be resolved within the bounds of the individual case. Nor-Cal Adjusters v. Commissioner, 503 F.2d 359">503 F.2d 359, 362 (CA9 1974), affg. a Memorandum Opinion of this Court; 17Kennedy v. Commissioner, supra; Paula Construction Co. v. Commissioner, 58 T.C. 1055">58 T.C. 1055, 1059 (1972), affd. without opinion 474 F.2d 1345">474 F.2d 1345 (CA5 1973). The two elements of a reasonable compensation issue--"reasonable" and "compensation"--are often intertwined and analyzed as one. See Kennedy v. Commissioner, 72 T.C. at 801-805. Many factors are relevant in determining whether amounts paid were reasonable compensation, but no single factor is decisive; rather, we must consider and weigh the totality of facts and circumstances in arriving at our decision. Mayson Mfg. Co. v. Commissioner, 178 F.2d 115">178 F.2d 115, 119 (CA6 1949), revg. an unreported Memorandum *430 Opinion of this Court. In evaluating the record in this case, we bear in mind that respondent's determination must be deemed prima facie correct and petitioners are charged with the burden of establishing that the bonuses and commissions paid were reasonable compensation for services performed by Daniel. Laure v. Commissioner, 70 T.C. 1087">70 T.C. 1087, 1097 (1978), on appeal (CA6 Feb. 27, 1979); Levenson & Klein v. Commissioner, supra; Shield Co. v. Commissioner, 2 T.C. 763">2 T.C. 763, 769-770 (1943). On the basis of the record as a whole, we have made the ultimate findings of fact set forth, supra. The following indicia of "reasonable compensation" appear in this case: (1) Daniel did not control Brandywine. For Daniel to receive the payments challenged by respondent, Daniel secured the assent of the other principals. The other principals did not receive commensurate increases. Each dollar of "disproportionate" increase thus paid to Daniel diminished the amount available to the other principals, whether by way of compensation, dividend, or value in stock. 18*431 (2) After 1973, Daniel's responsibilities were substantially greater than they had been before 1974, in that Daniel had essentially sole responsibility for contract bidding--a responsibility that *432 he previously had shared with the other principals. Proper execution of this responsibility was of critical importance to Brandywine. (3) The bulk of Daniel's increase in pay arose from the incentive bonus arrangement that was entered into early in 1974. The concept of the incentive bonus arrangement (though not necessarily the details of the arrangement) was rationally related to Daniel's contract bidding responsibilities. The "bottom line", of course, is profits, and much of Daniel's bonus depended on the amount of Brandywine's profits. However, while all the principals had roles in the profit picture, Daniel clearly had the major voice in the sales volume picture. But a focus on sales alone might result in inadequate consideration being given to profits. Under the circumstances, it was reasonable to base Daniel's incentive bonus on both profits and sales. (4) Daniel had the unique qualifications of having dealt with Brandywine's customers as its executive marketing representative, as well as being involved with executive decisions in all other areas involved in this highly technical customized-part-producing company for 22 years. Of the four principals, Daniel was the only *433 one with extensive marketing and bidding experience, as well as experience in every other aspect of the business. It would have been difficult to find a replacement with such a breadth of proven background. (5) Brandywine's payments to the principals were not proportional to their stockholdings. Indeed, respondent's determinations as to reasonable compensation are more nearly proportional to stockholdings than are Brandywine's payments. See section 1.162-7(b)(1), Income Tax Regs.(6) Brandywine's dividend distributions in 1974 and 1975 were substantially greater than they had been in earlier years, both in terms of dollar amounts and as percentages of after-tax profits. The following indicia of unreasonableness of compensation appear in this case: (1) A bonus formula without a ceiling runs a substantial risk of producing a windfall, especially if the sales element of the formula is unaffected by the profitability of the sales. (2) A bonus formula that provides benefits without requiring improvement over prior periods' performance, especially when the base pay is substantial, appears to focus more on the employer's ability to pay rather than on the value of the employee's services. *434 (3) Very little of Brandywine's profits were paid as declared dividends. Petitioners' expert witness utilized a method whereby members of the expert's staff visited Brandywine and interviewed the principals and the shop foreman in order to understand the job content of the various positions in Brandywine. Based on that information, each position was assigned points for its relative value to Brandywine (measured by the respective "Know-How, Problem Solving, and Accountability" for each such position). Brandywine's internal pay structure was then compared to the salary policies of 300 industrial companies, which were mostly Fortune 1000 Companies with annual sales ranging from 80 to 100 million dollars. From this comparison, petitioners' expert opined that a reasonable base salary for Daniel would be $ 87,000 for 1974 and $ 94,000 for 1975, in each case assuming payment of additional incentive amounts. He considered a reasonable incentive plan for Daniel separately from base salary and did not evaluate the plan used by Brandywine, but suggested an alternative plan. At the outset, he determined that profits, not sales, are the "paramount measure" for corporate performance in this *435 case and pegged the suggested incentive plan to pretax profits. In view of his observation that Brandywine's business was cyclical in nature, he assumed that a competent profit level for any given year would equal that for 1973, and that an annual growth of 25 percent in pretax profits would be outstanding performance. Based upon these assumptions, the bonus suggested for Daniel is 50 percent of such profits in the range from competent to outstanding performance and 33-1/3 percent of such profits earned in excess of outstanding performance. Applying this suggested plan to the tax years 1974 and 1975 results in bonuses of $ 238,800 and $ 56,600, respectively, which, in turn, when added to proposed base salaries results in an opinion that payments of $ 325,800 and $ 150,600, respectively, for these years, would be reasonable for Daniel's services. Respondent's expert initially analyzed data for 1974 and 1975 from the American Management Associations' 1975 and 1976/1977 Top Management Reports regarding the average of the total direct compensation (salary and bonus) paid to chief executives of companies in the durable goods and fabricated metal products categories which had annual *436 revenues or net income after taxes within the range of that of Brandywine. From this data, he correlated average compensation paid to such executives in such companies with annual revenues or net income after taxes, by means of regression line formulas. From this he graphically plotted a central trend line of the data. He also plotted upper and lower trend lines, 33 percent above and 33 percent below the central trend line.He then "tested" the trend lines by plotting the top total direct compensation paid officers as a function of annual revenues or net income after taxes of Brandywine and twelve companies in the same Standard Industrial Classification used by Brandywine in its Dun and Bradstreet listing. These twelve companies were all publicly owned and had annual revenues ranging from about $ 12 to $ 170 million in 1974 and from about $ 12 to $ 235 million in 1975; these companies were used because respondent's expert did not have available the data for privately-owned companies of comparable industrial classification to Brandywine. This expert testified that in his opinion the classification used might not be appropriate for Brandywine, but had been used because Brandywine*437 used it in its Dun and Bradstreet listing. Brandywine was the only company found to be significantly above the trend lines in terms of highest total direct compensation paid as related to annual revenues or net income after taxes. An essential feature of respondent's expert's trend-line analysis is that total direct compensation of the examined employees varies directly with the employers' revenues and with the employers' net income after taxes. This analysis was confirmed by this expert's analysis of Research Institute of America, 1975 Executive Compensation Report. In respondent's expert's view, Brandywine's incentive plan was atypical primarily because it lacked a "threshold" earnings level to be achieved and there was no ceiling on the bonus formula to prevent a windfall in a fortuitously profitable year. Based upon the average of the upper trend rates of total direct compensation to annual revenue or net income after tax from the above studies, respondent's expert considered the maximum amount of compensation (salary and bonus) for a chief executive of a company with Brandywine's level of such revenues or such income to be $ 89,400 and $ 85,300 for 1974 and 1975, respectively. *438 (However, see note 11, supra.) Respondent's expert focussed on compensation for a person with functions that appear to be more limited than those served by Daniel. Additionally, respondent's expert acknowledged that Brandywine's field of business was significantly different from many of the businesses that he used for comparison; he did the best he could with what was available. Finally, respondent's expert gave no indication of the extent to which the averages he used in developing his trend lines included bonuses other than incentive bonuses--i.e., other than bonus agreements intended to provide significant incentives to the affected employees. Petitioners' expert focussed on Daniel's work responsibilities to the exclusion of marketplace evaluations of these responsibilities when combined into single jobs. In contrast to respondent's expert, who put controlling weight on the size of the company, petitioners' expert gave no weight at all to that empirical factor. Petitioner's expert constructed a compensation package different from the one used in the instant case and reported the results of the application of that package to the facts here of record. However, he gave no reasons *439 for his choices of particular amounts and percentages, which were critical in arriving at his numerical conclusions. Each expert, in short, focussed on some elements and drew conclusions which ignored the other elements here present. The great differences in their conclusions put us in mind of The Blind Men and the Elephant, a poem by John Godfrey Saxe (Vol. 1, The Home Book of Verse, selected and arranged by Burton Egbert Stevenson, 9th Ed., 1953, pp. 1877-1879). In the poem, six blind men, each examining a different part of an elephant, variously concluded that the elephant was like a wall, a spear, a snake, a tree, a fan, and a rope. And so these men of Indostan Disputed loud and long, Each in his own opinion Exceeding stiff and strong, Though each was partly in the right, And all were in the wrong! On balance, we are most influenced by the above indicia of reasonableness, rather than the opinion of either party's expert. We conclude that the maximum reasonable compensation for Daniel's services was $ 250,000 for 1974 19 and $ 150,000 for 1975. As to the amounts up to these levels, we *440 believe that Brandywine and the principals other than Daniel intended to pay compensation. We see no evidence bearing out respondent's assertion that the principals other than Daniel caused Brandywine to make the payments because they "wanted to help Daniel through difficult financial times." (Resp. opening brief, p. 19.) Firstly, the principals other than Daniel also had large families and may have had needs of their own. Secondly, nothing in the record suggests that Daniel's needs were short-term in nature. If Daniel's needs were not short-term, what would cause the other principals to believe that funds would be available to assist them when they in turn would encounter financial needs? Thirdly, if assistance of Daniel had been a significant motive, then other methods were available that were more likely to pass the tax collector's muster without dispute. We are persuaded that Daniel's needs played a significant part--they impelled Daniel to make his demands and they served to convince the other principals that Daniel would not allow the pre-1974 arrangements to continue. We are persuaded by the record before us that these matters impelled Brandywine to substantially sweeten *441 the pot of compensation, by way of a bonus incentive arrangement, which (with the concomitant change in Daniel's responsibilities) was designed to keep Daniel with Brandywine and increase the effectiveness of his work in improving Brandywine's profit. Respondent urges us to separate the effects of the change in Brandywine's system of bidding from the effects of the change in Brandywine's system of compensating Daniel. We decline to do so. On the record before us it is clear that both changes evolved as parts of a single package. This is buttressed by the logical relationship of the changes. The change in the bidding system, putting more responsibility on Daniel, is a basic reason for our conclusion that the amounts of reasonable compensation are substantially more than the amounts determined by respondent. We now consider petitioners' contention that $ 10,000 of the amount paid Daniel by Brandywine in 1974 was for services rendered in 1972, with respect to which payment was postponed. Amounts paid in a later year for earlier years' services may be deducted when paid, if the services were undercompensated in the earlier years. Lucas v. Ox Fibre Brush Co., 281 U.S. 115">281 U.S. 115 (1930); *442 Cropland Chemical Corp. v. Commissioner, 75 T.C. 288">75 T.C. 288, 297-298 (1980), on appeal (CA7 March 21, 1981); R. J. Nicoll Co. v. Commissioner, 59 T.C. 37">59 T.C. 37, 50-51 (1972). In order to be allowed the deduction, the taxpayer must establish the amount of undercompensation for such services ( American Foundry v. Commissioner, 59 T.C. 231">59 T.C. 231, 239-240 (1972), affd. in part and revd. in part 536 F.2d 289">536 F.2d 289, 293 (CA9, 1976)) and that the payment in the later year is intended as compensation for such services. Perlmutter v. Commissioner, 373 F.2d 45">373 F.2d 45, 48 (CA10, 1967), affg. 44 T.C. 382">44 T.C. 382 (1965). Petitioners have established that each of the principals' salaries was reduced by $ 20,000 in 1972. However, the fact of a salary reduction does not lead automatically to a conclusion that the principals were undercompensated for 1972. We cannot tell, from the record before us, what would have been an appropriate level of compensation in 1972. Consequently, we cannot determine the extent, if any, of Daniel's undercompensation for that year. Compare American Foundry v. Commissioner, supra, with Cropland Chemical Corp. v. Commissioner, supra, and R. J. Nicoll Co. v. Commissioner, supra.See also LaMastro v. Commissioner, 72 T.C. 377">72 T.C. 377, 384 (1979). *443 We conclude, then, that the record does not justify our adding any amount--on account of 1972--to the $ 250,000 we have determined was paid as reasonable compensation to Daniel in 1974. As a result, we conclude that Brandywine is entitled to deduct, and the individual petitioners are entitled to treat as earned income, $ 250,000 for 1974 (rather than the $ 305,000 claimed by Brandywine and the $ 115,000 allowed by respondent) and $ 150,000 for 1975 (rather than the $ 194,000 claimed by Brandywine and the $ 115,000 allowed by respondent). The apparent discrepancies referred to in notes 9 and 10, supra, are to be resolved in the Rule 155 computation. Decisions will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to sections of the Internal Revenue Code of 1954 as in effect for the taxable years in issue. 2. The parties have reached a basis for settlement of the only other issues, which relate to the corporate petitioner's 1974 income tax. This agreement is to be given effect in the computation under Rule 155, Tax Court Rules of Practice and Procedure.↩3. A "cellar" shop is a machine shop without a full range of equipment, which cannot produce many precision parts, but may manufacture a few well.↩4. Both the 1974 Form W-2 for Daniel from Brandywine, and the individual petitioners' 1974 Federal income tax return, show total compensation of $ 340,000. For that year, Brandywine deducted amounts totalling $ 217,378 and $ 92,488 for pension and profit-sharing plans, respectively. The record does not indicate whether any portion of these amounts was paid on behalf of Daniel, nor does it explain the discrepancy between the $ 305,000 compensation deduction claimed by Brandywine and the $ 340,000 shown on Daniel's Form W-2 and on the individual petitioners' 1974 Federal income tax return.5. Notwithstanding that the agreement provided that part of Daniel's bonus was to be "twenty (20) percent of [Brandywine's] * * * taxable income", each year Daniel was given twenty percent of the sum of that year's (a) taxable income for Brandywine and (b) 20-percent bonus for Daniel. Thus, each year this portion of Daniel's bonus amounted to 25 percent of Brandywine's taxable income. 6. The actual amount paid to Daniel was $ 180,000. The difference between the amount paid and that due under the above computation is attributable to use of projected figures for 1974 as of December of 1974, and not actual figures for 1974.↩7. Both the 1975 Form W-2 for Daniel from Brandywine, and the individual petitioners' 1975 Federal income tax return, show total compensation of $ 197,445.13. For that year, Brandywine deducted amounts totalling $ 233,316.20 and $ 84,905.13 for pension and profit-sharing plans, respectively. The record does not indicate whether any portion of these amounts was paid on behalf of Daniel, nor does it explain the discrepancy between the $ 194,000 compensation deduction claimed by Brandywine and the $ 197,445.13 shown on Daniel's Form W-2 and on the individual petitioners' 1975 Federal income tax return.↩5. Notwithstanding that the agreement provided that part of Daniel's bonus was to be "twenty (20) percent of [Brandywine's] * * * taxable income", each year Daniel was given twenty percent of the sum of that year's (a) taxable income for Brandywine and (b) 20-percent bonus for Daniel. Thus, each year this portion of Daniel's bonus amounted to 25 percent of Brandywine's taxable income. ↩8. The actual amount paid to Daniel was $ 69,000. The difference between the amount paid and that due under the above computation is attributable to use of projected figures for 1975 as of December of 1975, and not actual figures for 1975.↩9. See notes 4 and 7, supra↩, regarding the differences between the amounts deducted by Brandywine and the greater amounts shown on Daniel's Forms W-2 and on the individual petitioners' Federal income tax returns. 10. Respondent treats $ 150,000 and $ 119,756.13 as being eligible for "maxitax" treatment by the individual petitioners for 1974 and 1975, respectively. No explanation appears for the differences between these amounts and the amounts allowed by respondent as deductions for Brandywine. ↩11. In his written report, respondent's expert stated that $ 89,400 for 1974 and $ 85,300 for 1975 was the upper end of the "appropriate compensation range" for Daniel. At the trial, under questioning, he testified that, in his opinion, compensation of 25 percent to 35 percent above these amounts would be "a maximum of reasonable compensation that [he] * * * would expect." Respondent, on brief, treats the 35-percent level (the amounts set forth in table 5) as his expert's illustration of amounts that would be unreasonable, and contends that the $ 89,400 and $ 85,300 figures are his expert's "maxima for the respective years".↩12. SEC. 162. TRADE OR BUSINESS EXPENSES. (a) In General.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-- (1) a reasonable allowance for salaries or other compensation for personal services actually rendered * * *↩13. Subsequent amendments of this provision (changing "earned income" to "personal service income" and revising the definition), by section 302(a) of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1554, and by sections 442(a) and 701(x)(1) of the Revenue Act of 1978, Pub.L. 95-600, 92 Stat 2878, 2920, do not affect the instant case.14. SEC. 911. EARNED INCOME FROM SOURCES WITHOUT THE UNITED STATES. (b) Definition of Earned Income.--For purposes of this section, the term "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as a compensation for the personal services actually rendered. * * * [The subsequent amendments of the section heading (by sec. 202(f)(1) of the Foreign Earned Income Act of 1978, Pub. L. 95-615, 92 Stat. 3100, and by sec. 4(c)(1) of Pub. L. 96-595, 94 Stat. 3467) and of subsection (b) (by sec. 1906(b)(14)(A) of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1834) do not affect the instant case.]15. The record is not clear as to what amounts Brandywine contributed to its pension and profit-sharing plans for Daniel for 1974 or 1975, and respondent has not indicated whether his determinations of reasonable compensation should include any such amounts. See, e.g., Edwin's v. United States, 501 F.2d 675">501 F.2d 675, 679 (CA7 1974); Charles E. Smith & Sons Co. v. Commissioner, 184 F.2d 1011">184 F.2d 1011, 1014 (CA6 1950), affg. an unreported Memorandum Opinion of this Court; LaMastro v. Commissioner, 72 T.C. 377">72 T.C. 377, 382-383↩ (1979); sec. 1.404(a)-1(b). Income Tax Regs. Under the circumstances we, too, will ignore these contributions.16. T.C. Memo. 1967-7↩. 17. T.C. Memo. 1971-200↩.18. Petitioners argue that we are bound to find the amounts paid Daniel as compensation to be reasonable because they are the result of an "arm's-length bargain," citing section 1.162-7(b)(2), Income Tax Regs.Respondent contends that the fact that the other shareholders were either Daniel's relatives or friend, considered with his overall financial needs in the years in issue, should lead us to conclude the payments in issue were not intended as compensation for Daniel's services, but to help him out of a bad financial situation. We do not believe that we are bound by this "bargain" as petitioners contend, but can decide if the amounts paid constitute a reasonable allowance for compensation under all the circumstances. See section 1.162-7(b)(3), Income Tax Regs.↩ However, in deciding whether such amounts do constitute reasonable compensation, we give weight to the fact that the other principals diminished the amounts available to themselves. We also note that respondent does not contend that any part of the disputed amounts should be excludible from the income of the individual petitioners under section 102 (relating to exclusion of gifts).19. The tax treatment of the additional $ 10,000 paid in 1974 for 1972 is considered below.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623096/ | Evan Jones Coal Company, Petitioner, v. Commissioner of Internal Revenue, RespondentEvan Jones Coal Co. v. CommissionerDocket No. 33374United States Tax Court18 T.C. 96; 1952 U.S. Tax Ct. LEXIS 217; April 21, 1952, Promulgated *217 Decision will be entered for the respondent. Excess Profits Tax -- Equity Invested Capital -- Property Paid in for Stock -- Basis -- Sections 718 (a) (2) and 113 (a) (8). -- The petitioner was incorporated in 1921 and issued its stock in that year for a lease. The basis of the lease to be included in equity invested capital is the transferors' basis since sections 113 (a) (8) and 112 (b) (5) apply, as does section 202 (c) (3) of the Revenue Act of 1921. It is immaterial that the incorporators acquired the lease prior to December 31, 1920, and intended to transfer it to the corporation later to be created. In any event the evidence does not show that the lease had a value sufficient to affect the excess profits tax credit. H. W. Haugland, Esq., for the petitioner.John H. Pigg, Esq., for the respondent. Murdock, Judge. MURDOCK *96 The Commissioner determined a deficiency in the excess profits tax of the petitioner of $ 15,788.56 for its fiscal year ended July 31, 1943, and one of $ 10,665.66 for its fiscal year ended July 31, 1944. The only issue for decision is whether use of the excess profits credit based upon invested capital to which the petitioner is*218 entitled will result in lesser tax than if the credit based upon income is used.FINDINGS OF FACT.The petitioner was incorporated under the laws of the Territory of Alaska on January 19, 1921. It filed its returns for the taxable years with the collector of internal revenue for the district of Washington.Evan Jones at some time prior to July 24, 1920, made application to the United States for a lease on coal lands in the Territory of Alaska. He and four associates entered into an agreement on July 24, 1920, reciting that he had made application for the lease in his own name but it was intended for the use and benefit of all of the parties to the agreement. They agreed that the parties would form a corporation to be known as Evan Jones Coal Company as soon as practicable after the granting of the lease and Jones would transfer the lease to the corporation; the four associates would deposit $ 500 apiece *97 in a local bank for the use of the company, and, upon the granting of the lease, would each deposit an additional $ 1,000 and 30 days thereafter an additional $ 1,000 each, for the development and improvement of the lease; one of the associates was to be treasurer of the*219 company and Jones was to be superintendent in charge of mining operations at a salary of $ 300 a month, plus traveling expenses; all parties to the agreement were to have equal rights under the lease, were to share equally in the profits derived from the operations of the property, and, upon the organization of the corporation, were to have equal amounts of its capital stock; upon expenditure of the $ 10,000 already mentioned, the four associates were each to advance $ 2,500 and Jones was to advance $ 1,200, pro rata, as the money might be needed by the company; the associates were to furnish a bond required by the United States upon the granting of the lease, provided that when the monies advanced by each should amount to $ 3,800 Jones was to assume an equal liability on the bond and be responsible for an equal portion of any monies due under the bond; and, if the lease was not granted, all the unexpended monies advanced by the associates were to be returned to them, and they were to pay Jones a total of $ 3,000 "in full compensation for all time, labor, and money expended" by him.The lease, dated August 10, 1920, between Evan Jones and the Department of the Interior permitting *220 the former to mine coal on a royalty basis was acknowledged by Jones on September 14, 1920.The five individuals signed and acknowledged Articles of Incorporation of the Evan Jones Coal Company on September 4, 1920, but they did not file those Articles with the proper authorities of the Territory of Alaska until January 17, 1921.The five individuals held a meeting on September 24, 1920, which they described as the first meeting of the incorporators of Evan Jones Coal Company. They purported to elect officers to act until such time as the incorporation of the company was completed. They adopted by-laws.A corporate seal was obtained in 1920.The board of directors of the petitioner held its first meeting on February 9, 1921. Officers were elected and the acts of the incorporators were ratified and approved. Jones submitted at that meeting a proposal that, in order to carry out the agreement of July 24, 1920, he would transfer the lease to the corporation "at a price of $ 128,800.00, such price to be given me in shares of stock of the Company at the par value of One Dollar per share" and he would purchase 1,200 additional shares from the company at $ 1 per share. The directors *221 then adopted a resolution reciting that the lease had a reasonable value of $ 128,800 in their judgment and they accepted the proposal of Jones to *98 transfer the lease to the corporation in exchange for 128,800 shares of its stock and to issue an additional 1,200 shares to him for cash.Minutes of a meeting of the board of directors of the petitioner held on March 5, 1921, indicate that up to that time one of the associates "was still $ 1,000.00 short of having completed his original stock subscription of $ 5,000.00, he having paid in only the sum of $ 4,000.00."130,000 shares of the stock of the petitioner were issued to Jones on March 5, 1921, and the certificate was immediately canceled, after which the shares were issued in equal portions to the five associates. The record does not show whether or not any other stock was issued or how much cash was paid in for shares.The fair market value of the lease at the time it was acquired by the corporation was less than $ 20,000.OPINION.The petitioner is entitled to the excess profits credit based upon income or to one based upon invested capital whichever is more beneficial. Section 712. The Commissioner has allowed the proper*222 credit based upon income. The petitioner claims that the credit to which it is entitled based upon invested capital is larger since its equity invested capital includes $ 128,800 representing the value of the lease paid in for stock, and that event took place in 1920. The Commissioner agrees that the credit based upon invested capital will result in the lesser tax if, but only if, the acquisition of the lease is reflected in equity invested capital at approximately $ 128,800. Section 718 (a) (2), as it applied to the taxable years, provided that property paid in for stock should be included in the computation of equity invested capital "in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange."The general rule is that the basis of property for determining loss upon a sale or exchange is the cost of the property, but section 113 (a) (8), as it applied to the taxable years, provided that if the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) then the basis shall be the same as it would be in the hands of the transferor adjusted*223 for any gain or loss recognized to the transferor upon the transfer under the law applicable to the year in which the transfer was made. Section 112 (b) (5) provided that no gain or loss should be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, immediately after the exchange such person or persons are in control of the corporation, and the amount of stock received by each is substantially in proportion to his interest in the property prior to the exchange. Section 202 (c) (3) of the *99 Revenue Act of 1921 contained a similar provision. The five associates had equal interests in the lease prior to the transfer and each received and owned one-fifth of the stock of the petitioner as a result of the transfer. Thus, the transaction whereby the petitioner acquired this lease comes precisely within those provisions and no gain or loss was recognizable on that transaction. The basis of the lease to the petitioner for loss is thus the transferor's basis.The petitioner tries to escape that result by arguing that the property was acquired prior to December 31, 1920. Section 113 (a) (8) *224 provides "If the property was acquired after December 31, 1920, by a corporation -- (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) * * *." The lease was acquired solely by the issuance of stock. Obviously the acquisition was not completed within the meaning of section 113 (a) (8) (A) until the issuance of the stock which necessarily took place after December 31, 1920, since there was no corporation and there was no stock until after that date.The above conclusion is fatal to the petitioner's contention. It has never addressed itself to the question of the basis of the transferors, does not claim that that basis was substantial, and the record does not show what that basis was. However, it does show that it was relatively small, for example, less than one-fifth of the $ 128,800, and such a basis would do the petitioner no good.Even if the transaction of acquisition took place prior to December 31, 1920, the petitioner would still fail to make a case. The basis of the lease would then be its cost. Its cost was in shares of stock of the petitioner. The only asset back of those shares so far as this record shows *225 was the lease. See Regulations 112, section 35.718-1. The petitioner contends, but has failed to prove, that the value of the lease at that time was $ 128,800. It must rely entirely upon the minutes of the meeting of the board of directors for February 9, 1921, in which it is recited that the property offered by Jones in exchange for the 128,800 shares of the petitioner "is adjudged by this board to be of the reasonable value of $ 128,800.00." However, the evidence as a whole shows that the value of the lease was not more than a small part of that amount.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623097/ | RAINIER COMPANIES, INC. (formerly Sicks' Rainier Brewing Co.), Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRainier Cos. v. CommissionerDocket No. 6870-71.United States Tax CourtT.C. Memo 1977-351; 1977 Tax Ct. Memo LEXIS 88; 36 T.C.M. (CCH) 1404; T.C.M. (RIA) 770351; October 3, 1977, Filed *88 This case, originally decided in 61 T.C. 68">61 T.C. 68 (1973), is before us on remand in part from the U.S. Court of Appeals for the Ninth Circuit, Rainier Companies v. Commissioner, an unreported opinion (9th Cir. 1976). Our holding that a transfer to the City of Seattle was in no part a gift due to a lack of donative intent was reversed and we were directed to determine the amount of charitable contribution which petitioner made. Held: while under the valuation procedures utilized to value the land the stadium had no value, there was a bargain element in the sale of the land. Held,further, the value of this bargain element is $100,000. F. A. LeSourd, for the petitioner. Richard J. Shipley, for the respondent. IRWINSUPPLEMENTAL MEMORANDUM OPINION IRWIN, Judge: Our original opinion in this case (61 T.C. 68">61 T.C. 68) was filed on October 23, 1973. The decision dealt with three issues, to wit: (1) Whether petitioner's sale of its baseball stadium site to the City of Seattle was an involuntary conversion under threat of condemnation entitling petitioner to defer recognition of the gain under section 1033; 1(2) Whether*90 petitioner's alleged donation of stadium improvements to the City constituted a charitable contribution under section 170; and (3) Whether petitioner realized ordinary income of $5,000 under section 1245 upon transfer of personal property to the City in connection with the stadium sale. In our original decision this Court held (1) that the stadium property was not sold to the City under threat or imminence of condemnation; (2) that petitioner did not make a charitable contribution to the City because it lacked the requisite donative intent; and (3) that petitioner did not recognize any ordinary income under section 1245(a) as a result of its transfer of personal property to the City. Petitioner appealed from our decision on issues (1) and (2) to the Court of Appeals for the Ninth Circuit. That court affirmed our original opinion on the nonapplicability of section 1033, but reversed our finding that the transfer was not a charitable contribution due to the lack of donative intent on the part of the petitioner. More specifically, the Circuit Court stated: All*91 of the evidence presented below supports the appellant's contention that the gift of the stadium to the city was not in anticipation of greater saleability of the underlying land nor of any other benefit to Rainier. Mr. Ferguson, the president of Rainier at the time of the sale, testified that the stadium was given to the city so that baseball could be continued in Seattle. The Mayor of Seattle testified that the city had no interest in purchasing the stadium but only the land itself and that the Rainier Company gave the stadium to the city for the civic purpose of providing a place for baseball to be played in the city. Given that the city would not purchase the stadium but was interested in the land only, it is clearly contrary to the evidence to say that the stadium was an additional inducement to the city to purchase the land itself. Since there was no evidence in the record upon which the Tax Court could base a finding that the transfer of the stadium was other than a gift, the appellant is entitled to a charitable deduction. * * * [Rainier Companies v. Commissioner, an unreported opinion (9th Cir. 1976).] 2*92 We were directed to determine the amount of charitable contribution to which petitioner is entitled. Pursuant to an order of this Court the parties agreed no further evidence would be introduced, and that we could determine the amount of the charitable contribution from the existing record. However, both parties did file additional briefs. We must now determine the amount of the charitable contribution made by petitioner. Petitioner contends the value of the donated stadium and thus the amount of the contribution is $240,000 utilizing a cost approach to make the valuation. Petitioner arrives at this figure by determining the reproduction cost of the stadium and deducting therefrom an amount reflecting the depreciation and obsolescence of the existing structure. However, in the event we do not agree the cost approach is appropriate, petitioner submits alternative values contending that either an income approach or a "bargain-sale" approach is appropriate in arriving at the amount of the contribution. Using the income approach, petitioner arrives at a value for the stadium of $206,083. He arrives at this value by capitalizing a projected $28,000 rental figure for the stadium*93 over a ten-year period using a six percent capitalization rate. Petitioner submits a final figure of $100,000 should we find the appropriate valuation procedure to be that of a "bargain-sale." 3 This figure is derived from the difference between an appraisal of the land and stadium together of $1,250,000, the highest expert appraisal submitted, and the final sales price for the land alone of $1,150,000. Respondent, on the other hand, contends the stadium has no significant value, especially in light of the cost of removal which, of necessity, is an element inherent in the value of this gift. He generally disputes all of petitioner's attempts to value the stadium apart from the land and asserts that the value of the land and stadium together was approximately the same as the City's purchase price for the land alone and, therefore, the conveyance of the stadium to the City resulted in no charitable*94 contribution. It is well settled that the fair market value of a contribution made in property determines the amount of the deduction. Fair market value is defined as: 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 sell and both having reasonable knowledge of relevant facts. * * * [Sec. 1.170-1(c), Income Tax Regs.] The question as to fair market value is one of fact. While appraisal and valuation often appear of great precision, this appearance belies the accuracy of any final determinations of value. These determinations are themselves only estimates. Any value finally determined is, in the end, simply based on the trial court's ultimate finding of fact based on the record as a whole.And these ultimate findings of fact are based upon the court's subjective judgment as to the weight given the evidence considered. Petitioner's initial contention is that the value of the stadium should be based on cost of reproduction less depreciation and obsolescence, citing*95 First Wisconsin Bankshares Corp. v. United States,369 F. Supp. 1034">369 F. Supp. 1034 (E.D. Wisc. 1973). In that case, a 52-year-old building was donated to Milwaukee County. There, as in the case before us, the market value method was used to value the underlying land. However, the court there found that same method of valuation could not be used to determine the fair market value of the building because there was no evidence of sales prices for other similar properties. The court also found the income method unavailable because the building was to be used for public purposes and, since few such buildings are ever rented, there were no comparable rental properties to be considered in the valuation process. As a result, the court found reporduction cost less depreciation constituted the only meaningful measure of market value. Whatever may have been the merits of such a method of valuation in that case, we do not believe it governs here. Rev. Proc. 66-49, 2 C.B. 1257">1966-2 C.B. 1257, states at section 2.07: With respect to reproductive cost as a measure of fair market value, it must*96 be shown that there is a probative correlation between the cost of reproduction and fair market value. Frequently, reproductive cost will be in excess of the fair market value. 4In the present case there is absolutely no correlation between reproduction cost and the fair market value of the stadium. Utilizing the cost of reproduction as the measure of fair market value generally assumes that the property being valued is worth replacing. 5 This is not the case here. It is conceded by the expert witnesses and the parties that the highest and best use of the subject real property is not as a stadium site, but rather as a shopping center. The land was valued and purchased on that basis. We do not feel we can assign a fair market value to the stadium based on a method of valuation having so little relation to the facts as they exist. Similarly, we do not believe the stadium should be valued using the capitalization of earnings method. This method is also inconsistent with the highest*97 and best use value of the land. To use this method would mean even though petitioner received a purchase price based on the highest and best use of the land, we would be valuing the stadium on some basis other than that highest and best use of the site. The land and improvements are a unit; the use of the stadium is dictated by the use of the land and the valuation procedure which we utilize must give recognition to that fact. 6There is another difficulty in using the capitalization of earnings method. While petitioner has provided us with projected annual rentals of the stadium, such projections ignore the fact that a portion of such rentals is necessarily attributable to a*98 use of the land. Clearly, any rental paid for the stadium's use is in part a payment for the use of the land. Since petitioner has not provided us with a method of apportioning the projected rentals between the land and the stadium, he has not carried his burden of proof and we cannot value the stadium on this basis. Rule 142(a), Tax Court Rules of Practice and Procedure.The only remaining method of valuation available is that of "bargain-sale," that is, the difference between the value of the entire property and the amount realized. This method of valuation seems to be the best available in the case before us because it values the land and stadium on a consistent basis, recognizing the highest and best use of the land. Each of the three appraisals in the record utilized a market approach to value in order to arrive at a valuation figure for the land. Each appraisal either disregarded or assigned a zero value to the stadium in recognition of the use to which the land would be put. However, it is clear there was an element of value for the unit above the amount realized by the taxpayer. We will now proceed to assign a value to that increment. For purposes of valuation*99 we must rely on the three appraisals in evidence. All appraisers agreed the highest and best use of the site was as a community shopping center and each of them valued the site on that basis. The first appraisal, dated August 16, 1965, made at the request of petitioner's predecessor, valued the site at its highest and best use to be $1,175,000 less the cost of $28,655 for removing the stadium. The appraisal was rounded to $1,150,000. This appraisal utilized a $2 per square foot value; however, this value was qualified by stating that the actual value of the land would be significantly higher, approximately $2.25, but for the fact that "fair market value" had to be limited to $2 because at this point in time "investors seeking land for such use so far in this market are extremely reluctant to go beyond arbitrarily fixed maximums of their own making." This appraisal went on to state that "[as] time passes this limit [$2] may and probably will be exceeded." Because of the values assigned by subsequent appraisals, we find this statement to be of significance. The second appraisal, made at the request of the City of Seattle, dated September 15, 1965, assigned a value to the site*100 of $1,198,000, valuing it in its "present condition." This appraisal utilized a $2.15 per square foot value for the site and specifically noted the upward trend of land prices in the immediate area. The final appraisal, also made for the City of Seattle, dated February 10, 1967, valued the site as of January 4, 1966 (the date of conveyance), utilizing a per square foot value of $2.25 for the land if vacant and unimproved. As a result, the third appraisal assigned a total value to the site of $1,250,000. In light of the apparent trend of land values, and the specific caveat attached to the first appraisal, we adopt this final appraisal as the correct value of the stadium site on the date of conveyance. The one remaining element of value with which we must deal is the cost of removing the stadium so as to put the land in a condition to effect its highest and best use. The first appraisal deducted the removal cost from the final value it found for the land so as to arrive at a net value for the stadium site. However, the two subsequent appraisals stated that because the stadium could provide some interim use until plans could be put into effect toward utilizing the land in the manner*101 of its highest and best use, the value so provided was sufficient to offset the projected cost of removing the stadium structure. Because such a finding is consistent with our valuation of the stadium site at its highest and best use, we find it unnecessary to reduce the value of the gift by the cost of removing the stadium. As a result, we find petitioner made a charitable contribution in the amount of $100,000. Decision will be entered under Rule 155. Footnotes1. All statutory references refer to the Internal Revenue Code of 1954 as in effect for the years in issue.↩2. The Court of Appeals apparently felt we found the stadium provided the excess value element to the transaction. However, because our initial opinion found a lack of donative intent, we did not have to focus on the cause of any excess value which petitioner may have transferred to the City. This is made clear in our original opinion where we stated: Because donative intent on petitioner's part is lacking, the value of any benefit bestowed upon the City, either through the "donation" of the stadium or through a bargain sale, cannot constitute a deductible charitable contribution. * * * [61 T.C. at 77.] Thus, while the Court of Appeals spoke of the stadium as the subject of the gift, the essential element of its holding, and the specific issue on which our prior opinion was reversed, was our finding that there could be no gift because petitioner lacked the requisite donative intent. Having been reversed on that issue we feel we must now determine what constituted the gift element, if any, of the transaction. Once this is done, we can then proceed to determine the amount of the contribution.↩3. It should be noted that the significance of the term "bargain-sale" in this opinion is limited to valuation. There was no bargain-sale basis provision in the Code in the taxable years at issue. Section 1011(b). Cf. Potter v. Commissioner,38 T.C. 951">38 T.C. 951↩ (1962).4. Stratton v. Commissioner,T.C. Memo. 1969-50 (1969), affd. per curiam 422 F. 2d 872↩ (2d Cir. 1970).5. Bonbright, Valuation of Property, p. 159 (1937).↩6. Three appraisals were made for the purpose of this litigation. None of them utilized an income capitalization approach in arriving at a final value. Indeed, with respect to the income capitalization approach petitioner's own witness stated: The income production potential of the Sicks' Stadium property has been explored at some length and it is concluded that the stadium is unable to produce enough income to even satisfy the requirements of the land let alone return anything to improvements.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623098/ | M. C. Parrish & Company, Petitioner, v. Commissioner of Internal Revenue, RespondentM. C. Parrish & Co. v. CommissionerDocket Nos. 111764, 112652United States Tax Court3 T.C. 119; 1944 U.S. Tax Ct. LEXIS 211; January 27, 1944, Promulgated *211 Decisions will be entered under Rule 50. 1. Petitioner's principal business was that of purchasing at a discount warrants issued by the State of Texas payable out of the general revenue fund. It did not purchase these warrants from the state, but purchased them from the original payees thereof and held them from six to nine months until they were called in by the state and paid. Held, for the taxable years 1937, 1939, and 1940, the difference between the cost to petitioner of the warrants purchased and the amount later collected from the state is includable in gross income under section 22 (a) of the Revenue Act of 1936 and of the Internal Revenue Code as gains, profits, and income derived from dealings in property and is not exempt from taxation as interest upon obligations of a state under section 22 (b) (4) of the same act and code.2. Upon the record, held, petitioner is entitled to certain deductions for bad debts for the years 1939 and 1940, which became worthless in those years.3. Upon the record, held, petitioner is entitled to a certain deduction for depreciation for the year 1939.4. In its return for 1937 petitioner reported the receipt of a certain amount*212 which it labeled "Interest collected on State of Texas obligations." It did not return this amount under the heading of "Gross Income" in schedule A of the return but did include it in schedule B under the heading of "Nontaxable and partially exempt income." Under issue (1) above this amount is held by us to be properly includable in petitioner's gross income. The amount is in excess of 25 percent of the amount reported under the heading of "Gross Income" in schedule A. Held, the amount so reported by petitioner in schedule B was omitted from "gross income stated in the return" as that phrase is used in section 275 (c) of the Revenue Act of 1936, and that the period of limitation upon assessment and collection is therefore five instead of three years after the return was filed as provided under the general rule in section 275 (a) of the same act. R. B. Cannon, Esq., and Claude Collard, C. P. A., for the petitioner.Samuel G. Winstead, Jr., Esq., for the respondent. Black, Judge. BLACK *120 These proceedings, duly consolidated, involve deficiencies in income and excess profits taxes determined by the respondent against petitioner for the calendar years 1937, *213 1939, and 1940 in amounts as follows:ExcessDocket No.YearIncome taxprofits tax1126521937$ 538.75$ 475.0911176419393,482.431,468.071126521940547.94NoneIn Docket No. 112652 petitioner assigned the following errors:(a) The determination of deficiency Income and Excess Profits Taxes for the year 1937 is erroneous because the Statute of Limitations against the assessment of such deficiencies has heretofore expired.(b) In the alternative, the petitioner pleads that if the Statute of Limitations has not expired with reference to the year 1937 (as set forth above), the respondent erred in computing net income for the said year 1937 in that he failed and refused to determine that the petitioner realized exempt income arising from discount on state warrants aggregating the sum of $ 15,512.52.(c) In his determination of net income for the year 1940, the respondent failed and refused to determine that the petitioner realized exempt income arising from discount on state warrants aggregating the sum of $ 22,966.21.(d) Respondent erred in failing and refusing to allow as a deduction from 1940 income debts owing to Petitioner in the total amount*214 of $ 497.25 which became worthless within the taxable year 1940.The Commissioner made one adjustment for the year 1940 which petitioner does not contest.Assignment (d) was raised by an amendment to petition. On brief the respondent "concedes the petitioner is entitled to bad debt deductions for 1940 in the amount of $ 497.25."*121 In Docket No. 111764 petitioner assigned the following errors:(a) The Commissioner of Internal Revenue failed and refused to determine that, during the said year 1939, the petitioner realized exempt interest-income from obligations of the State of Texas aggregating the sum of $ 48,093.67.(b) Respondent erred in failing and refusing to allow as a deduction from Petitioner's 1939 gross income debts totaling $ 741.54 which became worthless within the taxable year.(c) Respondent erred in failing and refusing to allow as a deduction, in determining Petitioner's 1939 net taxable income and income tax liability, depreciation in the amount of $ 359.29 sustained in 1939 with respect to a building and furniture and fixtures used in the operation of Petitioner's trade and business.The Commissioner made two adjustments for the year 1939 which petitioner*215 does not contest.FINDINGS OF FACT.Petitioner is a corporation chartered about April 1935 under the laws of the State of Texas, with its office and principal place of business located at Austin, Texas. The returns for the taxable years here involved were filed with the collector of internal revenue for the first district of Texas at Austin, Texas.1. Issue as to warrants. -- During the depression the Legislature of the State of Texas voted several series of "Texas Relief Bonds." The money for the interest and sinking fund on these bonds was taken out of the general revenue fund (see art. 842b, sec. 7, Vernon's Civil Statutes of the State of Texas Annotated). This created a large deficit in the general revenue fund. Thereafter, warrants drawn on the general revenue fund could not be paid when issued. The warrants were issued in numerical order and paid in that way as funds came in from the various departments segregated to the general revenue fund. When a sufficient sum of money accumulated in the general revenue fund the practice was early adopted, and has since been continued, by the state treasurer of making what is known as a "call." This is done by the state treasurer*216 wiring, or calling a number or all of the banks in Texas on the day the call is made and by publishing at Austin a list of the warrants for which he has funds available for payment.It was possible for a person, by close study of the state's affairs and keeping himself informed, to forecast with reasonable accuracy when a warrant would be paid. There could be ascertained from the comptroller's department the various collections going into the general fund, the type of collections, and the time when they would come in, and in this way the period for the call could be gauged. In 1937 the length of time that elapsed between the issuance of a warrant on the general revenue fund and its payment was from five to six months. In 1939 this period was approximately eight or nine months.*122 In 1931 petitioner's organizers, M. C. Parrish and Maud Potts, operated a small bank in the neighborhood of the University of Texas. In 1931 they paid off all the depositors, discontinued the banking business, and proceeded for a while to operate a small insurance company. Gradually, as a side line, they embarked on the practice of purchasing at a discount warrants drawn on the general revenue*217 fund of the State of Texas from holders thereof who had received such warrants from the state in payment for goods or services. By 1935 this dealing in state warrants had grown to such proportions that in that year petitioner was organized to take over this business.In the course of their dealings in general revenue fund warrants of the State of Texas petitioner's organizers, prior to the incorporation of petitioner, developed an established clientele consisting principally of contractors engaged in construction work and dealers in supplies purchased by the State of Texas. This clientele was taken over by petitioner upon its organization. The procedure followed in acquiring state warrants was substantially as follows:The contractors or suppliers would place with the state a bid for construction work or for supplies. Before such bid was made the bidder would contact petitioner and have it give them its firm commitment to purchase the warrants that would be received from the state for the construction work, or for the supplies, in the event the bid was successful. Petitioner would analyze the condition of the general revenue fund and determine the probable length of time before*218 payment of the warrant could be expected. Based on this estimate, a rate of discount would be fixed at which petitioner agreed to purchase the warrant from the contractor or supplier when issued to him. The contractor would then add the amount of this discount to the cash price of the article sold, or the construction work to be done, and submit his bid in one lump sum for an amount so determined. Immediately upon receipt of the warrant it would be sold to petitioner for its face amount less the amount of discount which the parties had agreed upon. Petitioner would then hold the warrant until called by the state treasurer and paid by him in cash.In addition to petitioner's purchases at a discount of state warrants from contractors as detailed above, it also during the taxable years in question dealt in many such warrants acquired from state employees. The manner in which the petitioner acquired these warrants from state employees is stated more in detail hereinafter under issue 2, relating to bad debts.The warrants in question call for the payment of a fixed sum but do not have a fixed maturity. They do not provide for the payment of interest and were not issued at a discount. *219 A typical warrant is as follows: *123 State ComptrollerofPublic AccountsGeneral RevenueNo. 388304 FundTreasury WarrantThe Treasurer of the State of Texas Will Pay to the Order ofAustin, TexasDateDept.Appr. No.Feb. 2543PBSAFD-26-BQuincy J. Lowman$ 18.80Exactly 18 Dollars 80 CentsOut of any money appropriated by an act of the Texas State LegislatureCom.[Signed] Jesse James[Signed] Geo. H. SheppardState TreasurerState Comptroller of Public AccountsPetitioner purchased the state warrants which it acquired from its customers at a discount of from one to one and a half percent, but never less than one percent.In its Federal income and excess profits tax returns for the calendar years 1937, 1939, and 1940 petitioner disclosed the respective amounts of $ 15,512.52, $ 48,093.67, and $ 22,966.21 as income from discounting state warrants. It did not treat these amounts as taxable income, but treated them as interest on an obligation of the State of Texas, exempt from Federal income and excess profits taxation.In the notices of deficiency from which these appeals *220 are taken the respondent increased petitioner's reported income (loss) for the calendar years 1937, 1939, and 1940 by the said sums of $ 15,512.52, $ 48,093.67, and $ 22,966.21, respectively.At some time prior to October 28, 1938, petitioner placed some of the warrants with certain banks as collateral security for loans from the banks. The loans were for the face of the warrant less the discount charged by petitioner when purchased by petitioner from employees of the state or contractors. The banks would charge petitioner interest on the average daily balances. As the warrants were called the banks would collect from the state the face value of the warrant and credit petitioner's account with the amount collected. This practice ceased with the death of M. C. Parrish, Sr., who died October 28, 1938. During 1939 these banks paid petitioner $ 28,834.25 which amount represented the difference between the interest charged petitioner by the banks and the discount petitioner had charged its customers. The $ 28,834.25 thus received by petitioner in 1939 was a part of the above mentioned amount of $ 48,093.67. Petitioner kept its books upon the cash receipts and disbursements basis. *221 2. Issue as to bad debts. -- During the years 1939 and 1940 petitioner, among its other activities, made extensive small loans to salaried *124 employees of the State of Texas. These loans were made in the form of cash advances against the issuance of the salary warrants that such employees expected to receive for their services to the state. Petitioner adopted the practice of advancing the earned portion of the salary due from the state to the employee under an arrangement whereby the funds advanced were charged to the employee's account with petitioner and petitioner was secured by an assignment of the borrower's salary warrant made in anticipation of the receipt of the warrant. Upon receipt of the warrant, usually delivered over by the state treasurer to petitioner direct, under the assignment to it, the discounted value of the warrant, less the cash loan or purchase advance and the interest or service charge made in connection therewith, was paid over by petitioner to the borrower-assignor. Within the taxable years 1939 and 1940 loans of this description made by petitioner, totaling $ 741.54 for the year 1939 and $ 537.25 for the year 1940, for various reasons became*222 worthless and uncollectible.Of the debts so becoming worthless in 1939, $ 498.95 was claimed as a deduction in petitioner's Federal income tax return for 1939 as a part of a deduction for bad debts in the lump sum amount of $ 5,299.40 charged off in the return and was allowed as a deduction from 1939 income by the respondent in his determination of the deficiencies for that year. The remainder of the debts so becoming worthless in 1939, totaling $ 242.59, was not charged off in petitioner's 1939 return, nor was any allowance therefor made by the respondent in his determination of the deficiencies for that year.Of the debts so becoming worthless in 1940, totaling $ 537.25, no portion thereof was deducted by petitioner on its return for the year 1940, and no allowance therefor was made by the respondent in his determination of the deficiency for that year.3. Issue as to depreciation. -- In 1935, petitioner built on leased land a small frame office building, the outside walls of which were of metal lath with stucco over it; it had a composition roof and a wooden floor. The cost of this building when completed in 1935 was $ 1,135.80. As petitioner's business grew the building*223 was added to in 1938 and again in 1940, so that petitioner's investment in the building at the close of each of the taxable years, from 1935 to 1940, inclusive, was as follows:Dec. 31, 1935$ 1,135.80Dec. 31, 19361,135.80Dec. 31, 19371,135.80Dec. 31, 1938$ 3,305.87Dec. 31, 19393,305.87Dec. 31, 19403,954.43Petitioner's lease on the premises upon which this building was constructed had a term of 15 years from 1935, and under its provisions petitioner was obligated to move the building off at the termination of the lease and restore the ground to its original condition. It was not *125 renewable. The composition roof and the stucco exterior of the building can not be salvaged to advantage as petitioner would just about break even in selling the salvage from the building and putting the land back in the original shape. For 1939 no depreciation was claimed in the return and no depreciation was allowed in the notice of deficiency for that year.Because petitioner's lease will expire by its terms in 1950, the remaining useful life to petitioner of the building from 1937, 1938, 1939, and 1940 is 13, 12, 11, and 10 years, respectively.For the years ended*224 December 31, 1935 to 1940, inclusive, petitioner invested in furniture and fixtures in amounts as follows:1935$ 456.851936456.851937888.461938$ 1,525.3019391,940.0019401,975.00The useful life in petitioner's business of these furniture and fixtures was 10 years from the date of acquisition. Respondent has not allowed depreciation on petitioner's furniture and fixtures for 1939 because none was claimed on the return.4. Issue as to statute of limitations. -- Petitioner's "corporation income and excess profits tax return" for the calendar year 1937 was filed with the collector of internal revenue for the first district of Texas on March 9, 1938. The last day prescribed by law for the filing of the return was March 15, 1938.The deficiency notice covering petitioner's income and excess profits tax liability for the calendar year 1937 was mailed to petitioner on July 17, 1942, which was more than three years but within five years after the return for 1937 was filed.Under "Schedule A -- Net Income Computation" of petitioner's return for 1937 petitioner reported, under the heading "Gross Income" opposite item "14. Total income" the figure $ 11,426.94*225 (this figure did not include any of the $ 15,512.52 profit which petitioner had earned in 1937 in dealing in Texas State warrants), under the heading "Deductions" opposite item "27. Total deductions" the figure $ 21,782.49, opposite item "28. Net income for excess-profits tax computation (item 14 minus item 27)" the minus figure $ 10,355.55, and opposite item "31. Net income for income tax computation" the minus figure $ 10,355.55.Under "Schedule B. -- Reconciliation of Net Income and Analysis of Earned Surplus and Undivided Profits" petitioner reported opposite item "19. Nontaxable and partially exempt income: (a) Interest on: (1) Obligations of a State, Territory, or political subdivision thereof, or the District of Columbia, or United States possessions" the figure $ 15,512.52. This is the same figure which petitioner contends is exempt from taxation under issue (1) herein.*126 A typewritten schedule attached to petitioner's return for 1937 contains the following statement:M C Parrish & Co., 1937.Receipts:Losses Recovered100.00Services charges collected3,566.08Commission on sale of Def. Warrants3,357.66Suspense account (Cash overage)4,403.30Total[sic]11,426.94Interest collected on State of Texas obligations15,512.52Total receipts26,939.46*226 The above amount of $ 15,512.52 should have been included as a part of petitioner's gross income under schedule A of the corporation income and excess profits tax return which it filed for the year 1937. The "amount of gross income stated in the return" as that term is used in section 275 (c) of the Revenue Act of 1936 did not include the said amount of $ 15,512.52. This $ 15,512.52 is in excess of 25 percent of the amount of gross income stated in petitioner's return for the calendar year 1937.OPINION.As indicated in our opening statement, the questions presented by the assignments of error are: (1) Did the respondent err in failing and refusing to hold that the profits earned and collected by petitioner in each of the years 1937 1939, and 1940, with respect to warrants drawn by the treasurer of the State of Texas on the general revenue fund of the state, constituted interest on an obligation of the state specifically excluded from taxable income by section 22 (b) (4) of the Revenue Act of 1936 and of the Internal Revenue Code? (2) Did the respondent err in failing and refusing to allow certain deductions for bad debts for the years 1939 and 1940? (3) Did the respondent err*227 in failing and refusing to allow certain deductions for depreciation for the year 1939? (4) Is the assertion by the respondent of any deficiency in either income or excess profits taxes for the year 1937 barred by the statute of limitations? These questions will be considered in the order stated.1. Petitioner contends that the amounts in question of $ 15,512.52, $ 48,093.67, and $ 22,966.21 represent interest upon the obligations of a state and as such are exempt from taxation under section 22 (b) (4) of the Revenue Act of 1936 and of the Internal Revenue Code. The respondent contends that the amounts in question represent gains, profits, and income derived from dealings in warrants and as such are to be included in gross income under section 22 (a) of the Revenue Act of 1936 and of the Internal Revenue Code. The material provisions *127 of this section are substantially the same in both the act and the Code, and those of the Code are set out in the margin. 1*228 Petitioner argues that G. C. M. 10452, C. B. XI-1, p. 18, tends to support its contention, but has cited no court decision or other authority in its favor. The notes involved in G. C. M. 10452 were issued at a discount, which at once distinguishes that ruling from the situation here. The warrants involved in these proceedings were not issued at a discount, notwithstanding petitioner's contention to the contrary. Petitioner contends that since prior to the submission of their bids to the state some of the payees of the warrants secured petitioner's commitment as to the rate of discount at which it would purchase the warrants and since this discount was included as a part of the bid price, namely, the market price plus the discount, the practice of the state "in issuing its general revenue fund warrants, under the circumstances described, constituted nothing more nor less than the borrowing of money on its noninterest-bearing obligations issued at a discount." We do not agree with that contention. It is our opinion that the entire amount of the warrant is the purchase price which the state agreed to pay for the particular commodity*229 in question or the cost of the services in those cases where warrants were issued for services rendered the state. Cf. Daniel Bros. Co. v. Commissioner, 28 Fed. (2d) 761; Henrietta Mills, Inc. v. Commissioner, 52 Fed. (2d) 931. During the taxable years in question the person or firm making the bid would submit the bid in one lump sum without breaking it down to show any element of discount.A simple illustration, we think, will show the error of petitioner's contention that the State of Texas was selling its warrants at a discount. Suppose that a contractor who sold the State of Texas certain grocery items for its penitentiary system received a state warrant for the amount of the goods which he sold and, instead of selling the warrant at a discount, kept it until there was money in the general fund to pay it and collected it in full. Would such contractor have to return in his gross income any interest or discount earned on his state warrant? We think not. The State of Texas had not issued the warrant to him at a discount. It had simply paid him the *128 agreed purchase price for his goods. He may have*230 added something to the price of his goods to take care of the delay which would transpire before he got his money, but that certainly would not be interest or discount. This illustration is equally applicable to the salary warrants of state employees, in which the evidence shows petitioner had many dealings. The state added nothing to the face amount of the warrants to take care of the lapse of time before they would be paid. If an employee kept his warrant until there was money in the general fund to pay it, he collected his salary in full. If he did not keep it until there was money in the general fund to pay it but sold it at a discount to a dealer such as was petitioner, he of course suffered a loss, but such loss does not represent any interest or discount on state warrants so far as the state is concerned. The loss came out of the employee's pocket and not out of the state's.We hold that the amounts in question are not exempt from taxation as interest upon obligations of a state under section 22 (b) (4), but should be included in gross income within the specific provisions of section 22 (a) and the rationale of Willcuts v. Bunn, 216">282 U.S. 216.*231 Petitioner offered some evidence with the intention of contending that in any event $ 28,834.25 of the $ 48,093.67 included in its gross income for 1939 should be excluded on the ground that, if income, it was income in prior years. There was no assignment of error to this effect. But, aside from that objection, the evidence shows that petitioner received the $ 28,834.25 in 1939 from banks with which it had been dealing and had not reported it as income in any prior year, and, since it reported on the cash receipts and disbursements basis, the amount was properly included in petitioner's 1939 income.2. Petitioner, by amendments to the respective petitions filed in these proceedings at the hearing, assigned error on the part of the respondent in failing and refusing to allow as deductions for bad debts $ 741.54 in 1939 and $ 497.25 in 1940. The reason for these amendments was due to the change in the law 2*233 relating to bad debts as enacted in section 124 of the Revenue Act of 1942, the material provisions of which are in the margin. 3 At the hearing petitioner proved that certain debts totaling $ 741.54 had become worthless within the taxable year 1939, and that certain debts*232 totaling $ 537.25 had become worthless within the taxable year 1940. The returns offered in evidence *129 disclosed that petitioner had deducted as bad debts the amount of $ 5,299.40 in 1939 and no amount as bad debts in 1940. In his determination of the deficiencies the respondent made no adjustments regarding bad debts for either year. In his brief the respondent contended that in the absence of evidence showing that no part of the debts totaling $ 741.54 was contained in the larger amount of $ 5,299.40, no additional allowance should be made for the year 1939; and that for the year 1940 petitioner should be limited to $ 497.25, the amount claimed in the amendment to the petition. Subsequent to the filing of briefs petitioner filed a motion, which was granted, "To Reopen Record and for Leave to Take and File Deposition," and the parties thereafter stipulated that, of the $ 741.54 of debts which became worthless within the year 1939, $ 498.95 was included in the larger amount of $ 5,299.40 and $ 242.59 has never been deducted by petitioner or allowed by respondent.We hold that for the year 1939 petitioner is entitled to an additional allowance for bad debts in the amount of $ 242.59, and that for the year 1940 petitioner is entitled to an allowance for bad debts in the amount of $ 497.25. The proof showed that debts owed petitioner to the amount of $ 537.25 became worthless in 1940. However, petitioner in assignment of error (d) for 1940 alleged error only as to bad debts of $ 497.25.After the hearing petitioner filed "Motion to Amend Pleadings to Conform to Proof." The grounds of this motion were "That at the hearing had in these proceedings the right of Petitioner to deductions for depreciation and bad debts in*234 excess of the amounts formally plead was clearly established." This motion was granted. However, petitioner has not filed any amendments to its petition since the granting of said motion. After the granting of this motion petitioner should have filed amendments which pointed out the increased deductions for which it was contending. See Rule 17, our Rules of Practice. Petitioner having filed no amended assignments of error to conform to the proof, our decision is limited to the assignments of error in the original petition and in amendments to the petition which were properly filed at the hearing.3. Petitioner, by an amendment to petition in Docket No. 111764 filed at the hearing, alleged that the respondent erred in not allowing a deduction of $ 359.29 for depreciation of its building and furniture and fixtures for the year 1939. Based upon the proof offered at the hearing, the respondent concedes that petitioner is entitled to depreciation for the year 1939 of $ 256.56 on the building and $ 194 on the furniture and fixtures. These amounts exceed by $ 91.27 the amount asserted by petitioner in its assignment of error for 1939. However, since the Commissioner concedes the larger*235 total and the evidence sustains *130 it, the amounts conceded by respondent will be allowed in the computation under Rule 50.4. Are the deficiencies for 1937 barred? The applicable statute is section 275 of the Revenue Act of 1936, the material provisions of which are in the margin. 4*236 The return for the calendar year 1937 was filed on March 9, 1938, but under section 275 (d) it shall be considered as if it was filed on March 15, 1938. See section 53 (a), Revenue Act of 1936. The deficiency notice was mailed on July 17, 1942. Therefore, if the three-year period provided for under section 275 (a) is applicable, the deficiencies are barred; and if the five-year period provided for under section 275 (c) is applicable, the deficiencies are not barred.In Emma B. Maloy, 45 B. T. A. 1104, we had occasion to construe the term "gross income" as used in section 275 (c) of the Revenue Act of 1934, which section is identical with section 275 (c) of the Revenue Act of 1936. In the course of our opinion we said:* * * We think it evident that the term "gross income" as used in section 275 (c), supra, refers to the statutory gross income required to be reported on the return. The heading, "Gross Income", on the form of the return calls for the inclusion there only of gross taxable income. That amount does not include that portion of capital gain which is not to be taken into account in computing taxable income, nor does it include nontaxable*237 interest on Government securities. Section 275 (c) refers to the omission from gross income of an amount "properly includible therein" * * *Did petitioner omit the amount of $ 15,512.52 in question for the year 1937 from its gross income as stated in the return? We held under the first issue that this amount was properly includable in petitioner's gross income for 1937 under section 22 (a) of the Revenue Act of 1936. Petitioner twice reported the amount in its return, once under schedule B as nontaxable income and again in the typewritten schedule as a part of the "total receipts," but at neither place was the amount reported as "gross income." The term "gross income" is defined in section 22 (a), supra. See footnote 1; see also Emma B. Maloy, supra.Petitioner did not report the amount of $ 15,512.52 as gross income under section 22 (a); it reported the amount as an exclusion from gross income under section 22 (b) (4). Although an *131 amount may be disclosed fully on the return, if it is not reported as a part of the gross taxable income, it is not a part of the "gross income stated in the return" as that phrase is used in section*238 275 (c), supra, Emma B. Maloy, supra;Estate of C. P. Hale, 1 T. C. 121; American Liberty Oil Co., 1 T. C. 386; Katharine C. Ketcham, 2 T. C. 159; American Foundation Co., 2 T.C. 502">2 T. C. 502. In the typewritten schedule of "Receipts" attached to the return the amount was labeled "Interest collected on State of Texas obligations." If this had been the proper label, such "receipts" would not have been includable in petitioner's gross income under section 22 (a), but would have been specifically excludable from gross income and exempt from taxation under section 22 (b) (4). The latter way is the way in which petitioner reported the receipts of $ 15,512.52, and it still contends under issue (1) that this amount should be excluded from gross income. We hold that petitioner omitted from its "gross income stated in the return" the amount of $ 15,512.52. The amount of "gross income stated in the return" was $ 11,426.94. Since the amount omitted from gross income was properly includable therein, and since this amount is in excess of 25 percent *239 of the amount of gross income stated in the return, it follows that the deficiencies for the year 1937 are not barred by the statute of limitations.Decisions will be entered under Rule 50. Footnotes1. SEC. 22. GROSS INCOME.(a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *(b) Exclusions From Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter;* * * *(4) Tax-free interest. -- Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, * * *↩2. Sec. 23 (k) (l), Internal Revenue Code↩.3. SEC. 124. DEDUCTION FOR BAD DEBTS, ETC.(a) General Rule. -- Section 23 (k) (relating to bad debts and securities becoming worthless) is amended to read as follows:"(k) Bad Debts. --"(l) General Rule. -- Debts which become worthless within the taxable year; * * ** * * *(d) Effective Date of Amendments * * * and the other amendments made by this section shall be effective with respect to taxable years beginning after December 31, 1938.↩4. SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.Except as provided in section 276 --(a) General Rule. -- The amount of income taxes imposed by this title shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.* * * *(c) Omission from Gross Income. -- If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed.(d) For the purposes of subsections (a), (b), and (c), a return filed before the last day prescribed by law for the filing thereof shall be considered as filed on such last day.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623099/ | BISMARK REALTY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bismark Realty Co. v. CommissionerDocket No. 9097.United States Board of Tax Appeals12 B.T.A. 677; 1928 BTA LEXIS 3480; June 18, 1928, Promulgated *3480 Respondent's determination of invested capital sustained. Nathan D. Shapiro, Esq., for the petitioner. J. L. Deveney, Esq., for the respondent. ARUNDELL*677 ARUNDELL: The respondent found a deficiency of $205.88 in income and excess-profits taxes for the year 1919, in connection with which it is claimed he erred in the computation of invested capital for 1918. FINDINGS OF FACT. The petitioner, a New York corporation, with principal offices at 50 Court Street, Brooklyn, N.Y., was organized in 1910 with a capital stock of $1,000. Its activities were confined almost exclusively to the purchase and sale of real estate. The books of account of the petitioner consisted of cards on which entries were made for each purchase of property. At December 31, 1917, the petitioner owned eight pieces of real estate. The cost of, and outstanding mortgage, on each property, together with the petitioner's equity therein at the close of 1917, were as follows: PropertyCostMortgageEquity104-A Somers Street$5,250$4,000$1,250171-3 Rochester Avenue7,5004,0003,500360 to 363 Broadway28,42517,00011,425706 Willoughby Avenue18,65015,0003,650890 Broadway13,92511,5002,4252111 Dean Street10,1006,7503,3501974 Eastern Parkway33,60021,75011,850643 Madison Street (acquired in exchange)2,200*3481 *678 In the year 1917 the petitioner made a profit of $544. "Loans payable" at the close of 1917 amounted to $7,694.60. Respondent's determination of invested capital for the year 1919 was absed on invested capital at January 1, 1918, of $18,655.40. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623101/ | AUGUST WAEGEMANN AND BARBARA WAEGEMANN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Waegemann v. CommissionerDocket Nos. 1026-90, 3116-91, 22809-91, 27414-91United States Tax CourtT.C. Memo 1993-632; 1993 Tax Ct. Memo LEXIS 644; 66 T.C.M. (CCH) 1808; December 28, 1993, Filed *644 Decision will be entered under Rule 155. For petitioners: Donald Del Grande. For respondent: Mary E. Wynne and Cynthia K. Hustad. CLAPPCLAPPMEMORANDUM FINDINGS OF FACT AND OPINION CLAPP, Judge: Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Docket No. 1026-90 -- August and Barbara Waegemann: Additions to TaxSec.Sec.Sec.YearDeficiency6653(a)(1)(A)6653(a)(1)(B)66611984$ 8,014,315$ 402,0661$ 2,010,32919852,262,052113,1032565,513Docket No. 3116-91 -- Global, Inc.Additions to TaxSec.Sec.Sec.Sec.Sec.YearDeficiency6653(a)(1)6653(a)(2)6653(a)(1)(A)6653(a)(1)(B)66611985$ 280,167$ 14,0081 -- --$ 70,0421986314,185----$ 15,709278,5461987884,045----44,2023221,011Docket No. 22809-91 -- August E. and Barbara A. Waegemann Additions to TaxSec.Sec.Sec.YearDeficiency6653(a)(1)(A)6653(a)(1)(B)66611986$ 1,364,057$ 68,2031$ 341,014*645 Docket No. 27414-91 -- August E. and Barbara A. Waegemann Additions to TaxSec.Sec.Sec.YearDeficiency6653(a)(1)(A)6653(a)(1)(B)66611987$ 522,730$ 26,1371$ 130,683Respondent also determined that all of the deficiencies were due to tax-motivated transactions and, therefore, petitioners in each of these cases are liable for additional interest under section 6621(c), formerly section 6621(d), for each of the years at issue. After concessions by the parties, the issues for decision are: (1) Whether August and Barbara Waegemann (petitioners) are entitled to deduct interest paid in 1984 and 1985 on purported loans secured by plantations in Vanuatu. We hold that they are not. (2) Whether petitioners are entitled to deduct in 1984 and 1985 depreciation on plantations in Vanuatu. We hold that they are not. (3) Whether certain items of income of Global, Inc. (Global), for the years 1984, 1985, 1986, and 1987 should be included in petitioners' taxable income for those years. We hold that they should. (4) Whether petitioners are entitled to deduct partnership losses in 1984 in connection *646 with Union Square Development Co. (USDC). We hold that they are not. (5) Whether a purported loan of $ 320,000 from Beneficial Mortgage Co. B.V. (Beneficial) to petitioners should be included in petitioners' taxable income for 1984. We hold that it should. (6) Whether petitioners are entitled to deduct interest purportedly paid to Beneficial in 1985. We hold that they are not. (7) Whether petitioners are entitled to deducted interest purportedly paid to San Martine Properties of Amsterdam B.V. (San Martine) in 1984 and 1985. We hold that they are not. (8) Whether certain items of income of International Marketing, Ltd. (IML), for the years 1984, 1985, 1986, and 1987 should be included in petitioners' taxable income for those years. We hold that some items should and some items should not. (9) Whether certain items of income of Denver Investors Development, Ltd. (Denver Investors), for the year 1984 should be included in petitioners' taxable income for that year. We hold that they should. (10) Whether all or part of a $ 713,000 purported loan from Eurofinance B.V. (Eurofinance), to Consolidated Mining Co. (CMC) should be included in petitioners' taxable income for 1984. *647 We hold that it should. (11) Whether petitioners are entitled to a $ 385,402 net operating loss carry forward to 1984. We hold that they are not. (12) Whether petitioners are entitled to an $ 18,165 investment interest deduction for 1986. We hold that they are not. (13) Whether petitioners are liable for increased interest under section 6621(c), formerly section 6621(d), for 1984, 1985, 1986, and 1987. We hold that they are. (14) Whether petitioners are liable for additions to tax under section 6653(a)(1) and (2) for 1984 and 1985, and under section 6653(a)(1)(A) and (B) for 1986 and 1987. We hold that they are. (15) Whether petitioners are liable for additions to tax under section 6661 for 1984, 1985, 1986, and 1987. We hold that they are. (16) Whether Global is entitled to interest expense deductions of $ 254,800, $ 413,380, and $ 3,044 for the years 1985, 1986, and 1987, respectively. We hold that it is not. (17) Whether Global is entitled to depreciation deductions of $ 223,894, $ 231,577, and $ 233,940 for the years 1985, 1986, and 1987, respectively. We hold that it is not. (18) Whether Global is entitled to net operating loss carryforwards of $ 90,365, $ 424,878, *648 and $ 682,553 for the years 1985, 1986, and 1987, respectively. We hold that it is not. (19) Whether Global had additional income of $ 114,00 from the sale of a carwash in 1986. Given our holding with respect to petitioners, we hold that it did not. (20) Whether Global had additional income of $ 1,974,900 for forgiveness of indebtedness in 1987. We hold that it did. (21) Whether Global is liable for increased interest under section 6621(c), formerly section 6621(d), for 1985, 1986, and 1987. We hold that it is. (22) Whether Global is liable for additions to tax under section 6653(a)(1) and (2) for 1985 and under section 6653(a)(1)(A) and (B) for 1986 and 1987. We hold that it is. (23) Whether Global is liable for additions to tax under section 6661 for 1985, 1986, and 1987. We hold that it is. All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. FINDINGS OF FACT We incorporate by reference the joint stipulation of facts, the first through twelfth supplemental joint stipulations of facts, and the attached exhibits. At the time*649 the petitions in these cases were filed, petitioners were residents of Hillsborough, California, and Global had its principal place of business in San Rafael, California. The EntitiesIn mid-1977, August Waegemann (petitioner) approached Quentin L. Breen (Breen), a California tax attorney, to undertake tax planning for him and his family. The tax planning included the establishment of foreign situs trusts to act as holding companies for foreign corporations. The trust structure was designed, in part, to ensure that any corporation owned by the trusts would not be considered to be a controlled foreign corporation or a foreign personal holding company. In order to implement the plan suggested by Breen, petitioner's aunt, Emilie W. Mitchell, established three trusts. One trust was the Emilie Mitchell Trust, a Bermuda trust established November 18, 1977. The Bank of Bermuda was the trustee and the initial corpus was $ 1,000. The beneficiaries were petitioners, petitioners' daughter and grandson, Clarise A. and Bryan C. Blanchard, the issue and heirs of petitioners, the John Birch Society, and all organizations qualified under section 501(c)(3). Petitioner served as trust*650 protector for the Emilie Mitchell Trust, with the power to remove the trustee and appoint a new trustee, provided the new trustee met certain qualifications. The second trust was also a Bermuda trust established November 24, 1977, and called the Free Enterprise Foundation (FEF). The beneficiaries of FEF were charitable organizations recognized under the laws of Bermuda. The Bank of Bermuda was the trustee and the initial corpus was $ 10. Petitioner was the trust protector of FEF until he resigned in 1986, at which time his daughter became trust protector. The third trust was the Brandywine Charitable Trust (Brandywine), a British Virgin Islands trust established February 24, 1981. The beneficiaries of Brandywine were charitable organizations that satisfied the requirements of section 501(c)(3). The trustee was the Caribbean Trust Co. and the initial corpus was $ 50,000. Petitioner was the trust protector of Brandywine until he resigned in 1986, at which time his daughter became trust protector. As trust protector of FEF and Brandywine, petitioner had essentially the same power to remove and replace the trustee as he had for the Emilie Mitchell Trust. The Bank of Bermuda, *651 as trustee for the Emilie Mitchell Trust and FEF, held 499 of the 500 outstanding shares of Sphinx Enterprises Ltd. (Sphinx) stock. Sphinx was a British Virgin Islands corporation formed by George B. Mitchell (Mitchell), an unrelated person, on September 7, 1977. Mitchell owned the remaining share of Sphinx stock. Sphinx owned 100 percent of Societe Agricole Hebraise (SAH), an unregistered New Hebrides corporation, 100 percent of Rowley Properties, Inc. (Rowley), a Panama corporation, and 100 percent of IML, a British Virgin Islands corporation. Prior to September 7, 1982, Sphinx transferred its interests in SAH, Rowley, and IML to Evansville Insurance Co., Inc. (Evansville), a Panama corporation. Once it had transferred all of its assets, Sphinx ceased operations and redeemed its outstanding shares. Evansville was originally a wholly owned subsidiary of Sphinx. In October 1982, Sphinx assigned its interest in Evansville to FEF. Brandywine was the sole owner of Bray Trading Co., Ltd. (Bray Trading), a Hong Kong corporation. Global was a wholly owned subsidiary of Bray Trading. Global was incorporated in Nevada in February 1982. Brandywine also owned Alabaster, Inc. and *652 B. Benreed Investment, Ltd. (B. Benreed). B. Benreed was incorporated in Hong Kong and was the sole shareholder of Denver Investors, a Colorado corporation. Also involved in some of the transactions at issue were partnerships in which petitioner was a partner. USDC was a Colorado general partnership formed for the purpose of developing property in Lakewood, Colorado (the Lakewood property). Petitioner and Sam Miller (Miller) were each 50-percent partners in USDC. Union Square Sales Co. (USSC) was another partnership owned by petitioner and Miller which participated in the purchase and development of the Lakewood property. Petitioner and Miller were also 25-percent partners in CMC from March 1983 until October 1984. The other partner of CMC was Claude Lee (Lee). In addition, various foreign financing companies participated in some of the transactions at issue. These included San Martine, New World Properties, B.V. (New World), Beneficial, and Eurofinance, all Netherlands companies; Sun Tak Shun Finance, Ltd. (Sun Tak Shun), a Hong Kong company; and Hong Kong Shanghai Finance Group (HKSFG), a Bahamas company. New Hebrides Plantations TransactionSometime in late 1977*653 or early 1978, petitioners became interested in acquiring plantations in New Hebrides. Petitioner consulted the Alexander & Baldwin Agribusiness Corp. (Alexander & Baldwin) regarding the earnings and development potential of a plantation (My plantation) owned by Jean My (My). Petitioner also considered hiring Alexander & Baldwin to manage the plantation, but chose not to pursue that course because of the monetary investment that would have been required. Petitioner negotiated with My for the purchase of his plantation, and the sale was completed on April 29, 1978. The agreed sale price was $ 590,000, consisting of a cash downpayment of $ 150,000 and a $ 440,000 note. The note was payable in two installments: $ 240,000 due April 30, 1979, and $ 200,000 due April 30, 1980. Petitioner and My later negotiated a $ 100,000 increase in the sale price which petitioner paid on June 4, 1979. The sale of the My plantation was structured as a sale to Sphinx with title held by Societe Civile Sarami. On May 1, 1978, Sphinx signed a lease agreement with SAH giving SAH a 10-year lease on the My plantation. The lease payments were $ 154,000 for the first 4 years and $ 200,000 for the remaining*654 6 years. Sphinx also encumbered the My plantation with a mortgage securing a $ 1,400,000 loan from New World on May 22, 1978. Under the terms of the loan, Sphinx was to make interest payments of $ 154,000 for the first 4 years and $ 200,000 for the remaining 6 years. The principal balance was due after 10 years. Those terms were very similar to the terms of a $ 1,400,000 loan Sphinx had made to New World on May 1, 1978. The final stage of petitioners' plan to acquire the My plantation was an exchange agreement between Sphinx and petitioners. Sphinx agreed to transfer its interest in the My plantation subject to the New World loan and the lease, and petitioners agreed to transfer their interests in various properties in California subject to certain leases and loans. The transfer of interests purportedly occurred on May 22, 1978. On that date, petitioners also signed an assumption of the New World loan. In mid-1978, petitioners decided to purchase a second plantation in New Hebrides (Maile plantation) owned by Societe Civile D'Aores (SCDA) which was wholly owned by Dr. and Mrs. James Stakely (the Stakelys). The process of acquiring the Maile plantation was very similar to*655 the My plantation acquisition. Petitioner negotiated a $ 250,000 sale price for the Maile plantation and the sale occurred on September 11, 1978. The sale of the Maile plantation was structured as a transfer of the Stakelys' ownership rights in SCDA to Sphinx for $ 250,000, followed by a transfer of Sphinx's rights in SCDA to petitioners purportedly in exchange for petitioners' interest in a certain shopping center in Reno, Nevada. A portion of the purchase price was financed by a $ 150,000 loan from Commercial Bank of Australia (CBA) to SCDA and petitioners. The loan was secured by a mortgage on the Maile plantation. Sphinx was not a party to the CBA loan. In anticipation of the Maile plantation transfer, Sphinx leased the plantation to SAH for 10 years beginning August 15, 1978. The lease payments were $ 75,000 per year. In addition, on September 1, 1978, New World loaned Sphinx $ 650,000 secured by a mortgage on the Maile plantation. Under the terms of the loan, Sphinx was to make interest payments of $ 78,000 for the first 4 years and of $ 100,000 for each year thereafter. The principal balance was due after 10 years. The terms of the loan from New World to Sphinx were*656 very similar to the terms of a $ 650,000 loan from Sphinx to New World made on the same day. When the Maile plantation was transferred to petitioners, they took the property subject to the lease to SAH and to the loan from New World. Although the plantations were purportedly leased by SAH, petitioner controlled their operations. He installed his daughter and son-in-law (the Blanchards) as managers of the plantations and received detailed accountings of operations. In addition, petitioner participated in contract negotiations related to plantation operations and made personnel decisions. In 1980, New Hebrides gained its independence and changed its name to Vanuatu. The new Government of Vanuatu nationalized all agricultural property owned by nonresidents and placed petitioners on the undesirable aliens list. Petitioner continued to operate the plantations through various managers and tried to convince the Government of Vanuatu that the property should be returned to its rightful owners. However, petitioner eventually liquidated the plantations to the extent he could and stopped making payments on the notes held by My and CBA in 1981 and 1982, respectively. Petitioners continued*657 to make the interest payments on the New World notes until 1985 and deducted those payments on their Federal income tax returns. Petitioners also deducted depreciation on the plantations on their Federal income tax returns until 1985. Crestview, Stockton, San Francisco and Raleys TransactionsPetitioners owned a 50-percent interest in a shopping center in Watsonville, California, called "Crestview". Earl Tom Pyle (Pyle) owned the other 50 percent. Petitioners also owned 50-percent interests in two parcels of real property in San Francisco (the San Francisco property) in which Pyle was the other 50- percent owner and a 100-percent interest in a parcel of real property in Stockton, California (the Stockton property). In August 1978, petitioners transferred legal title to Crestview and the San Francisco and Stockton properties to San Francisco Land & Title Co. (San Francisco L & T) pursuant to a holding agreement in which San Francisco L & T agreed to hold title to the properties for the benefit of petitioners. In addition, petitioners owned 49 percent of a shopping center in Reno, Nevada, called "Raleys". Two corporations that were wholly owned by petitioners owned 29 *658 percent of Raleys and unrelated third parties owned the remaining 22 percent. In August 1978, petitioners and their wholly owned corporations transferred legal title to their interests in Raleys to Reno Land & Title Co. (Reno L & T) pursuant to a holding agreement in which Reno L & T agreed to hold title to the property for the benefit of petitioners and their wholly owned corporations. On May 22, 1978, petitioners instructed San Francisco L & T to hold Crestview and the San Francisco and Stockton properties for the benefit of Sphinx. The transfer of beneficial title was purportedly effected in exchange for the transfer of the My plantation from Sphinx to petitioners under an agreement effective October 10, 1977. Similarly, on October 9, 1978, petitioners instructed Reno L & T to hold Raleys for the benefit of Sphinx pursuant to an agreement between petitioners and Sphinx effective June 26, 1978. Under the agreement, petitioners purportedly agreed to exchange their interest in Raleys for Sphinx's interest in the Maile plantation. Despite the purported transfer of Raleys, Crestview, and the San Francisco and Stockton properties to Sphinx, petitioners continued to hold themselves*659 out as the owners of those properties and continued to exercise control over them. Neither the county recorder's office nor the county assessor's office was ever informed about the change in ownership of Crestview. In 1979, Union Oil Co. of California sent petitioner a tax questionnaire and a letter asking petitioner to forward the questionnaire to the new owner if the property had changed hands. Pyle responded to the inquiry with a letter stating that the property was still under the same ownership. During 1981 and 1982, in a suit with Montgomery Ward, petitioners filed a complaint in which they indicated that they were the lessors on the Crestview lease to Montgomery Ward, and petitioner testified in a deposition and in court that he owned Crestview. In addition, petitioner continued to sign leases on the property and listed the property as personal assets on financial statements he provided to various banks. Until after 1988, all of the income from Raleys, Crestview, and the San Francisco properties was deposited into accounts on which petitioners had sole signatory authority. In 1982, Sphinx purportedly sold its interests in Raleys, Crestview, and the San Francisco properties*660 to Global. The initial deposit on the sale to Global was paid by Bray Trading from funds which had come from USSC through New World, Rowley, and Brandywine. A portion of the money used to finance Global's purchase of the property came from a purported loan between Global and Sun Tak Shun arranged by Eurofinance. The funds for the loan originated with Brandywine and passed through Bray Trading to Sun Tak Shun. None of the entities involved in the purported financing ever recorded a mortgage against Raleys, Crestview, or the San Francisco properties. Money from Global was sent offshore in the form of payments on the loan from Eurofinance; however, the funds were sent back onshore again in the form of loans to USDC. Even after the purported transfer of Raleys, Crestview, and the San Francisco properties from Sphinx to Global, petitioners continued to hold themselves out as the owners of those properties. In 1982, petitioner, without consulting anyone, made the decision not to sell Raleys to the minority owners. Acting as lessors, petitioners signed a November 27, 1984, lease termination agreement on the portion of Crestview leased to the Bank of America. Both San Francisco L*661 & T and Reno L & T continued to consider petitioners to be the owners of Raleys, Crestview, and the San Francisco properties. As late as 1988, petitioner signed, as the owner of Crestview, an application for environmental review with the city of Watsonville. Moreover, petitioner controlled Global's operations and was the only one who gave Global's president instructions regarding Global's income and operations. In the summer of 1989, Global purportedly sold Raleys to a third party and Crestview to Pyle, claiming a loss on both sales. Money from the sale of Raleys was paid into petitioners' bankruptcy estate. Additionally, Global paid petitioners' legal fees for their bankruptcy proceeding. The remainder of the purchase price for Raleys and the entire purchase price for Crestview were transferred offshore. Lakewood Property TransactionsPetitioner and Miller formed USDC in 1979 for the purpose of purchasing and developing the Lakewood property. Prior to the written agreement petitioner and Miller operated the business as Union Square Land Co. The property was appraised at approximately $ 14 million as it was and $ 17 million if certain changes were made. On April 5, 1979, Miller*662 signed an option contract to purchase the Lakewood property for $ 7 million and paid $ 350,000 into an escrow account toward the purchase. Under the option contract, the sale was to close on October 1, 1979. On September 26, 1979, the closing date was extended to October 10, 1979. In March 1979, petitioner and Miller, for Union Square Land Co., entered into an agreement with Rowley to negotiate the purchase of the Lakewood property for Rowley. Petitioner and Miller also arranged financing for the purchase from various sources, including simultaneous sales of portions of the property. On October 18, 1979, the sale was completed, and Denver Land and Title, a subsidiary of Rowley, took title to the Lakewood property for the benefit of Rowley. On that same day, New World purchased the Lakewood property from Rowley for $ 13,500,000. New World gave Rowley a note for $ 12,659,083 at 17-7/8 percent interest with no payments due for 3 years. Also on the same day, New World sold the Lakewood property to USSC for $ 13,500,000. USSC gave New World a note for $ 12,659,083 at 18-percent interest with no payments due for 3 years. At all times, Denver Land and Title continued to hold legal*663 title to the Lakewood property. In 1984, USDC 2 sold portions of the Lakewood property that had been developed. In calculating the gains on the sales, USDC computed the bases using prorated portions of $ 13,500,030 as the initial bases. Also in 1984, a circular flow of funds occurred, in which payments made by USDC on its loan from New World were routed through various entities and funneled back through Beneficial to USDC. USDC filed a partnership return for 1984 reporting a loss of $ 1,695,107. Petitioner's Schedule K-1 assigned $ 847,553 of that loss to him. House LoansIn July 1978, petitioners received a loan of $ 180,000 from Sphinx through San Martine. The note provided for annual payments of $ 19,800 until December 31, 1984, at which time the remaining principal and accrued interest were due. *664 The loan was secured by petitioners' house in Hillsborough, California. The loan structure was designed to keep the economic consequences within the family group and to take advantage of the tax treaty between the United States and the Netherlands. The loan was fully paid with proceeds from another loan in June 1984. In January 1980, petitioners received another loan from Sphinx through San Martine. The loan was for $ 200,000, and under the terms of the note, petitioners were to make annual payments of interest at 15 percent until December 31, 1984, at which time the principal and any accrued interest were due. The loan was secured by petitioners' house in Hillsborough, California, which was valued at $ 400,000. Including the $ 200,000 loan, on March 11, 1980, there were liens recorded against petitioners' house totaling $ 509,380.30. No principal payments were ever made on the loan and interest payments were no longer made after 1985. Neither San Martine nor Sphinx (or its successor Evansville) ever instituted foreclosure proceedings on petitioners' house. In June 1984, petitioners received a $ 320,000 loan from Beneficial which was also secured by their house. The note*665 provided for annual interest payments of 15 percent until December 31, 1984, at which time the principal and any accrued interest were due. Again, no principal payments were ever made, and no interest payments were made after 1985. Nevertheless, Beneficial never instituted foreclosure proceedings. The money used to fund the San Martine loans and petitioners' payments on all of the house loans went through a series of circular transactions from petitioners to various offshore entities and back to petitioners or petitioner's partnership, USDC. International Marketing LimitedPetitioners owned a note executed by Matteo Aiello and Robert V. LoForti (the LoForti note) in the original amount of $ 189,000. Petitioners also owned a note executed by Nobuko D. and James W. Washington (the Washington note) in the original amount of $ 7,475. On May 1, 1984, petitioners sold the LoForti note and the Washington note to IML for the face amounts of the notes. At that time, the principal balance of the LoForti note was $ 138,657 and the principal balance of the Washington note was $ 4,685. On June 5, 1984, petitioner informed the borrowers on the notes that he had sold the notes and*666 all future payments should be sent to IML. IML made a demand for full payment of the Washington note on September 19, 1984, and sold the LoForti note to the Blanchards on July 1, 1990, for $ 45,000, $ 26,000 less than the face amount of the note. Petitioners also owned one-half interests in an oil and gas lease in Ellis County, Kansas (the Staab oil lease), in a note secured by a deed of trust on real property in San Francisco, California (the Jackson note), and in a note secured by a security agreement (the Cassidy note), all of which petitioners sold to IML on May 1, 1984. The sale price for those assets was $ 225,000. On May 26, 1984, petitioner informed Pyle, the other one-half owner of the Staab oil lease, that he had sold his interest in the lease to IML and that all future payments on the lease were to be sent to IML. Pyle also owned the other one-half interests in the Jackson and Cassidy notes and forwarded the payments on those notes to IML. When the Jackson note was paid in full, IML received one-half of the proceeds. IML was also involved in real estate deals with Paxton, a corporation in which petitioner was a 50-percent shareholder. The other 50 percent of the*667 stock was owned by Charles M. Byrne. On January 29, 1982, Barbara B. McCulloch granted Paxton an option to purchase lots 35, 39, and 51 of tract 2266 in Rancho Mirage, California. (Hereinafter the lots will be referred to by lot number.) The purchase price of the lots was set at $ 30,000 each if the option was exercised before May 31, 1982. The price increased to $ 35,000 per lot if the option was exercised between June 1, 1982, and May 31, 1983, and to $ 40,000 per lot if the option was exercised between June 1, 1983, and May 31, 1984. The option was to expire if not exercised by May 31, 1984. On May 2, 1984, Paxton entered into an agreement with IML under which Paxton agreed to exercise its option on lots 35, 39, and 51 and simultaneously sell the lots to IML for $ 125,000. The sale was closed on May 31, 1984. The funds for the sale were provided by Evansville, IML's shareholder. On December 31, 1985, IML sold lot 39 to Richard G. and Marie E. Marek for $ 110,000. On July 14, 1986, IML transferred $ 20,000 to Commonwealth Land & Title Co. (Commonwealth), and on November 4, 1986, IML transferred $ 58,000 to Commonwealth. IML owned one-half of the shares of Commonwealth. *668 Commonwealth owned the houses in which the Blanchards' lived from July 1986 until sometime in 1988. Paxton also owned other lots in tract 2266, including lots 16 and 24. On July 24, 1978, Paxton granted a deed of trust to California Canadian Bank on lots in tract 2266, including lots 16 and 24, to secure a $ 1 million loan. Paxton sold lots 16 and 24 to Reno L & T on March 7, 1980, for $ 2,500 subject to the existing liens and deeds of trust. Reno L & T purchased and held the lots for the benefit of SAH. Despite the sale to Reno L & T, Paxton granted a deed of trust on lot 24 to Paul A. Winn, M.D. Employees' Pension Fund on January 12, 1982. Evansville transferred beneficial interest in lots 16 and 24 from one of its subsidiaries, SAH, to another of its subsidiaries, IML, on December 13, 1985. Evansville and IML treated the transfer as a nonrecognition transaction. Lot 24 was sold to Clearwater and Co. in December 1985 for $ 120,000. All of the proceeds of the sale of lot 24 were used to pay off Paxton's obligation to California Canadian Bank. Such a payment was required in order to obtain a release of the bank's security interest in lot 24. Petitioners purchased lots *669 2, 3, 4, 5, 6, and 7 of tract 2266 on October 14, 1977, for $ 238,624.55 in cash and a note for $ 50,000. On January 12, 1978, petitioners entered into an agreement to sell lot 3 to Mel J. Young (Young) and Crestview Cadillac, Inc. Due to a problem with the title, Young and Crestview Cadillac sued petitioners to rescind the sale. As part of the settlement of the litigation, petitioners gave Crestview Cadillac a note for $ 100,000 secured by a deed of trust on lot 3. The deed of trust was recorded on December 1, 1982. In July 1983, petitioners purportedly sold lot 3 to Evansville for $ 175,000. Evansville gave petitioners a note for $ 100,000 at 6-1/2 percent interest. The note was due on April 1, 1987. On July 15, 1983, Evansville executed a document stating that it was transferring its interest in lot 3 to IML. Petitioners executed a deed of lot 3 to IML on September 5, 1983. The deed was never recorded, and no one ever informed Crestview Cadillac, the Riverside County recorder's office, the Riverside County assessor's office, or California Canadian Bank of the sale. Petitioners reported a loss of $ 55,859 on their 1983 Federal income tax return as the result of the sale*670 of lot 3. On March 20, 1984, petitioners purportedly sold lot 4 to Evansville for $ 75,000 cash and the assumption of a $ 60,000 note payable to California Canadian Bank. On the same day, Evansville assigned any interest it had in lot 4 to IML. Petitioners executed a deed in favor of IML on lot 4 on April 2, 1984. The deed was never recorded. No one ever informed the Riverside County recorder's office, the Riverside County assessors office, or California Canadian Bank of the sale. On October 8, 1984, petitioners entered into contracts with B. Lee and Lucile J. Karns (the Karnses) for the sales of lots 3 and 4. The Karnses agreed to pay $ 380,000 for lot 3 and $ 225,000 for lot 4. The sales were closed on December 21, 1984, and the net proceeds of the sales were distributed directly to petitioners. Denver Investors TransactionsOn February 1, 1980, USDC obtained a $ 4 million construction loan secured by a deed of trust on part of the Lakewood property. USDC used the funds to build the Marie Callender restaurant (Marie Callender) on lot 4 of the Lakewood property and the Mann 6 Theater movie theater (the Mann Theater) on lot 6 of the Lakewood property. USDC purportedly*671 sold Marie Callender and the Mann Theater to Denver Investors on September 1, 1981. The sale price was $ 3,350,000. Denver Investors paid $ 1,600,000 in cash and executed a note for $ 1,750,000. The interest rate on the note was 22 percent payable annually and the principal balance was due September 1, 1991. The funds for the purchase of the restaurant and the theater by Denver Investors came from USDC as part of a circular flow of funds. Despite the purported sales of Marie Callender and the Mann Theater to Denver Investors, William Dawn continued to manage the properties, and at all times he considered himself an employee of USDC. In addition, the rents from the properties continued to be collected by USDC, and there is no evidence that they were ever paid over to Denver Investors. In 1982 and 1983, USDC listed Marie Callender and the Mann Theater as assets on financial statements. On April 1, 1983, the Blanchards purportedly purchased the Mann Theater for $ 2 million; however, the sale was never recorded. In addition, there is no evidence that any of the rent from the Mann Theater was ever paid to the Blanchards. Instead, all of the rents from the Mann Theater and Marie*672 Callender were paid to USDC until the ultimate sale of the properties to Mother Lode Partnership on October 19, 1984. At the closing on the sale to Mother Lode Partnership, payments were made to pay off various liens on the property. However, no payment was made to USDC to pay off the purchase money note made by Denver Investors on the purported purchases of Marie Callender and the Mann Theater from USDC. Consolidated Mining Co. TransactionsOn February 15, 1983, CMC entered into a loan commitment agreement with Eurofinance. Under the agreement, Eurofinance agreed to fund up to $ 3 million in loans to CMC over 20 months. On the same day, Eurofinance entered into an agreement with HKSFG under which HKSFG agreed to fund the loans Eurofinance was making to CMC. From April 22, 1983, through March 23, 1984, CMC received a series of loans totaling $ 3,110,500, $ 2,397,500 in 1983 and $ 713,000 in 1984. For each loan, CMC executed a separate note. The terms of the 1983 notes were all identical. The notes were 10-year notes with a 20-percent interest rate which was adjustable annually. The interest was payable annually beginning on December 31, 1984, and the principal was*673 payable at maturity. The terms of the 1984 notes were identical to the 1983 notes except that the first interest payments were not due until December 31, 1985. No payments were ever made on any of the notes and the loans were unsecured until February 8, 1985, when petitioner signed a security agreement pledging CMC's Dragon Consolidated Mining Co. stock. On its 1984 Federal income tax return, CMC reported, at the beginning of 1984, assets of $ 3,500,000 and liabilities of $ 3,079,281. Eurofinance and HKSFG were acting as conduits for Rowley in the loan transactions. For each note from CMC to Eurofinance there were corresponding notes from Eurofinance to HKSFG and from HKSFG to Rowley. Moreover, the 1983 loan transactions were part of a circular flow of funds that originated with USDC and flowed through New World, Rowley, HKSFG, Eurofinance, CMC, and back to USDC. The funds from the 1984 loans came from the trusts through their subsidiaries, Evansville and Alabaster, into Rowley. The funds from the loans were controlled by petitioner. He prepared detailed instruction on the use of the funds, including transfers to USDC and other companies, whose relationship to CMC is unclear. *674 OPINION In order to make our decision in these cases, we must examine each of the transactions described and ascertain whether it was bona fide transaction or merely a sham. It is a generally accepted principle that "the substance of a transaction rather than the form in which it is cast is determinative of the tax consequences unless it appears from an examination of the statute and its purpose that form was intended to govern." Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 754 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). In performing substance-over-form analysis, the Supreme Court has "looked to the objective economic realities of a transaction rather than to the particular form the parties employed." Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 573 (1978). We have defined a sham as "the expedient of drawing up papers to characterize transactions contrary to objective economic realities and which have no economic significance beyond expected tax benefits." Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332, 347 (1985). The key to the true nature of a transaction is the intent*675 of the parties involved, which we must discover by analyzing all of the surrounding facts and circumstances. Id. at 348. If the transaction is purported to be a sale, some of the factors to be considered are: (1) Whether legal title passes; (2) how the parties treat the transaction; (3) whether an equity was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (5) whether the right of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. [Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221, 1237-1238 (1981); citations omitted.]Another relevant factor is whether the deal was made at arm's length. Falsetti v. Commissioner, supra at 348. If the transaction in question is purported to be a loan, some of the important factors to consider are: (1) whether a note*676 or other evidence of indebtedness exists; (2) whether interest is charged; (3) whether there is a fixed schedule for repayments; (4) whether any security or collateral is requested; (5) whether there is any written loan agreement; (6) whether a demand for repayment has been made; (7) whether the parties' records, if any, reflect the transaction as a loan; (8) whether any repayments have been made; and (9) whether the borrower was solvent at the time of the loan. [Goldstein v. Commissioner, T.C. Memo. 1980-273; citations omitted.]However, we have emphasized that "The key inquiry is not whether certain indicia of a bona fide loan exist or do not exist, but whether the parties actually intended and regarded the transaction to be a loan." Id.In the instant cases, because respondent has not stipulated the legal effect of many of the operative documents for the transactions at issue, petitioners must do more than merely point to the documents as evidence of the transaction without presenting independent evidence of the substance of the transactions. See Gurdin v. Commissioner, T.C. Memo. 1988-31. Petitioners argue*677 that they have presented such evidence in the form of testimony by petitioner and his attorney in the transactions. However, we did not find petitioner, Breen, or Daniel Parks to be credible and do not consider their testimony to be reliable evidence of the transactions in question. Petitioners have argued rather strenuously that the evidence in these cases demonstrates that the trusts and their subsidiary corporations are separate legal entities and that the informalities in the administration of the trusts are not enough to warrant disregarding the individual entities. Petitioners cite La Fargue v. Commissioner, 689 F.2d 845">689 F.2d 845 (9th Cir. 1982), affg. in part, revg. in part and remanding 73 T.C. 40">73 T.C. 40 (1979), and Stern v. Commissioner, 747 F.2d 555">747 F.2d 555 (9th Cir. 1984), revg. and remanding 77 T.C. 614">77 T.C. 614 (1981), in support of their argument. La Fargue and Stern involved taxpayers who set up foreign situs trusts and transferred property to the trusts in exchange for lifetime private annuities. In those cases, the court scrutinized the transactions and determined that *678 the taxpayers did not have sufficient control over the trusts to justify disregarding the taxpayers' characterizations of the trusts and that any informalities in trust administration were too minor to be of any consequence. Moreover, the court determined that the taxpayers had relinquished control over the property that was transferred, and the trusts were not mere conduits for the income from that property; therefore, the transactions at issue were respected as sales. We agree that, in the cases before us, the informalities in the administration of the trusts and the limited power petitioner had to remove the trustees are not sufficient to warrant disregarding the trusts generally. Nevertheless, we do not find that La Fargue and Stern compel us to conclude that the individual transactions at issue must be respected. The sham transaction doctrine requires us to examine each transaction to determine whether it has economic substance. Such analysis is factual in nature and can be concluded only based on the specific evidence presented in the instant cases. The Plantation DeductionsRespondent disallowed petitioners' deductions for depreciation on the My and Maile*679 plantations for 1984 and 1985, and the deductions in 1984 and 1985 for interest on the New World loan secured by the plantations. Respondent argues that the transfer of the plantations through Sphinx and the creation of the $ 1,400,000 and $ 650,000 debts to New World were shams designed to create interest deductions for petitioners. Respondent's contention is that petitioners purchased and ran the plantations, and the loans and the leases were simply designed to create interest deductions using a circular flow of funds. Moreover, respondent points out that petitioners no longer owned the plantations once they were nationalized and, therefore, were not entitled to depreciation deductions on the properties. Petitioners argue that the transfers of the plantations through Sphinx were commercially reasonable and "involved no more exotic tax planning than an Internal Revenue Code 1031 tax-deferred exchange." In addition, petitioners contend that they retained control over the plantations even after they were nationalized and continued to make mortgage payments and to report the lease payments until their bankruptcy in 1985. Therefore, petitioners assert that they are entitled to depreciation*680 deductions and to interest deductions through 1985. We agree with respondent. As we explain in detail below, we conclude that no section 1031 exchange took place because petitioners never relinquished their ownership of Raleys, Crestview, and the San Francisco and Stockton properties. As a result, there is no reasonable explanation for the transfer of the plantations through Sphinx except as a vehicle for creating interest deductions. The evidence demonstrates that petitioners negotiated the purchases of the plantations and, after the purchases, controlled their operations despite the purported lease to Sphinx and its subsidiary SAH, corporations which petitioners claim are independent legal entities outside of petitioners' control. In addition, the loan transactions themselves were suspect. The loans totaled $ 2,050,000, but were secured by property with a total purchase price of $ 840,000 and total purchase money debt of $ 590,000. Nevertheless, the terms of the loans required only annual interest payments of approximately 11 percent and no principal payments until the notes were due 10 years later. Finally, careful scrutiny of the transaction shows that the interest payments*681 made by petitioners were not bona fide payments; they were simply part of a circular flow of funds. Petitioners would receive payments from SAH under the lease. Then, not coincidentally, petitioners would make interest payments of approximately the same amount to New World. New World was then required to funnel the money back to SAH's parent, Sphinx, in the form of interest payments on the loans Sphinx had made to New World. We conclude that such a circular flow of funds lacked economic substance, especially given the questionable terms of the loans. Accordingly, we hold that petitioners are not entitled to deductions for interest paid to New World on the loans secured by the Vanuatu plantations. In addition, we agree with respondent that petitioners lost any interest they had in the Vanuatu plantations well before 1984 and 1985. The evidence shows that before that time, the plantations had been nationalized by the new Government of Vanuatu, and petitioners had given up hope of ever having the properties restored to their ownership. Even though petitioners continued to operate the plantations after they had been nationalized, they were not entitled to depreciation deductions*682 because such a disposition of the properties would be considered a retirement of the asset from service, and a taxpayer is not entitled to depreciate an asset once it is retired from service. Secs. 1.167(a)-10(b) and 1.167(a)-11(d)(3), Income Tax Regs. Therefore, we hold that petitioners were not entitled to depreciation deductions on the Vanuatu plantations in 1984 and 1985. Global IncomeRespondent determined that certain items of income from Global should be included in petitioners' taxable income. Respondent argues that the transfer of Raleys, Crestview, and the San Francisco and Stockton properties to Sphinx, and the subsequent transfer of Raleys, Crestview, and the San Francisco properties to Global were shams. Respondent contends that petitioners continued to exercise the degree of control over those properties consistent with ownership and, therefore, should be taxable on all of the income from their lease and sale. Petitioners argue that the transfer to Sphinx and the subsequent sale to Global were bona fide transactions and that respondent is reading too much into their continued control over the property. Petitioners contend that petitioner exercised control*683 over the property because Sphinx, Global, and the other owners of the property were happy with his management and wanted him to continue to manage the property. Moreover, they assert that the instances in which petitioner held himself out as owner of the properties were merely errors in judgment on his part. We disagree with petitioners' assessment of the evidence. Legal title to the properties was never transferred to Sphinx or Global. Although on paper the parties treated the transactions as transfers to Sphinx and Global, the evidence shows that numerous times from 1978 until 1989 petitioners held themselves out to be the owners of the properties. In addition, others involved with the properties acted as though no sale had occurred. Because all of the properties were leased, neither Sphinx nor Global ever had the right to possession of the properties and neither ever exercised any control over the properties. Finally, all of the income from the lease and sale of the properties went into an account over which petitioners had sole signatory authority, and part of the proceeds from the sale of Raleys to a third party went into petitioners' bankruptcy estate. Based on all of*684 these factors, we conclude that the transfers to Sphinx and Global were shams, and petitioners are liable for Federal income tax on the income from Raleys, Crestview, and the San Francisco properties. We note that respondent has conceded that, if petitioners must include the income from these properties in their income, they are entitled to certain adjustments for operating expenses which are enumerated in respondent's proposed findings of fact. USDC Partnership LossesRespondent disallowed petitioners' deduction for losses from USDC because USDC underreported the gain on the sales of parts of the Lakewood property and took interest deductions for a purported loan from Rowley through New World that was a sham. Respondent argues that USDC purchased the Lakewood property for $ 7 million, and the purported sales to Rowley and New World were merely shams designed to increase USDC's basis in the Lakewood property and to create an interest deduction. Petitioners argue that, although USDC had the opportunity to purchase the Lakewood property for $ 7 million, the partnership did not have the funds to complete the sale without over $ 1 million of funds from Rowley. Petitioners *685 contend that, because Rowley put up all of the equity for the purchase of the Lakewood property while its interest in the property was subordinated to the other financing loans, it was commercially reasonable for Rowley to receive the first $ 6,500,000 of profit from the development of the property. Petitioners point to all of the paperwork of the sale to support their contention that the sale to Rowley was bona fide. As we noted above, without more, the documents of the sale are not sufficient evidence of the substance of the transaction. Petitioners have provided us with nothing beyond the documents except a rather incredible explanation for the structure of the transaction. Petitioners would have us believe that USDC was willing to pay a $ 6,500,000 premium to Rowley in order to obtain less than $ 2 million of funding for its purchase of the Lakewood property. As we stated about a similar transaction in Thompson v. Commissioner, 66 T.C. 1024">66 T.C. 1024, 1051 (1976), affd. 631 F.2d 642">631 F.2d 642 (9th Cir. 1980), "Under the circumstances, the bona fides of such an arrangement are suspect on their face." The evidence shows that petitioner *686 and Miller handled all of the negotiations for the purchase and arranged all of the financing. In addition, until the closing, they held themselves out as the purchasers. The purported loans from Rowley to New World and from New World to USDC for the purchase of the Lakewood property did not require any payments to be made for 3 years, except payments on the purchase money notes from third parties that were wrapped into the loans. In addition, any payments USDC made to New World were funneled through various offshore entities back to USDC. Consequently, we hold that the sale of the Lakewood property to Rowley, the subsequent sale to New World and USDC, and the resulting loans were shams. The true substance of the transaction was a purchase of the Lakewood property by USDC for $ 7 million. House Loan Income and DeductionsRespondent determined that petitioners were required to include in their income for 1984, $ 320,000 that was purportedly a loan from Beneficial. In addition, respondent disallowed petitioners' mortgage interest deductions on that loan and a $ 200,000 loan made by San Martine in 1980. Respondent contends that the loans were not bona fide loans, but were*687 part of a circular flow of funds designed to create interest deductions while keeping the economic consequences within the family. Petitioners argue that the house loans were bona fide loans. Petitioners point to the deeds of trust on their house which secured the loans and the lenders' title insurance policies as evidence of the legitimacy of the loans. Moreover, petitioners contend that their position is strengthened by the fact that petitioners made all of the interest payments on the loans until their bankruptcy in 1985. However, we conclude that the evidence to which petitioners point is not enough. The deeds of trust on petitioners' house were not sufficient security for the loans because in both cases the liens on petitioners' house were greater than the value of the house. Therefore, the loans essentially were unsecured, at least in part. In addition, the fact that the lenders were able to obtain title insurance does not in any way prove that the loans were bona fide. Finally, given the circular flow of the money used to fund the loans and to make the payments, the regular payment of interest has no significance, especially when no principal payments were ever made*688 and no foreclosure proceedings were ever instituted. We conclude that the house loans were shams designed to shuffle petitioners' money around and manufacture interest deductions without any genuine economic consequences. Therefore, we hold that the $ 320,000 loan from Beneficial to petitioners was income to petitioners in 1984 and that petitioners are not entitled to deduct the interest on that loan or the 1980 loan from San Martine. IML IncomeRespondent determined that various items of income of IML should be taxable to petitioners in 1984, 1985, 1986, and 1987. Respondent contends that the sales of petitioners' interests in the Washington, LoForti, Cassidy, and Jackson notes and of the Staab oil lease to IML were shams and petitioners are taxable on the income from those assets. In addition, respondent asserts that the sales of lots 35, 39, 51, 16, and 24 by Paxton to IML were shams. Finally, respondent claims that the sales of lots 3 and 4 by petitioners to IML were also shams and petitioners were the actual sellers when the property was sold to third party purchasers. Respondent argues that petitioners controlled these assets and benefited from their ultimate dispositions*689 and, therefore, should be taxable on the income from and on the gain on the sales of those assets. Petitioner argues that the sales of the assets to IML were legitimate business deals that petitioners entered into to raise funds. With regard to the notes and the Staab oil lease, we agree with petitioners. The evidence shows that petitioners surrendered control over the notes and the oil lease and did not benefit from their ultimate disposition. Once the transfer to IML was complete, income payments on the assets were made to IML, not petitioners. Moreover, when the notes became due, IML made the demands for payments and received the funds. Finally, we do not find the discount sale of the LoForti note to petitioners' daughter and son-in-law, 6 years after the sale to IML, to be an indication that petitioners had control over the assets or that they benefited from them. Therefore, petitioners are not taxable on the notes or the Staab oil lease. We also conclude that petitioners are not taxable on the gain from the sales of lots 39 and 24. Although we agree with respondent that there is reason to question the genuineness of the sales to IML, we see no reason to attribute the*690 ultimate sales to petitioners. The owner of the properties before the purported sales to IML was Paxton, not petitioners, and Paxton benefited from one of the sales by having its debt to California Canadian Bank paid off with the proceeds. Petitioners owned 50 percent of Paxton; however, there is no question that for tax purposes they are separate entities. Respondent points to the Blanchards' rent-free use of houses owned by Commonwealth as evidence that petitioners benefited from these sales and should be taxed on them. However, the link between the sales proceeds and the houses is tenuous, and we do not consider it to be a sufficient reason for disregarding Paxton as a corporate entity. However, we conclude that petitioners are taxable on the gain from the sales of lots 3 and 4 to the Karnses. Although petitioners purportedly sold lots 3 and 4 to IML, no deeds were ever recorded and the lienholders on the lots were never told of the sales. Moreover, petitioners acted as the sellers in the transaction with the Karnses. They signed the sales contracts and received the sales proceeds. Therefore, we find that the sales of lots 3 and 4 to IML were shams. Given our above analysis, *691 we hold that petitioners are not taxable on any of the income of IML except the gain on the sales of lots 3 and 4 in Rancho Mirage, California. Denver Investors IncomeRespondent determined that the $ 1,045,000 gain on the sales of Marie Callender and the Mann Theater should be taxable to petitioners. Respondent contends that the sales of those properties to Denver Investors and the subsequent sale of the Mann Theater to the Blanchards were shams. Petitioners argue that the sales were bona fide, insisting that the circular flow of funds was commercially reasonable and that USDC received no tax benefit from reporting the transaction as it did. We agree with respondent. Whether or not petitioners actually received a tax benefit is not relevant to the question before us. The relevant inquiry is whether USDC's sales of Marie Callender and the Mann Theater were bona fide. Although on paper they appear to be valid sales, in reality they were not. Neither Denver Investors nor the Blanchards ever received any of the income from the properties. In addition, USDC held itself out as the owner of Marie Callender and the Mann Theater as late as 1983. Moreover, Denver Investors*692 never paid for the properties. The money for the cash downpayment came from USDC as part of a circular flow of funds, and the note for the balance of the purchase price was never paid off. As a result, we hold that petitioners are taxable on the $ 1,045,000 gain on the sales of Marie Callender and the Mann Theater in 1984. CMC Loan IncomeRespondent determined that petitioners are taxable on $ 713,000 in loans to CMC in 1984. Respondent argues that petitioner was in complete control of all of CMC's accounts and directed all transfers from those accounts, including those to petitioner's partnership USDC. Moreover, respondent contends that the 1984 loans were not bona fide loans, but were merely devices for funneling funds from offshore to petitioner's partnerships. Petitioners argue that the loans to CMC were bona fide loans. As evidence of their contention, petitioners point to the promissory notes and the increased interest rate, which purportedly compensated the lender for the unsecured nature of the loans. Moreover, they discount petitioner's control over the funds in CMC's accounts as a normal occurrence when a borrower knows a loan is about to be funded. We agree*693 with respondent that the loans were shams and are taxable to petitioners. The 1984 loans were part of a series of loans begun in 1983. The circular flow of the funds in connection with the 1983 loans demonstrates that the parties did not respect the transactions as true loans and were merely using that form to fund USDC while creating interest deductions. Moreover, while the parties observed all of the formalities of loans by executing promissory notes setting forth an interest rate and a schedule of payments, they did not act in a commercially reasonable fashion with regard to the loans. The loans were initially unsecured and there is no evidence of the value of the collateral that was eventually used to secure them. The initial interest payments were not due for more than a year after the loans were made. No interest or principal payments were ever made and no demand for payment was made. Moreover, by the time the 1984 loans were made, the amounts of the loans to CMC were almost equal to the value of its assets. Therefore, we conclude that the 1984 loans were not bona fide loans, but were merely a means to funnel funds from the trusts to petitioners. That the money from*694 the loans should be taxable to petitioners is evidenced by the degree of control petitioner exercised over the funds. Although, at the time, petitioner purportedly had only a 25-percent interest in CMC, he had complete control over the accounts and ordered transfers between CMC and various companies whose ties to CMC are unclear. In addition, petitioner ordered funds from CMC to be transferred to USDC, even though there is no evidence that CMC and USDC were engaged in any business transactions together. Petitioner's exercise of control over CMC's funds gave him the benefit of the purported loans to CMC. Accordingly, we hold that petitioners are taxable on the $ 713,000 loan to CMC in 1984. NOL and Investment Interest DeductionsRespondent disallowed petitioners' net operating loss (NOL) carryforward in 1984, $ 385,402 of which is still at issue, and an $ 18,165 investment interest deduction in 1986. In the proposed findings of fact, respondent asks us to find that petitioners have not introduced any evidence to support their claims to those deductions. Petitioners object to those proposed findings, citing certain accountant's workpapers that are part of the record. *695 Neither party presents any argument on this issue. The workpapers to which petitioners direct us do not prove that petitioners are entitled to the NOL carryforward or the investment interest deduction. In fact, we could find no mention of either in those papers. Petitioners bear the burden of proof on this issue. Rule 142(a). Since petitioners have failed to provide any proof of their entitlement to the NOL carryforward or the investment interest deduction, we hold that those deductions are appropriately disallowed. Global IssuesRespondent disallowed interest and depreciation deductions and NOL carryforwards for Global's 1985, 1986, and 1987 tax years. In addition, respondent determined that Global had additional income from the sale of a carwash in 1986 and from forgiveness of indebtedness in 1987. Neither party has specifically discussed these issues; however, our findings with respect to the Raleys, Crestview, and San Francisco properties transactions affect these adjustments. Because we found that the sales of those properties to Global were shams, petitioners are taxable on the gain from the sale of the carwash; therefore, Global is not taxable on that gain. *696 In addition, because the transactions were shams and Global never owned the properties, it is not entitled to deductions for depreciation or interest related to those properties. Finally, because petitioners and Global have presented no evidence or argument with regard to the remaining issues, we assume that they have conceded those issues, and we uphold respondent's determination. Additions to TaxRespondent determined that petitioners were liable for increased interest under section 6621(c), formerly 6621(d), for 1984, 1985, 1986, and 1987, and for additions to tax under section 6653(a)(1) and (2) for 1984 and 1985, under section 6653(a)(1)(A) and (B) for 1986 and 1987, and under section 6661 for 1984, 1985, 1986, and 1987. Respondent determined that Global was liable for increased interest under section 6621(c), formerly section 6621(d), for 1985, 1986, and 1987, and for additions to tax under section 6653(a)(1) and (2) for 1985, under section 6653(a)(1)(A) and (B) for 1986, and 1987, and under section 6661 for 1985, 1986, and 1987. Petitioners and Global bear the burden of proof on the additions to tax. Rule 142(a); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972).*697 Petitioners' and Global's argument on this issue consists only of general protestations that they kept careful books and records and timely filed their tax returns, and that the transactions in which they engaged were not shams. Given our findings that petitioners and Global engaged in sham transactions for the express purpose of reducing their Federal income taxes, we conclude that their general statements regarding keeping careful books and records and timely filing returns are not sufficient to satisfy their burden of proof. Therefore, we hold that petitioners and Global are liable for additions to tax under sections 6653(a)(1)(A) and (B) and 6661, and for increased interest under 6621(c). Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: Global, Inc., docket No. 3116-91; August E. Waegemann and Barbara A. Waegemann, docket Nos. 22809-91 and 27414-91.↩1. 0 percent of the interest due on $ 8,014,315.↩2. 50 percent of the interest due on $ 2,262.052.↩1. 50 percent of the interest due on $ 280,167.↩2. 50 percent of the interest due on $ 314,185.↩3. 50 percent of the interest due on $ 884,045.↩1. 50 percent of the interest due on $ 1,364,057.↩1. 50 percent of the interest due on $ 522,730.↩2. It is not clear why USDC was selling property that was purchased by USSC. There appears to be a very close relationship between the two partnerships, and the parties seem to treat them interchangeably.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623104/ | Harold M. Rosen v. Commissioner. Leo S. Rosen v. Commissioner.Rosen v. CommissionerDocket Nos. 2775, 2776.United States Tax Court1945 Tax Ct. Memo LEXIS 67; 4 T.C.M. (CCH) 938; T.C.M. (RIA) 45310; October 3, 1945*67 Held on the facts that in the taxable year petitioners were not carrying on business in partnership with their wives within the meaning of the revenue laws, and that petitioners are taxable on the entire income from their business. Samuel R. Rosenthal, Esq., 77 W. Washington St., Chicago, Ill., and C. Claire Moore, C.P.A., for the petitioners. Richard L. Greene, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion These consolidated proceedings involve income tax deficiencies for the calendar year 1941 in the following amounts: Docket No. 2775$7,366.41Docket No. 27766,309.91The question for decision is whether the entire income of the American Grease Stick Company, a partnership, is taxable to the petitioners or whether a portion thereof is taxable to their wives - in other words, whether a valid bona fide partnership existed between the petitioners and their wives. Certain minor adjustments made by the Commissioner are uncontested. Findings of Fact Petitioners are brothers, residing at Muskegon, Michigan. Marcia S. Rosen is the wife of petitioner, Harold M. Rosen. Marcia and Harold filed separate income*68 tax returns for the calendar year 1941 with the Collector of Internal Revenue for the District of Michigan. Florence Rosen is the wife of petitioner, Leo S. Rosen. They, too, filed separate income tax returns for the calendar year 1941 with the Collector for the District of Michigan. Prior to 1931, Harold had been in the service station business for a number of years. During that period he originated and developed a stainless lubricant stick for use on car door fittings. He sold his service station business in the fall of 1931 and commenced manufacturing and selling the lubricant, doing business under the name American Grease Stick Company. The lubricant stick was sold under the trademark "Door-Ease." On December 3, 1931, Harold filed with the County Clerk, Muskegon County, Michigan, a "Certificate of Persons Conducting Business Under Assumed Name." Leo was in the real estate business and Harold used Leo's office to keep his records, to receive telephone calls and as a mailing address. Harold's limited resources were soon exhausted. He was quite substantially in debt in 1932. At that time Leo was also heavily obligated on real estate mortgages. In September, 1932, Harold*69 assigned the business to Florence, Leo's wife, for the purpose of obtaining capital and of preventing his creditors from taking the business. Notice of assignment of the business to her was filed by Harold with the County Clerk on September 30, 1932, and on the same day Florence filed a certificate with the Clerk to the effect that she was doing business under the assumed name, American Grease Stick Company, as successor to Harold Rosen. From 1932 through 1938, partnership returns were filed by the company showing a division of the net profits after payment of salary to Harold in the proportion of 51 per cent to Harold, and 49 per cent to Florence. Florence was to furnish the necessary capital to the extent of her ability. She had some help from her family and was in a position to obtain money. She performed no personal services for the business. Loans made by Florence and the members of her family were included in an account carried on the books of the company under the style "Leo S. Rosen Special Loan Account." Prior to 1935, Leo devoted part time to the business of the company. Thereafter he devoted his full time as an employee. In 1934, Harold married Marcia who was a widow. *70 By her former marriage she had one son, whom Harold adopted. She had some money of her own and made loans to the company in 1935 and after, which were carried on the books of the business as an account payable to her. Other members of the family also made loans from time to time. In 1936, the family loans were subordinated to the claims of outside creditors. The following table shows the year end balances of loans to the company: Accts. Payable19321933193419351936Leo Rosen et al.$3,415.95$6,559.34$7,105.84$5,975.84$5,335.84Harold Rosen500.00Marcia Rosen1,428.001,850.00Rena Deutsch2,278.501,953.58Rosen Interests2,307.572,132.57Ernest Klein1,000.00655.00155.00Isaac Rosen andIsaac Rosen Est.141.00241.00175.00Accts. Payable1937193819391940Leo Rosen et al.$4,895.84$3,945.84$ 50.00Harold RosenMarcia Rosen1,050.00800.00475.00Rena Deutsch1,503.58778.58Rosen Interests1,932.57882.57Ernest KleinIsaac Rosen andIsaac Rosen Est.At the time Marcia made loans to the business, Harold was informed by his accountant*71 and by his attorney that under Michigan law a husband and wife could not be partners. Some time in 1938 Leo, who was then devoting his full time to the business as an employee and who had reduced his contingent indebtedness to a comparatively small amount, wanted to become a part owner of the business. He discussed the matter with Harold and Florence, who were willing for him to have a share in the business. Leo's counsel then informed him that if Florence made him a gift, it would have to be of her entire interest. On February 8, 1939, Harold, Leo, and Florence Rosen, the latter acting individually and as trustee, entered into an agreement which reads in part as follows: "1. That the said Harold M. Rosen and Leo S. Rosen do hereby become and will remain partners in the business of manufacturing, blending, compounding, buying, selling, and dealing in grease sticks, oils, wax lubricants, petroleum products, and of conducting a general manufacturing and distributing business for a period not limited by he terms of this agreement. "2. The business shall be conducted under the name and style of the American Grease Stick Company. The territorial scope of the operations of the business*72 shall have no limitations or restrictions. The headquarters of the business shall be in Greater Muskegon. Michigan, or such other place or places as the partners shall from time to time determine. "3. Both Harold M. Rosen and Leo S. Rosen will at all times, when physically able, diligently employ themselves in the business of the partnership and carry on the same to the greatest advantage thereof. "4. The capital and resources of the business shall consist of all the stock of material and merchandise; all machinery and tools of every description, all office furniture and fixtures, all moneys, all choses in action, bank accounts, contracts, accounts receivable and commercial paper, all formulae and trade secrets, all patents and patent rights issued or pending, all trademarks, registered or otherwise, issued or pending, all sales organization facilities, and everything else belonging to and being the entire business as a going concern, together with the Good Will of such business heretofore owned and conducted by Florence Rosen, doing business as the American Grease Stick Company, and located at No. 1146 Hoyt Street, Muskegon Heights, Michigan, all of which said capital, assets*73 and resources are, concurrent with the execution of this agreement, to be duly and properly transferred to said co-partnership by such conveyances and instruments as are necessary to make such transfers and to vest said co-partnership with the title thereto. "5. Within 15 days after the execution of this agreement, and as a part of the consideration hereof, it is understood and agreed that of the amount of approximately $3,900.00 owing by the American Grease Stick Company to Florence Rosen and Leo S. Rosen personally, as indicated on the books of the American Grease Stick Company in the account designated 'Leo S. Rosen Special Loan Account,' all of said amount shall be cancelled and turned into the said American Grease Stick Company as capital, with the exception of $700.00, which said $700.00 shall continue to be owing as an account payable and shown on the books of the American Grease Stick Company under the account designated 'Leo S. Rosen Special Loan Account' in the said amount of $700.00. "6. Any and all patents used in connection with the business heretofore obtained by Harold M. Rosen, or for which he has any application pending, are herewith assigned to and made a part*74 of the firm's assets. * * * * *"13. The partners shall be entitled to ownership in the capital and resources of the said business, and also entitled to the net profits from the said business and liable for the obligations thereof in the following proportions: Harold M. Rosen 51%, Leo S. Rosen 49%. * * * * *"16. This agreement shall be construed and does supersede and replace all previous agreements regarding the business of American Grease Stick Company, or any interest therein, made by or between any or all of the parties hereto in connection with all interest or ownership in and to the said American Grease Stick Company, and, in this respect, includes agreements with both Florence Rosen, individually, and Florence Rosen, as trustee." * * * * *The item of "approximately $3,900" in paragraph 5 of that agreement refers to the figure of $3,945.84 listed in the above statement of loans to the partnership under the Leo Rosen Account at the end of 1938. On the same day Florence filed with the County Clerk a notice of assignment of the business to Harold and Leo, and the latter two filed a certificate that they were doing business under the assumed name, American*75 Grease Stick Company. Thereafter, Harold and Leo conducted the business as partners, having a 51 per cent interest and a 49 per cent interest, respectively. In the latter part of 1940, Wesley DeLong, the Rosen's auditor, told them that his partner, after making a considerable study of partnership cases pertaining to Michigan law, had concluded that it would then be possible for the brothers to make gifts to their wives of a portion of their holdings in the company. After talking with their attorney about the matter, Harold and Leo told their wives late in 1940 that they were going to give them interests in the business, to be effective as of January 1, 1941. Harold told their attorney to draw up an agreement in writing so as to give a 25 per cent interest to Marcia and a 22 per cent interest to Florence. From January, 1941, until the latter part of March of that year Harold and Marcia were away on a trip to California. On April 2, 1941, Harold, as first party, Leo, as second party, Marcia, as third party, and Florence, as fourth party, executed an agreement which, after reciting that on or about January 1, 1941, Harold had orally agreed to assign an undivided 25 per cent interest*76 in the assets and business of the partnership to Marcia and Leo to assign an undivided 22 per cent interest to Florence, reads as follows: "1. The parties hereto hereby confirm and agree to be bound by said oral agreements and the party of the first part hereby assigns. transfers and sets over unto the party of the third part an undivided twenty-five per cent (25%) interest, and the party of the second part hereby assigns, transfers and sets over unto the party of the fourth part an undivided twenty-two per cent (22%) interest in all of the machinery, tools and equipment of every description, all office furniture and fixtures, all contracts and books of account, and of everything else belonging to and being a part of the business as a going concern, together with the good will of such business, conducted by the undersigned, Harold M. Rosen and Leo S. Rosen, as copartners under the name and style of American Grease Stick Company, located at No. 1146 Hoyt Street, Muskegon Heights, Michigan. "2. This agreement shall become effective as of January 1, 1941, and the party of the third part and the party of the fourth part shall be entitled respectively to 25% and 22% of all the income*77 and profits from the business of the said co-partnership earned subsequent to said date remaining after the payment of salaries of the first party and of the second party, which shall be charged as an expense of the co-partnership business, but said third party and said fourth party shall not become personally liable for any of the obligations of said co-partnership. "3. The foregoing assignment shall not entitle the party of the third part or the party of the fourth part to become or be considered as partners in the said business, or to participate in the management of the business of said co-partnership, nor shall it give to either of said parties any right to in any way interfere with the said parties of the first and second part, Harold M. Rosen and Leo S. Rosen, in conducting said business; to determine the policies of the said business, including the decision to be made from time to time respecting the amount of earnings which shall be distributed or retained in the business as capital; or to limit or curtail the salaries to be drawn by said partners, Harold M. Rosen and Leo S. Rosen, from said business. "4. Amounts advanced from time to time, either to the party of the third*78 part or the party of the fourth part, during any fiscal year of the co-partnership shall be considered and treated as advances against her pro rata share of the partnership earnings, which are to be subject to distribution in the form of dividends during such year. Should the amounts so advanced to either of said last mentioned parties in any year be in excess of her pro rata share of earnings to be distributed for said year, said excess shall thereupon be treated as an amount owing by her to said co-partnership, and she shall be obligated to reimburse said co-partnership in the amount of said excess. "5. Said third party and said fourth party hereby accept said assignment subject to the foregoing terms, conditions, limitations and restrictions, and they severally agree to be bound thereby." Copies of the agreement were delivered to the wives. A supplemental agreement, executed by the same four parties on April 4, 1941, provided for the carrying of life insurance upon the lives of the partners, for the formation of a new partnership upon the death of either partner and for the incorporation of the business upon the happening of certain contingencies. It further provided that*79 no party to the agreement could sell, assign, or encumber his or her interest in the business or its assets without the written consent of all the other parties. The instrument also conains the following provision: "* * * Inasmuch as neither the party of the third part [Marcia] nor the party of the fourth part [Florence] has become a partner of the other parties to this agreement by reason of her ownership of an interest in the business of said co-partnership, the death of either the party of the third part or the party of the fourth part shall not operate to dissolve the partnership." Gift tax returns were filed by Harold and Leo, each reporting a gift to his wife of an interest in the business. Because of the exemptions and exclusions no tax was due thereon. In 1941 the single capital account of the company was divided into four individual accounts showing the respective interests of the brothers and their wives. Harold and Leo previously had had separate drawing accounts, and new drawing accounts were set up on the books for Marcia and Florence. The assistant cashier of the bank with which the company did business and the president of the company's major supplier were*80 informed in 1941 of the interests given to the wives. No change was made in 1941 in the Michigan registration of persons conducting business under an assumed name. The business of the American Grease Stick Company was the manufacturing and selling of the "Door-Ease" product and, in addition, a dripless oil and a rubber lubricant. There were substantial investments in inventories, accounts receivable, and manufacturing equipment, as shown by the following table: 12/31/3812/31/3912/31/4012/31/41Inventories$ 9,278.78$13,343.42$16,082.03$34,218.42Trade Accounts Receivable8,259.5710,275.9113,160.6814,780.64Fixed Assets8,241.449,751.029,963.6610,325.67Trademarks and Patents598.78702.73705.73641.15Net Worth15,197.1133,271.8248,216.9282,034.93The gross receipts of the business, as reflected in the income tax returns, were $159,843.51 for 1939, $167,132.89 for 1940, and $227,229.27 for 1941. The cost of goods sold, exclusive of administrative and selling expenses, was $63,077.31 in 1939, $67,732.97 in 1940, and $92,921.97 in 1941. The net income reported in the returns was $44,892.38 in 1939, $50,794.87*81 in 1940, and $75,984.40 for 1941. Substantial amounts were spent for advertising and sales promotion. The company's products were recommended by all the major automobile manufacturers, and sales were made to leading automobile jobbers throughout the United States and Canada, to the large oil companies, to chain stores, and to automobile accessory stores. By 1941 the company had representatives in distributing points in all the states and in many foreign countries. In 1941 Leo, a graduate of the University of Michigan College of Business Administration, was sales and office manager. He had charge of sales promotion, advertising, contacting men in the field organization, finances, bookkeeping, and office work. Harold was general production manager and had charge of production and research, supervising the general operation of the plant. He had no technical training and often consulted engineering and chemical experts in connection with development of the products and processes of the business. Advertising counsel also were frequently engaged by the company. The plant employed 15 or 16 people in 1941 and their monthly salaries averaged $1,500. There were 35 or 40 salesmen, to whom*82 commissions of approximately $20,000 were paid. In 1940 Harold Rosen drew a salary of $15,000, and Leo $13,500. In 1941 each drew a salary of $9,000. After the execution of the instruments of April 2 and April 4, 1941, there was no change in the every day operations of the business except for the bookkeeping entries establishing separate capital and drawing accounts. Harold and Leo continued to operate and control the business as they did before and performed the same services. Neither Marcia nor Florence performed any personal services for the company in 1941. They did not participate in or interfere in any way with the conduct and management of the business and had nothing to do with determining the policies to be pursued. They were paid no salaries and had nothing to say about what portion of the earnings would be distributed and what retained as capital, or about the amount of salaries to be drawn by their husbands. They contracted no debts in the name of the partnership. Harold and Leo alone determined what amounts of money would be subject to withdrawal. Neither Marcia nor Florence was authorized to sign checks drawn against the company's bank account. They made withdrawals*83 by obtaining checks from the bookkeeper. The checks had to be signed by either Leo or Harold and countersigned by the bookkeeper. When both Leo and Harold had to be away on business, they would leave signed blank checks with the bookkeeper, and their wives often made withdrawals when they were away by going to the bookkeeper and obtaining checks. The drawings of the wives were not the same. Their first withdrawals were made in April, 1941. Marcia's 1941 drawings totaled $8,248.96 and Florence's $5,317. Both Marcia and Florence had separate bank accounts and often deposited their withdrawals in those accounts. Each had an allowance from her husband for household expenses, which was larger in 1941 than in 1940. Harold and Marcia purchased their home jointly. During 1941, Marcia had no income except from the business. She used a portion of her partnership withdrawals to make payments on their home. She also used her withdrawals to purchase luxury furnishings for the home, carpeting, antique silver, etc. She sent some of the money to her son at college and with other portions of the funds she bought war bonds. Her husband was co-owner on some of the bonds and her son on others. She*84 also paid premiums on life insurance policies on her husband's life, she being the beneficiary of such policies. Harold bought her wearing apparel for her, with the exception of an occasional extravagant item. With her withdrawals from the business Florence bought some antique furniture, china, figurines, things for her children, and other luxury items. She also invested in war bonds. Leo paid for her wearing apparel. A Michigan intangible tax return for the year 1941 was filed by American Grease Stick Company, in which return Harold, Leo, Marcia, and Florence were shown as the partners. A federal partnership return of income for the year 1941 was filed in the name of the company, showing net income in the amount of $75,984.40, distributed in the following shares: Harold M. Rosen$24,075.94Marcia S. Rosen14,496.11Leo S. Rosen24,655.79Florence Rosen12,756.56$75,984.40The shares of Harold and Leo include their salaries, $9,000 each. The respondent determined that 51 per cent of the partnership net income of $38,752.05 was taxable to Harold and that 49 per cent thereof, or $37,232.35, was taxable to Leo. Opinion ARUNDELL, Judge: In these*85 cases we are called upon to decide whether the net income of the American Grease Stick Company (hereinafter referred to as American) for the year 1941 is taxable to petitioners alone or proportionately to them and their wives. Petitioners contend that they made bona fide gifts to their wives of interests in American; that the wives invested such interests in the capital of American; that the wives were, in effect, limited partners for income tax purposes; and that, at all events, the income of American received by the wives was derived from property owned by them and therefore taxable to them. Respondent takes the position, in substance, that the arrangement between petitioners and their wives is but another scheme for the division of income among members of a family. It is our opinion that respondent did not err in holding the entire income of American taxable to the petitioners. At the outset, it may be observed that the very instrument in which the petitioners purported to give their wives interests in the business expressly provided that the wives should not "become or be considered as partners in the said business" and that they should not "become personally liable for any of*86 the obligations of said co-partnership". Again, in the supplemental agreement of April 4, 1941, it was provided that since the wives had not become partners, the death of either of them should not operate to dissolve the partnership between the petitioners. After the execution of those instruments, no change whatever, other than bookkeeping entries, was made in the every day operation of the business. No certificate of persons doing business under an assumed name, so as to show the interests of the wives, was filed with the County Clerk - a practice which had been diligently observed in all the previous transfers of ownership of interests in American. Petitioners continued to operate and control the business as they did before. Even in terms, they purported to divest themselves of as little dominion and control as possible - just sufficient, it would seem, to satisfy the barest formalities. Admittedly neither of the wives performed any personal services. They did not participate in or interfere in any way with the conduct and management and had no voice in the determination of policies and nothing to say about the use and control of the property which they allegedly "owned". They*87 were not authorized to sign checks drawn on partnership funds in the bank. They had nothing to say about the amount of salaries paid to petitioners, and had no voice in the determination of how much of the earnings from the property which they allegedly "owned" they could withdraw. What they did draw, they expended in the main for family purposes. There is no showing that the combined expenditures of husband and wife for such purposes differed materially in amount or in kind after the April 1941, agreements. Harold admitted to the Revenue Agent, Mr. Knoll, during an investigation in 1944, that he and Leo decided how much the wives would be permitted to withdraw from the business. Petitioners attempted to explain the provisions of the agreements to the effect that the wives should not become or be considered as partners by stating that such provisions were not consonant with then existing Michigan law. They testified that when they executed the 1939 partnership agreement between themselves, they wanted to bring their wives into American with them but were advised that husband and wife partnerships were not permitted under Michigan law. They testified, further, that the 1941 instruments*88 were executed because in the meantime their accountant and their attorney had informed them that it was then possible under Michigan law. Harold stated: A. Along the latter part of 1940, as I recall it, my auditor told me, "You know, you wanted to make your wife a partner in this business." I said that I did. He said, "I have learned that we can work that out." I was very happy to have that information and immediately told my wife that I could work out an arrangement whereby I could give her a proper interest in the company. Still, when the 1941 instruments were executed, the petitioners expressly provided that their wives should not be partners. It may be that there was some justifiable question about Michigan law with respect to husband and wife partnerships, cf. , but Michigan law apparently presented no obstacle to the formation of valid bona fide partnerships in other cases even prior to 1939. See, for example, , and , in each of which the partnership was formed in 1937. A more plausible explanation of the provisions stipulating that the*89 wives should not be partners, it seems to us, is that petitioners had no real purpose or intent to divest themselves of any ownership of property. The 1941 instruments, together with the subsequent conduct of the parties, are consonant with a plan and an intent to allocate a portion of the net income of American to the wives so as to reduce petitioners' surtax burden, petitioners at the same time retaining and exercising almost complete control and dominion over all the property and assets of the business. Furthermore, the apparent facility with which the, at least nominal, ownership of American shifted back and forth among the family members from time to time is not conducive to a belief that petitioners had a real intent irrevocably to divest themselves of, and to vest in their wives, all the attributes of ownership of a corpus or res, to which may be attributed the production of the income, or any part thereof, reported as the wives' distributive share. In a somewhat similar case, where a husband purported to give his wife an interest in his business but provided that she was "not to be considered as a partner in the" business and that she was not to be liable for losses, the*90 Circuit Court of Appeals for the Eighth Circuit held, affirming our memorandum decision, that the husband was taxable on the income reported as distributed to the wife. . Petitioners urge that the provisions granting them authority to conduct the business placed no condition or restrictions on the gifts of "interests" in the business; that their exclusive management must be viewed in relation to the partnership and not to the gifts; and that partners may agree to lodge in one or more partners the sole management of the business. We find no fault with such contentions as general propositions of law; but where, as here, it is highly questionable whether there was any real intent to divest one's self of ownership, to surrender dominion and control, not only what the parties purport to do but what they actually do becomes important. Petitioners rely principally upon the Tower and Scherer cases, supra, and upon , and . They might have cited many other cases in which family partnerships were recognized for tax purposes, but we think no useful purpose*91 would be served by reviewing those cases in detail and pointing out distinctions between them and the instant case, and it would of course be idle to attempt to reconcile all the decisions of this and other courts in family partnership cases. It may be observed, however, that in the cases particularly relied upon by petitioners, formal articles of partnership were executed, in which the wives were expressly recognized as partners, sharing in the profits and losses. In none of them (and two of them involved Michigan partnerships) was it provided that the wives should not "become or be considered as partners". In the final analysis, each family partnership case must be decided upon its own peculiar facts. We have set out in detail the reasons which bring us to the conclusion herein that in 1941 petitioners were not "carrying on business in partnership" with their wives, within the meaning of the revenue laws. What we have already said, we think, disposes also of petitioners' contention that even if the wives were not partners, the income of American received by them was derived from property owned by them and therefore taxable to them. We are unable to conclude that petitioners' *92 wives actually owned interests in the property of the business, that is, in a corpus or res, as distinguished from interests in the income. Petitioners have endeavored to come as close to the line as possible. We think they have overstepped it. In substance, to borrow Justice Cardozo's language in , petitioners have "contrived to keep the larger benefits of ownership and be relieved of the attendant burdens." Decisions will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623105/ | J. P. Allen v. Commissioner.Allen v. CommissionerDocket No. 39723.United States Tax Court1953 Tax Ct. Memo LEXIS 122; 12 T.C.M. (CCH) 994; T.C.M. (RIA) 53290; August 31, 1953*122 Albert Philipson, Esq., 1001 15th Street, Washington, D.C., for the petitioner. Mark Townsend, Esq., for the respondent. MURDOCK Memorandum Opinion MURDOCK, Judge: The Commissioner determined a deficiency of $4,551.34 in the income tax of the petitioner for 1948. The issues for decision are whether the Commissioner erred in disallowing deductions for an alleged bad debt and for court costs in attempting to collect it. The facts have been submitted by a stipulation. The petitioner filed his individual return for 1948 with the collector of internal revenue for the District of Nebraska. He stated on the return that his occupation was "Real Estate, Insurance and Bank Executive." He reported gross income of $19,264.58 consisting of salaries from two banks, dividends, rents, commissions, capital gains and interest. His deductions, in the total amount of $18,411.17, included $426.91 "Court costs and attorney fees in connection with suit on foreclosure of Brown loan" and $15,875 "Bad debt loss (adverse decision by State Supreme Court rendering collection on real estate mortgage impossible due to technicality in law. Amount of loss determined by original cost of land*123 sold less all payments received on contract.)" The Commissioner, in determining the deficiency, disallowed both deductions and explained: "Bad debt was disallowed because it was determined to be bad in the year of 1934. Court Costs for attempted collection of non existant bad debt disallowed." The petitioner in May 1930 entered into a contract with Lester M. Brown for the sale to Brown of a farm, including depreciable property, in Hitchcock County, Nebraska, for $47,625, payable $2,625 in cash and the balance in semi-annual installments of $1,000 each with 6 per cent interest on the unpaid principal. Brown paid a total of $3,625 of the purchase price and interest for about one year and thereafter made no further payments. Brown, assisted by Allen, applied for and obtained in November 1934 loans of $5,000 and $2,500 from the Federal Land Bank and the Land Bank Commissioner. The approval conditions were that the proceeds of the two loans pay in full all of Brown's indebtedness except that secured by a chattel mortgage on his personal property, that Allen sign the notes as comaker, and that Allen convey some additional land to Brown. Brown executed and delivered to Allen on December 7, 1934 his*124 two notes for $18,000 each secured by a mortgage of $36,000 on the lands but the notes and the mortgage had to be surrendered in obtaining the loans of $7,500. The conditions of the loans were complied with and the proceeds of the loans were received by Allen. Thereafter, Brown made payments on the debts thus created. Brown executed and delivered to Allen his two demand notes for $18,000 each several years later as evidence and renewal of the indebtedness claimed by Allen to be due on the May 1930 contract for the sale of the farm. Allen returned those notes to Brown on February 24, 1942 and received one note from Brown for $18,000 secured by a mortgage on the farm. Allen assigned the note and mortgage to W. B. Abrahamson on November 3, 1945 for "One Dollar and other valuable consideration" and the latter, as owner, entered suit in the District Court of Hitchcock County, Nebraska, apparently in February 1947, to foreclose the mortgage. The District Court, in an opinion prior to May 5, 1947, found that Allen's claim against Brown "was extinguished by virtue of accepting the proceeds of the loans pursuant to the conditions required by the Federal Land Bank and Land Bank Commissioner; *125 that the subsequent notes of $18,000.00 each made and delivered to the creditor, J. P. Allen, about two or three years thereafter were executed and delivered without consideration; that the $18,000.00 note and mortgage dated February 24, 1942, involved in this action were executed and delivered without consideration and therefore unenforceable." The Court dismissed the action. The Court gave as its reason: "A payment or other performance by a third person, accepted by a creditor as full or partial satisfaction of his claim, discharges the debtor's duty in accordance with the terms on which the third person offered it." Restatement, Contracts, Sec. 421, Krause v. Swanson, 141 Neb. 256">141 Neb. 256, 3 N.W. (2d) 407; Fender v. McCain, 144 Neb. 58">144 Neb. 58, 12 N.W. (2d) 541. That opinion was affirmed by the Supreme Court of Nebraska, apparently on February 6, 1948. Allen testified in the foreclosure suit that the farm had cost him $18,000 and he "put on six or seven or eight thousand worth of improvements" but the record does not show Allen's adjusted basis for gain or loss on the property conveyed to Brown. Counsel for the Commissioner stated when the case was submitted*126 here that "Respondent is holding the Petitioner to strict proof that the debt in fact existed in 1948; that it had value at the beginning of that year and became worthless during that year." The petitioner argues that there never was a time prior to 1948 when he could have taken a deduction for his loss, but it is difficult to see how any right to a deduction survived the events of 1934. Cf. Luke & Fleming, Inc., 1 B.T.A. 12">1 B.T.A. 12; Federal Fuel Co., 3 B.T.A. 814">3 B.T.A. 814. Allen had agreed that nothing further was owed him by Brown in connection with the land and he then had nothing to show that any further amount was owed him. It was several years later that Brown gave him the two new notes for $18,000. But, regardless, of when, if ever, he could have taken a deduction of some kind, nevertheless, the record does not establish his right to the deduction claimed for 1948. The Nebraska Courts held that nothing was owed Allen after 1934, so that there was no debt. Furthermore, he had assigned his entire interest in the 1942 note and mortgage to Abrahamson prior to 1948 so that he had no rights whatsoever at the end of 1947 and none at any time in 1948, so far as this record*127 shows. All that happened in 1948 was that the Supreme Court of Nebraska apparently affirmed the lower court holding that Abrahamson could not foreclose and take the property from Brown. It does not appear that that decision affected the petitioner adversely or that a decision favorable to Abrahamson would have benefited the petitioner. The petitioner failed to show that any existing debt due him from Brown became worthless during 1948. The record is inadequate in other respects to show that the Commissioner erred in disallowing the deduction. The evidence is likewise inadequate to show that the petitioner is entitled to the deduction of $426.91 which he claimed on his return as "Court costs and attorney fees in connection with suit on foreclosure of Brown loan." There is no showing that the petitioner spent any amount in 1948 or why he would spend any amount for court costs and attorney fees in connection with the suit on foreclosure of the Brown loan since he had assigned his interest in the note and mortgage to another on November 3, 1945, was not a party to the foreclosure suit, and so far as this record shows, had no interest in the suit. He has failed to refer to any provision*128 fo the Internal Revenue Code which would allow him a deduction for 1948 under such circumstances. Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623106/ | F. E. McGillick Company, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentF. E. McGillick Co. v. CommissionerDocket Nos. 54088, 54089, 54090, 55479, 55480, 55481, 55482, 57819, 57820United States Tax Court30 T.C. 1130; 1958 U.S. Tax Ct. LEXIS 98; August 21, 1958, Filed 1958 U.S. Tax Ct. LEXIS 98">*98 Decisions will be entered under Rule 50. 1. Trust required to accumulate current income and providing for future payment of gifts, annuities, taxes of grantor, and other purposes benefiting private individuals, held, not exempt under section 101 (6), I. R. C. 1939, and, held, further, not entitled to deduction for income devoted to charity under section 162 (a), I. R. C. 1939.2. Corporation organized to engage in business for profit, held, not exempt under section 101 (6), I. R. C. 1939.3. Respondent's disallowance of deduction for salaries and determination that gain on exchange was corporate income, held, approved.4. On the facts, additions to tax under sections 291 (a) and 294 (d) (1), I. R. C. 1939, held, properly imposed. William Wallace Booth, Esq., and Kenneth P. Simon, Esq., for the petitioners.Max J. Hamburger, Esq., George J. Rabil, Esq., and Roy E. Graham, Esq., for the respondent. Opper, Judge. OPPER30 T.C. 1130">*1131 In these consolidated proceedings respondent determined the following deficiencies:PetitionerYearIncome taxAdditionsdeficiencyto taxFrancis Edward McGillick Foundation1949$ 435,849.711 $ 108,962.4319504,845.471 1,211.37195166,901.121 16,725.28195210,091.841 2,522.96F. E. McGillick Company19501,700.641 425.1619517,297.101 1,824.28195220,473.991 5,118.50F. E. McGillick and A. Louise McGillick1949429,353.3719506,850.84195153,150.402 3,129.02F. E. McGillick195210,938.722 680.073 1,133.451958 U.S. Tax Ct. LEXIS 98">*99 By amended answer respondent seeks an increased deficiency against the Foundation in income tax and addition to tax for the year 1952 in the respective amounts of $ 12,126.48 and $ 3,031.62, making total deficiencies claimed for that year against that petitioner in the respective amounts of $ 22,218.32 and $ 5,554.58.The issues are:(1) Whether the Francis Edward McGillick Foundation was an organization exempt from income taxes within the purview of section 101 (6), I. R. C. 1939, during the years 1949 through 1952, and if not: (a) Was the Foundation during the years 1949 through 1952 entitled to deductions from its gross income under section 162 (a), I. R. C. 1939? (b) Did distributions of property by the F. E. McGillick Company to the Foundation during the years 1949 through 1952 constitute taxable dividends? (c) Was $ 10,000 per annum reasonable compensation for the services rendered by F. E. McGillick as trustee, president, and general manager of the Foundation during 1950? (d) Is the Foundation subject to additions to tax under section 291 (a), I. R. C. 1939, for failure to file returns for the years 1949 through 1958 U.S. Tax Ct. LEXIS 98">*100 1952?30 T.C. 1130">*1132 (2) Whether the F. E. McGillick Company was an organization exempt from income taxes within the purview of section 101 (6), I. R. C. 1939, during the years 1950 through 1952, and if not: (a) Did the Company realize a taxable gain in 1952 from an exchange of property? (b) Was $ 10,000 per annum reasonable compensation for the services rendered by F. E. McGillick as trustee, president, and general manager of the Company during 1950? (c) Is the Company subject to additions to tax under section 291 (a), I. R. C. 1939, for failure to file returns for the years 1950 through 1952?(3) Whether the income of the Francis Edward McGillick Foundation was taxable to F. E. McGillick as grantor under the provisions of section 22 (a), section 166, or section 167, I. R. C. 1939, during the years 1949 through 1952.(4) Whether F. E. McGillick is liable for additions to tax under section 294 (d) (1), I. R. C. 1939, for failure to file a declaration of estimated tax for 1952.Respondent concedes that the addition to tax under section 294 (d) (2), I. R. C. 1939, for underestimation of estimated taxes by petitioners, F. E. McGillick and A. Louise Schultz McGillick, is not applicable for the calendar 1958 U.S. Tax Ct. LEXIS 98">*101 years 1951 and 1952.FINDINGS OF FACT.All of the facts were stipulated and are found accordingly.Petitioner, the F. E. McGillick Company, hereafter called the Company, is a corporation organized on June 22, 1932, under the laws of Pennsylvania, having its principal place of business at 503 North Homewood Avenue, Pittsburgh, Pennsylvania. During the years in issue, it engaged in the business of buying and selling real estate, holding real estate for investment purposes, and renting and managing various properties owned by it. The Company also owned and operated a motion-picture theater from 1949 through 1951.Petitioner, F. E. McGillick, hereafter called McGillick, formed the Company by the transfer of property owned by him, having a net cost basis, adjusted for depreciation, of $ 187,647.63, and cash of $ 500, in exchange for the total authorized capital stock of 50 shares. On January 3, 1933, McGillick transferred property having a net cost basis, adjusted for depreciation, of $ 57,339.16 to the Company, and on December 31, 1942, he contributed cash in the amount of $ 4,000 to the Company.The accounting books and records of the Company were kept on an accrual basis, and its accounting 1958 U.S. Tax Ct. LEXIS 98">*102 period was the calendar year. Prior to 1950, the Company filed its corporate income tax returns with the collector of internal revenue for the twenty-third district of Pennsylvania, but for the years 1950 through 1952, it filed no such returns. 30 T.C. 1130">*1133 The failure to file returns for these latter years was not due to reasonable cause.Petitioner, A. Louise Schultz McGillick, hereafter called Louise, owned 1 share of stock of the Company from December 29, 1949 through 1952. Petitioner, the Francis Edward McGillick Foundation, hereafter called the Foundation, owned the remaining 49 shares and had its principal office at 503 North Homewood Avenue, Pittsburgh, Pennsylvania. The Foundation was created on January 6, 1937, as a trust under the laws of Pennsylvania by McGillick, who assigned 41 shares of stock of the Company to the Foundation. The declaration of trust provides:the Trustees * * * declare that they will hold [the] property transferred to the * * * Foundation as well as all other property which they may acquire as Trustees, together with the proceeds and profits thereof, in trust, to manage * * * as * * * designated in this Agreement * * *FIRST:* * * *F. E. McGillick until his 1958 U.S. Tax Ct. LEXIS 98">*103 death shall vote the * * * 41 shares of the * * * Company, as Trustee, and shall be President and Manager of the Foundation, with power to add to the Foundation other assets he may * * * donate, add other Trustees, and change the proceedings of Trustees' Meetings.* * * *IN CONSIDERATION OF the donations to and formation of the * * * Foundation, I, * * * McGillick, Donor, do hereby * * * direct the * * * Foundation through its Trustees to assume, pay, and carry out the following bequests and obligations, which are fully set forth in my Last Will and Testament, a copy of which is included herein and made a part hereof. Where Executors are mentioned in my said will, they are to act as Trustees of this Foundation. My Will and the Foundation are the same. At my death, all the Executors mentioned in my Will are to be Trustees of the Foundation.The Trustees hereby accept this trust subject to the aforementioned bequests and obligations of the Donor as set forth in his Last Will and Testament, as follows:LAST WILL AND TESTAMENT OF * * * McGILLICK.* * * *1. I direct that all my funeral expenses and expenses of administration of my estate be paid out of my estate * * *2. I give * * * unto 1958 U.S. Tax Ct. LEXIS 98">*104 my Executors * * * $ 1,000.00, to be expended for masses for the repose of my soul.3. I give * * * unto my Executors * * * $ 2,500.00, to be expended for and in the erection of a suitable family marker * * *4. I give * * * unto my Executors * * * $ 1,000.00, IN TRUST, however, to invest and keep invested, and to use the income therefrom in keeping markers, etc., and my cemetery lots * * * and markers of my parents' graves * * * in repair and good condition. * * *5. I give * * * my sister, Elizabeth McGillick, * * * $ 400.00 per year, * * *6. I * * * direct my Executors * * * to pay to my brother, Thomas J. McGillick, * * * $ 100.00 per year * * *7. * * * I * * * give * * * my wife, Margaret A. McGillick, * * * $ 5,000.8. I give * * * to my four children, * * * Francis E. McGillick, Charles A. McGillick, Louis J. McGillick and Marie Elizabeth McGillick Corbett, * * * 30 T.C. 1130">*1134 $ 5,000.00 each, to be paid out of my estate * * * after my decease without sacrificing any real estate. I also give * * * to each child * * * $ 2,500.00, to be paid * * * 5 years after my decease; and * * * $ 2,500.00, to be paid * * * 10 years after my decease, or a total to each child of * * * $ 10,000.00. * * * [If] 1958 U.S. Tax Ct. LEXIS 98">*105 any child be deceased and have no issue, then his or her legacy shall go into and become a part of my residuary estate.9. I * * * give * * * to my Executors, * * * who shall be Managers of the * * * Foundation, IN TRUST, * * * all the rest * * * of my estate, * * * to invest and to re-invest, and to pay from the net proceeds * * * the following annuities: To my wife, Margaret A. McGillick, * * * $ 1,500.00 per year * * *; to my children, * * * Francis * * * Charles * * * Louis * * * and Marie * * *, $ 1,500.00 per year * * *. If there is not sufficient income to pay my wife and children their annuities as set forth, then I direct my Executors to pay first to my wife * * * $ 1,500.00, and then to pay to each of my children one-fourth of the balance of the net proceeds then remaining. However, I direct that my Executors pay to each of my children whatever balance is owing any year to make the * * * $ 1,500.00 annuity, as soon as it is possible * * *. It is my desire that * * * if the whole is not paid in any one year, the balance shall be paid when it is made in the following year or years from income or sales. * * * If any child be deceased and have no issue, then his or her annuity 1958 U.S. Tax Ct. LEXIS 98">*106 shall go into and become a part of my residuary estate.Upon the death of my wife * * * and all my children * * * the annuities shall cease * * * and I * * * direct my Executors to transfer * * * unto the * * * Foundation * * * the balance of principal, all unpaid income or net proceeds, and all my residuary estate * * *10. The foregoing bequests and annuities * * * shall not be subjected to or liable for any debts, contracts, or liabilities of any beneficiary, nor shall * * * [they] be the subject of sale, assignment, or pledge by the beneficiary entitled thereto.11. I direct that all taxes, state and federal, direct and collateral, shall be paid by my * * * Executors * * * out of my estate, without deduction of the same from any of said legatees or beneficiaries.* * * *13. Whereas it is my desire to devote a substantial portion of my estate to charitable and educational uses and purposes, now, therefore, to these ends, I do hereby create and establish the * * * Foundation.I * * * direct my Executors * * *, in case I have not done so during my lifetime, to * * * organize a charitable and educational corporation * * * having powers to administer and control the affairs and property 1958 U.S. Tax Ct. LEXIS 98">*107 of the * * * Foundation, and to carry on the objects, uses and purposes of the said trust * * *Upon the * * * organization of such corporation, I empower my Executors to convey * * * to said Corporation, monies, property or assets to provide for the two special funds created in paragraphs 16, 17, and 18 of this * * * Will, and to convey * * * to said Corporation, at such other times as in their discretion they may deem advisable, property and assets belonging to me and to which the * * * Foundation may * * * become entitled. In case any of my bequests should fall leaving any funds not herein provided for, the same shall go to the Foundation, for such charitable, educational and public * * * purposes as the * * * Managers of the * * * Foundation * * * shall * * * direct in conformity with my wishes hereinafter set forth.14. I give to my * * * Executors * * * and their successors in the trust, full power * * * to manage, control, protect, sell, lease, invest, re-invest, and keep invested all the monies, securities, and other property * * * it shall receive 30 T.C. 1130">*1135 under this trust; and to pay all taxes * * *, also all premiums of insurance, and to keep the improvements upon the real estate 1958 U.S. Tax Ct. LEXIS 98">*108 insured and in good * * * repair, and to incur and pay such expenses necessary * * * out of the income belonging to the trust. I do not restrict the Managers * * * to any particular form or kind of investment, nor as to such as are allowed by law of Pennsylvania for the investment of trust funds, but I leave * * * [that] to the sound judgment and discretion of the * * * Managers * * *I give the * * * Managers * * * [of the Foundation] power and authority to hold, sell, convey and transfer any and all of its property, real and personal, or to exchange the same for other property, real or personal, free and discharged of this trust, to sell either at public or private sale, for such price * * *, at such time * * *, and upon such terms * * * as the * * * Managers * * * may determine * * ** * * *16. I * * * direct my Executors * * * to pay to the * * * Foundation for use of the Roman Catholic Diocese of * * * Pittsburgh * * * the sum of * * * $ 25,000.00, to be known as the F. E. McGillick Priesthood Fund, for the following purposes: To be invested and re-invested, and the income therefrom to be given each year to the Catholic Bishop of the Diocese of Pittsburgh * * * to be used for the 1958 U.S. Tax Ct. LEXIS 98">*109 education of worthy poor boys and young men to the priesthood. * * *17. I * * * direct my Executors * * * to pay to the * * * Foundation for use of the Roman Catholic Diocese of * * * Pittsburgh * * * the sum of * * * $ 25,000.00, to be known as the Margaret A. McGillick Sisterhood Fund, for the following purposes: To be invested and re-invested, and the income therefrom to be given each year to the Catholic Bishop of the Diocese of Pittsburgh * * * to be used for the education of worthy poor girls and young women to the sisterhood * * *18. I * * * direct my Executors, * * * when in their judgment it is advisable so to do, to set aside any part of the * * * $ 25,000.00 towards either of the funds mentioned in paragraphs 16 and 17. * * *19. I * * * direct my Executors * * * when in their judgment and discretion there are more than sufficient funds to provide for the annuities to my wife and children, to transfer or set over to the * * * Foundation any surplus to form or create the * * * Priesthood Fund and the * * * Sisterhood Fund. After the creation of these two funds, I * * * direct my Executors, when in their judgment and discretion it is possible, to transfer * * * unto the * 1958 U.S. Tax Ct. LEXIS 98">*110 * * Foundation, whatever funds have accumulated which are not needed to care for the annuities, salaries, and other expenses, for the purposes and uses as set out in paragraph * * * 21. I also * * * direct my Executors to transfer * * * unto the * * * Foundation, upon the death of my wife and all of my children, the principal fund of my estate and all the unpaid income or net proceeds thereof.* * * *21. I * * * direct the Managers of the * * * Foundation to invest and re-invest all funds, and from the annual proceeds or net income after expenses are paid, to pay * * * 1/2 thereof to the Catholic Bishop of * * * Pittsburgh * * * to be used toward the institution of as many free scholarships as such income will maintain * * *. * * * This fund is to be known as the F. E. McGillick Educational Fund.22. This payment of * * * 1/2 the income from the * * * Foundation * * * shall cease * * * when, in the opinion of my Executors, the principal and accumulations in the * * * Foundation are sufficient to establish a school in the 30 T.C. 1130">*1136 Pittsburgh Diocese large enough to accommodate * * * 50 pupils. Said school is to be * * * known as the Francis Edward McGillick Vocational School. * * * After 1958 U.S. Tax Ct. LEXIS 98">*111 this school is on a self supporting basis, other schools may be established in other locations if the Managers of the * * * Foundation deem it advisable * * ** * * *24. After a Vocational School or Schools are founded, it is my * * * desire that the assistance given by free scholarships * * * be continued by the Managers of the * * * Foundation. I * * * direct the Managers * * * either to set aside a special fund out of the * * * Foundation or create a fund by taking a percentage of the net earnings from any school for this purpose. Said funds to be invested and re-invested, and the income therefrom to be applied to free scholarships. * * ** * * *26. I direct my Executors and the Managers of the * * * Foundation to employ Miss A. L. Schultz * * * as Secretary to my Executors and to the * * * Foundation, at an adequate salary, but not less than * * * $ 2,500.00 per year, * * * and I direct that the said salary * * * shall * * * begin immediately after my decease.27. My sons, or as many of them who wish, are to be employed in the handling of my estate and Foundation, at an adequate compensation, with no bearing as to my bequests to them. In case P. L. Corbett needs employment, and 1958 U.S. Tax Ct. LEXIS 98">*112 it is possible, he is to be employed.* * * *31. I nominate, constitute and appoint my three sons, Francis * * * Charles * * * and Louis * * *, and my son-in-law, P. L. Corbett, * * * and Miss A. L. Schultz, Executors of this my last Will and Testament. Said Executors shall also be Managers of the * * * Foundation. No bond shall be required of my executors, or Trustees, or Managers of the * * * Foundation, hereby appointed, nor of their successors.The following data concerns the potential claimants under McGillick's will:NameRelation to McGillickDataElizabeth McGillickSisterDied May 4, 1944.Thomas J. McGillickBrotherDied Aug. 31, 1940.Margaret A. McGillickFirst wifeDied May 14, 1943.Francis E. McGillick, JrSonBorn Oct. 10, 1892.Charles A. McGillickSonBorn Sept. 28, 1894.Louis J. McGillickSonBorn Nov. 5, 1897,Died April 29, 1953.Marie E. McGillick CorbettDaughterBorn April 12, 1900.A. Louise Schultz McGillickSecond wifeBorn July 12, 1893.Francis Edward McGillickBorn Feb. 10, 1864.The Bishop of the Diocese of Pittsburgh was first advised of the existence of the Foundation on May 16, 1956.Subsequent to the hearing in these proceedings, the Foundation filed an account with the Orphans' 1958 U.S. Tax Ct. LEXIS 98">*113 Court of Allegheny County, Pennsylvania. After oral arguments and the submission of issues on briefs, the court on September 24, 1957, rendered the following opinion and decree:30 T.C. 1130">*1137 OPINIONBOYLE, P. J.In the audit of the first and partial account of the trustees of the Francis Edward McGillick Foundation several questions are submitted for determination by the Court as follows: 1. Whether the deed of trust creating the Foundation is irrevocable.2. What portion of the income and principal of the trust is permanently dedicated to charitable uses.3. What additional compensation shall be allowed to the trustees.The settlor, Francis Edward McGillick, created a Foundation by deed of trust bearing date of January 6, 1937. The settlor's will, dated May 26, 1936, was incorporated into and made part of the trust instrument. In Paragraph "First" of the deed of trust it is provided: "FIRST: The said trustees and their successors in their collective capacity shall be designated as far as practicable FRANCIS EDWARD McGILLICK FOUNDATIONand under that name shall, as far as practicable, conduct all business and execute all instruments in writing or otherwise in the performance of their trust."The trust 1958 U.S. Tax Ct. LEXIS 98">*114 instrument recites, inter alia: "FOURTEENTH: The fiscal year of the trustees shall end on the 31st day of December in each year.IN CONSIDERATION OF the donations to and formation of the Francis Edward McGillick Foundation, I, Francis Edward McGillick, Donor, do hereby authorize, empower and direct the said Foundation through its Trustees to assume, pay, and carry out the following bequests and obligations, which are fully set forth in my Last Will and Testament, a copy of which is included herein and made a part hereof. Where executors are mentioned in my said Will, they are to act as Trustees of this Foundation. My Will and the Foundation are the same. At my death, all the Executors mentioned in my Will are to be Trustees of the Foundation.""The trustees hereby accept this trust subject to the aforementioned bequests and obligations of the Donor as set forth in his Last Will and Testament, as follows: * * *" (Underscoring supplied.)Incorporation of the Foundation after the settlor's death, in the event that he does not effect the incorporation in his lifetime, is provided for in paragraph 13 of the settlor's will which is part of the deed of trust.The trustees appointed by the 1958 U.S. Tax Ct. LEXIS 98">*115 settlor in the trust instrument are himself, his wife, Margaret A. McGillick, now deceased, and A. Louise Schultz McGillick, present wife of the settlor.At the date of the execution of the trust instrument the settlor transferred to the Foundation 49 shares of the capital stock of the F. E. McGillick Company, a Pennsylvania corporation. In 1949 and 1951 valuable parcels or real estate were added to the trust res. Since December, 1949, the income from the trust has been accumulating in the hands of the trustees. The value of the estate at the date of the present accounting is shown by the record to be $ 1,133,039.91.The deed of trust, including, as it does, the will of the settlor, provides for the administration and settlement of his testamentary estate and the payment of certain charges and legacies. The residuary estate is given in trust to provide annuities for the settlor's widow, children and some other relatives and to provide monies for the Foundation for the maintenance of two educational funds and a system of vocational schools.30 T.C. 1130">*1138 1.There are no dispositive provisions in the deed of trust apart from those in the will which is included in the instrument. No power of revocation 1958 U.S. Tax Ct. LEXIS 98">*116 is reserved in the deed of trust. In Ingel's Estate, 372 Pa. 171">372 Pa. 171, 372 Pa. 171">176, it is held:"* * * trusts are irrevocable unless a power of revocation is expressly reserved: * * *"See also Thompson v. Fitzgerald, 344 Pa. 90">344 Pa. 90; Donnan's Trust Estate, 339 Pa. 43">339 Pa. 43; Fishblate v. Fishblate, 238 Pa. 450">238 Pa. 450; Kraft v. Neuffer, 202 Pa. 558">202 Pa. 558; Rynd v. Baker, 193 Pa. 486">193 Pa. 486; Wilson v. Anderson, 186 Pa. 531">186 Pa. 531.The fact that an executed will of the settlor is made part of the declaration of trust does not render the declaration void or ambulatory and the trust res and the income therefrom are bound irrevocably by the provisions of the instrument: Mayor and City Council of Baltimore v. Williams, 6 Md. 235">6 Md. 235, 6 Md. 235">262, 6 Md. 235">263; Restatement of Trusts, sec. 330, Comment (e) and Illustration (2); Padfield v. Padfield, 72 Ill. 322">72 Ill. 322; Hamilton Trust Company v. Bamford, 141 A. 267; Hammett v. Farrar, 29 S. W. 2nd 949; Brainerd v. First National Bank, 169 S. W. 2nd 802.Notwithstanding that the settlor might make some other disposition by will of his property which is outside the trust, yet, as to the property given and conveyed to the Trustees of the Francis Edward McGillick Foundation in the lifetime of the settlor under the provisions of 1958 U.S. Tax Ct. LEXIS 98">*117 the deed of trust of January 6, 1937, the said deed is conclusive and irrevocable.2.There is no provision in the deed of trust for the distribution of the income of the Foundation during the life of the settlor. Very specific directions are given for the payment of income after his death. The provisions in the instrument for charitable and educational uses are all included in the will which is incorporated in the deed of trust. This is evidence of the settlor's intention that distribution for these purposes is not to be made until his death.This intention of the settlor is further evidenced by the fact that the Foundation has never been incorporated. In Paragraph 13 of the will the settlor directs his executors to incorporate the Foundation if he has not done so in his lifetime. There is no charitable corporation with the name Francis Edward McGillick Foundation existing at the present time, although the trustees hold the income and corpus of the trust for the benefit of the unincorporated Foundation established at the inception of the trust.The donor appears to regard this trust as a decedent's estate, with provision for the payment of funeral expenses, administration expenses, 1958 U.S. Tax Ct. LEXIS 98">*118 other charges, legacies and annuities to be paid before the charitable provisions of the trust become operative. A strong indication of this appears in Paragraph 19 of the will which is part of the trust instrument and provides as follows: "19. I hereby authorize, empower and direct my Executors, hereinafter named, when in their judgment and discretion there are more than sufficient funds to provide for the annuities to my wife and children, to transfer or set over to the Francis Edward McGillick Foundation any surplus to form or create the F. E. McGillick Priesthood Fund and the Margaret A. McGillick Sisterhood Fund. After the creation of these two funds, I authorize, empower, and direct my Executors, when in their judgment and discretion it is possible, to transfer and set over unto the Francis Edward McGillick Foundation, whatever funds have accumulated which are not needed to care for the annuities, salaries, and other expenses, for the purposes and uses as set out in paragraph twenty-one (21). I also authorize, empower and direct my Executors to transfer and set over unto the Francis Edward McGillick 30 T.C. 1130">*1139 Foundation, upon the death of my wife and all of my children, the principal 1958 U.S. Tax Ct. LEXIS 98">*119 fund of my estate and all the unpaid income or net proceeds thereof."In the case at bar there is an implied direction to accumulate the income of the trust during the lifetime of the settlor. This is a logical inference where the carrying out of the provisions of the trust instrument will be secured thereby: Billings Estate, 268 Pa. 71">268 Pa. 71, 268 Pa. 71">74; Rhode Estate, 5 Fid. Rep. 189, 192.There are conflicting provisions in the deed of trust. The entire instrument must be considered and effect given to all of its reconcilable parts in order to carry out the intent of the settlor as expressed in the language which he used: Wolters Estate, 359 Pa. 520">359 Pa. 520, 359 Pa. 520">525; Damiani v. Lobasco, 367 Pa. 1">367 Pa. 1, 367 Pa. 1">6, 367 Pa. 1">7.The entire estate embraced by the deed of trust of January 6, 1937, is committed irrevocably by the settlor to the charitable uses therein provided, subject only to the payment of expenses, charges, legacies and annuities which he has directed. The proper distribution of the income and principal of this trust to the charitable beneficiaries named in the trust instrument may only be made after the settlor's death and after the other charges against the fund have been paid or provided for.3.The Court approves 1958 U.S. Tax Ct. LEXIS 98">*120 the claim which the trustees have submitted for additional compensation.Distribution of the balance shown by the account will be made without prejudice to any rights which the Meadville Park Theater Corporation may have in the same by reason of an alleged fraudulent conveyance by the settlor on January 2, 1952, of an account receivable of F. E. McGillick Company to the trustees of the Foundation. The claim of the Meadville Park Theater Corporation is approximately $ 14,000.00 and the value of the account receivable is $ 146,833.31.A decree will be entered in accordance with this opinion.DECREEAnd now to wit September 24, 1957, the account in this case having been filed and confirmed nisi and having been examined and audited by the Court, upon consideration thereof it is decreed that the account be confirmed absolutely, and that the funds in the hands of the accountant, to wit $ 1,133,039.91, be paid in accordance with the schedule of distribution hereto attached and made part hereof unless exceptions are filed within ten days.Per CuriamSCHEDULE OF DISTRIBUTIONBalance$ 1,133,039.91Balance for Distribution1,133,039.91To Francis Edward McGillick and A. Louise Schultz McGillick, Accountants Compensation$ 18,583.55To Accountants for purposes specifiedin Declaration of Trust balance onPersonalty, Securities per Firstand Partial Account$ 636,833.31Principal Realty per First andPartial Account346,376.04Income Cash131,247.011,114,456.361,133,039.91Opinion 1958 U.S. Tax Ct. LEXIS 98">*121 filed by Boyle, P. J.At the time of the creation of the Foundation in 1937, the net assets of the Company had a fair market value of over $ 500,000. 30 T.C. 1130">*1140 During the calendar years 1949 through 1952, the net fair market value of the assets of the Company, other than those distributed to the Foundation on December 31, 1949, was in excess of $ 500,000.On March 15, 1951, the Foundation by its trustees applied for a ruling exempting it from Federal taxation under the provisions of section 101 (6), I. R. C. 1939. The exemption application stated that the Foundation engaged in the "Operation of rental properties, sales of real estate, investments," and that it derived its income from "Rentals of properties, sales of lots, investments in properties for foundation purposes." The exemption application further stated that McGillick rented and sold properties owned and operated by and for the Foundation, and devoted the benefits of his long experiences to the determination of investments, his purpose being to build up the funds of the Foundation to enable it to carry on the work for which it was created.On October 3, 1952, respondent ruled that the Foundation was neither organized nor operated exclusively 1958 U.S. Tax Ct. LEXIS 98">*122 for purposes coming within the meaning and intent of section 101 (6), I. R. C. 1939. After receiving this ruling, the trustees requested a reconsideration by letters dated October 16, 1952, March 17, 1953, and March 24, 1953. On June 12, 1953, the head of Special Technical Services Division of the Treasury Department affirmed the original ruling.The only tax returns filed by the Foundation from 1937 through 1952 were those filed in 1950 through 1952 on Form 990-A (Return of Organization Exempt from Tax under section 101 (6) of the Internal Revenue Code). 2 The failure to file Federal income tax returns Form 1120 for the years 1949 through 1952 was not due to reasonable cause. On these returns the Foundation stated that the nature of its activities was the "Rental and sales of real estate." McGillick and Louise, who was an attorney, signed these returns as president and treasurer, respectively. For the years 1950 through 1958 U.S. Tax Ct. LEXIS 98">*123 1952, the Foundation reported the following income:195019511952Rent received through agent$ 73,713.35$ 76,029.64$ 84,735.06Rent collected by Foundation34,232.9435,896.3750,734.60Income from subsidiaries3,929.834,405.492,558.57Total income111,876.121 116,353.64138,028.23Total expenses98,491.5682,456.56113,063.32Net income from operation13,384.5633,897.0824,964.91Distribution1,000.001,350.001,750.00Amount transferred to earned surplus12,384.5632,547.0823,214.9130 T.C. 1130">*1141 The Foundation also reported income earned by the Company as follows:195019511952Gain from sale of lots$ 28,503.59$ 8,284.88$ 17,057.75Rental income17,898.1628,550.5417,539.99Miscellaneous income6,374.7227.61Income from theaters4,797.43513.88Interest income645.68556.32527.09Total income58,219.5837,933.2335,124.83Total expenses54,289.7533,527.7432,566.26Net income transferred to Foundation3,929.834,405.492,558.57The Foundation received no income from 1937 through 1948 when the Company, by deed dated December 30, 1949, transferred to the Foundation title to certain parcels of real property. The conveyance provided, among other things, as follows:This Conveyance is Made Subject, however, 1958 U.S. Tax Ct. LEXIS 98">*124 to the payment by the * * * Foundation of all mortgages now outstanding against said above described properties.This Conveyance is also made subject to the payment by the * * * Foundation of certain monies to the wife, children and grand-children of * * * McGillick, and to certain charitable institutions, after the decease of * * * McGillick, as set forth in a certain Instrument in writing, dated May 26, 1936, and supplements thereto.This Conveyance is also accepted by the * * * Foundation with the understanding that none of the above recited properties are to be sold during the lifetime of * * * McGillick.These parcels of real property transferred to the Foundation were income-producing properties held by the Company primarily for investment purposes. The interest in real properties which the Company conveyed to the Foundation had a net fair market value on December 30, 1949, of $ 566,038.58 over and above the mortgages in the amount of $ 194,711.42. The cost of the properties to the Company was $ 478,895.52.On December 31, 1951, the Company transferred to the Foundation two improved parcels of real estate. The fair market value of the interest in properties transferred to the 1958 U.S. Tax Ct. LEXIS 98">*125 Foundation was $ 64,257.16 and the properties were subject to mortgages in the amount of $ 4,257.16. The cost to the Company was $ 39,149.92.During the years 1950 through 1952, the officers and trustees of the Foundation held title to the shares of stock in the Company and to the property which had been distributed by the Company to the Foundation. The trustees continued to rent this property and manage it in a manner much the same as had the Company.On April 2, 1952, the Company transferred to two individuals named Norbert F. and Ruth Dougherty $ 5,000, plus 3.125 acres of land, which had a tax basis to the Company of $ 4,730.31 and a fair market value of $ 22,563.07. In exchange, the individuals transferred to the 30 T.C. 1130">*1142 Foundation property which had a fair market value of $ 80,000, and which was subject to a mortgage in the amount of $ 52,436.93, which was assumed by the Foundation. The Company, in closing its books for the calendar year 1952, charged the $ 5,000 and the recorded book cost of the land in the amount of $ 1,822 against and in reduction of an existing indebtedness owed by the Company to the Foundation.During the years 1949 through 1952, McGillick and Louise were husband 1958 U.S. Tax Ct. LEXIS 98">*126 and wife and resided at 503 North Homewood Avenue, Pittsburgh, Pennsylvania. For the years 1949 through 1951, McGillick and Louise filed joint income tax returns with the collector of internal revenue for the twenty-third district of Pennsylvania. For the year 1952, McGillick filed an individual income tax return with the district director of internal revenue at Pittsburgh, Pennsylvania. He failed to file a declaration of estimated tax for that year.On the return filed by McGillick and Louise for the calendar year 1950, McGillick reported $ 20,000 as salary from the Company. On the Form 990-A filed by the Foundation for 1950, $ 10,000 of such salary was shown to have been paid by the Foundation and the remaining $ 10,000 was shown to have been paid by the Company. The amount reported as paid by the Foundation was returned to the Company and credited as an advance by McGillick. McGillick had no salary from the Foundation or the Company in 1951 and 1952.During the years 1949 through 1952, McGillick and Louise were the sole trustees of the Foundation. McGillick was president and general manager of the Company and the Foundation and Louise was their treasurer. Substantially all 1958 U.S. Tax Ct. LEXIS 98">*127 of the Foundation's income for the years 1949 through 1952 has been accumulated by its trustees.For the years 1932 through 1952, the Company's income, salary accrued for McGillick's services, salary retained by McGillick, withdrawals from and advancements to the Company by McGillick were as follows:McGillickNet incomeSalary ofSalaryYear(loss) perF. E.retainedincome taxMcGillickby F. E.WithdrawalsAdvancementsreturnMcGillick(DR)(CR)1932($ 1,714.20)$ 3,500$ 3,5001933(37,877.95)7,000$ 8,990.09$ 20,187.121934(9,265.33)18,534.3426,216.641935(7,165.76)19,080.8921,626.571936(382.32)12,00022,595.8132,754.971937(210.65)13,80029,501,4136,843.041938(43.66)50023,130.5718,957.081939(270.54)28,189.6120,854.931940(193.67)18,608.1919,344.321941(123.29)16,669.0021,030.001942(358.89)20,905.5322,313.581943(6,942.73)23,155.7812,575.861944(504.07)11,003.3715,879.4919451,482.07 10,00010,00013,565.082,141.57194646,089.38 25,00010,00017,953.2977,294.6119471,016.46 32,00011,950.5922,979.361948399.06 40,0005,884.9476,159.71194917,989.39 20,0005,00036,391.9110,800.0019503,929.83 10,0008,146.8916,000.0019514,405.49 13,741.6121,055.5619522,558.57 30 T.C. 1130">*1143 By the end of 1951, McGillick's advances exceeded his withdrawals 1958 U.S. Tax Ct. LEXIS 98">*128 by $ 147,015.51. He donated this amount to the Foundation in 1952. A reasonable salary for McGillick's services to the Company in 1950 is $ 6,000. A reasonable salary for his services to the Foundation is $ 6,000.The Company's current earnings and profits for the years 1949 through 1951 were $ 10,475.87, $ 1,693.43, and $ 17,450.70, respectively. Its current earnings for the year 1952, including the gain to it on the exchange of property with the Doughertys, were $ 17,167.37. The Company had no accumulated earnings and profits during the years referred to.The Company was not organized or operated exclusively for the purposes set forth in section 101 (6).Some part of the Foundation's net earnings may inure to the benefit of private individuals. During the years 1949 through 1952, none of the Foundation's gross income in excess of amounts conceded by respondent was paid or permanently set aside for the purposes specified in section 23 (o), I. R. C. 1939, or used exclusively for religious, charitable, or educational purposes.OPINION.I.Respondent's alternative argument that section 166 applies to this trust 31958 U.S. Tax Ct. LEXIS 98">*130 will not bear analysis. It is based on the form of the instrument which 1958 U.S. Tax Ct. LEXIS 98">*129 incorporates in the deed a "will" in which McGillick sets forth the purposes of the gift. But we are concerned here only with the property already given, and with respect to that, it is well settled, as petitioners point out, that the "will" loses its ambulatory character and that the gift is irrevocable. Hamilton Trust Co. v. Bamford, 141 A. 267 (N. J. Ch. 1928), affirmed per curiam without opinion 147 A. 909 (N. J. Err. & App. 1929); Hammett v. Farrar, 29 S.W.2d 949 (Commission of Appeals, Texas 1930); Restatement, Trusts sec. 330, comment e and illustration 2. 4 Of course, other property may (or may not) be left by McGillick when he dies. As to that, any current will, whether or not identical with the one incorporated 30 T.C. 1130">*1144 in the deed, may be effective. But as to the property now vested in the trustees, and as to the income from it during the instant years, which is all that is here involved, the form of the document and the fact that it is called a "will" is totally irrelevant. Section 166 is accordingly inapplicable since the trust is not revocable.This being so, petitioners contend that, even though a part of the Foundation's income may accumulate and eventually inure to the benefit of the private individuals who are to receive bequests and annuities under the directions in McGillick's "will," this does not prevent an otherwise eligible charity from attaining exemption under section 101 (6). 5 The payments in question are said to be considered prior charges against the property donated, and with respect to all that remains, organizations have been held to be created and operated exclusively for the purposes specified. Lederer v. Stockton, 260 U.S. 3">260 U.S. 3; Emerit E. Baker, Inc., 40 B. T. A. 555; Edward Orton, Jr. Ceramic Foundation, 9 T.C. 533, 1958 U.S. Tax Ct. LEXIS 98">*131 affd. (C. A. 6) 173 F.2d 483. See also William L. Powell Found. v. Commissioner, (C. A. 7) 222 F.2d 68.Here it may be that one of the purposes of the Foundation is religious and that some of its property and income may turn out to be dedicated to that objective. But the gifts to be made from the fund and which were to be paid before any charity would benefit were not merely charges on the original transfer as in 260 U.S. 3">Lederer v. Stockton, supra;Emerit E. Baker, Inc., supra;Edward Orton, Jr. Ceramic Foundation, supra. They were not payable immediately out of either income or principal, and 1958 U.S. Tax Ct. LEXIS 98">*132 the former has to be accumulated until McGillick's death, under the State court decree. 6It cannot thus be said now, as it was in the cited cases that any immediate gift has been made to an individual; and that hence the gift to charity has merely been reduced by the charge so created. It is possible and even probable that the income now being earned may be used for the benefit of these individuals, the donees, in the future. There is nothing in the record to demonstrate that at the time of final distribution there will remain enough of the corpus to pay the described obligations and gifts without resorting to the accumulated income, nor indeed anything to convince us that the trustees cannot 30 T.C. 1130">*1145 first exhaust the accumulations before resorting to corpus. 7 On that ground alone, we should disapprove the attempted resort to section 101 (6), requiring as it does that the purpose of the organization shall be "exclusively" charitable and that no part of the income can inure to the benefit of a private individual. Gemological Institute of America, 17 T.C. 1604, 1958 U.S. Tax Ct. LEXIS 98">*133 affirmed per curiam (C. A. 9) 212 F.2d 205; Mabee Petroleum Corp. v. United States, (C. A. 5) 203 F.2d 872.In addition, however, it seems clear that the administration expenses of McGillick's estate, as well as all kinds of his taxes and certain debts, are payable in the future out of these funds. 8 This is a direct benefit to him, increasing the private wealth which he can safely dispose of in his lifetime. Had he provided that these funds were to be used to pay his butcher bills or his house rent, they would clearly inure to his personal benefit, Louis W. Hill, 33 B. T. A. 891, affd. (C. A. 8) 88 F.2d 941; Estate of A. E. Staley, Sr., 47 B. T. A. 260, affd. (C. A. 5) 136 F.2d 368, certiorari denied 320 U.S. 786">320 U.S. 786, and not be eligible for preferred treatment under section 101 (6). Scholarship Endowment Foundation v. Nicholas, (C. A. 10) 106 F.2d 552, certiorari denied 308 U.S. 623">308 U.S. 623. 1958 U.S. Tax Ct. LEXIS 98">*134 We see no distinction in theory from the present provision making this gift, principal and accrued income, liable, as it does, for personal expenses to which he may now or in the future be subject.Furthermore, the required payment of salary to McGillick for services, which he is already obligated to perform for the Company and the similarly required future payments to his sons, and which are, or certainly may in the future be unreasonably large, prevents us from being able to say that this Foundation was "organized" exclusively for charitable purposes. See Texas Trade School, 30 T.C. 642.The latter propositions are, perhaps, also consistent with respondent's other alternative that petitioner McGillick is taxable on the trust income under section 167 because the income is in effect distributed or accumulated for his benefit, or under Helvering v. Clifford, 309 U.S. 331">309 U.S. 331. But since 1958 U.S. Tax Ct. LEXIS 98">*135 this is expressly an alternative, we prefer to rest our decision on the principal contention, and content ourselves with disposing of this by holding, in accordance with the deficiency notice, that the Foundation is not an exempt organization under section 101 (6).30 T.C. 1130">*1146 II.What we have said also disposes of petitioners' further contention that the Foundation is entitled to deduct the entire amount of income received because this is either currently distributable to, or must be accumulated for charitable uses. Secs. 162 (a) and (b). That it is not currently distributable is now conceded by petitioners, in accordance with the holding of the local Probate Court. 9 In addition, there is no real showing, as we have already pointed out, that some part or all of the accumulated income may not eventually come into the hands of private individuals. It cannot thus be treated as irrevocably destined for charity. Boston Safe Deposit & T. Co. v. Commissioner, (C. A. 1) 66 F.2d 179, affirming 26 B. T. A. 486, certiorari denied 290 U.S. 700">290 U.S. 700.III.When we come to the Company, a more elementary situation 1958 U.S. Tax Ct. LEXIS 98">*136 is presented. It is a commercial corporation engaged in the real estate business and presumably organized and operated for profit. The only theory on which its income could be viewed as nontaxable would be an application of the "feeder" doctrine. Roche's Beach, Inc. v. Commissioner, (C. A. 2) 96 F.2d 776; Willingham v. Home Oil Mill, (C. A. 5) 181 F.2d 9, certiorari denied 340 U.S. 852">340 U.S. 852; C. F. Mueller Co. v. Commissioner, (C. A. 3) 190 F.2d 120. But see United States v. Community Services, (C. A. 4) 189 F.2d 421, certiorari denied 342 U.S. 932">342 U.S. 932; Donor Realty Corporation, 17 T.C. 899; Joseph B. Eastman Corporation, 16 T.C. 1502; Eaton Foundation v. Commissioner, (C. A. 9) 219 F.2d 527, affirming a Memorandum Opinion of this Court; John Danz, 18 T.C. 454, affd. (C. A. 9) 231 F.2d 673, certiorari denied 352 U.S. 828">352 U.S. 828; Randall Foundation v. Riddell, (C. A. 9) 244 F.2d 803. Cf. section 301 (b), Revenue Act of 1950, amending section 101, I. R. C. 1939; section 601, Revenue Act of 1951; S. Rept. No. 2380, 81st Cong., 2d Sess. (1950), p. 116.But while the ownership of its stock by the Foundation does indeed provide a possible charitable destination for some of the earnings distributed 1958 U.S. Tax Ct. LEXIS 98">*137 by it as dividends, it cannot be said that the Company was organized as well as operated for charitable purposes. Under section 101 (6), the organization is as important as the operation and one is as essential to exemption as the other. There can be no dispute that here the Company was organized solely as a commercial venture. That alone bars its exemption. In that respect the case is vitally different from such cases as Mueller where the "feeder" corporation was organized as such and with no other destination for its income.30 T.C. 1130">*1147 It may be added that the record requires a finding that not all of the income of the Company would be devoted to the Foundation in any event. At least 1 share of its stock is claimed by a private individual, and it is our best judgment from the stipulation that such a claim would be sustained.On this issue, also, the deficiency must be approved.IV.It seems to be accepted by both parties that the distributions by the Company to the Foundation from 1949 through 1952 were taxable as dividends only to the extent of the stipulated earnings and profits existing in those years; and that any excess is to be applied first against the Foundation's basis with the balance 1958 U.S. Tax Ct. LEXIS 98">*138 taxable as capital gain.Although these matters are stated to be in controversy, the briefs apparently eliminate any real issue. The figures are not materially in dispute and the computations involved can be left to the proceedings under Rule 50. The slight discrepancy in amounts has been resolved in our findings in favor of respondent for lack of proof to the contrary. 10V.McGillick's salary from the Foundation is said to be reasonable because in accord with customary allowances to trustees under Pennsylvania law. 111958 U.S. Tax Ct. LEXIS 98">*139 There are several difficulties with this contention. In the first place it was in 1950, not 1949, that McGillick was awarded the salary of $ 10,000 which is in issue. But the large income collections upon which the fees are computed by petitioners were received in 1949, not 1950. The 1950 receipts would not warrant anything like the fees contended for by petitioners under their assumption of what a Pennsylvania court would award. Parenthetically, it may be noted that there is no evidence that any application for approval of the compensation in dispute was ever made to the local Probate Court. In the second place, as has been noted in connection with the preceding point, most of the distribution, even in 1949, was from capital and it becomes highly doubtful whether any court would award fees based on income receipts under such circumstances.Respondent has determined that $ 6,000 was reasonable compensation to McGillick for his services to the Foundation in 1950, and we 30 T.C. 1130">*1148 find nothing in the record to demonstrate the error of that determination.The deficiency 1958 U.S. Tax Ct. LEXIS 98">*140 in this respect is sustained.VI.In a previous controversy between the Company and respondent, we decided that a reasonable annual salary for McGillick's services to the Company for the years 1948 and 1949 was $ 12,000. F. E. McGillick Co., a Memorandum Opinion of this Court dated December 11, 1953. After the December 30, 1949, distribution of $ 566,038.58 to the Foundation, the Foundation had property with a fair market value in excess of $ 500,000 which had until then belonged to and been managed by the Company. The earnings attributable to this property owned by the Foundation in 1950 far exceeded the earnings on the property retained by the Company. We have already concluded that McGillick's services to the Foundation in 1950 were worth $ 6,000. The facts existing in 1950 are materially different from those which were previously before us, and this issue must be decided de novo. Glenshaw Glass Co., 13 T.C. 296. Upon consideration of the facts presented, we have concluded that petitioners have not proved that McGillick's services in 1950 to the Company were worth more than $ 6,000 nor that the Company was entitled to a deduction of any greater amount. Respondent's determination 1958 U.S. Tax Ct. LEXIS 98">*141 in this respect is accordingly sustained.VII.Petitioners contend that respondent erred in charging the Company with a taxable gain on the exchange of certain cash and property for other property. Petitioners appear to be arguing that the distribution by a corporation of a dividend in appreciated property is not taxable to the corporation. General Utilities Co. v. Helvering, 296 U.S. 200">296 U.S. 200. In this case, however, the Company transferred property and cash to a third party and received other property from it in return. At that point the Company was taxable on the difference between its basis and the fair market value of the property received. Sec. 111, I. R. C. 1939. The fact that it distributed the property so received in the course of completing the transaction with the third party cannot have the effect of eliminating the taxability of a transaction, the characteristics of which had already become fixed. Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331; Rose Kaufmann, 11 T.C. 483, affd. (C. A. 3) 175 F.2d 28. That the Company never physically received the property but caused it to be transferred directly to the Foundation does not affect the Company's tax liability. United States v. Joliet & Chicago R. Co., 315 U.S. 44">315 U.S. 44; 1958 U.S. Tax Ct. LEXIS 98">*142 Commissioner v. First 30 T.C. 1130">*1149 , (C. A. 5) 168 F.2d 1004, certiorari denied 335 U.S. 867">335 U.S. 867; Helvering v. Horst, 311 U.S. 112">311 U.S. 112.It is unnecessary to consider whether the gain from this exchange might fall within one of the statutory nonrecognition provisions, since no such contention is advanced.Although the matter is not clarified in the briefs, respondent's request for increased deficiencies against the Foundation for 1952 appears to be the result of this same transaction. The receipt by the Company as income of the profits on the exchange would place them in possession of an equivalent amount of additional earnings and profits adequate to support the finding that the receipt of the proceeds of the exchange by the Foundation, stated to be in the amount of $ 17,832.76, constituted an additional taxable distribution by the Company. 12 This aspect being raised by respondent's amended answer seeking an increased deficiency, the burden of proof as to any disputed facts accordingly rests upon respondent. However, all of the facts of the transaction appear to be in evidence and are contained in our findings. Whatever burden of proof was accordingly involved, respondent must hence be 1958 U.S. Tax Ct. LEXIS 98">*143 held to have sustained. Respondent's computation of the amount of gain not being questioned, the determination as well as the increased deficiency claimed in the amended answer is approved.VIII.Respondent determined deficiencies in additions to tax under section 291 (a), I. R. C. 1939, for the failure of the Foundation to file income tax returns for 1949 through 1952 and for the Company's failure to file for 1950 through 1952. No returns were filed by either organization in these years, except for the Forms 990 and 990-A filed by the Foundation for 1950 through 1952.Petitioners point out that Louise, the treasurer 1958 U.S. Tax Ct. LEXIS 98">*144 of both the Company and the Foundation, was an attorney, and would have us conclude that this alone establishes reasonable cause. This we are unable to do, for there is no showing that Louise had any connection with petitioners' tax matters except to sign the Forms 990 and 990-A. See C. R. Lindback Foundation, 4 T.C. 652, affirmed per curiam (C. A. 3) 150 F.2d 986.No other excuse is even intimated as to the Company, but it is also suggested that the pendency of the applications for exemption 30 T.C. 1130">*1150 constituted reasonable cause as to the Foundation. But until long past the time for filing the 1949 return, no such request had even been filed. As to 1950 through 1952, we regard the matter as controlled by Automobile Club v. Commissioner, 353 U.S. 180">353 U.S. 180. There the Supreme Court held that "the Form 990 returns are merely information returns in furtherance of a congressional program to secure information useful in a determination whether legislation should be enacted to subject to taxation certain tax-exempt corporations competing with taxable corporations. Those returns lack the data necessary for the computation and assessment of deficiencies and are not therefore tax returns within the 1958 U.S. Tax Ct. LEXIS 98">*145 contemplation of § 275 (a)." (Emphasis added.) It is true the question there was the running of the statute of limitations rather than the addition to tax. But if the paper filed was not a return for any purpose, we fail to see how the mere pendency of the application for exemption can be considered a legitimate excuse for failing to file any return whatever for 4 successive years.The situation is quite different from that in Hartford-Connecticut Trust Co. v. Eaton (C. A. 2) 34 F.2d 128, to which petitioners refer. That was a case where a fiduciary Form 1041 had been filed instead of the return Form 1040. It was later held in Germantown Trust Co. v. Commissioner, 309 U.S. 304">309 U.S. 304, that the former was a return for purposes of computation and collection of the tax in that all of the material except the tax computation itself was called for by it. In the Germantown Trust case for purposes of the statute of limitations, as in Hartford-Connecticut Trust Co. v. Eaton, supra, 1958 U.S. Tax Ct. LEXIS 98">*146 in the case of the addition to tax, it is evident that a fiduciary return Form 1041 is quite different from a Form 990 which was required, as petitioner correctly states, by section 54 (f) rather than by section 142.The conclusion of any adequate excuse for failing to file a return cannot, as we have already noted, be reconciled in the case of a Form 990 with 353 U.S. 180">Automobile Club v. Commissioner, supra, which the Supreme Court obviously did not think inconsistent with its previous decision in 309 U.S. 304">Germantown Trust Co. v. Commissioner, supra. And the statement in petitioners' brief that "Congressional intent appears to be substantiated by the provisions of Section 6501 (g) of the 1954 Code, wherein Congress declares the return executed by a charitable organization will begin the running of the Statute of Limitations," actually leads to the diametrically opposite conclusion as to the delinquency penalty. Cf. John Danz, supra at 465.The deficiencies in additions to tax are approved.IX.The final question is McGillick's liability for additions to tax under section 294 (d) (1), I. R. C. 1939, for failure to file a declaration of 30 T.C. 1130">*1151 estimated tax for 1952. Petitioners have submitted neither evidence 1958 U.S. Tax Ct. LEXIS 98">*147 nor argument to justify this failure. The deficiency in this respect must therefore be sustained, except that the amount which will depend upon McGillick's taxable income may be arrived at in the recomputation.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: F. E. McGillick and A. Louise McGillick, Docket Nos. 54089, 55480, 57819; Francis Edward McGillick Foundation, Docket Nos. 54090, 55479, 57820; F. E. McGillick, Docket No. 55481; F. E. McGillick Company, Docket No. 55482.↩1. Under sec. 291 (a)↩.2. Under sec. 294 (d) (2)↩.3. Under sec. 294 (d) (1)↩.2. It is stipulated that the "Foundation did file Forms 990-A for the taxable years 1950 to 1952, inclusive." The exhibits accompanying the stipulation, however, show that in 1950 the Foundation filed two forms, both of which are designated Form 990 rather than 990-A.↩1. Includes miscellaneous income of $ 22.14.↩3. SEC. 166. REVOCABLE TRUSTS.Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested -- (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or(2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, then the income of such part of the trust shall be included in computing the net income of the grantor.↩4. A similar conclusion was reached by the Pennsylvania Orphans' Court. See Findings of Fact, pp. 1137-1139.↩5. SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.* * * the following organizations shall be exempt from taxation under this chapter -- * * * *(6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation. * * *↩6. This decree states: "In the case at bar there is an implied direction to accumulate the income of the trust during the lifetime of the settlor. * * *"↩7. See, e. g., the Probate Court's opinion: "The proper distribution of the income and principal of this trust to the charitable beneficiaries named in the trust instrument may only be made after the settlor's death and after the other charges against the fund↩ have been paid or provided for." (Emphasis added.)8. The Probate Court's opinion refers to the fact that "[the] donor appears to regard this trust as a decedent's estate, with provision for the payment of funeral expenses, administration expenses, other charges, legacies and annuities to be paid before the charitable provisions of the trust become operative."↩9. Some was in fact distributed to charity, and for that part respondent has allowed the Foundation credit.↩10. A somewhat related issue is discussed under point VII, infra↩.11. "The Pennsylvania Courts have developed a normal charge or standard commission for trustees by constant setting of the same fee which the trustees may claim. This standard commission or fee is 2 percent of the proceeds of the sale of real estate and 5 percent of other receipts. Stevenson's Estate, 4 Whart. 89 (Pa. 1839); Lilly's Estate, 37 A. 557, 181 Pa. 478">181 Pa. 478; Smith's Estate, 2 A. 2d 779, 332 Pa. 581">332 Pa. 581; Ashman's Estate, 67 A. 841, 218 Pa. 509">218 Pa. 509. The term 'usual commission' is 5 percent of trust receipts. Lilly's Estate↩, supra.This 5 percent commission is a convenient yardstick readily available for the use of courts, trustees and beneficiaries to determine the reasonableness of the fiduciary's compensation." (Petitioners' brief.)12. It is not clear how respondent arrived at the figure mentioned. He did not include in his determination as a taxable distribution the total amount of the equity in the property received from the Company by the Foundation which was stipulated to have a fair market value of $ 27,563.07 ($ 80,000 less mortgage assumed of $ 52,436.93), nor even that amount reduced by the indebtedness to the Foundation of $ 6,822. Since, however, the only increased deficiency requested is based on the smaller amount, this is the outer limit of what should be included in the Foundation's income.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623107/ | SOL LEFKOWITZ and ROSLYN LEFKOWITZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentLefkowitz v. CommissionerDocket Nos. 5553-77, 2968-79.United States Tax CourtT.C. Memo 1980-318; 1980 Tax Ct. Memo LEXIS 268; 40 T.C.M. 978; T.C.M. (RIA) 80318; August 14, 1980, Filed Sol Lefkowitz, pro se. Michael A. DeLuca, for the respondent. 1980 Tax Ct. Memo LEXIS 268">*269 SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies and additions to tax in the joint Federal income tax of Sol Lefkowitz and Roslyn Lefkowitz for calendar years 1973, 1974, and 1975 as follows: DeficiencyAddition to TaxinUnder Sec. 6651(a), 1Docket No.YearIncome TaxI.R.C. 19545553-771973$3,997.222968-7919743,521.96$880.492968-7919753,596.04899.01Some of the issues raised by the pleadings have been disposed of by the parties, leaving for our decision the following: (1) whether during the years in issue petitioners had a depreciable basis in certain improvements and equipment acquired in 1968 from petitioner-husband's parents; (2) if so, the proper method for calculating allowable depreciation deductions for the taxable years 1973, 1974, and 1975; and (3) whether petitioners are liable for an addition to tax under section 6651(a) for failure to timely file their 1974 and 1975 Federal income tax returns. 1980 Tax Ct. Memo LEXIS 268">*270 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Sol Lefkowitz (petitioner) and Roslyn Lefkowitz, husband and wife, who resided in Glen Cove, New York, at the time of filing their petition in this case, timely filed their joint Federal income tax return for calendar year 1973 with the Internal Revenue Service Center, Holtsville, New York. Petitioners filed an amended joint Federal income tax return for calendar year 1973 in September 1974. The Internal Revenue Service Center at Holtsville, New York, received petitioners' joint Federal income tax returns for the calendar years 1974 and 1975 on December 18, 1975, and April 25, 1977, respectively. Petitioner is a self-employed attorney whose office is located in his residence. Petitioner employed a full-time secretary in his law office from mid-December 1973 until September 26, 1975. When this secretary left in September 1975, petitioner did not hire a replacement secretary. Mrs. Lefkowitz took over some of the work which had been done by the secretary. From sometime in 1968 throughout the years in issue, petitioners operated Lefkowitz Summer Homes (Summer Homes), a resort motel. During1980 Tax Ct. Memo LEXIS 268">*271 the years in issue Summer Homes included a number of bungalow buildings, a swimming pool, tennis courts and equipment located on land in Monticello, New York. The property on which the bungalows stand is a portion of a 65-acre tract of land purchased for $15,000 in 1945 by petitioner's parents, Morris and Rachel Lefkowitz, and two other persons. At that time the land was improved with a farmhouse, chicken coops, a barn which had been converted into three apartments, and three bungalows. Thereafter a dispute arose amongst the three owners, and they decided to auction the property to the highest bidder amongst the three of them. As a result of the auction, petitioner's parents repurchased the property with another man for a total price of $24,000. Petitioner's parents and the other owner initially divided the property and operated separate bungalow cottage businesses. They built a number of additional cottages for summer rentals. Some years later petitioner's parents bought the property interest of the other owner and became the sole owner of the property. In approximately 1959, 11 acres of the land was condemned for construction of the New York Thruway. As a result of the1980 Tax Ct. Memo LEXIS 268">*272 condemnation petitioner's father received between $50,000 and $60,000. 2On October 11, 1967, petitioner's parents sold 25 acres of their remaining 54 acres to the Sullivan County Harness Racing Realty Corporation. Under the terms of the sale the purchaser executed a mortgage in favor of the sellers for $20,000, bearing interest at a rate of 6 percent per annum, payable January 2, 1968. The "Bargain & Sale Deed with covenants" was dated October 11, 1967, and was received, acknowledged and recorded by the Sullivan County Clerk's Office on the same day. On January 1, 1968, petitioners acquired the Summer Homes property from petitioner's parents. They agreed to a sales price of $100,000. No money was transferred at that time. However, petitioners assumed a mortgage payable to the National Union Bank with a balance of $12,000 and additionally issued two purchase money mortgages, one in the amount of $35,000 in favor of petitioner's parents, and the other in favor of his sister in the amount of $20,000. 1980 Tax Ct. Memo LEXIS 268">*273 The "Bargain & Sale Deed with covenant" and the two purchase money mortgages, each dated August 15, 1968, were acknowledged as received by the Sullivan County Clerk's Office on August 16, 1968. The "Bargain & Sale Deed with covenant" provided for the conveyance of-- ALL that certain plot, piece or parcel of land, with the buildings and improvements thereon erected, situate, lying and being in the Town of Thompson, Sullivan County, New York, known and distinguished as the south part of farm lot Number five in division lot twenty-five of Great Lot No. 1 of the Hardenburgh Patent * * *. All mortgages were paid in full prior to the date of the trial of this case. On their 1968 Federal income tax return petitioner's parents reported two sales as follows: DescriptionLandBungalow Colony 3Type of PropertyReal EstateReal EstateDate Acquired19451945Date Sold1/20/681/2/68Gross Sales Price$20,000$100,000Depreciation Allowed(or Allowable)Since Acquisition$66,106.18Cost or Other Basis$11,236.60$168,450.86Gain or Loss$8,763.40($2,344.68)1980 Tax Ct. Memo LEXIS 268">*274 On their income tax returns for the calendar years 1968 through 1972, petitioners claimed depreciation deductions on the acquired property as follows: DepreciationAllowed orAllegedAllowable inDescription ofCost orDateYears PriorPropertyOther BasisAcquiredto 1968Frame Bldg.$43,5001945-55$22,370Swimming Pool15,50019554,845Equipment16,084195914,472Frame Bldgs.42,7721956-6111,815Equipment4,7541960-613,575Frame Bldg.15,2211962-632,667Equipment3,7421962-632,391Equipment4501964180Frame Bldg.14,50019651,305Equipment2,5001965750Equipment2,6741966534Frame Bldg.8,9091967267Equipment1,8451967184Total$172,451$65,355Deprec.Deprec.Description ofYearsTaken inTaken inPropertyRate19681969Frame Bldg.SL 6%$2,610$2,610Swimming PoolSL 6%700700EquipmentSL 10%1,608Frame Bldgs.SL 6%2,5062,506EquipmentSL 10%475475Frame Bldg.SL 3%457457EquipmentSL 10%394394EquipmentSL 10%4545Frame Bldg.SL 3%435435EquipmentSL 10%250250EquipmentSL 10%267267Frame Bldg.SL 3%267267EquipmentSL 10%184184Total$10,198$8,5901980 Tax Ct. Memo LEXIS 268">*275 Deprec.Deprec.Deprec.Description ofTaken inTaken inTaken inProperty197019711972Frame Bldg.$2,610$2,610$2,610Swimming Pool700700930EquipmentFrame Bldgs.2,5062,5062,506EquipmentFrame Bldg.457457457Equipment374374Equipment454545Frame Bldg.435435435Equipment250250250Equipment267267267Frame Bldg.267267267Equipment184184184Total$8,095$8,095$7,951Petitioners prepared their own 1974 income tax return with the exception of the Summer Homes Schedule C, which was initially prepared by their accountant. Petitioners filed an application for extension of time to file their 1974 Federal income tax return. The application requested an extension until October 15, 1975. On granting the extension, the Internal Revenue Service marked the application "Final." While the Internal Revenue Service did not receive petitioners' 1974 income tax return until December 18, 1975, petitioners had dated it October 15, 1975. Petitioners completely prepared their own 1975 Federal income tax return after having filed three requests for extensions of time. The Internal Revenue1980 Tax Ct. Memo LEXIS 268">*276 Service granted two extensions; however, the third request was denied on the grounds that an extension of time to file a tax return may not be granted for a period in excess of six months. The tax return, which petitioners dated April 15, 1976, was received by the Internal Revenue Service on April 25, 1977. On their joint 1973, 1974, and 1975 income tax returns, petitioners claimed depreciation deductions with respect to the Lefkowitz Summer Homes in the amounts of $13,955, $14,720, and $14,739, respectively. 4 Respondent in his notice of deficiency for petitioners' taxable year 1973 disallowed $8,290.00 of depreciation claimed with respect to Lefkowitz Summer Homes with an explanation that this amount was claimed with respect to items fully depreciated prior to 1973. In his notice of deficiency for the taxable years 1974 and 1975 respondent disallowed the depreciation claimed with respect to Lefkowitz Summer Homes in full explaining that "you have failed to establish your basis for depreciation on such assets." In his notice of deficiency with respect to the taxable years 1974 and 1975 respondent determined that since "you have not shown that the failure to file [your returns1980 Tax Ct. Memo LEXIS 268">*277 for 1974 and 1975] in time was due to reasonable cause, 25 percent of the tax is added as provided by section 6651(a) of the Internal Revenue Code." OPINION Respondent takes the position that the Summer Homes property when acquired by petitioners had a fair market value in excess of the $67,000 paid by petitioners and that therefore the transaction was a bargain sale. Accordingly, respondent states that a determination of petitioners' unadjusted basis in the acquired property is governed by section 1015(a), which provides: SEC. 1015. BASIS OF PROPERTY ACQUIRED BY GIFTS AND TRANSFERS IN TRUST. (a) Gifts After December 31, 1920.--If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property1980 Tax Ct. Memo LEXIS 268">*278 at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value. If the facts necessary to determine the basis in the hands of the donor or the last preceding owner are unknown to the donee, the Secretary or his delegate shall, if possible, obtain such facts from such donor or last preceding owner, or any other person cognizant thereof. If the Secretary of his delegate finds it impossible to obtain such facts, the basis in the hands of such donor or last preceding owner shall be the fair market value of such property as found by the Secretary or his delegate as of the date or approximate date at which, according to the best information that the Secretary or his delegate is able to obtain, such property was acquired by such donor or last preceding owner. Relying upon section 1.1015-4, Income Tax Regs., 5 respondent asserts that petitioner's unadjusted basis in the acquired property is $102,345. This is the amount of petitioner's parents' adjusted basis in "Bungalow Colony" at the time of the transfer as shown on Schedule D of their 1968 income tax return. 1980 Tax Ct. Memo LEXIS 268">*279 Petitioners contend that, pursuant to section 1015 and section 1.1015-4, Income Tax Regs., their unadjusted basis in the acquired property is $107,096. Petitioners calculate this figure from an alleged depreciation schedule, not introduced in evidence in this case, which petitioner's parents allegedly maintained with regard to the property. Pursuant to the reputed depreciation schedule, petitioners calculated the parents' unadjusted basis in the property at $172,451 and the depreciation allowed or allowable in years prior to 1968 as $65,355. We agree with respondent that under section 1015 and section 1.1015-4, Income Tax Regs., petitioners' unadjusted basis in the acquired property is $102,345. Petitioners have failed to introduce the depreciation schedule to which they refer or any reliable evidence of their basis in the bungalow property other than those figures used by their parents on their 1968 income tax return. Therefore, from the evidence in this record we conclude that petitioners' unadjusted basis in the property is $102,345. Petitioners argue that all of the $102,345 unadjusted basis is attributable to depreciable assets. Respondent contends that the unadjusted1980 Tax Ct. Memo LEXIS 268">*280 basis must be allocated to the underlying land as well as to the improvements and equipment located thereon. To counter respondent's position petitioner asserts that petitioner's parents sold the underlying land in a separate transaction. Petitioners support their contention by referring to the parents' 1968 income tax return which lists on Schedule D a "Land" sale on January 20, 1968. For a number of reasons we conclude that the separate land transaction listed on the parents' income tax return was not for the land underlying the improvements and equipment acquired by petitioners. First of all, as prepared by petitioners' realty attorneys, the Abstract of Title of the premises conveyed from petitioner's parents to petitioners states that petitioner's parents convey to petitioners-- ALL that certain plot, piece or parcel of land, with the buildings and improvements thereon erected, situate, lying and being in the Town of Thompson, Sullivan County, New York, known and distinguished as the south part of farm lot Number five in division lot twenty-five of Great Lot No. 1 of the Hardenburgh Patent * * *. [Emphasis added.] Indeed, it is difficult to conceive of petitioner's1980 Tax Ct. Memo LEXIS 268">*281 parents separately selling to petitioners or a third party the land on which the "Bungalow Colony" is located. A second reason for our conclusion is that the sale of land to Sullivan County Harness Racing Realty Corporation was subject to a mortgage in the amount of $20,000 payable January 2, 1968. While the date of the $20,000 sale of "Land" listed on petitioner's parents' income tax return is 18 days later than the date on which the $20,000 mortgage was payable, it is possible that the payment was not received until January 20, 1968. The record shows that petitioner's father was alive and in good health at the time of trial. However, petitioner failed to have his father clarify for the Court the land that was the subject property of the January 20, 1968, sale. The record shows that petitioners prior to 1973 were allowed $42,929 as depreciation on the buildings and other improvements on the property in 1968 when it was acquired from petitioner's parents. However, the record does not show the portion of the $102,345 basis of the property which is allocable to the land. The record shows that sometime after 1945 petitioner's parents together with another person repurchased the1980 Tax Ct. Memo LEXIS 268">*282 65-acre tract for $24,000. Originally petitioner's parents had paid their one-third part of the $15,000 cost of the entire 65-acre tract purchased along with two other persons. However, the record is silent as to when and for what price petitioner's parents acquired the one-half interest in the property which had at the time of repurchase been acquired by the other owner. In 1959, petitioner's father received between $50,000 and $60,000 when 11 acres of the land was condemned. This fact suggests that the amount paid by petitioner's parents to the other owner for his one-half interest in the land may have been a very substantial amount. In any event, there is no evidence in this record to indicate that petitioner's parents' basis in the land transferred to petitioners in 1968 was not at least $60,000. At the trial petitioner testified that the price paid by his parents to the other owner for his one-half interest in the property might show in an abstract of title which the parties agreed to place in evidence. However, the abstract as entered in evidence does not list deeds prior to 1964. All this abstract shows is that petitioner's parents acquired the entire interest in the1980 Tax Ct. Memo LEXIS 268">*283 property prior to 1964. It does not show the date of the acquisition or the amount paid for the interest acquired. Petitioners have the burden of proving respondent's determinations incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). Petitioners have failed to establish that their $102,345 unadjusted basis did not include in addition to depreciable assets the underlying land. They have also failed to show the basis of the land and therefore have failed to show that the basis of the depreciable assets acquired in 1968 had not been fully recovered by depreciation deductions allowed prior to 1973. Respondent's determination that petitioners did not have a sufficient amount of unadjusted basis following their taxable year 1972 to allow the claimed depreciation deductions during the years in issue is sustained. Accordingly, we need not consider the issue of whether in the years here involved the allowable depreciation, as based on the corrected unadjusted basis, must be calculated at the same rate and by the method selected on petitioner's income tax return, or whether petitioners ar permitted to deduct annually the same dollar amount in depreciation as that taken1980 Tax Ct. Memo LEXIS 268">*284 by the transferor. Petitioners also contest respondent's determination of the additions to tax under section 6651 for failure to timely file their income tax returns for calendar years 1974 and 1975. Section 6651(a)(1) provides that failure to timely file a Federal income tax return results in the application of an addition to the tax of the dilatory taxpayer of 5 percent per month up to a maximum of 25 percent unless the taxpayer proves the failure is "due to reasonable cause and not due to willful neglect." 61980 Tax Ct. Memo LEXIS 268">*285 Petitioners take the position that their failure to timely file their tax returns was due to reasonable cause rather than willful neglect. The question of whether petitioners' failure resulted from "reasonable cause" is a question of fact, and the burden of proof is upon the petitioners. Shomaker v. Commissioner,38 T.C. 192">38 T.C. 192, 38 T.C. 192">202 (1962); Latham Park Manor, Inc. v. Commissioner,69 T.C. 199">69 T.C. 199, 69 T.C. 199">219 (1977), affd. in an unpublished opinion, 618 F.2d 100">618 F.2d 100 (4th Cir. 1980). Petitioner testified that although he was aware of the proper filing date, the failure to file resulted from the lack of proper secretarial assistance in his law office and the inaccessibility of certain records located in Monticello, New York. However, petitioner testified that he made no efforts to hire a new secretary after his secretary left on September 26, 1975, since he could not afford the expense. However, Mrs. Lefkowitz did take over some of the work previously done by the secretary. Petitioner testified that although the records needed to complete the tax returns were inconveniently located in Monticello, New York, he often traveled from Glen Cove to Monticello1980 Tax Ct. Memo LEXIS 268">*286 twice weekly. Additionally, petitioner indicated that the returns were delayed because he and his wife were extremely busy with his law practice and Summer Homes rental business. As we stated in Dustin v. Commissioner,53 T.C. 491">53 T.C. 491, 53 T.C. 491">507 (1969), affd. 467 F.2d 47">467 F.2d 47 (9th Cir. 1972), we expect a taxpayer to exercise "ordinary business care and prudence * * * not [to] take on such a load that he could not fulfill his own legal obligations within the required time." In spite of the facts that petitioners requested extensions of time for filing and that several impediments contributed to petitioners' delay in completing their 1974 and 1975 tax returns, we find as a fact that petitioners' failure to timely file their income tax returns for 1974 and 1975 was not due to reasonable cause. Accordingly, we approve respondent's determination of the addition to tax under section 6651. Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954 as amended and in effect in the years in issue.↩2. Petitioner was of the opinion that his parents did not report the gain realized on this condemnation as taxable since the proceeds were invested in like kind property.↩3. Based on this schedule respondent's counsel at the trial conceded that the adjusted basis of petitioner's parents in the land and depreciable assets of the Bungalow Colony when the property was acquired by petitioners was $102,345.↩4. One of the issues disposed of by agreement of the parties was the depreciation allowance in 1974 and 1975 with respect to improvements made by petitioners after 1968.↩5. Sec. 1.1015-4(a) provides in part: Sec. 1.1015-4 Transfers in part a gift and in part a sale. (a) General rule. Where a transfer of property is in part a sale and in part a gift, the unadjusted basis of the property in the hands of the transferee is the sum of-- (1) Whichever of the following is the greater: (i) The amount paid by the transferee for the property, or (ii) The transferor's adjusted basis for the property at the time of the transfer, and (2) The amount of increase, if any, in basis authorized by section 1015(d) for gift tax paid (see sec. 1.1015-5).Petitioners have not alleged that the gift portion of the transaction was a net gift and that they paid any gift tax on the transfer. Therefore we need not consider whether the unadjusted basis as determined under subparagraph (1) of this regulation should be adjusted for gift tax paid.↩6. Sec. 6651(a)(1) provides: SEC. 6651. FAILURE TO FILE TAX RETURN OR TO PAY TAX. (a) Addition to the Tax.--In case of failure-- (1) to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), subchapter A of chapter 51 (relating to distilled spirits, wines, and beer), or of subchapter A of chapter 52 (relating to tobacco, cigars, cigarettes, and cigarette papers and tubes), or of subchapter A of chapter 53 (relating to machine guns and certain other firearms), on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623108/ | J. D. Loizeaux Lumber Company v. CommissionerJ. D. Loizeaux Lumber Co. v. CommissionerDocket No. 10504.United States Tax Court1947 Tax Ct. Memo LEXIS 182; 6 T.C.M. 738; T.C.M. (RIA) 47177; June 20, 19471947 Tax Ct. Memo LEXIS 182">*182 1. A debt owing to petitioner on note and open account from a trade customer which respondent disallowed as a deduction in 1943, the year in which petitioner recovered a judgment which was returned unsatisfied, held to have become worthless in 1940, in which year petitioner is entitled to the deduction. 2. Petitioner in 1941 sold stock in another corporation through a broker to a cousin of petitioner's treasurer for a nominal amount. Held, petitioner is not entitled to a long-term capital loss deduction on account of the sale of the stock in 1941, where it failed to establish that the stock had not become worthless in a prior year. 3. Both petitioner and its subsidiary corporation kept books and filed income tax returns on an accrual basis. In the period from 1930 through 1941 the subsidiary became indebted to petitioner on a note, open account, and certain mortgages. In 1942 the subsidiary transferred all its assets to petitioner in consideration of the cancellation of its indebtedness to petitioner. Held, that the amount of bad debt deduction to which petitioner is entitled in 1942 in connection with this transaction may not include interest on the note, open account, and mortgages1947 Tax Ct. Memo LEXIS 182">*183 which neither petitioner nor the subsidiary accrued on their books and which petitioner did not report as income in its tax returns. Edward R. Burt, C.P.A., 259 Broadway, New York 7, N. Y., Theodore Pearson, Esq. and William H. Harrar, Esq., for the petitioner. Francis X. Gallagher, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion In this proceeding respondent determined income tax deficiencies for 1940 of $3,637.72; for 1941, $3,280.90, plus a 10 per cent delinquency penalty of $328.09; and for 1942, $18,740.38. He also determined a deficiency in declared value excess profits tax for 1942 in the amount of $41.62. Petitioner claims an overpayment for 1942. The questions presented are: (1) Whether petitioner is entitled to deduct a bad debt loss of $14,515.31 due from one Alexander Milne in any of the years 1939, 1940, 1941, or 1942; (2) whether petitioner is entitled to a loss deduction for 1941, on account of a sale of stock in Rendol Investing Company; (3) whether petitioner is entitled to a bad debt deduction in 1942 as a result of a transaction whereby petitioner acquired all the assets of the Queen City Improvement Company1947 Tax Ct. Memo LEXIS 182">*184 and, if so, in what amount. Findings of Fact Petitioner is a corporation organized in 1903 under the laws of New Jersey with principal office and place of business in Plainfield, New Jersey. Its returns for the taxable years here in question were filed with the collector of internal revenue for the fifth district of New Jersey. Petitioner's books were kept and its tax returns prepared on an accrual basis. Alexander Milne, a building contractor in Plainfield, New Jersey, had been a customer of petitioner for many years. From 1926 to 1930 his purchases amounted to about $300,000, and from 1931 to 1937 they totaled approximately $119,000. During 1937 petitioner's sales to Milne were $10,481.36, and $37,165.10 was collected from him. At the end of the year he owed a balance to petitioner of $14,515.31 for building materials which petitioner had furnished him. This balance was evidenced in part by a promissory note for $10,499.31 and in part by an indebtedness on open account of $4,016. After 1937 he made no further purchases from petitioner, and petitioner made no further collections from him. Most of the petitioner's customers are building contractors. Approximately 75 per cent1947 Tax Ct. Memo LEXIS 182">*185 of petitioner's merchandise is sold to them on credit, and at least 60 per cent of the customers do not have money to pay for the merchandise until it is fabricated into a building and the contractor has been paid for his work. It is common practice in petitioner's business for a contractor's account to remain unpaid for several years and until such time as he gets one good job which enables him to pay off his existing indebtedness. Meanwhile, it is necessary for petitioner to carry his account. On August 16, 1938, a judgment for $2,974.27 was entered by Phoenix Indemnity Company against Milne; and on July 26, 1940, another judgment for $688.92 was entered by Peter McFayden against Milne. Both of these judgments were unpaid as of February 10, 1947. Milne made a renewal note to petitioner on July 16, 1940, payable two months after date, but he failed to pay it at maturity. There was a fairly good resumption of business in the contracting field beginning in 1940, but Milne, who was growing older, did not participate in it. In the latter part of 1942, petitioner placed the claim against Milne in the hands of an attorney for collection, and on March 17, 1943, petitioner recovered1947 Tax Ct. Memo LEXIS 182">*186 judgment for $12,234.84 (on the note only), which judgment was returned unsatisfied in the same year. Petitioner claimed a deduction in the amount of $14,515.31 as a worthless debt in its 1943 return. Respondent disallowed the deduction in that year, and petitioner did not protest his determination. The Alexander Milne debt of $14,515.31 became worthless in 1940. Lester Renninger, a building contractor, was one of petitioner's customers. He owned a number of shares in Rendol Investing Company, the sole business venture of which was the construction and operation of an apartment building in Plainfield, New Jersey. Petitioner furnished lumber for this construction and charged it to the account of Renninger, who was the contractor for the building. In 1926 Renninger was substantially indebted to petitioner on open account, and on October 2, 1926, he transferred to petitioner 50 shares of stock in Rendol. Petitioner credited his account with $5,000. The property of Rendol was encumbered by a first mortgage, which became due in 1931. In 1933 Rendol permitted the mortgagee to collect the rents from the mortgaged property and apply them to taxes, expenses, and mortgage charges. This1947 Tax Ct. Memo LEXIS 182">*187 arrangement continued until November 5, 1943, when foreclosure proceedings were started against Rendol by the holders of the first mortgage. The property was sold in the foreclosure proceedings on or about March 24, 1944. In 1941 petitioner sold 49 shares of its Rendol stock for $46.55 to Mrs. Wilhelmina H. Bradley, a first cousin of petitioner's treasurer. The sale was made through the brokerage house of Orvis & Company. In its tax return for 1941, petitioner claimed the difference between its cost of the 49 Rendol shares, $4,900, and the selling price, $46.55, as a long term capital loss in the amount of $4,853.45. Respondent disallowed the deduction. Queen City Improvement Company was a corporation organized in 1914 under the laws of New Jersey with principal office and place of business in Plainfield. During all the period here pertinent and up to June 30, 1942, petitioner owned all the stock of Queen City. Queen City kept its books and prepared its tax returns on an accrual basis. Prior to January 1, 1930, by transactions not here material, petitioner had lent $100,000 cash to an unaffiliated third party, had received therefor a mortgage in that amount, and had assigned1947 Tax Ct. Memo LEXIS 182">*188 it to Queen City in exchange for Queen City's promissory demand notes aggregating $100,000, bearing interest at six per cent per annum. On January 1, 1931, Queen City gave petitioner a second renewal note for that amount, payable on demand, and bearing interest at six per cent. This note was entered on the books of petitioner as an asset of $100,000 and on the books of Queen City as a liability of the same amount. It remained outstanding continuously until June 30, 1942. At various times petitioner also made advances to Queen City on open account and furnished building material for the maintenance of many Queen City properties, resulting in a substantial open account indebtedness owed by Queen City to petitioner. The books of the petitioner show the following amounts of indebtedness (note and open account combined), exclusive of interest, owed to it by Queen City as of the dates indicated: January 1, 1931$184,590.36January 1, 1932215,992.30January 1, 1933257,916.15January 1, 1934269,695.70January 1, 1935289,591.02January 1, 1936301,049.51January 1, 1937167,857.11January 1, 1938128,782.60January 1, 1939138,207.06January 1, 1940142,969.69January 1, 1941157,857.97June 30, 1942142,943.001947 Tax Ct. Memo LEXIS 182">*189 The books of Queen City show its indebtedness to petitioner on the respective dates in substantially identical amounts. On December 31, 1936, Queen City transferred to petitioner the $100,000 mortgage above referred to, together with other mortgages aggregating $25,000 in principal amount, and petitioner credited its accounts receivable from Queen City with an amount equal to the principal and accrued interest on these mortgages, that is, $133,454.14. This reduction is reflected in the reduced amount of the combined note and open account indebtedness of Queen City to petitioner as of January 1, 1937, as shown in the preceding table. Prior to closing the books of both corporations on December 31, 1930, an entry was made on the books of Queen City accruing $6,000 as a liability for interest to petitioner on the $100,000 note indebtedness and an entry was made on petitioner's books accruing $6,000 as interest receivable on the note. Petitioner treated this accrual as income for 1930, included it in its income tax return for that year, and paid tax thereon. From 1931 through 1941 no accrual of interest on the note was entered on the books of either corporation, no interest was accrued1947 Tax Ct. Memo LEXIS 182">*190 on the books of either corporation on the amounts which Queen City owed to petitioner on open account, and petitioner reported no interest on these items as income in its tax returns for those years. It was petitioner's practice to collect interest from its general trade customers on open account indebtedness at the rate of one-half of one per cent a month on the unpaid balance. Its customers were aware of this practice, and petitioner's form of monthly statement to customers always bore a legend "Subject to interest 30 days from date of purchase." On the average, petitioner collected between $4,000 and $6,000 a year as interest on its accounts receivable. In 1927 petitioner had sold lumber to Watchung Apartments, Inc., a corporation which then owned 410-420 Watchung Avenue and which was erecting an apartment building thereon. As security for uncollected bills, notes, or such other claims against Watchung Apartments, Inc., as might later develop, petitioner held a third mortgage on the property in the amount of $25,000. When the building was completed in 1928, the property was encumbered by four mortgages. On February 20, 1929, 410-420 Watchung Avenue was conveyed by Watchung1947 Tax Ct. Memo LEXIS 182">*191 Apartments, Inc., to Queen City, and the latter assumed and agreed to pay all four mortgages then on the property in amounts as follows: First mortgage to Fidelity Union Trust Company in the amount of $85,500; a second mortgage to R. Henry Depew in the amount of $20,000; the third mortgage to petitioner in the amount of $14,471.25; and a fourth mortgage to Fairfield Manor, Inc., in the amount of $16,500, plus interest of $1,199.59. On February 21, 1929, petitioner purchased the fourth mortgage from Fairfield Manor for a cash payment of $2,500. To prevent the loss of its third and fourth mortgages by a then threatened foreclosure, petitioner made the following cash payments during 1929 to the holders of prior liens: March 6, 1929 -R. L. Lee, Tax Col-lector$ 6,743.19March 6, 1929 -Fidelity Union TrustCompany for inter-est3,847.50March 6, 1929 -Fidelity Union TrustCompany for amor-tization3,000.00Sept. 8, 1929 -Fidelity Union TrustCompany for amor-tization and interest2,737.50Oct. 24, 1929 -Second mortgagee foramortization5,000.00Dec. 2, 1929 -Second mortgagee foramortization and in-terest5,570.84$26,899.031947 Tax Ct. Memo LEXIS 182">*192 By reason of the cash payments made by petitioner, the total due petitioner from Queen City in connection with the mortgages was increased to $59,069.87, that is, the total of the balance due on the third mortgage $14,471.25, the amount due on the fourth mortgage $17,699.59, and the $26,899.03 paid to the holders of the prior encumbrances. Petitioner's total tax basis on these items was $43,870.28. In addition, the mortgages provided for interest at the rate of six per cent, but no interest was ever accrued on the books of either petitioner or Queen City or reported by petitioner as income in its tax returns. Fidelity Union Trust Company foreclosed its first mortgage on 410-420 Watchung Avenue and bought in the property at a sheriff's sale, which was confirmed by the New Jersey Chancery Court on June 15, 1940. Balance sheets of Queen City as of December 31 for the years 1930 through 1938, as reported in its tax returns, show that Queen City's assets exceeded its liabilities, including those to petitioner, by more than $100,000. Most of Queen City's assets consisted of real estate, equities in real estate, and junior mortgages. It lost a large number of these assets by foreclosure1947 Tax Ct. Memo LEXIS 182">*193 after 1939. On June 30, 1942, Queen City transferred all of its assets to petitioner in exchange for petitioner's cancellation of Queen City's indebtedness. The minutes of petitioner and Queen City authorizing this exchange provided that if Queen City's assets should exceed its indebtedness to petitioner, petitioner would surrender stock of Queen City to such extent. The value of the assets thus transferred, less the liability of Queen City assumed by petitioner, was $150,032.09. The facts stipulated by the parties which are not set forth herein are adopted by reference. Opinion ARUNDELL, Judge: The first question relates to the Alexander Milne debt. Petitioner took no deduction on account of this debt until it filed its return for 1943, that being the year in which a judgment against Milne was obtained by it and returned unsatisfied. After respondent audited petitioner's 1943 return and disallowed the debt, the petitioner amended its petition in this proceeding to make claim for deduction of the debt in 1939 (for purposes of an operating loss carry-over to 1940), 1940, 1941, or 1942. On brief, petitioner contends primarily that the proper year for the deduction is 1940. 1947 Tax Ct. Memo LEXIS 182">*194 Respondent's position on this issue is that there has been no proof that the debt had any value after 1937. We think there is sufficient evidence to demonstrate that the debt did not become worthless prior to 1940. It is true that a taxpayer's beliefs are not controlling on an issue of worthlessness, , but a practical approach is called for in determining the question. The mere inability of the debtor to pay at a particular time, which may be only a temporary condition, cannot compel the conclusion that the debt is worthless as of that time. In determining when a business debt becomes worthless, a practical approach requires that some consideration be given to such factors as the nature of the transaction out of which the debt arose, the course of dealings between the parties, the nature of the business of both debtor and creditor, and other similar circumstances. It appears from the evidence that in the years from 1926 through 1937 Milne had purchased and paid for about $400,000 worth of materials from petitioner. Most of petitioner's customers were contractors who could not pay for material purchases until they had completed their1947 Tax Ct. Memo LEXIS 182">*195 buildings and collected from the owners. It was a common practice in petitioner's business to have to carry the accounts of contractors two or three years until they could obtain a profitable construction job and realize moneys with which to pay their indebtedness. In view of these circumstances, we think respondent's position that the Milne debt had no value after 1937 is not well taken. Nor, in our opinion, is the mere entry of one judgment against Milne in 1938 determinative of the worthlessness of the debt as of that time. It could not then be known whether Milne's financial difficulties would be only temporary. In 1940, however, a second judgment was entered against Milne, and he did not pay either judgment in that year. He gave petitioner a renewal note in July 1940 but failed to pay it at maturity. When there was an improvement of business in the contracting field beginning in 1940, Milne was unsuccessful in getting his share and did not participate in the renewed activity. It was then apparent that he had come upon bad times in his own business and was unable to pay any of the claims against him. In our opinion, sufficiently identifiable events occurred in 1940 to establish1947 Tax Ct. Memo LEXIS 182">*196 the complete worthlessness of the Milne debt, and we accordingly hold that petitioner is entitled to deduct it for that year. The second issue concerns the claimed loss on the Rendol Investing Company stock by reason of its sale in 1941. With respect to this transaction, petitioner's treasurer testified that although the stock was sold through a broker to his cousin, the sale was not prearranged and he did not induce his cousin to buy the stock. Nevertheless, the purchase price paid by Mrs. Bradley was so obviously nominal as to suggest, in view of the other circumstances, that the stock may have had no value prior to the sale. It is well settled that if stock has already become worthless, a taxpayer may not postpone deducting his loss by holding the stock until a later year and then selling it for a nominal sum. ; . Respondent disallowed the loss claimed upon the sale. His position is that the stock had already become worthless in an carlier year. In view of the circumstances of the sale and the nominal purchase price, we think it was incumbent upon petitioner to show that1947 Tax Ct. Memo LEXIS 182">*197 the stock had not become worthless in a prior year. This, in our opinion, petitioner has not done. The action of the mortgagee in taking over the rents in 1933 may or may not have been an identifiable event fixing the worthlessness of the Rendol stock as of that time, depending upon circumstances not made to appear in this record. At least petitioner has not shown that it was not such an event. We may not assume, as petitioner would have us do, that the stock had a potential value merely because the mortgagee did not commence foreclosure proceedings until 1943. There is no evidence as to the amount of the mortgage or the value of the assets of Rendol Investing Company at any time. The proof is insufficient to establish even a potential value for the stock as of the beginning of 1941. We therefore hold that respondent did not err in disallowing the loss claimed by reason of the sale in that year. The bad debt issue in connection with the Queen City transaction in 1942 was raised for the first time in the petition and was not as such the subject of a disallowance in the deficiency notice. The right to a deduction was denied in respondent's answer, and the only ground urged on brief1947 Tax Ct. Memo LEXIS 182">*198 by the respondent for disallowing any deduction is that the advances to Queen City were in reality contributions to capital. He cites . There is nothing in the instant record, however, to support a finding such as was made in the American Cigar case that when the advances were made the petitioner believed that the obligations which they created were worthless and uncollectible. On the contrary, the stipulated facts and other evidence show a real and bona fide relationship of debtor and creditor existing between petitioner and Queen City on the $100,000 note, the open account, and the 410-420 Watchung Avenue mortgage indebtedness. It appears that Queen City was wholly solvent at all times from 1930 through 1938, although it lost many of its assets through foreclosure after 1939. If the value of the assets received by petitioner was less than the amount of the debt owing to it from Queen City, petitioner is entitled to a bad debt deduction for the difference. ; . The question as to which the parties more seriously1947 Tax Ct. Memo LEXIS 182">*199 differ on this issue is whether petitioner's basis for the debt includes interest on the note, open account, and mortgages. No interest was ever accrued by either petitioner or Queen City or reported in petitioner's returns on the note, the open account, or the mortgages, with the exception of $6,000 interest on the note which both corporations accrued in 1930 and which petitioner then reported as income. Petitioner contends that interest should have been accrued; and, as a part of its basis for the debt, it makes claim to $135,273.23 as interest due on the note and open account, and $42,530.11 as interest due in connection with the mortgages. It is willing, if we should hold that these items constitute a part of its basis, to pay whatever tax would have been due in the years from 1931 to 1942 if the claimed interest had been included in its gross income in those years. The explanation offered by petitioner for its failure to accrue interest is that in 1931 and 1932 its president and its treasurer, who were in charge of its financial affairs, were ill and away from the business. It is argued that the failure to accrue was due to mistake or oversight. This, however, is hardly a satisfactory1947 Tax Ct. Memo LEXIS 182">*200 explanation of the failure to accrue interest in all of the years from 1933 through 1942. Furthermore, as to interest on the open account, we cannot assume that merely because a practice existed in petitioner's business to charge its general trade customers with interest on their open account, such practice would extend to an open account indebtedness from its own subsidiary. In any event, section 29.23 (k)-2 of Regulations 111 contains the following provision: "Worthless debts arising from unpaid wages, salaries, rents, and similar items of taxable income will not be allowed as a deduction unless the income such items represent has been included in the return of income for the year for which the deduction as a bad debt is sought to be made or for a previous year. * * *" We do not understand petitioner to contend that this regulation is invalid, and we think it is an entirely reasonable one. So far as the claimed interest is concerned, petitioner is here attempting to obtain a deduction for loss of items on which it has no cost, which neither it nor Queen City treated as owing to it, and which it never reported as income. Although there is testimony on behalf of petitioner1947 Tax Ct. Memo LEXIS 182">*201 that it did not waive the right to any interest, we are not convinced on this record that the interest it now claims, more or less as an afterthought, represented a valid indebtedness owing from Queen City to petitioner. Nor are we convinced that the failure to accrue interest was due merely to a mistake or oversight. That petitioner is willing to adjust its tax liability for prior years on account of the claimed interest does not justify treating as capital, at this late date, items which petitioner through all these years never treated as income or took through its income account to capital. Not having taken the claimed interest into income and reported it in its returns, petitioner, under the above regulation, has no basis therefor to deduct as a bad debt. Cf. ; see also (No. 71), and cases there cited. We hold that petitioner's basis for deduction consists of its cost of $43,870.28 in connection with the mortgages, plus the amount of the combined open account and note indebtedness on June 30, 1942, $142,943. It is not clear from the stipulated facts whether this latter item includes the $6,0001947 Tax Ct. Memo LEXIS 182">*202 interest which petitioner accrued and reported for taxation in 1930. If it does not, the basis will be increased by that amount. The difference between the sum of these items and the value of the assets petitioner received, $150,032.09, will be the measure of the bad debt deduction to which it is entitled for 1942. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623110/ | Ancel Greene and Company, Petitioner, v. Commissioner of Internal Revenue, RespondentAncel Greene & Co. v. CommissionerDocket No. 85184United States Tax Court38 T.C. 125; 1962 U.S. Tax Ct. LEXIS 151; April 23, 1962, Filed 1962 U.S. Tax Ct. LEXIS 151">*151 Decision will be entered under Rule 50. Petitioner agreed in contracts entered into with the Federal National Mortgage Association (FNMA) to sell mortgages thereto that FNMA could deduct from the purchase price of the mortgages a certain percentage of the outstanding principal balances thereof and retain such amounts as subscriptions to FNMA's capital stock. FNMA required that anyone from whom it purchased a mortgage enter into such a contract with it. Petitioner was issued a share of FNMA $ 100-par stock for each $ 100 so withheld by FNMA but this stock had a fair market value considerably less than $ 100 per share at the date of its issue to petitioner. Petitioner kept the stock for periods ranging from a few months to over 2 1/2 years and received dividends thereon. Petitioner sold some of the stock. Held:1. Petitioner received payment for its mortgages in cash and stock and the amount includible in its income from receipt of stock is the fair market value of the stock at the date of its issue.2. The stock sold by petitioner was a capital asset with a basis to petitioner of its fair market value at the date it was issued to petitioner. Edith DeBusk, Esq., for the petitioner.Charles 1962 U.S. Tax Ct. LEXIS 151">*152 B. Sklar, Esq., for the respondent. Scott, Judge. SCOTT 38 T.C. 125">*125 OPINION.Respondent determined deficiencies in petitioner's income tax for its fiscal years ended March 31, 1956, 1957, and 1958, in the amounts of $ 1,647.66, $ 643.99, and $ 1,075.06, respectively. For its fiscal years ended March 31, 1956, and March 31, 1957, petitioner claims overpayments in the amounts of $ 595.55 and $ 420.63, respectively.The issues for decision are:(1) Whether any portion of the amounts withheld in the taxable years here involved by the Federal National Mortgage Association from the purchase prices of mortgages sold to it by petitioner and 38 T.C. 125">*126 applied as a subscription to capital stock of that association in accordance with its requirements and its contracts with petitioner is not includible in or is deductible from petitioner's income.(2) Whether the shares of common stock in the Federal National Mortgage Association received by petitioner from that association in accordance with the contracts requiring subscriptions to the stock upon purchase by the association of mortgages were capital assets at the time of petitioner's sale thereof, and if so, the amount of capital gain or loss in the year of sale.All 1962 U.S. Tax Ct. LEXIS 151">*153 of the facts have been stipulated and are found accordingly.Petitioner is and at all times pertinent hereto has been a corporation organized and existing under the laws of the State of Texas with its principal place of business in Waco, Texas. It keeps regular books of account on a cash basis and prepares its Federal income tax returns on the basis of a fiscal year ended March 31. Its returns for the fiscal years ended March 31, 1956, 1957, and 1958, were timely filed with the district director of internal revenue at Austin, Texas.During the years here involved petitioner was at all times engaged in the business of buying, selling, and servicing mortgages on real estate. During these taxable years it sold to the Federal National Mortgage Association (hereinafter referred to as FNMA) mortgages with total unpaid balances of $ 366,227.48, $ 421,237.91, and $ 669,909.94, respectively. The contracts pursuant to which these sales were made provided in part as follows:2. The purchase price shall be an amount equal to -- percent 1 of the outstanding principal balance of the mortgage at the end of the day immediately preceding that of the date of the voucher * * ** * * *4. The Seller shall 1962 U.S. Tax Ct. LEXIS 151">*154 pay to the Purchaser at the time of disbursement, and hereby authorizes the Purchaser at that time to deduct from the amount to be disbursed by reason of the payment of the purchase price, the following:(a) A purchase and marketing fee in the amount of -- percent 1 of the outstanding principal balance of the mortgage at the cut-off time, and(b) A subscription to the capital stock of the Purchaser in the amount of 3% 1 of the outstanding principal balance of the mortgage at the cut-off time.FNMA as presently constituted was created by Act of Congress on July 1, 1948 (ch. 784, sec. 1, 62 Stat. 1207), and rechartered on August 2, 1954 (ch. 649, title II, sec. 201, 68 Stat. 612, 12 U.S.C. sec. 1716), to establish in the Federal Government a secondary market facility for home mortgages. It is authorized to make commitments to purchase and to purchase home mortgages which are insured under the National Housing Act, as amended, or which are guaranteed under the Servicemen's Readjustment Act of 1944, as amended, subject to certain conditions, limitations, and restrictions.38 T.C. 125">*127 One condition of purchase is that the seller of a mortgage to 1962 U.S. Tax Ct. LEXIS 151">*155 FNMA shall "make payments of non-refundable capital contributions" equal to a prescribed percentage of the unpaid principal amounts of the mortgage at the time of purchase. This percentage is determined by FNMA and during the periods here involved was as follows: From November 1, 1954, to August 9, 1956, 3 percent; from August 9, 1956, to September 21, 1956, 2 percent; from September 21, 1956, to January 5, 1957, 1 percent; and from January 5, 1957, to February 3, 1961, 2 percent.On the date of the sale the seller receives in cash the agreed percentage of the balance due on the mortgage less the prescribed percentage allocable to capital contributions and less the cost of Federal documentary tax stamps, which must be affixed when the stock is issued. On the first day of the following month there is issued to the seller common stock of FNMA with a par value of $ 100 per share in an amount equivalent to the total deductions for capital contributions on loans purchased during the preceding month. If such amount is not an even multiple of $ 100, the excess is carried forward and credited to stock to be issued to the seller in subsequent months.There was a market for FNMA stock in the 1962 U.S. Tax Ct. LEXIS 151">*156 years 1955 through 1958 but the market value varied during this period of time from month to month from a low of $ 40.50 to a high of $ 63. During its fiscal years ended March 31, 1956, 1957, and 1958, petitioner's capital contributions to FNMA totaled $ 10,986.82, $ 5,710.02, and $ 12,805.79, respectively, for which it was issued stock having a par value of $ 10,900, $ 5,700, and $ 12,900, respectively. The total market value of such stock computed by using the market price of the various shares of stock during the month in which such shares were issued was $ 5,624.97, $ 2,806.74, and $ 6,960.38 for its fiscal years ended March 31, 1956, 1957, and 1958, respectively. As of March 31, 1958, petitioner had a credit of $ 2.63 as a capital contribution for which stock was unissued as of that date.On April 16, 1957, petitioner sold 100 shares of FNMA stock, of which 56 shares had been held by it for more than 6 months, 49 of such shares having been held for more than 15 months. In January 1958 petitioner sold 50 shares of FNMA stock, of which 17 shares had been held for over 6 months and the remaining shares for less than 6 months. As of March 31, 1958, petitioner owned 145 shares 1962 U.S. Tax Ct. LEXIS 151">*157 of FNMA stock of which 12 shares had been held for 32 months, 40 shares for 29 months, 8 shares for 24 months, 6 shares for 12 months, 18 shares for 11 months, and 22 shares for 10 months. Petitioner received dividends on the FNMA stock held by it.Petitioner was not a dealer in corporate stock during the years here involved and was not otherwise engaged in the trade or business 38 T.C. 125">*128 of buying or selling corporate stock. The FNMA stock which petitioner owned was not held by it for sale to customers in the ordinary course of its business.During its fiscal years ended March 31, 1956 and 1957, and until June 1957, FNMA stock was carried on petitioner's books in an account containing investments in stocks and bonds. In June 1957 the total cost of petitioner's unsold FNMA stock was removed from the general stock and bond account on its books and set up in a separate account therein entitled "Stocks and bonds -- Federal National Mortgage Association."In computing its taxable income on its Federal income tax return for each of the years here involved petitioner deducted as an ordinary and necessary expense of doing business the difference between the amount of its capital contributions to FNMA 1962 U.S. Tax Ct. LEXIS 151">*158 for stock acquisitions during the years and the yearly average market value of an equivalent amount of FNMA stock. The deductions thus arrived at were $ 5,492.20, $ 2,227.85, and $ 4,668.55 for its fiscal years ended March 31, 1956, 1957, and 1958, respectively.Respondent in his notice of deficiency disallowed the claimed adjustments in each of petitioner's fiscal years with the following explanation:(a) It is determined that the payments made by you for common stock of the Federal National Mortgage Association must be capitalized. Since the stock is not an inventory item or an item held by you for sale to customers in the ordinary course of business, it may not be valued at the lower of cost or market but must be valued at cost.It is petitioner's position that the consideration it received upon the sale of its mortgages to FNMA consisted of cash and securities and that, therefore, the income realized by it from each such transaction was the amount of the cash received plus the fair market value of the securities (FNMA stock) received in the year of issue. Petitioner further contends that all the FNMA stock held and disposed of by it was property held for resale and therefore was 1962 U.S. Tax Ct. LEXIS 151">*159 not a capital asset within the meaning of section 1221 of the Internal Revenue Code of 1954, and that the losses resulting from the sale of such stock are ordinary losses deductible in full in computing its taxable income.Respondent takes the position that the contracts between petitioner and FNMA provided for two separate transactions; one, the purchase of the mortgage by FNMA, and two, the capital contributions by petitioner, and that therefore the FNMA capital stock received by petitioner was a capital asset with a cost basis to petitioner of $ 100 per share. Respondent thus argues that the loss upon the sale of the FNMA stock constituted a capital loss represented by the difference in the selling price of the stock and the basis thereof at $ 100 per share.38 T.C. 125">*129 Both parties contend that the legislative history of sections 162 (d) and 1054 of the Internal Revenue Code of 1954 support their positions. The legislative history of these sections is set out and discussed in some detail in our recent decision in McMillan Mortgage Co., 36 T.C. 924">36 T.C. 924 (1961). As noted therein, the House Committee Report (H. Rept. No. 1662, 86th Cong., 2d Sess. (1960), 1960-2 C.B. 816) stated:In making this statutory 1962 U.S. Tax Ct. LEXIS 151">*160 amendment, however, your committee intends no inferences to be drawn as to the tax treatment accorded FNMA stock before the enactment of this provision.Therefore, in this case as in 36 T.C. 924">McMillan Mortgage Co., supra, we draw no conclusions from these amendments.Considering the facts of this case, we conclude as we did in 36 T.C. 924">McMillan Mortgage Co., supra, that petitioner's contracts with FNMA were not severable and that they provided, as petitioner contends, for the receipt by it of cash and stock. Cf. Schumacher Mortgage Co. v.United States, (W.D. Tenn.) 1 an unreported opinion decided May 27, 1960, cited in 36 T.C. 924">McMillan Mortgage Co., supra at 933, wherein the conclusion was reached that the exchange of cash and stock for mortgages under contracts identical to those here involved constituted a single, and inseparable transaction. We hold that petitioner is required to include in income in each of its fiscal years here involved as receipts from mortgages sold to FNMA the cash receipts plus the fair market value of the FNMA stock issued to it at the date of the issue of such stock. The latter amounts are as set forth in our findings, $ 5,624.97, $ 2,806.74, 1962 U.S. Tax Ct. LEXIS 151">*161 and $ 6,960.38 for its fiscal years 1956, 1957, and 1958, respectively.While the facts in the instant case with respect to the requirement of FNMA that the stock be purchased, the provisions of the contracts with respect to the purchase, and the issuance of FNMA stock are identical except as to amounts and dates with those in 36 T.C. 924">McMillan Mortgage Co., supra, and Schumacher Mortgage Co. v.United States, supra, the facts with respect to the carrying of the stock on petitioner's accounts and the holding of the stock differ in the instant case from those involved in the McMillan Mortgage Co. and Schumacher Mortgage Co. cases. In McMillan Mortgage Co., as well as in Schumacher Mortgage Co., the taxpayer involved held the FNMA stock for relatively short periods of time and with no intent to hold such stock as an investment. In the instant case the petitioner held substantial portions of its FNMA stock for periods in excess of a year and a half and at the end of the last fiscal year here involved was still holding some stock which had been held by it over 2 1/2 years. The evidence does not disclose the reason why petitioner held this stock, and because 38 T.C. 125">*130 of failure of proof in this regard, 1962 U.S. Tax Ct. LEXIS 151">*162 we assume against petitioner that this stock was held by it as an investment either for the receipt of the dividends paid to it by FNMA or in hope that the market price of the stock would increase over what it had been at the time petitioner received the stock.In 36 T.C. 924">McMillan Mortgage Co., supra, in holding that the stock held by the taxpayer there involved was not a capital asset within the meaning of section 1221 of the Internal Revenue Code of 1954, we relied on a number of cases in which taxpayers have been required to purchase assets in connection with their business and had immediately disposed of such assets. These cases are distinguishable from the instant case on the same basis as they were distinguished in Gulftex Drug Co., 29 T.C. 118">29 T.C. 118 (1957), affirmed per curiam 261 F.2d 238 (C.A. 5, 1958), wherein we stated:The short holding period in the four cited cases was consistent with the contention that at the time of the purchase and continuing to the time of sale the sole purpose was to acquire whiskey. However, the purpose for which stock is owned and held can change, and the purpose at the time of sale is determinative of the effect of the sale for tax purposes. Carl Marks & Co., 12 T.C. 1196">12 T.C. 1196, 12 T.C. 1196">1202; 1962 U.S. Tax Ct. LEXIS 151">*163 C. E. Mauldin, 16 T.C. 698">16 T.C. 698, 16 T.C. 698">707, affd. 195 F.2d 714; Philber Equipment Corporation, 25 T.C. 88">25 T.C. 88, 25 T.C. 88">92, reversed on other grounds 237 F.2d 129; Arthur E. Wood, 25 T.C. 468">25 T.C. 468, 25 T.C. 468">474.In 29 T.C. 118">Gulftex Drug Co., supra, the stock involved had been purchased at its market price on the date of its purchase for the purpose of taking advantage of the whisky-purchasing privileges attached thereto but had been held for a period of approximately 9 years during which time dividends thereon had been paid and it was sold at the quoted market price on the date of its sale. In the Gulftex Drug case we held that the stock there involved was a capital asset and that the loss on its sale was a capital loss. Although no issue was raised as to the proper computation of the loss on the sale of the stock involved in the Gulftex Drug case, it is apparent from the facts therein that the loss was the difference in the cost of the stock to the taxpayer and its sales price. In the instant case, since the FNMA stock sold by petitioner was received as part of the consideration of the amount paid to petitioner by FNMA for mortgages sold to it, the basis to petitioner is its fair market value at the date of issuance thereof 1962 U.S. Tax Ct. LEXIS 151">*164 to petitioner.We sustain respondent in his contention that the shares of FNMA stock sold by petitioner in 1957 and 1958 were capital assets and hold that the gain or loss upon such sales should be computed by using as the basis of each share of stock sold, the fair market value of such share at the date of its issue to petitioner.Decision will be entered under Rule 50. Footnotes1. The percentage amounts varied from contract to contract.↩1. 5 A.F.T.R.2d (RIA) 1738↩. 60-2 U.S.T.C. par. 9524. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623111/ | STRUTHERS-ZIEGLER COOPERAGE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Struthers-Ziegler Cooperage Co. v. CommissionerDocket No. 32884.United States Board of Tax Appeals18 B.T.A. 537; 1929 BTA LEXIS 2023; December 18, 1929, Promulgated 1929 BTA LEXIS 2023">*2023 A net loss is available to a corporation in an affiliation as a deduction from its income where the said loss was sustained by it. W. W. Smith, Esq., for the petitioner. A. Carnduff, Esq., for the respondent. MORRIS18 B.T.A. 537">*537 This proceeding is for the redetermination of a deficiency in income tax of $2,000.15 for the year 1924. The sole question urged by the petitioner is that the respondent erred in increasing the taxable income of the petitioner for the year 1924 by an amount of $11,998.35 representing its net losses for the years 1922 and 1923. FINDINGS OF FACT. The petitioner is a corporation organized and incorporated under the laws of Michigan and its principal office is in Detroit. The petitioner's agents purchased certain properties in Vicksburg, Miss., in December, 1923, and on January 1, 1924, the Vicksburg Cooperage Co. was incorporated under the laws of the State of Mississippi with an authorized capitalization of $100,000, of which $80,000 par value was issued to the petitioner, its parent company, for properties. An income-tax return was filed for the year 1924, in which the income of the petitioner and its affiliated1929 BTA LEXIS 2023">*2024 company, the Vicksburg 18 B.T.A. 537">*538 Cooperage Co. was consolidated, and the net losses of the parent Company, the petitioner here, for the years 1922 and 1923, aggregating $11,998.35, were applied in reduction of the income of the consolidated group. The respondent disallowed this deduction in the computation of taxable income for 1924. In disallowing the said deduction the respondent says in his deficiency notice: "Net losses of the parent company for 1922 and 1923 may not be applied to reduce the income of the consolidated group, the new group being a separate entity." OPINION. MORRIS: This proceeding was submitted upon the pleadings. Counsel for the respondent urges that the net income of the consolidated group for 1924, of which the petitioner is the parent, can not be reduced by net losses of said parent company sustained during 1922 and 1923 because, as the respondent states in his deficiency letter, the new group is a separate entity. The respondent's counsel cites , and the cases therein cited, as dispositive of the question at issue. In that case we said: 1929 BTA LEXIS 2023">*2025 During 1921, as well as 1922, the Hutt Cattle Co. sustained a net loss in the operation of its business. Such a loss would be available to it under section 204(b) of the Revenue Act of 1921 as a deduction from its income for 1922, . It had no income but a loss for that year. It is urged, however, that the loss in 1921 can be carried over and used as a deduction in 1922 against the income of the affiliated corporations; in substance, that the net loss of the Hutt Cattle Co. for 1921 may serve to reduce the taxable income of the Hutt Contracting Co. in 1922 because these two were affiliated in the later year. This must be denied on the authority of our decisions in ;; ; and . In , where a similar question was considered, involving section 204(b) of the Revenue Act of 1918, which, for our purpose, is no different from the section of the Act1929 BTA LEXIS 2023">*2026 controlling the issue here, we said, after holding that each individual corporation of an affiliated group was a "taxpayer" within the meaning of the statute: We do not believe that it was the intention of Congress to deprive any taxpayer of the benefits afforded by section 204 by the statutory provision relating to consolidated returns. In our opinion there is nothing contained in the statute, either in express terms or by necessary implication, which would deprive a corporation of the benefit of the net loss provision of the statute merely because it was affiliated with another corporation. Since, under the statute, each member of an affiliated group is a "taxpayer" and the relief granted by section 204 is given to "any taxpayer," it is our opinion that an affiliated corporation which suffered a net loss in 1919, 18 B.T.A. 537">*539 prior to the beginning of the period of affiliation, and which net loss exceeded the amount of its net income for 1918, is entitled to deduct the excess of such net loss from its individual net income for 1920, and to that extent the consolidated net income is thus reduced. The instant case is not one where the petitioner is seeking to reduce its own1929 BTA LEXIS 2023">*2027 net income for the taxable year by a net loss of a distinctly different corporation becoming a member of the affiliated group after the loss was sustained. The petitioner is the parent company which sustained the loss for 1922 and 1923. We are, therefore, of the opinion that it is entitled to deduct said net loss to the extent of its individual net income for 1924. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623112/ | DOUGLAS DONOGHUE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDonoghue v. CommissionerDocket No. 5503-76United States Tax CourtT.C. Memo 1977-276; 1977 Tax Ct. Memo LEXIS 170; 36 T.C.M. 1112; T.C.M. (RIA) 770276; August 16, 1977, Filed Douglas Donoghue, pro se. Bernard Mark, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: On August 13, 1976, respondent filed a motion to dismiss the petition in this proceeding for lack of jurisdiction on the ground that the petition was not filed within 90 days after the notice of deficiency was mailed to petitioner, as provided by section 6213(a). 1 On September 22, 1976, the Court received a document from petitioner which was filed as of the date received as petitioner's objection to respondent's motion. A hearing on the motion1977 Tax Ct. Memo LEXIS 170">*171 was held in New York, New York on February 7, 1977. FINDINGS OF FACT On March 18, 1976, a statutory notice of deficiency erroneously dated March 18, 1975, was sent by certified mail to the petitioner at his last known address. On March 25, 1976, the respondent sent petitioner a letter, dated March 25, 1976, advising the petitioner as follows: Dear Mr. Donoghue: On March 18, 1976, a notice of deficiency, Form L-21B or L21, was mailed to you. Please note that the date stamped on the notice of deficiency is March 18, 1975, whereas it was in fact mailed on March 18, 1976. This letter is sent to you to alert you to the correct date and to advise you that the 90 day period (or, if applicable, the 150 day period) stated in that letter, should be computed from March 18, 1976. Petitioner did, in fact, receive both the notice of deficiency and the letter of March 25, 1976. The 90-day period for filing the petition expired on Wednesday, June 16, 1976 (not a legal holiday in the District of Columbia), this period being1977 Tax Ct. Memo LEXIS 170">*172 computed from the date the statutory notice of deficiency was mailed. The petitioner mailed his petition by certified mail to the United States Tax Court on June 17, 1976, as indicated by the stamp on the envelope containing the petition, which was 91 days after the mailing of the notice of deficiency. The petition was filed by the Court on June 18, 1976, 92 days after the notice of deficiency was mailed, and 85 days after the March 25, 1976 letter was mailed. Petitioner was a resident of Montclair, New Jersey at the time the petition in this case was filed. OPINION Section 6213(a) provides that a petition must be filed with the Tax Court within 90 days from the date the statutory notice of deficiency is mailed. Unless such petition is filed or mailed 2 within such 90-day period, this Court does not acquire jurisdiction of the case. ; . An untimely petition must therefore be dismissed for lack of jurisdiction, . The issue for our determination in this case is whether this Court has jurisdiction1977 Tax Ct. Memo LEXIS 170">*173 over a petition admittedly mailed to this Court 91 days after the date the statutory notice of deficiency was mailed to the petitioner. Petitioner received a notice of deficiency with respect to the calendar year 1974 that was mailed by the respondent March 18, 1976. This date of mailing is not in dispute. However, the notice of deficiency was itself erroneously dated March 18, 1975. On March 25, 1976, respondent mailed a letter to petitioner advising him of the error, informing him that the correct date on which the notice of deficiency was mailed was in 1976 not 1975. Respondent's informal letter simply pointed out an error obvious on the face of the notice and reminded petitioner that March 18, 1976 was the proper date from which to compute the 90-day period. Petitioner contends that the date from which the period for filing a petition in this case should be calculated is March 25, 1976, the date the corrective letter was mailed, in which case his petition would be timely filed. Respondent, on the other hand, contends that the corrective letter has no effect upon commencement of the 90-day period during which a petition must be filed with this1977 Tax Ct. Memo LEXIS 170">*174 Court, in which event the petition was untimely. We agree with respondent. In order for petitioner to prevail, he must, at the very least, convince this Court that he was misled by the circumstance of the erroneous date contained on the notice of deficiency and the receipt of the correction letter into believing that he had 90 days beginning March 25, 1976 in which to file a petition with this Court.Cf. ; , revg. an unpublished order of this Court. This he simply has not done. Petitioner stated during the hearing on this motion that he intended to file his petition three months, not 90 days, from the date the statutory notice of deficiency was mailed. The statement is consistent with the explanation contained in petitioner's objection to respondent's motion to dismiss that "my intent was to get it in within 90 days but my laymans [sic] mind had mistakenly translated that into 3 months." In fact, petitioner did mail his petition to this Court within 3 months of the March 18, 1976 date the notice of deficiency was mailed, which, unfortunately1977 Tax Ct. Memo LEXIS 170">*175 for petitioner, was 91 days after March 18, 1976. We find that petitioner's failure to timely file his petition was due to his substitution of 3 months for 90 days. Moreover, the corrective letter in no way resembles a statutory notice of deficiency either in form or content, and it very clearly identifies the date of mailing of the notice of deficiency from which to compute the 90-day period. We conclude, therefore, that petitioner was not misled by any error in the notice nor by the corrective letter. In general, section 6213 and its predecessors were designed to provide taxpayers with the right to elect prepayment judicial review of a proposed deficiency. See H. Rept. No. 179, 68th Cong., 1st Sess. 7, 8 (1924); (concurring opinion). In the instant case, petitioner received actual notice of the proposed deficiency. This notice was more than sufficient to afford petitioner a reasonable opportunity to prepare and file a timely petition with this Court. Under these circumstances, petitioner's failure to satisfy the requirements for access to a prepayment forum deprives us of jurisdiction. While we reach this decision1977 Tax Ct. Memo LEXIS 170">*176 with extreme reluctance, we recognize that the statute we construe and a long line of decisions leave us no other course. Hopefully, Congress will not delay much longer in amending the statute to provide a grace period that will prevent the many taxpayers in petitioner's situation from being deprived of a prepayment hearing by an inadvertent and wholly innocuous error on their part. 3Accordingly, we conclude that the petition filed herein was untimely and that respondent's motion to dismiss for lack of jurisdiction should be granted. An appropriate order will be entered. Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year in question.↩2. See sec. 7502.↩3. See sec. 10(a)(1) of H.R. 13831, 94th Cong., 2d Sess. 11 (1976).↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623113/ | ALFREDO V. YATES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentYates v. CommissionerDocket No. 17093-86.United States Tax CourtT.C. Memo 1988-565; 1988 Tax Ct. Memo LEXIS 594; 56 T.C.M. 844; T.C.M. (RIA) 88565; December 13, 1988. 1988 Tax Ct. Memo LEXIS 594">*594 Held, on the facts, petitioner is not entitled to a theft loss deduction for 1983. Alfredo V. Yates, pro se. Elizabeth P. Flores, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Chief Judge: Respondent determined a deficiency of $ 2,919 in petitioner's income tax for the year 1983. The sole issue for decision is whether petitioner is entitled to a theft loss deduction under section 165. 1FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in New York, New York, at the time his petition herein was filed. In 1983 petitioner worked as a police officer in the personnel division of the New York City Police Department. Petitioner's responsibilities in personnel included interviewing, hiring1988 Tax Ct. Memo LEXIS 594">*596 and correspondence work. In addition to his work as a police officer, petitioner taught self-defense courses at a local YMCA. In 1983 he reported income of $ 30,321 on his income tax return. He also claimed a $ 15,000 theft loss deduction which, after reduction by the statutory formula under section 165(h)(1), resulted in an $ 11,868 deduction. 2 Petitioner alleged that a professional con artist lured him into surrendering $ 15,000 in cash with false promises of profits from overseas investments in natural gas. In an attempt to substantiate his claimed theft loss, petitioner produced savings passbooks and a cancelled check, drawn on an account in petitioner's name. Three of the savings passbooks indicate that on September 19, 1980, petitioner withdrew the following amounts from term accounts and incurred the listed penalties for early withdrawal: BankWithdrawalPenaltyBrooklyn Savings Bank$ 1,186.86$ 87.38Brooklyn Savings Bank1,219.73107.00(acct: "IN TRUST FOR ANTHONY K. YATES")Eastern Savings Bank2,428.15203.90(acct: "ITF ANTHONY YATES (SON)")On October 13, 1980, almost one month after withdrawing1988 Tax Ct. Memo LEXIS 594">*597 the above amounts, petitioner withdrew from one of his bank accounts an additional $ 3,500 by cashing one of his own personal checks made out to "cash" at a Citibank branch in the Bronx. A fourth savings passbook indicates that in the following spring, on May 29, 1981, petitioner withdrew $ 960.38 from a Dollar Savings Bank account reading "In Trust For Derrick Yates" and incurred a penalty of $ 74.69 in so doing. On August 2, 1983, petitioner filed a police report which stated that he had been the victim of grand larceny in the amount of $ 15,000. The police closed the file on petitioner's grand larceny complaint on the same day it was filed. OPINION Petitioner's claimed theft loss is the sole issue in dispute. Petitioner alleges that he was swindled out of $ 15,000, which amount he concludes is deductible as a theft loss under section 165. In opposition, respondent contends that petitioner does not merit a deduction for the alleged theft loss because he has failed to substantiate the loss. We agree with respondent. Respondent's determination in the statutory notice of deficiency is presumptively correct and petitioner bears the burden of proving otherwise. Rule 142(a). 1988 Tax Ct. Memo LEXIS 594">*598 We further note that petitioner bears the burden of proving by a preponderance of the evidence that a theft actually occurred. Rule 142(a). Petitioner has failed to meet this burden. To carry his burden of proof, petitioner must establish the following three elements of theft loss under section 165, 3 namely -- (1) that a theft has occurred under the laws of the jurisdiction wherein the alleged loss took place. Monteleone v. Commissioner,34 T.C. 688">34 T.C. 688, 34 T.C. 688">692 (1960); Muncie v. Commissioner,18 T.C. 849">18 T.C. 849, 18 T.C. 849">851 (1952); (2) the amount of the theft loss. Gerstell v. Commissioner,46 T.C. 161">46 T.C. 161, 46 T.C. 161">175 (1966); section 1.165-8(c), Income Tax Regs.; and (3) the date of discovery of the loss. McKinley v. Commissioner,34 T.C. 59">34 T.C. 59, 34 T.C. 59">63 (1960); section 165(e); section 1.165-8(a), Income Tax Regs.1988 Tax Ct. Memo LEXIS 594">*599 For reasons set out below, the Court does not reach the issue of when petitioner discovered his alleged theft loss in this case. Petitioner must prove that a theft occurred under New York law, as the first leg of his argument under section 165. New York's penal code categorizes the theft alleged by petitioner as larceny by false pretenses. Petitioner's police report specified the alleged crime as grand larceny. Under section 155.35 of N.Y. Penal Law (McKinney 1983), the alleged crime could be categorized as grand larceny in the second degree. However, for purposes of our analysis theft in the form of the lesser offense of larceny by false pretenses will suffice. N.Y. Penal Law section 155.05 (McKinney 1983). The elements of larceny by false pretenses under New York law are: (1) an intent to deprive an owner of property, (2) the making of a false representation, (3) knowledge of the representation's falsity, (4) obtaining the owner's property and (5) inducing the owner to give up his property in reliance upon the false representation. People v. Chaitin,94 A.D.2d 705">94 A.D.2d 705, 462 N.Y.S.2d 61">462 N.Y.S.2d 61 (2d Dept. 1983), affd. 61 N.Y.2d 683">61 N.Y.2d 683, 472 N.Y.S.2d 597">472 N.Y.S.2d 597, 460 N.E.2d 1082">460 N.E.2d 1082 (1984).1988 Tax Ct. Memo LEXIS 594">*600 For purposes of section 165(c)(3), this Court has adopted the broad definition of theft announced by the Fifth Circuit in Edwards v. Bromberg,232 F.2d 107">232 F.2d 107, 232 F.2d 107">111 (5th Cir. 1956), as "covering any criminal appropriation of another's property to the use of the taker, particularly including theft by swindling, false pretenses, and any other form of guile." Paine v. Commissioner,63 T.C. 736">63 T.C. 736, 63 T.C. 736">741 (1975), affd. without published opinion 523 F.2d 1053">523 F.2d 1053 (5th Cir. 1975). Petitioner has failed to persuade us that he was the victim of a theft under any definition. The record is composed of petitioner's testimony, certain of petitioner's savings passbooks, one of petitioner's cancelled checks and petitioner's police report. Neither the savings passbooks nor the cancelled check, made out to cash, are sufficient standing alone to prove to what use petitioner put his funds. Similarly, petitioner's police report merely echoes his testimony. As we have found as a fact, the reported case was filed three years after its alleged discovery and closed by the police department without further action on the same date the report was filed. In our judgment, 1988 Tax Ct. Memo LEXIS 594">*601 petitioner filed the report for the sole purpose of buttressing his tax case and for no other purpose. By failing to produce corroborating evidence of a theft, petitioner has attempted to sustain his burden of proof solely on the basis of his own testimony. Unfortunately for petitioner, his testimony lacks credibility. It is well established that we do not have to accept petitioner's uncontroverted and uncorroborated testimony on its face. We are free to disregard petitioner's testimony based upon contradicting facts, omissions in his testimony, his manner during testimony, his sincerity or lack thereof and inherent improbabilities in his statements. Kean v. Commissioner,51 T.C. 337">51 T.C. 337 (1968), affd. in part, revd. in part on other grounds 469 F.2d 1183">469 F.2d 1183, 469 F.2d 1183">1188 (9th Cir. 1972). Our conclusion that we must discount much of petitioner's testimony is based upon petitioner's evasive, ambiguous and vague portrayal of events. Petitioner's testimony may be outlined as follows: In 1980 petitioner met a professional con man named Dr. Wali Shariff (Shariff) at the YMCA where petitioner taught self-defense. After hearing that Shariff was "an investor in precious1988 Tax Ct. Memo LEXIS 594">*602 metals" and observing Shariff's carriage, conduct and impressive three piece suits, at the YMCA, petitioner came to the conclusion that Shariff was a successful American businessman. Over time, petitioner's confidence in Shariff was established and Shariff informed petitioner "that he [Shariff] was working with various countries in helping to build natural gas." Shariff offered petitioner the opportunity to share in the natural gas boom by earning commissions for securing investors from the V.I.P. area of the YMCA. Petitioner's sales efforts met with no success and he received no commissions. During this time, petitioner inquired about Shariff's reputation at the YMCA. The YMCA beauty salon operator informed petitioner that Shariff was "a good person" who had supposedly handled investments for Muhammad Ali and other professional boxers in the past. Petitioner testified that he did not ask for and was unaware of Shariff's work or home addresses or phone numbers. Petitioner reached Shariff through a telephone answering service and Shariff returned petitioner's calls. In 1980 Shariff showed petitioner documents adorned "with seals and stuff on them, stamps from the United Nations1988 Tax Ct. Memo LEXIS 594">*603 and everything, heads of state and what not." After seeing these documents, petitioner was convinced that Shariff's natural gas deal was legitimate. Shariff invited petitioner "to come down to the United Nations to meet with some heads of state," but petitioner refrained as he reasoned Shariff was "handling that aspect" of investing petitioner's $ 15,000 with "heads of state" at the United Nations. Petitioner testified that in exchange for petitioner's cash Shariff promised a handsome return that "was supposed to be like 50 percent and it was supposed to come, like, maybe within that year or a year." After petitioner gave Shariff the $ 15,000, he testified that he continued to talk with him on the phone. Petitioner would call Shariff's professional answering service "periodically" and Shariff would return petitioner's call. Finally, petitioner told Shariff, "Listen, you are playing me for a fool." Petitioner testified, "But it was unpleasant. I never -- he never called back and after that I left messages on the answering service and he never returned the calls after that. And I never saw him again." Our observation of petitioner's manner in testifying persuades us that he1988 Tax Ct. Memo LEXIS 594">*604 was a man of sophistication and "street savvy" who had benefited from his experience as a police officer in the Bronx, and was not a person easily taken in by a con man over an extensive period of time, as petitioner would have us believe. His testimony does not convince us that petitioner gave his life savings to a complete stranger. Petitioner allowed the alleged crime to go unreported for over a year until, he stated, a woman at an I.R.S. office advised him to file a complaint with the police. Petitioner testified that the reason why he did not file a complaint earlier was that "I was bickering, you know, bickering." With "myself and guys I would ask in the street whether they saw this guy [Shariff], would they see him, you know." We assume that petitioner, as a police officer, was aware of the importance of filing a complaint as soon as he discovered his cash had supposedly vanished with Shariff. We interpret petitioner's testimony to mean that he would in all likelihood never have filed a police complaint unless prompted to do so by someone at the I.R.S. Furthermore, whether or not petitioner was out of pocket for whatever reason, he has failed to prove the amount. The1988 Tax Ct. Memo LEXIS 594">*605 passbooks produced at trial reveal that petitioner withdrew $ 5,795.12 from four savings accounts, three of which were trust accounts for his sons Anthony and Derrick. Petitioner testified that he also borrowed some money from his mother, although he was unable to recall the amount. Petitioner alleges that he then gave the total unspecified amount of bank withdrawals and borrowed cash to Shariff. Petitioner further testified that the only record of this transaction is to be found in the savings passbooks. Petitioner was unable to recall the date, time, place or other details of the transfer of his life savings. On October 13, 1980, petitioner cashed a check for $ 3,500 at a Citibank branch in the Bronx. He testified that Shariff accompanied him to the bank and that he gave Shariff the full $ 3,500, in cash. Although petitioner could neither recall the places at which the alleged cash transfers occurred nor the dates of transfer, he had no difficulty in recalling that his additional cash payments to Shariff equaled the exact amount of $ 5,704.88, which allowed petitioner to arrive at his total claimed theft loss of $ 15,000. Petitioner testified that the reason he paid Shariff1988 Tax Ct. Memo LEXIS 594">*606 in cash and not in check was that he believed payment by check "would have created problems of transferring the money and losses incurred from transfer and that would affect the profits made. And as a result investors would not get as much as they were going to get because of the extra payments they would have to have." We are not persuaded by the logic of this rationalization. We are also troubled by petitioner's inability to explain why he did not request or receive receipts of any type. We believe that as a police officer who daily worked in the personnel division of the police department, he was familiar with records, files, and the customary paperwork associated with this kind of job, and that petitioner recognized the importance and significance of records and receipts. Yet petitioner testified that he gave his life savings to a virtual stranger without asking for a receipt of any type. The only alleged written record of Shariff's existence and petitioner's involvement with him were "three to four post cards" from London, Paris and Sierra Leone advising that Shariff was "just dropping you a line, Al [petitioner]. Business is going well. See you when we get back to1988 Tax Ct. Memo LEXIS 594">*607 New York." Unfortunately, to petitioner's knowledge Shariff never returned from his trip to Sierra Leone, and petitioner threw the post cards into an incinerator after becoming "mad" one day. In conclusion, we hold that petitioner has failed to establish either the amount by which he was allegedly swindled or that the series of events as he has portrayed them actually occurred. Consequently, petitioner is not entitled to the theft loss deduction as claimed, and we so hold. To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to sections of the Internal Revenue Code as in effect during 1983. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. See n.3, infra.↩3. As in effect for 1983, section 165 stated in pertinent part: (a) GENERAL RULE. -- There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. (b) AMOUNT OF DEDUCTION. -- For purposes of subsection (a), the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. (c) LIMITATION ON LOSSES OF INDIVIDUALS. -- In the case of an individual, the deduction under subsection (a) shall be limited to -- * * * (3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. * * * (e) THEFT LOSSES. -- For purposes of subsection (a), any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss. * * * (h) CASUALTY AND THEFT LOSSES. -- (1) GENERAL RULE. -- Any loss of an individual described in subsection (c)(3) shall be allowed for any taxable year only to the extent that -- (A) the amount of loss to such individual arising from each casualty, or from each theft, exceeds $ 100, and (B) the aggregate amount of all such losses sustained by such individual during the taxable year (determined after application of subparagraph (A)) exceeds 10 percent of the adjusted gross income of the individual.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623114/ | ANTHONY ZECCHINI AND ANN ZECCHINI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentZecchini v. CommissionerDocket No. 30995-88.United States Tax CourtT.C. Memo 1992-8; 1992 Tax Ct. Memo LEXIS 16; 63 T.C.M. 1717; T.C.M. (RIA) 92008; January 6, 1992, Filed 1992 Tax Ct. Memo LEXIS 16">*16 Decision will be entered under Rule 155. Michael A. Zimmerman, for petitioners. Scott P. Borsack and Curt M. Rubin, for respondent. GERBER, JudgeGERBERMEMORANDUM FINDINGS OF FACT AND OPINION Respondent, in a notice of deficiency mailed August 31, 1988, determined Federal income tax deficiencies and additions to tax under sections 6653(b)(1)1 and (2) and 6661 for petitioners, as follows: Additions To TaxYearDeficiency1 Sec. 6653(b)(1) Sec. 6653(b)(2)Sec. 666119802 $ 336,0702 $ 168,035----1981277,728138,864----1982244,596122,2983$ 61,1491992 Tax Ct. Memo LEXIS 16">*17 Respondent also agrees that petitioner Ann Zecchini is not liable for any additions to tax under sections 6653(b) or 6653(b)(1) and (2). The parties have stipulated and resolved several issues, and the following issues remain for our consideration: (1) Whether certain payments made to obtain business are ordinary and necessary under section 162(a), and if they are, whether the payments are illegal within the meaning of section 162(c). (2) Whether petitioners are collaterally estopped from denying that said payments are illegal. (3) If deductible, whether petitioners have substantiated certain of said payments claimed on their returns. (4) Whether petitioner Anthony Zecchini is liable for additions to tax for fraud under section 6653(b). (5) Whether petitioners are liable for an addition to tax under section 6661 for their 1982 taxable year. (6) Whether the period for assessment for the 1980 taxable year had expired at the time of the issuance of the notice of deficiency. FINDINGS OF FACT The parties have stipulated facts and exhibits which are incorporated by this reference. Petitioners, who were husband and wife during all pertinent times herein, had their legal residence1992 Tax Ct. Memo LEXIS 16">*18 at Vero Beach, Florida, at the time their petition was filed in this case. Petitioner Anthony Zecchini (petitioner or Zecchini) began working in the financial area in 1966 for Purcell Graham as a clerk and was eventually promoted to a supervisor's position. During 1971, he left Purcell Graham to begin work at F. M. Mayer as a supervisor. Petitioner was eventually promoted to assistant cashier and established a stock loan department for F. M. Mayer. Petitioner received (from F. M. Mayer) commissions on income generated from stock loan activity. During late 1976 and early 1977, F. M. Mayer went out of business and petitioner began his own stock loan business. Petitioner's business was conducted under the name United Securities Service Co. (USSC) during the years in issue. Petitioner's business was to find a broker (lending broker) who would loan certain shares of corporate stock and another broker (borrowing broker) who wished to temporarily borrow the same shares in exchange for the loan of money equivalent to the monetary value of the loaned stock. 2 For arranging the transaction, petitioner would receive an amount equal to the difference in the rate (the call rate) the lending1992 Tax Ct. Memo LEXIS 16">*19 broker was willing to pay and the lesser rate that the borrowing broker agreed to accept for a transaction. As a stock loan finder, petitioner acted as a broker between the lending broker and borrowing broker and neither would be aware of the amount the other paid or offered. The majority of stock loan business was limited to about 100 entities, with about 80 in New York, New York, and 20 located in Chicago, Illinois. During the first few years, petitioner received relatively little business and he had to supplement1992 Tax Ct. Memo LEXIS 16">*20 his income with evening work in an unrelated service job. During 1979, petitioner began making additional payments to secure business through employees of the stock loan departments of various financial products companies. The stock loan department employees were able to negotiate call rates from which petitioner received his commission. The commission was the difference between the call rate of the lender and borrower, both of which were negotiated by petitioner. Petitioner, in turn, would pay a portion of his commission to the stock loan department employee in order to secure the transaction. Petitioner did not know whether the stock loan department employee's employer was aware of or had consented to the receipt by their employee of payments for business from petitioner. In addition to these payments, the stock loan department employees were "wined and dined" and given gifts by the finders. Substantially all (99 percent) of petitioner's business during the years in issue was generated from transactions where the stock loan department employee was paid an amount for the business by petitioner. Petitioner also was able to parlay business by means of reciprocal transactions. 1992 Tax Ct. Memo LEXIS 16">*21 Once he was making payments to various stock loan department employees, petitioner would receive regular amounts of business from the employer's brokerage house. Many brokerage houses had the need to both loan and borrow shares of stock. Petitioner was then able to obtain reciprocal business from other brokerages' stock loan departments. In other words, petitioner would consummate the stock loan transaction and would receive new business in exchange, which, in turn, could be taken to another brokerage house for another reciprocal transaction, and so on. Petitioner explained that a single $ 3 million stock loan transaction could be parlayed into $ 90 million or more of transactions by a good stock loan finder. Petitioner believed that the financial products companies paid the same call rate for the transaction that would have been paid if petitioner had not paid the stock loan department employees. Petitioner deducted the payments made to various stock loan department employees from the gross commissions received in reporting his 1980, 1981, and 1982 Federal income tax. Respondent disallowed the entire amount of said deductions. For the taxable years 1980, 1981, and 1982, 1992 Tax Ct. Memo LEXIS 16">*22 petitioner claimed cost of goods sold of $ 398,867, $ 821,154, and $ 584,104, and respondent disallowed $ 270,682.38, $ 520,663.20, and $ 474,520.69, respectively. The amounts disallowed by respondent are comprised of the following items: AmountsItem1980198119821 Howard Weil $ 95,796.43 $ 383,154.29$ 278,322.10Cash81,150.0087,000.0086,400.00Norman Persick12,350.0014,000.002 Paine Webber 11,500.00James Ingram10,100.00Frank Parlatore500.00Kerry Healy13,000.00Paul Foti22,783.916,000.00Joe Chiffriller300.00Flagship National Bank30,647.00Harry Sharman500.00Miscellaneous expenses57,535.8213,000.0031,500.00Subtotal $ 268,932.25$ 520,438.20$ 446,169.10Amounts conceded bypetitioner $ 1,750.00 225.0028,351.59Total disallowed$ 270,682.25$ 520,663.20$ 474,520.69Twenty thousand dollars of the $ 1992 Tax Ct. Memo LEXIS 16">*23 95,796.43 shown as the Howard Weil part of respondent's 1980 adjustment was incorrectly placed in that category, and the correct amount for the Howard Weil part of respondent's adjustment should be $ 75,796.43. Petitioner, for 1980, 1981, and 1982, had claimed as reductions to income amounts transferred from his business bank account to the Howard Weil brokerage house. The transfers were characterized as stock loan payments. The amounts transferred for 1980, 1981, and 1982 were $ 109,324.27, $ 440,113.45, and $278,322.10, respectively. Of those amounts, $ 75,796.43, $ 383,154.29, and $ 278,322.10 remain in dispute. The transfers were made to an account in the personal names of petitioners and did not constitute stock loan payments, with the exception of amounts attributable to stock purchased on behalf of James Ingram (Ingram). Petitioners deducted these amounts as part of cost of goods sold in the same manner as they had done with respect to amounts paid to or held for stock loan managers. Ingram was a brokerage house employee during 1980 through 1982 and petitioner purchased about $ 225,000 (or about $ 75,000 per year) of securities in his own account for the benefit of Ingram1992 Tax Ct. Memo LEXIS 16">*24 representing a payment to Ingram for directing some of his employer's business activity to petitioner. After petitioner had pled guilty (see discussion infra) and respondent was involved in examining petitioner and attempting to collect tax, about $ 250,000 in securities was turned over to Ingram by the Government. Ingram was then required to convert the securities to cash and to remit the cash to the Government. In addition, Ingram maintained a Paine Webber account in his own name, to which petitioner made a payment or provided securities in the amount of $ 11,500. Also, during 1980 petitioner paid Ingram $ 10,100 by check. During 1982, petitioner wire transferred $ 30,647 to the Flagship National Bank, which Ingram used to purchase a Florida condominium. Beyond the $ 75,000 per year purchased for Ingram, petitioner mischaracterized the remainder of the amounts transferred to his Howard Weil account as reductions from business income. These amounts were for petitioner's personal use. During 1980, 1981, and 1982, petitioner issued checks made payable to cash in the amounts of $ 81,150, $ 87,000, and $ 86,400, respectively. No records were maintained or offered showing1992 Tax Ct. Memo LEXIS 16">*25 that any of the above-referenced cash was paid by petitioner to brokerage house loan managers to secure business. Respondent did not agree that any of the cash payments were made to loan managers in order to obtain business. Petitioner would make certain of the payments for stock loan business in cash. Many times the payments were made at locations remote from the loan managers' place of employment. Petitioner and various stock loan managers intended not to advise the stock loan managers' employers of the payments made in return for stock loan business. During the years 1980, 1981, and 1982, petitioner made cash payments to various loan officers in the amounts of $ 40,750, $ 43,500, and $ 43,200, respectively. The other half of the cash amounts disallowed have not been shown to be identified with specific payees for specific purposes. Petitioner also gave gifts and made payments to or on behalf of Norman Persick, James Ingram, Frank Parlatore, Kerry Healy, Paul Foti, Joe Chiffriller, Harry Sharman and others in connection with his attempts to obtain stock loan business during the taxable years 1980, 1981, and 1982. In connection with stock loan transactions and related activity, 1992 Tax Ct. Memo LEXIS 16">*26 petitioner waived indictment and was charged by an information with three criminal counts, including conspiracy to commit certain acts with various named stock loan department employees in violation of securities, mail, interstate commerce, and tax laws. The information charged petitioner with making the payments (referred to in the information as "kickbacks", "bribes", and "under the table" payments). During 1985 petitioner pled guilty to all three counts and was sentenced to 1 year and 1 day in prison and probation. In pertinent part, the Information contained the following counts and charges: COUNT ONEThe United States Attorney charges: BACKGROUND OF THE CONSPIRACY1. * * * the Depository Trust Company * * * ("DTC") * * * cleared and processed securities transactions for the New York Stock Exchange, the American Stock Exchange, the National Association of Securities Dealers and various broker-dealers and banks. * * * 2. * * * ANTHONY ZECCHINI was the president and owner of United Security Service Company, a stock loan finder * * * 3. * * * At various times relevant to this Information co-conspirators Kerry M. Healy and Norman N. "Woody" Persick controlled1992 Tax Ct. Memo LEXIS 16">*27 the stock loan department at Howard, Weil. * * * 11. * * * co-conspirator Dowdell Carter was the night supervisor in the settlement section of DTC. As the night supervisor, co-conspirator Carter had authority to process various securities transactions through DTC and had control over various accounts at DTC. THE CONSPIRACY12. From in or about December, 1979 to in or about December, 1983, * * * ANTHONY ZECCHINI unlawfully, wilfully, and knowingly did combine, conspire, confederate and agree together with others * * * to commit offenses against the United States, including violations of Title 18, United States Code, Sections 1341, 1343, 1952, and 2314, and Title 15, United States Code, Sections 78j(b) and 78ff, and (b) to defraud the United States of America and the Internal Revenue Service * * * in the ascertainment, evaluation, assessment and collection of income taxes. OBJECTS OF THE CONSPIRACY13. * * * ANTHONY ZECCHINI and his co-conspirators * * * caused[d] certain mail matter to be placed in post offices * * * in violation of Title 18, United States Code, Section 1341. 14. * * * ANTHONY ZECCHINI and his co-conspirators * * * caused[d] to be transmitted by1992 Tax Ct. Memo LEXIS 16">*28 means of wire and radio communications in interstate and foreign commerce, certain writings, signs, signals, pictures and sounds, in violation of Title 18, United States code, Section 1343. 15. * * * ANTHONY ZECCHINI and his co-conspirators * * * traveled in interstate commerce * * * with intent * * * [of] carrying on of an unlawful activity, to wit, commercial bribery, in violation of the laws of New York, Texas and Louisiana, all in violation of Title 18, United States Code, Section 1952. * * * GOALS OF THE CONSPIRACY18. The principal goal of the conspiracy * * * was unlawfully to enrich the defendant ANTHONY ZECCHINI and his co-conspirators, * * * through a series of fraudulent stock loan transactions involving DTC and the various brokerage houses * * *. In particular, the defendant ZECCHINI and his co-conspirators agreed to transact millions of dollars of stock loan business through United Security Service Company in exchange for thousands of dollars of illegal kickbacks and commercial bribes. In addition, the defendant ZECCHINI and his co-conspirators unlawfully and without authorization "borrowed" millions of dollars from DTC and fraudulently embezzled and misappropriated1992 Tax Ct. Memo LEXIS 16">*29 in excess of $ 700,000.00 from DTC and diverted it to ZECCHINI's account at Howard, Weil for their own use and enrichment. MEANS OF THE CONSPIRACY19. * * * (a) In 1977, * * * ZECCHINI established United Security Service Company as a stock loan finder. In the regular course of this business, ZECCHINI would arrange for one broker-dealer or financial institution ("lending broker") to lend stock to another broker-dealer or financial institution ("borrowing broker") in temporary exchange for the monetary value of the stock. The lending broker would further agree to pay a certain interest rate or rebate for the use of the borrowing broker's money. Ordinarily, United Security Service Company would earn its finder's fee for such a transaction through the difference in the rebate rate that the lending broker would agree to pay and the lesser rebate rate that the borrowing broker would agree to accept for such transaction. THE KICKBACK SCHEMES(b) From 1977 until 1979, * * * ZECCHINI was unable to generate substantial stock loan finder's business for United Security Service Company. Many stock loan managers refused to do any business with ZECCHINI unless paid a bribe; still1992 Tax Ct. Memo LEXIS 16">*30 others suggested that ZECCHINI could increase the level of his business by making payments "under the table." Accordingly, in late 1979, ZECCHINI began to offer kickbacks to key stock loan employees at various brokerage firms. Typically, ZECCHINI and the stock loan employee would agree that each month ZECCHINI would secretly withhold a certain percentage of the rebates due and owing to the lending broker. Thereafter, ZECCHINI would surreptitiously pay the employee the agreed upon amount. Between 1979 and 1983, these illegal kickbacks and commercial bribes totalled in excess of $ 500,000.00. * * * The DTC-Viner Frauds(f) Along with a co-conspirator at Edward A. Viner & Co., Inc., and Dowdell Carter, * * * ZECCHINI also participated in a series of fraudulent stock loan transactions involving Viner and DTC. Specifically, ZECCHINI and his co-conspirators caused Viner to borrow large amounts of securities and immediately thereafter to deliver those securities to brokerage firms such as E. F. Hutton and Shearson American Express that had not in fact agreed to accept those securities. Abusing his position as night supervisor at DTC, * * * Carter, with the aid of other co-conspirators, 1992 Tax Ct. Memo LEXIS 16">*31 would and did fraudulently trick, coerce and convince these brokerage firms to "park" these securities overnight. As part of these bogus stock loan transactions, these brokerage firms would transfer millions of dollars to Viner for its overnight use without collecting a rebate or ordinary interest payment. (g) Eventually various victim brokerage firms declined to accept these unauthorized stock deliveries or upon discovering the "mistaken" deliveries would in fact attempt to collect a rebate. Thereupon, * * * [Zecchini and others] fraudulently arranged to deliver securities from Viner to dormant and closed accounts at DTC in exchange for millions of dollars that Viner was not entitled to receive. By timing these fraudulent transactions for Thursdays and by misdirecting the securities within DTC, ZECCHINI and his co-conspirators thus repeatedly obtained the use of DTC's monies for periods ranging from one to four days. (h) Having fraudulently arranged temporary control of money belonging to other brokerage firms or DTC, * * * ZECCHINI and others] would then arrange for Viner to earn substantial profits in the form of rebates on still other stock loan transactions. Because Viner1992 Tax Ct. Memo LEXIS 16">*32 was collecting rebates without having to pay interest on the fraudulently obtained monies, these illicit profits totalled thousands of dollars. In order to distribute these illegal profits, the co-conspirator at Viner arranged for payments of "finder's fees" from Viner to United Security Service Company. ZECCHINI, in turn, kicked back substantial portions of these "finder's fees" in cash to the co-conspirator at Viner and Dowdell Carter. The DTC Embezzlement Scheme(i) In addition, * * * [ZECCHINI and others] misappropriated and stole substantial sums of money from DTC for their own use and enrichment. * * * (j) Either shortly before or after the monies were purloined from DTC, substantially similar sums were wire transferred from the * * * ZECCHINI's account at Howard, Weil to his account in Brooklyn, New York. Subsequently, ZECCHINI distributed prearranged percentages of the stolen monies to co-conspirators Carter, Healy and Persick. In the end, ZECCHINI directly received more than $ 365,000.00 or approximately half of the embezzled DTC funds. * * * COUNT TWO* * * 21. On or about April 15, 1982, * * * ZECCHINI did * * * knowingly attempt to evade and defeat1992 Tax Ct. Memo LEXIS 16">*33 a large part of the income tax due and owing by him to the United States of America for the calendar year 1981 by filing and causing to be filed with the United States Internal Revenue Service a false and fraudulent income tax return on behalf of himself and his wife, wherein he stated that their taxable income for the 1981 calendar year was $ 55,246.00 and that the amount of tax due and owing thereon was $ 18,728.00, whereas, as ZECCHINI then and there well knew, their true taxable income was substantially greater, to wit, approximately $ 411,412.79, and further that their true income tax due and owing to the United States was in the approximate amount of $ 253,125.04. (Title 26, United States Code, section 7201) COUNT THREE* * * 22. On or about April 15, 1983, * * * ZECCHINI did * * * knowingly attempt to evade and defeat a large part of the income tax due and owing by him to the United States of America for the calendar year 1982 by filing and causing to be filed with the United States Internal Revenue Service a false and fraudulent income tax return on behalf of himself and his wife, wherein he stated that their taxable income for the 1982 calendar year was $ 56,220.001992 Tax Ct. Memo LEXIS 16">*34 and that the amount of tax due and owing thereon was $ 18,518.00, whereas, as ZECCHINI then and there well knew, their true taxable income was substantially greater, to wit, approximately $ 331,542.10, and further that their true income tax due and owing to the United States was in the approximate amount of $ 155,696.05.(Title 26, United States Code, Section 7201) New York State commercial bribery laws (N.Y. Penal Law sec. 180.00 (McKinney 1988)) are generally enforced. OPINION We first consider whether the payments made by petitioner to or on behalf of various stock loan managers were ordinary and necessary within the meaning of section 162(a). Petitioner bears the burden of proof on this issue. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933). If we find that the payments were ordinary and necessary, we then must consider whether the payments are "illegal" within the meaning of section 162(c). Respondent bears the burden of proof on this issue. Secs. 162(c)(2), 7454. In connection with the question of the legality of the payments, respondent contends that petitioner is estopped from denying the illegality of the payments because he had 1992 Tax Ct. Memo LEXIS 16">*35 pled guilty to charges containing allegations that said payments were illegal. Issue 1. Were the Payments Ordinary and Necessary?Under section 162(a) deductions are allowed for "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". The determination of whether an expense is ordinary or necessary is a question of fact to be decided based on all relevant facts and circumstances, with emphasis on specific facts concerning the type of business and the manner in which a taxpayer engaged in said business. Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467 (1943). "Ordinary" means usual and customary in the industry. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488 (1940); Frederick Steel Co. v. Commissioner, 42 T.C. 13">42 T.C. 13 (1964), revd. on other grounds 375 F.2d 351">375 F.2d 351 (6th Cir. 1967). More specifically, the term "ordinary" has been defined to primarily be a function of whether an expenditure is currently deductible or capital in nature. Commissioner v. Tellier, 383 U.S. 687">383 U.S. 687, 383 U.S. 687">689 (1966); Brizell v. Commissioner, 93 T.C. 151">93 T.C. 151, 93 T.C. 151">159 (1989). 1992 Tax Ct. Memo LEXIS 16">*36 The term "necessary" has been defined, in the context of section 162, to mean "'appropriate and helpful' for 'the development of the taxpayer's business'". 383 U.S. 687">Commissioner v. Tellier, supra at 689 (quoting 290 U.S. 111">Welch v. Helvering supra at 113); 93 T.C. 151">Brizell v. Commissioner, supra at 160. We find that the payments made to or on behalf of stock loan managers by petitioner were both ordinary and necessary within the meaning of section 162(a). The testimony of petitioner and several of the stock loan managers, to whom petitioner made payments for business, was that the payments directly affected the amount of business that petitioner received. Although there was some testimony that stock loan transactions occurred without additional payment to the stock loan managers, it was a regular practice for the managers to receive part of the stock loan finder's commission during the years under consideration. Moreover, stock loan transactions occur within a relatively small business community in two cities. The witnesses who testified in this case, including petitioner, represent a sizable portion of those who were involved in stock 1992 Tax Ct. Memo LEXIS 16">*37 loan transactions during the years in issue and they were aware of the practices in other brokerage firms. It is also clear from the record that petitioner's business success was directly and proportionately related to the payments to stock loan managers. Issue 2. Were the Payments Illegal?Section 162(c)(2)3 provides that certain illegal payments, which would otherwise be deductible under section 162(a), are not deductible. The burden of proving that a payment is an illegal payment within the meaning of section 162(c) is on respondent "to the same extent as he bears the burden of proof under section 7454". Sec. 162(c)(2). Accordingly, respondent must prove by clear and convincing evidence that the payments were illegal under section 162(c)(2). 93 T.C. 151">Brizell v. Commissioner, supra at 161; sec. 1.162-18(b)(4), Income Tax Regs.1992 Tax Ct. Memo LEXIS 16">*38 In an effort to meet his burden of proof, respondent argues that the payments made to managers constituted bribery under New York law. Respondent further contends that petitioner is collaterally estopped to deny that the payments constitute bribery because of his conviction based upon charges in an Information. In addition and/or in the alternative, respondent contends that he has shown the payments in the record to be in violation of New York law. Collateral Estoppel - We address the collateral estoppel issue first because the underlying principal of collateral estoppel was intended to preempt a second adjudication of the same issue. Under the doctrine of res judicata, or claim preclusion, a judgment on the merits in a prior suit bars a second suit which involves the same parties or their privies and is based on the same cause of action. On the other hand, under the doctrine of collateral estoppel, or issue preclusion, the judgment in the prior suit precludes, in the second cause of action, litigation of issues actually litigated and necessary to the outcome of the first action. Parklane Hosiery Co. v. Shore, 439 U.S. 322">439 U.S. 322, 439 U.S. 322">326 (1979). Collateral estoppel1992 Tax Ct. Memo LEXIS 16">*39 applies to issues of fact or law previously litigated, even though the claims may differ. Meier v. Commissioner, 91 T.C. 273">91 T.C. 273, 91 T.C. 273">286 (1988). In Montana v. United States, 440 U.S. 147">440 U.S. 147 (1979), the Supreme Court refined the Parklane parameters for use of collateral estoppel. In Montana the Court used a three-prong test: First, whether the issues presented in the subsequent litigation are in substance the same as those in the first case; second, whether controlling facts or legal principles have changed significantly since the first judgment; and third, whether other special circumstances warrant an exception to the normal rules of preclusion. 440 U.S. 147">Montana v. United States, supra at 155. See 91 T.C. 273">Meier v. Commissioner, supra at 282-286; Estate of Best v. Commissioner, 76 T.C. 122">76 T.C. 122, 76 T.C. 122">134 (1981). Here, respondent attempts to affirmatively estop petitioner from denying that he bribed various stock loan managers based upon petitioner's guilty plea to a three-count indictment. Petitioner counters that his plea of guilty is not equivalent to a "full and fair opportunity" to litigate the1992 Tax Ct. Memo LEXIS 16">*40 earlier case, citing Allen v. McCurry, 449 U.S. 90">449 U.S. 90, 449 U.S. 90">95 (1980). Petitioner also argues that his plea of guilty was to conspiracy under 18 U.S.C. section 371, and to violations of section 7201. Petitioner goes on to argue that the underlying allegations in the indictment concerning 18 U.S.C. section 1952 were not the focus of the indictment and plea of guilty, and accordingly, should not result in an estoppel on those aspects of the indictment and conviction. The fact that petitioner's conviction of the criminal charges resulted from his plea of guilty rather than a trial on the merits does not obviate the potential for collateral estoppel as to those matters underlying the conviction. Arctic Ice Cream Co. v. Commissioner, 43 T.C. 68">43 T.C. 68 (1964). A guilty plea is a conviction which is as conclusive as a jury's verdict, and it enables the court to render judgment and impose its sentence upon the defendant. Kercheval v. United States, 274 U.S. 220">274 U.S. 220, 274 U.S. 220">223 (1927). More specifically, a guilty plea to a conspiracy charge has been held to be sufficient to employ the doctrine of collateral estoppel with respect to the underlying charges1992 Tax Ct. Memo LEXIS 16">*41 upon which the conspiracy was founded. See, for example, DeCavalcante v. Commissioner, 620 F.2d 23">620 F.2d 23 (3d Cir. 1980), affg. Barrasso v. Commissioner, T.C. Memo. 1978-432; Keogh v. Commissioner, T.C. Memo. 1975-197. In this case petitioner was charged with conspiring to violate 18 U.S.C. sections 1341, 1343, 1952, and 2314, and 15 U.S.C. sections 78j(b) and 78ff. The principal goal of the conspiracy was described as enrichment through a series of fraudulent stock loan transactions and in particular the transaction of millions of dollars of stock loan business by petitioner "in exchange for thousands of dollars of illegal kickbacks and commercial bribes." Paragraph 15 of the Information charged that petitioner and his coconspirators carried on "an unlawful activity, to wit, commercial bribery, in violation of the laws of New York, Texas and Louisiana, all in violation of Title 18 U.S.C. sec. 1952." At the presentment of the Information, petitioner acknowledged all three charges and unconditionally reaffirmed his plea of guilty. At the sentencing, petitioner's counsel acknowledged that petitioner had made kickbacks and that1992 Tax Ct. Memo LEXIS 16">*42 it was illegal, and petitioner acknowledged his counsel's statements and that he had nothing to add to them. Although the specific instances and amounts are delineated in the Information, petitioner was not charged with bribery or paying kickbacks in a specific amount. Accordingly, petitioner is estopped to deny that his payments to stock loan managers amounted to bribery under State law, but he is not estopped from denying the amounts that respondent has determined. Petitioner also attempts to mitigate the effect of the bribery charge by arguing that the circumstances under which he paid kickbacks to stock loan managers constituted extortion by the stock loan managers, rather than bribery by petitioner. If petitioner can show that the payment was in response to extortion on the part of the stock loan managers, then the payment would not be considered illegal within the meaning of section 162(c). Petitioner is correct that extortion is a defense to commercial bribery. See People v. Dioguardi, 168 N.E.2d 683">168 N.E.2d 683, 168 N.E.2d 683">692 (N.Y. 1960); Hornstein v. Paramount Pictures, Inc., 37 N.Y.S.2d 404">37 N.Y.S.2d 404, 37 N.Y.S.2d 404">412-413 (N.Y. Sup. Ct. 1942), affd. 41 N.Y.S.2d 210">41 N.Y.S.2d 210 (1943),1992 Tax Ct. Memo LEXIS 16">*43 affd. 55 N.E.2d 740">55 N.E.2d 740 (1944). Under New York statutes extortion includes obtaining property by compelling or inducing another person to deliver property by means of instilling fear. See N.Y. Penal Law sec. 155.05 (McKinney 1988). An express threat is not necessary and a threat may consist of innuendo or suggestion. People v. Dioguardi, 168 N.E.2d 683">168 N.E.2d at 689. We note that petitioner pled guilty to charges of conspiracy which, in part, involved bribes and kickbacks paid to stock loan managers. In the same Information in which petitioner was charged, the stock loan managers were named as coconspirators and no charges of extortion were made regarding them. More importantly, the record in this case reflects that petitioner and other stock loan managers were aware that payments were being made by finders to obtain stock loan business. The stock loan community consisted of relatively small numbers of participants in two cities, and stock loan managers were aware of this industry practice. The regular aspect of this practice is, in part, one of the elements we considered in reaching our conclusion that the payments in question were ordinary and necessary1992 Tax Ct. Memo LEXIS 16">*44 within the meaning of section 162(a). In the setting of this case, this question is a "chicken and egg" controversy and each side would argue that the other initiated or promoted the payment to avoid criminal charges. The charges here were cast in terms of kickbacks and bribes and are not of the type that should be classified as having been compelled by fear or a threat of any kind. If a finder wanted to obtain stock loan business from certain stock loan managers, he had to share his commission or fee. Additionally, there was trading of stock loan transactions between finders and stock loan managers and mutuality among participants in the stock loan community. Accordingly, we hold that petitioner was not a victim of extortion, but that he bribed others to generate business. Petitioner also raises the point that some of the payments were made to people in Texas and Louisiana, in addition to payments in New York. Petitioner argues that respondent has not shown that these were in violation of local law. Respondent counters that petitioner operated out of New York and that New York law applies to those acts in which some part of the offense took place in another jurisdiction, 1992 Tax Ct. Memo LEXIS 16">*45 so long as the other jurisdiction punishes the same criminal conduct. See N.Y. Crim. Proc. Law sec. 20.30(1) (McKinney 1981). Commercial bribery is illegal in New York. N.Y. Penal Law sec. 180.00 (McKinney 1988). Commercial bribery is also illegal in Louisiana and Texas. See La. Rev. Stat. Ann. sec. 14:73 (West 1986); Tex. Penal Code Ann. sec. 32.43(c) (West 1991). Accordingly, we agree with respondent that petitioner's actions constituted bribery in New York, even where part of the activity occurred in Texas or Louisiana. Having decided that petitioner's payments were illegal within the meaning of local law, we must decide whether respondent has met his burden of showing that section 162(c) applies. Through affirmative use of collateral estoppel, respondent has shown that the payments made by petitioner constituted commercial bribery which is a criminal offense in New York and other States where a portion of the transactions occurred. Under section 162(c)(2), however, respondent is also required to show, in addition to the violation of a criminal penal statute, that the statute in question is "generally enforced". Respondent, to satisfy his burden, offered as a witness a1992 Tax Ct. Memo LEXIS 16">*46 chief attorney in the fraud bureau of the office of the district attorney of New York. The witness testified that N.Y. Penal Law section 180.00 (McKinney 1988) is generally enforced and specific examples of its enforcement were referenced. See Greater Display & Wire Forming, Inc. v. Commissioner, T.C. Memo. 1988-231. Section 1.162-18(b)(3), Income Tax Regs., defines a criminal statute as being "generally enforced unless it is never enforced or the only persons normally charged with violations thereof in the State * * * enacting the law are infamous or those whose violations are extraordinarily flagrant." Respondent's witness answered questions which reflecting that N.Y. Penal Law section 180.00 (McKinney 1988) is generally enforced. Petitioner questioned respondent's witness about the size of the staff enforcing the statute in question and about the aggressiveness of the district attorney's office's attempts to detect violations. In this regard, absence of an aggressive policy of detection of violations of a criminal statute is not fatal to the question of whether the statute is generally enforced, when other factors explain any lack of a prosecutorial record. 1992 Tax Ct. Memo LEXIS 16">*47 Boucher v. Commissioner, 77 T.C. 214">77 T.C. 214, 77 T.C. 214">219 (1981), affd. 693 F.2d 98">693 F.2d 98 (9th Cir. 1982). Although questioning by petitioner's attorney tended to show that the number of prosecutions and staff available to seek out violations was relatively small, the evidence shows that there have been prosecutions and they were not only enforced against the infamous or where the violations were extraordinarily flagrant. Accordingly, we hold that respondent has carried his burden of showing that petitioner's payments were illegal payments within the meaning of section 162(c)(2) and are not deductible. Our holding that payments to stock loan managers in this case are not deductible under section 162(c)(2) obviates the need to decide whether petitioner has substantiated any such payments not agreed to by respondent. We accordingly proceed to decide whether petitioners are liable for any of the additions to tax determined by respondent. We first consider whether petitioners are liable for sections 6653(b) and 6653(b)(1) and (2) additions to tax. If any part of any underpayment for the taxable years is due to fraud, the addition under section 6653(b) will apply, 1992 Tax Ct. Memo LEXIS 16">*48 not only to the underpayment attributable to fraud, but to the entire underpayment. Fraud must be proved by clear and convincing evidence. Sec. 7454; Rule 142(b). The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Mensik v. Commissioner, 328 F.2d 147">328 F.2d 147 (7th Cir. 1964), affg. 37 T.C. 703">37 T.C. 703 (1962); Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). Fraud is never presumed, but rather must be established by some independent evidence. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85 (1970). Fraud may be proven by circumstantial evidence and reasonable inferences drawn from the facts because direct proof of the taxpayer's intent is rarely available. Spies v. United States, 317 U.S. 492">317 U.S. 492 (1943); Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983); Stephenson v. Commissioner, 79 T.C. 995">79 T.C. 995 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984). The taxpayer's entire course of conduct may establish the requisite fraudulent intent. 80 T.C. 1111">Rowlee v. Commissioner, supra;1992 Tax Ct. Memo LEXIS 16">*49 Stone v. Commissioner, 56 T.C. 213">56 T.C. 213 (1971). Respondent aruges that petitioner is estopped from denying that he filed fraudulent returns for the taxable years 1981 and 1982. We agree. Petitioner's unconditional guilty plea to violations of section 7201 with respect to his 1981 and 1982 taxable years is sufficient to establish that his returns were fraudulent for those taxable years. Allen v. McCurry, 449 U.S. 90">449 U.S. 90, 449 U.S. 90">95 n.6 (1980); Manzoli v. Commissioner, 904 F.2d 101">904 F.2d 101, 904 F.2d 101">105 (1st Cir. 1990); Fontneau v. Commissioner, 654 F.2d 8">654 F.2d 8, 654 F.2d 8">10 (1st Cir. 1981). It is well established that "The constituent elements of criminal tax evasion and of civil tax fraud are identical." Hicks v. Commissioner, 470 F.2d 87">470 F.2d 87, 470 F.2d 87">90 (1st Cir. 1972). We conclude, therefore, that petitioner fraudulently intended to evade Federal income tax for his 1981 and 1982 taxable years. The question that remains is whether respondent has carried his burden of proving fraud for petitioners' 1980 taxable year, a year for which petitioner is not estopped to deny the fraud determination. Respondent argues that the evidence in the1992 Tax Ct. Memo LEXIS 16">*50 record establishes fraud for 1980. In this regard, respondent relies upon eight separate transactions during 1980 wherein petitioner had transferred a total of $ 95,796.43 to his personal brokerage account and claimed these amounts as part of his cost of goods sold. Respondent also argues that the criminal conviction for 1981 and 1982 is evidence of fraud for 1980, showing intent or state of mind through subsequent "bad acts". Finally, respondent argues that petitioner maintained false and misleading books and records. The evidence in this record reflects that petitioner claimed additions to his personal stock brokerage account as part of his cost of goods sold, even though only a part of the accretions to that account represented amounts held on behalf of stock loan managers as payments in exchange for business. We note that $ 20,000 of the $ 95,796.43 amount for 1980 has been found to be attributable to one of the stock loan managers. Claiming false deductions has been considered an indicia of fraud. Estate of Temple v. Commissioner, 67 T.C. 143">67 T.C. 143, 67 T.C. 143">161 (1976); Hicks v. Commissioner, 56 T.C. 982">56 T.C. 982, 56 T.C. 982">1019 (1971), affd. 470 F.2d 87">470 F.2d 87 (1st Cir. 1972);1992 Tax Ct. Memo LEXIS 16">*51 Neaderland v. Commissioner, 52 T.C. 532">52 T.C. 532 (1969), affd. 424 F.2d 639">424 F.2d 639 (2d Cir. 1970). The $ 20,000 claim, as part of cost of goods sold, has a different probative value for purposes of the fraud issue. To the extent that petitioner claimed deductions for amounts paid or held for the benefit of stock loan managers, it would be more difficult to reach the conclusion that those claims resulted in fraudulent understatements of income. Any amounts petitioner claimed as part of cost of goods sold which he knew were actually personal funds more likely represent the type of false deductions which could form the foundation for a fraudulent understatement. The $ 75,796.43 deducted for 1980 represented 19 percent of the $ 398,867 cost of goods sold claimed for 1980. That is a significant amount and would tend to mitigate any claim that the amount deducted was an honest error. We note that petitioner did not offer thorough or effective reconciliation of his claimed cost of goods sold. Instead he relied on his testimony that cash amounts were paid, without providing specific amounts. If specific amounts and payees had been provided, they could have been1992 Tax Ct. Memo LEXIS 16">*52 verified or disproved through several of the stock loan managers who testified at trial. Petitioner's actions here, including dealing extensively in cash, making bribes and kickbacks, causing his tax return preparer to report the $ 75,796.43 as a deduction when it clearly was not are indicia of fraud and taken together support a finding of fraud here. Finally, respondent argues that the section 7201 conviction for the subsequent 2 years should be considered in support of a finding of fraud because it tends to prove intent or state of mind through a pattern of conduct established by subsequent acts or events and failure to report substantial amounts over a number of years. Although it is clear that we cannot find fraud for 1980 based upon petitioner's guilty plea for 1981 and 1982, our finding with respect to 1981 and 1982 may be considered to show a pattern, intent, and/or state of mind. Failure to report substantial amounts of income over a number of years has been used to show fraudulent intent. Vannaman v. Commissioner, 54 T.C. 1011">54 T.C. 1011 (1970); Rogers v. Commissioner, 111 F.2d 987">111 F.2d 987, 111 F.2d 987">989 (6th Cir. 1940), affg. 38 B.T.A. 16">38 B.T.A. 16 (1938).1992 Tax Ct. Memo LEXIS 16">*53 The same would be true of the overstatement of deductions. Moreover, evidence of prior or subsequent bad acts is relevant to prove intent or state of mind where prior or subsequent acts are part of a pattern. United States v. King, 768 F.2d 586">768 F.2d 586, 768 F.2d 586">587-588 (4th Cir. 1985); United States v. Hadaway, 681 F.2d 214">681 F.2d 214, 681 F.2d 214">217 (4th Cir. 1982). Sufficient evidence of pattern and practice are present in this case and we have taken it into account in finding fraud for petitioner's 1980 taxable year. Accordingly, we hold that petitioner is liable for an addition to tax under section 6653(b) for his 1980 taxable year. We also hold that, due to estoppel, petitioner is liable for additions to tax under section 6653(b) for his 1981 taxable year and under section 6653(b)(1) and (2) for his 1982 taxable year. Our holding that petitioner's 1980, 1981, and 1982 tax returns were fraudulent within the meaning of section 6653(b) resolves any question concerning the period of limitations for assessment because those periods would not expire in accord with section 6501(c)(1). Petitioner claimed travel and entertainment deductions for the taxable years 1980, 1981, 1992 Tax Ct. Memo LEXIS 16">*54 and 1982, and respondent disallowed said deductions in the amounts of $ 2,053, $ 22,528, and $ 12,048, respectively. By means of the parties' stipulation, petitioners conceded (as being personal rather than business expenses) $ 3,866 and $ 2,029 of the amounts respondent disallowed for 1981 and 1982, respectively. At trial, petitioner testified concerning amounts the parties stipulated were paid to various credit card companies. Although petitioner stated that such amounts were for business travel and entertainment, no records were produced showing the specific amount of each expense, the time and place of the expenditure, the business purpose of the expense, and the business relationship of the person for whom the expenditure was made. Section 274(d) requires records reflecting the above information in order for petitioner to be entitled to a deduction. Although we are convinced that petitioner must have incurred travel and entertainment expenditures, we are unable to allow any amount unless petitioner meets the record-keeping requirements of section 274 -- which he has failed to do. Accordingly, we hold that petitioner is not entitled to any travel and entertainment deductions1992 Tax Ct. Memo LEXIS 16">*55 in excess of the amount allowed by respondent. Finally, respondent determined that petitioners are liable for an addition to tax under section 6661 for their 1982 taxable year. Section 6661, as amended by section 8002(a) of the Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509, 100 Stat. 1874, 1951, provides for a 25-percent addition where there is a substantial understatement of income tax. A substantial understatement is one that exceeds 10 percent of the tax required to be shown for a taxable year. Petitioners reported an $ 18,518 tax liability for 1982 and our holding here will result in an understatement far in excess of the 10-percent threshold of section 6661. Petitioners, on brief, argued that the section 6661 addition does not apply because "it has not been established by the respondent that there is a substantial understatement of income tax for 1982." No other argument was offered by petitioners and, that being the case, we hold that the section 6661 addition to tax is applicable with respect to petitioners' 1982 taxable year. To reflect the foregoing, Decision1992 Tax Ct. Memo LEXIS 16">*56 will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩1. For the taxable years 1980 and 1981, sec. 6653(b) only is effective. For the 1982 taxable year, secs. 6653(b)(1) and (2) and 6661↩ are effective. 2. Respondent admits to a mathematical error concerning the 1980 income tax deficiency and addition to tax, reducing those amounts in controversy to $ 159,032 and $ 79,516, respectively. ↩3. 50 percent of the interest due on $ 138,836.↩2. For example, Firm A may need to cover a short position attributable to a short sale or because of the need to deliver shares to a customer. Firm B may be willing to loan the shares to Firm A. Firm B receives cash from Firm A in exchange for the loaned shares. At the end of the loan period, Firm A receives equivalent shares in exchange for the return of the cash from Firm B. In addition, Firm B pays a "call rate" (which at one particular time was 1-1/2 points under prime) for the use of the money.↩1. Howard, Weil, Labouisse, Friedrichs, Inc. (Howard Weil). ↩2. Paine, Webber, Jackson, Curtis, Inc. (Paine Webber).↩3. Sec. 162(c)(2), in pertinent part, provides: OTHER ILLEGAL PAYMENTS. -- No deduction shall be allowed under subsection (a) for any payment * * * made, directly or indirectly, to any person, if the payment constitutes an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty * * *. For purposes of this paragraph, a kickback includes a payment in consideration of the referral of a client, patient, or customer. * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623116/ | JULES KLEBANOFF, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKlebanoff v. CommissionerDocket No. 127-71.United States Tax CourtT.C. Memo 1973-174; 1973 Tax Ct. Memo LEXIS 113; 32 T.C.M. 832; T.C.M. (RIA) 73174; August 7, 1973, Filed Mortimer Todel, for the petitioner. Larry Kars, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: The respondent determined deficiencies in income tax and additions to the tax to1973 Tax Ct. Memo LEXIS 113">*114 be due from 2 the petitioner as follows: Additions to the Tax Docket No.YearDeficiency in Income TaxSec. 6653(b) 1Sec. 6654(a) 127-711960$7,670.96$4,234.82127-71196110,098.345,540.49127-71196215,474.887,737.44$426.98127-71196314,518.667,970.01By amendment to answer duly filed, in the alternative to the addition to the tax for fraud under sec. 6653(b), respondent has pleaded the additions to the tax for delinquency and negligence under sections 6651(a) and 6653(a), respectively, as follows: Additions to the Tax yearSec. 6651(a)Sec. 6653(a) 1960$1,917.74$ 383.5519612,524.59504.9219623,868.72773.7419633,729.67725.93 3 Petitioner failed to introduce any evidence or testimony with respect to the addition to the tax under section 6654(a) determined to be due for the year 1962. Accordingly, he will be deemed to have conceded the propriety of that adjustment. Accordingly, those issues remaining for decision are as follows: (1) Whether petitioner substantiated1973 Tax Ct. Memo LEXIS 113">*115 claimed deductions for expenses incurred in his business in excess of the amounts previously allowed by respondent in each of the years 1960 to 1963, inclusive. (2) Whether any part of any underpayment of the tax required to be shown on petitioner's returns for the years 1960 to 1963, inclusive, was due to fraud within the meaning of section 6653(b). (3) In the alternative to the addition to the tax for fraud, whether petitioner is liable for the additions to the tax for delinquency and negligence under sections 6651(a) and 6653(a), respectively. 4 FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. The petitioner, Jules Klebanoff (hereinafter referred to as "petitioner" or "Klebanoff") is an individual whose legal residence at the time the petition herein was filed was in New York, New York. Petitioner filed delinquent Federal income tax returns for the years 1960 to 1963, inclusive, with the district director of internal revenue, Manhattan, New York, on October 10, 1967. Petitioner is a broadly educated individual who was well aware of his obligation to file1973 Tax Ct. Memo LEXIS 113">*116 Federal income tax returns. 2 He spent one year in the business school of the University of Illinois; attended the University of Pennsylvania, followed by a tour of duty with the 5 U.S. Army; attended Associated College where he accumulated enough credits to be accepted at Brooklyn Law School where he remained for two years; and thereafter attended the Graduate School of Writing in Mexico for two years. During each of the years in question, Klebanoff operated a moving and storage business as a sole proprietorship doing business as Budget Movers. Petitioner maintained no office other than his apartment for the conduct of his business. No books or records of his business income or expenses were maintained by petitioner. In addition to his moving business, during the year 1962 Klebanoff was the superintendent of an apartment building in New York City. On April 12, 1967, an information was filed with1973 Tax Ct. Memo LEXIS 113">*117 the United States District Court, Southern Judicial District of New York charging petitioner with four counts of willfully failing to file income tax returns for the years 1960 to 1963, inclusive. On July 25, 1967, petitioner pleaded guilty to two counts of the four-count information, pertaining to the years 1962 and 1963. 6 On Schedule C of each of the delinquent returns filed for the years 1960 to 1963, inclusive, petitioner states on the line provided for gross receipts, "As indicated per Federal indictment." The same amounts specified as his gross income in the aforementioned information for each of the respective years was reported as gross receipts on such schedules. The gross income figures contained in the information were reconstructed by the respondent on the basis of checks deposited to petitioner's bank account maintained under the name "Budget Movers" at the Manufacturers Hanover Bank. Such amounts included no receipts of cash not deposited to petitioner's checking account. Petitioner admitted that he had cash business receipts that were not deposited to said account and that some checks received were cashed rather than being deposited. Also on each Schedule1973 Tax Ct. Memo LEXIS 113">*118 C, petitioner reported a net profit of "10% [of gross receipts] estimated by taxpayer," with the explanation that "taxpayer has only fragmentary or no records, therefore net profit is estimated (estimate based on profit % of other individuals in same business)." 7 Petitioner's reported gross receipts, estimated business expenses, and reported net profit for the years in question are as follows: YearGross ReceiptsExpensesNet Profit 1960$50,887.68$45,798.89$ 5,088.77196159,620.4653,658.415,962.05196274,648.2167,183.497,464.82196376,285.7868,657.207,628.58From an examination of petitioner's cancelled checks for the year 1960, the respondent determined that petitioner incurred business expenses in that year aggregating approximately 47 percent of gross receipts. A deduction from gross receipts was accordingly allowed in the amount of $24,081.29 for 1960. In the years 1961, 1962, and 1963, for which no checks or other documentation was available to respondent, similar allowances were made in the amounts of $27,803.73, $34,970.14 and $35,530.26, respectively. Petitioner contests the disallowance of the amounts by1973 Tax Ct. Memo LEXIS 113">*119 which his claimed expenses exceed the deductions permitted by respondent. 8 OPINIONDuring the years 1960 to 1963, inclusive, petitioner was in the business of household moving and storage. As he testified, his business was operated "out of pocket." No books or records of his gross receipts or expenses were maintained and the only evidence from which such amounts could be reconstructed were the records of his checking account, which were not introduced at the trial.From this scant record, on the basis of his testimony, petitioner asks this Court to find that his expenses equaled 90 percent of his gross receipts in each of the years in question. We decline.Section 162(a) allows as a deduction "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Since the burden of proof is on the petitioner, it is incumbent upon him to first show that such expenses were "paid or incurred" before an inquiry into the 9 amount of the deduction need be made. Rule 32, Tax Court Rules of Practice; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).In the present case, based upon an examination of Klebanoff's cancelled1973 Tax Ct. Memo LEXIS 113">*120 checks for the one year they were available, respondent determined that an amount equal to 47 percent of petitioner's gross receipts was allowable as a deduction. A similar percentage was allowed in each of the following years, for which no such documentation is available. Petitioner did not establish that any greater amounts were expended in his business. The determination of the respondent must be sustained. SeeRobert Neaderland, 52 T.C. 532">52 T.C. 532 (1969), affd. 424 F.2d 639 (C.A. 2, 1970), certiorari denied 400 U.S. 827">400 U.S. 827 (1970).With respect to the issue of fraud, the burden of proof is upon the respondent to show fraud through clear and convincing evidence. Section 7454(a); Kreps v. Commissioner, 351 F.2d 1 (C.A. 2, 1965); affirming 42 T.C. 660">42 T.C. 660 (1964). Fraud must usually be gleaned from the conduct 10 of the taxpayer and the circumstances in question. M. Rea Gano, 19 B.T.A. 518">19 B.T.A. 518 (1930). Willful failure to file required returns is a circumstance to be considered, but without more does not of itself establish the element of fraud. Stoltzfus v. United States, 398 F.2d 1002 (C.A. 3, 1968); 1973 Tax Ct. Memo LEXIS 113">*121 Cirillo v. Commissioner, 314 F.2d 478 (C.A. 3, 1963). In order to impose the penalty for fraud the circumstances surrounding the failure to file returns must strongly and unequivocally indicate an intention to avoid the payment of taxes. Cirillo v. Commissioner, supra.From an examination of the whole of petitioner's conduct, this Court is convinced that such an intention was present.Petitioner was a well educated individual who was well aware of his responsibility for the payment of his lawful taxes. Notwithstanding this knowledge, petitioner consistently ignored his obligation to file income tax returns and to keep adequate records of his business. In addition, he conducted much of his business in cash and admittedly received some gross receipts in cash. Those cash amounts were not included in the gross receipts 11 reported by petitioner on his returns, where he used the same gross receipts figures as developed by respondent for purposes of the criminal information. It is obvious from an examination of those returns and from petitioner's testimony that in filing such returns, even after he had pleaded guilty to two counts of the information, petitioner's1973 Tax Ct. Memo LEXIS 113">*122 concern for accuracy was minimal.Petitioner has also failed to offer any satisfactory explanation of his failure to file the required returns, as might tend to mitigate against such failure. Cf. Jones v. Commissioner, 259 F.2d 300 (C.A. 5, 1958). Despite an obligue reference to personal and business problems during the course of his testimony, petitioner has provided this Court with no specifics thereof in justification of his failure.The foregoing factors lead us to the inescapable conclusion that petitioner's failure to file was part and parcel of his intention to avoid the payment of the tax he knew to be due the Government. His actions 12 indicate an intent to pay tax only if and when the agents of the respondent caught up with him. The imposition of the penalty provided for under section 6653(b) is sustained. Having reached this conclusion, it follows that the petitioner is not liable for the additions to tax under sections 6651(a) and 6653(a).In accordance with the foregoing,Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended. ↩2. Petitioner admitted that he had previously failed to file returns for 1955 and 1956. While it does not appear in the record whether he was criminally prosecuted for such failure, Klebanoff testified that the matter was "taken care of" and that the taxes had been paid. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623117/ | Albert W. Rockwood v. Commissioner.Albert W. Rockwood v. CommissionerDocket No. 20272.United States Tax Court1951 Tax Ct. Memo LEXIS 327; 10 T.C.M. 150; T.C.M. (RIA) 51047; February 13, 19511951 Tax Ct. Memo LEXIS 327">*327 Benjamin C. Perkins, Esq., 22 Beacon St., Boston 8, Mass., for the petitioner. Leo C. Duersten, Esq., for the respondent. RAUMMemorandum Findings of Fact and Opinion Respondent determined a deficiency in income and victory taxes for the year 1943 in the amount of $967.25. The only question in issue is whether the Commissioner erred in ruling that Section 107 (a) of the Internal Revenue Code was inapplicable to a payment of $15,000 received by petitioner in 1942. The year 1942 is involved in the computation of petitioner's taxes for 1943 by reason of the forgiveness feature of the Current Tax Payment Act of 1943. Findings of Fact The facts are covered in part by a stipulation which is hereby adopted. Petitioner is a lawyer who resides and practices in Massachusetts. He filed his individual income tax returns on the cash basis for the calendar years 1942 and 1943 with the collector of internal revenue for the district of Massachusetts. On April 7, 1938, petitioner was appointed General Counsel of the New River Company, a corporation, and on December 7, 1938, its board of directors voted that petitioner be paid a retainer of $250 a month1951 Tax Ct. Memo LEXIS 327">*328 from April 1, 1938, such retainer to cover the usual and ordinary business of the corporation to come before him, with the understanding that if any unusual services were required, extra compensation was to be paid. On April 4, 1939, the board of directors increased the retainer to $6,000 a year from April 1, 1939, payable in installments of $500 a month, with a similar understanding that extra compensation would be paid for such special work or unusual services as might be required from time to time. Petitioner's employment as General Counsel was not on a full-time basis and he was free to handle legal matters for other clients which he did, but he put the New River Company's business first because of the retainer. He continued as General Counsel until April 1940, and did not handle the usual and ordinary legal business of the company after April 13, 1940, when his retainer ceased. His total compensation for services covered by the retainer during the period that he was General Counsel, April 1, 1938, to April 13, 1940, was $9,000. At various times while he was General Counsel, petitioner undertook to handle six separate legal matters on behalf of the New River Company, not covered1951 Tax Ct. Memo LEXIS 327">*329 by the retainer. Some of those special matters required his services after he ceased to be General Counsel. He did not do all of the New River Company's legal work when he was General Counsel and other attorneys were employed by the company in various other matters. Each of the six separate matters referred to above involved services covering a period of less than thirty-six calendar months, although the services for all six matters, taken in the aggregate, covered a period in excess of thirty-six calendar months. The first such matter was undertaken on July 26, 1938, and the last one to be closed was completed on November 14, 1941. After various efforts to arrive at an understanding with respect to petitioner's compensation for the special services, he, on June 2, 1942, submitted six separately itemized bills, each dated June 1, 1942, for an aggregate of $37,500. On September 24, 1942, the New River Company paid petitioner $15,000 which he accepted as full payment for all of the special services. The six matters involving the special services were as follows: (a) For the period from July 26, 1938, to December 18, 1939, petitioner performed a total of 70 hours of services in1951 Tax Ct. Memo LEXIS 327">*330 connection with a $75,000 loan from the White Oak Coal Company (a subsidiary of the New River Company) to the Fellenz Coal & Dock Co. for construction of a new coal handling and distributing plant at Milwaukee, Wisconsin. The June 1, 1942, bill which petitioner submitted for these services was in the amount of $1,750. (b) For the period from January 19, 1939, to September 30, 1940, petitioner performed 9 1/2 full days plus 108 additional hours of service either to the New River Company or its wholly owned subsidiary, the Mt. Carbon Company, in seeking to make available for river transportation of coal certain property located at Mr. Carbon, West Virginia, and in seeking the establishment of a freight rate that would render such river transportation economically feasible. The June 1, 1942, bill which petitioner submitted for these services was in the amount of $3,750. (c) For the period from March 27, 1939, to October 20, 1939, petitioner rendered a total of 55 hours of service in connection with an option from the Rowland Land Company to the New River Company involving a lease of certain property. The June 1, 1942, bill which petitioner submitted for these services was in the amount1951 Tax Ct. Memo LEXIS 327">*331 of $1,000. (d) For the period from June 28, 1939, to January 15, 1941, petitioner rendered a total of 23 3/4 full days, plus 575 additional hours of service in connection with certain Federal income and excess profits tax liabilities of the New River Company for the years 1933 to 1938, inclusive. The June 1, 1942, bill which petitioner submitted for these services was in the amount of $20,000. (e) For the period from October 31, 1939, to November 14, 1941, petitioner rendered a total of 2 1/2 full days plus 246 1/4 additional hours of service in connection with Federal unjust enrichment taxes for the years 1935 and 1936. The June 1, 1942, bill which petitioner submitted for these services was in the amount of $3,500. (f) For the period from November 15, 1939, to April 16, 1940, petitioner rendered a total of 19 1/4 full days plus 145 3/4 additional hours of service in connection with the purchase of certain coal properties and other assets from the estate of William Scott McKell. The June 1, 1942, bill which petitioner submitted for these services was in the amount of $7,500. During the period from April 7, 1938, to March 28, 1940, petitioner was a member of the board of directors1951 Tax Ct. Memo LEXIS 327">*332 of the New River Company. Opinion RAUM, Judge: Petitioner seeks the benefit of Section 107 (a) of the Internal Revenue Code1 with respect to the $15,000 which he received in 1942. Respondent, on the other hand urges that the 80 per cent condition of Section 107 (a) has not been met since petitioner's total compensation for the period involved must include the $9,000 retainer received prior to 1942 as well as the $15,000 fees for special services received in 1942, with the result that the total compensation involved is $24,000, of which the $15,000 constitutes less than 80 per cent. 1951 Tax Ct. Memo LEXIS 327">*333 We think that petitioner is not entitled to the benefit of Section 107 (a) His position requires that the six special matters be regarded as a unit, which was distinct from his general services. It is true that each of the six special matters had certain distinctive elements. But if we were to consider them as a unit growing out of single contract of employment, that contract in this case could only be the one establishing the basic attorney-client relationship which governed the rendition of general services and also provided for extra compensation in connection with any special or additional matters that might be referred to him. Accordingly, the unifying factor that would justify treating the six special matters as a single group would likewise require that the related services based upon the retainer be considered together with the others in determining the "total compensation" within Section 107 (a). Cf. J. Mackay Spears, 7 T.C. 1271">7 T.C. 1271, affirmed, 164 Fed. (2d) 486 (C.A. 3); Harry Civiletti, 3 T.C. 1274">3 T.C. 1274, affirmed, 152 Fed. (2d) 332 (C.A. 2), certiorari denied, 327 U.S. 804">327 U.S. 804; Paul H. Smart, 4 T.C. 846">4 T.C. 846,1951 Tax Ct. Memo LEXIS 327">*334 affirmed, 152 Fed. (2d) 333 (C.A. 2), certiorari denied, 327 U.S. 804">327 U.S. 804; Ralph E. Lum, 12 T.C. 375">12 T.C. 375; William J. Morrison, Jr., 12 T.C. 709">12 T.C. 709. And when they are considered together, the requirement that at least 80 per cent of the total compensation be received in one taxable year has not been satisfied. However, even if the special services be regarded as unconnected with petitioner's regular services, he is not entitled to prevail. For, to the extent that the six matters are regarded as separable from the petitioner's regular employment, they are equally separable and distinct from one another. Accordingly, since the services with respect to each matter did not cover a period of at least thirty-six months, Section 107 (a) would be inapplicable. Decision will be entered for the respondent. Footnotes1. SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY. (a) Personal Services. - If at least 80 per centum of the total compensation for personal services covering a period of thirty-six calendar months or more (from the beginning to the completion of such services) is received or accrued in one taxable year by an individual or a partnership, the tax attributable to any part thereof which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date of such receipt or accrual.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623119/ | FRANK DIAZ AND AMPARO R. DIAZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDiaz v. CommissionerDocket No. 1931-83.United States Tax CourtT.C. Memo 1986-98; 1986 Tax Ct. Memo LEXIS 510; 51 T.C.M. 594; T.C.M. (RIA) 86098; March 13, 1986. Jorge Rodriguez-Chomat, for the petitioners. Paul M. Naponick and Kenneth A. Hochman, for the respondent. JACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Tax YearDeficiencySec. 6653(a) 11978$7,845$8261979137This controversy1986 Tax Ct. Memo LEXIS 510">*511 concerns the amount of petitioner-husband's basis in the stock of United Atlantic Investment, Inc. on the date he sold it in 1978. Petitioner-husband claims that his basis in the stock was $25,000; whereas, respondent contends that the basis was $500. Respondent also asserts that petitioners are liable for an addition to tax for an underpayment of income tax due to negligence or intentional disregard of the rules and regulations for 1978. 2FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated by this reference. Frank and Amparo R. Diaz, husband and wife, resided in Coral Gables, Florida, at the time they filed the petition in this case. Amparo R. Diaz is a party solely by virtue of having filed a joint return with her husband for 1978 and 1979. Hereinafter Frank Diaz will be referred to as petitioner. Petitioner is an accountant, conducting his accounting practice under the name Diaz and Associates. He was also the sole1986 Tax Ct. Memo LEXIS 510">*512 stockholder and president of United Atlantic Investment, Inc. (UAI), a Florida corporation, from June 2, 1975, the date of its incorporation, until May 8, 1978, the date on which he sold all of his stock in UAI. UAI's initial capitalization was $500. Over the years, petitioner lent UAI approximately one hundred and twenty thousand dollars ($120,000). UAI reports its income on a fiscal year ending June 30. UAI's books and records are maintained by Diaz and Associates which also prepares UAI's tax returns. In reviewing UAI's tax return for the year ended June 30, 1977, petitioner observed that UAI's stated capital was $500. In January, 1978, he sent a written note to Raquel Rodriquez, an employee of Diaz and Associates and his sister-in-law, directing her to instruct the accountant in charge of the UAI account to reclassify $24,500 from the "loans from stockholder" account to the "capital stock" account. During February or March, 1978, UAI distributed $100,000 to petitioner, leaving UAI with less than $25,000 in tangible assets. On May 8, 1978, petitioner sold all his UAI stock for $125,000. Petitioners reported $100,000 as the gain realized from the stock sale; the gain1986 Tax Ct. Memo LEXIS 510">*513 reflected an adjusted basis of $25,000 in the UAI stock. Respondent contends that petitioner's basis in the UAI stock was $500; therefore, respondent alleges that petitioners' gain was $124,500. ULTIMATE FINDINGS OF FACT Petitioner's basis in the UAI stock was $25,000. OPINION This case hinges on whether there was a transfer of $24,500 from UAI's "loans from stockholder" account to the "capital stock" account prior to petitioner's sale of his UAI stock in May, 1978. Section 1012 provides that the basis of property shall be its cost. When incorporating a business, a stockholder has the prerogative, within constraints not relevant here, to denominate the amounts he advances to the corporation as either debt or equity, or some combination thereof. . In general, any subsequent transfer from debt to equity on the corporation's books increases the stockholder's basis in his stock. Sec. 1016(a)(1). We find that the transfer of funds from the loan account to the capital account occurred prior to the time petitioner sold his stock on May 8, 1978. The burden of proving that the transfer occurred prior to1986 Tax Ct. Memo LEXIS 510">*514 the sale is on petitioners. Rule 142(a). We found the testimony of petitioner and Raquel Rodriquez to be entirely credible and convincing. We believe that petitioner instructed the accountant in charge of UAI's books and records to reclassify $24,500 from debt to equity in January, 1978, and that these charges were made in compliance with petitioner's wishes prior to the sale of his stock in May, 1978. Accordingly, we hold that petitioner's basis in the stock sold on May 8, 1978 was $25,000 and that the realized gain on the sale was $100,000. To reflect the previously agreed adjustments, 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 tax years in issue.↩2. Petitioners previously agreed to certain adjustments for 1978 and 1979 and there is no dispute as to the additions to tax with respect to these adjustments.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4623154/ | Leonard J. Erickson v. Commissioner.Erickson v. CommissionerDocket No. 54828.United States Tax CourtT.C. Memo 1956-256; 1956 Tax Ct. Memo LEXIS 36; 15 T.C.M. (CCH) 1338; T.C.M. (RIA) 56256; November 19, 1956*36 Harry L. Brown, Esq., and Louis Herman, Esq., 149 Broadway, New York, N. Y., for the petitioner. Theodore E. Davis, Esq., for the respondent. RAUMMemorandum Findings of Fact and Opinion Respondent has determined a deficiency in petitioner's income tax for the calendar year 1949 in the amount of $6,157.42. The sole issue is whether a certain payment to petitioner by a corporation constituted the partial repayment of a loan as contended by petitioner, or a taxable dividend, as determined by respondent. Findings of Fact Petitioner is an individual residing at 1120 Park Avenue, New York City. His individual income tax return for the calendar year 1949 was filed with the then collector of internal revenue for the third district of New York. In 1945 Walter Reade, Sr., now deceased, approached petitioner and his brother Frank Erickson (hereinafter sometimes called "Frank") with respect to possible acquisition of a parcel of improved real property (hereinafter called the "property") located at 487-495 Park Avenue, in New York City. The owner of the property, Central Savings Bank in the City of New York (hereinafter called "Central"), had previously acquired it by*37 foreclosure. Walter Reade, Sr., indicated that the property could be purchased for about $600,000. He was of the opinion that after reconversion of the premises into a first-class motion picture theater, offices and stores, it would represent a sound investment. Petitioner agreed to take a 12 1/2 per cent interest in the venture, and Frank an interest of 37 1/2 per cent, the remaining 50 per cent being controlled by Walter Reade, Sr. A contract was executed requiring Walter Reade, Sr., to purchase the property from Central, and the purchase was in fact consummated on October 19, 1945. The improvements on that date consisted of a five-story office building. Title was taken in Walter Reade, Sr.'s name alone, but it was understood that petitioner and Frank were to have the aforementioned respective interests therein. Walter Reade, Sr., also planned to give a 25 per cent interest to each of his two children, Suzzanne Gage and Walter Reade, Jr., thus disposing of his one-half. The parties planned to form a corporation to take over the property, in which the Reade interests and the Erickson interests would each receive 50 per cent of the capital stock. The purchase price of the property*38 was $625,000. $150,000 was paid by check and the balance by a ten-year 3 1/2 per cent purchase money mortgage. In addition, closing expenses were incurred in the amount of $7,126.16. Walter Reade, Sr., and the Ericksons each paid one-half of the cash outlay of $157,126.16. The portion contributed by the Ericksons was paid by their nominee, Frank W. Watson (hereinafter sometimes called "Watson"). In this manner, petitioner paid $19,640.77 and Frank paid $58,922.31. In all transactions herein Watson acted solely as nominee for petitioner and Frank. Park Avenue - 59th Street Corp. (hereinafter sometimes called the "corporation") was organized on January 7, 1946, under the laws of the State of New York for the sole purpose of taking title to and operating the property. Capital stock of a stated value of $100 per share was issued as follows: James W. Watson50 sharesWalter Reade, Jr.25 sharesSuzzanne Gage25 shares No further certificates of capital stock were ever issued. Payment for the foregoing stock was noted by a debit to the loans payable accounts of Watson and Walter Reade, Jr. The stock in the name of Walter Reade, Jr., is unqualifiedly owned by him*39 as his property, and is under his sole control. It does not appear whether that of his sister is held by her under the same circumstances. Walter Reade, Jr., has continuously been president of the corporation since its inception. He was 29 years of age on October 30, 1946. Suzzanne Gage is Walter Reade, Sr.'s daughter and the wife of Edwin Gage, who has at all times been secretary of the corporation. She was 27 years of age on October 30, 1946. Her husband's age at that time was 31. Watson is Frank's son-in-law, and has been treasurer of the corporation ever since it was formed. On October 30, 1946, he was 26 years of age. The property was transferred to the corporation on October 30, 1946. The lapse of time between the formation of the corporation and the foregoing transfer was the result of difficulty encountered in obtaining a theater license. Litigation in Walter Reade, Sr.'s name, as owner, had been commenced against the appropriate official for the purpose of obtaining such license. The license was acquired, and the property was then transferred to the corporation. Prior to December 31, 1945, additional cash in the amount of $100,000 was advanced for use in alteration of*40 the building. Walter Reade, Sr., advanced $50,000 thereof and the Ericksons, through Watson, advanced the remaining $50,000, $37,500 by Frank and $12,500 by petitioner. Between January 1, 1946 andoctober 30, 1946, further advances were made for the same purpose in the total amount of $603,292.54. $206,855.62 of this latter amount was advanced by Walter Reade, Sr., $297,327.69 by Frank and $99,109.23 by petitioner. Prior to October 30, 1946, $28,500 had been paid on the purchase money mortgage. $15,614.97 thereof represented the payment of interest due and the remainder constituted amortization payments. On October 30, 1946, the property plus various other assets, subject to certain liabilities, was conveyed by Walter Reade, Sr. to the corporation. The following entries were made on the books of the corporation to reflect this transaction: November 1, 1946Dr.Cr.Cash in bank$ 45,533.88Petty Cash75.00Accounts Receivable - Park Ave. Theatre Ltd.3,175.47Building632,126.16Improvements: General Contracting$189,258.15Plastering46,649.40Plumbing53,862.73Air conditioning58,373.00Lumber268.12Steel103,953.00Electrical23,859.06Elevators14,392.00Hardware937.80Steam852.91Light590.01Signs277.75Insurance1,281.38Professional Services28,775.00Furniture & Fixtures39,334.66Salaries24,515.99Administrative Supervision9,000.00General Expense2,946.90Real Estate Taxes21,868.00620,995.86Payroll Taxes579.24Interest on Mortgage15,614.97Cost of Lease - World Wide Development Co.12,500.00 lLoans Payable - W. Reade, Sr.$335,418.70James Watson525,000.00Mortgage Payable462,114.97Withholding Tax - Payable1,078.40Miscellaneous Income650.00Deferred Rent Income6,250.00F.O.A.B. Tax Payable88.74To record acquisition of title to real estate at Park Avenue and 59th St., from Walter Readeper deed dated 10/30/46 together with all assets pertaining thereto and the assumption of allliabilities incurred in the construction and/or the operation of the building existing at November1, 1946 both known and unknown.*41 From October 30, 1946 to December 31, 1946, the additional sum of $139,581.30 was advanced to the corporation in respect of alteration and renovation of the building. Of that amount Walter Reade, Sr., advanced $64,581.30, petitioner advanced $18,750 and Frank advanced $56,250. Between January 1, 1947 and March 31, 1947, an additional $100,000 was advanced by petitioner and Frank for the foregoing purpose. Petitioner advanced $12,500 thereof and Frank advanced the balance. After March 31, 1947, the corporation repaid to the Ericksons funds previously advanced to it as above set forth on dates and in amounts as follows: DatePetitionerFrank5/ 1/47$ 10,416.675/28/4710,416.676/25/4710,416.677/28/4710,416.678/27/478,333.3212/18/47$31,250.0093,750.00$31,250.00$143,750.00On December 17, 1947, Walter Reade, Sr.'s wife, Gertrude B. Reade, advanced $125,000 to the corporation, which it then repaid to the Ericksons on the following day as above set forth. That action equalized the net advances by the Reades and the Ericksons. Prior to December 17, 1947, no notes were issued to any of the parties for their advances. However, *42 on December 17, 1947, unsecured notes bearing interest at two per cent per annum and maturing February 1, 1962, were issued as follows: Named PayeeAmountGertrude B. Reade$125,0001 Walter Reade 395,000James W. Watson520,000 On December 31, 1947, the foregoing amounts were reflected as notes payable in the books and records of the corporation. The notes to Watson and Walter Reade 1 were predated to February 1, 1947, while that to Gertrude B. Reade was dated December 17, 1947. The first $125,000 due on the Watson note and the Gertrude B. Reade note were to be paid simultaneously and in equal amounts. Thereafter payments on the balance of the Watson note and on the amount due on the Walter Reade note were to be made simultaneously and in equal amounts. Two alternative methods were commonly used in financing improvements. In some cases an improvement loan would be sought in advance of actual improvement. Other owners would wait until the property had been improved, and then*43 attempt to refinance the real estate as a whole. At the time the property was first acquired from Central it was the intention of the parties to advance funds of their own temporarily for alteration and renovation, then to refinance by means of a new first mortgage, once the alterations had been completed. Walter Reade, Sr., was of the opinion at that time that sufficient refinancing could be thus obtained to permit repayment of the entire amount of advances made. The possibility of initially financing the improvements by obtaining an improvement loan had also been discussed. It was decided that the better course would be to lend the money themselves and then refinance after the value of the property had been enhanced by the anticipated improvements. At or about 1946 in the general area in which the property was located, capital investment typically represented 15 to 20 per cent of the value of the property and the balance was represented by mortgage indebtedness. Cash invested would tend at that time to approximate one year's gross rental. Petitioner intended at all times that at least a substantial part of advances by him were temporary and were to be repaid upon refinancing*44 shortly after the work was completed. When the improvements were completed the interested parties attempted to refinance the property by a loan in the amount of $1,000,000. Central held the existing purchase money mortgage, and the parties first approached James Lee, who was a vice president of that institution, for the purpose of refinancing. Lee refused to refinance for reasons not relevant to this proceeding. He then pointed out to Walter Reade, Jr. that there was no prepayment clause whatever in the purchase money mortgage. Walter Reade, Jr. had not been previously aware of that fact. Other banks were approached for the purpose of attempting to refinance the property. The First National Bank of Boston indicated a willingness to make a first mortgage loan of $900,000, provided the purchase money mortgage was prepaid. A prepayment bonus of $20,000 was offered to Central. Walter Reade, Jr. attempted to have friends with banking connections intervene in his behalf, but prepayment was nonetheless refused. During the course of the acquisition and improvement of the property, advances by the Ericksons were substantially in excess of those by the Reades. They did not at that time*45 consider this to be material, inasmuch as it was anticipated that such excess advances would be repaid shortly from proceeds secured through refinancing. Subsequently, when it appeared that it would be difficult or impossible to refinance satisfactorily, the Ericksons insisted that the loans be equalized as between themselves and the Reades. Accordingly, Gertrude Reade advanced the aforementioned sum of $125,000 to the corporation. The corporation then used the funds so acquired to repay the Ericksons their respective shares of their excess advances. Interest at the rate of two per cent per annum has been paid on the foregoing notes since their issuance. Such interest was deducted by the corporation in computing its Federal income tax liability. Prior to 1949 no part of the principal was repaid. However, during 1949 the corporation made repayment of principal on the notes in the amount of $90,000, of which sum petitioner received $11,250. When Walter Reade, Sr. first acquired legal title, the property consisted of the land and a five-story apartment building. The latter had been converted into studios and art galleries, known as the Anderson Galleries. The land was rectangular*46 in shape, and consisted of 125 feet 5 inches on Park Avenue by 90 feet on 59th Street. The improvements consisted of stripping the building to its foundations and exterior walls and completely rebuilding it. As so improved it consists of a five-story fireproof and fully air conditioned store, theater, office and penthouse building. It contains approximately 1,050,000 cubic feet, and has a gross building area of 76,370 square feet and a net rental area of 61,400 square feet. The theater portion of the building constitutes one of the newest and most luxurious theaters in New York City. It contains approximately 600 seats. The lobby entrance consists of eight stainless steel, single panel plate glass doors. The walls are of marble facing and wainscot and decorative silver wallpaper. The orchestra lounge is heavily carpeted and has antiqued mirrored walls. Retention of the existing frame of the old building enabled the property to retain zoning advantages. The old building occupied the entire plot of ground. Under zoning regulations enacted subsequent to its erection, and in force in 1946, a new building could not similarly utilize the entire land area. This factor made common the*47 retention of the old frame in the reconstruction of buildings of this type. Reconstruction of the property here in question marked the beginning of a rapid post-war conversion of Park Avenue between 46th and 60th Streets into an outstanding office building section. Prior to October 30, 1946, there was in existence one lease for the second, third and fourth floors of the improved building at an annual rental of $75,000 for a period of ten years. By December 1, 1946, most of the balance of the building had been rented under three additional leases, at a total annual rental of $170,000. Two of the immediately foregoing leases, at a total annual rental of $140,000, were for a period of ten years. On March 8, 1947, another lease was secured for a five year term at an annual gross rental of $12,500. As of the period October to December of 1946 the fair market value of the property was $1,800,000. The property was assessed by the City of New York for the year 1946-1947 at $770,000, and in the years 1947-1948 and 1948-1949 at, respectively, $1,100,000 and $1,300,000. The legal requirements in force with respect to assessments in the Borough of Manhattan, City of New York, require that*48 real property be assessed at its full value for real estate tax purposes. However, the individual assessors normally fix their values for parcels of real property substantially in advance of the tax year to which a given assessment will apply. Consequently, increases in value, such as those occurring as a result of improvements or general appreciation in value of real estate in a local area, may be reflected inadequately or not at all in such assessments. The assessors do not consistently take into full consideration all factors contributing to actual value on the real estate market. And each assessor has too many individual properties to assess to permit detailed examination of each such property in determining its value. As a result assessed values are often higher or lower than the price for which a given piece of property would actually sell as the result of negotiations between a willing buyer and seller, neither of whom is under compulsion to execute a transaction. Various sales of property in the immediate area took place during 1946. 470 Park Avenue, an old 12 or 15 story apartment house, sold for $700,000. It was assessed at $925,000. 445 Park Avenue, an old unoccupied building*49 very similar to the old building on the property of the corporation prior to reconstruction, but slightly larger in land area, was sold for $1,300,000. It was assessed at $1,500,000. The amount in controversy received by petitioner in 1949 constituted the repayment of a portion of a bona fide loan and not the distribution of a taxable dividend. Opinion RAUM, Judge: The issue before us is essentially one of fact, whether the advances by petitioner (at least to the extent of the payment received by him in 1949) constituted bona fide loans or contributions to the permanent capital structure of the corporation. Cf. Estate of Herbert B. Miller, 24 T.C. 923">24 T.C. 923, 929 (on appeal C.A. 9); Ruspyn Corporation, 18 T.C. 769">18 T.C. 769, 776; Tribune Publishing Co., 17 T.C. 1228">17 T.C. 1228, 1234. No one factor, whether that of so-called "thin incorporation", proportionate debt-holding by stockholders, or any other, is itself determinative. The real issue is the intention of the parties. All such factors are merely evidence of such intention, and must be considered together with all*50 other evidence. Matthiessen v. Commissioner, 194 Fed. (2d) 659, 661 (C.A. 2); United States v. Title Guarantee & Trust Co., 133 Fed. (2d) 990, 993 (C.A. 6); Charles L. Huisking & Co., 4 T.C. 595">4 T.C. 595, 599. In any event, we do not find the debt to equity ratio in the instant proceeding so disproportionate as to weigh heavily against the petitioner. We are satisfied that the building as improved was of the fair market value of $1,800,000. There can be no question as to the bona fides of the purchase money mortgage held by the bank, and the ratio relevant here is that between the purported indebtedness to the Ericksons and the Reades in the amount of $1,040,000, and the equity left to the stockholders after the fair market value of the building is reduced by the sum of the foregoing mortgage indebtedness and the purported debt owed to the Ericksons and the Reades. So computed, that ratio is approximately four to one. Cf. Sheldon Tauber, 24 T.C. 179">24 T.C. 179, 183, acq., I.R.B. 1955, 2 CB 11. While such a debt to equity ratio justifies close scrutiny of the surrounding circumstances, particularly since the indebtedness here is*51 owed to stockholders or their close relatives in proportion to the stock held by members of the respective families, it cannot be said to be so extreme or unrealistic as to provide a strong inference that no part of the indebtedness in question was bona fide. The facts have already been stated at length, and no purpose would be served to restate them or the evidence upon which they are based. Viewing the record as a whole, we are satisfied that petitioner at all relevant times intended and expected that of the amounts advanced by him at least the bulk of his advances to the enterprise was of a temporary nature, and would be repaid shortly after completion of the improvements. When making such advances he was confident that sufficient refinancing would be obtainable for that purpose. The determinative fact is his intention at that time. That intent cannot be vitiated by changed circumstances or by subsequent or newly-discovered difficulties, unforeseen at the time. We are satisfied that petitioner at all relevant times intended at least a major portion of the advances by him to be loans to the corporation, and that there was in fact a bona fide indebtedness to him in an amount that*52 embraced at least the payment in controversy herein. 2Petitioner and the other interested parties had considered the possibility of a temporary improvement loan. Had they successfully negotiated such a loan it is inconceivable that respondent would challenge the bona fides of any such indebtedness to an independent lending institution. The record satisfies us that those parties, at least in part, put up their own money as a substitute for such loan. We are not impressed by respondent's reliance upon the absence of written evidence of indebtedness or of security at the outset. The lenders expected at least the major portion of the advances to remain outstanding only for a short period, and together they controlled the corporation directly, or indirectly through their families. The foregoing facts rob the initial absence of notes*53 and the informality of the transaction of much of the significance which respondent purports to see therein. The sum in the amount of $11,250 received by petitioner during the taxable year 1949 was not in excess of the amount owed him by the corporation, and was intended as partial repayment thereof. No part of that receipt constitutes a taxable dividend to petitioner, and respondent erred in determining a deficiency in petitioner's income tax for the calendar year 1949. Decision will be entered for the petitioner. Footnotes1. See footnote on next page.↩1. Neither the stipulated facts nor the note in evidence indicates whether the payee of this note was Walter Reade, Sr. or Walter Reade, Jr.↩2. We do not here decide whether the entire amount of advances by petitioner constituted a loan, or whether in fact a part thereof was more in the nature of equity capital. Our finding to the effect that there was a loan in excess of the amount received by petitioner makes unnecessary for purposes of the instant proceeding such further determination.↩ | 01-04-2023 | 11-21-2020 |
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